Service sector has potential to enhance country's prosperity

China's private sector may have grown at an unprecedented speed, taking advantage of new technologies, efficient capital, skilled labor and sophisticated supply chains. But it is still travelling a path envisaged by late Chinese leader Deng Xiaoping 40 years ago, that is, of an efficient supplier of manufacturing goods to the world.

China's just-ended two sessions have signaled a further boost to the private sector. This has been to the advantage of Chinese entrepreneurs and workers, offshore suppliers and consumers across the world. It has also stimulated industrial development through East Asian countries which are part of the regional supply chains, and helped stabilize prices in the Western world, thanks to China's achievements in green technology (solar photovoltaic cells, wind turbines, lithium batteries and electric vehicles).

But countries with traditional manufacturing industries have found it increasingly hard to compete with advanced economies. Many studies have been conducted by economists, and not all agree on the economic drivers. But they point to the efficiency and scale of Chinese production, support of the government's industrial policy, and home-country automation.

However complex the reasons, China's production footprint and trading capacity have now become so large that they appear to "swamp" other countries. Since the COVID-19 pandemic, China's annual trade surplus has reached $1 trillion, which has increased North American and Western European businesses' fears and heightened political tensions.

The US economy has been through a turbulent time — big developments in financial services, energy production and digital technologies offset by a significant contraction in traditional manufacturing.

In recent years, US administrations have seen import competition as a political threat and adopted increasingly aggressive economic policies to deal with it. It is necessary for the US to know how to deal with these challenges but very difficult to do so given the huge uncertainty surrounding US President Donald Trump's policy intentions and threats. Traditional trading ties are now being designed less for economic welfare and more to "safeguard national security".

The incumbent US administration appears to be reverting to a traditional trading policy, that of isolationism. This has happened before — the rebuttal of the League of Nations in the 1920s, the Smoot-Hawley tariffs in the 1930s, the rejection of the International Trade Organization at the 1940s Bretton Woods Conference, and the US' withdrawal from the Trans-Pacific Partnership in 2017.

But isolationism means decoupling from other economies. The US may feel it is possible to double down on its domestic economy, as its external trade represents only about a quarter of its GDP. But it is more complicated this time around because the US is a major part of the world economy, and US-China trade represents the biggest ever bilateral economic interaction in history. Also, for decades the US has led global trade rule-setting. Its recent decisions to withdraw from the World Health Organization, weaken the World Trade Organization, pull out of the Paris Agreement, downgrade other organizations such as the G20, and possibly even abandon the International Monetary Fund and the World Bank, all imply an end to the US' leading role in global affairs.

However, the US is also looking to weaponize its economy. Today, its security policy means restricting foreign access to strategic parts of the US economy. It also adopts aggressive policies to use trade to damage other economies.

There is a risk that a traditional industrial policy response from China — increased production to compete in Western marketsmay further worsen the already tense situation.

Most countries worried over the rising trade tensions between China and the US hope China does not respond more forcefully by adopting an aggressive trade policy. These countries are watching whether China will seek a bigger global leadership role by building on what it has already achieved (such as helping the establishment of the Asian Infrastructure Investment Bank and BRICS New Development Bank), with some countries encouraging China to do so. But this is easier said than done, because China's engagement with organizations such as the WTO has left scars, and the wide use of the US dollar and payment settlement systems will continue.

China could redirect its exports to newer markets to reduce its dependence on the US and Western Europe. But it has already been doing so for some years, with the Belt and Road Initiative helping it in that endeavor.

Besides, Eurasian, Latin American and African markets generate relatively less attractive returns, and as China seeks to diversify its exports, many smaller countries are also trying to reduce their own heavy dependence on the Chinese market.

Furthermore, Chinese foreign investment is still relatively low, even in Southeast Asia. Perhaps China should consider liberalizing border capital controls. It should also consider further off-shoring manufacturing, in order to concentrate on developing innovative technologies, and earning profits by developing high-value intellectual property. This will also expand China's service sector.

China has been taking measures to stimulate private consumption. But China's domestic consumption is still low compared with the US and some other advanced Western economies. This means China has the scope of using macroeconomic policy to create a better environment for boosting private spending.

As most Western economies reached high middle-income levels, their key economic driver shifted from industrial manufacturing to services, with their focus being on design, software, innovation, intellectual property protection, marketing and other professional services. Western companies such as Apple have shown this can be much more profitable than direct production. Such a policy will support neighboring economies, and is less likely to arouse tensions with trading partners.

China's manufacturing sector will continue to grow, but in relative terms, it may have reached "peak manufacturing". The path to prosperity is the service sector.

The author is chair of the New Zealand Pacific Economic Cooperation Council. The views don't necessarily reflect those of China Daily or NZPECC or other affiliations.

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