From a wobbly economy to an AI powerhouse: Why the world misjudged China’s strengths yet again

At the onset of the year, the world’s second-largest economy was left for dead.

Economists were predicting lost decades akin to what Japan experienced in the 1990s and its dominance of manufacturing was being challenged by Trump’s second term and the drive by exporters to diversify their supply chains and move operations abroad.

Global investors had largely fled, seeing that the country’s ‘3D’ problems— deflation, debt and demographics—were structural and insurmountable.

By year-end, the perception couldn’t be any more different. President Xi Jinping was [among the few leaders] who stood up squarely to Trump’s bullying tactics on trade. Xi forced him to back down by weaponizing Beijing’s control of rare earth materials.

It has kept its status as the world’s most vibrant factory, so much so that some are lamenting that Europe, for one, has nothing to sell to China. As for global money flows, foreign investors are returning as an AI boom has lifted the Hong Kong bourse to a four-year high.

How did China manage to shake off its malaise and dazzle the world with DeepSeek moments in tech, biotech and even defence? Were the seeds of success always there and elites in the West simply chose not to see them? It’s a bit of both.

First, Xi’s focus on higher education is finally paying off. These days, roughly 40% of high-school graduates go to university, versus 10% in 2000. Engineering is by far the most popular major for post-graduate studies.

As a result, the nation’s talent pool has greatly expanded: Between 2000 and 2020, the number of engineers ballooned from 5.2 million to 17.7 million in China; in 2022, 47% of the world’s top 20th percentile AI researchers finished their undergraduate studies in China, well above the 18% share from the US.

What this means is that by the law of large numbers, innovative breakthroughs are bound to happen and that China still has a cost advantage in advanced manufacturing.

Those under the age of 30 account for 44% of the total engineering pool, versus 20% in the US; compensation for researchers is only about one-eighth that of their American counterparts. Therefore, even if the likes of Apple want to quit China, they can’t.

Second, China is pragmatic. The AI arms race offers a good illustration. Whereas the US seeks the holy grail of artificial general intelligence, Xi is pushing the industry to be “strongly oriented toward applications,” locking in any advantages that AI might bring to sharpen the nation’s edge in manufacturing.

Across the country, industrial robots operate in so-called dark factories, where automation is so efficient that work happens with the lights dimmed. Companies are also using AI to speed up logistics and product-design cycles.

Productivity gains from AI and automation are for all to see: China’s trade surplus hit a record $1 trillion this year, beating rival export powerhouses like Germany and Japan, with the fastest growth coming from advanced manufacturing, such as cars, integrated circuits and ships.

Third, deflation cuts both ways. Investors dislike it because companies have no pricing power. On the flip side, local brands capable of charging premium prices at home have hit consumers’ soft spot, giving them export prospects as well.

The prime example is Guangzhou-based Pop Mart International Group. The company’s gross profit margin of 70% is more than twice what a generic toymaker can make, thanks to the wickedly cute and viral Labubu.

Going forward, Chinese brands will be increasingly known globally for their design and aesthetic flair. Shoppers will get to appreciate silent air-conditioners, quiet luxury designer bags, fragrances that rival Le Labo and even gelatos that taste as good as those in Italy, as my Sicilian calisthenics trainer proclaimed.

‘China chic’ is coming to wow the world—okay, perhaps anywhere but in the US, a market to which Chinese exports tumbled 19% this year.

The nagging question is how thought leaders in the West got the world’s second-largest economy so wrong. Of course, Beijing doesn’t make it easy—the country didn’t open up from pandemic-related lockdowns until the end of 2022.

But some of it, I suspect, is an aversion to visiting an autocracy whose political values are different from the Western elite’s core beliefs. Making money off China isn’t as easy as a decade ago, and some worry that, once there, they might get an exit ban.

But, amid all this, one thing is for sure: It would be a huge mistake to write off China, the world’s only other economic superpower that matters. ©Bloomberg