Can China’s hybrid state-capitalist economy learn to worship—or at least genuflect a bit deeper—at the altar of efficiency? As relations with wealthier, technologically advanced countries deteriorate, that is probably the most crucial economic question of the 2020s.
There are signs of real progress, much of it ironically driven by foreign pressure and the fear of stagnation as links with more open economies erode. But the enduring power of Chinese state-owned companies and their pull over the financial sector still represent huge vulnerabilities.
One clear and underappreciated example of progress is in intellectual property. Rhetoric from Washington notwithstanding, a majority of U.S. companies actually say IP protection in China is getting better, albeit from a low base, according to an American Chamber of Commerce survey this summer. Since 2014, China has set up a system of specialized IP courts and litigation has exploded, with over 481,000 IP cases in 2019, up nearly 50% from 2018.
New bankruptcy courts are also helping dispatch struggling companies more quickly, which could help address China’s chronic problem with “zombie” companies and free up scarce resources. The average length of bankruptcy cases in China is high: around 1.6 years on average over the past decade, or 60% longer than in the U.S., according to a recent National Bureau of Economic Research working paper.
But cases handled by the special courts—now roughly half of total bankruptcies, up from a negligible percentage in 2011—proceed about 35% more quickly than those in regular civil courts. Bankruptcy cases have also skyrocketed in numerical terms, rising from less than 5,000 in 2015 to nearly 19,000 in 2018 according to the Supreme People’s Court of China.
The news on bankruptcies isn’t all good, however. The recent surge in bankruptcy cases coincided with a crackdown on China’s shadow banking system that fell heavily on private companies, which have less access to formal bank loans than their state-owned counterparts.
The enduring problem of parasitic state-owned enterprises remains obvious. Despite a spate of SOE bond defaults in November, the extra yield that private industrial companies pay to borrow compared with SOEs has barely budged, according to data from Wind. Tough talk from Beijing has so far failed to comprehensively remove the impression that SOE debt is a safer bet.
That is a significant problem for China’s technological ambitions. Notably, China’s two poster children for technological prowess and global success—Huawei and Bytedance, owner of TikTok—aren’t state-owned enterprises. Bytedance enjoyed early support from U.S. venture capital. Huawei grew up with various forms of state support but ultimately thrived competing head-to-head in global export markets.
As relations with the U.S. erode, rising Chinese tech companies will probably encounter higher barriers to both foreign financing and foreign markets. If key internal Chinese markets remain unfairly tilted toward companies with good political connections, rather than the best products, China may struggle to birth many new companies truly pushing the technological frontier.
China’s would-be semiconductor champions, many of them state-owned, are in fact running into trouble at an escalating rate. Tsinghua Unigroup has now defaulted on multiple bonds. Semiconductor Manufacturing International Corp. is being added to a U.S. government export blacklist which could hamstring the company’s ambitions to develop current-generation chips.
The troubles of these state chip makers are therefore shaping up as an interesting litmus test of how much play China is really willing to give market forces in high technology. If, for example, SMIC starts losing customers or quality suffers as a result of escalating U.S. restrictions, will Beijing pressure companies like Huawei to keep buying from them anyway? Will state banks stand behind them?
If so, that will mean fewer resources available for companies that might have a better chance of really pushing the technological frontier—either in chip making or something else. SMIC already raised billions in new equity funding in 2020 and enjoys incredibly low bond finance costs: an SMIC bond maturing in 2022 currently yields just a little higher than a one-year central government bond, according to Wind data.
Beijing is essentially now engaged in a massive, long-shot attempt to build from the ground up an advanced semiconductor manufacturing capability that doesn’t depend on foreign suppliers—churning through gargantuan amounts of the Chinese people’s money in the process. Rather than trying to reinvent the wheel, a better economic strategy would be to mend its relations with the West and reform China’s dysfunctional credit system—then import chips and let Chinese markets and Chinese companies decide what China is really good at.
Sadly, that seems unlikely, given the current leadership’s ideological bent. If Beijing persists in a mercantile, actively hostile approach to core Western values and interests, the U.S. has options to respond. One strategy might be to do what it can to stay ahead at home by bolstering public investment in areas like research and education, while simultaneously taking targeted steps with allies to make Beijing’s moonshot as costly and wasteful as possible.
The tech battle between the U.S. and China has battered TikTok and Huawei and startled American companies that produce and sell in China. WSJ explains how Beijing is pouring money into high-tech chips as it wants to become self-sufficient. Video/Illustration: George Downs/The Wall Street Journal[object Object]
Write to Nathaniel Taplin at email@example.com