What China Needs To Do Now

Prof. Anil K. Gupta, global expert in China’s economy, offers his insights on China’s slowing economy, its obstacle for innovative growth and Hong Kong’s role in the global picture

By Mabel Sieh, Managing Editor, China Business Knowledge @ CUHK

It is not the slowdown of China but the management of it that matters, according to Professor Anil K. Gupta, the Michael D. Dingman Chair and Professor of Strategy, Globalization and Entrepreneurship at the Robert H. Smith School of Business in the University of Maryland, College Park.

Ranked as one of the world’s “most influential management thinkers” by Thinkers50, and “one of the world’s most influential professors of entrepreneurship” by HotTopics, as well as a “superstar” for research on emerging economies by The Economist, the global expert in China’s economy was in Hong Kong to speak at the CUHK Business School’s conference in September.

“The slowdown in China is a well-known fact and thus not a new story. The single biggest challenge for China now is how to manage its slowdown. This is what we have yet to see,” Prof. Gupta told Mabel Sieh, Managing Editor of The University of Hong Kong (CUHK) Business School’s knowledge portal, China Business Knowledge, in an exclusive interview before the conference.

A member of the World Economic Forum’s Global Agenda Council on Emerging Multinationals, Prof. Gupta is one of only three professors, among over 25,000 worldwide, to be elected a Lifetime Fellow of the three most prestigious academic bodies in his field – Academy of Management, Strategic Management Society, and Academy of International Business.

Being the author of several best-selling books including The Quest for Global Dominance, Getting China and India Right, and The Silk Road Rediscovered, the professor is a highly reputed scholar who is often asked to comment on all things China and India.

“As a global strategist, I have been studying and analyzing China and its economy for a long time. If you want to understand the global economy, you cannot exclude China – a major player in the world’s economy.”

Written and published extensively, some of Prof. Gupta’s work has been co-authored with his wife Haiyan Wang, managing partner of China India Institute. Wang is originally from Hefei of Anhui province in mainland China.

China Should Manage Its Slowdown with High Speed

“Given the current stage of China’s economy, a well-managed shift from investments to consumption would imply a roughly five percent annual growth in GDP as a sustainable rate of growth,” said Prof. Gupta.

“According to my analysis, if the Chinese leaders want the economy to grow by more than five percent, say 6.5 percent, the only way to do this is through artificial stimulus, such as boosting investment in fixed assets at a pace more than that is needed in the economy,” he added.

To manage its slowdown, according to Prof. Gupta, China should focus on reducing overcapacity by implementing its supply-side reform, as Chinese president Xi Jinping has set out to do.

“Forget about new investments, it is the exisitng overcapacity which needs to be taken away. It means shutting down the high levels of excess capacity in some big industries including steel, construction and machinery,etc.”

“Another urgent step is for China to shift from state-owned enterprises (SOEs) to market-owned private enterprises. The SOEs are not particularly productive or efficient. Overreliance on them leads to the misallocation of capital.”

All of these measures have already been stipulated by Chinese president Xi Jinping who elaborated his supply-side structural reform again at the 2015 Central Economic Work Conference, China’s highest economic meeting that reviews previous progress and maps out new plans.

But the real question is whether the reform will be taken seriously.

“Will there be more actions on the ground level than just talks at the top level?” Prof. Gupta wondered.

To maintain the growth of China, these changes also need to be implemented at a high speed.

“If these reforms do not get implemented with seriousness now, the economic situation is likely to become more difficult to handle in two to three years from now,” he said.

China Should Create a Safe Environment for Innovation

In terms of mega trends, Prof. Gupta observed that three major transformations are already happening in China, that is, “the shift from manufacturing to services, from investment to consumption, from imitation to innovation”.

While he recognized the progress that China has made in its transformation to services and consumption, he is not so sure about the effectiveness of the transformation towards becoming an innovation-driven economy.

“Progress on the input side, such as increase in R&D budgets, has been excellent. But in terms of output measures, China’s progress has been far less than stellar. To me, this suggests that the productivity of R&D investments has been rather low,” he said.

People often argue that the problem lies in the Chinese reserved culture and its examination-oriented education system, which also relies heavily on memorization. But the professor takes on a different view.

“I’ve met many Chinese students who came to the US to pursue graduate studies. Within just a few years, they began to exhibit a high degree of creativity. Obviously, it doesn’t seem that their education system back home has affected their innate creativity. Thus, in my view, culture isn’t the critical factor behind China’s slow progress regarding innovation.”

So what’s hindering China from innovative growth? It is how the R&D funds are allocated, according to Prof. Gupta.

“In the US and Europe, R&D funds are allocated by panels of eminent scientists, not government officials. Eminent scientists would look at how good the proposals are and how competent the scientists are. In China, however, the decision is made by government officials, often based on factors such as connections. They also tend to favour people who’ve been famous in the past, rather than currently active researchers. This practice has an adverse impact on the country’s R&D development,” he said.

The way China handles the technology companies also doesn’t encourage innovation, he reckoned.

“In China, the government uses a fairly explicit policy of granting market access in exchange for technology. In other words, if I give you access to my market, you will give me your technology. This concept is fundamentally wrong. It often results in the leading technology companies doing largely product-localization type of R&D instead of next-generation technology development in China. The big technology companies don’t want to risk losing their next-generation intellectual property.”

“The fastest way for China to become an innovation power is to protect the intellectual property of multinational companies and to do so stringently.” – Prof. Anil K. Gupta

He referred to the Silicon Valley phenomenon as an example of how the innovative industry has been able to flourish in the US.

“In the US, you often see innovation ecosystems emerge from the founding of a few technology powerhouses such as Fairchild Semiconductor and Hewlett-Packard. After some time, many of the scientists and engineers left to start their own companies. Some of these companies became big and successful. Then they lost many of their top scientists and engineers. It is this type of “spillover” effect which helps to create an extremely vibrant innovation ecosystem.”

“China has massive talents in technology and engineering education. The problem, however, is that, because the world’s top technology companies generally keep their next-generation R&D work away from China, the spillover effects tend to be much weaker. There simply isn’t that much leading-edge technology work that could spillover.”

“I think the fastest way for China to become an innovation power is to protect the intellectual property of multinational companies and to do so stringently. If the government doesn’t protect intellectual property, companies won’t have the confidence to invest in next-generation R&D work in China,” he said.

The Long Road to ‘One Belt One Road’

Apart from the challenge to manage its slowdown, Prof. Gupta also commented on the difficulty facing China’s biggest economic plan covering about 65 percent of the world’s population, about one-third of the world’s GDP, and about a quarter of all the goods and services in the world – ‘One Belt One Road‘, an initiative raised by Chinese President Xi Jinping while visiting Central Asia and Southeast Asia in 2013.

With China as the starting point, ‘One Belt One Road’ comprises the Silk Road Economic Belt and the 21st Century Maritime Silk Road. The former aims to establish a cohesive economic belt across Central Asia, West Asia, the Middle East and Europe with high-speed railway works; the latter aims to link Southeast Asia, the Indian Ocean and Africa by various port works. Both infrastructure projects will enhance trade, cultural exchanges and economic development for countries along the ‘belt’ and the ‘sea road’.

According to China Daily, since the launch of the initiatives, over US$250 billion worth of projects, ranging railways to power plants are under consideration.

Is China’s grand vision a great concept too far from reality?

“In principle, I believe that increasing connectivity is always a good thing, so building all the infrastructure from China to Europe and the Maritime Silk Road is a good thing,” said Prof. Gupta.

However, the professor also offered a pragmatic view regarding China’s ambitious plan.

“Who is going to finance the infrastructure? None of the Central Asian countries along the belt route has the money to finance the build-up. Theoretically, China has the means to finance much of it. But, how will China realize any return on this investment? The payoff from infrastructure investments is rarely direct. Instead, the payoff comes in the form of lower input and logistics costs for other sectors in the economy. Will China be willing to make hundreds of billions of dollars in investments while the returns accrue not to China but to the other countries?”

There is also the question of political uncertainty.

“Is Russia going to be happy for China to build a highway through the Central Asian countries which have historically been its “back yard”? Would Russia like to see them becoming the “back yard” of China?”

“Thus, the challenge of OBOR is not just economical, but also political. There are a lot of uncertainties ahead. That’s why I think its impact on China and the other Asian countries will be very slow,” he said.

Hong Kong as a Niche Player

Being the gateway to China, many expectations have been raised on the key role of Hong Kong. How does Hong Kong fit it the global picture? Can Hong Kong be a leader?

“Hong Kong has a relatively small economy so it is hard to expect it to be a leader in everything. The key is to find its niche. I think Hong Kong should look at its strengths and determine in which areas it can be a leading player,” said Prof. Gupta.

“For example, could Hong Kong be a leading player in Fintech, given its advantageous position as a major financial center in the world?”

Indeed, the government has been promoting Hong Kong as a Fintech hub. Just recently, Secretary for Financial Services and the Treasury Chan Ka-keung told the media that the Securities and Futures Commission and the Office of Commissioner of Insurance have introduced regulatory measures to allow brokers and insurance companies to explore and experiment on new fintech policies.

Chan also announced that Invest Hong Kong would host the very first Fintech Week in the city in November, inviting start-ups, technology firms, fund managers and venture capital investors from overseas and the mainland to conduct seminars and forums.

“I can see it’s possible for Hong Kong to become one of the world’s leading Fintech players.”

Another crucial success factor is university education, he added.

“To become a leader, you need to start with globally leading edge university education in science and technology. Without education, it’s almost impossible,” he said. “Fortunately, with institutions such as CUHK, HKUST and others, Hong Kong is well positioned in this regards,” said Prof. Gupta.