Is China the world's next innovation powerhouse?

China has set itself the goal of becoming a manufacturing superpower on a par with Germany or Japan by the middle of the century. Key to this goal is the “Made in China 2025” plan, which outlines a strategy for upgrading all areas of the economy to increase efficiency and maintain economic strength even as GDP growth slows. Inspired in part by Germany’s “Industry 4.0” concept, it is a more wide-ranging strategy that envisages not just networked industries, but a greater global role for Chinese firms in establishing appealing brands and generating groundbreaking ideas.

The big question about this strategy is whether China can create an innovation system that is up to the task of implementing it. Dr Bruce McKern, current visiting professor of international business at CEIBS, visiting research fellow at Oxford University and co-author of the upcoming China’s Next Strategic Advantage: from Imitation to Innovation (MIT Press, April 2016), argues that China can, and will, become an innovation powerhouse.

You recently spent three years in China exploring the country’s innovation system, speaking to many multinational and Chinese firms. What have been the key milestones in the evolution of China’s innovation system and where are we now in that process?

If you look at the last 20 years, there’s been a substantial change in China’s capacity to innovate. It’s exemplified by and in China’s large investments in infrastructure: setting up more than 100 science and technology parks to foster SMEs and research centres, for example. R&D investment has steadily increased and, as of 2013, stood slightly ahead of the EU average at around 2% of GDP. For a country that 30 years ago had very little in the way of science and technology infrastructure, this is a remarkable accomplishment. Today China spends about 40% as much as the US on R&D—comparable when adjusted for the relative size of its economy.

The progress made on the back of this can be seen in various outputs. China’s high-tech exports now contribute 37% of the global total, exceeding those of the US or the EU. But it’s important to remember that roughly 80% of China’s high-tech exports are processing exports into global supply chains—the value-added in China is quite low. Another measure is patenting. 2012 was the year in which China’s applications for domestic “invention” patents first exceeded applications for “utility” patents in the US. Some private-sector firms, notably the ICT giants ZTE and Huawei, now also produce leading proportions of all global PCT patent applications. As for publications in scientific journals, China is rapidly moving up. In 2012, it reached number one in computer science and chemistry. Researchers are producing top-quality work, particularly in fields that are national priorities.

Innovation is now an imperative as never before. China’s progress so far has been based on cheap labour, even in R&D, but that’s now less of an advantage. China now has no choice but to shift towards products based on intellectual input rather than just labour if it is to raise the domestic value-added.

China now has no choice but to shift towards products based on intellectual input rather than just labour if it is to raise the domestic value-added.

Let’s talk about the actors behind innovation. What roles will multinationals and Chinese SMEs play in China’s transition to a more innovative business environment and will they be given adequate space to grow compared with the state-owned giants?

It’s key that China become more open to multinationals, seeing them as partners to local firms—as they have been to a large extent in the past. China will continue to need the technology strengths that MNCs can provide, and I believe the leadership recognises that. But there’s a worry that the environment is changing in the wrong direction. Attracting MNCs into productive partnerships should become a top priority—backed by consistent actions at all levels of government.

China’s future innovation ecosystem will also rest on domestic start-ups and private firms. Chinese firms are already good at incremental innovation. They respond very fast to customer needs and have evolved from copying, to making “fit for purpose” products that are just right for customer needs, to transitioning along with their customers up to higher-quality market segments. That’s a very good basis for success, and it gives them cash to go outside China and get the things they need, such as brands and technologies. This is the third phase in the development of Chinese business: from seeking resources to seeking foreign markets and new knowledge.

The challenge will be to take the knowledge and experience gained abroad and transfer this into Chinese firms’ innovation networks. This is an area in which success has been varied. In the automobile sector, SAIC’s acquisition of Korean firm Ssangyong failed, although the former SOE is now performing well. On the other hand, Geely acquired Volvo and managed that very well. It’s allowing it to operate fairly independently, while spreading the knowledge of its scientists and engineers around within the group.

I’m confident that if some inhibitions are removed, SMEs in China will do very well. They have tremendous drive, they understand their customers very well and are very good at pre-empting the fast-changing market.

In a recent article, you suggested that firms should look “well beyond technological innovations” to find the benefits of conducting R&D in China. What areas of advantage should foreign firms be looking to leverage?

Innovation in China is certainly not just about technology. Chinese companies are extraordinarily good at understanding their customers, which is a difficulty for foreign companies in China. When it comes to creating products for China, in China, domestic companies are ahead.

But there are other aspects that multinationals can learn from. They frequently tell us how quick Chinese firms are to innovate and launch a new product, even if it’s not completely ready. They put it out and then watch, learn and adapt. This is something that multinationals can benefit from emulating.

Then there is the huge expansion of the knowledge base. There’s a much broader range of capabilities being developed by research institutes and universities, and it’s important for companies to be involved in this knowledge ecosystem.

Do multinationals recognise China’s potential as a knowledge base?

We’re still in the early stages. When you look at multinationals in China overall, little of their China-based research is resulting in international patents.

That said, more than 1,500 R&D centres have been set up in the country by multinationals. These companies have moved from adapting products for the Chinese market to the more fundamental work of creating products for China. Their next phase: to tap the knowledge base in China, to develop products not just for China but also for elsewhere. In our study of 52 MNCs R&D centres in China, we found that 27% were already doing R&D to tap China’s knowledge base and were looking to develop products in China for world markets.

One company that is already doing this is UK-based pharmaceutical firm GSK, which has chosen China as the location for its worldwide research centre on neurological diseases. It is responsible for the entire innovation process—from basic research through to clinical trials.

This is not possible in every field, but because of the increasing abilities of Chinese researchers, there are good ideas that can be tapped—particularly when combined with the size and the characteristics of the market that make it unique and an innovation proving ground. There are many valuable lessons MNCs can learn from engaging with China’s markets and its national innovation system. These include bold experimentation, rapid iteration, creating new categories, focusing on lean value and others. We detail these in our forthcoming book.

Last May, China unveiled its industrial development plan “Made in China 2025”. What is your take on the plan and is China’s innovation system, as it stands now, able to take on the ambitious goals it sets?

The key goal of “Made in China 2025” is to shift local industry towards higher-value-added products. An important point is that the plan doesn’t just talk about innovation: There seems to be a recognition now that innovation doesn’t stand alone, but must be coupled with an improvement in the wider environment.

Compared with previous strategies, there seems to be less emphasis on indigenous innovation and that may mean a greater acceptance of collaboration. What’s needed is more equal competition for foreign companies in return for technology inputs, though it remains to be seen how far China will go on this. Premier Li Keqiang has hinted at levelling the playing field, but there have also been some moves backwards.​

The key goal of “Made in China 2025” is to shift local industry towards higher-value-added products. ​

Speaking of headwinds, is there an inherent contradiction between the new National Security Law (announced in June 2015), which is likely to restrict data flows and openness to foreign technology, and the “Made in China 2025” plan?

It’s a dilemma for the Chinese government. China wants a much more intelligent infrastructure but, at the same time, is acutely aware of the national security implications. The more sophisticated the IT system, the more vulnerable it is to potential attacks. And efforts to make it less permeable are likely to be inhibiting to innovation. It will be difficult to balance—I think we’ll see more contradictory statements and actions.

Can China’s education system, in its current form, support an upgrading in the innovation system?

It’s still the case that Chinese scientists and engineers go overseas for training, which is a sign of weakness in China’s education system. There’s a desire to promote more independent-minded scientific thinking, but it’s not easy to bring about. There’s still the issue of control. Silicon Valley is an open, challenging and enormously diverse environment, where it’s common to challenge received wisdom—and China’s education system needs these values. Also, China has a very low proportion of immigrants, which account for a majority of US start-ups.

The tension between the need for more creativity in education and the desire for cultural control is something that the government will need to manage. If China wants to become equivalent to Germany and Japan by 2040, then it will need to allow a freer atmosphere for ideas. The 13th Five-Year Plan intends to give more autonomy to universities and research institutes, which is a promising step. But it will be hard to restrict increased intellectual freedom to science and technology.

The tension between the need for more creativity in education and the desire for cultural control is something that the government will need to manage. If China wants to become equivalent to Germany and Japan by 2040, then it will need to allow a freer atmosphere for ideas.

From what is known of the 13th Five-Year Plan and the “Made in China 2025” initiative, where do you expect to see the most progress in innovation in the next few years?

The 13th Plan won’t be finalised until March. As in previous plans, we’ll see several sectors identified for support—such as “Internet Plus” (countrywide broadband, the Internet of Things and local CPU manufacture); nuclear power development in the “eastern belt” of the country; environmental quality; and medical research. But I think we’ll also see a lot of changes in the overall economic environment intended to clear away the obstacles to moving up the value chain.

For instance, there may be further opening of the banking system, better access to finance for SMEs and a lessening of bureaucratic obstacles, as well as more pressure on SOEs to be competitive. Opening more sectors to foreign investment would help towards this goal. There may be some changes in the incentives for research institutes to commercialise ideas.

The free enterprise zones, such as the one in Shanghai, have good potential to encourage more transfer of ideas and technologies from foreign firms into Chinese SMEs, provided that the IP regime is implemented more effectively.

Looking further into the future, how do you see China’s role in global innovation evolving?

Economic growth is slowing and we are seeing related shocks in the stock market. Obviously, China’s slower growth will continue to dampen demand, especially for commodities, but the 13th Plan’s target rate of 6.5% pa growth is still robust. In the long term, I think that China has the basis to become the industrial giant it wants to be. It has already achieved a remarkable change in its innovation system, and I don’t see any strong inhibitors that would prevent this from continuing, provided that the institutional obstacles can be cleared away.

China has not needed to be a country of breakthrough innovations yet. It’s now reaching the point where it does. Because Chinese firms have been through a very intense phase of incremental innovation, I believe that they have the ability to do radical innovation when it’s needed. And it will be needed more and more as the problems facing China loom larger, from energy supply and environmental degradation to population ageing and health.

These will need big, radical solutions. The question is whether the environment is sufficiently stimulating for people to do it. China has shown a remarkable ability to adapt as time has passed, so there’s a good chance that by 2020 they’ll be surprising the world with their ability to innovate.