Debating China's Industrial Policy + Jordan in London
The famous face-off between Chinese economists Justin Lin and Zhang Weiying — command or commerce?
Jordan may be heading to London next week! Respond to this email if you’d like to meet up.
Nancy Yu returns to ChinaTalk with another coup de maître, this time on how Chinese economists and state actors weigh industrial policy versus the free market in aiding growth and innovation — as well as how China under Xi today seeks to Solomonically split the baby.
Industrial policy is a loaded term in modern China. In theories of international development, industrial policy refers to government interference in the market that promotes and protects particular industries’ strategic and national goals. In the Chinese context, however, the term is enmeshed with debates about the country’s economic and social reform since the 1980s. These debates point to conflicting visions of the nation’s future.
To its supporters in China, industrial policy is a rational force wielded by an enlightened state to expedite progress. They argue government planning is the most effective path to upgrade Chinese industries, reduce wealth inequality, and launch China into a technological giant rivaling the United States. China’s future, they believe, lies in the guiding hand of the party-state.
Conversely, critics draw parallels between industrial policy and the bygone era of planned economies. They contend that such planning inevitably distorts the free market, incentivizes corruption, increases risks, and potentially derails China's growth. To them, a strong and prosperous China hinges not on state interventions but on fostering a free and fair market.
In 2016, the two sides collided in the lecture hall of Peking University, where Justin Lin Yifu 林毅夫, former Senior Vice President and Chief Economist of the World Bank and a fervent supporter of industrial policy, squared off against Zhang Weiying 张维迎, an economics professor at Peking University and a prominent defender of free-market principles. Their debate received wide press coverage both domestically and internationally, and sparked heated discussions among economists. The following year, writings and lectures surrounding the debate were published in an anthology titled The Boundary of the Government 政府的边界.
The intellectual schism between Lin and Zhang echoes a longstanding tension in China’s economic thinking since the early years of reform: while the Party believes that industrial progress requires the foresight and organizational power of the party-state, they also understand that a free and fair market is the key to growth. This tension persists today, even as Xi Jinping increasingly relies on industrial policies to channel state resources to high-tech industries.
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Industrial Policy in China
Chinese economists first started to pay attention to industrial policy in the early 1980s due to the success of Japanese industrialization. In the wake of WWII, the Japanese government cooperated closely with private firms and shifted national resources to industries such as camera, automobile, and semiconductors. To a group of Japanese economists, these policies were the reason for the nation’s record growth during the Cold War. And the success of those policies received significant fanfare in China. In the 1980s, as political debate between socialism and capitalism reached an impasse, the “Japanese miracle” offered a third way to Chinese policymakers: instead of choosing between a planned economy and the free market, China could pursue a dual-track reform that combined market competition with government interference.
This desire to choose both the state and the market marked the general ethos of China’s economic policy for the ensuing decades. In 1987, the Thirteenth Party Congress report asserted that China needed to build a system that “used the state to regulate the market and used the market to guide the enterprises” 国家调节市场，市场引导企业. In this scheme, the Party recognized that the market was an efficient tool for resource allocation, but also maintained that the state played a critical role in directing its trajectory.
Due to the ambiguity of this formulation, from the 1990s onward the pendulum swung back and forth between the market and the state. Under the direction of Premier Zhu Rongji 朱镕基, China adopted more market-oriented policies and decreased the degree that the state directly supported any industries. This trend reversed in 2006, when the state sought to direct the technological upgrading of Chinese industries by investing in “megaprojects” such as high-end manufacturing technology, oil and gas fields, and large passenger aircraft. Then, the global financial crisis gave rise to a wave of stimulus packages and investments in 2008. The influx of state money into the market fueled fears among economists that China was reversing its course on economic liberalization. When China’s GDP growth started to show signs of slowing around 2012, they sounded the alarm that China needed to reconsider its growth model.
The economists’ concerns about the nation’s slowing growth coincided with the ascension of a new leader in the Party. When Xi first took power in 2012, many wondered which direction he would steer China. Some saw hopeful signs of market liberalization. In 2016, for example, the Party launched supply-side structural reform, a program designed to solve the overcapacity problem by cutting subsidies for bloated state-owned enterprises. The reform raised so much hope among liberals that some even likened it to the supply-side economics of Reagan and Thatcher. But 2016 was the same year that Xi adopted a slew of industrial policies, directing state money to high-tech industries under the initiative of “Innovation-Driven Development.” At the time, it looked as though the nation had arrived at a crossroads.
It was amid this atmosphere of uncertainty and anticipation that Peking University invited Justin Lin and Zhang Weiying for a public debate on the merit of industrial policy. In many ways, this debate was the continuation of a three-decade-long pursuit of Chinese intellectuals for the right path for their nation’s progress. But unlike the first three decades of reform and opening, people in 2016 were less bullish. The worrying signs of economic slowdown and murmurs about the “middle-income trap” gave their debate a new sense of urgency.
The Lin-Zhang Debate
Before their 2016 face-off, Lin and Zhang had each etched their names as the spokesmen for the divergent visions of China’s reform. Lin, presenting himself as a Chinese nationalist, consistently underscored his conviction in the great rejuvenation of the Chinese nation under the Party’s leadership. His patriotic persona — perhaps a calculated move — conceals an intriguing past. Despite his standing as a pro-CCP academic, Lin is Taiwanese by birth and a decorated ground force captain in the Republic of China Army. In 1979, he defected to the People’s Republic of China by swimming across the Taiwan Strait, carrying nothing but two basketballs and his military ID. In Lin’s words, his defection was fueled by a sense of patriotism cultivated during his participation in the Taiwanese student movement to assert Chinese sovereignty against Japan over the disputed Senkaku Islands. This conflict crystallized his conviction that “China would not be respected internationally if it does not rejuvenate” 如果中华民族不复兴，中国在国际上不可能得到尊重.
Lin saw a unique opportunity for this rejuvenation within the leadership of the Party. After he was granted refuge in mainland China, Lin ascended in the academy, obtaining an economics master’s degree at Peking University, a PhD at the University of Chicago, and a postdoctoral fellowship at Yale University. Between 2008 and 2012, Lin held tenure at the World Bank as the Senior Vice President and Chief Economist, and began to formulate a theory of development centered around the role of a “proactive government” — the New Structural Economics. Following his return to Peking University in 2012, he became an ardent supporter of industrial policy and obtained high positions in the PRC’s Political Consultative Conference.
The New Structural Economics revolves around the concept of industrial upgrading. It posits that all economic growth follows this basic pattern:
Every economy’s comparative advantage — determined by its factor endowments such as labor, natural resources, and capital — evolves over time. For example, a low-income nation initially endowed with an excess labor force would develop labor-intensive industries such as textile manufacturing.
As capital accrues, resources are funneled to more advanced technologies and production methods, propelling enterprises into capital-intensive sectors like iron and steel manufacturing. Lin calls this process structural transformation.
According to Lin, China’s slowing growth is the result of ineffective structural transformation. The market, despite being a good tool for resource allocation, often veers away from the outlined pattern of structural upgrade due to two types of market failures.
The first is the externality problem, elucidated by Lin through a vivid analogy of “crab eating.” In the realm of technological innovation and industrial upgrading, the first entrepreneur who “eats a crab” faces significant externalities: if he fails, he will bear all the costs, letting the latecomers know that crabs are not edible; if he succeeds, though, latecomers will follow suit, and the first entrepreneur will not capture all the profits generated by “crab eating.” Thus, Lin argues, absent policy interference, the asymmetry between the costs of failure and the benefits of success would discourage enterprises from allocating resources to innovation.
The second failure stems from the coordination problem. Successful industrial upgrades, he argues, require the perfection of infrastructure such as highways and intellectual-property protection — and private enterprises lack the resources to undertake these projects without government involvement. Absent these kinds of infrastructure, the transaction costs for industrial upgrade would be too high for enterprises.
To counter these challenges, Lin argues that the state must shoulder the risks of innovation through industrial policy. Success in this endeavor hinges on identifying industries with “latent comparative advantage” — industries that enjoy low factor costs of production according to the economy’s present comparative advantage — and supporting them through subsidies, investment in new technologies, and infrastructure to lower transaction costs. In his prescription, successful industrial upgrade hinges on the combination of a “proactive government” 有为政府 and an “effective market” 有效市场.
All of these would sound like tall tales to Zhang Weiying’s ears. In China, Zhang is notorious for his uncompromising defense of free-market principles. Influenced by the ideas of Friedrich Hayek and Milton Friedman from a young age, Zhang first emerged in public discourse in 1983 with an article titled “In Defense of ‘Money’” 为“钱”正名; despite the political taboo at the time, Zhang’s radical argument cut through the ideological bromides and laid bare the logic underpinning the country’s market reform. After graduating from a top-ranking university in Xi’an 西安 in 1982, Zhang worked for the Commission for Economics and Institutional Reform, a ministerial-level agency overseeing state policy on economic and social development, and later obtained a state scholarship to attend Oxford University for an economics PhD. He is most well-known for his theory of dual-track price reform and the privatization of state-owned enterprises. In 1997, he secured his professorship at Peking University.
Industrial policy, from Zhang’s perspective, is nothing but a “planned economy in disguise,” condemned to failure due to incentive distortions and the limits of human cognition. Innovations are unpredictable; before technologies are tested by the market, no one can foresee which ones will significantly affect our lives. According to Zhang, a state that attempts to predict the future and guide innovation is nothing but a high roller gambling with taxpayers’ money. Zhang also predicts a rent-seeking problem with industrial policy. As the government gives certain enterprises preferential treatment such as market access, subsidies, and financial credit, industrial policies would incentivize enterprises to seek those benefits through bribery. In Zhang’s words, industrial policies, anywhere, fail because of “human ignorance and human indecency” 人的无知和人的无耻.
Zhang thinks Lin’s theory about market failures stems from flawed notions about the market. Lin relies on a set of assumptions that reduces entrepreneurs to mere “calculators” of marginal utility and marginal cost. But this is not how real entrepreneurs act. Instead, Zhang argues that successful entrepreneurs are natural risk-takers. Turning on Lin’s “crab eating” analogy, Zhang retorts that he is sure that the first person who ate a crab didn’t do so because of government subsidies. To Zhang, the market is a voluntary association of entrepreneurs which would progress naturally if only the government left it alone. Under this view, the market failures Lin speaks of stem not from flawed market mechanisms but from a flawed economic model.
To Zhang, then, industrial policy is not the antidote to China’s economic slowdown. Entrepreneurs are. Rather than relying on industrial policy to foster innovation, Zhang believes that the state must give entrepreneurs more liberty, foster the rule of law, and create an even playing field for all industries. In other words, China’s industrial progress depends on how much the government can restrain its power.
The Lin-Zhang debate reveals several trends in Chinese economic thinking after their economy showed signs of slowing around 2010. And despite their schism, Lin and Zhang have a few points of convergence that reflect the consensus among mainstream Chinese economists:
First, they agree that market liberalization has been instrumental in China’s progress; that China’s prosperity in the past thirty years has been a result of its integration in global trade; and that it was able to sustain rapid growth because it built a thriving manufacturing sector with its excess labor force and imitated the technologies and organizational experience from developed nations.
Further, they agree that technological innovation is the key to escape the “middle-income trap”; the old path of technology transfer is no longer sustainable. While they disagree over the means, they agree that future growth hinges on the ability of Chinese tech firms to innovate and acquire more advanced methods of production.
Third, their divergence reveals a general schism in Chinese economic thinking over the boundary of the government. In their disagreement, Zhang’s critique of Lin’s conception of the market is especially important: while Zhang sees the market as a sphere of spontaneous association where entrepreneurs may unleash their creative energy, Lin understands it as a useful mechanism for resource allocation. Meanwhile, to Lin — as well as the CCP — the market is something that can be horned and directed for national purposes.
Finally, it is important to note what they omitted in the debate: neither discussed the role of political ambition and national security in driving economic policy. That omission qualifies the weight of Lin’s and Zhang’s theories — and economic concerns in general — in national policy making. Ultimately, the need for national security and the CCP’s political ambition to lead the world in science and technology will come in tension with the economic forces that Lin and Zhang elaborate upon.
Dilemma of Party Will
The trends that the Lin-Zhang debate highlights are important in understanding China’s economic policies under Xi Jinping. From the false signs of market liberalization in his early years to the unmistakable call for economic nationalism in the 20th Party Congress, Xi Jinping’s economic policy has undergone an arc that puzzled Chinese and international onlookers alike. This arc would make a lot more sense when one takes these Lin-Zhang-debate trends into account.
When Xi first came to power, China’s declining growth rate called for a decisive response. Pursuant to the mainstream argument among Chinese economists, Xi adopted an “innovation-driven development strategy” 创新驱动发展战略 centered around the mission of structural upgrade. As he remarked during a Politburo study session in 2016, “inadequate capacity for innovation is [China’s] Achilles’ heel. Innovation-driven growth has become the pressing demand for China’s development. Therefore, I stress repeatedly that innovation is development; innovation is the future.” The focus on innovation is not controversial from the perspective of Chinese economists. But how might the Party foster such innovation?
In the ensuing years, the CCP was caught between Zhang Weiying’s market option and Justin Lin’s state option. What has broken the tie is the Party’s political will — to attain the Chinese Dream of Great Rejuvenation, it is insufficient for Chinese industries merely to catch up with the West; instead, they must surpass the West in both GDP and technological capacity. Motivated by this ambition, Party strategists tried to have the best of both worlds: on the one hand, the CCP is convinced of its ability to catch the wave of a technological revolution by concentrating state money and resources in high-tech industries; on the other hand, it cannot deny that market liberalization, globalization, and entrepreneurship have played indispensable roles in driving China’s economic success. Zhang Weiying’s argument makes intuitive sense to the generation of Chinese who have witnessed the country’s growth after it turned away from a planned economy.
In implementing its political will, the Party is pushed and pulled by these divergent economic arguments as it crafts industrial policies. The Made in China 2025 program, for example, states that research programs should be “market-driven and government-guided” 市场主导，政府引导. This formula seeks to sidestep the disadvantages of government planning that Zhang outlines by combining market forces with government steerage. This tension is also reflected in Xi’s New Development Pattern, a blueprint for China’s economic development which Xi introduced just before the making of the 14th Five-Year Plan in 2020. To Xi, it is necessary to engineer a growth pattern in which “the domestic cycle is the mainstay, with the domestic cycle and international cycle providing mutual reinforcement.” In other words, Xi wanted China both to retain the benefit of global trade and to become more self-reliant in manufacturing core technologies.
Lastly, the tension between political will and the necessity of market forces is fully on display in the “new-style whole-of-nation system” 新型举国体制, a science and technology action plan that the Party launched in 2019. The name “whole-of-nation system” harkens back to the national research teams that Mao Zedong used to develop the atomic bomb, the intercontinental ballistic missile, and the artificial satellite. Despite the heavy allusion to state-controlled scientific research, the Party takes care to distinguish the new from the old whole-of-nation system. As an article in Party theory publication Qiushi 求是 explains, the new system leverages the force of the market while also recognizing that private enterprises are the main actors in technological innovation. Unlike the old system, the new system would channel state resources into the market, instead of recreating a closed ecosystem of state laboratories.
Xi Jinping is leveraging more state power over the market to fulfill the Party’s political ambition. Even so, it is important to note the constraining forces at play. In essence, Xi’s industrial policy is shaped both by the divergent rationales among Chinese economists and the Party’s ambition to steer the nation’s economy toward the technological frontier.