Morgan Stanley: The Hefei Model Is Hard to Replicate, Industrial Policy Cannot Substitute for Rebalancing Reforms
Miles Bennett
Morgan Stanley argues that Hefei's industrial-policy success rested on a rare confluence of timing, boldness, and local endowments that cannot be systematically replicated; even with stronger exports and better-targeted policy, the structural bias toward investment over consumption remains unresolved.
What did Hefei actually get right?
Hefei's government acted not as a conventional subsidy-giver but as an ecosystem planner and venture capitalist — deploying fiscal capital as patient money, anchoring lead firms, then building supplier networks around them.
Three defining bets: 2008 — backed BOE's Gen-6 LCD line, giving Anhui 10% of global display capacity. 2016 — provided three-quarters of CXMT's initial capital, creating China's only mass-production DRAM maker and the world's fourth-largest. 2020 — rescued NIO with RMB 7 billion, triggering BYD, Volkswagen, and Changan to set up plants and drawing over 500 component suppliers.
The result: Hefei's real GDP nearly doubled in a decade, reaching RMB 1.4 trillion in 2025; the city climbed from 24th to 18th nationally.
This means → Hefei did not simply throw money at industries. It positioned itself precisely before competitive landscapes had formed — and that is exactly what latecomers cannot replicate.
If Hefei was so successful, why can't it fix the deeper problem?
The telling data: over the past five years Hefei's industrial output and exports outperformed, yet retail sales growth lagged and local deflation was worse than the national average.
In plain terms = industrial policy redirects where money is invested, but it does not fix the total imbalance of "too much investment, too little consumption" — factories got stronger while household wallets did not keep up.
This reflects the core contradiction in China's macro challenge: the supply side keeps strengthening while the demand-side gap stays wide open.
What happens if other cities copy Hefei?
Morgan Stanley warns that Hefei's success conditions are inherently scarce — precise timing, early boldness, local endowments, and an industry demand cycle arriving at just the right moment. Remove any one and the model breaks.
Latecomers face higher entry barriers, less room to attract anchor firms, and more crowded end-markets.
If regions race to replicate the surface formula — "government capital + recruit a lead firm + build an industrial park" — piling into the same hot sectors, the result is nationwide duplicate investment that worsens the very overcapacity Beijing is trying to curb.
This means → the essence of the Hefei model is "the right move at the right time," but imitators tend to copy only the "spend big" part.
Exports are booming — can external demand carry the load?
Morgan Stanley forecasts China's export growth at roughly 10% this year, well above the 2.2% average for 2023–2025; the global export share could rise from 15% to 16.5% by 2030.
The catch: today's export drivers are capital-intensive industries with weaker job creation, so the income pass-through from exports to households is smaller than in previous cycles.
In plain terms = factories are earning more abroad, but they are not creating proportionally more jobs — strong external demand does not automatically mean stronger household income.
A bigger risk: relying on foreign demand to absorb excess supply makes the domestic economy more exposed to global-cycle swings and trade friction.
What do inflation and growth look like from here?
GDP forecast: 4.8% this year, 4.7% next — but with a K-shaped split. New-economy segments such as AI and energy transition are growing fast, yet they are narrow and capital-intensive, unlikely to drive broad income gains.
Inflation path: PPI is projected to rebound to 1.5% in 2026 — the first positive reading in four years — but improvement is concentrated in upstream and AI-linked industries. Once the energy-cost impulse fades, PPI turns negative again at −0.4% the following year. CPI: 0.8% this year, 0.6% next. GDP deflator: 0.5% this year, 0.3% next.
This means → deflation appears to be easing on the surface, but the recovery is confined to a handful of sectors with very limited pass-through to consumer prices — the price environment most people experience will barely improve.
What does Morgan Stanley see as the real way out?
Three core reforms: ① Shift cadre performance metrics from industrial output to household income and consumption growth. ② Reduce fiscal reliance on VAT — a tax levied on production stages that inherently rewards making more goods, not consuming them — and raise the share of direct taxes. ③ Strengthen the social safety net to convert households' excessive precautionary savings into spending.
The reality check: the 15th Five-Year Plan's consumption-boosting language remains aspirational, lacking binding targets; geopolitical pressures also reinforce the supply-side development reflex.
In plain terms = better industrial policy and stronger exports can make the growth numbers look better, but as long as the incentive structure stays unchanged — cadres are judged on output, the tax system rewards production — the root cause of deflationary pressure will not go away. That is the real question the Hefei model leaves for China's macro policymakers.
Content is for reference only, not financial advice.