Lu Feng: Don't set limits on China's industrial development

In March 2024, Lu Feng, a professor at Peking University's School of Government, and team members Wang Chen, He Pengyu, and Li Meng published an article titled "The Key to Revitalizing Growth: Untying the Shackles on China's Industrial System". This paper systematically discusses a kind of "self-imposed limitation" faced by China's industry, and argues that the slowdown in industrial growth is the main reason for China's economic slowdown in recent years.

In his early years, Lu Feng worked in the then State Economic Commission and the State Planning Commission, and received his Ph.D. in Political Science from Columbia University in 1999. Since 2004, Roadwind has published a series of research reports on China's industrial policy discussions on automobiles, large aircraft, mobile communication standards, nuclear power, and liquid crystal displays.

In recent years, Lu Feng has repeatedly emphasized the importance of traditional industries and basic industries, and the idea of pursuing only a small number of "high-tech" and leaving aside the traditional industrial system with the highest proportion of China's economy (traditional industries account for about 80% of the entire industrial system) is wrong. Previously, in an exclusive interview with the Economic Observer, Lu Feng clearly stated his position: "Don't divide the industry into three, six, nine and so on."

Lu Feng believes that the proportion of the industrial system is determined by the objective laws of the economy, so it is often difficult to achieve expectations by promoting "strategic emerging industries" and other ideas, and it is even more difficult to plan the "future industry".

Lu Feng believes that the essence of the previous part of the "de-capacity" policy is to set a self-imposed limit on China's industrial development under the influence of "dichotomy" thinking, and underestimate the upper limit of China's industrial development.

According to the definition in the article, the "dichotomy" policy thinking divides China's economy into two: on the one hand, the "old kinetic energy", that is, the traditional industries that account for the main body of the industrial system, and on the other hand, high-tech industries, emerging industries, and service industries (as represented by "Internet+", the semiconductor industry did not receive much attention at that time).

In the long article "The Key to Reviving Growth: Untying the Shackles of China's Industrial System", Lu Feng and his team systematically demonstrate this point with a large number of cases. With Lu Feng's consent, the Economic Observer sorted out five key issues related to China's industrial development in a problem-oriented way based on the above-mentioned articles, and presented this article that was different from the mainstream economic viewpoint. This content mainly extracts the main views on the law of industrial development and the problem of capacity reduction in the original article. For the reasons for the formation of the "dichotomous" view, please refer to the second part of the article, "Breaking the Self-imposed Limits on Economic Development with the Great Revival of the "World View".

1. What are the reasons for the slowdown in China's economic growth in recent years?

The fundamental reason for China's economic downturn in recent years is that the growth momentum of the industrial system has been suppressed by the "dichotomy" policy thinking. About a decade ago, there was a powerful "public opinion" in Chinese society, which described China's high economic growth in the first decade or so of the 21st century as "extensive development", "investment-driven" and "overcapacity", which led to an "imbalance" in China's economy. As a result, China's industrial system, which has contributed to high growth, is seen as the source of the problem.

During the period from 2000 to 2013, when China's economy was growing at the fastest rate, the average growth rate of industry (10.88%) was higher than the average growth rate of gross domestic product (GDP) (9.95%), and during the economic downturn from 2014 to 2023, the average growth rate of industry (5.42%) was lower than the average growth rate of GDP (5.96%).

In addition, although the share of the value added of the service sector in GDP has increased significantly from 2014 to 2023 (from 48.3% to 54.6%), it has not offset the impact of the downturn in industrial growth on the overall economy. This simple analysis tells us that the most important factor that has led to the downturn in China's economy in recent years has been the sharp decline in industrial growth.

2. Is traditional industry backward?

Many people think that the fundamental characteristic of "traditional industry" is "old" (it has existed for a long time), but this is a misconception that is taken for granted. The fundamental characteristic of traditional industries is that they are stable in the form of products. The reason for this characteristic is very simple, industry is developed around human food, clothing, housing and transportation, once the applicable product form is found, it will not be easily changed, such as textiles, steel, tires, automobiles, airplanes and other products The basic form remains unchanged.

However, the stable form of the product does not mean that the technical connotation of the product remains unchanged. In fact, traditional industries have been changing driven by market competition and innovation – today's textiles and tires are substantially different from those of a few decades ago, either the materials have changed, or the production processes have changed, and often both. These changes certainly involve the assimilation or integration of new technologies (e.g., electronics are used in the production of textiles and tires today), but the original industrial base and basic product forms are always the conditions for the birth of new products or systems.

After the Second World War, the concept of "high-tech industry" emerged with the development of industries such as computers, semiconductors, software, chemical and biopharmaceutical, new medical diagnostic equipment, etc. These industries are characterized by a very rapid rate of technological change, but "high-tech" is defined in terms of R&D expenses as a ratio of sales revenue, not really by the complexity of the technology. According to this classification, automobiles and machine tools are classified as medium-tech industries. But in reality, the technology of automobiles and machine tools is very complex, and the reason why their R&D cost ratio is not so high is that a large amount of their R&D activities are made through on-site improvements that are closely linked to the production process.

This question reminds us that we need to be careful when using the classification of high-tech and traditional industries. In fact, all classifications of industry, such as heavy and light industry, capital-intensive and labor-intensive industries, are only general classifications that focus on a certain characteristic of industry, and do not reflect the close links and ambiguities that exist between industries.

We cannot mistakenly confuse the common phenomenon of new products gradually replacing old products with new industries instead of traditional industries, which are also constantly introducing new products and updating themselves. Thus, the diffusion of new technologies across different industrial sectors, rather than the substitution of some for others, is the main engine in which a country can sustain economic growth.

High-tech industry and traditional industry are in a symbiotic relationship, interdependent on each other, and there is no possibility that they can replace each other. On the supply side, the industrialization of any new technology or the development of new industries must be supported by existing industries, otherwise even basic tools and equipment cannot be obtained; on the demand side, traditional industries are the largest users of high-tech industries.

3. Who will promote "future industries" and "strategic emerging industries"?

The proportional relationship between the industrial sectors is determined by the objective laws of the economy, and is not subject to the subjective will of people. The higher the economic share of "strategic emerging industries", the better, because there is no substitution between industries.

The 13th Five-Year Plan for the Development of National Strategic Emerging Industries, released in November 2016, stipulates that by 2020, "the added value of strategic emerging industries will account for 15% of GDP, forming five new pillars with an output value of 10 trillion yuan, including a new generation of information technology, high-end manufacturing, biotechnology, green and low-carbon, and digital creativity." "This planning goal was not accomplished. According to media reports in July 2023, the relevant person in charge of the Ministry of Industry and Information Technology introduced: "In 2022, the added value of strategic emerging industries such as new generation information technology, high-end equipment, and new energy vehicles accounted for more than 13% of GDP (not reaching 15%). ”

In fact, new energy vehicles were not included in the 2016 plan as "strategic emerging industries", which shows that the rapid development of new energy vehicles is unexpected by the government.

One of the latest popular policy thinking is to promote the development of "future industries" by deploying the research and development of cutting-edge technologies.

The "industry of the future" can be conceived, but the concept cannot be used as the basis for formulating policies.

The "industry of the future" cannot be planned. Even if we believe that they will eventually arrive, and know that investment in new technologies will eventually pay off, we cannot know the path and timing of their arrival, nor can we know their actual shape and competitive rules.

In fact, the correct policy thinking that the government needs to establish is to firmly believe that today's industry is the foundation for the production of tomorrow's industry, not only because the larger and more solid the foundation, the more likely it is to produce new industry, but also because all today's industries can renew themselves through technological progress and innovation. In terms of industrial development, the "new" and the "old" have never been completely separate and opposed to each other. Innovation is to change the existing rules of doing things, but the driving force of innovation comes from overcoming the shortcomings of the existing rules, and the ability required for innovation comes from the accumulated knowledge and experience.

Therefore, the government can guide the direction and encourage the research and development of cutting-edge technologies, but it must pay attention to the development of existing industries, and at the same time, the process of leading to "future industries" must be left to the enterprises and markets of existing industries. Only by admitting that we do not know anything can we reap the unexpected joy of technological and industrial development.

Fourth, can promoting a single technology lead to economic development?

Technological progress is the most important factor in long-term economic growth, but the mechanism and process by which technological progress affects economic growth are much more complex than most people realize.

There are three points that must be pointed out: first, if technological progress has an effect on economic growth, it must adjust the form of products, and products are produced industrially, so technological progress and innovation can only act on economic growth through industrial development; second, no matter how important new technologies are in the long run, their main role in economic growth does not occur in the stage of their breakthrough, but in the stage of their continuous improvement and diffusion; third, for those so-called general technologies (such as steam engines, electric power applications, integrated circuits, etc.), their role in economic growth, but also through the application and continuous improvement of the entire industrial system can be fully utilized.

The idea of replacing industry with technology is the concept of "industrial digitalization", which has been popularized by government departments and academia in recent years, and its logic is that "digitalization" is regarded as the key to promoting industrial upgrading, and can be promoted through administrative means. In fact, behind this logic lies the motive of the "dichotomy": since industrial upgrading can be done by injecting technology into the "backward" industrial system from the outside (such as forcing enterprises to "go to the cloud"), then industrial digitalization can be used to replace traditional industries.

Industrial digitalization still has to go through the improvement and application innovation of existing industries, because it is limited by two conditions:

First, for digitalization, although data can be processed into a virtual world, it must come from the real industrial world (unreal data is useless). If there is no industry now, there will be no real industrial data, and there will be no possibility of industrial digitalization.

Second, digitalization must have economic benefits for industrial development – such as helping to provide better or lower-cost products and services, otherwise no companies will be willing to pay for digitalization, either starve the professionals involved in digitalization to death, or fool governments into providing bottomless investments. Therefore, digitalization is always a means of "empowerment", not industrial energy itself, which cannot escape the law that productivity improvement must follow the law of replacing human labor with machines.

Artificial intelligence (AI) is still digital in nature, so its industrial application faces similar obstacles: first, the need to obtain real and accurate massive industrial data, and second, the need to make new and important advances in intelligent machines or robots that connect digital networks to production, as well as corresponding changes in industrial organization.

Therefore, the possibility of applying artificial intelligence to industry still depends on the application innovation of industrial enterprises (so the general large model is not necessarily the optimal technical route for industrial artificial intelligence), and the cumulative process of industrial application computing technology, from the informatization of machine control systems and operations to the digitalization of product development and production processes, is still the basis for the application of artificial intelligence technology. Even if AI can have a significant impact on productivity improvement, it is still an "enabler" technology that cannot replace existing industries, but rather depends on industrial application innovation to continue to develop.

Emphasizing the complementarity of the industrial system is not to belittle the role of developing high-tech industries, but to emphasize that this complementarity is the key mechanism by which technological progress affects productivity improvement and economic growth, that is, innovation in one industrial sector leads to technological progress in other industrial sectors, and the diffusion and continuous improvement of new technologies in many industrial sectors will give full play to their economic effects. It is precisely from the perspective of the integrity of the industrial system that it is absolutely necessary for China to develop high-tech industries, because this is the main driving force for the technological progress and upgrading of the industrial system.

5. Should traditional industries be "de-capacity"?

For Chinese industry, the most impactful policy in the past 10 years has been "capacity reduction".

The "Guiding Opinions on Resolving the Contradiction of Serious Overcapacity" issued in October 2013 pointed out that "the contradiction of oversupply in some industries in mainland China is becoming increasingly prominent, and the overcapacity of traditional manufacturing industries is generally ......"; Serious overcapacity has increasingly become the source of conspicuous contradictions and many problems in the mainland's economic operation. ”

The document specifically lists industries such as steel, cement, electrolytic aluminum, flat glass, and shipbuilding, but also stipulates that the document "also guides other industries with excess capacity to resolve them." At that time, due to the economic impact of the global financial crisis, China's industry, which had just experienced high growth, did have a lack of demand. The policy document is aimed at the overcapacity phenomenon caused by insufficient demand, and the illegal capacity management such as "strip steel" that existed at that time is also true.

However, the more critical question is the cause of this phenomenon: Is the overcapacity of China's industry cyclical or structural? If it is cyclical, it is a short-term problem, and if it is structural, it is an absolute, long-term problem.

On October 28, 2016, the "Iron and Steel Industry Adjustment and Upgrading Plan (2016-2020)" said: "In the next few years, the pattern of sluggish aggregate demand and overcapacity is difficult to fundamentally change, and economic growth cannot be as before, once it picks up, it will continue to rise and achieve several years of high growth, and overcapacity has been impossible to digest through sustained and high-speed economic growth in history." The prominent contradictions and problems facing economic development are structural, not cyclical, and are determined by the deep-seated contradictions accumulated over a long period of time and the changes in the development conditions such as environmental resources. ”

According to this guideline, the document has such a prediction that today seems to greatly underestimate China's development momentum: "From a domestic point of view, the intensity of steel consumption and the total consumption of mainland steel in the 13th Five-Year Plan period will show a downward trend...... Domestic crude steel consumption is expected to decline to 650 million tons to 700 million tons in 2020 on the basis of reaching a peak of 760 million tons in 2013, and crude steel output is 750 million tons to 800 million tons. ”

The truth is quite the opposite. Steel prices have rebounded cyclically since the end of 2015, orders have grown rapidly, and the steel industry has also turned a profit in 2016 (the capacity utilization rate in April of the same year was as high as 88.93%, significantly exceeding the world average). A similar situation has been observed in other industries classified as having significant overcapacity.

China's crude steel production is still growing slowly, above 900 million tonnes in 2018 and 1 billion tonnes (1.06 billion tonnes) in 2020, thanks to stubborn demand. In 2021, 30 million tonnes of production were cut, and in 2022 the reduction continued, cutting 12 million tonnes (to 1.018 billion tonnes).

In 2023, the profits of key iron and steel enterprises will fall sharply, and the policy will be changed to flat control of production capacity (no increase or decrease). As a result, steel production rose back to 1.03 billion tonnes that year, and direct and indirect exports of steel were very strong.

In any case, the "dichotomy" thinking cannot withstand a "soul torture": why can't China reach the level of one ton of steel per capita?

In the local area, metal products, building materials, tires, ceramics, textiles, papermaking, shoemaking and even furniture manufacturing have become "street rats" that are "shouted and beaten by officials": the world's most technologically advanced electrolytic aluminum production line was shut down for "illegal production capacity" just after it was built, just because it was labeled as "old kinetic energy". At the same time, the "dichotomy" thinking has led to a bias in the understanding of the "conversion of old and new kinetic energy", some local governments are chasing a few fashionable "high-tech" industries in the implementation process, and nearly 3,000 counties across the country want to develop biopharmaceuticals, new energy and semiconductors (after 2018), and a large number of homogeneous investment promotion and speculation activities have disintegrated the foundation of local traditional advantageous industries.

It has to be pointed out that the "dichotomy" is favored by some departments, not because of its theoretical and logical persuasiveness, but because of the power logic behind it. We extracted some words from the letter reported by the Metallurgical Industry Association of a northern province to the Provincial Department of Industry and Information Technology on November 5, 2019 according to the enterprise symposium to help understand the dissatisfaction of some "involved" enterprises with the practices of government departments at that time: "At present, some areas will normalize the suspension and restriction of production, which does not comply with the law" "For continuous production equipment (such as blast furnaces), frequent start and stop operations, and some areas also require the furnace to be picked up when the furnace is stopped", resulting in an increase in the resource consumption of the unit and an increase in pollution emissions, and " Accidents mainly occur when the production equipment is started and stopped";" Emission standards and environmental protection facilities require changes in the time interval is too short, the amplitude is too large" "The ecological environment department requires the workshop and raw material yard to be fully enclosed, and the safety (department) requires that there is a vent, and there is always one party (can) punish the enterprise, especially the ecological environment department, and often punish the top level" "There is no unified planning for environmental protection inspection, there is no plan, multi-level inspection of provinces, cities, counties, districts, townships and towns, multi-head inspections of different departments, inspections are too frequent, and enterprises have to receive multiple batches of different inspectors a day, tired of coping"" The inspection standards are different, and the quality of the inspectors is uneven...... The enterprise has implemented the requirements put forward by the previous inspection team, and the latter inspection team has asked them to rectify."

It is precisely because some government departments can arbitrarily shut down enterprises in the name of environmental protection, energy consumption, quality, standards, safety, market supervision, etc. (private enterprises bear the brunt) that the so-called "lack of confidence in the market" has been caused.

The key problem in China's economic development lies in the fact that if China wants to upgrade its industries and develop high-tech industries, it must maintain economic growth, and the main driving force for maintaining economic growth is still the industrial system with traditional industries as the main body (traditional industries account for about 80% of the entire industrial system). Just when these industries are still in the process of technological breakthroughs and upgrading, they have been labeled as "overcapacity" and suppressed.