After decades in the double digits, the year-on-year growth rate of China’s GDP fell to about 6.0 percent in the third quarter of 2019. This was the slowest growth rate since the first quarter of 1992. In a mid-September interview with Russian media, Chinese Premier Li Keqiang said that it is ‘very difficult’ for China’s economy to continue growing at a rate of 6% or more.

Many believe that the gradual slowdown of China’s once rapid economic growth was due to the 16-month long ongoing trade war between the United States and China, which deeply dampened consumer confidence and hurt sales of goods. However, this only partially explains this quarter’s lower rate. Far before the trade war commenced in June 2018, China’s economic engine had already been cooling down; the GDP growth rate had dropped from 10.6% in 2010 to 6.9% in 2015. This cool-down has begun stabilizing, with the growth rate only decreasing by about 1% in the most recent 4 years. The primary factors that caused the slowdown have been declining industrial output and low productivity in the service sector.

The decline in industrial output can be traced back to China slowly losing its comparative advantage in manufacturing production. This has been due to its aging population and rising wages. To address this, China is seeking to achieve qualitative growth by shifting from the current labor-intensive, low value-added production to “smart” growth, which relies more on high-quality technology production, green energy, and services. These core ideas are enshrined in China’s ambitious “Made in China 2025” (MIC 2025).

MIC 2025 is aimed at improving innovation in China’s manufacturing industry to enhance the sector’s production and competitive capabilities. Major fields that MIC 2025 intends to improve include next-generation Information technology, high-end numerical control machinery and robotics, aerospace and aviation equipment, maritime engineering equipment and high-tech maritime vessel manufacturing, advanced rail equipment, energy-saving and new energy vehicles, new materials, and biomedicine and high-performance medical devices.

The U.S. Chamber of Commerce described these industries as “critical to economic competitiveness and growth in the 21st century.” However, the U.S. is concerned about Chinese rhetoric promoting “indigenous innovation, domestic brands, secure and controllable standards, and localization of production and data.” It criticizes China for not following its commitment made by President Xi Jinping in 2018 at Davos, which outlined strong support for globalization and open-market principles. The U.S. is concerned that the rhetoric and practices of MIC 2025 may not fully coincide with China’s commitment to market-oriented reforms.

Moreover, the U.S. also expressed its serious concerns over the potential security implications of MIC 2025. Forced technology transfers, intellectual property theft, ill-treatment of foreign capital, and cyber espionage could help enhance China’s domestic manufacturing production. Furthermore, the U.S. fears that these could also benefit China’s military capability. For example, some of the relevant industries, such as aerospace, aviation equipment, and next-generation information technology could be utilized to develop more advanced unmanned technologies that would enhance the fighting capability of Chinese drones.

One industry appeared to attract the most concern: information and communication technology (ICT). The information and telecommunications industry is one of the major focuses of Made in China 2025. China’s huge commitment to develop and, most importantly, construct ICT infrastructure, such as 5G, reflects its understanding that the ICT industry is crucial for sustaining domestic economic growth. Despite its primary purpose of economic development, ICT technology’s obvious spillovers into military capability and surveillance continue to worry the U.S.

It is understandable that the U.S. feels threatened by China’s desire to rapidly expand its ICT industry. However, the U.S. decision to block, blacklist, or even sanction some of China’s leading ICT companies, such as Huawei or ZTE, undermines any future initiatives to push for international oversight or regulation of ICT implementation. As China continues to carry on the developments outlined in MIC 2025, the current means of U.S. interference, though it addresses security concerns, may be both strategically and economically counterproductive.

China’s sustainable growth should not, and will not, solely depend on MIC 2025. Since the ultimate goal of China’s economic policies is to maintain a high growth rate, its policies need to target both its declining industrial production and its burgeoning services sector. Therefore, China’s development will depend on a synergistic combination of MIC 2025 policies, continuous domestic reforms, and suitable trade deals, all of which will encourage greater competition which leads to higher quality domestic growth.

Due to the fact that MIC 2025 is mostly driven by internal factors, the U.S. response is unlikely to contain China’s manufacturing sector development. Rather than attempt to contain MIC 2025, the U.S. would be best served by encouraging its private sector to further participate in the growth of the Chinese economy. As MIC 2025 encourages technological advancement, Chinese private companies will increase their demand for both financial and technological services. U.S. companies are the most competitively suited to meet this demand. By recognizing the inevitability of China’s manufacturing growth, and positioning itself to help that growth in its own comparatively advantageous way, the U.S. will expedite both Chinese economic growth and its own.

Cross-border services could bring in a win-win situation for the two countries. In 2017, the services sector in the U.S. added around 77.4% of the value to its GDP, and services make up around one-third of U.S. total export of goods and services. The Trump administration has been considering reducing the trade deficit by increasing more U.S. exports; however, the trade negotiations with China pay little attention to securing a U.S. advantage vis-a-vis Japan and Europe, the other two major service exporters to China. Even up until the end of 2018, China’s service industry contributed only around 50% of its GDP, which is about one-third less than in comparative developed countries. As China’s services industry becomes a top choice for foreign investors, foreign direct investment (FDI) in it has climbed from 24.7% (2005) to 68.1% (2018) of China’s total FDI, which suggests huge growth potential.

If China wants to sustain its rapid economic growth, then moving up the value chain and specializing in more economically significant sectors is a must. Cross-border services are not only growing 60% faster than traditional trade in goods; these services also generate much higher economic value. Despite the long wait, China’s announcement of more specific, deepening reforms and opening up with ‘Chinese characteristics’ indicate that these reforms will continue. On the international level, given the fact that economic regionalization has been increasing due to geographic proximity, China’s integration with other Asian countries in multilateral free trade partnerships, such as RCEP, requires that China further committed to market liberalization in order to satisfy other states, such as Japan, South Korea, and India.

For the U.S., exporting services to China is a broad market. In 2018, travel services and IP charges accounted for the two largest shares (56.1% and 14.8%, respectively) of U.S. cross-border services exports to China. Of the U.S. service exports to China, only 8% are financial services. As China’s reforms are gradually implemented, such as lifting price controls, adjusting tax incentives, eliminating investment barriers, and accelerating the opening up of the capital account, there is an increasing demand for services imports. As China’s largest services importer, the U.S. would benefit the most by working with China to fully liberalize its services sector.

By sidelining itself, the U.S. will not only lose its ability to investigate the perceived threat of China but also the potential role it could play by participating in China’s opening up, which would provide both economic gain and political leverage. The recent enactment of Decree No. 720 and Decree No. 722 of the State Council of the People’s Republic of China focused on modifying regulations in foreign capital banks and insurance companies, as well as improving the business environment, indicating that China is taking steps to improve the institutional structure of its services sector. The entry of U.S. capital at this moment could become a strong market force pushing China towards deepening, liberal economic reforms. Going the opposite direction will only cause more U.S. businesses to leave the Chinese market in the dust while other Chinese trading partners seize this opportunity, just as what happened when European and Japanese auto companies took advantage of a 2018 Chinese tariff cut that left out their U.S. competitors.

The only way the Chinese economy could continue moving forward under the current international environment is to accelerate reforming and opening up. As ICAS Senior Research Fellow, Sourabh Gupta, has stated, “Pressure from the US and Europe will in fact be a crucial driver of these reforms which, again, will hold China in good stead”. At this key point, where both countries are undergoing economic structural change, it is crucial for the two largest economies in the world to use this opportunity to cooperate and contribute to the stability of the world economy. More economic decoupling, instead of cooperation, may harm the U.S.’s comparative advantage. While the EU and Japan continue to explore their own ways of participating in China’s economy, the U.S. should use these trade negotiations as a vantage point for reconsidering both their bilateral relationship and its private sector’s advantage point in the Chinese market.

Yilun Zhang is a Research and Administrative Assistant at the Institute for China-America Studies.
Mengze Li is a Research Assistant at the Institute for China-America Studies.
This article was edited by Stephen Dwyer, a Research Assistant at ICAS.