Vertical and Horizontal Risks Along Industry Chains and a Dual-Pillar National System

International competition in trade has intensified since 2018, which we believe is determined by the objective, changing, and increasingly balanced strengths of countries. A shift from international competition in trade to deglobalization is being accelerated by the Russia-Ukraine conflict. The rollout of the US CHIPS and Science Act of 2022 has had further impacts on established patterns of cooperation, and international industry chains face security challenges caused by looming deglobalization. By examining horizontal and vertical risks, this chapter sheds light on the implications for the evolution of industry chains, financial reshaping, and institutions amid security challenges. Vertical risks refer to the increased costs of transactions between all parts of industry chains amid deglobalization. The costs weigh on the existing pattern of serial production, and are essentially supply-side risks. Efforts to mitigate these risks require a centralization-based transformation of industrial organization. Specifically, vertical integration on the supply side of the chip industry and other high-tech industries and horizontal integration on the demand side of natural resource industries can help reduce vertical risks by utilizing the innovation capabilities of large companies and other organizations. Horizontal integration on the demand side of natural resource industries can also help improve China's bargaining power in international markets, thereby reducing vertical risks in natural resource industries. Horizontal risks refer to the decentralization of China as one of the core nodes for global production capacity. Such risks are essentially demand-side risks and can be mitigated by diversification. Region-wise, we believe the moves to proactively switch the mature production capacity of textiles, home appliance, and other industries from China to Southeast Asia and surrounding countries, can increase regional cooperation. More importantly, we think competition among diversified small companies and “natural selection” can improve the capability of guiding innovation, and exports of the renewable energy industry and other industries in which China has advantages can build a new “China-surrounding countries” technology diffusion model. Domestic demand is insufficient in China, as shown by the country's low household consumption rate (household consumption as a percentage of GDP). In addition to eliminating consumption barriers in auto and other industries, greater importance should be attached to the efforts to propel fiscal and tax reforms so as to alleviate the effects of compulsory savings, build an “olive-shaped society” (CICC Global Institute, CICC Research. Building an Olive-Shaped Society (《迈向橄榄型社会》, Chinese version). CITIC Press Group. June 2022.) and tap the potential of diversification in consumption. From the perspective of serving the real economy, we think the moves to propel restructuring of the financial sector should follow the principles of the separation of the financial business from industrial sectors and the separation of various financial sub-sectors from each other so as to support the co-existence of centralization and diversification of industry chains. Positive interactions between financial markets and the real economy are not spontaneous, and require policy intervention. This means that efforts should be made to build a national system that encompasses the strengths of governments and markets, and the strengths of financial markets and the real economy. A catching-up system for “big companies, big governments, and big banks” can help mitigate vertical risks, and a leading system for “small and medium-sized enterprises (SMEs), system construction, and capital markets” can help reduce horizontal risks. A dual-pillar national system, which is an important mechanism for efforts to cope with security challenges along industry chains, should be a necessary condition, rather than a sufficient condition. The two pillars play an essential role in dealing with security challenges, and efforts should be made to resolve boundaries between governments and markets, the metrics of monopoly and competition, and the relationships between large and small companies.