In January, Chinese company DeepSeek stunned financial markets with the release of its generative artificial intelligence model R1. It matched the efficacy of market leading US firm OpenAI’s most advanced models but was produced at a fraction of the cost.

The DeepSeek announcement is one in a series of recent developments that marks a new stage in China’s economic evolution.

Over the last four decades economic reform and China’s entry into the global trading system have transformed China’s economy and raised it from low- to upper middle-income status. There has been a sea change in the research and development capabilities of China’s universities and domestic companies, with Chinese businesses now on par with world leaders in several sectors.

From being the workshop of the world, known for manufacturing basic goods at low cost, China has evolved into a producer of technologically complex goods from computers and telecommunications equipment to electric vehicles, machine tools and drones. Western incumbents in high value-added sectors are facing increasing competition from China.

Take EV batteries. Many modern ones are based on Lithium Iron Phosphate (LFP) technology, which originated in the US in the nineties but was largely ignored by manufacturers, given meagre short-term returns and doubts over its effectiveness. It was Chinese battery companies, especially CATL, that directed research towards this technology and made transformative refinements. CATL now accounts for about 40% of the global market for EV batteries. Just last month, CATL announced its Shenxing 2 LFP battery that delivers a range of 520km with just five minutes of charge.     

UK reviewers have been impressed with the latest crop of Chinese cars. Autocar has said that “Chinese models are up there with the best in the business” with the Xpend G6 model described as a “credible Tesla Model Y rival, with an upmarket interior, decent ride quality and a price advantage over the American EV”.  Commenting on the market for small electric cars Topgear concluded: “When you dig into what the [Chinese-made] MG4 does for the money, it's probably the only car in the class to recommend”.

Chinese companies have become world leaders in the markets for batteries and solar panels. But how innovative are they across other advanced industries?

To answer this question, the US Information Technology and Information Foundation (ITIF) conducted a 20-month investigation of Chinese industrial capabilities in  ten advanced technology sectors, from robotics and chemicals to biopharmaceuticals and nuclear power. Its study, published last September, found that Chinese firms are leading innovation in nuclear power and EVs/batteries. In four other sectors – robotics, quantum computing, artificial intelligence and display technology – China is not far behind the global leaders and is making rapid progress. The ITIF assesses that at this pace of development, China is likely to equal or surpass the western leaders in less than a decade.    

Other indicators point in the same direction. A study by Japan's National Institute of Science and Technology Policy in 2022 found that China had overtaken the US in the number of scientific papers published annually, accounting for 23.4% of the world's scientific publications between 2018 and 2020. For those harbouring doubts over the quality of publications, the Japanese study found that China is now also the biggest source of the world's top 1% most frequently cited papers (followed by the US and the UK).

Patents tell a similar story. An ITIF study shows that, in 2010, Chinese firms accounted for less than 1% of patents granted by the US Patent and Trademark Office. By 2020, that had risen to 7%, with China granted the third highest number of patents behind the US and Japan. The US, nonetheless, leads on turning ideas into profit. World Bank data show that in 2023 China's intellectual property licensing receipts were less than a tenth of US levels.   

Nonetheless, this is a remarkable transformation driven by a number of factors – rapid growth, private and public investment and, most of all, government policy.

Through its 'Made in China 2025' initiative launched in 2015, the government has poured money into ten key industries, with the aim of making them world leading producers of high-end equipment and goods. While some critics have questioned the efficiency of the initiative, it has significantly boosted government spending on R&D.

According to the OECD, China's expenditure on R&D was 72% of America's in 2013. By 2023, it had grown to 96% and has been rising at just under 9% every year, a significantly faster pace than the US.

Government subsidies and tax credits, and a general rise in corporate profitability have also supported private sector investment in research. The European Commission compiles an annual list of the top 2,000 businesses investing in R&D. In 2013, only 93 of these firms were located in China, compared to 658 in the US. By 2024, the number of Chinese firms in the list had risen more than fivefold to 524, compared to 681 in the US and 322 in the EU.      

China's emergence as a global technology leader poses a threat to America’s domination in the field. The DeepSeek announcement wiped nearly a trillion dollars from the market value of American tech majors. US president Donald Trump said it was a “wake-up call” for US companies. Prominent venture capitalist Marc Andreessen called it AI’s “Sputnik moment” – a reference to the shock felt in the West in 1957 on the news that the Soviet Union had beaten the US in putting the world’s first satellite into orbit. 

Unlike earlier competitors in the field of technology, such as Japan or South Korea, in China the West faces a strategic rival. Yet the relationship is complex and involves both interdependence and rivalry. As the EU puts it, “China is a partner for cooperation, an economic competitor and a systemic rival”.

The launch of Sputnik caused alarm in the West and ignited a ’space race’ that, with  the  moon landing in 1969, America won. Yet the Soviet Union was not a major rival in terms of economic heft or civil technologies. China, as the world’s largest trading nation and the world’s second biggest, most populous economy, is. 

The US, like the EU, sees China as a systemic competitor. But the two great western blocs are responding very differently.

The US has gone in the direction of economic ‘decoupling’ seeking to reduce economic and technological ties with China, especially in strategic sectors including semiconductors, critical minerals and advanced technologies. The EU has explicitly rejected decoupling, and instead pursues what it calls ‘de-risking’. It aims to reduce dependencies in key sectors, increase supply chain resilience and protect key technologies without severing economic ties. The UK has taken a similar approach, one that yesterday led the US chief trade adviser, Peter Navarro, to brand Britain a “compliant servant of communist China”.  

The rise of China is causing a reset in trade and economic cooperation among its western partners. What, precisely, that means is open to a wide variety of interpretations.