Process knowledge to build manufacturing capabilities

China may be the best modern illustration of Joel Mokyr’s argument that growth and development happen when propositional knowledge is translated into prescriptive knowledge through dense networks. Without explicitly articulating using this framework, the narratives described in Patrick McGee’s Apple in China (see this and this) and Dan Wang’s Breakneck demonstrate the essence of Mokyr’s argument.

The fundamental point is that both Apple (through iPhone) and Western multinational corporations in general helped China by transferring useful knowledge (what Wang calls ‘process knowledge’) and creating rich industrial ecosystems seeped with technical expertise acquired iteratively over several years. It helped that China, like the pre-Industrial Revolution England, had a culture that gave primacy to the acquisition of useful knowledge over theoretical propositional knowledge. 

I just completed Dan Wang’s book, Breakneck. The big premise of the book, the reason why the US is lagging behind China in making things is because the former is ruled by lawyers and the latter by engineers, is too simplistic and questionable. Jonathon Sine has an excellent critique. 

However, the book has a compelling explanation for how and why China built up its manufacturing prowess. It echoes the description by McGee of how Apple’s intense and long-drawn engagement in the co-creation of Foxconn’s iPhone manufacturing capabilities played a critical role in the development of China’s world-beating manufacturing ecosystem of designers, tooling engineers, component suppliers, managers, and assembly-line workers. This is a good description of the emergence of the ecosystem.

The smartphone components were getting better every year, part of a trend that Chris Anderson, former editor of Wired, called “the peace dividend of the smartphone wars.” The hundreds of billions of dollars invested in the smartphone supply chain have caused the cost of electronic components – cameras, sensors, batteries, modems – to plummet. That’s why we are able to carry around sensors in our pockets that used to be available to only a select few military powers.

Many companies have grown around this peace dividend. Indeed, Shenzhen is the headquarters of many of China’s most dynamic companies, including BYD, the world’s largest EV maker; DJL, the world’s largest consumer drone maker; and Huawei, the beleaguered company that is the world’s largest telecommunications equipment maker. Electric vehicles are full of electronic components borrowed from smartphones; the consumer drone is roughly a reassembly of a smartphone camera and sensor with propellers for flight. The magic of Shenzhen in the combination of the world’s most creative hardware engineers sitting in a sea of components that improve every year amid a labour force of millions who know how to put together electronics. This buzzing ecosystem has produced many other products that follow in Apple’s wake, like hoverboards, electric scooters, virtual reality headsets, and who knows what’s next?

Wang highlights the importance of three aspects of technology in production, specifically the last aspect of process knowledge. 

First, technology means tools. These are the pots, pans, knives, and ovens required to prepare a dish. Second, technology means explicit instruction. These are the recipes, the blueprints, the patents that can be written down. Third and most important, technology is process knowledge. That is the proficiency gained from practical experience, which isn’t easily communicated. Ask someone who has never cooked before to do something as simple as fry an egg. Give him a beautiful kitchen and the most exquisitely detailed recipe, and he might still make a mess…

Process knowledge is hard to measure because it exists mostly in people’s heads and the pattern of their relationships to other technical workers. We tend to refer to these intangibles as know-how, institutional memory, or tacit knowledge. They are embodied by an experienced workforce like Shenzhen’s. There, someone might work at an iPhone plant one year, for a rival phone maker the next, and then start a drone company. If an engineer in Shenzhen has an idea for a new product, it’s easy to tap into an eager network of investors. Shenzhen is a community of engineering practice where factory owners, skilled engineers, entrepreneurs, investors, and researchers mix with the world’s most experienced workforce at producing high-end electronics.

Silicon Valley used to be like this too, but now it lacks a critical link in the chain – the manufacturing workforce. The value of these communities of engineering practice is greater than any single company or engineer. Rather, they have to be understood as ecosystems of technology. The American imagination has been too focused on the creation of tooling and blueprints. Andy Grove, the legendary former CEO of Intel, said it best in 2010: that the US needs to focus less on “the mythical moment of creation” and more on the “scaling up” of products. Grove saw Silicon Valley transition from doing both invention and production to specialising only in the former. And he understood quite well that technology ecosystems would rust if the research and development no longer had a learning loop from the production process…

American manufacturers spent the better part of the last three decades unwinding its stock of process knowledge when it opened so many factories in China. Every US factory closure represents a likely permanent loss of production skill and knowledge. Line workers, machinists, and product designers are thrown out of work; then their suppliers and technical advisers struggle as well. Entire American communities of engineering practice have dissolved, leaving behind a region known as the Rust Belt. Some mayors and governors tried to step this receding tide. But they were continuously scorned by economists and executives, who sought low-wage production in the name of globalisation. Still today, many American economists doubt there is anything special about manufacturing and put their faith in the inevitable march to a service economy…

It became part of the elite consensus that the US could lose manufacturing. This consensus portrayed union bosses, as well as the handful of heterodox economists, as sentimentalists for resisting offshoring. Neither the Clinton nor the George W Bush administration restrained American firms from moving manufacturing operations to China. Now, it’s more obvious that the departure of manufacturing has created economic and political ruination for the US. We are still only beginning to understand how much it set the country back technologically…

If we think about technology ecosystems as communities of engineering practice, it makes sense that factory closures accelerated as process knowledge dissolved, prompting production problems and more job losses. And it also makes sense that Chinese workers went from merely assembling iPhones to producing some of their most valuable components as well. As one country lost its process knowledge, the other gained whole industries.

He describes how Tesla contributed to the development of China’s emerging dominance of EV car manufacturing.

Beijing did something unprecedented for Tesla in 2018: it allowed the company to fully own its plant in Shanghai. Previously, any automaker that wanted to produce in China had to partner with a domestic company. So Japanese, German, and American companies dutifully partnered with state-owned enterprises in order to access the enormous market. The state had hoped that these domestic companies would learn from the likes of Toyota and Mercedes-Benz and match their quality. In reality, Chinese automakers were sluggish from their research dependence on their foreign friends.

Tesla’s presence jolted China’s EV market. China’s business community began using the term “catfishing” for what Tesla was doing in China. The idea was that introducing a powerful new creature into the domestic environment would make Chinese firms swim faster. That’s exactly what they did to raise their game. When Tesla vehicles started rolling out of the Shanghai Gigafactory in 2019, BYD saw its sales decline by 11%, while profits fell by 42%. But Tesla would eventually do the whole market a favour. As in the US, the company’s audacious branding stimulated consumers to think of EVs as more than high-powered golf carts. And Tesla made investments in China’s tooling ecosystem that other automakers exploited to produce better cars. BYD benefited as well, reporting record profits in 2023 and becoming the world’s largest EV maker. And even the Communist Party’s main newspaper praised how Tesla produced the “catfish effect” for Chinese firms.

As Grace Wang, founder of Shenzhen-based Luxshare poetically expressed, “Flying with phoenixes will nurture outstanding birds.” It is another lesson that capitalist Shenzhen has taught the Communist Party: Market competition tends to lower prices and raise quality. 

Apple and Tesla have made a huge effort to train its Chinese workers to manufacture their products – and earned fabulous sums of money by doing so. These stories are replicated in varying degrees across China’s other communities of engineering practice, production hubs for shoes and garments in the eastern city of Wenzhou, medical equipment in Wuxi and Suzhou, and, most wonderfully of all, guitars in the mountains of Guizhou’s Zheng’an County. Overall, China’s manufacturing workforce employs more than a hundred million people, around eight times that of the US (13 million in 2025)… 

American companies have spent two decades building communities of engineering practice in China, made up of people who roll up their sleeves to figure out how to overcome their daily bottlenecks.

At the heart of this narrative about economic growth is the importance of persistent and boring implementation, over the Aha! moment of inspiration presented by ideas and inventions. This is a good summary:

Americans expect innovations from scientists working at NASA, in universities, or in research labs. They celebrate the moment of invention: the first solar cell, the first personal computer, first in flight. In China, on the other hand, tech innovation emerges from the factory floor, when a new product is scaled up into mass production. At the heart of China’s ascendancy in advanced technology is its spectacular capacity for learning by doing and consistently improving things… The US likes to celebrate the light-bulb moment of genius innovators. But there is, I submit, more glory in having big firms making a product rather than a science lab claiming its invention… Every day, millions of workers in factories to build up technological process knowledge. That is the basis of China’s tech power. China has become a tech superpower by exalting process knowledge and the communities of engineering practice that keep it alive.

There are a few observations that are of relevance for India as it charts its journey of building a globally competitive manufacturing base. 

1. Mokyr points out that the Industrial Revolution happened in England and not continental Europe, and attributes this to its culture of tinkering and refining, and interest in material progress. This required useful knowledge that the fabricants could use, as against the more theoretical and esoteric knowledge that savants created. 

Similarly, China had a culture of pursuing process knowledge. When faced with competition from Apple and Tesla, instead of folding up and retreating, these companies leveraged the ecosystems of process knowledge and engineering practice created by Apple and Tesla. They fought back to build their own products and compete (and outcompete) the foreigners. Huawei, Oppo, Xiaomi, Vivo, BYD, Geely, SAIC, Nio, Xpeng, and so on are the outcomes of this. 

Do Indian manufacturers and startups have the culture to embrace process knowledge, iterate diligently, build ecosystems of engineering practice, and move up the value chain? What are examples from India of such technology or industrial ecosystems that stand at the cutting-edge of their sectors?

2. The conventional wisdom on industrial progress, especially in technology-intensive sectors, is that of academia and industry working together to co-create products by transferring research into development at an industrial scale. While this is the approach that the US and other Western economies followed, China appears to have taken a different direction. Instead of spending time on the generation of propositional knowledge in its research institutions, it borrowed (or copied) this knowledge from wherever available and focused on the prescriptive knowledge required to scale up manufacturing. This is the classic industrial tinkering model.

Chinese firms rely on academia more in terms of getting skilled manpower to work in their factories. With the government’s guidance, Chinese colleges and universities have been running courses on niche areas like battery chemistry and rare earth processing for several years. They have kept flowing a continuous supply of high quality skilled workforce. 

This is of particular relevance for India, where academia-industry collaboration is limited, but also where industrial R&D is abysmally low (0.7% of GDP compared to China’s above 2.5% of GDP). Indian firms must necessarily multiply their R&D expenses manifold if they are to create the vibrant and high-productivity industrial ecosystems like those in China. They must invest in nurturing a culture of engineering excellence that seeks to constantly innovate and aspire to the global frontier of quality and technology. 

3. Another feature of Mokyr’s arguments and China’s success is the importance of clusters in producing things. A manufacturing base does not emerge in isolation from the production of individual firms. It requires the creation of ecosystems of engineering practice, where skills and expertise are transferred through learning by doing, and knowledge and technology spillovers. Clusters enable the diffusion and spread of process knowledge among businesses and their suppliers, and among competing firms. 

Massive industrial clusters have been central to the development of China’s manufacturing prowess. China has more than 500 towns that specialise in specific products for the global market, with some being responsible for 63% of world’s shoes, 70% of its spectacles, and 90% of its energy-saving lamps. Sample this from Wang,

Every year, as new models emerge, Apple needs new components or processes that a new design requires, like a certain type of adhesive or a screw of a slightly different size. Therefore, Apple constantly had to scramble to find suppliers on short notice. “Almost always, “the engineer continued, “we found someone in Shenzhen by asking a guy who knows a guy whose cousin might be able to produce a few hundred thousand new screws.” Virtually everything one needs to produce any electronic product can be found in a short drive around Shenzhen. Proximity creates efficiency. When it’s time to do stuff, a company can collapse coordination that usually takes weeks into a business meeting lasting hours by convening all the relevant suppliers in one room the next morning. And if something goes wrong, there are a lot of friendly neighbouring factories to call.

Unfortunately, India’s efforts in this direction, primarily in the form of SEZs, have been constrained by the size of these clusters. I blogged here on how the lack of clusters has been a constraint to the emergence of scale manufacturing in India. 

4. The creation of globally competitive ecosystems of engineering practice that value process knowledge for continuous improvement invariably sets in motion something like the Red Queen Effect. Companies must adapt and evolve continuously to even maintain the relative status quo in the highly competitive and dynamic global marketplace. 

Only firms exposed to global competition have the incentive to pursue this strategy. The incentives of firms in a closed market, or those happy with serving a large segment of their domestic market, will be only to minimise costs. They are likely to discount quality and technology. In simple terms, Indian firms must necessarily Make in India for the World.

There’s the real risk that Indian firms will remain entrapped in the bad equilibrium of making less than competitive products for India’s large price-sensitive consumer base. 

5. The example of how Chinese companies responded to the competition from Tesla is a testament to the aspirations of Chinese companies. In a short period of time, BYD and Co. were able to turn the tables on Tesla and emerge as undisputed global leaders in EVs. They first copied the engineering excellence of Tesla and continuously improved on it to then gradually surpass it. Underpinning this was the communities of engineering practice created by Tesla. 

In contrast, as I have blogged on numerous occasions, Indian companies, across sectors, have struggled to innovate and become globally competitive. 

The Ken has an article about how the garment makers of Tirrupur, who contribute over half of all India’s knitwear exports, failed to innovate and are now fighting to survive the loss of the US market. They remained stuck with the commoditised and lower value-added bulk supplies of cotton garments to the large US retail clients, with their low margins and large volumes, but stable and assured demand. They missed the opportunity to shift to man-made fabrics earlier and to blended fabrics in recent years, and did not venture into the higher value-added and higher margin mid-sized European who are much more demanding on fashion trends and quality. 

It will be extremely challenging for Indian companies to match the resolve and ambition shown by the Chinese EV manufacturers, nurture communities of engineering excellence, and become globally competitive. 

In conclusion, stripped of all the jargon and in simple terms, Mokyr’s work and the success of China is a big shout-out to the strategy of progress through continuous problem-solving and iterative adaptation, one which has relevance far beyond mere building of manufacturing capabilities to many things in life in general.

Weekend reading links

1. Lawrence Freedman has a good history of recent years of the Middle East.  

2. The US equity markets are a seven-trick pony.

See also this.

This is a good graphic of circular deals in the US AI ecosystem.

3. Greek PM Kyriakos Mitsotakis urges caution on the green transition.

The green transition cannot be an end in itself. For many years, Europe elevated decarbonisation above everything else. Other goals — employment, industrial production, strategic autonomy — these lost when they went up against decarbonisation. We cannot afford to stay on this path. Decarbonisation is vital but it is not the only objective. If we must accept some emissions for a bit longer to save our industries or to maintain social cohesion, so be it. We must have these debates honestly. We cannot begin with climate neutrality and hope everything else falls into place.

4. Friedrich Merz and Germany facts of the day

According to pollster Insa, two-thirds of Germans now say they are dissatisfied with the ruling coalition — a 20 point increase from June. Merz, never especially popular, is bearing the brunt: he has slipped to 18th place in Bild’s ranking of preferred politicians, trailing six of his coalition ministers and AfD co-leader Alice Weidel... Core German industries are shrinking, he laments. German steel output declined 12 per cent in the first half of this year compared with last year. And car manufacturing plants, which produced nearly 6mn vehicles in 2017, three-quarters of which were for export, now produce 4mn.

Germans don't seem to like Gerhard Schroeder and his acclaimed (outside the country) Harz reforms.

Schröder’s reputation has been tarnished by his Kremlin ties; he joined the board of Russian state-owned oil group Rosneft and lobbied for the building of Nord Stream’s second gas pipeline between Russia and Germany. Within the SPD, his so-called Hartz labour reforms, which spawned low-paid minijobs and triggered high-profile party defections that helped to create the leftist Die Linke party, remain a toxic legacy. “In DC at an IMF meeting, in Paris at the OECD or in Singapore you mention the ‘Hartz’ reforms, everyone applauds,” says a former SPD government official. “At any local SPD convention, the room temperature drops five degrees.” The SPD — which in February recorded its worst election result since the late 19th century, with a 16 per cent share of the vote — has spent the past two decades seeking to roll them back. These efforts led to a minimum wage in 2015 and culminated with the Bürgergeld, the latest version of a tax-funded basic income for the jobless or underemployed, introduced in 2023.

5, Tesla's third quarter profits fell by a quarter and operating margin dived from 10.8% to 5.8%. Similar trends in income from regulatory credits,

Income from regulatory credits trading plunged 44 per cent to $417mn in the quarter after the US government reduced fines for non-compliance on car emissions standards to zero, in effect killing the trading schemes. Tesla made $2.8bn in profit from trading programmes last year, with about three-quarters of that coming from the US.

6. Janan Ganesh is perhaps the most brilliant FT columnist. Highlighting the gushing and alarmist commentary about AI, he makes the point that history is made through politics and not technology.

Well, Earthlings, here are some entirely realistic scenarios in politics over a shorter time range. France elects a hard-right president who, without leaving the EU, impedes it from within until it ceases to function. Russia does something to a Nato member state that appears to constitute an “armed attack” under Articles 5 and 6 of the Treaty. The Sahel — where more than half politiof all terrorism-related deaths on Earth now take place, compared to hardly any in 2007 — becomes a base for attacks on the west. (Think turn-of-the-millennium Afghanistan, but much closer to Europe and America.) Britain or France or both suffer a bond crisis that triggers, at best, a necessary change in economic policy, and at worst civic unrest. These subjects don’t go undiscussed, of course, but the amount of oxygen they receive compared to tech talk is out of line. 

As a rule of thumb, be sceptical of any “futurologist” who doesn’t major overwhelmingly on politics. The grandest visions for AI — huge consumer surplus, huge job losses too — could happen. The departures of Xi Jinping (72) and Vladimir Putin (73) are going to happen, with implications for multitudes even outside their own two countries. The spread of possible outcomes is wide: from a détente between the west and the Eurasian autocracies under a new generation of leaders to an even higher pitch of conflict that is harrowing to think about. So, by all means, speculate about the potential of tech. But understand that one or two completely plausible political developments would drown out any effect that tech is likely to have on daily life. Even a modest trend, such as Europe’s projected increase in defence spending, has implications for taxes and therefore private consumption that it would take a major innovation to equal or cancel out. 

Consider the very recent past. Nothing has affected businesses and consumers since the pandemic as much as the surge of inflation. Whatever you choose to cite as the culprit — the Ukraine war, monetary looseness, lockdown-induced damage to supply chains — it was political. That experience should have reminded us of the primacy of the public realm. Instead, the fascination with technology as the shaper of realities has only increased over the period.

7. From a CAG performance audit report on the state of ULBs in 18 states of India.

According to the audit, on average, only 4 out of the 18 powers under the 12th schedule are fully under the autonomous control of ULBs, with most functions being performed with regular interference from the state government or parastatals, often without any representation from local bodies. In addition, ULBs are being deprived of making their own recruitment decisions, as the staff assessments are conducted by the state government, leading to frequent underestimation of personnel requirements... This lack of autonomy has not only resulted in fewer sanctioned positions but has also left one out of three posts vacant across the 18 states, depriving ULBs of the human resources necessary to carry out their functions properly... According to the report, 61 per cent, or 1,600 of the 2,625 ULBs in 17 states assessed, didn’t have an elected council, with only five states appointing a mayor through a direct election.

8. Amidst all the alarm about public debt, Martin Sandbu points out that borrowing costs are high only compared to the 15 years or so of after the GFC of very low interest rates. He points out that the US government now devotes the same share of GDP to interest paymens as it did in the late nineties, just under 4%.  

9. Kai Wu has the graphic that sums up the dilemma facing AI companies. 

10. China's scale of excess capacity is staggering.

China now makes 55 per cent of the world’s steel, 57 per cent of commercial vessels, 76 per cent of lithium-ion batteries, more than 60 per cent of EVs, and 80 per cent of photovoltaic products, despite chronic involution gripping these sectors... The country now has 58 satellite makers and 30 rocket companies and more than 60 humanoid robot manufacturers. Domestic commentators already warn of capacity outstripping demand and of companies needing to “go out” to foreign markets to survive. The pattern repeats itself: what begins as glut at home could end as supremacy abroad.

Chinese firms in these sectors with such levels of excess capacity must aggressively pursue export markets. They must also slash costs relentlessly and surive on razor-thin margins, or increasingly assume losses. But the limits to such export-led growth are now evident. 

11. As rare earths become one of the hottest commodities, Australia has emerged as the global leader in spending on the exploration of these minerals.

Interesting that India has the third largest reserves.

12. Edward Luce on Trump's America that is gripped by fear.

Revenge is one of Trump’s three recurring impulses. The others are making money and dominating the airwaves. Dissenters hinder each of these aims. Presidents of universities, chief executives of Fortune 500 companies, partners at law firms and senior military privately despair at Trump’s methods. But each has sound stakeholder reasons for keeping their concerns private. Universities stand to lose billions of dollars of federal research funds; chief executives and their workforces face regulatory reprisal; law firms end up on federal blacklists; soldiers are trained to uphold the chain of command... people are scared of crossing Trump this time. In researching this piece, I interviewed dozens of figures, including lawmakers, private sector executives, retired senior military figures and intelligence chiefs, current and former Trump officials, Washington lawyers and foreign government officials. Such is the fear of jail, bankruptcy or professional reprisal, that most of these people insisted on anonymity. This was in spite of the fact that many of the same people also wanted to emphasise that Trump would only be restrained by powerful voices opposing him publicly. At times, it has felt like trying to report on politics in Turkey or Hungary...

As a rule of thumb, the more an organisation has to lose, the likelier it is to submit to Trump’s demands... Under threat of being debarred from the federal government, and thus losing corporate clients, many big law firms have declined to hire or represent people on Trump’s enemies list. “It’s not a list but I think there will be others,” said Trump after Comey was indicted. The universe of lawyers who would represent his targets has shrunk dramatically. None of the team who worked for Jack Smith, Biden’s special counsel who indicted Trump for allegedly attempting to overthrow the 2020 election and hoarding classified documents in Mar-a-Lago, has since found a job. Family members are not spared. Maurene Comey, the former FBI chief’s daughter, was fired as a federal prosecutor in July. The pleas of staff to FBI director Kash Patel not to fire a senior official whose wife was dying of cancer fell on deaf ears.

Technocracy and fiscal management

I have blogged on multiple occasions, pointing to the perils of excessive reliance on experts. 

Central banks are considered the epitome of technocracy in economic policymaking. Much has been written about how independent central banks manned by technical experts and using technical rules like the Taylor Rule and inflation targeting have tamed inflation and ensured macroeconomic stability. Never mind the several questions and disputes surrounding this narrative. I have blogged here, here, here, and here, trying to place central bank independence and competence in perspective. 

Since the global financial crisis, there has been an extraordinary expansion of the toolkits used by central bankers. Policies like quantitative easing, yield curve control, purchases of corporate bonds, forward guidance, and so on, all emerged anew into the monetary policy basket under the leadership and technical expertise of academic scholars and experts like Ben Bernanke and Janet Yellen. These policies have been hailed for rescuing and restoring the economy and financial markets, both during the GFC and after the COVID-19 pandemic.

However, it is now apparent that the long period of monetary accommodation engendered by these policies, under the watch of esteemed experts, has contributed to an addiction to cheap money, perpetuated zombie companies, turbocharged financial models like private equity, and inflated financial market bubbles. It’s a legitimate and very compelling argument that these policies have prevented the small recessions necessary to clean up excesses and realign incentives. 

Instead of technocracy binding politicians to the mast and restraining them from the pursuit of excessively loose monetary policy, the expert central bankers appear to have shown the politicians the way with new toolkits to perpetuate cheap money policies. The most egregious expression of this reshaping of expectations is Donald Trump’s demands from the US Federal Reserve. 

This fetish with technocracy is not confined to central banking. Based on the successes attributed to technocratic central banking, economists have argued in favour of fiscal councils to independently evaluate and monitor the expenditure and tax policies of governments. They say that fiscal councils, with their independent role, can counter the deficit bias of governments and prevent fiscal dominance. Accordingly, many Western countries have some form of fiscal councils. 

In this context, Andrew Haldane, former Chief Economist of the Bank of England and one of the most respected economic commentators, has set the cat among the pigeons by questioning the role played by the UK’s Office of Budget Responsibility (OBR) in the country’s fiscal management. The OBR was established in 2010 to provide an independent assessment of the country’s public finances and thereby depoliticise fiscal policy analysis. It mimics the independent fiscal policy councils operating in some countries, which provide an independent view on the Government’s macroeconomic forecasts and fiscal decisions. 

However, the OBR’s role goes beyond mere assessment of fiscal policy to playing the central role in making macroeconomic forecasts and assessing the impact of fiscal measures. It had, as Haldane writes, “monopoly rights over judgments on debt sustainability.” In other words, the Treasury outsourced its role in this to the OBR, including transferring much of its in-house expertise to do this role. This was a pure form of technocracy. 

Haldane says this outsourcing to a technical entity has contributed significantly to the UK’s current economic stress by subordinating economic growth to excessive fiscal discipline, with its inevitable political consequences. 

Since 2010, fiscal policy has involved delicately balancing measures to stimulate growth with maintaining fiscal discipline. The OBR’s mandate covers only the second. Its scoring of fiscal measures decisively tips the institutional balance towards conservatism over growth. Or rather, it has reinforced the Treasury’s long-standing fiscal-first instincts… After years of under-investment, the UK’s public sector capital stock is estimated to be around £2tn lower than its international counterparts in 2019, a gap almost certainly larger now. Not coincidentally, growth has stalled. An unedifying sequence of gossamer-thin growth plans has been accompanied by mounting political disquiet at OBR conservatism.

This culminated in Liz Truss’s decision to sideline the OBR in preparations for the fateful 2022 “mini” Budget. The resulting bond market meltdown led present chancellor Rachel Reeves to hardwire OBR assessments into fiscal events, making the de facto monopoly de jure. Buyer’s remorse has been rapid. With a weakening outlook and far too little fiscal wriggle room, Reeves finds herself impaled on the OBR’s horns. On its educated guesses — and that inevitably is what they are — now hang the fortunes of the chancellor, the economy and tens of millions of taxpayers… Nigel Farage, whose Reform UK party leads comfortably in opinion polls, suggests that weak growth is the OBR’s fault.

As Haldane writes, the OBR appears to have done its job all too well, only to the extent of squeezing hard on economic growth itself. In this backdrop, Haldane’s suggestion is to limit OBR’s role to auditing the Treasury’s assessments. 

One way of freeing the government’s fiscal hands is by partially taking back control of fiscal assessments. Outsourcing your brain is rarely wise. As with the Bank of England for monetary policy, the Treasury should produce and publish its own economic projections and assessments of fiscal choices. The OBR’s role, as in other countries, would then be to audit these assessments. With the Treasury no longer as tightly bound by OBR conservatism, the institutional balance would be tipped towards growth while preserving independent scrutiny. Increasing transparency around fiscal choices improves public debate.

In the context of the debate about the superiority of independent technocratic entities like central banks or fiscal councils, especially given the fiscal bind in the UK, India’s post-pandemic experience is instructive. 

The country’s fiscal framework, enshrined in the Fiscal Responsibility and Budget Management (FRBM) Act, mandated governments to keep their gross budget deficits under 3% of the GDP, a benchmark that has no objective basis but was straight borrowed from the EU (where, too, it was forced without any objective basis). While it was never strictly followed (except for state governments), it nudged successive central governments not to stray too far from this number. 

The pandemic helped break away from this constraint and allowed the central government to find an average of nearly 2.5 percentage points of GDP of additional fiscal space (comparing the six years immediately before the pandemic with those immediately after). This additional fiscal space has been critical, almost single-handedly responsible, in sustaining and boosting economic growth. It is to the government’s credit (a surprisingly less acknowledged thing) that it used this additional fiscal space not to dole out subsidies and other revenue expenditures, but on good-quality capital expenditures that created durable assets, and also to clean up its budget books. 

The big post-pandemic fiscal deficit and the failure to reverse course quickly to the FRBM benchmark raised criticism from experts and opinion makers. They warned of macroeconomic instability, a surge in public debt, capital flight, growth squeeze, and a knock-on effect on the equity markets. None of these has materialised, and, despite the headwinds from global uncertainties and weaknesses, the Indian economy remains in reasonably good shape. 

Inflation has been low and growth high, especially when compared to peers and advanced economies. In fact, while it will be a matter of debate, there may now be a case to even revisit the fiscal framework to anchor the benchmark at about 4% of GDP.

The point here is not to reject technical expertise and technocracy in macroeconomic policymaking and public policy in general, but to caution against excessive reliance on them. Public narratives tend to endow them with expertise and prescience far in excess of what they possess, especially in complex areas like macroeconomic decision-making. Given the deeply political nature of these decisions, it’s more appropriate if they are taken within governments, by drawing on the inputs and expertise of technical experts.

China update - October 2025

This is the latest in the series on the Chinese economy. This post will look at some of the emerging macroeconomic problems and how the country built up its current dominant position in clean energy technologies. 

A big problem facing the Chinese economy is the problem of neijuan, or involution (excessive price competition) in a fiercely competitive domestic market. It has made even President Xi Jinping caution against the accumulation of excess capacity.

“Artificial intelligence, computing power and new energy vehicles. Do all provinces in the country have to develop industries in these directions?” Xi told the Central Urban Work Conference, a high-level Communist party meeting on urban development, according to state media.

This has its origins in the shift towards investments in manufacturing, especially into new quality productive forces like green technologies, in the aftermath of the bursting of the real estate bubble in 2021. Despite directives from top, the manufacturing sector shows little signs of slowdown.

But with China’s investment in manufacturing still rising at a blistering pace — up 7.5 per cent this year after a 9.5 per cent rise in 2024 — there is no end in sight. Yan Se, assistant professor in the department of applied economics at the Guanghua School of Management in Peking University, said at a recent seminar that China’s share of global manufacturing value-added could rise to 40 per cent in the next five years, from about 27 per cent now.

Three graphics that capture the problems posed by China’s manufacturing addiction and the accumulated excess capacity. First, the proportion of loss-making firms has been rising across sectors. 

Second, at the macro-level, it is manifesting in the form of nine consective quarters of falling prices.

Third, it has deeply distorted the economy’s structure, prioritising capital formation and undermining consumption. 

A new report from Yuhan Zhang, principal economist at the China Centre of the Conference Board, says

Many of China’s lower-tier metropolises were heavily dependent on such investment to produce economic growth. Such cities had investment-to-GDP ratios on average of 58 per cent last year, compared with China’s already-high national average of 40 per cent. For OECD member states, the figure is closer to about 22 per cent… The study also found that in lower-tier cities, high investment intensity usually coincided with weak labour productivity and lower total factor productivity — a measure of output per input of capital and labour… “Misallocated investment and duplicated capacity are undermining efficiency,” Zhang wrote in the report, flagging that “long-term gains from ‘new quality productive forces’ require human capital development, innovation, and more market-oriented resource allocation… Heavy fixed-asset spending appears to reduce efficiency rather than boost it, even if local governments are pouring money into ‘new quality productive forces’,” Zhang concluded.

A few graphics from JP Morgan that reiterate these trends. Nowhere is excess capacity more pronounced than in the automotive industry.

Even as China’s exports have surged, the intense competition has been strangling the companies involved. 

2. As trade tensions rise and the Cold War intensifies, Chinese exports to Western markets have been declining, and have been offset by a steep rise in exports to the emerging markets.

The JP Morgan report says that Mexico, Turkey, Indonesia, Brazil, South Africa, Thailand and Vietnam are among the countries that have imposed tariffs on Chinese industrial or consumer exports.

Chinese exports to other developing countries will become an ever-growing concern in its relationship with these countries. Thanks to the Cold War, China’s excess capacity is now being exported to developing country peers. 

All this makes it critically important that China finds a way to rein in its excess capacity. However, given the scale of excess capacity across sectors, this may not be possible without inflicting significant domestic pain in terms of job losses and knock-on effects on the economy. The other alternative is to incentivise domestic consumption, something which Beijing has so far been very reluctant to pursue. 

3. The JP Morgan report has some very relevant graphics on how mercantilist the Chinese economy is. The extent of industrial policy support far exceeds other major economies.

In many sectors, direct subsidies alone make up 15-35% of firm profits. 

All this makes China the standout mercantilist economy. 

4. One of the sectors where China still lags considerably behind the West, despite pouring tens of billions of dollars, is semiconductor chip manufacturing. However, it’s now making serious efforts to address the deficiencies and catch up. One area of focus is on the manufacture of equipment used to fabricate chips. 

Nikkei Asian Review has an excellent article on China’s attempts to master lithography techniques to make its version of ASML’s DUV machines. Chinese chip manufacturers like SMIC have succeeded in making tools used for etching, measurements, deposition, chemical polishing and more, but struggled with making the lithography machine.

The process of projecting and printing chip developers' designs onto a wafer is vital to the ultimate performance of the chip. But lithography machines are so complex and expensive that only three companies in the world -- ASML of the Netherlands and Japan's Canon and Nikon -- are capable of producing them. Last year, lithography accounted for nearly 25% of global spending on chipmaking equipment, according to industry group SEMI… ASML is the largest global chip tool maker by market capitalization, as well as the leader in immersion deep ultraviolet (DUV) technology, used to make chips for everything from smartphones to cars to defense equipment. The Dutch company is also the exclusive maker of extreme ultraviolet (EUV) lithography tools, which chip titans like TSMC, Samsung and Intel use to make the world's most advanced processors and memory chips… The high-NA EUV machine, as it is called, is now being shipped to TSMC and Intel for field trials, and the company expects broader industry adoption to follow. At $350 million apiece, the machine is the most expensive chipmaking tool ever built… ASML's high-NA EUV lithography machine weighs 150,000 kg, stretches 14 meters long by 4 meters high and 4 meters wide, and is made up of millions of components. Industry sources call it the most complex machine ever built.

This is a good illustration of how complex these machines are and the difficulties in mastering their manufacture.

EUV machines had to be completely redesigned, as its light source has a wavelength of just 13.5 nanometers, compared to 193-nanometers used in earlier DUV systems. In general, the shorter the light wavelength, the finer the chip design circuit patterns that can be printed. It took more than 20 years to turn the EUV concept into a commercial reality. While the first sample machines were shipped to clients in 2006, it wasn't until 2019 that TSMC and Samsung were using them to produce the world's most advanced chips. Developing high-NA EUV, the next generation of the technology, was just as complex. It took more than eight years, for example, just to redesign the projection optics and illumination systems, the core part of the machine that shapes and focuses the light to project chip designs onto wafers. The NA in the machine's name stands for numerical aperture, a measure of the ability of an optical system to collect and focus light. NA is a key factor in determining how finely circuits can be printed onto wafers. In simple terms, a higher NA means a machine can print smaller chip features. ASML supplier Carl Zeiss says the optical system in a high-NA EUV machine contains around 65,000 parts and takes a year to produce. Developing the system took over 10 million working hours and 25 years of collaboration with ASML..

Chiang Shang-yi, a board director of Foxconn and former R&D chief of TSMC, described lithography as “the most complex and resource-intensive step in chipmaking” and lithography machines as harder to build than other chip equipment. “ASML’s exclusivity, particularly in EUV tools, is greater than that of TSMC, the world’s top chipmaker, in making cutting-edge chips. Its success comes not only from developing its own technology but also from exclusive partnerships with top suppliers like Zeiss and Cymer.” ASML acquired Cymer in 2013 and took a nearly 25% stake in Carl Zeiss SMT, a subsidiary of Zeiss making advanced optics, in 2016… Mitsunobu Koshiba, former chairman of Japanese photoresist maker JSR, described ASML's machines as the "most complicated tool on this planet" and not something that every country can hope to produce.

Given the massive amount of knowledge and partners that must be brought together to make a lithography machine, it’s perhaps the most difficult equipment to manufacture. But that has not prevented the likes of SMIC and Huawei from trying.

In fact, Chinese firms have been making inroads across the semiconductor equipment landscape. 

China's top five chip tool makers have flourished amid the escalation of U.S.-China tensions since 2019. Their combined revenue has grown by 473% since 2019, with four out of five reporting record profits in 2024, Nikkei Asia's analysis found. In every chipmaking step except lithography, China now has its own player that could potentially challenge global leaders. Naura, often referred to as China's version of Applied Materials, is now the world's sixth-largest chip tool maker by revenue.

This is an illustration of how the Chinese have been strategic in their engagements, compared to short-sighted US manufacturers who are now scrambling, for example, in procuring rare earth metals. 

Chinese chipmakers are also continuing to stockpile equipment from global leaders when possible, purchasing nearly $34 billion worth of such tools from Japan between 2020 and 2024, according to Nikkei Asia analysis of Chinese customs data… In lithography, China's short-term strategy remains stockpiling. To hedge against further export controls, China purchased 8.92 billion euros ($10.45 billion) worth of tools from ASML in 2024. That rush of orders led to China accounting for 41% of ASML's system sales that year, the highest share of any market.

5. Arguably the most impressive industrial success story to emerge from China is its spectacular dominance of clean energy generation technologies. Reflecting this success, and even as clean energy pursuit slows down elsewhere, at the recent UNGA session, President Xi Jinping said that China would reduce its economy-wide greenhouse gas emissions and expand renewable energy six-fold in coming years. 

From being a copycat in clean technologies, over the last two decades China has emerged as the undisputed global leader in industrial scale innovation and R&D in the whole array of clean energy sectors.

See also this.

In 2015, the Chinese government initiated the Made in China 2025 program, to provide companies in 10 strategic industries with large, low-interest loans from state owned financiers, assistance in acquiring foreign competitors, and generous subsidies for scientific research. The objective was to control 80% of the domestic markets in those industries by 2025. Far surpassing those targets, the Chinese clean technology companies have come to dominate domestic and global markets. 

While Western countries like the United States and Australia pioneered now-widespread technologies like solar panels, batteries and supercapacitors (which are like batteries, only smaller, and provide quick bursts of energy), China is now building on those designs and creating new, groundbreaking versions… The Chinese government has encouraged cutthroat domestic competition that some economists have likened to “economic Darwinism.” Sam Adham, head of battery materials at CRU Group, a market analysis company, described a typical scenario: First comes a flood of subsidies into a particular industry that the government has deemed strategic. Companies pile in, filing dozens or even hundreds of patents along the way. In the final stage, Mr. Adham said, the government pulls the subsidies and the less competitive companies essentially are “culled,” while “the remaining companies emerge stronger and they go overseas and take market share there.”…

Take, for instance, batteries for electric vehicles. While the original breakthroughs in producing lithium-ion batteries were made in the United States three decades ago, further research received little government backing there. Meanwhile, Chinese companies grabbed the baton. BYD, based in Shenzhen, recently surpassed Tesla as the world’s largest manufacturer of electric cars, and CATL, a Chinese rival based in Ningde, produces the most batteries. BYD and CATL have both relied on lithium-ion batteries that use relatively inexpensive iron and phosphate, combined with lithium, rather than nickel and cobalt, which Western producers have favored. Through patented breakthroughs, the Chinese companies made their batteries lighter, longer-lasting, faster to charge and cheaper to produce…

China has nearly 50 graduate programs focused on battery chemistry and metallurgy. According to the Australian Strategic Policy Institute, 65.5 percent of widely cited technical papers on battery technology come from researchers in China, compared with 12 percent from the United States… As of July, Beijing has restricted any effort to transfer out of China eight key technologies for manufacturing electric vehicle batteries, be that through trade, investment or technological cooperation. 

6. The Times has a long read on China’s build out of massive solar and wind generation farms in the Tibetan Plateau to harness the high altitude region’s vast deserted plains, brighter sunlight, and windy conditions. It reports that China is building an enormous network of clean energy industries on the world’s highest plateau.

No other country on the planet is using high altitudes for solar, wind and hydropower on a scale as great as China’s on the Tibetan Plateau. The effort is a case study of how China has come to dominate the future of clean energy. With the help of substantial government-directed investment and planning, electricity companies are weaning the country off imported oil, natural gas and coal — a national priority… the Talatan Solar Park, dwarfs every other cluster of solar farms in the world. It covers 162 square miles in Gonghe County, an alpine desert in sparsely inhabited Qinghai, a province in western China… Electricity from solar and wind power in Qinghai… costs about 40 percent less than coal-fired power… has a capacity of 16,930 megawatts of power, which could run every household in Chicago. It is still expanding, adding panels with a target of growing to 10 times the area of Manhattan in three years. Another 4,700 megawatts of wind energy and 7,380 megawatts of hydroelectric dams are nearby…

More than a decade ago, eight dams were built on the Yellow River as it drops 3,300 feet, flowing off the eastern side of the plateau and down into eastern China. More are under construction to balance and supplement the solar energy being generated in Qinghai Province… Two additional hydropower projects are being built in high mountain valleys near the Talatan Solar Park. The plan for both, Qinghai officials said, is to use excess solar power generated during the day to pump water up into the projects’ reservoirs several miles up. The water will be allowed to drop down through mountain tubes to the plateau at night, spinning giant turbines to generate immense amounts of electricity. 

Several electricity-intensive industries are moving to the region to tap its inexpensive power. One is the task of turning quartzite from mines into polysilicon to make solar panels. Data centers for artificial intelligence are also drawn to the area. Qinghai plans to increase its data center capacity more than five times by 2030… The data centers consume 40 percent less electricity, their main operating cost, than similar ones at sea level because air-conditioning is barely needed, said Zhang Jingang, the executive vice governor of Qinghai. Air warmed by the data centers’ computer servers is circulated through underground pipes to heat other buildings in Yushu and Guoluo, replacing coal-fired boilers… 

High-altitude projects affect relatively few people in sparsely populated settlements. China pushed more than one million people out of their homes in west-central China a quarter-century ago and flooded a vast area for the reservoir of the Three Gorges Dam. This year, China has been installing enough solar panels every three weeks to match the power generation capacity of that dam…

7. Any development of renewable power generation capacity must be complemented with the rollout of requisite transmission capacity. 

Another NYT long read describes how China is building ultra-high voltage electricity transmission lines to transport renewable power from its deserted, sunny, and windy north and western regions with their roaring rivers to the cloudy and windless load centres in the east with its sluggish rivers, where 90% of its people lives and which hosts most of the factories. One UHV line stretches 2000 km.

To put this in perspective, in addition to the UHV line shown above, China has 41 others, each capable of carrying more electricity than any transmission line in the US, and uses direct current technology with barely any transmission losses that make them more efficient than transmission lines elsewhere. 

The most recent public Chinese data, from the end of 2024, showed 19 lines transmitting power at 800 kilovolts. Another 22 lines operated at 1,000 kilovolts. One of them, the behemoth terminating in Guquan, transmits enough electricity at 1,100 kilovolts to power more than seven million American households or 40 million to 50 million Chinese households… the United States has a handful of 765-kilovolt lines and a few running at 500 kilovolts or less, according to the Electric Power Research Institute, a nonprofit research group. The 765-kilovolt lines together total about 2,000 miles — the length of a single line across China. The Soviet Union built a power line in Central Asia that was designed to operate at 1,150 kilovolts. But it used less powerful equipment and has not run at full tilt for decades.

The development of China’s ultrahigh-voltage lines was given a push in 2009, during the global financial crisis. The central government approved enormous investments in their construction to create jobs and head off an economic slowdown. China’s leaders staked ambitious plans for electric vehicles and high-speed rail lines around the same time. In March 2011, the construction of ultrahigh-voltage lines gained further momentum from the partial meltdown of three nuclear reactors after an earthquake and tsunami in Fukushima, Japan. Beijing delayed many prospective nuclear reactors, which had been planned near cities, and doubled down on transmission lines from remote areas.

Across the world, the biggest challenge to building any transmission lines, much less UHV lines with greater health risks, has been in overcoming opposition from local residents and securing right of way. These lines cause small electric shocks that can potentially have fatal consequences. The article points to people complaining of static electricity preventing them from holding the fishing rod when fishing or the umbrella in rain when near the closely bunched lines. However, the Chinese government, with its top-down industrial planning, has been able to overlook this and quickly proceed with construction. 

8. Finally, no article on China today can be complete without its remarkable dominance in rare earth minerals. As it imposed export controls over 12 out of the 17 rare earth elements, this puts their importance in the defence sector in perspective. 

In the first week of the Iran-Israel conflict in June this year, approximately 800 missiles were exchanged. Each contained anywhere between two and 20 kilogrammes of rare earth elements, including two, dysprosium and terbium, now subject to Chinese export controls. Based on conservative estimates from the limited data, this means anywhere between 1.6 and 16 metric tonnes of rare earth elements were vaporised in that conflict in seven days. Ukraine’s extraordinary recent performance in its drone war against the Russian invasion is almost entirely dependent on electronics and magnets imported from China. Ukraine is now less concerned about whether European arms deliveries will arrive on time and more worried about the flow of tech imports from China. In the past 30 years, China has become the world leader in the processing of most of the 54 raw minerals that the US Geological Survey classifies as critical for US industry, including the defence sector. Currently the Chinese can process virtually any mineral 30 per cent more cheaply than its competitors.

Rana Faroohar writes about how the US surrendered to China its rare earth refining and processing and magnets manufacturing base. 

In 1992, Deng Xiaoping announced the country’s desire to turn rare earths into the “oil” of China. In the mid-1990s, amid a general deregulation of global trade that led to more permissive investment screening and tolerance of offshoring, the US Committee on Foreign Investment in the US, under the Clinton administration, approved General Motors’ sale of Magnequench — an Indiana-based company that manufactured the rare earth magnets used in computer hard drives, consumer electronics and jet guidance systems — to Chinese owners with close ties to Beijing…The Cfius approval was based on a promise that the factory would stay in Indiana. It didn’t. After a few years, the entire Indiana operation was shut down, and production and equipment were moved to China… But it wasn’t only a lead in production that the US willingly gave up — it also failed to protect its access to raw materials. Until the late 20th century, the US was the world’s leading producer of rare earth minerals, mainly through the Mountain Pass mine in California, which opened in 1952. Stricter environmental standards, lower productivity and a lack of support for industrial policy in the US led to its closure in 2002. Mountain Pass was eventually reopened in 2012, but by then the Americans had no domestic refining capacity and had to ship their raw materials to China for processing.