Why China is not an innovation powerhouse?

Shanghai from the Jin Mao Tower

Shanghai from the Jin Mao Tower (Photo credit: thewamphyri)

By Guy de Jonquières, Special to CNN

Editor’s note: Guy de Jonquières is a senior fellow at the European Centre for International Political Economy. This article is based on his recently published paper, Who’s Afraid of China’s High-Tech Challenge?

Some of the sheen may be wearing off China’s miracle growth story as it faces a growing array of economic challenges. But the country’s drive to become an innovation powerhouse and global leader in science and advanced technologies continues to inspire shock and awe abroad.

China has already overtaken the United States and Japan to become the largest recipient of patent applications and is forecast to outstrip the U.S. as the biggest source of scientific publications by 2020. Its universities turn out about 2 million engineering graduates annually, more than any other country.

Beijing’s plans are more breathtaking still. The most far-reaching is the Strategic Emerging Industries initiative, which is backed by state funding of as much as $2 trillion over five years and aims to leapfrog today’s global leaders in sectors such as clean energy, information technology, biotechnology, advanced manufacturing and new materials.

However, as so often in China, all is not quite as it seems. Surging national patent applications, it turns out, have been spurred less by an explosion of innovation than by numerical government targets for filings and lavish state incentives to ensure they are met. This looks suspiciously like a case of “Never mind the quality, just feel the weight.”

In 2011, for example, fewer than a third of patent applications in China were classified as “innovation” patents, and these accounted for only one tenth of all patents granted between 1985 and 2010. Studies have also found patents granted to Chinese owners generally to be of lower quality than those held by non-Chinese.

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The difference is reflected in the huge imbalance between the income China receives from foreign royalties on patents it has issued – $1 billion in 2011 – and its $18 billion royalty payments that year to patent holders abroad. Though internal technology transfers by multinational companies to their Chinese affiliates account for some of the $17 billion deficit, China clearly still relies far more on imported technologies than on those it has developed itself.

The country’s fast-growing research and development efforts will be critical to closing that gap – and China is certainly throwing money at the problem: last year, it spent almost $300 billion on R&D, second only to the United States and more than Japan and Germany, the next two largest spenders, combined.

However, R&D spending measures only input, not output, which is what matters to technological and industrial success. By that yardstick, there are many questions about how well China performs. It possesses many clever – even brilliant – scientific brains and engineers. But they are minority. A 2008 study by Duke University found engineering degrees in the U.S. were generally superior to those in China, while all but a few of 80 companies worldwide surveyed in 2005 by McKinsey, the management consultancy, judged U.S.-educated engineers to be far more employable than those educated in China or India.

Other constraints also hinder R&D in China. In its universities, intense rivalry for career advancement among researchers has led to widespread academic plagiarism and corruption; fear or intolerance of failure, especially in the large state sector, tend to deter imaginative risk-taking, while political repression of dissent and an education system heavily based on rote learning hardly encourage original thinking and creativity.

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Innovation also involves far more than invention. It requires the ability to translate laboratory breakthroughs into successful products and services that tap into market demand. That, in turn, means harnessing a far wider and more complex combination of skills and capabilities than just technical competence.

A widely-used indicator of a country’s progress towards that goal is Total Factor Productivity (TFP), which measures all the economic inputs that cannot be explained by productivity of capital and labor: for example, technical skills, management capabilities, organizational competence, accumulated knowhow and the ability to apply as well as to develop technology.

In the decade or so up to 2007, China achieved rapid annual gains in TFP. Since then, however, they have fallen by as much as half. A recent study by Ernst & Young, the accountancy firm, says that instead of moving closer to the “technology frontier” – the TFP benchmark set by the most advanced economies – China is slipping steadily further away from it.

If China is to fulfill its leaders’ dreams of dominating world markets for the products and services of the future, it will need capable companies to deliver them. It boasts some nimble, enterprising and fast-growing technology companies, such as Huawei in telecom equipment and Baidu, Sina and Alibaba in online services, which have been adept at pioneering new markets. But they are still few in number and many have yet to venture far beyond China’s borders.

So how should China respond? To breed more industrial winners, the country needs to overcome several self-inflicted handicaps. Perhaps the biggest is a highly unbalanced economy that depends excessively on fixed asset investment – about half of GDP – for growth. This is the result of a skewed financial system that floods banks with abundant artificially cheap capital, much of which is then lent to manufacturers, construction companies and property developers. The system, combined with local governments’ frenzied efforts to boost growth and employment, has spawned massive excess capacity, eroding borrowers’ profitability and their capacity to repay mounting debt.

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The economy is distorted further by political favoritism, which channels preferential financing and many other privileges to the state-owned enterprises (SoEs) that dominate many sectors of the economy. However, the SoEs are slow-moving and far less efficient than the private companies that are the main innovators and pace-setters in many of China’s high-tech growth markets. Indeed, some studies have found that collectively the SoEs destroy, rather than create, wealth.

China’s new leadership, headed by President Xi Jinping and Premier Li Keqiang, are well aware of the need to tackle these problems. Effecting change, however, means confronting an array of thorny challenges, starting with entrenched resistance from the many politically powerful interests that profit handsomely from keeping things as they are. It’s still unclear which way the battle over reforms now raging in the ruling Communist party will go.

Another of China’s disadvantages is that few of its companies yet possess an international presence or much experience of operating abroad. Most lack globally recognized consumer brands and the marketing expertise and distribution channels needed to control the downstream activities where established western competitors often earn much of their profit.

Increasingly, Chinese companies are seeking to make up for those deficiencies by acquiring businesses in the West. But despite the state’s deep pockets and a reputation for paying fancy prices, that route can also be an obstacle course. Many “crown jewel” foreign companies aren’t for sale – and if they are, Chinese bidders can run into local political opposition or barriers erected on national security grounds, especially in the United States.

Far from being poised to sweep to global dominance in innovation and high-technology, China is still struggling to catch up with the established world leaders. It has made some notable progress, including breeding some resourceful and fast-growing companies. However, many of these advances have been achieved in spite of, rather than because of, China’s state and its extensive control over the economy.

Whether China can ever produce fundamental breakthroughs or innovators to match Thomas Edison, Henry Ford or Steve Jobs remains an open question. What is increasingly apparent, though, is that China’s capacity to transform the global order in science and technology depends critically on its ability to confront tough challenges it faces at home.

Source: CNN



Categories: Economies, Innovation, Universities

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