Look Forward | Episode 38: China’s Industrial Policy Reset: Autonomy and Productivity

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Naki Mendoza: [00:00:00] Hello, and welcome to the Look Forward podcast powered by the S&P Global Institute, the platform for enterprise thought leadership across S&P Global. I'm Naki Mendoza, executive conference director for CERAWeek, and I'll be your host today. Markets are moving faster, risks are shifting, and decision-makers need foresight.

In this podcast, we bring you expert perspectives from across S&P Global on the macroeconomic, market, energy, and technology forces shaping what comes next, helping you navigate uncertainty and look forward with confidence. In this episode, we are looking at China, economic juggernaut, manufacturing powerhouse, and as a result, a geo-economic force.

Over the past decade, China's industrial policy has often been described in headline terms: self-reliance, subsidies, capacity expansion. [00:01:00] But new S&P Global cross-divisional research suggests something more nuanced is underway. The Chinese government is now operating under what we call a dual industrial mandate, autonomy on one side, productivity on the other.

This matters not just for China, but for global supply chains, competitors, and policymakers trying to understand where China is heading next. To unpack this, I'm joined today by Aries Poon, one of the lead authors of this research, also one of the co-hosts of this very Look Forward podcast. We're turning the tables around where host becomes guest, and we look to Aries for insights on the findings and insights from S&P Global's research.

Aries, welcome as a guest to the podcast.

Aries Poon: Thanks, Naki. It is good to be the guest for a change

Naki Mendoza: Indeed. Well, let's start with the big picture. It's been widely understood that China has always pursued industrial policy. So what's actually new about this current phase, and why [00:02:00] do you characterize it in this research as a dual mandate of autonomy and productivity?

Aries Poon: That's a very good question. So what, um... You're right, China has always have an industrial policy. But what is different this time is how it is framed and what it is trying to correct. Because, uh, what we can see is the current approach is increasingly organizing around what we call a dual mandate, as you mentioned, on the...

So imagine there are two pillars. On the one hand is the autonomy, on the other hand is the productivity. So what we mean or what the Chinese government means by product, uh, autonomy is the attempt to, um, reduce, um, exposure to, um, external vulnerabilities in areas such as advanced technology, critical inputs, and supply chains.

And the other pillar is productivity, which is an attempt to address the diminishing returns from the investment-led economic model [00:03:00] that we have seen in previous, uh, years, and also the aim to improve, uh, efficiency on the long term. So this dual mandate actually is, um, what we do see is marking a shift from previous focus, which are primarily emphasizing on, um, uh, capacity building and scale expansion.

The main reason for that shift is because the national security principle is now becoming the central organizing principle of economic policies. At the same time, um, China has been for years building a large industrial base and, uh, the policymakers is making it more explicit in extracting gains from the efficiency of this base that they have been building.

So, um, in short, yes, there is some, uh, industrial policy. You know, it's still industrial policy, but what is new is the attempt to reconcile this, um, strategic [00:04:00] autonomy with, um, economic sustainability while facing tighter domestic and external constraints.

Naki Mendoza: If this indeed is a new shift in strategy, how and, and when did this repurpose strategy begin to evolve?

Aries Poon: Uh, good question. Um, I would frame, I would frame that as a, um, a sort of like a years-long evolution of the focus of industrial policy by the Chinese government, um, because the autonomy and the productivity framework actually would be, you know, best understood as they were emerging policy directions and, uh, slowly becoming visible over the last few years and now being embedded systematically in the Chinese government's long-term planning.

Because when you... when we look at the previous sort of policy, which is the 14th five-year plan, um, they're already a strong [00:05:00] component of, um, technological self-sufficiency and reliance. But in the current framework, which is the 15th five-year plan, the national security, as I mentioned, is becoming the central organizing, uh, principle, uh, for economic policy.

So in short, um, the dual mandate arguably has already, um, begun, but what we're seeing now is not a sudden policy shift, but more a gradual evolution, um, from earlier focus on capacity expansion to right now is more a, a more balanced policy intent to achieve both, um, autonomy and productivity gains.

Naki Mendoza: Yeah.

So let's dig into these two mandates. Autonomy, understandably, it gets most of the attention, especially in semiconductors, chips, AI, and critical inputs. But your report, it also emphasizes that productivity is not secondary. Why has productivity become so [00:06:00] central now?

Aries Poon: The simple answer is, um, so I'll give you...

Take a, take a step back. So productivity is carrying a much bigger weight in the policy conversation in China these days, mainly because the previous attempt on capacity expansion, scale building, has run into its limits. In fact, when we look at China's productivity growth, it started slowing even before the pandemic.

So our, our team identify at, at least three reasons for that. Number one is, um, China was approaching the so-called technological frontier. Number two is more state, um, or more resources were being channeled into state-led investment, where many of those did not effectively translate into efficiency gains.

And the last one is domestic, uh, consumption or demand, uh, remaining weak. You know, we all know, for example, the property downturn has [00:07:00] weighed on not only, uh, household consumption but also weighing on the local government finances. And we've also seen pockets of softness in manufacturing in some sectors across the economy, even though the overall top-line number as a manufacturing supply remains strong.

So that means simply investing more is not going to solve the problem. In fact, what they are trying to do is trying to generate more output or, um, encourage more innovation, more competitiveness through better use of resources, not just more resources. That's why you're going to see in the current policy conversation, we've seen a lot of mentioning on consolidation, on, um, uh, technological adoption and market discipline and so on.

Naki Mendoza: So autonomy, it explains where the state is focusing resources, but productivity, as you've explained, it [00:08:00] explains why the m- old model is no longer working as efficiently as hoped. So that brings us to how this dual mandate manifests across different sectors. Let's start with advanced manufacturing and AI, areas like chips and AI infrastructure.

Based on the report, it seems that China appears willing to tolerate inefficiencies at higher costs. So how does that fit into the autonomy productivity framework?

Aries Poon: Yes. So, um, in the advanced, um, manufacturing areas or AI areas, obviously the autonomy pillar is going to be the dominant pillar. However, we would argue, or our report actually argues, that it's not actually that divorced from productivity consideration.

So I will bring in two points to illustrate that. Number one is, yes, um, in, uh, uh, um, in areas like semiconductor tooling or AI hardware, um, the Chinese government is willing to tolerate inefficiencies in the [00:09:00] near term. So we're talking about is lower yields or higher costs. And the main reason is they want to build a stronger domestic ecosystem and also reducing reliance on foreign inputs or what they call choke points, foreign choke points.

At the same time, this is where pro-productivity comes in because China also has a plan or framework, what it calls AI plus framework. What that means is a deliberate diffusion of AI into various sectors where they could also grow in productivity with the help of AI. For example, manufacturing, healthcare, education, et cetera.

So the logic here is, first, go for autonomy so, so to build capacity, then they will try to get productivity from building scale and application. Well, but I have to, I have to say this is the policy intent, and I'm... Of course, we'll later discuss whether this is, um, this is a [00:10:00] viable or whether this is a, an expensive route to achieve what the Chinese government wants to achieve

Naki Mendoza: And then on the other side of the coin from the emerging next gen technologies and industries are the more mature sectors, EVs, renewable energies, even shipping.

Uh, these are sections that have special pullouts and spotlights shined on in the report. In these more mature sectors, the policy stance, it looks different, and indeed, the report highlights these as particular successes, as success stories. What are policymakers trying to do here in those sectors?

Aries Poon: So in these, uh, sectors, um, obviously the productivity pillar is becoming more visible and more dominant because in, uh, areas you mentioned, um, China already has attained a global leading scale, right?

Already have very large scale. And the problem is the scale also comes along with overcapacity, [00:11:00] pricing pressure and margin compression, which means that what the government is or will likely doing... w-w-will likely to do, to do is to shift from a, from a system where there is blanket subsidies or blanket support and shifting into more conditional and selective, um, support, uh, mechanisms.

Uh, w- in this case, we would like, we would see greater emphasis or policy emphasis on, uh, market consolidation, exit of weaker players, um, competitive auctions, stricter approval, uh, project approvals and et cetera. So in the examples you mentioned, for example, EVs or renewables, we do see, um, the, uh, direct purchase subsidies have largely ended.

And what is left is, uh, indirect, uh, subsidies because the main policy intent really is to, um, force the firms to compete and innovate rather than surviving on policy support alone. So the whole idea actually is trying to [00:12:00] convert past capacity expansion into more sustainable, um, competition for those sectors.

Naki Mendoza: As we look across the different sectors and the levels of maturity and maturation across the industrial sectors, this would seem to create an inherent tension. You're at one-- on, on one hand, they're pushing scale in strategic sectors while trying to rein in excess capacity elsewhere. How difficult is it for policymakers to manage both sides at the same time?

Aries Poon: You are right on point, Aki. In fact, it is extremely challenging, and the tension would likely run through the entire system. So let's look at the pillar again. For the autonomy pillar, it actually requires long-term patient capital. Um, but when you think about it, it is exactly this... A-and also state direction, state intervention.

It is exactly these conditions that gave rise to the incentives to overinvest and to misallocate [00:13:00] resources that we have seen all-- in, in, in, in, in, in past decades. And the other pillar is productivity. So productivity requires, um, more efficient allocation of capital, uh, more market discipline, and, uh, stronger, uh, domestic demand.

And all of these could be quite hard to achieve under a system where, where, where it is heavily guided by, um, the state direction and also, you know, with, uh, in addition to the local government involvement. So here the catch is execution, right? The execution and also incentive alignment, they are key to translate the policy intent into the outcomes consistently that the government is trying to achieve.

Naki Mendoza: I want to switch to the external environment and externally, China's dual mandate approach, it's facing a global economy that's being shaped by [00:14:00] many forces: trade frictions, export controls, supply chain diversification, industrial policies that are in part a response from trading partners who see China's industrial stance through the lens of what you referenced earlier, overcapacity and price competition.

So how does this dual mandate affect China's relationship with global markets and trading partners?

Aries Poon: That actually is a very good question. In fact, from the point of view of other countries outside of China, they would likely see China actually sending out mixed signals. Because on the one hand, um, China will, will still rely on external markets, right, overseas markets, and to, to, to, to beef up GDP, to absorb some of the surplus output.

This will not go away. But at the same time, China is also trying to improve its strategic autonomy. That means China might more likely to employ tools like [00:15:00] export controls, domestic substitution, and, um, strategic resources, um, policy and et cetera. So these policies are actually running into or creating tensions with the trading partners who themselves are also trying to de-risk.

So, um, the result would be we'd still see integration, but it's not like a broadly open integration. It will be more, it will, it will be, it will be subject to more political and regulatory constraints, number one. Number two is the trade patterns will be a lot more segmented and conditional rather than broadly open

Naki Mendoza: You know, Aries, one striking element in this report is uncertainty around payoffs. What are the biggest risks that could prevent autonomy-driven investment from translating into sustainable productivity gains?

Aries Poon: So our team identifies at least four [00:16:00] types of direction of risk that will potentially prevent China's dual mandate approach to achieve the autonomy or productivity gains that it, uh, aims.

Uh, number one is capital misallocation remains a concern because here we do see there is a heavy, uh, direction from the state as in, you know, where the investment should be channeled. Um, so that's number one. Uh, instead... number one. Number two is the weak, um, consumption. So if domestic consumption in, in China remains weak for longer, w- that will inhibit the, uh, economy's ability to absorb the dom- the output that it produces domestically.

And that means China will even more needing the external markets to absorb its surplus output. And in, and but at the same time, autonomy, uh, remit is still there, so that will be creating even more [00:17:00] tension with trading partners. But this is on a big if, which is, you know, the, the, uh, domestic consumption remains w- weak for a much longer time.

And the third one is, um, technological uncertainty. If we had this podcast, uh, if we had this podcast 10 years ago, probably we would not be talking about AI, right? And, um, so you can see technology shifts very quickly. So today's investment into t- cutting-edge technology, how long that payoff is going to last, how long that the country's edge is going to be maintained by the investment today actually is always a question.

But again, this one is not unique to China. It's actually applicable to every country. And the last one is unique to China is the local government, uh, local government level, uh, uh, in, uh, governance and, um, uh, coordination. Because in China you always have the policy which is very sound from the central government, but then it gets to...

but because it needs [00:18:00] to reach the local level to get deployed and to execute, and oftentimes there is a misalignment of incentives between central government and the local government. And at the end, uh, you know, the local government's, um, different incentives I mentioned earlier that might dilute the overall, uh, policy, um, uh, impact.

So, uh, our team identified basically these four areas of risk that might derail, um, the, the, the, the, the policy.

Naki Mendoza: Could you maybe just say a word on that, on the, the discrepancies perhaps between the central government and the local governments? It's, it's a, it's a very important topic, not least of which because, um, bureaucracy is often associated with, uh, the Chinese state and just the layers of governance.

So maybe elaborate on that point p- perhaps.

Aries Poon: It's mainly because the local government faces a very different set of finan- fiscal constraints. For local governments, they get the in... they get the revenue from local taxes, from local infrastructure [00:19:00] projects, and housing projects, and, you know, and, and, and other businesses as well.

However, for central governments, actually they get a tax income from mostly the, the different provinces or different local governments. So they face very different fiscal constraint, which means that, um, because the property sector is not doing well, so one of the key income from the, for the local governments actually is weakened.

And which means that they have even more incentives to tied, uh, their projects or to tie the investment towards things or towards projects that would bring them jobs, that would bring them economic growth so that they could, so that that could bring them the necessary finances to make sure that they are staying afloat.

And these are the concerns that largely do not exist or do not apply for central governments. That's why these are the different, uh, uh, uh, or misalignment of incentives between, uh, the central and the local [00:20:00] governments.

Naki Mendoza: We've covered a lot in this conversation, and there's a wealth more to dig into in the report itself.

Uh, I have my takeaways based on this conversation, but as we, as we look to wrap, Aries, I wanna ask you if you could summarize some of the main takeaways for those that are, are launching into this report for the first time. What are the main things in a executive summary sense, in a wrap-up sense that you would like a reader to take away to know from this report?

Aries Poon: Sure, that's a good question. So I think, uh, the key idea is China's industrial policy is shifting away from s- sheer capacity building and, um, scale expansion into more selective approach, um, in expansion, where they would try to aim for the dual goals, which is, um, reducing the exposure to, um, external vulnerabilities.

That is the autonomy pillar. And also, um, [00:21:00] reviving the diminishing returns, uh, from investment that has been plaguing the economy for the past, um, decades. And with China doing this, this is the policy intent, very sound, very strategic. But at the end, whether the economic, uh, w-whether there will be economic payoffs, whether China can achieve the goal, depending on a lot of, uh, on the execution.

And in that part, um, the local government involvement, incentive alignment will be very critical to the success of the, um, policy.

Naki Mendoza: Excellent. So no longer just growth at any cost, nor is it necessarily purely about self-reliance. What I'm hearing, Aries, is that it is an attempt to balance autonomy with productivity, state direction with market discipline, and that balance, that tension remains fragile.

For global firms, investors, and policymakers, understanding how this dual mandate operates is becoming central [00:22:00] to navigating China-linked risk and opportunity. If you'd like to dive deeper into our research and our blog posts, visit spglobal.com or Look Forward Institute Resources. You can also connect with Aries on LinkedIn.

Thank you all for listening to the Look Forward podcast. Aries, thank you for being the guest. If you enjoyed this episode, please subscribe to Apple Podcasts, Spotify, or YouTube, and we will see you next time. Thank you, Aries