Understanding Beijing's Industrial Policy for the 21st Century

Domestic concerns with upping the country's high-tech industry are likely driving its rare-earth quota

Reuters

As news of China's second batch of 2011 rare earths export quota dominate headlines, few have discussed some of the underlying reasons for Beijing's stance on this resource. The Chinese have largely stuck to the "environmental damage" talking point--not entirely unfounded--in part because they want to avoid WTO action. Some in the US, as I've noted, believe that it was economic coercion by China to punish certain countries (see my previous takes here and here). To those commentators, it was yet another sign of an assertive China wielding an economic instrument of leverage. 

But I believe that like most things in China today, the primary motivations behind its actions on rare earths are developments on the home front rather than deliberate strategic calculations against foreign players. Perhaps few took notice of the release of the "National 12th Five-Year Plan on Science and Technology Development" last week (in Chinese). It is what I would consider a muscular industrial policy for the 21st century. The S&T plan takes many of its cues and content from the Ministry of Science and Technology's existing 15-year high-tech plan that shepherds the country through 2020. As with most such Chinese plans, it is replete with statistics and targets to impress. For instance:

• Total investment in R&D hit nearly 700 billion yuan in 2010, tripling from 2005. 
• R&D personnel grew 13% from 2005 to hit 2.6 million in 2010; meanwhile, 156 new research labs were built, bringing the total to 333.  
• It has 83 national new high-tech zones that created total economic output of 7.6 trillion yuan.

In the hardware department, which perennially dazzles the likes of Tom Friedman, China has spared no expenses. And yes, some of the figures deserve to be questioned--e.g. disaggregating public spending on R&D vs state-owned and private enterprise spending on R&D and so on. But I don't want to dwell on the veracity of the numbers. Because irrespective of the stats being "cooked", it is undeniable that China is relentlessly pursuing a sprawling industrial policy that it hopes will catapult it into the ranks alongside a Germany or Japan. 

So what does China want to do? According to the latest S&T blueprint: 

Target	2010	2015
R&D spending as % of GDP	1.75	2.2
R&D personnel per 10,000 workers	33	43
Ranking of citations in international science journals	8	5
Patent ownership per 10,000 people	1.7	3.3
# of patent applications (app/hundred person years)	10	12
Total contract trading in technology market (bn yuan)	390	800
High-tech value-added as % of total manufacturing industry value-added	13	18

And for the next five years at least, Beijing has hung these targets on 11 essential sectors:

1. Servers/routers/CPU and other core telecom equipment/technology
2. Integrated circuits/semiconductors (Taiwan will be integral)
3. New generation broadband and 4G LTE 
4. Computer numerical control machine tools/precision machinery 
5. Large oilfields and unconventional gas like coal-bed methane
6. Next generation PWR nuclear reactors 
7. Wastewater treatment and water pollution technology 
8. Genetically modified foods 
9. New, innovative drugs
10. Prevention and cure for AIDS, viral hepatitis, and other infectious diseases
11. Civilian commercial aircraft (the C919)

Now we arrive at the nexus of rare earths and industrial policy. This massive plan overlaps with and trumpets the anticipated "emerging strategic industries" plan, where clean energy and electric vehicles are specified as two of the key sectors. Both of these sectors are demand drivers of rare earths, used in magnets and batteries integral to these products. That domestic demand for rare earths is expected to rise certainly adds an important factor to Beijing's calculus in determining policies for the resources. Indeed, recent State Council statements unambiguously call for aligning rare earths management with facilitating the development of the emerging strategic sectors. From the industrial policy mandarins' vantage point, it makes perfect sense to create an integrated domestic high-tech supply chain, from the upstream (REs) to the downstream (batteries for EVs).

I'd argue that the desire to create a competitive high-tech industry is a better explanation of the motives behind Chinese behavior on rare earths than the conventional wisdom of an unapologetic mercantilist power throwing its weight around. Does China behave in mercantilist ways? Sure it does. But it's not necessarily the most compelling or accurate explanation for everything that China does.

More important than rare earth export quotas and nefarious designs is to what extent China will succeed in achieving what it has set out to do in the high-tech plan. It will not be batting 100 percent (or maybe even 50 percent), no one can. Of course China wants game-changers like anyone else. But it doesn't need them to still alter the competitive landscape to a considerable degree.

Sitting here in Washington, I hear an awful lot about Sputniks and "green-collar" jobs, much of it tinged with alternating "China envy" and "China derision". That is, along the lines of either "can you believe what kind of money the Chinese are putting into solar!" or "the Chinese are nothing but cheaters and compete unfairly, so we should get them back at their own game." Yet sorely lacking is a comprehensive assessment of how America needs to adapt to economic realities in the 21st century, with emerging Asia led by China inevitably part of that equation. We have been superb at identifying our enduring competitive advantages in human capital and innovation. But the problem, at least from where I sit, seems to be that many simply assume that the set of advantages will endure--that they do not require upkeep and sustained fertilization and cultivation. Or have we just been fooling ourselves these past few decade, if Tyler Cowen's The Great Stagnation proves to be right?

I tend to be on the optimistic side (just barely) in getting our house in order swiftly. Then again, we may not be able to pay social security come August 2, let alone invest in an "energy revolution". Perhaps my optimism is misplaced then. Well China, come August 3, you can run your victory lap (oh wait, you're still stuck with our Treasury bills)...