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Development and Reconfiguring of Industrial Chains Amid De-Globalization
Date:11.30.2022 Author:PENG Wensheng - CF40 Member; Chief Economist and Head of Research, China International Capital Corporation

Abstract: Against the background of de-globalization, the importance of geopolitics and national security has risen. Countries need to rely more on the initial scale of their own market to participate in global competition. Due to the large demand of domestic market, major powers have an edge in global industrial competition. For China to promote market competitiveness amid de-globalization, we should reduce “fragmentation” within the market and cope with new challenges posed by the shift towards non-tradable sectors and the development of the digital economy.

Since the outbreak of the Covid-19 pandemic, global supply chains have witnessed three rounds of shocks: when the pandemic emerged in 2020, the disruptions to economic activities reduced production and inventory and undermined employment; when global demand rebounded in 2021, the supply side suffered low inventory, weak production and disrupted transportation, which exacerbated the supply-demand imbalance; when the Russia-Ukraine conflict intensified in 2022, the supply of energy, raw materials, and food have been affected significantly. The shocks to global industrial and supply chains have amplified the implications of the pandemic and geopolitics for the world economy and pushed the private and public sectors to rethink the importance of supply stability.

At a micro level, businesses begin to value supply chain stability more. At a macro level, governments start to emphasize supply chain resilience and look at industrial competitiveness from both the aspects of efficiency and security. The report to the 20th National Congress of CPC put forward that “pursuing high-quality development as our overarching task, we will make sure that our implementation of the strategy to expand domestic demand is integrated with our efforts to deepen supply-side structural reform; we will boost the dynamism and reliability of the domestic economy while engaging at a higher level in the global economy; and we will move faster to build a modernized economy. We will raise total factor productivity, make China's industrial and supply chains more resilient and secure.”

Over the past 40 years of reform and opening up and high-speed growth, China has played a critical role in global industrial chains. In the face of new challenges, high-quality development requires us to balance the efficiency and security of industrial chains. To that end, the Research Department and Research Institute of CICC co-authored an in-depth report on Industrial Chains of Great Power – macro and industrial trends under the new landscape. Focusing on the dual dimensions of efficiency and security, the report analyzed the opportunities and challenges facing China’s industrial chains from diverse perspectives including macro and industrial, technological and policy, as well as domestic and international aspects, and underscored the importance of utilizing the advantage of economies of scale to facilitate the efficiency and security of China’s industrial chains under the new conditions. This paper will reflect on the development and adjustment of China’s industrial chains from a macro perspective.

I. DE-GLOBALIZATION: HISTORY HAS NOT COME TO AN END

The greatest contribution of economics to human society might be the promotion of free trade. Before Adam Smith's Wealth of Nations came out, the mainstream thinking held that wealth accumulation required the possession of gold and resource allocation relied on the seizure of land by force and colonization. Contrary to traditional thought, Adam Smith proposed wealth creation through free markets based on the division of labor and trade. Here, free markets refer to those that are not controlled by rent-seekers including feudal monarchy, aristocrats, and landlords. Although academic opinions are divided about the outcome of free trade - some view that free trade produces beneficiaries and losers and that protecting emerging industries and innovative fields is good for economic growth- economics generally tends to encourage free trade.

Over the past 40 years, neoclassical economics has been the dominant thought. At the policy level, it promotes economic marketization and financial liberalization, which facilitated trade in goods and services and significantly expanded the cross-border flow of capital, technology, and information. As technological advancement further reduces the costs of transportation and information communications, division of labor has been more specialized, and globalized industrial chains have become the main approach to improving efficiency and prosperity. In 1989, American political scientist Francis Fukuyama put forward the idea of "the end of history", arguing that the development of political history had reached its end and there is only one way to develop, namely, market economy and democratic politics; market economies will gradually form a unified learning and cultural community, and by that time politics will no longer be important, while the market will decide everything.

However, since the global financial crisis in 2008, drivers of de-globalization have expanded from the economic field to non-economic field, from the rise of trade protectionism to the outbreak of the Covid-19 pandemic and the Russia-Ukraine conflict. While the pandemic has dealt a heavy blow to supply chains in the short term, more evidence shows that geopolitics has again become a far-reaching factor in impacting global resource allocation, and the risk of industrial chain decoupling as a tool for geopolitical competition is mounting. In the era of de-globalization, history has not come to an end.

First, despite its huge disruptions to global supply chains, the Covid-19 pandemic also underscores the contribution of global trade. On the one hand, domestic production has been undermined due to constrained import of intermediate goods; on the other hand, while a nation’s own production was affected by the pandemic, imports from other countries (who were less affected at that point) serve as the alternative supply. At a micro level, the pandemic has greatly impacted global supply chains. But at a macro level, global industrial chains have demonstrated resilience during the pandemic. For example, China’s export has played a huge role in meeting other countries’ demand, with the share of international trade in GDP rising since the pandemic.

Second, geopolitics has had more profound impacts on reshaping global industrial chains, and what makes the matter more complicated is that it is hard to distinguish geopolitical considerations from trade protectionism. The rise of trade protectionism is associated with the widening income gap between the rich and poor in developed countries. To address the issue of wealth disparity, US liberals emphasize that liberalism exacerbates unfair distribution of income and globalization only benefits the wealthy few; the US conservatives stress external factors such as illegal immigration. As for geopolitics, both the lefts and rights in the US take into account geopolitical considerations; in particular, they believe that globalization provides opportunities for China to rise. Starting from the trade tension posed by the Trump administration to the current bipartisan consensus, the US has been trying to reduce its reliance on China’s supply and control the exports of some key technologies to China.

Though history will not simply repeat, it usually moves forward with the same rhythm. After World War I and the Spanish flu, the first wave of de-globalization occurred; the rise of nationalism and trade frictions during the 1920s eventually evolved into fascism and World War II. The current wave of de-globalization is also influenced both by the Covid-19 pandemic and the Russia-Ukraine conflict. Global trade and economic cooperation can not only improve efficiency but also promote world peace since the alternative for market transactions might be the seizure of resources by force. Economics has long deemed national security as a discipline far away from market analysis. However, the situation has changed, and economics needs to reconceptualize the interplay of factor endowment, economic integration, and geopolitics.

II. SPATIAL ECONOMY: THE WORLD IS NOT FLAT

In the first chapter of Wealth of Nations, there is a famous example: one person may produce only a few pins per day, but if the process is divided into 18 different stages and forms a division of labor, each person can produce thousands of pins per day, which improves efficiency dramatically. By expanding the division of labor and free trade to the world, first to trade of consumer goods, then to intermediate goods, today’s global industrial chains finally come into being. The spatial distribution of different stages of industrial chains reflects not only the cost of geographical distance but also the influence of factor endowment differences, technological progress, and institutional environment. While the division of labor in the global industrial chains brings benefits, it also comes with potential risks of instability. Balancing the efficiency of spatial layout and security thus becomes the key issue for the development of global industrial chains.

Traditional trade theories highlight the role of factor endowment from the perspective of space. The more input of factor endowments required for a country’s export products, the greater the cost advantage the country will have. Countries with abundant labor supply produce and export more labor-intensive products, while countries rich in capital produce and export more capital-intensive products. The complementarity between these countries thus becomes the driving force of international trade.

Neo-classical economics, which has dominated economic theory for 40 years, goes even further. By assuming that businesses choose production sites based on costs of production and transportation, capital would flow from developed countries with low returns to developing countries with high returns; the catch-up effect will make low-income countries grow faster than high-income countries and reduce the differences in labor and capital returns, thereby eventually equalizing the levels of economic development among countries. Over the past four decades, globalization does weaken the importance of geographical and spatial distance. Competition among businesses or individuals is no longer confined to a region or a nation but instead expands to the whole world. In his book, The World Is Flat: A Brief History of the Twenty-first Century, published in 2005, American journalist Thomas Friedman depicted “a flattening world” where spatial distance no longer matter and a global village is emerging. In such a flattening world, globalized internet and interaction lead to peaceful coexistence; the sense of distance between countries diminishes; governments have less control of their country’s economy and society.

Denying the significance of spatial location differences is denying reality. Only a few countries, primarily in East Asia, have caught up, and trade among developed countries frequently exceeds trade with low-income countries. One reason is economies of scale, which require manufacturers to expand a product as much as possible. However, with limited resources, large scale of one product means fewer types of goods, whereas consumer preferences are diverse. The contradiction between diverse consumption and economies of scale can be alleviated by a larger-scale division of labor and trade. Even if two countries have the same factor endowments, specialization and international trade can improve efficiency, which can explain a large amount of trade between developed countries.

The transportation cost of spatial distance is another factor that interacts with economies of scale. Transportation costs push production closer to consumers, limiting production concentration, but economic activity concentration brings economies of scale. Companies will benefit from industrial agglomeration if the benefits of economies of scale outweigh transportation costs. When transportation costs and economies of scale are considered, industrial agglomeration has the greatest advantage in high-demand markets. China's manufacturing industry benefited from low-cost labor in the early days of reform and opening up (after 1978). The cost of labor has risen in tandem with economic development and income growth, but thanks to its large market of final demand, China plays an increasingly important role in the global industrial chain.

The combination of economies of scale, consumption diversity, and transportation costs means that the spatial distribution of industrial chains is unbalanced, and the world is not flat. We must rediscover the significance of spatial location, not only in economic factors like transportation costs, but also in terms of understanding the role of non-economic factors like politics, society, history, and culture within the broader concept of geography and space. Enterprise agglomeration is influenced not only by economies of scale and transportation costs, but also by political and social policies, as well as different historical paths with regional differences. This means that the spatial adjustment of the industrial chain (re-shoring, near-shoring, friend-shoring) requires costs, including equipment relocation costs, sunk costs of long-term fixed investment, and negative externalities implied by dependence on infrastructure and public services. The adjustment of the industrial chain usually results in a decrease in efficiency and an increase in cost for the overall economy.

Will industrial chain adjustment increase its resilience and security? At the micro level, narrowing the spatial distribution and reducing intermediate links can stabilize the supply chain, but at the macro level, the resilience of the industrial chain does not necessarily come from re-shoring, near-shoring (Don't put all your eggs in one basket.) or friend-shore (Friends of today may be enemies tomorrow.), but the spatial dispersion of supply sources, including geographical, political and cultural differences. This is because risk diversification, in a broader sense, does not refer to the diversification of supply sources of a certain type of product, but the divergence of the total supply of the economy. It is unlikely that a country can produce all the commodities it needs for consumption. Compared with the era of globalization, the adjustment of the industrial chain driven by non-economic factors such as geopolitics will inevitably bring about a decrease in efficiency (increase in cost). But does it increase security? The conclusion is not certain.

Land space is another variable that has a major impact on the development of the future industrial chain, but its specific effects are not yet clear. To be precise, it is the impact of coping with climate change and green transformation. Land provides space to absorb carbon dioxide (forest carbon sink and carbon sequestration) and support renewable energy (solar, wind, hydropower). The use of land space can help humans cope with floods and droughts caused by extreme weather (such as reservoirs). The land is also involved in the transformation of traditional fossil energy production and related infrastructure. The manufacture of renewable energy equipment has economies of scale. Switching from fossil energy to renewable energy can increase China's energy security, but the use of renewable energy will occupy a large amount of land, resulting in diseconomies of scale. Addressing climate change may require changes to land uses and landforms.

For large countries, land supply does not seem to be a problem, but the land has its special properties as a factor of production. The land is immovable in space and inconvertible in time (while general productive capital converts today's consumption into tomorrow's consumption). The land is naturally monopolistic, and therefore the use of land is easily trapped into diseconomies of scale, rent-seeking, and corruption, distorting the allocation of resources, just like the natural supply of land is not tight, but housing prices in some big cities are abnormally high. In the era of the industrial economy, the role of land is declining, and neoclassical economics regards land as a part of productive capital. But now, as we cope with climate change, land is more regarded as an independent factor of production. There is competition among the multiple uses of land, and the impact of its new role on the industrial chain remains to be seen, but a preliminary judgment can be made: based on its diseconomies of scale, the increase in the importance of land will bring about an increase in costs.

Ⅲ. TECHNOLOGY IS NON-NEUTRAL: BALANCING EFFICIENCY, FAIRNESS, AND SECURITY

To deal with the impact of geopolitics and climate change (green transformation) on the industrial chain, taking into account efficiency and safety, the key is technological innovation and progress. Technological innovation has agglomeration and diffusion effects, two seemingly opposite forces that are carried by regional centers and global industrial chains. Urban economic activities have agglomeration effects –the agglomeration of elements brings economies of scale and scope. In particular, interactions between people help to generate and disseminate new ideas and technologies. Technology also shortens distance by supporting the spatial layout of specialized division of labor. The global industrial chain is not only the result of technological progress but also promotes innovation in turn.

In the past three decades, China and the US, as two major economies, have played a key role in global technological innovation and industrial chain development, which can be summarized as the G-2 model. The U.S. has advantages in invention and innovation and has led the development of some key technologies. China has advantages in production and market scale. By rapidly increasing the scale of commercial applications and reducing costs, China has increased global supply capacity and benefited consumers all over the world. China has shortened the distance from the technological frontier by participating in international competition and learning from the upstream and downstream of the industrial chain. Meanwhile, the profits brought by the Chinese market support the innovation capabilities of American companies and help them maintain their leading positions. Other countries participating in the division of labor in the industrial chain have improved the efficiency of economic operations. Some small economies focus on a few fields and become important producers of such products in the world.

The innovative G-2 model is now being challenged, as geopolitics is exerting more influence on scientific and technological cooperation and competition. The U.S. government is using industrial policies based on administrative power more and more frequently. For example, the Department of Defense, Treasury, and especially the Department of Commerce restrict exports or imports through entity lists. The U.S. government has recently issued new restrictions on the export of advanced semiconductors and related equipment to China, which are wider in scope and stricter than ever. China is facing increased external pressure on technology hardware, especially semiconductors. In the new geopolitical situation, the importance of independent innovation has increased.

An important characteristic of knowledge is non-competitiveness. One person's use does not affect other people's use, which enables sci-tech innovation with positive externalities and the attribute of public goods while leading to insufficient investment in innovation from the private sector. In addition, innovation input and output are often long-term cumulative and non-linear processes, with great uncertainty. Private institutions do not have enough patience and ability to bear the risk of failure. The public sector can hedge against the private sector's deficiencies in the above two aspects by playing two roles: One is to directly participate in innovation activities, such as investment in R&D and education, and the other is to create a market environment that encourages private institutions to innovate through policy and mechanism design.

It is generally believed that technology is neutral, neither good nor evil in itself, but with the intensification of geopolitical competition, technology may be endowed with political inclinations in some key areas. The non-neutrality of technology may also be reflected in other aspects such as social justice. Technological progress can change the cost difference brought about by factor endowments. When the cost of robots drops sharply and machines can replace humans, the manufacturing industry will return to developed countries. Developed countries and developing countries can manufacture the same commodity. Developed countries take advantage of abundant capital, and developing countries take advantage of the abundant labor force. The necessity of international trade decreases. The replacement of humans by machines increases the resilience of supply in developed countries, but at the same time may put some workers in a more disadvantaged position and aggravate their internal distribution problems.

The development of the digital economy also requires dealing with the problem of technological non-neutrality, as some digital technologies have inherent value orientation. The inventor of Bitcoin said in an email in 2008 that Bitcoin has a strong appeal to the liberalists because it could become a currency that does not require centralized third-party certification and is free from government intervention. Encryption means many individuals and computers make decisions from the bottom up. On the other hand, AI improves the efficiency of centralized machines that make decisions from top to bottom, which may play a role in strengthening centralization. The developers and users of Web3.0 can participate in the establishment of the platform, interact with the platform, and participate in the governance of the platform. In a certain sense, it is a bit similar to the elements of the Marxist commune, which is closer to the mode of production, distribution, and exchanging tools than the modern market economy.

It remains to be seen which aspect of technology will dominate in the future, but early signs have highlighted the importance of digital governance. Among the major economies, the digital governance of the U.S. tends to be liberal, the EU model pays more attention to supervision, and China is in the middle. Since the pandemic, digitalization has accelerated significantly, and digital supervision in many countries has also been strengthened. Digital technology is a double-edged sword. On the one hand, it promotes the division of labor and the development of the global industrial chain, bringing economies of scale. On the other hand, it also places new demands on the government's ability to control and regulate economic and social activities. In an environment of rising geopolitical importance, national security or data sovereignty issues are more prominent, excessive digital regulatory governance may exacerbate the fragmentation of the global economy, and the importance of the concept of the state in the digital age will increase rather than weaken.

Ⅳ. ECONOMIES OF SCALE: CHINA’S NEW ADVANTAGE

As mentioned, the combination of consumer diversity (requiring a certain size of population) and economies of scale at the production end promotes international trade and the global industrial chain. Under the trend of de-globalization, how should we understand the role of economies of scale and their impact on the industrial chain? Economies of scale refer to the process of increasing returns as the scale rises. To put it simply, when the input doubles, the output more than doubles. The increase in production scale improves production efficiency and reduces the cost per unit. On the one hand, the specialized division of labor and equipment increases labor productivity. Then, a certain market size means sufficient demand, which helps to share fixed costs to attract investors and entrepreneurs.

Over the past three decades, China has participated in global market competition and enjoyed rapid economic growth that benefited from the economies of scale of the global market, but it can’t deny the fact that small economies may gain more from participating in the global division of labor and cooperation. In the era of globalization, a company might face a market that is much larger than that of its home country, so small economies can enjoy economies of scale by focusing on and expanding a certain industry. For example, the output value of semiconductors accounts for more than 30% of Taiwan’s GDP. It is unimaginable that a closed economy will invest one-third of its resources in one sector. In the post-World War II era of globalization and free trade, many small economies enjoyed global economies of scale, and rapid growth, and therefore entered the ranks of rich economies.

The more integrated the economies are, the smaller the impact of country size in the political sense on economic growth, which can explain why the mainstream macroeconomic analysis in the past few decades has not paid attention to the size of the country in the traditional political concept. In the era of de-globalization, the role of economic factors such as free trade has declined, and the importance of non-economic factors such as politics, culture, and history has increased. Countries have less room to enjoy economies of scale by participating in the division of labor in the global industrial chain, which is bad news for all countries, but small economies suffer more. De-globalization strengthens the concept of a country in the geopolitical sense, and the size of a country's economy and the population becomes more important.

Especially in the knowledge-based economy, countries with a large population can support large-scale human capital and R&D investment, have more innovative talents, and thus faster technological progress, and technological progress has a strong spillover effect, once produced, it can be shared by all industries, a large country has a greater potential to obtain increasing returns to scale with a larger market size. The advantage of a big country is also reflected in the fact that more people share the cost of public goods. Lower per capita costs mean that everyone can enjoy better public services, including infrastructure, public health, and education. Large countries are also better able to protect themselves and have more security guarantees, while small countries may need to spend more resources on defense spending, crowding out other public service expenditures. Different regions within a major country can help each other (fiscal transfer payments, etc.), and are more capable of coping with various shocks, including natural disasters.

The importance of geopolitics and national security has risen under the background of de-globalization, stressing the need to rely on the initial scale of a country’s market to participate in international competition. With the help of the local market with huge demand, a big country can gain an advantage in international industrial competition and expand the original economies of scale effect by serving the global market. The industrial chain of a big country is more connected forward and backward and can take the lead in more industrial chains. In the era of de-globalization, bigger countries can have a greater influence on the global industrial chain and economic structure.

The Report to the 20th National Congress of the Communist Party of China points out that it will “leverage the strengths of China’s enormous market, attract global resources and production factors with our strong domestic economy, and amplify the interplay between domestic and international markets and resources.” China is the second largest economy in the world, with the largest population in the world, and its labor force is equivalent to the sum of the three populous countries of India, the U.S., and Indonesia. It has the potential to give full play to its advantages of scale, which is also expected to become a new growth point of China's economy in the future. However, not every big country can achieve economies of scale. There could be a large scale without economies of scale, so the most fundamental thing is market economy competition and consumption leadership. In retrospect, the Soviet Union’s planned economy disconnected production and consumption, canceling market competition that would have promoted the division of labor, and transactions, and its size advantage in total population, and eventually fell behind in competition with the U.S.

For China, promoting market competition in the context of de-globalization requires efforts to reduce internal market fragmentation and address new challenges posed by the shift to non-tradable sectors and the booming of the digital economy. As for the internal market, promoting the equalization of public services and reducing the income distribution gap will help boost consumer demand and bolster a large domestic consumption market. As for the non-tradable sector, land itself has the property of diseconomies of scale and can strongly capture development gains from other sectors, being an important factor for distorted resource allocation and widened income gap. China's economic development over the past two decades was supported by exports and real estate expansion. Both of them were significant to driving short-term demand. The difference between the two was that while exports are part of global market competition and contribute to a higher economic efficiency, real estate sector is naturally associated with monopolistic and rent-seeking behavior that undermines the efficiency of overall economic operations.

The challenge posed by the development of the digital economy is to balance economies of scale with issues of anti-monopoly, privacy protection, and transnational digital governance. Preventing monopolies requires efforts to support  external economies of scale, cluster effects, and upstream and downstream linkages, rather than encouraging the expansion of enterprise scale limitlessly. Automation and numerical control (CNC) have made it possible to increase the efficiency of production without the need for large-scale production and meet the needs of different consumers more rapidly. The development of the digital economy has seen the decline of internal economies of scale and the rise of the opposite. The challenges facing digital industrial policy lie in two main areas: first, how to enhance privacy protection and crack down unfair competition; second, how to prevent the integration of industry and finance of platform enterprises, as finance enjoys credit guarantee from the government and can only operate with licenses, while the integration between the two can solidify monopoly of platform enterprises and distort resource allocation.

V. THE RETURN OF INDUSTRIAL POLICY

The International Monetary Fund (IMF) released a report in 2019 titled "The Return of the Policy That Shall Not Be Named: Principles of Industrial Policy." It is about governments' renewed focus on industrial policy. Why can't the policy be named? Economic policy over the past 40 years has been guided by the Washington Consensus, which emphasizes privatization, deregulation, and free trade, i.e., small government, and big market. However, in the past two years, governments have rolled out special policies for some industries, and the return of industrial policy has become a consensus, which will have a significant impact on the development of the global supply chain.

In the market economy, industrial policy can affect resource allocation to various extent.  There were all kinds of policies adopted in the history, some being successful while others not. After World War II, tariff barriers were removed and trade protectionism declined. However, Japan and South Korea restricted foreign direct investment (FDI), which is another kind of protectionism. For some time, Europe and Japan put a lot of emphasis on the role of state-owned enterprises. French and Japanese governments formulated 5-year plans; some European countries used public banks to support SME development; Latin America implemented import substitution industrialization in the 1970s, etc. For another example, the U.S. has been a strong supporter of research and development (R&D), especially during the Cold War, when defense spending was an important source of R&D expenditures, which is arguably the strongest industrial policy in the world in terms of its impact in the decades since.

In the new context, how to view the role of industrial policy? Three dimensions must be given special attention. The first is protectionism in some countries that aims at promoting domestic employment and income. From the perspective of developed countries, a popular view is that globalization has led to a decline in employment in higher-income industries such as manufacturing. While the previous response is to reply on social policies such as providing better education and training, and improving social security, now emphasis is shifted to policies that target individual industries so as to change the competitive landscape. The second is policies to address externalities and market failures, most notably being government inputs and measures to promote science and technology innovation (STI), and policies to promote carbon reduction and green transformation. The third is geopolitical competition, of which science and technology competition is the core. These three dimensions are intertwined. For example, geopolitics is closely related to protectionism, making the corresponding industrial policies assume distinct external characteristics and direct or indirect links with international trade and investment.

In terms of STI-related policies, developed countries, especially the United States, have exhibited three trends. First, the government is deeply involved in increasing R&D funding and subsidizing the production of some high-tech products. Second, countries are exploring different models for funding R&D and innovation, often combining industrial policy with incentives to promote risk-taking by private firms. Third, governments have taken measures to make their countries gain more from innovation and technological progress, including limiting high-tech exports as well as encouraging domestic production, with the U.S. limiting exports of semiconductor manufacturing items on the one hand and directing chip production back to the U.S. by means of subsidies and other measures on the other. Clearly, U.S. industrial policy is extending from upstream R&D investment to specific industries in the midstream and downstream.

In the face of U.S. restrictions and competition, China has placed greater emphasis on science and technology innovation. In the 20th National Congress report, it was said “Innovation will remain at the heart of China’s modernization drive.” It was also mentioned that China will improve the new system for mobilizing resources nationwide to make key technological breakthroughs, enhance basic scientific and technological capacity, deepen structural scientific and technological reform so as to create an open and globally-competitive innovation ecosystem.

The industrial policies of the two largest economies in the world, China and the U.S., are both expanding from familiar areas (innovation R&D in the U.S. and manufacturing in China) to new areas. At the same time, major economies have set clear timelines for achieving carbon neutrality. Correcting global externalities like carbon emissions requires both technological innovation and the transformation of traditional industries, which may become the largest industrial policy in the coming decades. There are increasing signs that countries are moving toward a comprehensive and systematic approach to industrial policy.

In addition to giving policy priority and increased investment, efficiency of implementation will be the key. The special nature of innovation lies in a high degree of uncertainty and long-term investment, which requires public-private sector partnerships. Policy design needs to consider both incentives and penalties, and should allow people engaged in science and technology progress and innovation to have excess earnings. For example, they should be allowed to take part of the proceeds of intellectual property rights of government-supported projects in addition to normal salaries. At the same time, evaluation, tracking, reward and punishment mechanisms should be established for government-supported research projects, including conditional subsidies and sunset provision, etc.

Establishing a sound innovation ecosystem also requires other policies that wound complement each other so as to form a benefit-driven mechanism. In the case of China, two interconnected areas deserve the most attention. One is to correct the distortion of resource allocation by excessive marketization of the real estate sector. The key lies in establishing a new model of real estate development, increasing the supply of affordable housing, encouraging renting and selling, implementing a real estate tax, and turning land finance to land revenue. Another is to improve the structure of finance, the key lies in the separation of industry and finance, and separated operations. The former is to prevent government credit to banks from extending to the real industry, and the latter is to prevent credit guarantee of governments to banks from extending to the capital market, so that finance can better serve the real economy and the capital market can better support innovation.

China now is at a new stage of development featuring innovation, coordination, greenness, openness and sharing, which means that economic development not only pursues efficiency, but also values equity and security.

The article is based on the forward of the report Major Power’s Industrial Chains: Macro and Industrial Trends under the New Pattern. It is translated by CF40 and has not been subject to the review of the author. The views expressed herewith are the author’s own and do not represent those of CF40 or any other organizations.