Perspectives on Geopolitics, History, and Political Economy

How China is Rewriting the Rules of the Economic Game

Shanghai, Industrial Container Port - Image Source: shutterstock.com - Copyright: Zhao jian kang

Shanghai, Industrial Container Port – Image Source: shutterstock.com – Copyright: Zhao jian kang

By Mohamad Abou Hamia

Several developed and developing economies have been suffering from insufficient and sluggish economic growth for quite few years, while some other emerging economies, notably, China has been enjoying remarkable economic growth. The article suggests that the old era of the industrial revolution has given way to the new game of the knowledge economy, where the old economic rules are ineffective and obsolete.  Countries that are rewriting these new rules, like China,  are experiencing remarkable economic growth and are emerging as the new world powers. But those still applying the old rules, like the G-7 countries, risk losing their ground to the new players.

The G-7 countries headed by the United States have dominated the world economy for the past hundred years. In 2014, the Chinese purchasing power parity gross domestic product (PPP GDP) surpassed the US GDP for the first time in modern history, $17.2 trillion compared to $16.6 trillion (see Figure One). In 1990, the combined PPP GDP of the G-7 countries, the wealthiest nations at that time, was equal to $21.2 trillion, compared to $1.7 trillion in China. In 2014, the gap between the two PPP GDP diminished remarkably. The Chinese PPP GDP was equal to around half the combined PPP GDP of the seven economies, $17.2 trillions compared to $33.1 trillions respectively. Since 1990, the combined seven GDPs have grown by only 1.89% a year, compared to 10% a year for China (see Figure two).

What are the factors or the new rules of the economic games that China has applied to achieve this remarkable economic performance?

First, the Chinese growth over the last two decades has been caused by the huge expansion of technology exports (using the UNIDO classification). In 1990, China’s share of world technology exports was ranked 13th worldwide, well below all G-7 countries that were ranked in the top positions. In 2014, China emerged as the top world’s technology exporter by increasing its share from 2.01% in 1991 to 19.06% in 2014 (see Figure Three). On the other hand, the G-7 economies lost considerable competitiveness in the international technology market. The group’s combined share declined from around 63% in 1990 to 35% in 2014. The steady increase in the Chinese share to reach 19.06% in 2014 contributed in the declined in the gap between the two shares from 61.2% in 1990 to just 15.7% in 2014 (see Figure Four).

Any company wishes to compete sustainably in the international market needs to invest in knowledge, technology and innovation to address three vital criteria: customer preferences, product quality and competitive prices. Without investing in knowledge and technology, it would be hard for companies to meet these three criteria and to continue competing. In 1999, Motorola introduced just two new cellular phones (models: Timeport L7089 & v3688). In 2014, Samsung released as many as 56 different smartphones. Compared to the two 1999 Motorola models, Samsung’s 56 models address a wider range of customer preferences and incomparable quality at a much cheaper price.  Obviously, Samsung achieved that mainly by investing in knowledge, technology and innovation.

Second, knowledge is becoming a major source of economic growth. Research and development (R&D), if carefully planned and spent, could promote sustained economic growth. The G-7 countries have been the world’s biggest spenders on R&D. In 1996, their spending on R&D ranged from 0.95% of GDP in Italy to 2.77% of GDP in Japan; all G-7 spending on R&D exceeded the Chinese spending, which was merely equal to 0.57% of GDP (see figure five). Back then, the G-7 countries were enjoying decent growth and jobs, and China was preparing to open its economy to the world.

The 2013 R&D data show that Japan, Germany, the United States and France are still spending on R&D more than China, which spent more than the United Kingdom, Canada and Italy. However, from 1996 to 2013, Chinese spending on R&D grew an astounding 1591% (in real terms) compared to 57.2% in the G-7 countries combined in the same period. Among the G-7 countries, the highest growth rate in spending on R&D has been in Germany (71%), while the lowest growth rates has been in the France (33.2%) (see Figure Five).

The impact of R&D on economic growth does not depend only on the size of the spending. Policy makers need to carefully address and develop the economy’s capacity to absorb knowledge and to develop the knowledge infrastructure before increasing the spending on R&D. For example, the Chinese knowledge infrastructure might not be able to spend more than 2% of GDP on R&D, and the excess spending would have very little impact on economic growth. Also, the 3.5% spending on R&D in Japan might not be enough to promote economic growth, given the country’s advanced infrastructure.

Third, the patent data reveal that innovation in the G-7 countries is stagnant, while it has been growing exponentially in China, particularly after 2000. In 1990, around 490,000 patent applications were filed in the G-7 economies combined, compared to only six thousands applications in China. In 2014, the number of patent applications filed in China exceeded 800,000 compared to 642,000 filings in the G-7 countries combined (see Figure Six). Between 1990 and 2014, the patent application filings in China has grown an astonishing 13,637% compared to a 215% increase in the USA, the highest increase among the G-7 economies (see Figure Seven).

The Chinese patent law was enacted in 1984, which is relatively new compared to the US patent law, which was enacted two centuries earlier. The patent laws in the G-7 countries and in China have similarities and differences, and are far from being perfect and efficient. However, given that the patent laws in the G-7 economies are older, they might have developed a dense web of overlapping and well protected patents that restrict the use of existing knowledge to innovate. This would make innovation more costly and time consuming in these countries than in China.

Fourth, the G-7 countries have always had more researchers in R&D than elsewhere. Data from 2012 shows that China has failed to close the gap with the G-7 countries. In 1996, the number of researchers in China was equal to 442.57 researchers per one million of people, which then grew in 2012 to 1035.88 researchers per one million of people or around 134% between the two periods. Although the number of researchers in China grew faster than any in other G-7 countries, China still lags behind all the G-7 countries in its number of researchers (see Figures Eight & Nine). In addition, the list of top 50 universities in the world are mostly G-7 universities, notably the USA and the UK. Only one or two Chinese universities are on the list.

Contrary to conventional wisdom, the G-7 countries that have more researchers and the best universities in the world are in economic stagnation, while China with fewer researchers and less advanced universities is witnessing astonishing economic growth. Researchers and universities continue to have profound impacts on economic growth that no country could afford the costs of not investing in. However, the Chinese experience might provide a sign that we are living in an era where conventional research and academia no longer serve our economic growth and the standard of living. The kind and the quality of the researcher and the university we know today would be challenged and would be forced to change fundamentally in developed and developing countries. That is why the roles of researchers, universities and the overall educational system should be critically evaluated to avoid unbearable economic and social costs.

Education needs to address critical thinking, creativity and innovation to equip the future labor force. Universities and research centers should free the huge stock of knowledge (that was mostly funded by public money) to serve mankind instead of keeping it idle and protected by inefficient intellectual property laws. Researchers should conduct quality research to define and to solve critical social and economic challenges instead of conducting research to satisfy their promotional and salary purposes. The world economy needs young high-quality entrepreneurs, like Mark Zuckerberg and Elon Musk, who can create sizable wealth and jobs, instead of millions of new graduates desperately seeking low paid and unsustainable jobs.

The data in scientific and technical journals confirm the above argument. In 1990, China produced one article for every 60 articles produced in the G-7 countries. In 2013, China produced one article for every 2.3 articles produced in the G-7 countries, as China produced nearly the same number of articles as the USA. Between 1990 and 2013, China’s scientific and technical articles increased by 6,287% compared to 408% in Italy and 115% in the US (see Figures Ten & Eleven).

This article identified several factors that are clearly applied differently in China and the G-7 countries, which might explain their different economic performances. Such factors can be used as guidelines by countries to stay competitive in international markets, to sustain economic growth, to generate wealth and to create decent jobs. First, addressing an economy’s absorptive capacity for knowledge and the economy’s knowledge infrastructure are essential prerequisites to increase spending on R&D. Second, engaging the private sector in the knowledge creation process requires establishing efficient legal and regulatory frameworks for intellectual property rights. Third, channeling knowledge to serve the production of goods and services requires careful selection of the quality of researchers and research agenda. Finally, increasing the country’s export shares in the international market requires boosting its international competitiveness by increasing the knowledge content of its produced goods and services.

Ideology might also be playing a role in the different economic performances between the China and the G-7 Countries. In the late 1970s, communist China pragmatically reformed its economy based on open market economy principles and encouraged active participation in the private sector. At the same time, the government has remained at the center of the economy to address any market failure and to play an active economic role. On the other hand, the most economic activities in the G-7 economies have been carried out by the private sector. The governments, considered inefficient and bureaucratic, have not been trusted to play any economic role.

The attitude towards governments’ active role in the new economy should change in the G-7 countries. During the 2008 financial crisis, the governments’ heavy interventions in the G-7 economies were widely hailed for preventing a complete financial markets meltdown. This inconsistent attitude towards governments’ economic roles might be one the biggest obstacles facing economic growth in this new knowledge economy.

In this new era of knowledge economy, the government’s active role is urgently needed to address four possible critical market failures. First, investing in knowledge is something new, expensive and risky to the private sector; the inability of the private sector to invest properly and adequately in knowledge is a possible critical market failure that needs government intervention. Second, the private sector would not join the public sector to create knowledge without proper laws and regulations that guarantee return on investment. No one can establish such regulatory framework but the government. Third, the educational system needs to adapt to address the needs of the new economy. The current obsolete and outdated educational system cannot be addressed effectively without the government intervention. Fourth, in the new era, there should be close alliance and cooperation between the private firm and the educational system as one of the means for knowledge to serve production. The government is the only entity that can provide incentives for such needed alliance and cooperation.

The world economy is in an urgent need to rewrite the new rules of the economic game for a smooth transition between the industrial and knowledge eras and to avoid unbearable political, social and economic costs.

Professor Abou Hamia has taught economic courses in several universities in the US, Europe and the MENA region. He has published several articles in international journals and with international organizations. Currently, he is advising the United Nations on issues related to knowledge economy.

© Copyright 2016 Mohamad Abou Hamia. All rights reserved.

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