The second article argued that the fundamental difference between the American and Chinese economic systems is not capitalism versus socialism, nor markets versus the state. Rather, it is the outcome of different competitive environments.
American firms generally operate in markets that allow greater pricing power, higher margins and stronger shareholder returns. Chinese firms operate in intensely competitive markets where prices are continuously driven lower, margins compressed and consumers capture much of the gains.
The result is a paradox.
American companies often generate superior profits. Chinese companies often generate superior scale.
See also: The builders and the beneficiaries: from Global Crossing to AI
This article extends both arguments.
If relentless competition continuously drives down prices and margins in China, then a critical question follows: How do Chinese firms ultimately generate profits?
The answer is exports.
See also: Investing where the economics take us: Today, it is America
Yet, this is precisely where I believe much of the Western analysis of China goes wrong.
The dominant Western interpretation
Whether one reads the analysis of Rhodium Group, the writings of Michael Pettis, policy papers emerging from Washington and Brussels or recent commentary by Manu Bhaskaran in The Edge and others, a common narrative emerges.
China’s economic success is explained primarily through the actions of the state: industrial subsidies; state-owned banks; strategic planning; made in China 2025; dual circulation; government intervention.
Under this interpretation, exports are an instrument of state power.
China exports because Beijing wants it to. China builds industrial capacity because Beijing wants it to. China gains market share because Beijing subsidises it.
The implication is straightforward. China’s rise is fundamentally a story about state power.
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There is truth in this interpretation. The Chinese state undoubtedly shapes incentives, allocates resources, builds infrastructure, invests in education, establishes long-term priorities and creates the conditions within which markets operate.
But I believe many Western observers mistake a consequence for a cause.
The question is not whether industrial policy exists — it clearly does. The question is whether industrial policy alone can explain China’s competitiveness across hundreds of industries simultaneously.
That is a far more difficult proposition.
Industrial policy may help explain semiconductors, aerospace, high-speed rail or other strategically important sectors.
But can it explain electric vehicles (EVs), batteries, food delivery, ride-hailing, e-commerce, household appliances, solar panels, consumer electronics, industrial machinery and hundreds of other industries simultaneously?
The notion of an “industrial policy of everything” stretches credibility.
A more convincing explanation lies elsewhere.
The Western lens
The dominant Western interpretation is shaped by several intellectual traditions.
The first is mercantilism — the belief that exports are a source of national power.
The second is industrial policy — the belief that governments shape economic outcomes through subsidies and strategic planning.
The third is geopolitics — the belief that economic activity is ultimately an extension of state competition.
The fourth is national security — increasingly the framework through which trade, technology and industrial production are understood.
Viewed through these lenses, China’s rise appears obvious.
The state directs capital. The state identifies strategic industries. The state builds industrial champions. The state expands exports. The state gains power. The logic is coherent.
But there is another way to interpret the same facts.
The market lens
Instead of geopolitics, begin with economics. Instead of state, begin with the firm. Instead of industrial policy, begin with competition.
The relevant frameworks become industrial organisation, economies of scale, marginal cost economics, competitive market dynamics and the theory of the firm. Viewed through this lens, China’s rise looks very different.
Ironically, China may have operationalised one of Friedrich Hayek’s most important economic insights more effectively than most capitalist Western democracies.
Hayek, an Austrian economist and philosopher, argued that no central planner could ever possess the dispersed knowledge held by millions of individuals making decisions within markets. Prices, competition and profit signals coordinate economic activity far more efficiently than bureaucratic planning because information is distributed throughout society rather than concentrated in government.
China did not embrace Hayek politically. But following Deng Xiaoping’s reforms, it increasingly embraced competition, markets and decentralised economic decision-making. The state continued to set broad objectives and strategic priorities.
Yet, within those parameters, millions of firms, entrepreneurs, suppliers and consumers were largely left to compete, experiment, fail and adapt.
The result was not the absence of state influence. Rather, it was the creation of the most intensely competitive large-scale domestic market in modern human history.
Many Western observers continue to interpret China’s success primarily as evidence of state planning. But much of that success may reflect Hayek’s insight operating at unprecedented scale.
The Chinese state may have built the arena, but competition within that arena determined the winners.
Across EVs, ride-hailing, food delivery, solar panels, batteries, consumer electronics, e-commerce, industrial machinery and household appliances, hundreds or even thousands of firms compete simultaneously.
Consumers are highly price-sensitive. Products are rapidly copied and improved. Margins are relentlessly compressed. Competition is unforgiving. Companies that fail disappear. The result is a constant process of price destruction, productivity improvement and technological diffusion.
In other words, the mechanism driving China’s success may not primarily be state planning. It may be capitalism operating at extraordinary scale.
The missing link from my earlier thesis
In “The political economy of modern capitalism”, we argued that China’s competitive structure naturally produces lower prices than America.
Consider ride-hailing.
Uber enjoys substantially higher margins than DiDi. Not because American managers are more capable. Not because Chinese managers are less efficient. But because Chinese consumers are more price-sensitive and Chinese firms face much more intense competition.
The same pattern appears across industry after industry. Competition drives prices lower. Lower prices compress margins. Consumers benefit. Shareholders receive less.
The consequence is that Chinese firms face a structural challenge.
If competition continuously drives prices lower, where do profits come from?
The answer is scale. Produce more. Sell more. Lower unit costs. Increase absolute profits even if margins remain thin.
But there is another step.
Scale improves valuations. Higher valuations reduce cost of capital. Lower capital costs enable further investment. More investment drives expansion and additional innovation.
The cycle becomes self-reinforcing.
And once domestic scale is exhausted, the next logical step is global scale.
Exports are therefore not primarily a policy choice. They are the natural consequences of the economics described in the earlier article.
A washing machine explains China better than trade theory
Consider something as ordinary as a washing machine.
In Malaysia, consumers can purchase Bosch washing machines manufactured in Germany, Türkiye or China.
The German-made machine often commands the highest price, the Turkish version somewhat less. The Chinese-made equivalent is often the cheapest.
More interestingly, within China itself, Bosch competes against Xiaomi, Haier, Midea and numerous domestic brands. Many of these products are not technologically inferior. Some are arguably more technologically advanced, incorporating smart-home integration, predictive maintenance and advance energy-management system.
Yet, they often sell at a fraction of the price. The conventional explanation is subsidies, but that explanation is weak. These prices are for domestic sales.
The more important reality is competition. Chinese manufacturers compete against dozens of equally capable rivals in a market of 1.4 billion consumers. The result is relentless downward pressure on prices.
What Western observers often see as export competitiveness is first created by domestic competition. Exports merely reveal to the rest of the world what has already happened inside China.
Why exports become inevitable
This distinction changes our understanding of exports. Western observers often see Chinese products flooding global markets and conclude that exports are the objective. In reality, exports may simply be the consequence.
The objective of every private company remains unchanged. To survive. To grow. To generate profits.
The challenge is that domestic competition makes profits increasingly difficult to achieve within China alone. Prices fall. Margins compress. Returns on capital decline.
Yet, companies continue investing, innovating and expanding.
Why? Because scale changes the economics.
Exports therefore become an economic necessity.
Companies need larger markets to absorb productive capacity. They need higher sales volumes to spread fixed costs. They need profits to improve valuations. They need valuations to lower their cost of capital. And they need capital to finance the next cycle of innovation. Exactly what defines a capitalist system.
This is where many Western analyses stop too early. They assume exports are the objective.
For firms, exports are merely the means. Profits are the objective. Valuations are the objective. Lower capital costs are the objective. Future innovation is the objective.
Exports are simply the path that allows those objectives to be achieved.
The ecosystem effect
This also explains something many Western analysts correctly observed but misattribute.
China possesses industrial ecosystems that are extraordinarily difficult to replace.
Whether it is the Pearl River Delta, Yangtze River Delta, Shenzhen’s electronic ecosystem, China’s EV supply chain, China’s battery ecosystem or China’s solar manufacturing base, these ecosystems are often presented as evidence of successful industrial policy.
But another interpretation is possible.
They are the natural outcome of decades of competition, investment, learning-by-doing, supplier formation and scale.
The state may have helped create the conditions, but ecosystems ultimately emerge because firms, suppliers, workers and customers continuously interact within markets.
No government planner can micromanage millions of daily commercial decisions.
Every additional supplier lowers costs. Every additional competitor improves efficiency. Every additional customer expands scale. The ecosystem becomes self-reinforcing.
The result is an economic machine whose competitiveness grows stronger over time.
Competition versus coordination
Much of the debate about China is framed incorrectly. The question is often presented as a choice between state and market, planning and capitalism, socialism and free enterprise.
But China’s experience suggests a more interesting question: What matters more for economic success — coordination or competition?
The Chinese state has undoubtedly coordinated investment, infrastructure, education and long-term development.
But coordination alone does not explain why Chinese firms have become so competitive.
In fact, many countries also attempt industrial planning. But few have produced globally dominant ecosystems across so many industries simultaneously.
The missing ingredient is clearly competition.
Coordination may explain why capacity was built. Competition explains why costs fell.
Coordination may explain why industries emerged. Competition explains why firms became efficient.
Coordination may explain why China entered the race. Competition explains why it remains difficult to catch.
The Chinese state may have supplied the direction, but competition supplied the discipline.
And in economics, discipline often matters more than direction.
Why this matters
The distinction is not academic; it has profound policy implications.
If China’s success is driven primarily by subsidies and industrial policy, then the response is straightforward.
Impose tariffs. Restrict imports. Match subsidies. Protect domestic industries.
But if China’s competitiveness is rooted in market dynamics and ecosystem development, then the challenge is far deeper.
Subsidies can be copied. Tariffs can be imposed. Industrial policies can be replicated.
Ecosystems cannot.
America and Europe increasingly believe they are competing against the Chinese state.
Yet, the state may not be the primary source of China’s strength. Its real strength may lie in an ecosystem containing millions of entrepreneurs, thousands of competing firms, dense supply chains, rapid technology adoption and a domestic market large enough to reward scale while punishing inefficiency.
That is not a problem easily solved by tariffs, nor is it one easily reversed by political negotiations.
Connecting economics to investing
This also explains another puzzle explored in our article last week titled “Investing where the economics take us: Today, it is America”.
A country can build the world’s most competitive industrial ecosystem and still produce disappointing shareholder returns.
China’s system has been extraordinarily successful at delivering lower prices, greater scale and stronger industrial competitiveness.
America’s system has been extraordinarily successful at converting innovation into profits, profits into valuations and valuations into shareholder wealth.
The best industrial system is not necessarily the best stock market.
National competitiveness and shareholder profitability are not the same thing.
Investors who confuse the two risk making expensive mistakes, as we learnt to our detriment when we bought Chinese stocks. Indeed, it was our attempt to understand this paradox that led us to explore the idea of twin capitalism in a four-part series, of which this article is the final instalment.
The question nobody asks
If China’s model is so successful, why have Chinese equities disappointed investors for so long?
The answer lies in the very competitive dynamics that created the country’s industrial success.
For years, the gains from productivity improvements have flowed largely to consumers rather than shareholders.
Competition drove prices lower. Lower prices expanded markets. Larger markets increased scale. Scale strengthened ecosystems.
But profits remained elusive.
This is why China could simultaneously build world-leading positions in many products while generating relatively modest shareholder returns.
Yet, surely, the economics suggest this may not be the final destination.
As industries mature, weaker competitors disappear. Consolidation occurs. Excess capacity is absorbed. Marginal costs continue falling while competitive intensity gradually moderates.
At that stage, the economics begin to change.
The same scale that once compressed profits can begin to generate them.
The same ecosystem that once prioritised growth can begin to monetise its dominance.
The same companies that spent years competing on price can begin competing on technology, brands, services and global reach.
This is the question investors should be asking.
The great irony
The great irony is that both sides may be partly correct.
The Western interpretation correctly observes the role of the state. The alternative interpretation correctly observes the role of markets. The disagreement lies in determining which force is primary.
Western analysts tend to view competition as a consequence of state policy.
This article argues the reverse. The state created the conditions. Competition created the outcomes.
Industrial policy may explain why China entered the race. Competition explains why it keeps winning.
The real competitor
The West sees China’s rise largely through the lens of state power. China’s rise may instead be rooted in competitive market forces operating within a uniquely large and dynamic ecosystem.
Both sides observe the same facts; they simply interpret them differently.
The Western interpretation sees a state-directed machine. It interprets China through the lens of distortions: subsidies, overcapacity, trade dominance.
The alternative interpretation sees a state-enabled but market-driven system that may be one of the most competitive capitalist environments ever assembled.
Ironically, the West often criticises China for not being capitalist enough.
Yet, China’s export success may be the result of being more ruthlessly competitive than any capitalist systems the world has previously experienced.
The West believes it is competing against Beijing. It may eventually discover that its real competitor is something far more formidable: hundreds of thousands of Chinese firms competing relentlessly against one another.
The first phase of China’s rise was building scale. The second phase may be monetising scale.
The first phase challenged Western manufacturing. The second phase may challenge Western capital markets.
And if America’s greatest strength has been its ability to monetise innovation, China’s next challenge may be to monetise scale.
If that transition occurs, the debate about China will enter an entirely new chapter. For the question will no longer be whether it can build globally competitive industries; it already does. The question will be whether it can convert industrial dominance into sustained profitability. And that may become the most important economic story of our time.
Conclusion
The West sees exports and assumes a national strategy. But firms do not export for patriotism. They export for the same reason firms everywhere do: profits, valuations and survival.
China’s rise is therefore less a story of state power than of capitalist necessity operating at unprecedented scale. The state may have built the arena, but competition determined the winners.
If so, China’s rise may be remembered as one of the greatest competitive economic ecosystems ever assembled in human history. Hayek would have been proud.
(Note: There is one more missing link. We have not yet explained why China became uniquely capable of generating such intense domestic competition in the first place. Why China and not India, Indonesia or Brazil — they all have large populations. We don’t have a unique perspective, and it is an area that is fairly well researched. Or perhaps one day we will return, when we gain better and original insights.)
Portfolio commentary
The Malaysian portfolio rose 1.1% for the week ended June 16. The three gaining stocks were Public Bank (+5.2%), Malayan Banking (+4.5%) and Hong Leong Industries (+2.7%). On the other hand, Kim Loong Resources (-0.7%), LPI Capital (-0.4%) and United Plantations (-0.2%) ended the week in the red. Total portfolio returns now stand at 223.2% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 6.5% over the same period, by a long, long way.
The Absolute Returns Portfolio gained 2.1% last week. Total portfolio returns now stand at 28.4% since inception. The biggest gainers were Talen Energy (+21.8%), Schneider Electric (+10.1%) and Alphabet - CL C (+2.5%) while the top losers were Alibaba Group Holding (-5.8%), Microsoft (-4.6%) and Sun Hung Kai Properties (-1.3%).
Last but not least, the AI Portfolio also closed higher after the recent tech-led selloff. The portfolio is up 4.8%, lifting total portfolio returns to 28.8% since inception. The top gainers were Roundhill Memory ETF (+21.9%), Marvell Technology (+14.6%) and Naura Technology (+14.0%). Alibaba (-5.8%), Akamai Technologies (-1.6%) and Datadog (-0.4%) were the biggest losers last week.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
