A sinologist specializing in Eastern art history once noted on Chinese culture: “Chinese people have long started using modular systems in their work and have developed them to astonishingly advanced levels. They apply these systems in language, literature, philosophy, social organization, and the arts. Indeed, the invention of modular systems seems to perfectly align with the Chinese way of thinking.”

If this German scholar were to observe contemporary China, he would recognize that modularization extends beyond the cultural sphere. Much like our ancestors utilized radical components to craft Chinese characters, employed molds to create terracotta warriors, and used wooden movable type for book printing, modularization plays a significant role across diverse sectors of the modern Chinese economy. In areas such as  labor division within enterprises, collaboration between enterprises, and government-enterprise relations, there is a trend towards modularization. Originating from manufacturing, modularization has also permeated platform-based service industries, enabling the “mass production” of these services.

In other words, in contemporary China, modularization is far from being a technical innovation phenomenon; it is a general trend that transcends boundaries between different fields and disparities in industries. When we shift our focus to the leading enterprises’ production organization methods in key industries such as electronic information and automotive manufacturing since the 1990s, we can see that their formation is closely related to various forms of modularization, which can be understood as the result of cross-domain evolution of modularization.

The modularization of product development is a prerequisite for the global expansion of value chains and the formation of the smile curve. In China’s consumer electronics industry, the modularization of product development has led to the modularization of organizational structure and business models.

In China, the impact of modularization extends beyond manufacturing industries. Alongside the growth of platform-based services such as logistics and express delivery, modularization is now making its mark in the service sector as well. The significant economies of scale inherent in platform-based services, characterized by extensive coverage and reduced unit costs, combined with the enormous scale of the Chinese economy and comparatively lax regulations on labor conditions, have propelled the rapid advancement of platform-based services in China, surpassing the pace seen in other nations.

Despite the advantage of modularization in enhancing enterprise production capacity in the short term, it also presents significant challenges for developing countries. On one hand, while this technological change implies reduced production entry barriers, the influx of numerous enterprises inevitably leads to decreased profits and employee incomes. On the other hand, within the context of the contemporary global division of labor, this technological shift signifies that crucial technologies are controlled by enterprises in developed countries, thereby increasing the difficulty for enterprises in developing countries to achieve technological progress. In summary, for developing countries, the adverse impact of modularization lies in its restriction on enterprises’ technological capabilities, profits, and wages at a low level, thereby limiting the potential for social progress in these nations.

In general, the three major East Asian countries are considered to have experienced similar development models: massive investment, export-driven growth, and systematic government intervention. However, unlike China, Japan and South Korea did not undergo large-scale policy adjustments characterized by directional shifts before becoming developed economies. This difference can be discussed as a technological system during the stage of mutual catch-up among the three countries.

During the catch-up stage, Japan and South Korea did not experience widespread adoption of modularization. Instead, both countries witnessed economic expansion within relatively stable technological frameworks, where advancements in production capacity and technological capabilities reinforced each other. The steady improvement of workers’ skills facilitated the comparatively smooth completion of the urbanization process in Japan and South Korea.

However, during China’s catch-up stage, modularization was directly linked to the expansion of leading industries. This connection did not always lead to a positive feedback loop between production capacity and technological capabilities. Rural migrant workers faced challenges in achieving urbanization through skill enhancement and wage advancement. Moreover, the impact of modularization did not stop at the electronics industry but extended to other industries such as automobiles manufacturing and platform-based services.

It is worth emphasizing that, at least in the catch-up process of other East Asian economies, this dual-faced production organization method with its multiplicity has never emerged. Hence, achieving proficiency in adapting modular production organization methods or mastering the modularization process becomes an unprecedented and highly challenging task. Of course, challenging tasks often come with significant rewards. We understand that modularization is the common technological foundation for industrialization processes in contemporary developing countries. Therefore, if China can successfully master the modularization process through its policy adjustments, such policy adjustments will undoubtedly have world historical significance.

In 2023, Chinese electric vehicles (EVs) unleashed a whirlwind globally. During the first half of the year, Chinese electric vehicle sales accounted for 64.3% of the total global sales volume, with Chinese brands occupying 12 of the top 20 positions in terms of sales volume. How did Chinese electric vehicles advance to the forefront of the world stage in just 22 years after the Chinese government designated electric vehicles as a major project under the National High Technology Research and Development Program of China (the “863 Program”) in 2001, surpassing well-known fuel vehicle enterprises in developed countries?

This article employs the "six forces model of industrial policy-competitive advantage,” to explain the rapid rise of China’s electric vehicle industry. To promote the development of the electric vehicle industry, governments at all levels in China have been actively enhancing factor supply, building infrastructure, reducing transaction costs, expanding market size, fostering industrial clusters, and promoting competition between industries. These efforts aim to assist domestic brands in cultivating competitive advantages that are unparalleled by those of other countries.

A government that actively fosters competitive advantages exhibits strong proactivity. Once it recognizes the strategic significance of an industry to the national economy, it will spare no effort to mobilize all available resources, creating conditions for development even when none exist. Without the steadfast will to achieve national industrialization or the robust execution and coordination capabilities, China’s electric vehicle industry could not have developed so rapidly. Such a government not only rediscovers neglected factor endowments but also endeavors to create and strengthen those that were previously absent or comparatively weak.

Such a government, characterized by its commitment to building competitive advantages, emerged during the development period of China’s economy transitioning towards independent innovation within an open economic environment. Its role is neither to entirely replace (by designating “champion enterprises”), nor to solely rely on the invisible hand of the market. Instead, it employs various policy instruments to create institutional environments and structural conditions conducive to the competitive development of businesses. This does not mean the government possesses omniscience or omnipotence, but rather that it has the ability to experiment, learn from mistakes, and make timely adjustments.

The reason China has surpassed Germany and Japan in the development of electric vehicles is because, since the 1990s, the information and communication technology (ICT) industry and closely related venture capital industry have experienced significant growth. Electric vehicles represent a high-risk industry for researching and developing disruptive technologies, with their core being supported by ICT-driven intelligence. If China had not started developing the ICT industry and venture capital in the 1990s, there would not have been subsequent significant developments in industrial internet, big data, cloud computing, and artificial intelligence.

Among the four automotive giants of the United States, China, Germany, and Japan, the United States, despite having a top-notch information industry, has lost its advantage in traditional manufacturing. While Germany and Japan have first-rate traditional manufacturing industries, their information industries are relatively lagging. Although China ranks second in both industries, it does not have any significant shortcomings and has sufficient human capital and technological accumulation in both industries.

The combination of strong traditional fuel vehicle manufacturing capabilities with the support of venture capital and cutting-edge technology in the information and communication industry largely constitutes China’s unique competitive advantage in the development of electric vehicles.

Behind the emergence of such favorable structural conditions lies a unique institutional arrangement. China and the United States, as well as Germany and Japan, respectively demonstrate, from both positive and negative perspectives, that to drive continuous emergence of new technologies in an industry, it is essential to encourage the continuous development of new industrial organizations through competition policies. To achieve a diverse industrial organizational structure, the diversity of incentive mechanisms brought about by financing and ownership is fundamental.

Without a strong venture capital sector and a flexible labor market, the United States would not have given birth to Tesla, and China would not have seen the emergence of numerous new players in the automotive industry.

Only by maintaining contact with cutting-edge technologies worldwide and actively engaging in direct competition with foreign enterprises can China’s industrial policy timely adjust the development direction of the electric vehicle industry. With the ongoing evolution of deglobalization, “decoupling” and “de-risking” are increasingly becoming concerns for enterprises. The key source of competitive advantage for enterprises is shifting from resource allocation efficiency represented by global production methods to organizational economic efficiency represented by vertical integration.

 

The uniqueness of the Chinese economy stems from dynamic local development practices that continuously challenge and expand mainstream views in the social sciences regarding economic development. The economic rise of Hefei, the capital city of Anhui Province in eastern China, once a typical underdeveloped region, serves as another new example of local development practices in China. From 2000 to 2022, Hefei’s GDP surged from 32.5 billion yuan to 1.2 trillion yuan. In 2022, the output value of strategic emerging industries, such as semiconductor displays and integrated circuits, accounted for 56.2% of Hefei’s large-scale industrial output value, reaching a historical high of 77.9% in the industrial growth contribution rate. The “Hefei Model” behind this rise represents the latest type of Chinese local developmentalism.

The Hefei Model can be summarized as leveraging government equity investment as a catalyst, with its foundation built on the supply chain coordination of an industry. It features innovative enterprises as the primary actors and the development of strategic emerging industry clusters as its focus. The government equity investment and the supply chain coordination are the core components of this model.

Government equity investment addresses the issues of where the funding comes from and how to attract businesses. The Hefei government has extensively drawn from the market-driven investment and financing strategies of venture capital firms, pioneering a capital attraction model featured with “investment led by state-owned capital - targeted issuance - project implementation - equity exit - cyclical investment.”

The supply chain coordination addresses questions about where to allocate funds and which industries to develop. The Hefei government is not passively following or implementing national industrial policies but instead, it fosters emerging industries along the inherent upgrading and supply chain coordination logic within the local industry.

It particularly leverages demand from downstream end-product manufacturers and midstream core component manufacturers to a considerable extent. For example, initially, to address the lack of core components and semiconductor display issues in the upgrade of the local home appliance industry, the Hefei government collaborated with BOE Technology Group (BOE) to establish a semiconductor display industry. Subsequently, it capitalized on substantial demand for supply chain coordination in semiconductor displays, computers, and automotive manufacturing to foster the development of key upstream industries such as driver chips, storage chips, and power batteries.

The Hefei Model is often simplistically regarded as a masterpiece of local government work. However, it is neither a deliberate design by the government nor the result of spontaneous accumulation by the market. Initially, the Hefei Model stemmed from the inherent demand for upgrading the traditional household appliance industry and the investment experience benefitted from the extensive expansion of BOE.

Specifically, the Hefei Model was jointly created by the Hefei government and BOE during the investment process for constructing the 6th generation TFT-LCD production line, mobilizing the entire city’s efforts. Subsequently, successive Hefei governments inherited valuable experiences gained from government equity investment and supply chain coordination in the industry, successfully replicating them in the creation of emerging industries such as integrated circuits and new energy vehicles.

Apparently, the Hefei government didn’t simply aim to “get the market and administrative regulations right” and then wait for private sectors and market forces to act spontaneously. Instead, it assumed the role of a “local entrepreneurial government” with a strong entrepreneurial spirit, continuously driving high-risk industrial innovation activities with professional insight and strategic actions. Accompanying the interaction between government and enterprises, and the complex industrial practice process, is the emergence and evolution of the Hefei government’s industrial governance capability.

This dynamic capability empowers the Hefei government and its investment team with greater courage and a more advantageous position compared to private sector entities in promoting the development of strategic emerging industries.

However, the government and officials are not the sole entity in the Hefei Model. The economic entities that effectively harness the government’s substantial resources and translate them into market-proven results, reshaping the industrial competitive landscape, are pioneering innovative enterprises such as BOE, Lianbao Technology, Nexchip Semiconductor Corporation, Changxin Memory Technologies, Inc., and NIO Inc. Therefore, a comprehensive understanding of the Hefei Model can only be achieved by delving deeply into the interaction process between local entrepreneurial governments and the innovative enterprises.

This also means that excessive mythologization of the Hefei Model will prove futile. The Hefei Model inherently emerges from the unique industrial structure and the interaction process between the government and enterprises in Hefei. Any effort to study the Hefei Model must be grounded in a clear understanding of the needs of enterprises and the content of industries. It especially requires the correct handling of the relationship between local traditional industries and emerging industries, as well as between downstream end-product manufacturers and upstream core component manufacturers.

 

China’s implementation of human resource strategies during two distinct phases of industrialization—developing labor-intensive industries and promoting industrial transformation and upgrading—reflects the institutional logic of a developmental state in establishing skill formation systems. On one hand, the government enhances the education level and general skills of the labor market through promotion of widespread primary and secondary compulsory education, providing abundant low-cost labor for labor-intensive industries. This is the driving force behind China’s creation of the “world’s factory” and the economic miracle it has achieved. During this phase, the quantity of workers required by enterprises outweighs the emphasis on quality.

As economic growth shifts towards technology and capital-intensive industries, basic education and general skills are far from sufficient to adapt to the innovation of production technology. Enterprises need to enhance workers’ levels of professional education and specialized skills in order to fully utilize total factor productivity. This is the starting point for acquiring new growth momentum during economic transformation. Therefore, the government adopts various policy measures to expand skill supply in response to emerging skill demands. And the efforts to increase investment in skill development is in line with the rationale of developmental skill formation theory.

However, a skill formation system solely led by the government may not effectively fulfill its role. The persistent “skill shortage” at the enterprise level reflects a failure of government intervention. Delving into the reasons, there are at least three aspects to consider. Firstly, the government-led skill formation system exhibits a certain degree of inward focus, whereby macro-level policy objectives are often narrowed down to fulfilling performance tasks or even serving the self-interests of different departments or organizations during the implementation process. Secondly, the government’s response to market demand primarily manifests in macro policies, which lack precision and encounter operational challenges, resulting in insufficient effectiveness. Thirdly, the singularity and lag of the state-led skill supply approach contradict the complexity and timeliness of skill demand, leading to low supply efficiency and difficulties in quality assessment.

The inherent limitations of the government-led skill formation system in the above three aspects cannot be effectively addressed through internal institutional adjustments and mere improvements alone. It requires a certain degree of market intervention to correct them and achieve a balance between skill supply and demand with high-quality development.

Specifically, on one hand, public vocational education, as the cornerstone of the national skill formation system, receives the majority of government investment. However, its inward focus is evident, with the education authorities’ assessment indicators becoming the guiding principles for vocational education development, thus forming interest groups inconsistent with economic policy objectives. To address this, market forces should be leveraged to allow various market entities, especially high-quality and specialized training institutions and centers, to participate in vocational education and training. They should also receive a certain proportion of government investment, enabling them to expand channels, foster competition, and enhance quality.

On the other hand, industry and enterprise demands represent the most significant signals in the labor market. When formulating skill policies, the government should establish  demand-driven decision making principles. This involves assessing the types, standards, and quantity of high-skilled workers based on the laws of industrial upgrading and trends in technological progress. Acquiring full, timely, and accurate information is crucial to prompt educational and training institutions to make flexible responses and adjustments.

Furthermore, the government should establish a favorable institutional framework through legal and economic mechanisms to encourage engagement from interested parties, such as enterprises, trade unions, vocational schools, training institutions, training centers, and individuals. Specifically, it should stimulate the enthusiasm and initiative of enterprises, enabling them to benefit from enhancing workers’ skills and ensuring returns on their investments in skill development. This, in turn, fosters a virtuous cycle of demand-driven supply.