Is China the world’s largest company?
Innovation and Communism are two words that don’t mix. At least, that’s the prevailing view when you talk to investors in the West.
But the widespread perception that China cannot innovate due to top-down bureaucracy is changing. It’s becoming increasingly apparent to us that the frenetic pace of innovation in China is not happening in spite of the country’s top-down political system. It might just be that it’s happening because of it.
The gale of Creative Destruction.
China may not be a market economy in the classical sense, but look no further for a textbook example of Creative Destruction. According to Austrian political economist Joseph Schumpeter, the “gale of creative destruction” is a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one”. This is precisely what’s occurring across the length and breadth of China, as the country reorientates from acting as the global supply chain towards a business model founded on domestic demand and self-sufficiency.
China has craved economic independence since the very beginning. You probably know this story, but 500 years ago, China had a navy that was the envy of the world. We're talking about 3,500 state of the art ships crewed by up to 1,500 sailors (to put this in perspective, the US Navy today has only 430 vessels). Then it destroyed the entire Treasure Fleet, because the Chinese political elite was alarmed at the rise of a merchant class who had become rich from international trade and decided china could be completely self sufficient.
Today, the trade dispute with the US is accelerating a return to the kind of economic independence favoured by the Ming Dynasty. What doesn’t kill you makes you stronger, and a more balanced and self-sufficient Chinese economy is seemingly within grasp. And that is thanks to more than massive investment in innovation at a governmental level.
A symbolic gesture.
At a recent meeting with a Chinese investment bank, a very smart dude told us that “foreign investors understand earnings and valuations, but they don't understand the spirit and culture of China.”
The Great Wall is emblematic of that spirit, a physical tribute to a worldview characterised by long-term strategic thinking, teamwork, stamina, and the ability to mobilize resources (both people and materials). The obvious contemporary example is China’s mind-blowing high speed train network, which expanded from 50,000 km in 1978 to 130,000 km in 2018.
For a taste of what’s to come, consider the actions of Chinese president Xi Jinping at the very start of the US trade dispute. He didn’t fly to Washington DC or retreat to Zhongnanhai, a former imperial garden that serves as the central headquarters for the CCP and the State Council of China. Instead, he went to Jiangxi, where China’s defeated Red Army started its Long March in 1934. Xi’s choice of destination at such a highly charged political moment was a symbolic gesture that says much about China’s long term strategy when it comes to trade, infrastructure, technology… everything.
The largest company the world has ever known.
The most knowledgeable people we know on the subject of China all say the same thing. To understand China, look at China itself, not the world beyond its borders. This country isn’t governed like a country. It’s managed like a company – the largest company the world has ever known.
The model is somewhat familiar. The success of Singapore has served as how-to-guide for how to build a corporatist state, with government as board of directors, president as CEO and general public as willing consumers. The bargain seems to be “put aside your freedoms and we’ll offer you safety, stability and prosperity”, and the result is a society defined by Confucian principles of community and hierarchy. But Singapore is small – with a population approaching 6 million, it wouldn’t even break into the top 10 largest cities in China. China’s mission to scale the corporatist model across its 1.4bn population is ambitious, audacious and fraught with risk.
Breaking down the process by which success can be achieved highlights the challenge, but also the peculiar elegance of combining communist and capitalist principles to drive large scale economic development and raise living standards for billions of people. The state’s methodology is simple:
Create state monopolies.
Privatise them, becoming the biggest shareholder in the process.
Extract rent to reinvest in the system.
Forget the not-for-profit mentality of classical communism – this is a new iteration, one optimised around profit maximisation for the state rather than the satisfaction of “social needs” espoused by Marx.
The global picture.
When it comes to understanding how China perceives itself, domestic potential is everything. Viewed in this light, Belt and Road isn’t a grand neo-imperialist plan – it’s the external manifestation of China’s intense internal ambition. The deal with emerging economies like those in Africa and Central Europe is simple – “you buy my products, I buy your resources”. In other words, what appears to be a preoccupation with expansion is simply a concern with securing resources (and redistributing surplus capacity) to fuel domestic growth and the maturation of the Chinese economy.
Technological advancement is the key to the successful pursuit of highly sought after economic independence. Not only does tech advancement help the entire economy become more efficient and productive – it enables China to pursue economic independence more rapidly. Indeed, companies like Huawei are now building out their domestic supply chains.
In time, home-grown innovation will help China to expand its reach globally. “Made in China” means something altogether different from what it did only a few years ago. The vast scale of the domestic market gives China an unfair advantage when it comes to driving production unit costs ever lower, facilitating attractive price points and making “affordable quality” a reality for foreign consumers. And if you think what Chinese manufacturers have achieved with smartphones is impressive, wait until you see what’s coming with autos. As the Chinese economy matures, other countries will simply be unable to compete when it comes to things like electric vehicles, home appliances and even complex B2B products like construction machinery.
A delicious irony.
There is a delicious irony to the world’s most powerful Communist administration applying business school logic to the way it governs.
The CCP has created an internal hierarchy that is positively Darwinian. It’s a machine that churns out fiercely competitive administrators, with power transferred to new political elites that stand out through brutal and ruthless competition. Like all the best companies, the state promotes from within, ensuring continuity and high levels of operational competency by appointing people to high office with deep expertise of governing on a practical level. The result is that the Politburo is populated by seasoned administrators who are ready for the task of governing on a national level, since they have already managed provinces that are home to 100m+ people.
The one party political system has district advantages when it comes to pursuing rapid economic development. We’ve all heard of 4, 5 and even 10 year economic plans; it is often said that China is the only country in the world with a 100 year plan. Whilst the US and other western countries struggle to see past the next electoral cycle (and many companies seem incapable of seeing past the next quarter), China ruthlessly executes on its long-term vision of economic independence. By doing so, it benefits from strong compounding effects, driving growth across industries that have been identified as strategically important.
An inherently fragile system.
This is not a value judgement. We are certainly not saying the Chinese system is better than the modus operandi in the West. Indeed, we’re mindful that bureaucracy (and it’s ugly sister, corruption) remain a problem in China. But we mustn’t make the classic mistake of associating bureaucracy with inefficiency. In the western world, the two come hand in hand – in China this is no longer the case.
China’s centralised politics is certainly supportive of rapid economic development, but it can be argued that the system is inherently fragile, since the concentration of risk is far greater than that of a decentralised bottom-up capitalist model. The race to innovate and build breakthrough technologies is not only a manifestation of China’s indomitable spirit – it’s an essential ingredient in the CCP’s (so far highly successful) efforts to hold the system together. We used to think that a one party system had little incentive to innovate – now we see that they have far greater incentives than democratically elected governments.
Just look at how the Age of the Computer is playing out in China. The Internet was supposed to be a great vehicle for democracy and plurality. In the late 1990s, many people believed that the World Wide Web would result in a kind of technological utopia in which information would be freely accessible to all. Perfect knowledge would result in a perfect society, and governments would be held to account by populations with the ability to collectivise and resist authoritarianism. We thought we were getting new patterns of information dissemination via decentralized networks, with less opportunity for governmental intrusion. What we got is the perfect conditions for state surveillance, The Great Firewall of China.
The mother of invention.
The big reveal is that superficially libertarian principles of modern mass media (especially social media) actually work to reinforce the status quo and solidate incumbent political structures. We’ve seen this in the Middle East, where the abortive Arab Spring failed to deliver the democratic transformation it promised, and we’ve seen it in China, where the Internet is used to monitor, monetise and ultimately control people on an unprecedented scale – albeit with their best interests at heart.
Now the same thing is happening with AI. Kai-Fu Lee’s brilliant book AI Super-Powers points out that China is pouring billions of dollars and thousands of engineers to working full-time on AI breakthroughs. This move promises to further consolidate the Chinese government’s control over the way its people discover, consume and share content, products and experiences.
What about blockchain? Xi Jinping’s recent call for greater levels of research and investment into blockchain sent Bitcoin skyrocketing for good reason – official state sanctioning of specific innovations in China is rare and clearly reflects a recognition of the power and potential use cases for this technology on the part of the Chinese state. The state is already adept at monitoring people; Blockchain presents the tantalising opportunity to surveil the entire financial system. Again, we encounter a technology that appears quintessentially decentralised and democratic presenting compelling opportunities for a system that seeks to centralise economic management. A pattern is emerging.
Who knows how the next chapter in the story plays out? China now eclipses the US as the world’s largest overall public and private R&D investor, outspending the US government on intramural funding in 2017 ($67.4bn to $47.1bn). China is the leader in patent applications, with 40% of the global total, a share more than 2 times larger than that of the United States and 4 times larger than that of Japan.
Genetic engineering promises great things for those with the expertise (and ethical ambivalence) to “test and iterate”. And when “the good of the nation” is at stake, progress can happen rapidly whatever the short term “cost” may be. Whatever happens next, China could possibly be the most innovative state in the world. And that is not because it wants to be. It’s because it has to be.