China: stuck in second division?

Asia, with China at its centre, is set to grow ever richer or so we are told. But what if China fails to emerge and the region falters? As George Magnus of UBS points out in a recent note, "past economic performance is not a good guide to the future".

A World Bank study shows that only 13 of the 101 countries deemed "middle income" in 1960 had become rich or "high income" states by 2011. So it's easy to get stuck in the second division.

What might go wrong in China's case? For starters, says Magnus, the West is hardly down and out. America's lead in cheap shale oil and gas extraction technologies is rapidly lowering energy costs for American firms. Western companies are also set to dominate the "coming global manufacturing revolution" in 3D printing, or "additive manufacturing technology".

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Products are built from computer-generated designs by adding layers of different materials until completion. This localised and customised manufacturing plays to the West's strengths rather than China's. Long global supply chains, large inventories and outsourced large-scale manufacturing will be less important.

The Silicon Valley model of innovation, customised production and after-sale maintenance, will be key. Rising labour costs in China will accelerate the trend. Meanwhile, China might not find it so easy to compete and innovate in its own right. When it comes to global patents, China lags a long way behind the West.

Its innovation and technology shortcomings seem rooted in a socio-cultural and incentive system that discourages radical change and favours quantity over quality. It is telling, reckons Magnus, that until 2003 China was trying to develop high-speed rail and track without foreign help, but eventually had to buy in patents from abroad to get the job done.

Further liberalisation of the economy and an independent legal system would bolster innovation and enterprise. But it's not clear that the new leadership will move far enough in this direction. Vested interests blocking useful reforms are a potential danger. Given all this, China could well get "stuck" in a "middle income trap".