Historically, numerous low-income countries have increased their total wealth, as expressed by a higher GDP per capita, via cheap but labor-intensive industries such as textiles. However, once their income rose, this often reduced the initial competitive benefits that drove the strong growth, i.e. the cheaper labor.
Costs became too high to compete with nations where wages are even lower. At that point countries need to switch from a growth model based on cheap labor and capital to a growth model based on productivity growth. This requires investments in infrastructure and education and a system that encourages entrepreneurship and creativity. The political and legal systems are often not sufficiently developed to support this transition.
In economics, this phenomenon is described as the 'middle-income trap': countries get trapped in the middle-income range and do not grow to the higher-income levels. The middle-income trap can be visualized via the Stan Shih's Smile curve. The picture below demonstrates how much value is added in different stages of a supply chain. Especially in the early phases of the process, such as R&D, as in the later stages, involving marketing and sales, much value is added. However, the middle phases in which the actual manufacturing and assembly is done, creates less added value. China's economy is mostly focused on the middle part of this curve and China is planning to escape this trap.
Source: China Manufacturing 2025, Putting Industrial Policy Ahead of Market Forces, European Union Chamber of Commerce in China, 2017
Fourth industrial revolution
Escaping the middle-income trap has been one reason for China to release a 10-year plan titled 'China manufacturing 2025 (中国制造2025)' in 2015. The plan aims to reduce China's dependence on foreign technology and promotes the development of more Chinese high-tech manufacturers. Moreover, China has the ambition to be 70% "self-sufficient" in high-tech industries by 2025, and have a "dominant" position in global markets by 2049. The plan sets goals for developing ten specific industries, such as next generation IT, robotics and high-performance medical devices. Those ten sectors are essential in the fourth industrial revolution that is currently taking place, building on both the third industrial revolution and on the still ongoing digital revolution that started in the eighties. The fourth industrial revolution integrates physical, digital and biological elements, and includes developments such as big data and cloud computing in the supply chains. This new revolution has the attention of Western leaders as well, as illustrated by the topic of the World Economic Forum Annual Meeting 2016: Mastering the fourth industrial revolution.
China manufacturing 2025 applies numerous policy tools in order to pursue its objectives. Several measures, however, have raised criticism from the European Union and the United States as they are concerned that China will gain a competitive advantaged as it protects its companies from foreign competition and because foreign companies often can't operate independently in China resulting in the confiscation of intellectual property. They are also concerned that political considerations might be prioritized over economic incentives. China, however, has pointed out that its average income per capita is still well below that of the developed world and that its 10-year plan is necessary to increase its per capita income to be competitive in the global marketplace, plus to avoid the middle-income trap. Also, China has responded that this plan is comparable to the actions that other developed countries have taken in the past such as the use of tariffs and government support to help native industries develop in the early days of industrialization.
Given China's role in international trade, the 10-year plan and the measures taken to accomplish its goals can have a significant impact on the global economy. Trade tensions, especially between the US and China, are currently a concern for financial markets. In July 2018 the US for instance applied a 25% tariff on $34 billion of Chinese goods and introduced another 10% tariff on $200 billion of imports. The rate on this last batch, would increase to 25% at the end of the year. However, that increase has now been postponed for three months pending further negotiations between the US and China. Also, US legislation gives President Trump the power to take measures, such as levying tariffs, if those are deemed necessary for security reasons. The EU on the other hand has imposed anti-dumping measures in the past on several Chinese products.
Yet, China Manufacturing 2025 also provides opportunities for global businesses. Companies can establish partnerships with Chinese counterparts to provide components, technology or manage skills for the areas as covered by the plan.
All in all, the impact of China on the global economy is important to assess. Therefore, the developments with regards to the Chinese trade tensions and the China Manufacturing 2025 plan are monitored carefully.