Why Does China Make So Much?

Chinese ship in Jiangsu, China (photo by Bing Shang on Unsplash.com)

The rush of Chinese products in global markets is not caused by dark strategy or deceitful subsidies. It’s driven instead by something more dry and powerful: the fact that China’s tax and financial systems encourage companies to build more and faster over efficiency and profitability. It’s not ideology. It’s incentives, math, and momentum. And, lest I forget, the Chinese also make good stuff.

Taxation

China’s modern tax system dates back only to 1994. It has been widely accepted by Chinese society and also successful in raising lots of money for the government. Unlike the American model, the system does not rely heavily on income and property taxes. Rather, most of China’s tax revenue comes from value-added taxes (VAT) on goods and services where produced and business taxes. The distinction matters.

Lizzi C. Lee, a Fellow on Chinese Economy with the Asia Society, writes in the current issue of Foreign Affairs that the combined mechanics of government-banking-company in China favors rapid expansion and scale over refinement. She argues that “the internal plumbing of China’s political economy incentivizes business to produce too much stuff.”

In his book The Administrative Foundations of the Chinese Fiscal State, Professor Wei Cui of the University of British Columbia provides additional color emphasizing that China’s tax structure and administration uniquely, and effectively, intertwine social, political, and fiscal orders while sidelining legal norms that have traditionally shaped Western markets. As with most things in the complicated entity that is China, this represents another example of the Chinese doing something we in the West have trouble wrapping our heads around.

Stuff

Ms. Lee and Professor Cui help us understand why China structurally produces so much, as well as why it will be so hard to change meaningfully. But I do not think this is the principal reason why those Chinese-made EV’s, solar panels, batteries, cell phones, machinery, parts, and so much more are the hottest items from Southeast Asia to South America and from Europe to North America.

The simple answer to that question is that China supplies good, high-quality products at prices that people want. In other words, we like their stuff. More than forty years ago, comedian George Carlin began skewering the amount of stuff that Americans amass. “Have you noticed that [someone else’s] stuff is shit and your shit is stuff?” Four decades later, Chinese manufacturing has exploded, matured, and continues to develop, and people around the world are all now super accumulators.

Government-Banking-Company Feedback Loop

Back in China. the systematic feedback loop Ms. Lee explores connects governments, banks, and companies in an unbroken chain of incentives. Local officials are evaluated by the central government based on how much their jurisdictions produce, how many people they employ, and thus how much tax revenue they generate. Promotions and rewards depend on these metrics. The bigger the output, the better the career prospects.

Banks, tightly controlled by the State, reinforce the pattern by favoring large, fast-growing companies they see as safer bets. Companies, in turn, are forced to “copy quickly, scale up even faster, and price aggressively.” Local governments and banks double down to support the companies, ensuring that production, jobs, and tax receipts stay high. Survival in the system comes down to Scale, Scale, Scale.

The downside is predictable. The system that powered China’s meteoric rise now produces thin profits, deflationary pressures, and a resulting drag on further innovation. Savage price wars fuel the need for even greater volumes. The machine keeps running because everyone in it is rewarded for keeping it running.

The central government recognizes that this is a problem, both for its global trade relations and more so for domestic vulnerabilities. The Communist Party has tinkered at the edges, so far unsuccessfully. If this tightly-wound arrangement pops, as another did with real estate in 2021, the threat to stability throughout China will be significant.

Looking more closely at China’s manufacturing excess is illustrative in helping us understand why something that is passionately pilloried has a more prosaic foundation. China pumping out massive quantities of goods is not going away anytime soon. This is in part because of their systematic structure and also because the world keeps gobbling up what they are making.