By Zhu Tian

What is the digital economy? Although there is no clear delineation of the digital economy, China’s National Bureau of Statistics released a document in 2021 which for the first time defines the expanse of the digital economy and provides a statistical standard for measuring it.

This document classifies the digital economy into five categories, the first four of which are grouped under digital industrialisation: namely, digital product manufacturing (e.g., computers and mobile phones), digital product services (e.g., wholesale and retail of digital products), digital technology application (e.g., software development and cloud computing), and industries that rely primarily on digital technologies (e.g., e-commerce and internet finance). These four categories usually are known as the core industries of the digital economy (or just the digital economy in a narrow sense). The fifth category, classified as industry digitalisation, includes all efficiency gains from digitization. Statistically, this refers to the added value generated by the digital transformation of various industries. These five categories combined represent the digital economy in a broad sense.

China is making headways in digital industrialisation, led by tech giants such as Huawei, Tencent, Alibaba, JD.com, Meituan, and ByteDance, while also making significant progress in industry digitisation. According to the National Bureau of Statistics, the core industries in the digital economy accounted for 7.8% of China’s GDP in 2020. This number is expected to rise to 10% by the end of 2025.

By comparison, the digital economy accounted for 9.6% of the GDP in the US in 2019 (making it the third largest sector in the US, following real estate and manufacturing). In the EU, this percentage is lower than in China, at less than 7%.

The digital economy plays a limited role in driving the overall economic growth

Although China currently lacks sufficient data to make a comprehensive and quantitative analysis of the impact of the digital economy on the overall economic growth, data from the US may serve as a good reference.

From 2005 to 2019, the US digital economy (from a narrow interpretation) grew at an average annual rate of 6.5%, while the country’s GDP grew at an average of 1.8% per year. However, while the digital economy was growing much faster than the overall GDP, it only comprises less than 10% of the national economy. Furthermore, the annual growth rate of non-digital industries in the US was estimated at 1.45%, indicating that the rapidly-growing digital economy only accelerated the country’s overall GDP growth by 0.35%. These figures show that, despite its fast growth, the digital economy has not been a major driving force for the overall US economy. The figures will surely be different in China, but they are still likely to tell a similar story.

GDP growth has two sources: labour productivity (GDP generated per unit of labour) and labour supply. In recent years, China’s GDP growth has been almost entirely reliant on labour productivity growth (which has averaged around 6%). Even if the labour productivity growth comes entirely from the digital economy, there is no obvious reason why it will grow faster in the next few years than it did in the past. China has already seen an unprecedented rise in this sector over the past few years, so there is only a slim chance the growth of the digital economy will reach a new high in the coming years.

Therefore, no matter how fast the digital economy grows, it won’t be easy to drive China’s labour productivity growth above 6%. On the other hand, China’s labour supply is bound to go downward due to pandemic restrictions, supply chain bottlenecks, and sluggish demand. Given the situation this year, it is very possible that the labour supply in China may even drop by 3-4% or more. Suppose this figure can be offset by an assumed 6% growth in labour productivity, the total GDP growth may only be 2-3%. Therefore, the digital economy alone cannot cope with the downward pressure on the economy. A healthily growing economy needs to be driven by all sectors, as well as favourable policies and a business-friendly macro-environment.

China’s digital economy should be driven by the market system and private enterprises

From a macro point of view, China has a number of natural advantages in developing the digital economy: a huge talent pool, abundant capital, and an enormous domestic market. The country’s 1.4 billion people provide rich soil for e-commerce platforms and digital media, both of which constitute the digital economy’s main business models relying on the “scale effect” and “network effect.”

COVID-19 may have accelerated the growth of the digital economy to some extent. E-commerce companies like Meituan shot up during the pandemic as people in lockdown depended on online platforms to buy food and basic necessities. The development of digital technologies has also allowed us to work from home, host online forums, place online orders, and generate health codes and close contact tracing in the fight against COVID-19. None of these would have been imaginable 10 years ago without the booming digital economy.

So, as we reap the benefits of the digital economy, how can we further promote it by making good use of the three advantages mentioned above? This is actually a question of how to deal with the relationships between the market, government, and businesses. On one hand, the development of the digital economy should be driven primarily by the market. Whether in the US or China, representative companies in their digital sectors are private ones that have carved their own place out in the market, rather than being favoured by policymakers. On the other hand, the digital transformation of industry should also be navigated by companies themselves as there is very little that the government can do in this regard.

In economics, there is a theory of “infant industry” protection where countries, especially developing ones, can protect home industries in their early stages against established competitors abroad through supportive policies in order to develop their domestic economy. While this argument may sound plausible, in practice there is little evidence that such protection has much of a positive effect.

For example, domestic search engines have been protected in China, but it is hard to say their growth was better than other non-protected industries. By contrast, Chinese e-commerce platforms Alibaba and JD.com won over the home market by overturning Amazon and eBay, while smartphone brands such as Xiaomi, OPPO, vivo, and Huawei have also thrived without protection.

The most important task for governments in the digital economy is not outlining industrial plans and policies, but ensuring data security and that companies protect their users’ data and prevent data misuse. Policymakers may also help to facilitate the construction of digital infrastructure.

All in all, governments should be prudent about regulating the digital economy. They should not be rash or aggressive, but rather respect the market and listen to the voices of companies and consumers before announcing policies. Ultimately, the driving force for China’s booming digital economy lies in private enterprises and lightly regulated market.

Zhu Tian is the Santander Chair in Economics and Director of the EMBA Programme at CEIBS. He is an expert on the Chinese economy and the author of the recently-released book, Catching Up to America: Culture, Institutions, and the Rise of China. For more on his teaching and research interests, please visit his faculty profile here.