The Second Phase of the China Miracle? Opportunities and Risks

by Michael Swaine

The Second Phase of the China Miracle? Opportunities and Risks 

In his first term, Chinese president Xi Jinping has unveiled two long-term strategic initiatives that he hopes will define China’s continued economic development over the coming decades. The first is the Belt and Road Initiative (一带一路 – BRI), an ambitious development strategy focused on enhancing connectivity between China and 65 other countries. The second is Made in China 2025 (中国制造2025年 – MIC), the first of a three-phased plan to comprehensively upgrade China’s industrial capacity.

Since the launch of former leader Deng Xiaoping’s “reform and opening up” policy in 1978, China has experienced an unprecedented period of economic development dubbed the “China Miracle”. However, in recent years, the Chinese economy has slowed for a number of reasons – among them an aging population and soaring domestic debt. Official growth targets for 2017 were set at 6.5% after growth slumped to a 26-year low in 2016. This drop in growth is being framed, by the ruling Communist Party at least, as the beginning of an economic transformation from a low-tech manufacturing-driven and export-led economy to one underpinned by professional services and domestic consumption. The BRI and MIC initiatives lie at the heart of Xi’s vision for this transformation, and present foreign investors with fresh opportunities and new risks.

Belt and Road Initiative

The BRI seeks to revive and expand the ancient Silk Road, a trade route spanning the Eurasian landmass, while also establishing a maritime route passing through Southeast Asia to Africa and the Gulf States. The initiative centres on a vast network of infrastructure projects linked by bilateral and regional trade agreements. First announced in 2013, BRI forms the cornerstone of Xi Jinping’s economic programme.

Four years in and the BRI has had some success – over 50 state-owned enterprises have invested in over 1,700 (largely infrastructure) projects linked to the initiative during this period. The Chinese government has already committed US$900 billion in funding; this could reach US$4 trillion over the coming decades. In May 2017, Xi Jinping hosted 28 heads of state, and high-level delegations from many more countries, at the BRI Forum for International Cooperation in Beijing. Xi announced an array of new projects, substantial increases in financing, and the signing of numerous trade agreements.

The immediate opportunities for foreign investors are evident. The Chinese are actively seeking direct investment and foreign partners with whom to collaborate on major projects. They are looking for support from foreign financial institutions and firms operating in, among others, the financial services, construction, transport and logistics sectors. The City of London, as the largest clearing centre for the Renminbi outside of Greater China, is particularly well-placed to play a role in mobilising finance and resources for projects across the BRI routes.

Made in China 2025

MIC, first announced by the State Council in 2015, is directly inspired by Germany’s ‘Industry 4.0’ plan. It seeks to comprehensively upgrade China’s manufacturing sector. The initiative is part of a longer-term strategy which aims to make China a world leader in high-end manufacturing by 2049. MIC targets virtually all high-tech industries that make strong contributions to developed economies, including automotive, aviation and robotics. By 2025, China hopes that domestic suppliers will produce 70% of its basic core components and important basic materials.

China’s manufacturing processes remain relatively unsophisticated. Most Chinese factories have only basic levels of automation and little to no digitisation. In the short-term, foreign companies may see new opportunities to assist Chinese firms achieve their industrial aims, including through the supply of high-tech equipment, design and consultancy services. In the longer term, the aim is for domestic firms to supplant foreign high-tech manufacturers; however, it is hoped that the initial necessary deepening of cooperation with foreign companies will facilitate a more permanent integration. If MIC succeeds in establishing a largely independent domestic high-tech manufacturing sector, this will be as part of a more integrated global system with China playing a central, but not hegemonic, role.

Embracing the change and mitigating the risks

BRI and MIC demonstrate Xi Jinping’s political will to implement a transformative economic agenda. Despite the “win-win” rhetoric, his ambitions are driven by an approach that undeniably has China’s interests – and, more importantly, those of the Communist Party – at its core. As the first stage of China’s ‘economic miracle’ draws to a close, the Party is searching for a new source of legitimacy. Xi has boldly sought to achieve this by reasserting China’s past greatness through an aggressive geopolitical economic programme, rolled out in tandem with a strategy to comprehensively upgrade the domestic manufacturing base.

Foreign investors will be increasingly aware of the opportunities of China’s new push, but they should also recognise and seek to proactively mitigate the risks: 

  • Foreign companies hoping to partner with Chinese firms on BRI projects must have a thorough understanding of their Chinese partner from the outset. Given the levels of investment being ploughed into the initiative, numerous companies – both state-owned and private – want to get involved. Not all of these firms will be desirable business partners and proactive due diligence is required to enable informed decision making regarding the selection of a local partner.  

  • It is also critical to understand the inherent risks relating to investments based in a third country. Several jurisdictions that the BRI routes pass through – including, for example, Pakistan, Iran and Russia – present complex political, security, reputational and compliance challenges.

  • MIC has come under fire for its aggressive pursuit of technology transfer, which is typically granted in exchange for near-term market access. Domestic firms are perceived to be given unfair market treatment, which could ultimately force foreign companies out of China, as well as giving state-sponsored Chinese firms an unfair advantage abroad. Firms must consider the longer-term strategic and commercial implications when negotiating terms of agreement with their Chinese counterparts. Notably, the threat of intellectual property theft – while still a concern for foreign firms – has declined significantly in recent years. In addition to the Chinese government tightening IP laws to encourage domestic innovation, firms are increasingly opting to invest and legally acquire technologies, rather than obtaining them through illicit means.

  • To plug the existing gap in technology, Chinese firms have been investing heavily in the West, making strategic acquisitions of firms that can move China up the value chain. Stringent screening processes should be implemented to ensure that key sectors and companies receive adequate protection, both by curbing direct access to sensitive industries, and by ascertaining the identity of ultimate investors. In some instances, key acquisitions are orchestrated by the Chinese state from behind complicated and opaque ownership structures.

  • BRI and MIT both aim to facilitate China’s greater integration into the global economy. As this happens, foreign firms should be aware of the broader cyber security risks from China where approximately a third of global cyber-attacks originate. In addition to hacks on government departments and national infrastructure, this has also included targeted attacks on western firms. Companies should ensure that robust cyber security measures are in place to counteract the increased vulnerabilities associated with a greater interaction with China.  

Taken as a broader economic platform, BRI and MIC should, on balance, be viewed as a positive development for foreign firms looking toward China. They will bring lucrative investment opportunities and, perhaps more importantly, deepen economic, social and even political ties. To fully capitalise on these opportunities, however, foreign companies should be proactive in understanding the local operating environment and partner organisations.  

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Michael Swaine

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