The 'Cheating' Debate and China's Innovation Potential

Key Insight

Accusations that China achieved industrial success by 'cheating'—through subsidies, manipulated interest rates, exchange rates, energy prices, and barriers to foreign competition—are frequently leveled. Historically, every country that developed a successful 'catch-up' industrial economy has employed similar tactics, including the United States, which was known for disregarding intellectual property and maintaining high tariffs until World War II. While China's exchange rate was considered undervalued from 2001 to 2010, its share of global manufactured exports rose from 5 percent to 15 percent, averaging 1.1 percentage points annually. However, even as the exchange rate appreciated and other costs rose (2010-2013), China still gained approximately 0.9 percentage points of global market share each year, reaching nearly 18 percent by 2013, suggesting fundamental factors like favorable geographical placement, combining Third World labor costs with First World infrastructure, were more critical than currency manipulation.

The claim of ultralow interest rates subsidizing heavy industry is also nuanced; cheap capital played a supporting role, benefiting from a surge in profitable investment rather than being the primary cause. Industrial firms largely financed expansion through reinvested profits, and private companies grew faster than state-owned enterprises (SOEs) despite paying higher interest rates. Regarding energy prices, Beijing's primary goal has been stability, not artificially low levels. Chinese gasoline prices were about 27 percent higher than in the United States from 2011 to 2014, and when crude oil prices fell by half in late 2014, U.S. gasoline prices dropped significantly more than Chinese prices. For industrial power, which accounts for about three-quarters of China's electricity use, prices were comparable to Germany and significantly higher than in the U.S. (nearly 13 cents per kilowatt-hour versus about 6.5 cents U.S. average at the end of 2014), indicating that energy costs were not notably cheap.

Violation of Intellectual Property Rights (IPR) is a contentious issue, but it is a tactic historically used by technologically backward nations to catch up, seen in Europe's porcelain industry, Britain's tea industry, 19th-century U.S. textiles, and post-WWII Japan, South Korea, and Taiwan. While China's IPR violations are large-scale and its legal system weak, the ultimate harm to Western businesses is often hard to discern; many foreign software and consumer product firms still maintain dominant global positions and profitable operations in China. China's 'Indigenous Innovation' policy, which included technology transfer requirements for foreign firms, is viewed more as a business negotiation to gain a greater share of technology development profits for Chinese firms, rather than pure theft. However, China's innovation potential is challenged by a focus on 'adaptive' innovation rather than groundbreaking new products, a policy confusion between 'innovation' and 'autonomy' (which can lead to inefficient domestic substitutes), and aggressive restrictions on the free exchange of ideas and censorship, which are fundamentally inimical to sustained innovative achievement.