The ambition of China hawks in the Trump administration is to maintain American dominance by halting China’s economic rise. It’s strange that President Xi Jinping appears to be working toward the same end.

The risk for any economy approaching China’s level of development is that it gets ensnared in the middle-income trap. Once the low-hanging fruits of urbanization and industrialization have been plucked, countries tend to get stuck in second gear.

Latin America, the former Soviet Union and the largest Middle Eastern countries have never managed to close the gap with the US, Europe and Japan that opened up a century ago. The only nations that have really succeeded in making the transition have been petro-states, members of the European Union, and a handful of relatively small, export-oriented Asian economies -- Singapore, Hong Kong, Taiwan and South Korea.

That immediately suggests a problem for China. One factor that probably drove the four Asian success stories was the size of the global market for their specialized exports relative to their populations, which led to a substantial net inflow of value-added per capita. Even after they opened up their economies, more populous nations such as Russia, Mexico and Turkey failed to achieve a comparable export-led growth spurt -- a problem that should be an order of magnitude greater in China’s case.

To be sure, Beijing’s economic planners seem well aware of the risk. The Made in China 2025 program that has raised hackles in the West looks like nothing so much as an attempt to build a group of high-value export industries that can help the country hurdle its way out of the trap -- one of the key characteristics of economies that have achieved the feat, according to a 2017 study for the Asian Development Bank. It’s not enough just to have a lot of exports, according to a 2012 paper by associates of the bank: The products involved need to be diverse, sophisticated and of a type to encourage a virtuous circle of technological development.

That’s where Xi is pushing the country in the wrong direction.

Building that sort of export sector is unpredictable, and works best when there’s a wide array of private businesses with myriad different approaches. But as Bloomberg Opinion contributor Richard McGregor wrote in November, China’s president has persistently downplayed the benefits of the private sector and favored sclerotic state-owned national champions instead.

Rhetorically, this shows up in his frequent encomia to zili gengsheng. The term, usually translated as self-reliance, was used by Mao Zedong to denote the isolationist autarky of the Great Leap Forward era. Xi, however, employs it even in speeches where he’s meant to be praising the opposite reform-and-opening-up policy pursued by Deng Xiaoping.

As my colleague Noah Smith argued last month, that’s more than just rhetoric. Fixed-asset investments by private businesses in China came to 37.8 trillion yuan ($5.5 trillion) in the 11 months through last November, an increase of 18 percent from three years earlier, according to government data. Those by state and state-owned enterprises climbed at twice the rate -- 36 percent -- to 21.6 trillion yuan. In the fight for investment capital from the country’s lenders, the government is gradually crowding out the private sector.

That’s the wrong part of the economy to be favoring, given China’s need for export-led growth. In 2013, state-owned enterprises accounted for only 11 percent of overseas shipments, with private domestic companies on 39 percent and 47 percent coming from local affiliates of foreign companies.

The investments are also failing on their own terms. While public fixed-asset spending at the end of 2017 was up 88 percent from five years earlier, profits from state-owned enterprises increased only 17 percent. That divergence is particularly worrying, since a plateau in productivity growth is another key factor keeping countries trapped in middle-income status.

China’s economic rise over the past two decades has been so rapid that it’s easy to miss the profound weaknesses lurking below the surface. But it’s worth remembering that the golden ages for the Soviet and Japanese economies were followed by periods of stagnation that are still ongoing.

The huge increase in the urban workforce that powered China’s rise has all but played out, with the country losing almost as many workers as Japan last year. Meanwhile, its capital stock per head in 2014 was about where Korea’s was in the late 1990s, and is likely to now be substantially higher.

As economist George Magnus wrote in his recent book “Red Flags,” “complex middle-income countries such as China have, by definition, exhausted much if not most of the potential to get growth by deploying and exploiting physical capital and labor.”

The slowdown is becoming apparent in areas as diverse as iPhone sales and labor productivity. The economy may have barely grown in 2018 and is facing “long-term and very difficult times,” Xiang Songzuo, the former chief economist at Agricultural Bank of China Ltd., said in a speech in Beijing last month.

Right now, Beijing needs to be pushing hard on all fronts to keep its growth engine running. But Xi’s self-reliance policy increasingly resembles the import-substituting industrialization favored by postwar Latin American countries. That delivered staggering growth for a while -- but ultimately left economies wallowing in debt and stuck at middle-income status.

China has the potential to escape the reversal that so many other rising economies have faced, but only if its government has faith in the productive genius of its citizens. The greatest enemy of Xi’s Chinese dream isn’t Donald Trump -- it’s Xi himself.


David Fickling
David Fickling is a Bloomberg Opinion columnist covering commodities as well as industrial and consumer companies. -- Ed.

(Bloomberg)