Editor’s Note: Based on reader feedback, we are making some changes to Deep Dive. The current Deep Dive will be going on hiatus on Feb. 7, allowing us to revamp the format. Look for the new and improved Deep Dive on March 14.

Summary

In 2015, Beijing released a series of ambitious industrial plans, the most prominent of which was called “Made in China 2025.” The blueprint itself is fairly anodyne; it lays out lofty goals that aim to refocus China’s economy away from labor-intensive manufacturing and toward high-tech and service industries. To try to blunt Western criticism, Beijing has effectively disowned the document itself, but its principal policies remain and are now the center of U.S. complaints about state-backed efforts to swipe Western tech and distort markets in China’s favor. The unspoken U.S. concern is what it would mean for the balance of power should the plan succeed.

For China, however, success is the only option. The low-cost manufacturing model that fueled its extraordinary economic rise has effectively run its course. The debt-fueled investment binge Beijing has relied on to stave off a socioeconomic crisis since the 2008 meltdown has peppered the Chinese system with financial landmines. It’s facing a demographic crisis and an ongoing trade war with the U.S. Thus, China is grappling simultaneously with an immediate risk of cataclysmic financial crisis and a longer-term risk of falling into the middle-income trap, where developing economies stagnate as the advantages of low production costs evaporate. At the same time, global manufacturing is undergoing a high-tech revolution, opening up opportunities for Beijing but also exposing China’s weaknesses.

In response, the Communist Party of China is relying on what it trusts most, its own power, to fundamentally transform the economy from the top down. In practice, this means shoveling money into state-owned firms and state-controlled universities and research centers in service of research and development priorities laid out by the State Council. China is applying economic statecraft to access markets and resources abroad and allegedly using commercial espionage and cyber-theft to help firms make up ground.

China is in a high-stakes ultramarathon to avoid the approaching crisis and running at a sprinters’ pace. But, increasingly, it’s fueling a backlash from foreign competitors that would prefer to see China remain on the sidelines. This Deep Dive takes a fresh look at Chinese industrial policy as defined by Made in China 2025 – its key components, its importance to Beijing, and its supposed threats to Western interests. It also explains why China won’t cave on the plan’s core philosophy. Ultimately, then, this report is about what the U.S. and China are going to be fighting about for years to come.

The Components

Made in China 2025 is the first of three 10-year plans aimed at guiding China’s transition to a high-value manufacturing economy by 2049, the all-important 100th anniversary of the founding of the People’s Republic of China (and the target date for completion of the ambitious Chinese military modernization program). By 2025, according to Chinese Minister of Industry and Information Technology Miao Wei, “China will basically realize industrialization nearly equal to the manufacturing abilities of Germany and Japan at their early stages of industrialization.” That China sees its manufacturing sector as effectively mirroring that of 1960s-era Japan says quite a bit about just how far it has to climb on the value ladder – and should belie narratives that China is already a manufacturing superpower.

In reality, China has long struggled with the stuff that fully modernized economies like the U.S., Japan and Germany have mastered, particularly development of core technologies and native innovation. China has been able to get by thanks to its large population and technology imports by foreign firms. But rising wages at home and rising competition from low-wage neighbors are squeezing profits in labor-intensive sectors. Moreover, Western anxieties about China’s growth in military power and market-distorting trade practices are increasingly threatening its access to core technologies in higher-end industries. Even before the Trump administration began tightening restrictions on Chinese firms, for example, Beijing was complaining that Western limitations on potentially “dual-use” civilian-military technologies, such as satellite tech, made it unreasonably difficult for Chinese companies to move into the high-tech civilian industries of the future. It can’t afford to stand pat.

Made in China admits as much, describing the task at hand thusly: “China’s manufacturing sector is large but not strong, with obvious gaps in innovation capacity, efficiency of resource utilization, quality of industrial infrastructure and degree of digitization. The task of upgrading and accelerating technological development is urgent.” The plan divides China’s shortcomings into four categories: innovation, quality efficiency, smart manufacturing and green development. Its overriding vision can be boiled down to a three-step process: indigenize R&D into core technologies and intellectual property; substitute Chinese tech for foreign tech at home; and make Chinese tech dominant overseas.

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Notably, Made in China also identifies 10 sectors, which are outlined below, where the bulk of this effort will take place. On average, Beijing wants 70 percent of basic core components in these sectors to be sourced from domestic suppliers by 2025. Already, according to the Rhodium Group, these sectors account for some 40 percent of China’s entire industrial value-added manufacturing. When looked at as a whole, some common themes emerge. One is that China is prioritizing sectors where it has a latent comparative advantage – that is, where its labor force, existing industrial footprint and massive consumer base stand to help domestic firms play catch up – but where hefty up-front investment is needed (and generally unavailable through private capital markets). Third, each of these sectors has enormous market growth opportunities overseas. Finally, each is needed to address a core domestic vulnerability and/or serve as a strategic tool abroad.

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New Information Technology

China is going big on next-level information technologies, from integrated circuits to big data to high-performance computing. For the next decade, the most prominent part of this push will be the development and export of fifth-generation mobile communication technologies (5G), which will open a new universe of consumer and industrial applications for technologies such as artificial intelligence and the so-called “internet of things.” This is one area where China is positioned for some success, as Chinese firms like Huawei are already dominant players in global markets and can reap major “first-mover” advantages, from market share to influence of global standards to application innovation. Such firms, however, are still heavily dependent on Western IP and component parts, particularly microchips – as demonstrated by the brief U.S. decision to cut off U.S. equipment to China’s ZTE, which very well could have killed the company. Its long-term success here will depend largely on advances in semiconductor development.

But 5G could also have profound geopolitical implications. The technology itself will have wide-ranging military and logistics applications, as well as new vulnerabilities to things like cyberespionage. If the U.S. and its allies are unwilling to expose critical logistical networks and sensitive military or intel-sharing operations to Chinese snooping in countries whose communication infrastructures contain certain Chinese technologies, it could very substantially limit U.S. defense partnerships in strategically important states.

Numerical Control Tools and Robotics

China’s most valuable asset has been its low-cost labor force. But Chinese firms can’t move up the manufacturing value chain if they’re making everything by hand. High-end products like cars and electronics require high-end industrial robotics, and Chinese progress has been mixed here. In 2017, for example, China had 138,000 industrial robots installed – three times the number of any other country and an increase of more than 120,000 over a decade earlier, according to the International Federation of Robotics. But the bulk were owned by foreign firms. Moreover, this amounted to just 68 robots per 10,000 industrial workers. The United States, by comparison, had 189 per 10,000 workers and the global leader, South Korea, had 631. Sophisticated robots also require sophisticated software, another point of Chinese dependence on foreign IP, and artificial intelligence applications. This push will become increasingly important as the effects of China’s looming demographic challenges become clear and as the productivity gains that have come with rapid urbanization run dry. To stay competitive, China will need to do more with fewer workers.

Aerospace and Aeronautics

Aerospace and aeronautics are apex industries. Given the immense investment and sophistication of the technology, expertise and accompanying logistical and regulatory structures required of the sector – and given that anything less than a near-flawless performance rating will keep a company grounded – if a country can compete there, it can compete just about anywhere. And given the increasing importance of aerospace to various military, communications and other applications, the sector is becoming essential to China’s wide-ranging ambitions in a range of fields.

With China set to be the world’s largest air passenger market within the next four years – and with global passenger traffic expected to double by 2036, according the International Air Transport Association – Beijing has been trying to compete with Boeing and Airbus since at least 2008. The state-backed Commercial Aircraft Corporation of China, or Comac, began production of the C919, a single-aisle commercial airliner akin to Boeing’s 737, in late 2011, but the project has been bedeviled by setbacks and delays, and Comac is still fully reliant on foreign suppliers of engines, avionics software and navigation systems. Made in China calls for Chinese commercial aircraft to supply 10 percent of the domestic market and 20 percent of the international market by 2025. It also calls for giant leaps forward in the space race, carrier rockets, satellite applications and deep space exploration – primarily using Chinese-made equipment. In a notable breakthrough, China’s homegrown satellite navigation system, Beidou, announced the launch of its global service in December. The firm, which began as a military project, has already shipped tens of millions of systems.

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Ocean Engineering Equipment and High-End Vessels

More than ever in its history, China is a maritime nation. Shipping is indispensable to its economy, and the boundless long-term growth in global demand for maritime trade heralds ample opportunities for Chinese firms. A massive shipbuilding footprint would also help China produce naval and coast guard vessels in wartime. As a result, Made in China calls for the country’s shipbuilding industry to supply at least half of global demand for high-tech ship design and manufacturing equipment. The plan also emphasizes underwater production systems and deep-sea exploration and resource exploitation – which have obvious implications for Chinese energy needs and the competition for resources in the hotly contested waters off Chinese shores, but also for Chinese advances in submarine warfare. There’s a reason regional countries scream bloody murder whenever Chinese research vessels show up in their waters.

High-End Rail Transportation Equipment

China’s build-out of high-speed rail networks at home has been nothing short of extraordinary. This year alone, it’s expected to build 4,200 miles (6,800 kilometers) worth of new domestic railway lines. Increasingly, China is also looking to export its rail technologies – and for good reason. According to the Asian Development Bank, the region needs an estimated $26 trillion in new infrastructure over the next decade to sustain economic growth. Rail is an obvious area where China can help make up the shortfall, and one that pairs naturally with the goals of its Belt and Road Initiative. China has been able to pair its diplomatic muscle with subsidies and manufacturing cost advantages to land major contracts across Southeast Asia, the Middle East and Africa. But Chinese rail firms lack the stellar safety reputation of their Japanese and European counterparts, and repeatedly undercutting the competition is expensive, so Beijing is keen to see its firms become more competitive on the technological and performance fronts.

Energy-Saving and New Energy Vehicles

This is another area where China is responding to both domestic and global needs. China, of course, is home to the world’s largest car market – General Motors sold more than 1 million more cars in China in 2017 than in the U.S. – and perhaps the world’s worst pollution. By supporting development of electric vehicles, Beijing is hoping to meet its burgeoning transportation needs while also making a dent in its smog problem, which President Xi Jinping has characterized as a national emergency. Accordingly, Beijing wants electric vehicles to make up some 40 percent of domestic car sales by 2025 (compared to just 2.7 percent in 2017). And it wants at least half of these new EVs to be Chinese. Ultimately, this is really about battery development. Innovation in battery technology would have wide-ranging implications in other fields as well as geopolitical ramifications, as proliferation of EVs will increase demand for minerals such as cobalt that are concentrated in a handful of states such as the Democratic Republic of Congo.

Power Generation

Chinese electricity generation capacity has more than quadrupled since 2000, and there’s little reason to think this growth will slow down anytime soon. Beijing is keen to meet this need as cleanly as possible – and with as much domestic content as possible. Accordingly, Made in China calls for 80 percent of components in large-scale thermal, hydro and nuclear power equipment to be sourced domestically by 2025. Power generation is another key area where China can play an instrumental role in the modernization of less-developed but strategically important states. Its signature BRI project in Pakistan, the China-Pakistan Economic Corridor, for example, is focused overwhelmingly on power generation and transmission.

Agricultural Machinery

China has a lot of mouths to feed. But for the past two decades, it’s been encouraging rapid urbanization to boost productivity and consumption and meet the needs of its labor-intensive industries. To fill the labor gap and sustain production with fewer workers, China is pushing to bring the agriculture sector up to the standards of advanced economies. The trade war, meanwhile, has made clear the extent of Chinese dependency on U.S. agricultural exports. Made in China calls for 70 percent of critical parts and at least 60 percent of high-end agriculture machines to be built domestically by 2025.

New and Advanced Materials

This encompasses a vast range of goods – from advanced composites to special function metals to “strategic frontier materials” such as superconductors, nanomaterials, biomaterials and graphene. These are the lighter, stronger and more sophisticated building blocks that everything from advanced circuits to rocket ships to submarines and fighter jets will be made from, and China is anxious about being dependent on foreign suppliers for any of them. Notably, this is one area where Beijing is pushing Chinese civil industry and the military to work together – a comparative advantage to the U.S. and its allies, given Beijing’s greater capacity to harness civil society capacity for strategic aims.

Biopharmaceuticals and High-Performance Medical Equipment

The global population is getting older, and China is getting older fast. For Beijing, this poses a major budgetary problem, as well as a social stability problem. Over the past 20 years, Chinese health spending has increased by an average of more than 11.5 percent annually, well above gross domestic product growth. Continued periodic protests by army veterans upset about not receiving pension and health benefits are one example of the potential disruption. Beijing is, therefore, prioritizing development of the pharmaceuticals sector, particularly biotechnology, which has been growing since 2008 and now stands at 30 percent of global pharma product sales. Beijing wants biotech to account for upwards of 4 percent of China’s GDP by 2020. Technologies like gene editing will be valuable in the agriculture sector, as well.

The Critics

Although some of these goals seem unrealistic and overly ambitious, the U.S. is taking them very seriously. Made in China is cited heavily in the White House’s Section 301 report, which lays out much of the U.S. rationale for the trade war. Each of the 10 industries has been targeted by U.S. tariffs, which have had some effect. According to official figures, production of industrial robots has declined by more than 12 percent year on year in December, growth in the new energy car industry has slowed to roughly 15 percent from 24 percent in November and integrated circuit production has been reduced by 2.1 percent. By comparison, many of the export industries on which China (and U.S. consumers) is currently dependent, such as consumer electronics, have largely been spared from tariffs.

The issue, according to the U.S., isn’t the specific plan. After all, Made in China is not all that different in principle from Germany’s 2011 “Industry 4.0” plan, which inspired parts of the Chinese plan, or the Obama administration’s “Advanced Manufacturing Partnership,” which sought to foster collaboration among the private sector, universities and the government in emerging technologies. (In terms of funding and scope, however, both the U.S. and German plans pale in comparison to China’s.) In the short-term, at least, China’s pursuit of a modernized manufacturing sector will provide extensive opportunities for foreign firms and require heavy foreign investment.

Furthermore, much of the project appears aspirational, at best. China has been trying and failing to foster native innovation and core technology development since long before 2015, with only scant success in reducing dependence on foreign tech and IP. Its state-led system is well-suited for compelling system-wide collaboration, filling in investment shortfalls, tailoring infrastructure development around the needs of key industries, and freeing companies from weighting decisions around quarterly earnings reports. Between 2000 and 2014, for example, Chinese state R&D expenditures increased nearly 850 percent, compared to around 30 percent for the U.S., and China is now second only to the U.S. in annual outlays here. (As a share of GDP, though, China still lags behind South Korea, Japan, Germany and the United States.) In the telecommunications, shipbuilding and robotics sectors, in particular, Beijing’s support for “national champions” is already seeing some success. And in 2017, China surpassed the U.S. as the leading source of funding in artificial intelligence technologies.

But China’s centrally planned system is ill-suited for this game in other ways. Its tight grip on funding channels leads to clumsy allocation of capital, as illustrated by the credit crunch currently suffocating the Chinese private sector. Its mixing of domestic political and commercial aims warps incentives, forces firms to carry bloat and stifles appetite for risk-taking. Companies won’t invest in R&D if they think the fruits of their labor will inevitably get gobbled up with impunity by a competitor owned by the nephew of a local party boss. Its mixing of geopolitical and commercial aims, meanwhile, exposes companies to international backlash. And firms in sectors where China simply has little experience, such as industrial software development, likely have too much ground to make up to expect to be competitive anytime soon, and are unlikely to receive much support from the state since it will need to continue to woo foreign competition to meet the domestic market’s needs.

So why do the U.S. and its allies see Made in China as such a threat? And is there room for negotiation? For the most part, the West has focused its criticism on the means with which China is pursuing the aims outlined in the plan rather than the aims themselves. This includes more nefarious tools such as commercial espionage and forced technology transfers. Beijing will not admit that the state sanctions such activities, but it evidently has some degree of control over them. Cyberattacks, for example, dropped dramatically for two years after Xi and Obama reached a deal in 2015, before increasing again as trade tensions have intensified, according to U.S. cybersecurity firm FireEye. And China has been slowly lifting foreign ownership caps, ostensibly making it easier for foreign firms to avoid joint ventures in which tech is expected to be handed over in exchange for access to the Chinese consumer market. So there’s some room for concessions, even if informal ones. Whether it sticks to any such pledges if and when Chinese firms fall short of indigenization targets is another matter.

The other point of contention is China’s state-led system itself. Despite some language pledging to give markets a more decisive role in resource allocation, Made in China broadly heralds a deepening of the state’s role in the economy. And it’s explicit about its import substitution aims, its intent to use state-funded acquisitions as a tool to access Western technology, and its plan to use state funding and preferential access to credit to tilt the balance in Chinese firms’ favor. In other words, Made in China merely magnifies existing concerns about Chinese distortion of global markets.

The Bigger Picture

China, naturally, sees the dispute from the opposite angle – that it is effectively following the development path already taken by U.S. allies, and thus that the West is playing a zero-sum game to keep China down. Beijing also doesn’t see much of a choice in the matter. To abandon the plan’s central philosophy and tools would be to abandon the CPC’s fundamental model of governance – and thus threaten its grip on power. U.S. pressure won’t change this; rather, it only underscores China’s sense that it needs to develop its own technological expertise. To concede wholly would be to leave itself exposed to U.S. pressure in the future on any number of issues.

Beijing’s suspicions are not entirely groundless, even if few Western officials are admitting as much. So long as China remained dependent on Western markets and technology, and a valuable part of supply chains for Western firms, there were mutual incentives to get along. What happens if and when these go away? If China were to succeed in avoiding the middle-income trap – not to mention avoiding an outright socio-economic crisis in the next few years – it would wield enormous power. Newfound wealth will inevitably translate into military power and new resources with which to pull neighboring countries firmly into China’s orbit.

Whether or not the West should be able to find a way to peacefully coexist with a powerful China, history and the nature of geopolitics tell us that established powers rarely cede their dominance to upstarts without a fight. And even if Beijing is merely doing what it thinks it must to avoid economic calamity, its regime type, military trajectory, and recent track record of weaponizing aid and investment for strategic purposes will be the unspoken context hanging over narrower U.S. complaints. The U.S.-China rivalry will continue whatever happens in trade negotiations in the coming months.

Phillip Orchard
Phillip Orchard is an analyst at Geopolitical Futures. Prior to joining the company, Mr. Orchard spent nearly six years at Stratfor, working as an editor and writing about East Asian geopolitics. He’s spent more than six years abroad, primarily in Southeast Asia and Latin America, where he’s had formative, immersive experiences with the problems arising from mass political upheaval, civil conflict and human migration. Mr. Orchard holds a master’s degree in Security, Law and Diplomacy from the Lyndon B. Johnson School of Public Affairs, where he focused on energy and national security, Chinese foreign policy, intelligence analysis, and institutional pathologies. He also earned a bachelor’s degree in journalism from the University of Texas. He speaks Spanish and some Thai and Lao.