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China, on its way to innovation

Xie Tingting
Updated: May 8,2015 5:10 PM

In the government work report this year, Premier Li Keqiang mentioned “innovation” 29 times, whereas in the 2014 Report it was mentioned only 3 times. In the 2014 Report, small and medium-sized enterprises (SMEs) were mentioned 4 times, while in 2015 SMEs and micro-sized businesses were mentioned a total of 8 times. As China seeks to transform its economy into the new normal and avoid the “middle income trap”, the central government is clearly looking toward innovation in order to transform its economy. At the core of this effort is the desire to encourage SMEs and micro-sized businesses to be the vehicles of innovation.

Buoyed by recent Chinese commercial success in the highly competitive cell phone market by Xiaomi, Huawei, Lenovo, ZTE and seven other rapidly growing Chinese cell phone manufacturers, and in the equally hot Internet services arena, via Alibaba, Tencent and Baidu, China seems to be turning away from its emphasis and reliance on state-owned enterprises (SOEs), toward small, medium and micro-sized enterprises (SMMEs); the traditional breeding grounds of jobs, innovative ideas and products.

But, China is not alone in its quest to encourage and support innovation, as every country in the world is trying to replicate the miracle of Silicon Valley. Given the economic softness, every country is trying to come up with ways to efficiently encourage innovation and most of those efforts are also centered on small, medium and micro-sized enterprises. In Germany, for example, officials are proposing long-term tax breaks and easier access to capital for startups. In Japan, the government is setting up special zones where foreign and Japanese entrepreneurs can start businesses with less red tape. The question is, what does China have in mind and will it work?

Apart from competing with other countries during difficult economic times, in order to understand China’s focus on innovation, it is first necessary to understand what the “middle income trap” is and why it has become a driving force in China’s economic outlook.

The “middle income trap” occurs when a country’s rising wages makes their manufacturing sector uncompetitive. Under this circumstance, wage costs are no longer able to offset poor logistics, inefficient use of resources and uncompetitive manufacturing processes. It is exacerbated by a lack of educated workers and innovative products. Examples include South Africa and Brazil, which have been unable to get beyond the “middle-income range” since their per capita gross national product reached $10,000-12,000. The symptoms of being in the “middle income trap” include a stagnant GDP, slowing investment, marginal growth in secondary and tertiary industries, and stagnant labor markets. As of 2014, China’s GDP per capita was at $11,525, based on purchasing power parity, putting China squarely in the “middle income trap” zone.

To avoid the “middle income trap”, as real wages rise, countries have to become more efficient and productive. If countries are able to move their manufacturing and service industries to the next competitive level, the rise in real incomes can actually help drive the economy by supporting a larger consumer base and thus contribute to continued and sustainable economic growth. The challenge of moving from a resource driven economic model, which is dependent on cheap labor and investment, toward growth based on efficient production and innovation is difficult and has stymied many emerging economies. Populist pressures to maintain jobs and increase social benefits, and a lack of critical infrastructure, education and innovation have thwarted the transition for most countries. The exception is South Korea, which invested heavily in infrastructure, education and research and development, resulting is an efficient world competitive economy, which has a treasure trove of scientific and technological intellectual property.

China’s approach to the “middle income trap” puzzle, as detailed in Premier Li Keqiang’s Work Report, emphasizes increased reliance on market forces to increase efficiency, continued infrastructure investment, educational reforms that emphasize more scientific and technical training, and less government red tape. China also plans to set up a 40-billion-yuan ($6.5 billion) government fund for emerging industries; provide more support for research development; and decrease regulations for in-bound and out-bound investment. The goal is clearly to create a new culture of innovation within China and to start tapping into its creative core.

A concrete example of what China is doing includes the 1,500 plus so-called incubators operated under the Ministry of Science and Technology’s Torch Program; a nationwide initiative that provides policy, financing and consulting services for high-tech firms. China is planning to increase the number of incubators by 15 percent each year. In addition the Ministry also runs an innovation fund that has channeled 3.5 billion yuan of investment into more than 3,000 projects in emerging industries.

Last year, almost 80,000 companies received services from government-run incubators. They are in strategic emerging industries that include energy-saving and environmental protection, next-generation information technology, bio-technology, advanced equipment manufacturing, new energy, new materials and new-energy vehicles.

The high-profile successes of Chinese companies like e-commerce giant Alibaba has also helped to fuel startups. Compared with Americans and Europeans, a Chinese national is now twice as likely to engage in entrepreneurship, according to Max von Zedtwitz, director of the Centre for Global R&D and Innovation, a research institute with a focus on studying innovation in China.

But, there are always those who doubt, and there are many questions that will still have to be answered. For example, many outside China still question whether China’s “Shanzhai” (copycat) culture, can morph into an innovation powerhouse. Their questions are reminiscent of the questions which accompanied the rise of the United States in the late 1800s and early 1900s, when European newspapers and governments harshly criticized the US, a nation that had broken Great Britain’s cloth monopoly by buying English mills, dismantling and then shipping them to the US, in some cases in the middle of the night. Every new rising power has borrowed from the powers which came before, but in each case, they have to bring new innovations if they are to survive.

There are also differences about the use of government run innovation development funds. There is a split between those who say it’s a necessary signal of the government’s commitment to encouraging innovation and those who believe the market can be a more efficient player. But if China can combine the government and market in a good way, then we can benefit from it on our road towards becoming an innovation nation.

Finally, as some say the challenge/difficulties will be in the details, such as cutting red tape, IPR protection, funding useful R&D, educational reform, legal reform, financial reform anti-corruption etc... All these factors will have to be effectively implemented and the overall state of the world economy is not something that China can control. One major factor will be the Chinese people and how we respond to the challenge - can and will we develop the courage and skills needed to take China to the next level of economic growth. But the more pressing question in my opinion is will China transition to an innovation nation? I believe we will; we are a hard-working pragmatic people and we have a government which is committed to leading the way.