In late 2017 a headline in the South China Morning Post declared: “China’s chance to lead global innovation may lie with 5G mobile technology development.”1 The accompanying story began as follows: “China is on the cusp of recasting itself as a leading technology innovator from a mere follower in the telecommunications industry,” a statement that conveys China’s growing ambitions to create new technologies, rather than adapt existing ones.2 These ambitions are rooted in China’s history, as westerners were reminded by the elaborate opening ceremonies at the 2008 Beijing Summer Olympics. Troops of performers colourfully celebrated China’s historical record as the inventor of gunpowder, the compass, paper, and moveable type, while its use of hydraulics and iron smelting predated such knowledge in Europe.
Since 2006 China has been in fast-forward mode as government ministries have rolled out successive ambitious plans to make the country an innovative society, with growing emphasis on science and technology and the declared aim to become a world leader in advanced manufacturing and, more recently, artificial intelligence (AI). Innovation performance is a central factor – as part of broader structural changes – in achieving more sustainable growth after decades of investment-led, export-oriented, rapid industrial growth. Initially that industrial growth was driven simply by adding more capital and labour, redeploying China’s abundant supplies of rural, low-cost labour to modern urban jobs, and encouraging the investment of domestic and foreign capital. As the labour force became more productive, wages rose, as did consumption. But China’s population is aging as a result of the one-child policy and the labour force has begun to shrink, reducing growth prospects, increasing uncertainty about investment projects, and reducing investment efficiency. Where, for decades, China had used three to four units of capital to produce an additional unit of output, in the 2010–15 period 5.6 units were required.3 Improving productivity growth through innovation became a priority.
CHINESE INNOVATION STRATEGIES
Innovation takes a variety of forms and produces a variety of outcomes. The goal of innovation is to create new knowledge and apply it in commercial applications to attain economic advantage. The innovation process involves learning by entrepreneurs and creative thinkers who design new ways of doing things; firms devise strategies, solve problems, and find new ways to deliver more output per unit of input, often through risky processes of trial and error. Innovation includes activities that range from discovery and invention to the adaptation and incremental upgrading of existing products, processes, and practices.
Much Chinese innovation, however, has been characterized as adaptation or “incrementally upgraded products with unprecedented rapidity.”4 During the past forty years of reform and opening up, China has been catching up to more advanced economies through industrial upgrading, encouraged and facilitated by policy and regulatory actions. But a turning point occurred in 2013, when Xi Jinping shifted the goal to that of facilitating China’s emergence as a global technology leader moving towards the technological frontier. China 2030, a joint research report published in 2013 by the State Council’s Development Research Center and the World Bank, proposed a market-based strategy to promote increased competition in all sectors, and even the withdrawal of government from direct involvement in production, distribution, and resource allocation.5 In 2015 Xi changed direction by expanding state-led intervention with the introduction of the Made in China 2025 (MIC 2025) industrial innovation strategy. The focus shifted from market-based reform to a mixed approach relying on market forces in some areas and in others a concerted push by the state for Chinese economic dominance. Substantial public funding poured into R&D in strategic emerging sectors and AI, where experts describe China as mere steps behind the United States.6 China has an impressive record in R&D spending,7 and is a world leader in patents filed. But these are “input” measures when what matters are “outputs” in terms of productivity gains.
China’s record of innovation that generates new ideas and commercializes them as new products varies across industries. In e-commerce and online services industries, Chinese enterprises have emerged as first movers, responding to demand from the country’s huge, fast-growing, and underserved number of middle-class consumers. As discussed below, other industries have also developed unique processes to improve efficiency and speed up R&D processes. Evidence of global competitiveness is more modest, however, among China’s large science- and engineering-based industrial firms, where learning and knowledge are essential for success in international markets.8
CHINESE INNOVATIONS IN E-COMMERCE
In China’s e-commerce and digital industries, a new breed of innovator has emerged among entrepreneurs with global mindsets who are familiar with cutting-edge technologies. Over the 2014–16 period, China became one of the world’s leading investors in digital technology, pouring an estimated $77 billion in venture capital into Chinese firms, representing a sixfold increase from $12 billion over the 2011–13 period.9 Accelerating this growth was the rapid rise in domestic demand and global diffusion of new technologies. McKinsey Global Institute estimates that China now accounts for 40 per cent or more of the worldwide value of e-commerce transactions.10 Both growing middle-class demand and the digital revolution, which facilitates input supply and product delivery, have supported scale economies in producing and paying for consumer goods and services. Insulated from foreign competition, significant parts of the Chinese market took on a life of their own. Moreover the spectacular development of online consumer markets in China still has far to run as digitalization moves beyond consumers to industrial and services producers.
China has unique advantages in such innovation. Most obvious is its 100-million-strong “consuming class,” whose numbers are expected to double by 2025.11 China also has well over 700 million Internet users (Table 2.1) supporting a vast scale of production. In such a large market, incremental innovations frequently produce more-than-incremental returns. Additionally, the size of the online population provides space for small new firms to enter the market. Chinese consumers are unusually receptive to new products and technologies. Mobile payment is a notable example of a new technology that has attracted a huge consumer response because it is easier to use than the more conventional and cumbersome credit and debit card services banks provide. As a result, China is becoming a cashless society far in advance of any other nation, with mobile payments estimated to have totalled $8.6 trillion in 2016 – in the United States that year, the total was $112 billion.12 This preference for mobile payments has also facilitated China’s development of financial technology (fintech) industries. Not surprisingly, the three original Chinese e-commerce giants – Baidu (a search engine), Alibaba (online shopping), and Tencent (social media), collectively known as BAT – have established financial affiliates to provide simple and quick payment services. Alibaba’s Alipay runs its own digital payments business, while Yu’e Bao, a financial affiliate of BAT, provides digital wealth-management services; both are owned by Ant Financial, valued at $150 billion in a 2018 fundraising initiative.13 Tencent developed payment services through Tenpay, online banking through WeBank, and WeChat, a multipurpose mobile app. Together these service providers control most of the mobile market in China. By 2015 as many as three new lending platforms were reported to be coming online each day – and an average of two others failed. A belated crackdown on online fraud failed, however, to prevent a collapse in P2P lending in mid-2018 because of the powerful effects of the deleveraging campaign on small borrowers and on lending platforms.
Table 2.1 Internet Users and Penetration, Selected Countries
| Country | Internet Users, 2017 (millions) | Internet Penetration, 2016 (users as % of population) |
| China | 772 | 52.2 |
| India | 462 | 34.8 |
| United States | 312 | 88.5 |
| Brazil | 149 | 66.4 |
| Japan | 119 | 91.1 |
| Russia | 109 | 71.3 |
| Nigeria | 93 | 46.1 |
Sources: Internet users: “Internet World Stats,” available online at https://www.internetworldstats.com/top20.htm; Internet penetration: Internet Live Stats, “Internet Users by Country, 2016),” available online at http://www.internetlivestats.com/internet-users-by-country/.
These networks of services allow users seamless movement across retail transactions and payment as well as savings and investment transactions in what is called a digital “ecosystem” that provides one-stop shopping for an ever-widening variety of goods and services available through “super apps.” The conveniences provided WeChat and Alipay customers are also effectively exchanged for a treasure trove of data about their lives and preferences as they purchase increasingly diverse services ranging from tuition payments for education to physical activity tracking, news services, and entertainment. WeChat’s super app includes forty functions; Alipay’s has ninety.14
The formidable volumes of data from more than 700 million Internet users are a major source of China’s emerging capabilities in AI. These data can be used by software engineers, if privacy laws permit, as inputs to the machine learning that is fundamental to artificial intelligence. In July 2017 the State Council issued a “New Generation AI Development Plan” and a roadmap for AI to become a $150 billion industry by 2030.15 Indeed the absence of data protection laws in China is a significant facilitating factor in the development of AI tools in fields such as health care and finance, but also in the nascent “social credit” system being developed by the Chinese authorities to evaluate both financial creditworthiness and personal trustworthiness. A cyber-security law that took effect in June 2017 mandates data localization, requiring foreign firms to store their Chinese data in China and forbidding them from using these data to offer services to third parties. Such a requirement prevents non-Chinese enterprises from pooling data across countries. But, as experts point out, data are only one dimension of AI capabilities; other key dimensions include algorithms, insights, and research, which know no borders.
The volume and diversity of information on China’s consumers is already providing the basis for AI applications. Baidu Medical Brain, for example, is intended to address structural problems in the health care system, such as the imbalance in available resources between rural and urban areas.16 Newer digital entrant Xiaomi is diversifying its smartphone applications for a wider range of aspects of consumer behaviour, while NetEase, an Internet technology company with a large mobile news application, is also building a digital ecosystem.17
As noted, government is relatively absent from this discussion of China’s burgeoning e-commerce and online activity, particularly as owner and regulator. SOEs are virtually absent from the list of large privately owned firms such as BAT, although they still predominate among listed companies. Instead, increasing numbers of privately owned enterprises appear as publicly listed companies. As recently as 2012, only 73 such firms had a market capitalization of more than US$1 billion and sufficient trading volumes; by 2017, the number had grown to 847. Many are in consumer goods, health care, and technology, while SOEs remain in traditional energy, materials, industrials, utilities, and real estate.18
The e-commerce example also illustrates how regulation lags innovation. Such a lag is not unique to China: explanations of the genesis of the 2008 global financial crisis prominently include the lag in the United States between the spread of financial innovations and regulators’ responses. In China, regulators were absent during the first decade of online activity. Only in 2016, eleven years after Alipay introduced online money transfers, did regulators move to cap individual permitted values. Scandals erupted as some online operators developed Ponzi schemes to defraud their customers. At least two multi-billion-dollar Ponzi schemes disguised as transactions between peer-to-peer lenders, and many smaller frauds, have taken investors’ funds or invested them badly. After the regulatory crackdowns began, P2P lending grew 43 per cent in outstanding loans between June 2017 and when the collapse began in June 2018.19 The core reason to regulate commercial banks is prudential: to create incentive frameworks that ensure appropriate leverage and modern risk management by banks entrusted with household and business savings. Yet when regulators fail to understand the risks of innovative financial products, they are slow to apply the fiduciary principles of oversight. This relatively hands-off approach towards privately owned enterprises in the online industries contrasts sharply with the state’s quantitative targets and interventions in manufacturing, where it aspires to become a superpower.
DELIVERING CHINESE INNOVATIONS
Sectoral studies by Cambridge University economist Peter Williamson and colleagues have contributed significant insights into Chinese innovations in new production processes and R&D to accelerate economic change. The forty cases Williamson and his colleagues look at are in a variety of industries, including e-commerce, personal computers, equipment industries for medical diagnostic devices and music equipment, pharmaceutical R&D, telecommunications equipment, mobile communication equipment, and original equipment manufacturing.20 Their examinations show that Chinese entrepreneurs approach disruption with intention, rather than through discovery. They also argue that market managers and entrepreneurs in the developed economies need to be more alert to disruptive innovations in emerging market economies by locating there, rather than by adapting innovations from imported products. Those exposed to disruptive innovation might need to re-engineer their own processes along the lines of disruptive innovations in emerging markets, such as industrializing R&D.
Industrializing the innovation process: Williamson and colleagues’ case studies show that disruptive innovations in target industries increase the efficiency of production and reduce costs. “Industrializing” the innovation processes does not rely on experimenting with new ideas by an investor or small team, nor does it involve large-scale, tightly defined processes. Instead the approach is to divide innovation into a large number of small steps and assign teams to work on each stage like an assembly line to accelerate the process of product development and the pace at which new products are brought to market. Telecom equipment manufacturer Huawei, for example, has accelerated production and reduced prices by adding many more engineers to each R&D project than would be the case in a traditional operation and organizing them into small teams, each with a specific task. Such modifications have allowed both economies of scale and specialization.
Modularizing product development: Modularization of product development is another innovative approach in which the design process is broken down into small units or modules that are then ‘knitted” together by software. Design improvements are speeded up by using a “launch + test + improve” sequence. Even building construction has been modularized, as dramatically demonstrated by the Changsha-based Broad Group, which constructed a fifty-seven-storey hotel in nineteen days.21
Parallel processing in R&D: Another innovation is parallel processing in R&D, a technique developed by Lenovo, borrowing from the idea of parallel processing used in supercomputers, whereby, instead of using a linear process, various R&D functions that are normally sequential are conducted simultaneously. The process is reported to work well where the underlying technology is unchanged, but the production process is disruptive of costs, applications, and business model innovations.
In summary, disruptive innovations are prevalent in Chinese companies in response to intense market competition. These companies share the common characteristic of scale that enables them to make decisions more rapidly than can their smaller competitors about cost-reducing changes or changes in the business model, because even moderate success can deliver results above breakeven. Although these findings are specific to China, Williamson and colleagues conclude that international competitors should pay heed, since they might require such capabilities to be successful in the next round of global competition in developing country markets, where lower-priced products and value for money will be critical factors for success.
BECOMING A WORLD LEADER IN ADVANCED MANUFACTURING
The role of market forces is less evident in Made in China 2025, often called China’s industrial policy, where the state dominates the economy to realize the goal of the country’s becoming a world leader in advanced manufacturing. To that end, the state encourages local content to reduce the growing risk of relying on foreign technologies, while funding outbound investment to obtain the technology and skills required for the targeted industries. MIC 2025 is a successor to the “Medium- to Long-Term Plan for the Development of Science and Technology” adopted in 2006 with the aim of transforming China into an innovative society by 2020 and a world leader in science and technology by 2050. Seven “strategic emerging industries” – energy-efficient environmental technologies, next-generation IT, biotech, high-end equipment manufacturing, new energy, new-energy autos, and new materials22 – were identified where China should achieve mastery through indigenous innovation, investment in R&D, accumulation of IP, and the obtaining of foreign technologies in exchange for granting access to the Chinese market.
In 2015 the Ministry of Industry and Information Technology rolled out MIC 2025, a ten-year innovation agenda influenced by Germany’s Industry 4.0 strategy to become a leader in advanced manufacturing production. MIC 2025 builds on key aspects of the existing “factory of the world” ecosystem, particularly the size of the supplier base. China has five times the size of Japan’s supplier base, 150 million factory workers, and good infrastructure all of which give it supply chain advantages, most spectacularly evident in the cost advantages of the solar panel industry, where China has become the world’s leading producer.23 MIC 2025 identifies ten priority sectors that overlap and expand the strategic emerging industries identified in 2006: advanced IT, robotics and automated machines, aerospace and aeronautical equipment, maritime equipment and hi-tech shipping, advanced rail transport equipment, new-energy vehicles and equipment, power and agricultural equipment, new materials, and biopharma and advanced medical products.24
Massive state funding is available for what appears to be a direct challenge to advanced manufacturing in the United States, East Asia, and Europe, and is intended to increase import substitution and reduce China’s dependence on foreign suppliers of sophisticated equipment, particularly digital and communications equipment.25 Domestic content has been set at 40 per cent of core components and materials by 2020, and 70 per cent by 2025. Outward investment is encouraged and supported in order to acquire core technologies through mergers and acquisitions. But the US administration’s decision to label China a strategic competitor has increased the risk of China’s continuing to rely on foreign technologies, and turned a spotlight on established discriminatory Chinese practices that restrict market access for foreign investors and force technology transfers in joint ventures. There are some exceptions. “Innovation demonstration zones,” announced in July 2017, are intended to treat foreign and domestic investments the same except in certain sectors.26 Market forces play a role, mainly in consumer goods and services production and distribution, where MIC 2025 calls for market institutions, stronger protection of intellectual property for small and medium-sized enterprises, more effective use of IP in business strategy, and recognition of technology standards.27
All levels of government in China are involved. Local governments, in particular, have pushed projects forward, speeding progress towards national goals, especially in robotics. Impressive indeed, but performance has to be weighed against evidence that funds are being misallocated and efforts duplicated in the rush. The heavy state role raises questions about the implications of such politicization for the innovation ecosystem. Will political goals and quantitative targets crowd out individual initiatives, fundraising, and risk-taking?
A careful assessment of MIC 2025 by Germany’s Mercator Institute for China Studies (MERICS)28 predicts that mismatched priorities between government and industry and overemphasis on quantitative targets, among other factors, will send mixed messages to investors. Tensions between political and economic goals are inevitable. Excessive focus on quantitative targets is likely to divert energies from bottom-up entrepreneurial innovation, and promises of generous funding will cause distortions and waste. As Barry Naughton and others have pointed out, China is ignoring the lessons of the success of Japan, South Korea, and Taiwan – particularly their decisions to reduce the role of the state to setting the economic framework, producing public goods, and improving productivity performance by freeing up market forces and promoting competition.29
A counterargument put forward in China is that misallocation of capital and living with excess capacity might be the acceptable costs of reaching the technological frontier. High-speed trains provide one example. To build them, firms were attracted from Japan, Canada, and France as joint venture partners and expected to share their technologies. As supply chains were localized, the Chinese partners benefited while their foreign partners lost their technological advantages and began to face their former joint venture partners as competitors. Although it is premature to predict MIC 2025’s potential for success, some draw a parallel with China’s experience with semiconductors. The industry was initially marked by excess capacity and lack of competitiveness, but after twenty years of effort, China has created a vast electronics base, one internationally competitive producer in Lenovo, and a largely indigenized electronics supply chain. Significantly, however, efforts to catch up and master the design and manufacture of semiconductors have yet to bear fruit – China imports more than 95 per cent of its high-end chips, and the Trump administration is using investment restrictions and export controls to slow progress.30
ENTERPRISE OWNERSHIP AND PRODUCTIVITY COMPARISONS IN CHINESE ENTERPRISES
Implicit in the MERICS assessment are concerns about the mixed effects of ownership on productivity performance. University of Toronto economist Loren Brandt and colleagues compare the productivity performance of SOEs and non-state firms in three different years (1998, 2007, and 2013),31 and find evidence of a remarkable shift through time. In 1998 non-state firm productivity averaged 15 per cent higher than that of state firms, with the gap evident in 80 per cent of the sectors studied. By 2013, however, productivity was lower in non-state firms than in SOEs in a majority of sectors. Significantly, this decline in productivity coincided with the disappearance of new entrants in these industries (largely private firms) and fewer incumbent firms, raising questions about the negative effects of state intervention, such as MIC 2025, that favours domestic firms and particular sectors. This evidence also suggests a decline in state support for liberalizing policies and for deregulation to promote competition.
In another study of differential behaviour by ownership, Nicholas Lardy focuses on the recent borrowing behaviour of SOEs and privately owned enterprises. He finds that the latter’s share of bank loans to non-financial corporations dropped sharply from 57 per cent of the total in 2013 to 19 per cent in 2015. In contrast the SOE share of such loans almost doubled, from 35 to 69 per cent over the same period. This trend can be expected to be exacerbated by the policy shift in 2016 towards tighter financial conditions to reduce systemic risk. Indications are that the biggest losers from tighter access to credit will be the less-well-known small and medium-sized enterprises that create most of the jobs.32
INNOVATION AND STATE INTERVENTION
Studies such as those of Lardy and Brandt and colleagues underline the importance of institutions for productivity performance. Government policies play a prominent role: protectionist policies that deny entry to foreign competitors in the e-commerce industry are seen as key factors in Chinese firms’ success in the home market as they adapt existing (foreign) technologies. While government ministries orchestrate strategic plans for China to become an innovative society, tensions are apparent between the Party’s primary concern to preserve political and economic stability and the economic freedoms and openness associated with a vibrant market economy. Seasoned outsiders and China watchers have warned of the potentially negative implications of this ambiguity. Henry Paulson, former Goldman Sachs chairman and US treasury secretary, observes in his book, Dealing with China, that success in an innovation-rich economy is driven by human ingenuity that thrives on free and open exchange: “You can’t run a successful business cut off from the world.”33 In a 2014 Harvard Business Review article, “Why China Can’t Innovate,”34 the authors argue that China has been successful with creative adaptation but has not led. The problem, they assert, is not innovative or intellectual capacity, but the restrictive political framework in which business and education must operate, which is “very much bounded.”
A number of other studies show that state intervention is successful in industries in which enterprises rely on substantial accumulation of knowledge and engineering skills. High-speed trains, mentioned above, are an example of state ownership and support, both to increase local demand and to negotiate joint venture agreements with foreign producers. China’s share of the global market for such trains is now 41 per cent. Wind power and communications equipment provide other examples featuring Chinese producers. In wind power, the original approach was to allow open bidding, which led to a flood of foreign imports. In response, SOEs were required to source 70 per cent of their components from domestic suppliers. These policies forced the creation of joint ventures in local production and diffused knowledge from foreign producers to local firms. By 2009 six of the ten top wind power firms were Chinese, and by 2010 they accounted for 93 per cent of world sales. The state has also helped them acquire knowledge through high-profile programs such as the 2003 Wind Power Concession Project.35
Science-based innovation is another priority area where state investments are being used to build institutions and capabilities, notably in pharmaceuticals, biotech, semiconductor design, and specialty chemicals. Such innovation takes a long time to pay off, and is hampered by slow regulatory processes, IP protection, inefficient allocation of government funding, and underinvestment by the private sector. But some Chinese firms in drug discovery are successfully using the accelerated innovation models of Williamson and colleagues.36
In telecommunications, in contrast, Huawei Technologies provides an example of the opposite behaviour: its response was to globalize. In this case, however, foreign partners were reluctant to share their cutting-edge technologies, and state support was not forthcoming. Huawei had to invest in developing its technology through expensive trial-and-error processes, but it eventually succeeded in creating its own sophisticated designs, albeit with R&D expenditures totalling 12 per cent of revenue. The strategy also included localizing innovation among centres situated around the world.37
As noted, China has not achieved its goals for the design and manufacture of semiconductors and semiconductor equipment, but continues to depend on foreign technologies and IP. The United States, the still-undisputed industry leader, has screened foreign bids for US firms in order to deny Chinese investors access to key technologies. In response China is now investing heavily in state-funded research through MIC 2025 and other state plans to develop a world-class semiconductor industry. Its reported aim is to produce 40 per cent of its requirements for semiconductors by 2020, up from 16 per cent in 2018.38 Foreign governments are now moving to protect their own competitiveness – for example, recent US legislation authorizes export controls of critical technologies and expands the scope and rigour of interagency reviews by the Committee on Foreign Investment in the United States (CFIUS) of commercial transactions in order to protect core technologies.
Finally, educational institutions are playing a critical role in China’s innovation future. Performance indicators are positive, as measured by the rapid expansion of higher education investments and enrolments and the recognition in global rankings of China’s investments in university education and evidence of rising quality of education. In 2015 nearly 37 million students were enrolled in higher education, up from 24 million in 2012.39 Support for university education has been significantly ramped up, turning out 6.8 million graduates in 2015, up from half that number in 2005.40 Offsetting this part of the picture, however, are two problematic factors: one is that many Chinese graduates fail to remain in the country, preferring to leave to study or do research abroad; the other is that the state has been tightening restrictions on content to rely more on national sources and institutions.
GLOBAL IMPLICATIONS
What are the implications of these various state roles in China’s innovation performance? First, China has a huge advantage of scale in developing digital services, AI, and machine learning in industries of the future. Looking ahead, the surge in digital services is providing the abundant processing power and data that, along with the rapid growth of available technical talent, are needed at the AI research frontier the Chinese government seeks.41 A problematic feature of this surge, however, is the data-localization requirement the government imposed in June 2017. In strategic terms, restricting such significant technologies to Chinese institutions prevents foreign competitors from being active in the Chinese market, and it protects Chinese IP. But it also reduces the likelihood that Chinese AI researchers, for example, will be permitted to work with foreign technology companies to develop global safety standards. The application of Chinese AI technologies such as facial recognition to public surveillance and security screening also raises questions about the differential treatment of privacy in China and abroad.
A second issue with global implications relates to China’s learning about and acquiring new technologies through outward FDI and mergers and acquisitions (see Chapter 4). Many of the enterprises involved are SMEs and job creators as well as entrepreneurial leaders among privately owned enterprises in a range of industries that the Chinese government has encouraged to obtain foreign technology through joint ventures with and acquisitions of foreign companies – and by controversial means such as forced technology transfers. Between 2013 and 2015, outward mergers and acquisitions surged in technology-based industries, and some Chinese technology firms located R&D centres abroad. Huawei has 16 R&D centres around the world while Haier and Sany have done the same.42 Lack of reciprocal market access for US investors seeking to enter the Chinese market, together with the rising public profile of the state-supported MIC 2025, has, as noted, prompted stepped up US scrutiny of Chinese investment in the United States and export controls of critical technologies.
The third, and related, issue is outright Chinese theft of IP from both US and European sources. In a 2017 report, the Blair-Huntsman bipartisan Commission on the Theft of American Intellectual Property published estimates of the cost of stolen trade secrets in the hundreds of billions of dollars, particularly in biotechnology.43 Critics, however, argue that such numbers are likely inflated by including perfectly legal scientific cooperation. Further, recent reports of US patent recipients show Chinese inventors receiving 11,241 patents in fiscal year 2016/17, a 28 per cent increase in a year, but still only 3.5 per cent of the total number of 320,003 patents issued that year. Huawei alone had received nearly 1,500 patents by the end of 2017,44 showing that electronic manufacturers are beginning to develop their own technologies and branded products.
Other data, however, show evidence of a growing market for the purchase of intellectual property in the United States. Nicholas Lardy has pointed out that, rather than theft or forced foreign technology transfers from multinational companies, China’s payments for foreign IP have risen rapidly, reaching almost $30 billion in 2017, ranking it as the fourth-largest acquirer, behind Ireland, the Netherlands, and the United States.45
In summary, China is emerging as a dynamic and ambitious player in technological innovation. It has the unique advantages of the swift adoption of smartphones, rapid related software development and e-commerce, and the huge market size and scale of its customer base. Investment bankers are increasingly impressed by the speed and scale of movement by dynamic Chinese entrepreneurs into fintech, biotechnology, and AI, and their focus on innovation in operating models and services, rather than on more traditional product innovation.46 Chinese entrepreneurs are also seeking growth opportunities in the rest of the world, often with official support and encouragement. Their success in customer-focused innovation at home can be extended to emerging market economies if Chinese enterprises can develop the necessary sales and marketing skills. Chinese examples of disruptive innovation also have relevance for those who can apply them in both advanced and emerging market economies.
CONCLUSION
Is China becoming the “leading technology innovator” proclaimed by the South China Morning Post? Such a query is helpful in framing the issue more broadly. As noted earlier, there are differing views of Chinese innovation capabilities. Those who point to evidence of Chinese capabilities and their distinctive approaches argue there is even a Chinese model of innovation. Others argue that China’s innovation capabilities are constrained by the underlying tensions between state and market, as indicated by industry-level data on ownership and productivity, forcing China to continue to rely on foreign sources for innovative technologies.
Size matters. China can afford failures on the road to success. Even incremental change in the huge Chinese market can have major effects, and already China has a record of notable achievement in e-commerce, consumer services, and, increasingly, financial services. Not to be overlooked, however, is the protection these sectors enjoy from competition with foreign entrants. Services – including finance, telecommunications, transportation, and media, each of which is dominated by less-productive SOEs – are largely closed to foreign investment, yet they are also among the fastest growing sectors as the economy rebalances. Opening this and other sectors to foreign competition, skills, and technologies could be growth promoting.
Key institutional concerns remain. State support for advanced manufacturing raises questions about the global future of industries populated by oversized SOEs with problematic competitiveness. Until the significant tensions between political and economic objectives inherent in SOEs’ incentive structures are resolved, we are unlikely to see modern-day Chinese innovations as important as gunpowder and the compass; continued adaptation is likely to be the rule, rather than the exception. Instead, as recent analyses by Nicholas Lardy and Brandt and colleagues suggest, unless the model of state-led capitalism is eased, it could undermine China’s long-term economic potential. Such evidence raises doubts about the South China Post’s optimistic prediction. The policy environment and incentive frameworks in China are sending mixed signals about the roles of the market and the state. MIC 2025 sends a clear message that the state knows best how to reach the technological frontier. The state still believes in top-down targets and quantitative evaluations, rather than in bottom-up innovation in response to market-based incentives – although there is encouraging evidence of breakthroughs in some Chinese industries. More evidence is required of market opening, measures to attract investment, and increased protection for intellectual property. The adoption of a new FDI law in March 2019 by National People’s Congress is a positive development, although the regulations to implement the law have yet to be written. That is when differences over the role of the state will become clearer.