Why Productive Finance is Crucial for China’s Development

China is at a critical juncture in its economic evolution. After decades of rapid industrialization, it is now transitioning toward a post-industrial economy, where the emphasis will shift from manufacturing and infrastructure development to services, technological innovation, and knowledge-based industries. This shift marks a significant turning point for the country’s economic future. 

The characteristics of this transition are becoming increasingly evident. China’s service sector already accounts for more than 56.7% of GDP in 2024, and it is growing rapidly. Alongside this, high-tech industries like artificial intelligence, robotics, and electric vehicles are emerging as new pillars of growth. These industries are being propelled forward by significant investments in research and development, as the country pushes to close the gap with leading global innovators. While traditional manufacturing is shrinking, industries such as high-tech, precision manufacturing, defense, and pharmaceuticals remain highly competitive. By 2024, R&D spending in China had reached 2.68% of GDP, reflecting a sharp increase from earlier years. 

However, this transformation also comes with challenges. As China moves away from industrial-driven growth, its economic growth is expected to moderate and become more stable, with a larger share of domestic consumption driving the economy. In post-industrial societies, growth tends to be more gradual, focused on innovation and technological development rather than rapid industrialization. At the same time, the growing income gap between high-skilled workers in knowledge industries and low-wage service sector employees raises concerns about social inequality and polarization. 

Amid this transformation, one of the most critical issues for China will be the development of a more robust and effective financial system. The current financial structure, heavily dependent on debt issuance and government bonds, is unstable. Its economic growth has largely been fueled by an expanding debt market, but this model is unsustainable. Over-reliance on government debt has created a system that is vulnerable to market fluctuations, stifling the potential of China’s financial markets to support long-term growth. 

The solution lies in the concept of productive finance. Productive finance refers to financial mechanisms that support real economic activity, particularly in technology and innovation, by facilitating long-term investment and resource allocation. Unlike speculative finance, which prioritizes short-term returns, productive finance seeks to generate value through strategic investments in the real economy. For China, embracing this approach is crucial if it wants to transition successfully from its industrial era to a sustainable post-industrial future. 

Drawing comparisons with the United States provides useful insights. The U.S. capital markets have long been a driver of growth, supporting innovation and technological advancement. The U.S. government’s use of tools like quantitative easing (QE) after the 2008 financial crisis helped stabilize markets and encourage growth. Similarly, China must build a financial system that serves as a foundation for innovation and economic development. The country’s capital markets need to be more transparent and efficient, with fewer regulatory obstacles and greater stability. 

For China to achieve this, it must focus on key reforms. First, strengthening its capital markets is essential. The country needs a financial system that can channel investments into high-tech sectors, rather than relying solely on debt issuance to sustain growth. Second, state-owned enterprises (SOEs) should evolve from being focused on traditional industrial activities to becoming productive financial entities. By doing so, SOEs can play a leading role in driving innovation and technological advancement, rather than simply managing state assets. 

Another key reform is to support China’s private sector in expanding internationally. The government must create favorable conditions for Chinese businesses to form international partnerships and expand globally. This can be achieved by providing political and financial support to help Chinese companies compete on the world stage. 

A crucial step in this would be the creation of a Chinese Wall Street, a major financial hub capable of attracting both domestic and international investment. By establishing a world-class financial district, China can strengthen its position as a global financial leader. This new financial hub would serve as a center for venture capital, private equity, and innovation-driven investments, providing the infrastructure needed to channel funding into high-tech industries and start-up ecosystems. 

To build this Chinese financial epicenter, China will need to further open up its capital markets, introducing more international financial instruments and capital flows. This includes creating an environment where investors can safely allocate resources into the country’s burgeoning technology sectors, with venture funds and tech-focused IPOs becoming a central part of the country’s financial landscape. Such a move would also encourage foreign financial institutions to establish a presence in China, fostering greater global financial integration. A thriving Chinese Wall Street could help provide the financial backbone for the next wave of technological innovations, from AI and quantum computing to renewable energy and biotechnology. 

While these reforms may seem daunting, they are necessary for China to adapt to its new economic reality. A productive finance system, aligned with technological innovation, will allow it to continue growing sustainably without relying on traditional industrial growth. 

The future of China’s economy depends on its ability to embrace this new model of growth. By focusing on quality over quantity and creating a financial infrastructure that supports long-term development, China has the hope to maintain its ascent in the global economy. This shift will also allow the country to address key challenges, including social inequality and environmental sustainability, by ensuring that growth is inclusive and sustainable. 

All in all, China’s transition to a post-industrial economy represents a major opportunity, but it requires a fundamental change in how the country approaches finance and growth. Developing productive finance will be key to achieving this transition, helping the country foster innovation and create a more sustainable economic model. This strategy will not only strengthen China’s economy but will also solidify its position as a global leader in the coming decades.