Why China can’t innovate (even though Chinese people can)

Why China can’t innovate (even though Chinese people can)

Published 07 March 2014 16:13, Updated 08 March 2014 00:06

Regina Abrami, William Kirby and Warren Mcfarlan

The Chinese people invented gunpowder, the compass, the water wheel, paper money and long-distance banking. Until the early 19th century, China’s economy was more open than the economies of Europe. Today, though, many believe that the West is home to creative business thinkers and that China is largely a land of rule-bound rote-learners.

When we ask why, the answers vary. Some people blame the engineers. “Most Chinese start-ups are not founded by designers or artists, but by engineers who don’t have the creativity to think of new ideas or designs,” argues Jason Lim, an editor at the website TechNode.

Others blame the government for its failure to protect intellectual property rights. Still others blame the Chinese education system. How can students so completely focused on test scores possibly be innovators?

From our decades of field experience and research in China, we see some merit in all those views. Those criticisms don’t tell the entire story, however. China has no lack of entrepreneurs or market demand. And given the government’s enormous wealth and political will, China has the potential to set the kind of economic policies and build the kind of education and research institutions that propelled the US to technological dominance.

But will that potential be realised? We see considerable challenges.

INNOVATION FROM THE TOP DOWN

In its 2006 “Medium- to Long-Term Plan for the Development of Science and Technology”, or MLP, the Chinese government declared its intention to transform China into “an innovative society” by 2020 and a world leader in science and technology by 2050. That was not empty talk. Beijing has a solid track record of setting policies, and then watching citizens and local government officials fall in line with them.

The aim of the MLP was to reduce China’s reliance on imported technology to no more than 30 per cent within a few years, to increase domestic research and development funding, and to leapfrog foreign rivals in what the government identified as “strategic emerging sectors”, among them biotechnology, equipment manufacturing and information technology. To that end, the Chinese government introduced export subsidies for Chinese firms and a policy requiring government ministries and state-owned businesses to procure goods, when feasible, from Chinese-owned companies. Despite objections that those moves violate the terms of China’s membership in the World Trade OrganiSation, few international firms have left, instead resigning themselves to supporting innovation within China.

There is perhaps no more potent demonstration of China’s ability to set, and often realise, ambitious goals than the government’s backing of high-speed rail and efforts to put humans on the moon, both massive projects that require funding on a scale seemingly impossible in the West. We believe such ambitions could jump-start innovation in much the same way that government-funded programs did in the United States in the second half of the 20th century.

INNOVATION FROM THE BOTTOM UP

There are limits, though, to what even so muscular a government as China’s can mandate when it comes to innovation. Against the government’s intentions run powerful currents that originate in China’s Communist system.

The Communist Party requires a representative to be present in every company with more than 50 employees. Every firm with more than 100 employees must have a party cell, whose leader reports directly to the party in the municipality or province. These requirements compromise the proprietary nature of a firm’s strategic direction, operations and competitive advantage, thus constraining normal competitive behaviour.

But even if the government were to disband party cells and redouble its efforts to encourage breakthrough innovation, there remains an even stronger disincentive: the economic realities of the markets in which Chinese companies operate. Why go to the trouble to pioneer innovative offerings when the rewards and growth prospects for incremental improvements are so vast?

Just as Japan caught up with the United States technologically in many industries during the three decades after World War II, China is now doing the same through incremental innovations. Adapting technology has become a standard and highly lucrative practice. Getting that technology through acquisitions, though, is an important new trend.

INNOVATION BY ACQUISITION

Much has been written about the current wave of Chinese overseas direct investment, most of which has focused on commodity resources, particularly in Africa and Latin America. The turn toward the US and Europe for technology, however, is no less significant. Tired of paying licensing fees and royalties, Chinese firms have increasingly sought to buy breakthrough innovation capabilities through acquisitions of both technology and talent.

Machinery manufacturer Sany, whose main international competitors include Caterpillar and Komatsu, initially attempted to succeed in the European and US markets by relying on homegrown talent and technology. But a few missteps encouraged the firm to establish R&D centres closely tied to its European and US regional headquarters and to staff them with professionals from those countries. And Sany’s 2012 acquisition of Putzmeister, Germany’s leading cement pump maker, gave the company access to a onetime competitor’s technology.

INNOVATION THROUGH THE NEXT GENERATION

China will soon turn out more PhDs each year than any other country in the world, as Chinese universities aim to be cradles of high-level research. The Chinese government and many other sources are pumping enormous revenues into the leading institutions. Within 10 years, the research budgets of China’s elite universities will approach those of their US and European peers.

Will Chinese universities set global standards in the 21st century? It is possible (even though none currently ranks in the global top 50) simply because of the resources they are likely to have. But the more important question is whether China has a good institutional framework for innovation.

Our answer at present is no. The governance structures of China’s state-owned universities still leave too many decisions to too few people. Chinese universities, like state-owned enterprises, are plagued with party committees. This system of parallel governance limits rather than enhances the flow of ideas.

The freedom to pursue ideas wherever they may lead is a precondition for innovation in universities. But by any comparative measure, faculty members in Chinese institutions have little or no role in governance.

Certainly, China has shown innovation through creative adaptation in recent decades. But can China lead? Will the Chinese state have the wisdom to lighten up and the patience to allow the full emergence of what Joseph Schumpeter called the true spirit of entrepreneurship? On this we have our doubts.

The problem is not the innovative or intellectual capacity of the Chinese people, which is boundless, but the political world in which their schools, universities and businesses need to operate, which is very much bounded.

(Regina Abrami is a senior fellow at the Wharton School, the director of the global program at the Lauder Institute and a senior lecturer in political science at the University of Pennsylvania. William Kirby is the Spangler Family professor of business administration at Harvard Business School and the T. M. Chang professor of china studies at Harvard University. Warren McFarlan is the Baker Foundation professor and the Albert H. Gordon professor of business administration emeritus at Harvard Business School. They are the authors of “Can China Lead? Reaching the Limits of Power and Growth”.)

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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