Made in China 2025: moving up the value chain

Innovation is expected to be the name of the game for the next 10 years, as the Chinese economic model shifts from quantity to quality.

In order to overcome the ‘middle income trap’, the Chinese government has devised a 10-year plan to transform China into an advanced global manufacturing economy. We review the ‘Made in China 2025’ policy, and highlight related investment opportunities as China seeks to move up the global value chain.

What is the ‘Made in China 2025’ plan?
The Chinese government announced its ‘Made in China 2025’ policy in May 2015: a ten-year comprehensive plan to transform China into an advanced global manufacturing economy. It focuses on 10 strategic industries representing nearly 40% of China’s entire industrial value-added manufacturing. Explicit industrial policy goals have been set, with growth and market share targets for strategic sectors and technologies that are to be filled by domestic production. The government is also seeking to improve domestic research and development (R&D), as well as to increase the share of domestically-developed intellectual property (IP) for high-value-added products. Further specific targets include leading the world in artificial intelligence (AI) by 2030.

Can China innovate?
Until the early modern era, China was one of the most innovative civilisations in history; we believe that China could surprise the world as an innovator once again. All the ingredients are in place: increasing R&D spending, higher numbers of patents granted, a large talent pool, growing start-up funding (venture capital and state funds) and government policy support (tax and other). These are the preconditions for a nation to become an innovator.

In terms of support for innovation, government policies should not be underestimated: in order to promote investment and innovation, China offers, since January 2008, a preferential corporate income tax rate of 15% to certified high-tech firms (instead of the statutory 25%). Chinese firms can also claim a tax deduction representing 150% of their R&D expenditure to reduce their taxable income. This combination of a lower preferential rate for certified firms and an R&D-spurring tax deduction ensure that China offers one of the most innovation-friendly tax arrangements among major economies.

Evidence for Chinese innovation capabilities
We provide five ‘pieces of evidence’ in order to prove our case that China is shifting from copycat to innovator: (1) the country’s increasing importance to the Apple Inc. supply chain; (2) the existence of a thriving and globally competitive household appliances industry; (3) China’s global leadership in digital commerce, digital payments, financial technology (‘FinTech’), artificial intelligence (AI) and ‘Big Data’; (4) evidence of ‘catch-up’ capabilities in semiconductors and robotics; and (5) the government’s emphasis on supporting ‘new energy vehicles’ (NEVs). We recommend investors build to our ‘Made in China 2025’ topic, as we believe some long-term winners have already emerged.

China has the most mobile phone and internet users in the world, at about 800 million each. The large number of internet users also mean larger amounts of data generated, which is a critical competitive advantage for Chinese firms, allowing strong technological and commercial development, particularly involving AI. Furthermore, the Chinese government is supportive of commercial ‘Big Data’ usage, with privacy concerns a small barrier to development, unlike in most major and advanced economies. This has led China to become a global leader and front-runner in several high-tech segments, such as digital commerce, which has developed rapidly thanks to rising mobile internet connectivity, improvements in logistics and intensive AI usage.

Investment summary
‘Made in China 2025’ is a blueprint for China to move up the value chain and overcome the middle income trap. The Chinese government will continue to support and promote innovation, which is a major driver of future growth. We recommend investors to build topical exposure to our ‘Made in China 2025’ topic, as some of the winners and dominant firms of tomorrow have already emerged.

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