The Dr Seuss theory of China industrial policy

US commerce secretary Wilbur Ross emerged last month from a visit to Beijing with a warning about China’s goals to develop robotics and other high-tech sectors, a surprising new tack given the Trump administration’s previous focus on jobs in traditional industries such as steel.

Are robots in Chinese factories about to threaten US robots’ jobs by working for lower wages? No, and even if they did, that’s not what concerns the White House. During his weekend in Beijing, Mr Ross had an earful from American business about a Chinese plan to create a range of cutting edge industries, called Made in China 2025.

Made in China 2025 is a top-down industrial policy that in its benign form unlocks loans and approvals for companies that meet Beijing’s goals to create internationally competitive industries at home. More troubling for the foreign companies complaining to Mr Ross, the favoured short-cut to “indigenous” high tech is not to develop and commercialise it but to pressure investors in China to hand over rights to the tech they’ve developed, in return for maintaining their market access in China.

But the unique combination of top-down planning with Beijing’s financial might makes schemes such as Made in China 2025 globally damaging to the industries it targets for reasons other than forced technology transfer. Take any product — let’s call it a thneed, after the useless knitted thing made by the greedy Once-ler in The Lorax, Dr Seuss’s environmental manifesto in rhyme.

In a nutshell, Chinese industrial policy works like this: the state identifies thneeds as a priority industry. Everyone and their nephew builds factories making thneeds because they know that puts them on the fast lane to bureaucratic approvals. Even better, they get easy loans because banks and private equity investors know thneeds are a favoured industry (and also, because Chinese banks hope the new money will allow the borrower to pay down outstanding debts built up making whatever was flavour of the month in the last round of policy incentives).

Pretty soon, just as in The Lorax, all the “brothers and uncles and aunts” are making thneeds too. They import new vehicles and equipment, sending prices through the roof. Foreign suppliers of the raw materials, the machines and components to make thneeds are overjoyed, and take out loans in their own countries to expand to meet China's amazing demand. It’s a bubble, basically, but like the Once-ler, who doesn’t realise he’s destroying his own business until the last Truffula tree is cut, neither the companies nor the investors caught in this profitable frenzy see it that way.

The first stage of this cycle benefits foreign businesses, a lot. Italian weaving loom manufacturers, Australian miners, US grain farmers and high-tech multinationals all benefit. Trade wonks even reason that the move “up the value chain” is an opportunity to balance the trade deficit and compensate for all the one-way shipments enabled by China’s massive manufacturing competitiveness.

Then, disaster hits. Everyone's factory is complete at more or less the same time, supply vastly exceeds market demand, and the companies all start exporting just to break even. Margins in the global thneed industry collapse and the international manufacturers of both thneeds and thneed looms scream bloody murder as their order books tumble. Tariff barriers go up in developed markets. One particularly unfortunate private Chinese manufacturer of thneeds goes bankrupt, leaving a huge crater on his city’s bank balance sheets. His demise provides ammunition to every other thneed maker in China to lobby Beijing for help.

Beijing might respond with subsidies so that Chinese consumers buy thneeds, or they might make it more difficult for foreign-made thneeds to enter the market by placing thneeds on the domestic purchasing catalogues for state-owned enterprises and government bureaus. Nonetheless, the thneed glut persists.

Luckily, it turns out that thneed marketing forms an integral part of the "One Belt, One Road" policy and Chinese banks are informed they can lift lending restrictions on over-capacity industries in order to provide policy loans to other countries to buy thneeds. Baffled international manufacturers of thneeds suddenly see their third country markets disappear too.

Rinse, repeat for the next target industry.

Similar dynamics have engulfed the solar panel industry (with the twist that the initial impetus was a plan for Chinese manufacturers to profit by European subsidies), medium and high-value steel, aluminium products, semiconductors, home appliances, hydropower engineering — the list goes on.

China’s huge market has so far absorbed the immense automotive and nuclear power components manufacturing capacity that has been built up, but it won’t for long. Meanwhile, Beijing is trying to tempt foreign automakers to lend a hand in creating the next pillar industry: electronic vehicles.

The Obama administration was attempting to tackle this problem at the root with its structural challenges to Chinese subsidies at the WTO. However, that effort was too slow and too subtle to make a good headline that showed that they were "doing something" about Chinese overcapacity.

The Trump administration disliked the Obama administration’s approach, so it is trying unilateral trade actions one category of goods at a time. But Mr Ross’s comments in Hong Kong imply that he realises there are larger structural dynamics at work.

Mr Ross knows from personal experience how this cycle works, because he invested in the US and Chinese textile and steel industries. Now China accounts for about half the world’s steel capacity, with exports likely to continue increasing for the foreseeable future.

So does Washington have a new plan for dealing with industrial policies like Made in China 2025? If you give Mr Ross 15 cents, a nail, and the shell of a great-great-great grandfather snail, he might tell you.

This article has been changed to correct the spelling of “thneed”.

The Dr Seuss theory of China industrial policy

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