Why China is Winning the AI Race?

This article is an interview with Professor Lan Xiaohuan from the School of Economics at Fudan University, featured in “Wenhua Zongheng”. Professor Lan Xiaohuan is a renowned economist and the author of the bestselling book ” Immersed in the Matter,” which provides a realistic foundation for economics textbooks that were previously disconnected from society. Depicting the role of the Chinese government in economic operations and its resulting impact, the unique mechanisms and evolving intervention methods of the government continuously shape China’s market environment and economic structure. The direct involvement of the government as an economic entity has a crucial influence on contemporary Chinese economy.

Wenhua Zongheng: Your previously published book “Immersed in the Matter” provides a detailed and insightful analysis of the role played by the Chinese government (especially local governments) in economic development over the past few decades and the resulting impact. It tells a unique story that diverges significantly from mainstream economics. Why does the entire framework of this book differ so greatly from that of mainstream economics?

Lanxiaohuan: This is quite natural. If you spend more time in China, you will realize that it is different from the United States. Whether you are studying economics, politics, or society, as long as you don’t stick to textbooks and have a bit of common sense, you will understand that China can never become the United States; their genes are just not the same species. You are an eagle, I am a tiger, each with its own strengths and weaknesses, but I can never become you, as we each have completely different ways.

I established this framework quite early. In 2017 and 2018, I traveled around various regions in China for two years, providing consultancy services to local governments for investment promotion. Our task was to attract large enterprises to Hubei Province through equity investment. Due to the substantial investment amount, I had the opportunity to meet many top investors, entrepreneurs, and work on significant projects. I also had deep interactions with local governments and various departments. These two years brought about a profound change in my perspectives. Previously, as a researcher, you might only get superficial information from various departments, but being on the client side is entirely different. You need to conduct thorough due diligence, have in-depth discussions with people from different departments, and deal with real and valuable information. In the end, you will understand how things are really done.

Essentially, the worldview presented in this book was shaped during these two years. While the content remains quite academic, the perspective has moved away from the Western economic view. Later, when designing a course at Fudan University, I wanted to share with senior students what the outside world is like. After teaching for two years, the pandemic hit, prompting me to write this book.

The most important aspect of this book is changing the perspective on how we view the world. You will come to realize that there is more than one way to do things. The Chinese government deeply involves itself in the economy. Although the Chinese government strongly supports enterprises and exhibits some commercial characteristics, fundamentally it is not a business entity but deeply involved in economic activities. This approach has proven successful as evidenced by the economic growth. If you travel around the world, you will discover that this is an economic miracle.

Wenhua Zongheng: “Immersed in the Matter” actually discusses some successful aspects of Chinese government involvement and promotion of economic development over the past few decades, such as land finance, land revenue, and the competition among local governments for investment attraction. However, in recent years, with changes in domestic and international conditions, including the observed slowing down of China’s economic growth, many people feel that the previous methods of driving economic growth through exports, urbanization, and infrastructure investments may have reached their limits. Therefore, there is a consensus forming that China’s economy needs to undergo a transformation and upgrade, focusing more on domestic demand and innovation to sustain growth. This may imply a necessary transformation in the ways local governments participate in economic development. Therefore, how should governments at different levels adjust their roles in economic development in the future, what challenges might they encounter during this adjustment process, and what issues need to be addressed?

Lanxiaohuan: The term “transformation” is actually a result seen in hindsight, but in reality, the world is a continuous process. In reality, those who are involved in practical operations certainly prefer to keep doing what they used to do, but it’s becoming increasingly difficult now. For example, the methods like land finance and various urban investment companies used to work smoothly before, with established frameworks and business models in place. However, it’s now suddenly discovered that this model is no longer viable. Yet, those directly involved in practical operations cannot suddenly change; they can only explore within the existing framework. This is what we refer to as the process of transformation. Perhaps in 10 or 20 years, people will realize that around 2015-2016, there was a transformation in the Chinese economy. But today, it continues to rely on past practices, although everyone is well aware that it’s challenging to move forward. This issue is not just a concern for local governments; it also pertains to the real estate industry that these practices rely on, which may no longer be sustainable. Therefore, everyone is currently exploring new directions.

In abstract terms, expanding domestic demand and technological progress cannot be achieved simply by switching gears. Ultimately, expanding domestic demand boils down to the issue of increasing the income of ordinary people. This is not something that can be achieved by implementing a single policy; it involves changes in the entire economic structure, distribution methods, and so on. The government may be more concerned with how to increase the income of individuals earning around twenty to thirty thousand a year, which is the lower-income group, to reach fifty to sixty thousand, rather than focusing on raising the income of those already earning over a hundred thousand. Different policy approaches are needed for the bottom 50%, the middle 40% of the middle class, and the top 10%.

For most people, it’s still a matter of increasing income. It may also involve how people in smaller areas in the northwest and northeast can increase their income. Without a source of growth, no matter what one does in those areas, income will not increase. People can only seek opportunities in big cities like Beijing and Shanghai or provincial capitals to potentially increase their income. However, this mobility involves various policies, at least the household registration system needs reform, and various social security measures such as the five social insurances and one housing fund must be in place. Additionally, the hometown should not be too destitute; if it collapses, what will happen to the elderly parents who remain there? Currently, the policy is a dual approach: on one hand, promoting various household registration reforms, with many provincial capitals having a zero threshold since 2020, removing previous restrictions based on education and points-based household registration. For instance, cities like Nanchang and Jinan have almost zero thresholds, except for some very large cities that still have restrictions. On the other hand, developing backward regions, revitalizing rural areas, improving the quality of life for those unable to leave, and allowing those who wish to migrate to do so with peace of mind. The outcomes of these efforts remain unknown, but I believe the direction is on the right track.

In the process of transformation, it’s crucial to avoid a sudden collapse of the old model and refrain from radical reforms, as this could lead to risks of debt defaults. Some local governments are facing financial difficulties during this transition. How can this be addressed? Of course, the central government provides support, but local governments also need to leverage their own assets. For example, while land finance and land finance are no longer as feasible, besides land, local governments also have state-owned enterprises (SOEs), and SOE reforms have been progressing rapidly in recent years. In the past, land was the most convenient asset to use since it required little technical expertise and served as excellent collateral for loans. On the other hand, managing SOEs posed more challenges, involving specific operational issues and complexities. Consequently, substantive progress in SOE reform was relatively slow for many years. However, in recent years, progress has been accelerating. The overarching goal is to improve SOE efficiency, divest non-performing assets, and transform previously stagnant assets into liquid and standardized forms for greater mobility.

Yellow pylons work at a construction site in China.

Various initiatives have been undertaken in recent years, such as establishing alternative platforms between the State-Owned Assets Supervision and Administration Commission (SASAC) and SOEs, such as state-owned capital investment platforms and state-owned capital operation platforms. Previously, SASAC directly managed SOEs, but now it oversees these platforms, allowing for more modern governance through board structures. However, the success of these endeavors and their effects will likely vary significantly across regions. There have also been numerous mergers and reorganizations among provincial state-owned enterprises. In the past few years, many regions have consolidated and restructured their urban investment platforms. Previously, to borrow more funds, a region might have multiple urban investment platforms simultaneously: one for infrastructure investment, one for transportation, one for industrial parks and real estate development, and another for cultural tourism. Now, these are being merged into larger entities to leverage the strengths of the successful platforms to support the less successful ones. With increased asset scale, more substantial funds can be mobilized. In summary, everyone is gradually exploring new paths, with different regions adopting varying approaches, and central SOEs and local state-owned enterprises pursuing distinct strategies.

Currently, those studying SOEs are questioning whether SASAC is undergoing self-reform. Previously, there was a group overseeing each SOE, with SASAC managing the group and the group overseeing the subsidiaries. The goal of current SOE reforms is to restructure these group-like entities into capital operation platforms (state-owned capital investment platforms and state-owned capital operation platforms), with SASAC evaluating these platforms rather than directly managing and assessing the SOEs themselves. However, the timing of implementation and effectiveness of these reforms remain to be seen. Running an enterprise is a highly complex endeavor, and I believe that results may not be visible within just one or two years. While there have been some cases in recent years, the overall progress will likely require a lengthy process, as it fundamentally involves the nature of public capital within the country. This is a significant issue, and the SOE reform attempts mentioned earlier indicate that the country is beginning to address this matter, but progress will only be visible step by step.

Wenhua Zongheng: Could you please elaborate on the issue of how public capital should exist in our country?

Lan Xiaohuan: When it comes to public capital, it’s not necessary to calculate its proportion in the entire national economy. Of course, we can calculate the percentage of public capital in all enterprises. However, this calculation seriously underestimates public capital. After abstracting away specific manifestations, there are four production factors in economics: land, labor (people), capital, and data. Looking at our country’s situation, mines and land are publicly owned; the capital market and a significant portion of the financial system are controlled by the Ministry of Finance. In China, it’s challenging to separate finance from the government, unlike in Europe and the United States. While people are not publicly owned, the four major conditions that enable people to become production factors—housing, education, healthcare, and retirement—are closely related to state ownership. Education, healthcare, and retirement are mainly provided by public institutions, not to mention that land is also state-owned in terms of housing. In other words, a thorough economic analysis should not only focus on the amount of capital but also consider the attributes and operating methods behind each production factor.

Data is the most crucial production resource for the future. China may become the “Saudi Arabia” of the data realm because in future technologies, data is the fundamental input. Major platforms treat data as private property in a disconnected state, but sooner or later, this isolation will end. Our data will eventually be interconnected because true scale and network effects only arise when data is interconnected. Over the past two years, we have seen strong regulatory measures on internet platforms, with a significant portion related to data security and monopolies.

How we view our socialist economic system with Chinese characteristics partly depends on how the world will change in the future. What is crystal clear now is that the ideology of capitalism and free markets that prevailed over the past 40 years has lost its allure. Even the United States has had many reflections. However, the future form will depend entirely on how future productivity develops. This wave of productivity improvement and technological progress will likely replace many people entirely, and the ultimate economic challenge may be a distribution issue: many people may not have jobs and will rely on the government for a universal basic income. This future may arrive sooner than we imagine. Concepts like universal basic income, which seemed implausible when first proposed in the 1980s, are now being taken very seriously by many countries in recent years.

Moreover, to implement universal basic income, a viable method is needed, and digital currency is a feasible option because it bypasses any intermediaries. You don’t need a bank account or social security contributions; each person has a digital renminbi account, and the central bank can directly provide funds. In fact, in terms of digital currency, we are the earliest among all major countries.

China’s official app for digital yuan is seen on a mobile phone next to 100-yuan banknotes.

Wenhua Zongheng: Speaking of which, data is a relatively new production factor that has emerged in recent years. Indeed, over the past decade, the Chinese government has not been heavily involved in the development of the internet. In the future, if the government intends to control this factor, how should it balance its regulatory objectives with the vitality of businesses and economic efficiency from an economic perspective?

Lan Xiaohuan: We can no longer approach data regulation with traditional thinking. Once all data is interconnected, the shape of businesses, regulatory objectives, and efficiency may be entirely different under new technologies. I am not certain about the future, but I am sure it will not be the same as it was in the past. The final form may involve taxing robots, AI, and algorithms, then using the proceeds to support those who have been replaced; or perhaps another approach, where robots and data are state-owned. The rationale behind both scenarios is the same: to achieve redistribution. In the midst of this explosion in productivity, the most critical issue is no longer about incentive mechanisms. Previously, the core of all social security and welfare system designs revolved around incentive mechanisms to prevent idleness, as society cannot sustain a large population of idle individuals. The fundamental philosophy of future public policies will be about redistribution, discarding the concept of idleness because the production process no longer requires your participation. This represents a profound transformation. Amid this technological and societal shift, the system that can sustain without collapsing will have a significant advantage. Countries that can effectively manage data and algorithms, handle unemployment, and have the foundational concepts, institutional framework, and technological infrastructure for redistribution will experience a relatively stable transition during this societal transformation. Certain Western scholars speculate that China may hold institutional advantages in the technological revolution of the 21st century based on these considerations, and there is some merit to this viewpoint.

Wenhua Zongheng: This is actually a relatively long-term perspective. In the short term, since the end of 2020, our country has been continuously strengthening supervision over internet companies. Initially, many people thought this was the right approach because everyone was fed up with the expansion of these internet platforms and their comprehensive penetration and influence on people’s lives. However, as time goes on, voices from the economics field, including the political field, will also emerge questioning whether excessive regulation or restriction will affect the competitiveness of Chinese internet companies internationally.

Lan Xiaohuan: Regarding the regulation of these technology and internet companies, I think it may exceed the current cognitive framework of academia. Some still treat internet companies as ordinary businesses and then think about operational and incentive issues. This may not be fundamental. From a data perspective, if China wants to become the Saudi Arabia of the data world, it may need to think more about the public and resource attributes of data. How to construct the regulatory model for these companies is an exploratory process and a continuous interaction between the government and businesses. It may start off strict, causing some negative effects, then as time goes on, both companies and the government will adjust. It can only be said that the so-called “barbaric growth” state of the past decade will definitely not continue. Recently, the National Development and Reform Commission issued a notice seeking opinions on the “data basic system view,” listing a plethora of viewpoints on the data basic system which everyone can take a look at, as it is very interesting.

Wenhua Zongheng: Based on the reports and documents issued by the central government in recent years, apart from data, what adjustments and reforms will be made to the other three production factors in the future?

Lan Xiaohuan: Let’s talk about land first. Land is originally in the hands of the government. For the government, what needs to be done in the future is to activate it, that is, to use land more efficiently. In recent years, there has been an attempt to conduct cross-provincial transactions of construction land indicators. People from the northwest have all moved out, so why do they need so many land indicators? Although Shanghai still has land, it lacks construction land indicators, which led to the cross-provincial transaction of construction land indicators. For example, Shanghai seems to have bought 30,000 mu of construction land indicators from Yunnan. With these indicators, Shanghai can develop another 30,000 mu of construction land, and correspondingly, Yunnan will have to open up 30,000 mu of arable land. Currently, the trading method is that the buyer’s local government applies for indicators from the State Council, the buyer transfers the money to the national treasury, and then the national treasury transfers it to the selling local government, mainly for local poverty alleviation and maintaining farmland. Not every place can be a seller right now; the current regulations are the “Three Zones and Three States”: Tibet Autonomous Region, Tibetan areas in Qinghai, Sichuan, Gansu, Yunnan, the four provinces, southern Xinjiang, Liangshan in Sichuan, Nujiang in Yunnan, and Linxia in Gansu.

The reform ideas for these four factors, such as land and household registration, are aimed at enabling the flow of land and labor nationwide, which is the so-called marketization of factors. Of course, the ownership of these production factors has not changed, but it is hoped that they will flow in a more market-oriented manner. If they do not flow, how can they be marketized? People must move to have market value; there is also a lot of stagnant capital that cannot move, but once state assets become capital, they become standardized and can move. Data is similar; previously, the data of various internet platforms were not interconnected, but now platforms are required to open up external links.

In conclusion, on one hand, the country emphasizes its own leadership, and on the other hand, it promotes marketization. This is how China has reformed in the past. Specific products were marketized first, and the dual-track system was pushed forward; when product market competition became fierce and pricing became more market-oriented, the marketization and property rights reform of factors were promoted; with product competition enhancing efficiency, there was international market competition and competition among various regions within the country. When product markets were liberalized in terms of pricing and competition, it was discovered that the quality and prices of products from state-owned enterprises were not as good as those from private or foreign enterprises, and they could not even be exported; to become more efficient, the ownership of state-owned enterprises should also be reformed, leading to the establishment of a corporate system and shareholding system. This is the experience of China’s gradual reform. The Soviet Union, on the other hand, attempted property rights reform without first setting up product markets, which resulted in economic collapse and oligarchic plunder. Later, China also carried out many property rights reforms, especially in separating ownership and usage rights.

Wenhua Zongheng: Over the past few decades, China’s economic rise can be attributed not only to government participation but also to its accession to the WTO and international markets. However, with the rise of European and American protectionism and the new trend of China-US trade friction, the external conditions that propelled China’s economic growth in the past have changed. How do you think these new trends will challenge the ways in which the Chinese government engages in the economy?

Lan Xiaohuan: First, in terms of who closes their doors first, they will be the first to suffer. If the United States closes its doors, the United States will suffer. The economies of scale in the market are even more significant than technology, so in the end, there will definitely be only one global market, not two. Those who attempt to fragment the market will be the first to perish. The Soviet Union ultimately perished due to its isolation. It is impossible to stifle technological progress, but it is possible to stifle market access. If technological suppression were successful, we might still be in the era of the British Empire, with no Germany, United States, or Japan. Technological catch-up is only a matter of time; latecomers will inevitably catch up because scientific knowledge cannot be blocked. Latecomers simply lack knowledge of how to develop technology and processes. The logic of chip design is very clear, known to industry professionals, but it is challenging to execute in reality due to insufficient time spent and knowledge acquired.

If the West wishes to fragment its market, it is a very challenging task, entirely different from the Soviet Union. The Soviet Union managed to isolate itself from the international market because it was driven by extreme political ideology, harboring animosity towards capitalists, which enabled it to prohibit profit-seeking by capitalists. This is impossible for capitalist countries because their politics are meant to serve capitalists. The essence of capital lies not in technology but in the market. It may be feasible to divide Russia’s market as its economic scale is relatively small. However, with the vast size of the Chinese market, how likely is it to be divided in the United States?

Secondly, China’s stance on openness has been consistent. Despite frictions, the signal over the past three years has been very clear: the doors of openness will continue to widen, never closing.

Thirdly, there are 8 billion people in this world. Instead of focusing solely on the 1 billion people in Europe, North America, Japan, and South Korea who have a better standard of living than us, we should also consider the five to six billion people whose living standards are lower than ours. Do they not have needs? These are the growth points of the future economy. Those who isolate themselves from this global market will undoubtedly decline.