I’m Jordan Schneider, Beijing-based host of the ChinaEconTalk Podcast. In this newsletter, I usually comment on and translate articles from Chinese media about tech, business, and political economy. But this week I’m trying something new…
Chinese Industrial Policy of the Week: Ships
With frustration boiling over on Chinese industrial policy, analysts and politicians across the aisle have started to advocate that instead of just throwing up tariffs, America should start spending money to boost domestic innovation. I’m starting a research project along the lines of Alexey Guzey’s exploration of the life sciences trying to answer what has and hasn’t worked in China, and how industrial policy relates to broader questions of Progress Studies.
Each week I’ll be summarizing one paper on the topic, starting with a Sept 2019 article by Panle Jia Barwick, Myrto Kalouptsidi, and Nahim Bin Zahur. You can find the full article ‘China's Industrial Policy: An Empirical Evaluation’ here and slides here. The authors go deep into the Chinese commercial shipbuilding industry.
On the plus side, the money spent in this area in the mid-2000s helped Chinese firms gain 40% global market share. Three-quarters of that growth came at the expense of Korean and Japanese firms’ output.
Looks good, right? Well, a few problems. First off, the total cost of subsidies from 2006-2013 was $90 billion, an enormous number when stacked up against the $250 billion in total revenue Chinese shipbuilders made in the same time period.
This money, unsurprisingly, was inefficiently allocated. The government spent over half of that $90 billion on entry subsidies such as land grants. These subsidies did little more than encourage small, inefficient firms to join the fray. The minnow firms only served to expand supply and reduce profit margins for their more productive competitors. Many of them ended up dying when, after the Great Recession, the industry hit a rough patch.
Production subsidies like export credits and investment subsidies like expedited capital depreciation were much more effective. “One RMB increase in the production and investment subsidy raises the industry’s revenue by RMB 1.8 and RMB 2.3, respectively.” So why did the government spend so much on entry subsidies? Likely because they are easier to finance.
In 2014, the government began to push firms to consolidate by issuing a ‘White List’ of 51 approved shipyards. They then got extra goodies like export credits and favorable loan rates. For the shipping industry, the authors approve of this policy insofar as it’s more cost-effective to err on the side of keeping mediocre firms alive than encouraging new players to enter. From the perspective of trying to maximize industry profit, however, the government gave too many slots on the White List to inefficient SOEs. But if the plan was for SOEs to win from the beginning, I don’t understand the point of entry subsidies in the first place.
Overall, “subsidies boosted production and investment but contributed to the development of a fragmented industry, reduced the capital utilization rates, and to a large extent, were dissipated through sub-optimal entry/exit decisions.” This sector didn’t reap many benefits from learning by doing (Marshallian externalities), largely because the commercial shipbuilding industry works off of mature technologies. The authors argue that the global shipbuilding industry is still too fragmented for subsidies to create a manufacturer large enough to raise prices and gobble up ‘rents on the table’, though recent consolidations in this space indicate that the Chinese government is perhaps trying to encourage this state of affairs.
What would’ve made for a better strategy? According to the economists’ model, the government would have gotten a 3x bang for their buck had they stuck to subsiding only during business cycle downturns. They also found that subsidies were convex, meaning that the more money spent, the less effective the marginal RMB put towards the policy became over time.
Did all this spending do much good for ‘progress’? Probably not. The subsidies largely weren’t invested into new R&D, didn’t make the industry any more profitable and mostly just gifted the world a temporary worldwide consumer surplus of $30 billion out of Chinese taxpayers’ pockets.
The Chinese government wasn’t trying to optimize its policy to please Ivy League economists. The CCP, as You Shu writes, overweights for “self-sufficiency,” driven by a “paranoia about being cut off from global supply chains.” In this context, the idea of Chinese trade dependent on ROK and Japanese boats likely hit a nerve. Further, China’s largest shipbuilders also contract for the PLA Navy, and gaining a foothold in the global market helped build out these firms’ production capacity. This was a more important driver for the policy than any expectations of positive ROI. For more on the civ-mil aspect of Chinese shipbuilding, see this piece by US Naval War College Professor Andrew Erickson, excerpted below.
China has the world’s largest shipbuilding infrastructure, and its development enjoys top-level leadership support, starting with Xi Jinping himself. Commercial production is price-capped in part by China’s relatively stable business and vendor base. It helps subsidize military production, an option closed to the United States given its paucity of commercial shipbuilding. Chinese shipbuilding is greatly facilitated by an unparalleled organizational structure for collecting and disseminating technology, and integrating it into development and production processes at an industrial scale. Moving forward, an important variable is the extent to which China can use its familiar approach of moving up the value chain and parlaying exceptional cost-competitiveness into exceptional quantity at sufficient quality.
China’s effort to exploit civil-military synergies offers both opportunities and challenges. This was vigorously debated by the contributors to the Naval War College China Maritime Studies Institute (CMSI)’s Naval Institute Press volume on Chinese Naval Shipbuilding. “Not a good mix operationally—colocation and coproduction are challenging if not counterproductive” was one of the more pointed critiques. Potential civil-military incompatibilities cited include culture, security, standards, design, engineering, propulsion, construction, and timescales.
Nevertheless, dual-use construction is undeniably emphasized in many authoritative Chinese industry policies and publications, and also in the form of a central commission for integrated military and civilian development headed by none other than Xi himself.
So these subsidies may not have helped the Navy much after all. But at least it must have felt great taking market share from Koreans and Japanese.
(From CSSC’s site)
Was this interesting? Want to get involved in this research project? Please reply to this email or add me on wechat at jordanschneider.
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