China's leap into the digital age was facilitated by a combination of physical and digital technologies and new business models. According to a recent study by Bruegel, China already spends more on research and development, as a percentage of GDP, than the European Union; and it now produces as many scientific publications as the US and more PhDs in natural sciences and engineering. And, by streamlining the exchange of information and facilitating coordination of complex tasks, the Chinese social-media app WeChat – with 938 million users as of the first quarter of 2017 – has contributed to previously unimaginable productivity gains.

According to the Boston Consulting Group, Chinese e-commerce platforms' business models have evolved differently from those in the West, as they have responded to Chinese consumers' rapidly increasing spending power and enthusiasm for innovation. Having been encouraged by the government to experiment with Internet-based business models, Chinese firms are upending traditional practices. And this is happening so quickly that even the government now feels pressure to catch up, by adopting new technologies such as blockchain and AI.

E-payments are a key factor in lowering business and transaction costs in China, because they improve efficiency in the retail sector, where prices can still be higher than in the US even when the products are made in China.

As more activities become digitised, China's integration into the global value chain will increasingly occur in digital spaces. Chinese producers can use 3D printing, robotisation, and Big Data and AI applications at the local level, while still tapping into global markets and sourcing ideas and skills from abroad. There are now endless possibilities for dividing production and consumption into separate stages. But this also implies that the new digital economy's many successes will be accompanied by many failures.

Indeed, Chinese policymakers will have to confront various "digital dilemmas" in the coming years. Many public utilities in China – such as airlines, railways, ports, and telecommunications – are single-product entities administered by state-owned enterprises (SOEs). Yet the new tech giants are multi-product, omni-channel platforms that cut across all sectors, including production, distribution, payments and, increasingly, wealth management.

As in a game of Go, China's leaders need to move the country's pieces – that is to say, effect change in the SOEs' business models – in the right place, at the right time, and in a coordinated fashion. Superficial complaints about the slow pace of SOE reforms ignore the strategic challenge of creating productive competition between SOEs and publicly listed tech giants in the digital space.

SOE managers can credibly argue that heavy regulations place them at a competitive disadvantage, and that the tech giants are eating their lunch by free-riding on state-administered telecommunication, transportation and financial channels. The tech giants, meanwhile, argue that if they could just move faster into inefficient production and distribution areas, not least mobile payments, productivity growth would accelerate.

Another dilemma is that digitisation is good for consumers, but possibly bad for employment and social stability. In a "Digital China", there will necessarily be winners and losers. But the sooner displaced workers can adapt to new realities, the healthier the system will be.


China's transformation into a knowledge-based economy occupying a central position in the global value chain will ultimately yield a "reform dividend". But as exciting as that transformation will be, it will also be dangerous. Never before has an economy so large undergone such far-reaching change so quickly.

Andrew Sheng is Distinguished Fellow at the Asia Global Institute at the University of Hong Kong. Xiao Geng, President of the Hong Kong Institution for International Finance, is a professor at the University of Hong Kong.

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