Why China now leads the way in innovation

China is set to become the globe's biggest innovator by the end of this decade

China is set to become the globe’s biggest innovator by the end of this decade, as its government pushes the need for bright ideas and China’s huge domestic market demands something new.

Updated 24 August 2016

China has long celebrated its Four Great Inventions – gunpowder, the compass, papermaking and printing. All four were developed many hundreds of years ago. But as the nation’s economic resurgence continues, both the Chinese Government and Chinese corporations are working to make China a world-leading innovator again.

In recent years, innovation and technology have become the loudest buzzwords of Chinese industry. According to 2014’s China Innovation Survey by global management consulting firm Strategy&, innovation is now the top priority for 42 per cent of Chinese companies, compared to just 21 per cent of multinational corporations.

A raft of innovation-focused government policies is encouraging change. For instance, although innovation is not a new theme, in China’s current Five Year Plan (2016-2020) it has taken on even greater significance.  In this one, "innovation-driven development" is repeatedly referred to as a new driver for China's economic growth.

The government has certainly recognised the importance of China developing new industries based on the internet and e-commerce, encouraging the integration of the internet with traditional sectors of the economy and promoting internet-based innovations.

On the back of these policies, Chinese patent applications are booming, rising from 40,000 in 2003 to more than 800,000 in 2013.

While much of the increase could be attributed to the government’s prodding, China’s patent progress cannot simply be ignored.

“Investment in the patent system has taught Chinese entrepreneurs and scientists the value of filing for patents,” says Tom Saunders, a senior researcher with innovation-focused charity Nesta.

“Now the Chinese Government is shifting incentives from quantity to quality.”

The innovation focus is having other effects, too. A report by the US National Science Board shows China’s share of global high-technology manufacturing leapt from 8 per cent in 2003 to 24 per cent in 2012. University of Sydney innovation expert Dr Thomas Barlow notes that in three Chinese provinces (Jiangsu, Shanghai and Tianjin) business research and development (R&D) spending per person exceeds that of Italy and Spain.

Based on current trends, the OECD estimates that by the end of the decade China will supplant the US as the world’s top investor in R&D. Such an economic shift in the world’s second-largest economy holds the potential to change not just China, but the rest of the world as well.

An economic imperative

For years now, Beijing has focused on the importance of innovation to China’s economic health. The country’s growth model of the last three decades – based on cheap, abundant labour, low rents and the mass production of low-value products – is well on its way to redundancy. Eastern China is headed for middle-income status, and parts of it are already there.

If China is to avoid getting stuck in this middle-income rut – like, say, Brazil – and follow Japan and South Korea into high-income status, then the government believes China needs to start designing its own products, rather than making someone else’s.

For years, too, sceptics found it easy to dismiss Beijing’s aspirations. Critics noted that both governments and large companies have tried and failed to produce innovation by edict.

And they argued that the economy’s central control, and in particular its grip on the education system, would strangle Chinese business creativity. As recently as 2014 these arguments appeared in a Harvard Business Review article titled “Why China Can’t Innovate”.

But other analysts point to Beijing’s repeated success at marshaling government resources to achieve economic change, and also emphasise the strength of its commitment to innovation.

“The Chinese have seen the way the Apple business model works,” says Francis Gurry, director general of the World Intellectual Property Organization.

“Very little of the value goes to the assemblage and all the value goes to California.” Gurry is one of many who believe that China’s push towards a knowledge economy will succeed.

China innovation expert Professor Bruce McKern set out China’s path to innovation in a 2012 paper Can China Innovate? His answer to that question is a firm “yes”.

“Many firms will fail,” he writes, “but in the Darwinian fight for success in their home and international markets, some will emerge as radical innovators.”

From cost innovation to unique products

McKern points out that smaller Chinese firms in fields from laptop production to nanotechnology have already begun to find radical new ways to cut costs while meeting their customers’ needs. This process is called “incremental innovation” or “cost innovation”.

When Shanghai-based WuXi AppTec, a drug research company, wanted to develop a new hepatitis treatment, it separated an existing production process into multiple steps, with teams of technicians assigned to work on each one. The firm adapted German software designed for managing assembly lines to streamline the multi-stage innovation process.

“It’s a commonsense approach,” says Saunders.

“For Chinese companies to reinvent things that they could already buy from overseas would be a total waste of resources.” Incremental innovation, he says, “plays to China’s strengths”.

Meanwhile, another force is pushing Chinese firms forward: Chinese consumers. Shaun Rein, managing director of the China Market Research Group (CRM), points out in his recent book The End of Copycat China that Chinese consumers no longer slavishly copy trends from the West, or even their own Chinese peers. In high-tech sectors such as mobile communications and e-commerce, they increasingly want products that are not just cheaper, but offer something new.

Tech leads the way

Prodded by the new generation of Chinese consumers, privately owned high-tech Chinese companies keen to succeed on their home turf are leading the way. The China Innovation Survey by Strategy& asked 368 China-based Chinese and non-Chinese businesspeople to name the most innovative Chinese enterprises of the moment. Of the top 10 companies, eight came from the high-tech sector, including Huawei, Alibaba, Tencent, Baidu and Xiaomi.

Each of these companies is ambitious, has demonstrated its capacity for innovation, and is selling to Chinese consumers. Each has the support of both Beijing and the Chinese banking sector. Each wants to create its own high-profile, fully international brand.

Today half of Huawei’s 170,000 employees work in R&D. The company is starting to conceive and manufacture breakthrough products and is one of the world’s top five patent filers. According to Interbrand, it has even broken into ranks of the top 100 best global brands, a first for a Chinese company. 

“Accompanied by a rise in patent and scientific paper numbers, Chinese companies are increasingly focusing on genuine creativity,” says Qing Wang, professor of marketing  and innovation at the University of Warwick’s Business School.

“Pioneers such as Huawei are showing that novel innovation pays.”

State-owned stimulation

International, innovation-based success stories such as Huawei and Alibaba may grab the headlines but they are still few and far between. Despite achievements in areas such as solar energy, supercomputing and space exploration, the Chinese Government is concerned that its efforts to boost creativity are not bearing enough fruit. Two-thirds of the Chinese economy still comprises state-invested and state-owned enterprises (SOEs), and few of them are hotbeds of innovation.

“The Chinese market is hyper-competitive and this has created a spirit of fearless experimentalism among private entrepreneurs,” says Saunders.

“The trick for Beijing now is how to embed this culture into China’s SOEs.”

Beijing’s latest Five Year Plan has a heavy emphasis on investment in science and technology, combination with a market-led focus on efficiency, quality, coordination and evaluation. As a result many hope that SOE employees will be given more leeway to work on riskier and initially less profitable projects.

International implications

China’s innovation model is already impacting on multinationals across the globe. In a 2014 paper – Innovation in Emerging Markets – The case of China – Bruce McKern and colleague George Yip (co-director of the Centre on China Innovation) noted that multinationals have poured extra funds into R&D centres in China over recent years. Pfizer, Microsoft and General Motors all now have R&D centres in the country.

McKern and Yip list the attractions of doing R&D in China: plenty of low-cost engineers and scientists; government innovation support; a huge and fast-growing market; and a new entrepreneurial spirit in the younger generation. And because Chinese consumers have not had years to develop buying habits, some firms could seize the opportunity to leapfrog competitors who are not operating in China.

Meanwhile, Chinese companies that are already achieving success through incremental innovation are using part of their profits to buy up cutting-edge multinationals. Rather than paying licensing fees and royalties, these firms are simply purchasing breakthrough innovation capability by acquiring overseas technology and talent.

The China Innovation Survey found that many business executives outside of China still expect Chinese companies to target developing countries with cheap, low-quality, derivative products. But in reality, more and more Chinese executives are using innovation to drive globalisation.

Future focus

Today, China’s capacity for innovation remains a work in progress. The country’s transition from an incremental to a breakthrough innovator will take time. But China’s private companies have already proven their ability to adapt to a fast-changing environment. Yeman shengzhan, or “brutal growth”, is the unspoken philosophy of the modern-day Chinese entrepreneur. Copying, tweaking, acquiring, inventing – whichever tool for profit and growth best fits the market will be used.

One thing is for certain. It would be foolish to bet that Chinese companies cannot follow the path already taken by South Korea and Japan, harnessing different forms of innovation to move further and further up the value chain.

In the China Innovation Survey, two-thirds of China-based respondents of multinational corporations said their companies face Chinese competitors that are at least as innovative as they are. As an ultra-competitive domestic market continues to hone Chinese innovation, this number is only likely to increase.

Australia's Innovation Challenge

CPA Australia argues that, like China, Australia needs to focus on innovation to sustain and promote economic growth. The nation is not short of innovative talent, but it faces a major challenge to provide a cutting-edge business environment in which innovation can thrive and productivity increase.

CPA Australia has repeatedly called on the Australian Government to boost innovation in both public and private sectors.

High-quality academic staff must be renumerated adequately and public research institutions also need appropriate funding.

CPA Australia also advocates raising the productivity of Australia's services sector, which employs the majority of Australian workers. Applying information technology will be essential, particularly in sectors such as banking, professional services and tourism where the country is already internationally competitive. CPA Australia wants tax and immigration policy adjusted to encourage entrepreneurship and stimulate domestic overseas investment in innovative businesses.

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