Wins and Losses: Chinese Industrial Policy’s Uneven Success

China's industrial policy is a controversial yet ubiquitous topic. Global concerns are surging over Beijing's use of state support to shape industries and to guide investment. In the United States, concerns over China's systemic use of industrial policy and accusations of structural overcapacity have undermined trust in multilateralism and the World Trade Organization (WTO). At the same time, China's perceived success in industrial policy has also revived interest in the United States and other market economies in pursuing their own state-led investment to enhance innovation, boost manufacturing, strengthen their resilience, and increase domestic employment.

Rapid progress by Chinese firms in many advanced sectors has raised alarm bells in Washington for years. Yet a comprehensive understanding of what drives success and failure in China's industrial policy - and its economy as a whole - is missing from U.S. policy discussions. Academic research indicates that industrial policy outcomes can vary significantly depending on the nature of the industry and the technology itself, the relative level of competition or market orientation of the policy, and the international environment, including access to foreign technology and markets. Moreover, industrial policy, defined as targeted state intervention in a specific sector, may not always be as effective as a generally enabling ecosystem that nurtures human capital and a positive regulatory environment. The experiences of countries in East Asia and beyond show that getting industrial policy "right" is difficult. China is no exception.

As the United States and other countries grapple with the effects of China's industrial policy globally and develop their own industrial strategies, it is important to have a more nuanced understanding of industrial policy's effectiveness. This feature will provide historical context on the development and progress of industrial policy in China and summarize the findings of recent pathbreaking academic research that clarifies where industrial policy has been successful and where it has failed. The report concludes by considering the implications for the United States and others.

Understanding Industrial Policy in China

Scholars have been researching how the state can enable economic growth and its role in the industrialization of less developed countries for decades. Much of the research on the role of the state in promoting growth is based on the successes of several East Asian economies in the post-World War II period. Japan and the so-called "four little dragons," South Korea, Taiwan, Singapore, and Hong Kong, all benefitted from unique and successful partnerships between the state and business that channeled resources towards growth sectors.

These East Asian economies benefitted from export-led growth models that enabled their companies to expand but also enforced discipline on companies by making them compete in non-protected markets. Reda Cherif and Fuad Hasanov have argued that export-led models were a key variable missing in India's post-independence import substitution approach. Others, like Peter Evans, have highlighted that institutional and bureaucratic characteristics of countries can also lead to significant variation.

The export-led model may be key to ensuring the success of industrial policy, but it is also a recipe for increased international tensions. Take Japan, which the United States accused of engaging in unfair non-market practices in the 1980s and 1990s. Many of those same concerns and debates apply to China's today and are magnified by the size of China's economy and broader security concerns, including deteriorated relations between China and the United States.

Industrial policy in China has followed its own course. As pointed out by Arthur Kroeber, China's approach has been distinctive due to the country's highly decentralized economic governance, its Communist legacy that has translated to high levels of state ownership, and, finally, its remarkable level of openness to foreign direct investment. Foreign-invested enterprises played an important role in fueling China's economic rise, which owes much to the significant, although managed, economic liberalization and integration with global markets of the past few decades. Several scholars have convincingly argued the current brand of state capitalism evolved in the past twenty years after expansive liberalization and the retreat of the state from non-strategic sectors in the 1990s and early 2000s, due to a combination of shifting strategic priorities, increased resources, and desire to enhance the role of the Party.

The strong emphasis on industrial policy in China has also coincided with an increased focus on strategic technologies and policies aimed at de-prioritizing economic sectors seen as less desirable (such as private education services). Over the past few years, the United States and several of its key partners have deployed industrial policy to spur innovation and increase value chain resilience across several advanced technologies, but these types of policies have been maturing for well over a decade in China. While government efforts to reduce China's reliance have accelerated under Xi Jinping, they have roots in previous administrations: for example, the "indigenous innovation" campaign launched in 2006.

Measuring Industrial Policy Success

Assessing the success or failure of industrial policy is challenging in part because its aims are not always clear or singular. For example: a policy may not succeed in boosting productivity or certain indicators of innovation such as patent registration numbers and may be inordinately costly, but it may help expand the market share of the targeted companies, increase economies of scale, reduce long-term costs for manufacturers, and reduce reliance on foreign value chains. Governments often target multiple goals at once including non-economic ones such as national security, which is becoming a growing priority in China.

Scholarship on Chinese industrial policy has focused on a variety of metrics:

• Global market share
• Total industry revenue
• Firm R&D expenditure relative to total revenue
• Industrial output growth and scale
• Number of patents filed in strategic areas
• Firm-level productivity

Despite reporting on Chinese tech suggesting that Beijing's industrial policy is equivalent to Midas touch, academic research indicates that the record of success is mixed, and scholars have identified a range of determining factors to consider. Figure 1 compares a selection of studies that were selected to provide a range of methodologies and cover various sectors, it is not meant to be exhaustive. For a more comprehensive list of studies please refer to the additional resources section.

Figure 1: Selected Assessments of the Effectiveness of Chinese Industrial Policy

The Findings

Most research evaluating the success of industrial policy is either focused on a specific metric that can be applied across sectors, often at the firm level, or assesses a small number of sectors using multiple metrics. There are several in-depth qualitative studies that take a historical and case study approach to analyze dynamics at the firm and sectoral level. This feature will only review a select number of studies and sectors.

In a recent paper, Lee Branstetter and Guangwei Li looked at financial statements for listed firms that report having received incentives from the "Made in China 2025" policy from 2015 to 2018. They identified 1,120 firms and analyzed their performance on a variety of metrics. According to the study, innovation subsidies have led to increases in R&D intensity (R&D spending relative to total sales). However, the scholars found no evidence that these firms experienced increases in domestic and foreign patenting, labor productivity, total factor productivity, or profitability.

This research is consistent with the findings from other work by Branstetter, Li and Mengjia Ren (2022), which found a negative correlation between firms listed on the Shenzhen Stock Exchange that reported receiving subsidies and their total factor productivity between 2007 and 2018. These findings raise questions as to the effectiveness and efficiency of subsidies linked to Made in China 2025, one of the flagship industrial policy initiatives of the past decade. Such findings are also echoed in research conducted by the OECD, which concluded that state-owned enterprises globally are more likely to receive state support but still underperform financially.

Another approach is to focus on measuring innovation rather than productivity, which is a stated Chinese government policy goal. Scholars Philipp Boeing, Loren Brandt, Ruochen Dai, Kevin Lim and Bettina Peters recently published a discussion paper evaluating trends in patents in China from 1985 to 2019. The paper does not explicitly evaluate industrial policy outcomes, but it does provide evidence for improvement in patenting by domestic institutions at a time when the state has been focusing on promoting innovation.

With the support of a large language model, the scholars sorted through the abstracts of all patents filed at the China National Intellectual Property Administration and then matched that information with firm-level data on registered capital from a comprehensive business registry for Chinese companies. The data analyzed by Boeing and his colleagues revealed a few significant trends among others: first, the importance of the average invention patent registered in China, measured as a function of impact and novelty, declined between 2000 and 2010, but increased over the next decade. Second, private firms and universities account for most of the growth in patents, while foreign companies represent a shrinking portion in terms of the quantity and importance of the patents. Third, since the early 2000s, Chinese patents have been less reliant on foreign knowledge.

Finally, some scholars have looked at how specific industrial policy tools function and their benefits or shortcomings. For example, professors Yifan Wei, Yuen Yuen Ang, and Nan Jia analyzed the performance of government guidance funds, which are funds created by the central and local governments aimed at injecting equity financing in companies in strategically targeted sectors. The authors highlighted that by 2021, there were more than 1,800 government guidance funds, with an estimated target capital size of $1.52 trillion. U.S. federal funding for R&D in 2021 was only $157.8 billion.

However, Wei, Ang, and Jia found that by 2021, only 26 percent of government guidance funds had met their target capital size, and about only one-third had made at least one investment. Several factors account for this gap: the lack of quality private-sector partners and ventures, leadership turnover and the inherent difficulties of evaluating the performance of the funds.

The picture that emerges from these firm-level and tool-specific studies is complex. Patent innovation in China looks to be increasing but whether that is due to industrial policy is unclear-and the strong performance of private firms vis-à-vis state-owned enterprises suggests that even if state support enabled their increased performance, enterprise characteristics also matter. Branstetter and Li's research points to broader problems in promoting productivity among companies that receive state support. More targeted analysis at the sectoral level provides insights into the dynamics and tradeoffs at play.

Sectoral Examples

According to several new studies, including a recent report by Bloomberg and a series of papers by the Information Technology and Innovation Foundation (ITIF), several strategic sectors in China have experienced significant progress across multiple metrics. The Bloomberg study, led by Francis Chan and Gerard DiPippo, is careful to focus on outcomes rather than drawing direct conclusions on the impact of industrial policy. Scholars have conducted research on a variety of sectors over the years, including ones with disappointing results like the traditional internal combustion engine vehicle sector and commercial aircraft. This feature will focus on three politically salient sectors: shipbuilding, electric vehicles (EVs), and semiconductors.

Shipbuilding

Professors Panle Jia Barwick, Myrto Kalouptsidi, and Nahim Bin Zahur carried out an extensive study evaluating industrial policy's impact on China's shipbuilding industry. At the turn of the 21st century, China accounted for less than 10 percent of world ship production, with Japanese and South Korean firms holding the lion's share of the global market. That changed during the 11^th and 12^th five-year plans (2006-2010 and 2011-2015, respectively) when shipbuilding was named as a pillar industry, ushering in a new wave of policies such as the Medium and Long Term Development Plan of Shipbuilding Industry which set a national production goal of 15 million deadweight tons by 2010 and 22 million by 2015. By 2023, China's shipbuilding output accounted for over 50 percent of the global total (See Figure 2).

Relying on data on shipyard orders, deliveries, and backlogs as well as data from the National Bureau of Statistics of China, the research team carried out counterfactual experiments to evaluate the effects of differing levels of industrial support on Chinese firms and Japanese and South Korean counterparts through 2014. They found that subsidies were very large: between 2006 and 2013 they amounted to RMB 550 billion. Entry subsidies (RMB 330 billion) accounted for the majority, followed by production subsidies (RMB 159 billion) and investment subsidies (RMB 51 billion). These subsidies had a significant impact across most metrics, including China's world market share, which increased by 40 percent between 2006 and 2013. Thanks to the industrial policies in place, the Chinese market share increased more rapidly than it would have otherwise. Three-fourths of the growth came directly at the expense of existing producers in Japan and South Korea, and only one fourth contributed to increase global industrial output.

A key finding of the research on shipbuilding is that different kinds of subsidies vary in their effectiveness and their distortionary effect. Among the different subsidy instruments the scholars examined, measures to promote firm entry (which included below-market land prices and simplified licensing requirements) were particularly costly because they incentivized unproductive firms to join the market. The policy led to a substantial increase in the number of firms, total industry capacity, and overall production, but also to lower capital utilization and a more fragmented industry structure. Global ship prices also declined due to the increased global supply affecting profit margins.

In addition, Barwick, Kalouptsidi, and Zahur found that subsidies aimed at increasing investment (such as low-interest loans) or production (such as subsidized material inputs, export credits, and buyer financing) were more effective in maximizing revenue because they were more likely to target larger and more efficient companies. The finding is consistent with research conducted in other sectors, including electric vehicles, that shows how subsidy design can lead to very different outcomes and that more market-oriented approaches can lead to more effective outcomes.

Overall, the policies targeting the shipbuilding sector were quite wasteful - the authors found for example that the number of shipyards declined by over 50 percent from 2009 to 2020 as unproductive firms were eventually culled. Moreover, the specific policy mix adopted only resulted in an 18 percent gross return rate, measured as lifetime profit gains of domestic firms divided by total subsidies. Still, the policies succeeded in not only creating a larger industry within China but also displacing international competitors.

Electric Vehicles

The Chinese electric vehicle (EV) industry's rapid growth has rapidly become a flashpoint in China's external commercial relations. Some observers see it as a model for green industrial policy, while others point to unfair competition, overcapacity, and global trade imbalances. However, while China's industrial policy has been a catalyst for the growth of the EV and other cleantech industries (see Figure 3), other factors have played an important role as well.

Most companies leading in China's EV market (with the notable exception of Tesla) are now Chinese-owned and rely on Chinese-dominated value chains. This is very different from the internal combustion engine (ICE)-based auto sector in China, in which Western manufacturers-through their Chinese joint ventures-dominated the leaderboards. There, the industrial policy strategy focused on technology transfer was far less successful, although success varied depending on how local governments and companies engaged with the foreign partner and may have produced significant knowledge spillovers that were helpful to China's auto companies.

Demand-side subsidies played an important role in promoting the EV industry. Professors Shanjun Li, Xianglei Zhu, Yiding Ma, Fan Zhang, and Hui Zhou estimated in their recent paper on the role of government in the EV market that central and local subsidies accounted for over half the EVs sold between 2015 and 2018, a significant push in a time when EVs were still a comparatively nascent industry. The subsidy policies were paired with a number of other policy tools aimed at boosting demand, including publicly funded charging infrastructure and the "green license plate" policy which provided preferential vehicle registration for EVs. This highlighted the importance of a growing domestic demand for manufacturers.

The EV industry, like other manufacturing sectors, has also benefited from supply side state support including access to financing through loans or equity from government investment funds as well as government grants. As the case of NIO's rescue package from Hefei in 2020 demonstrated, local governments continue to play a significant role in China's industrial policy. There are implications to the long-standing importance of local actors in the implementation of industrial policy in China. Local government flexibility and close interaction with companies can aid the implementation of industrial policy. However local goals can differ from central government ones, leading to overinvestment and fragmentation. Jonas Nahm 's analysis of the solar industry shows how enterprising firms can capitalize on differing goals to maximize support and still achieve innovation.

Early evaluations of the EV industry in China were less than sanguine, due to low sales, low-quality vehicles, and highly costly and inefficient subsidies. However, predictable government policies and flexibility benefited the industry. Beijing changed its policy after 2015, shifting to a far more centrally coordinated system where subsidy eligibility was linked to technical standards aimed at increasing the performance and quality of the vehicles and batteries. Since 2019, China reduced consumer subsidies even further and shifted to a credit-based policy modeled after the California's Zero Emission Vehicle mandate to push firms to produce more EVs. These policies also coincided with growing competition and consumer power. Chinese automotive companies may have benefitted from significant state support, but they have had to deliver a desirable product to succeed.

The failure of fuel cell vehicle technology, which was eligible for the same types of subsidies as EVs, highlights how other factors beyond state support are necessary for industrial policy to succeed. This points to the combination of factors that enabled Chinese cleantech firms, including EV manufacturers, not just to gain market share very quickly but also innovate. First, industrial policy efforts were undertaken at a time when the technology was still maturing, and global competitors were not well-established due to limited demand.

Second, Chinese companies were well-positioned to take advantage of incentives put in place by the government and had access to global value chains, talent, and capital. While foreign direct investment and foreign partnerships have not been the sole catalyst for the industry's development in China for EVs and other cleantech industries, they have certainly played an important role. Most of these technologies were not invented in China but struggled to find a market and a pathway to commodification and commercialization elsewhere.

Third, the nature of the technologies played to China's advantage. Batteries, solar panels, and other components for renewables are highly modular and benefit from economies of scale and "learning-by-doing," meaning that large-scale manufacturing can translate into increasingly high quality and low per-unit costs. They are also advanced but not as complex nor is the IP concentrated in the hands of a few companies as in the case with, for example, semiconductors. This is enhanced by increasing levels of automation in manufacturing that can lower costs, and which has been supported by industrial policy targeting industrial robots among other things.

Semiconductors

The semiconductor industry's strategic importance has driven an ongoing surge in policy initiatives around the world to expand domestic chip manufacturing capacity. China has been no exception to this trend, as Professors Pinelopi K. Goldberg, Réka Juhász, Nathan J. Lane, Giulia Lo Forte, and Jeff Thurk documented in their research on global trends in semiconductor industrial policy. Their research quantified both the number and value of semiconductor policies around the world. They found that industrial policy has been central to the development of the industry and was concentrated among current major producers in Europe, Japan, South Korea, and China in the examined period of 2010 to 2022.

Goldberg and her co-authors found that China is not an outlier in terms of the number of policies supporting the semiconductor industry (see Figure 5) but leads in industrial policy spending (see Figure 6) but concluded that given China's size, the expenditure is comparable to that of other countries. This contrasts with the OECD's work on the semiconductor value chain, which compared financial data for the largest semiconductor firms and found that Chinese companies received a greater amount of government support as a share of firm revenue than their international peers.

Undoubtedly, government policy has triggered a wave of investment in the industry. State media outlet China Economics Weeklyreported that between January and October 2020 alone, over 58,000 semiconductor-related companies were founded. However, in the case of a technology like semiconductors such fragmentation may have had less successful outcomes than in solar or EVs. Indeed, the quality and subsequent productive capacity of many of those investments was low. One high profile failure was the Hongxin Semiconductor Industrial Park located in Wuhan. Despite an initial $18.97 billion investment by 2021 it was abandoned. Mismanagement and corruption in the semiconductor industry appears to have been widespread enough to lead to several high-profile arrests in 2022.

Among those found guilty of corruption was Ding Wenwu, China's National Integrated Circuit Industry Investment Fund's former president. The fund is a key tool of China's industrial policy for semiconductors. As Wei, Ang, and Jia's research on government guidance funds showed, there can be significant challenges in ensuring that government funds operate as intended to support central government industrial policy plans.

China's progress in the semiconductor sector has been far slower than in shipbuilding or EVs. Among the possible reasons, Goldberg and her colleagues highlighted that cross-border technology transfer, whether through foreign direct investment, research collaborations, or technology licensing, has played a crucial role in the development of a strong semiconductor industry in other countries. This is partly due to the complexity of the technology itself, the need for specialized staff, and high entry costs which make technology diffusion more challenging than in the case of batteries, solar panels, or EVs. A couple of trends have put China at a disadvantage: before 2010 the Chinese government struggled to negotiate favorable technology transfer arrangements and more recently it has met significant hurdles in acquiring advanced chips, technology, and machinery due to U.S. export controls.

Despite China's challenges in the semiconductor industry, research done by Bloomberg, among others, has highlighted China's growing strength in chip packaging and testing. The Bloomberg study also found that while China had failed to reach its goals in semiconductor design, it still managed to expand its market share - from 2 percent in 2014 to 8 percent in 2023 - largely in mature-node analog chips, microcontrollers, and image sensors.

The experience of the semiconductor industry in China points to the need for a more comprehensive understanding of what makes industrial policy successful. Chinese chip companies have had no shortage of funding and incentives from the state, and yet they have struggled to compete with international firms due to a combination of technological constraints, restricted access to foreign technology, and the strength of established global competition. However, recent technological progress suggests that industrial policy may be able to produce indigenous innovation, although at a very high cost.

Conclusion and Policy Recommendations

China's experience with industrial policy points to the complicated interaction between multiple factors in determining outcomes. First, the type of technology matters. Complex technologies that are in the hands of incumbent players like semiconductors, commercial aircraft, or internal combustion engine vehicles are harder to make progress on. If a technology is less mature, there is more opportunity to achieve progress.

Second, not all industrial policies are the same. Policy design matters and increased competition, including with foreign firms, is more likely to lead to better outcomes for cost and innovation. This is consistent with historical cross-country analysis of industrial policy and points to the importance of responsive and entrepreneurial companies that can respond to policy incentives. The strong performance of private firms in the cleantech industry may be directly tied to company characteristics rather than policy in some cases. Third, access to foreign technology, investment, and markets offers huge advantages.

There are several lessons to be drawn from the research on industrial policy. The first is the importance of policy flexibility to adjust to the needs of firms, implementation agencies, and international developments; the second is that policies should be designed to reduce distortions and introduce as much discipline as possible for companies through competition and market incentives. Thirdly, policymakers should recognize the importance of global value chains to innovation and acknowledge the costs associated with a more isolationist stance. For example, although tariffs may be a useful tool to protect an infant industry, they should have clear timelines. Moreover, foreign direct investment can be a valuable instrument to incentivize competition and acquire new technologies. Finally, definitions of success matter: Chinese officials who oversee industrial policy may find it acceptable for these priority sectors to grow and gain market share rather than attain traditional commercial goals.

The incoming U.S. administration will inherit large-scale industrial policy programs in semiconductors and cleantech that will face competition from Chinese companies and will require new policy strategies. Policymakers are already debating the value of continuing such initiatives and how to move forward. Analyzing the experiences of other countries may offer some valuable lessons on how to enhance efficiency, effectiveness, and lower costs. Better understanding of when China has succeeded or failed because of industrial policy can provide better policy options for how the U.S. government should respond. For example, the cycles of overinvestment that lead to the proliferation of firms and subsequent industry consolidation, which are commonly found in sectors that benefit from state support in China, can have a positive impact on cost and innovation in some sectors like EVs but are expensive and have increased tensions between China and its trading partners.

Industrial policy in China also matters because of its impact on global trade. As work by the OECD's Trade and Agriculture Directorate has highlighted, the lack of transparency in state support levels is concerning and could lead to large distortions. Despite mixed evidence as to the effectiveness of industrial policy, a rise in competition between countries to attract investment and develop new value chains could lead to a "race to the bottom" in terms of providing companies with state support. Developing countries may be left further behind in the new wave of industrialization.

Yet in some cases, there may be positive effects to industrial policy. Goldberg and her coauthors found evidence of positive international spillovers from industrial policy in the semiconductor industry, for example. As a result of Chinese companies' innovation and dramatic cost reductions, global adoption of solar, EVs, and batteries has outpaced expectations with positive implications for the energy transition and energy costs.

The expansion of industrial policy in China and elsewhere also raises broader questions on the future of the global rules-based order. Current institutional arrangements are unequipped to deal with a world where multiple large economies are openly pursuing industrial policy. Although challenging to imagine in the current political environment, it will eventually become necessary to find a platform to negotiate new international agreements on the "rules of engagement" for industrial policy. Ultimately this type of engagement will require the United States and China to sit at the same table, but in the process, other arrangements may be found between like-minded countries. It will be in the United States' best interest to engage either bilaterally or multilaterally to be able to shape such a framework.

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