182. Is China's industrial policy working?

Episode Summary

Executive Summary: The episode examines China’s industrial policy, focusing on whether subsidies—especially Made in China 2025—successfully create innovation and productivity gains. Drawing on firm-level research, the guest argues China often subsidizes large, less productive, or declining firms rather than clear winners, and that targeted subsidies have shown little measurable effect on patents or productivity, while still triggering major trade frictions and global decoupling pressures.

Main Topics: Why governments subsidize (Priority: 5/5): The discussion opens with economic theory: markets underinvest in R&D, training, public goods, and pollution control, so subsidies can correct failures—but may also reflect politics and waste. How China subsidizes differently (Priority: 5/5): China’s state-owned banks, state-owned land, SOEs, procurement channels, and technology-transfer leverage give the government more tools to direct resources than many market economies. China’s industrial-policy evolution (Priority: 4/5): China moved from Mao-era directive planning to reform-era market liberalization within industries, then back toward cross-industry guidance and strategic targeting as growth slowed. Empirical findings on Chinese subsidies (Priority: 5/5): Using listed-firm subsidy disclosures after a 2007 reporting mandate, the research finds subsidies are not initially aimed at more productive firms and do not reliably raise productivity. Made in China 2025 and innovation goals (Priority: 5/5): The 2015 program marked a more explicit, aggressive push for indigenous innovation, market-share targets, and import substitution in sectors like EVs, robots, and medical devices. Trade conflict and policy implications (Priority: 4/5): The program helped fuel the U.S.-China trade war and broader backlash; the episode argues subsidies may distort trade and reduce global innovation even if they don’t boost Chinese productivity. Alternative policy paths (Priority: 4/5): The guest suggests shifting public spending upstream toward education, training, and basic research rather than subsidizing production-stage industrial competition.

Key Arguments: Governments can justify subsidies when markets underinvest in R&D, skills, infrastructure, or when addressing externalities, but subsidies often also serve political goals and create inefficiency. China has unusually powerful subsidy channels because the state can influence banks, land allocation, SOEs, procurement, and access to foreign markets/technology. China’s listed-firm subsidy data after 2007 allows firm-level testing of whether the government picks productive winners. The evidence suggests Chinese subsidies are, on average, directed toward larger and less productive firms, not the most efficient ones. Even subsidies labeled for R&D or equipment upgrading do not show a statistically significant positive effect on productivity. Made in China 2025 firms appear somewhat more innovative at baseline, but the program does not produce statistically significant gains in patents, labor productivity, or total factor productivity. A major purpose of subsidies appears to be stabilizing declining industries and preserving employment, which conflicts with allocating resources to frontier innovators. The program’s explicit market-share targets and scale made it more threatening to trading partners than earlier, more general industrial-policy rhetoric. Industrial policy is difficult for all countries; Japan and the West have faced similar problems when trying to target winners. Even if not productive for China, the subsidies can still distort global competition, discourage investment, and reduce worldwide innovation. A more effective and less conflict-prone strategy would be to invest in education, training, universities, and basic science rather than production-stage subsidy races.

Data Points: Year Made in China 2025 announced: 2015 - Chinese leaders launched the industrial-policy program that became central to the episode’s discussion. Year subsidy disclosure became mandatory for listed Chinese firms: 2007 - Chinese listed companies were required to disclose government subsidies in annual reports, enabling firm-level research. U.S.-China trade affected by tariffs and retaliation: More than half of U.S.-China trade - The trade war, partly driven by Made in China 2025, led to tariffs and retaliatory tariffs on a large share of bilateral trade. Chinese population referenced in context of growth benefits: 1.3 billion people - The episode frames productivity and innovation as important for living standards across China’s population. Chinese firms' target market share in Made in China 2025: 80% - One explicit target mentioned for Chinese producers’ share of domestic consumption in some industries. Chinese firms' target market share in Made in China 2025: 70% - Another explicit target mentioned for domestic supply in targeted sectors. Estimated scale of Made in China 2025 support: Hundreds of billions of dollars - Referenced as the likely magnitude of spending, though the exact total is hard to aggregate. Data end year used in main paper: 2018 - The firm-level evidence is based on a data set ending in 2018, with some checks extended into the early 2020s. Program leadership transition: 2012 - Made in China 2025 was associated with the new leadership that took power in 2012.

Pivotal Quotes: "we find that the Chinese government is not giving subsidies to initially more productive firms" — Lee Brandstetter: Core finding from the firm-level analysis of Chinese subsidy allocation. "the Made in China 2025 subsidies do not seem to be having the desired impact on the firms that disclose that they receive these subsidies" — Lee Brandstetter: Summary of results on patents, labor productivity, and total factor productivity. "if China wants to improve productivity and increase innovation, this does not seem to be a particularly effective way to do it" — Lee Brandstetter: Policy takeaway offered when discussing alternatives to production-stage subsidies.

Implications: China’s subsidy-heavy industrial strategy appears costly, politically destabilizing, and weak at generating measurable innovation. For listeners and policymakers, the episode suggests shifting from subsidy races to education, skills, and basic research may deliver better long-run gains with less trade conflict.