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China's New Science & Technology Strategy: Implications for Foreign Firms

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China's New Science & Technology Strategy: Implications for Foreign FirmsStunning development

According to “Science, Technology and Industry Outlook” released in late 2006 by the Organization for Economic Cooperation and Development, China has become the world’s second-largest spender on research and development. Its R&D expenditures reached $136 billion in 2006 in purchasing power parity terms, ahead of Japan’s $130 billion, although it is still less than half the U.S. spending of $330 billion (OECD 2006). The purchasing power terms are controversial and maybe misleading. According to the Chinese source, the 2006 R&D expenditures were only RBM294 billion ($37 billion). Nonetheless, these statistics represent an appreciable first step toward achieving one of the quantitative objectives set up by China’s Medium and Long-Term Plan for the Development of Science and Technology (2006-2020). Launched by the Chinese government in early 2006, the plan is intended to turn China into an innovative nation by 2020, Its quantitative objectives include:

  • Investing 2.5% of its increasing gross domestic product in R&D
  • Raising the contributions to economic growth from technological advances to more than 60%
  • Limiting dependence on imported technology to no more than 30% of value added
  • Becoming one of the top five countries in the world in the number of invention patents granted to Chinese citizens and in the number of citations of Chinese-authored scientific papers.

While the purchasing power figure must be used with care, and while China’s R&D expenditures as a percentage of its GDP – 1.41% in 2006 – has not yet reached that of a world leader in research and innovation, the underlying trend is that Chinese R&D spending has been growing by an impressive average of more than 20% over the past decade and faster than that of GDP (NBS and NBS/MST). The last several years also have witnessed the increasing role of enterprises in China’s national innovation system; their contributions to the nation’s R&D expenditures now account for about two-thirds of the total. Apparently, China will spend considerably more over the next 15 years, as mandated by the medium and long-term plan.

Moreover, the essence of the plan is that science and technology will drive China’s future economic development, thus enabling the PRC to “leapfrog” into positions of leadership in emerging fields such as information technology, biotechnology and nanotechnology. The Chinese objective is nothing less than to put in place a national capability for promoting “indigenous innovation.” The plan also introduces a policy framework for implementation of a series of new regulations and initiatives to support indigenous innovation, including providing preferential treatment for 1) innovation within domestic enterprises, government purchases, high-tech exports, and the assimilation of foreign technology; 2) encouraging foreign corporate R&D activities in China; and 3) strengthening intellectual property protection for Chinese innovators. In a word, the potential impact of the plan will be to shape the current and future trajectory of Chinese technological and economic development.

What does the plan mean to the development of the business environment and the operations of multinational corporations in China?

Reducing technological dependence

To begin with, “indigenous innovation” (zizhu chuangxin, also translated as “independent” or “homegrown” innovation) not only has become a buzz term but also has led to considerable confusion inside China and abroad because, in its ambiguity, it has been construed by some as echoing techno-nationalist notions of self-reliance (zili gengsheng) from the Maoist period – when Chinese research and innovation activities were largely cut off from the international community and experienced significant retardation as a result. In explicating the concept, however, the plan points to zizhu chuangxin as having three components: genuinely “original innovation” (yuanshi chuangxin), “integrated innovation” (jicheng chuangxin, or the fusing together of existing technologies in new ways), and “re-innovation” (yinjin xiaohua xishou zaichuangxin), which involves the assimilation and improvement of imported technologies.

Closely related to the emphasis on indigenous innovation is one of the quantitative objectives of the plan, noted above, to reduce China’s dependence on imported technology to less than 30%. Here, the dependence of a nation on foreign technology is calculated by dividing the value of imported technology by the nation’s domestic R&D expenditures plus the net technology exports, that is, the value of the technologies exported minus the value of technologies imported. This formula is a bit odd, and indeed, represents a Chinese “indigenous innovation” in the study of science & technology and innovation policies. On its face value, the dependence on foreign technology can be limited by either increasing domestic R&D expenditures and technology exports, or decreasing technology imports, or a combination of both.

Unfortunately, reality is much more complicated than the theory suggests. Boosting R&D spending is one thing, but turning R&D into innovative products that are competitive domestically and internationally is quite another matter. Many Chinese firms do not possess sufficient human and financial resources to engage in large-scale innovation activities – only about a quarter of China’s large and medium-sized enterprises have science & technology centers, and less than 40% are engaged in S&T activities (NBS/MST, 2006, p.107). Therefore, at least for the time being, technology imports and other forms of technology introduction from outside China will continue to play an important role in building Chinese innovation capacity. The critical point is not whether the PRC should limit the importation of foreign technology, but whether China can harness and add value to imported technology. This, in turn, is linked to how they spend their R&D money, including that portion targeted for facilitating the absorption of foreign technology.

In fact, this objective reflects a serious contradiction inside the plan itself. On the one hand, innovation based on imported technology falls into the second component of indigenous innovation, as mentioned, and therefore significant efforts need to be devoted to the digestion and assimilation of such types of technology. The policy measures accompanying the plan also emphasize this fact. On the other hand, the plan points out that China should not depend so heavily on technology imports as the source of innovation. In fact, this contradiction most likely reflects the differences of interests between China’s S&T policy makers, represented by the Ministry of Science and Technology, which advocates indigenous innovation and the reduction of foreign technology dependency, and Chinese enterprises, which, supposedly at the center of innovation, are less likely to bet on internally generated know-how from their more pragmatic, self-interested perspective. Interestingly, this apparent contradiction also has raised concerns among the international business community. A careful reading of the plan only reinforces the sense that reducing dependence on foreign technology may be more of a political slogan than a practical objective.

Attracting multinationals for R&D activities

The goal of decreasing reliance on foreign technology also appears contrary to the desire to attract more R&D activities by multinationals to China, as specified by the plan and reinforced in comments made by officials from China’s Ministry of Commerce in December 2006. After China re-opened its door in the late 1970s, foreign corporations started entering China. The first to come were companies focused primarily on labor-intensive manufacturing activities in toys, clothing, and other low-end products. As China’s investment environment improved, multinationals gradually moved higher value-added operations to China, not only to penetrate the huge Chinese domestic market, but also to climb the value chain by taking advantage of the effects of the learning curve in terms of the relatively higher quality but less expensive labor force in the PRC.

Since the late 1990s, multinationals have started to develop an R&D presence in China by opening research and engineering centers and collaborating with top Chinese universities. According to the statistics from China’s MOFCOM, foreign corporations set up 980 R&D centers in China as of 2006, up from 24 in 1997. The number is probably overstated as there are most likely only 300 or so substantial foreign corporate R&D centers. Many so-called R&D centers are not independent but are affiliated with a specific venture’s Chinese operations. Their registration with Chinese MOFCOM is designed, largely, to take advantage of the preferential treatment that the Chinese government is offering. Moreover, many such R&D efforts by foreign corporations in China are less part of a global innovation strategy and more related to the company’s localization strategy – being closer to their Chinese operations and localizing products for the local market (Serger 2006). Viewed from this perspective, these R&D activities and their contribution to China’s innovation efforts should not be exaggerated.

On the other hand, at least 30 large multinationals currently have more than 60 facilities engaging in innovative research in China. These centers, by Microsoft, IBM, Intel, GE, Motorola, Nokia, Unilever, Procter & Gamble, AstraZeneca, and others, represent a significant commitment by these companies; their activities cannot be explained simply by the attraction of the Chinese market. They are part of a larger global innovation reconfiguration. In such instances, multinationals are attracted by China’s “brainpower” rather than Chinese brawn. Multinationals are plugging into China’s talent pool, accessing high-quality researchers from domestic enterprises, research institutes, and universities to fortify their high-end scientific and engineering workforce around the world. The rapid growth of these types of R&D efforts may seem somewhat surprising in view of the bad press China receives about the problems of intellectual property rights protection. Nonetheless, it seems multinationals find the upside benefits worth the risks, even with the high degree of labor turnover in the Chinese economy.

While encouraging more and more of this type of investment, China’s leadership also is concerned about whether these R&D centers will be effective instruments of technology transfer and whether they will bring technological spillovers to Chinese enterprises. As the world economy shows signs of becoming more protectionist and the benefits of globalization erode in some areas, the PRC leadership wants to move quickly to bring R&D into the country as a way to enhance access to high-end know-how. Whether this will occur, and via what vehicles and channels, are the big questions surrounding foreign R&D in China. Still, with support from the central government in Beijing, many local governments in the PRC are competing intensely with one another to attract these R&D investment projects.

Given the orientation of the plan, combined with global outsourcing trends, as long as China continues to turn out highly educated scientists and engineers, the country will be a magnet for the new R&D activities of multinationals. Consequently, there will be a restructuring and remapping of the global R&D landscape, through which China will surely be one of the beneficiaries. For one thing, high-end R&D from multinationals helps China to utilize global R&D resources. Indeed, as a whole, funding from the foreign sources has already contributed some 15% of China’s R&D expenditures – presumably most from multinational corporations.

Stimulating high-tech exports

The plan also aims to further develop China’s high-tech industries, including stimulating high-tech exports through tax and other incentives. Since the 1990s, high-tech exports have become an important growth engine for the Chinese economy (Figure 1). But, China’s impressive high-tech trade statistics need to be scrutinized. First, while the PRC’s export-oriented strategy has yielded obvious positive results, basic processing and assembling with key components from abroad for export purposes has accounted for a significant part of China’s high-tech exports.

Figure 1 China’s High-Tech Trade

Source: NBS/MST.

Second, China’s export-led high-tech industry has been based on low labor costs and imported foreign technologies or even components. China has become a big assembly line for products made of high-tech parts from abroad plus some lower-tech domestic components. Most of the Chinese “indigenous” exports are lower-end products involving basic processing and manufacturing techniques, while imports in general are much more sophisticated. There has been a tendency for the world’s leading multinationals, especially those in the information and communications technology area, to move their manufacturing facilities or outsource production to China – not because of Chinese competitiveness in technology, but largely because of its comparative advantages in labor. Clearly, China has moved and will further move steadily up market. Being labor-intensive, however, these types of so-called “high-tech” exports bring only a slim profit margin, sometimes as low as 2%-3%, to Chinese firms.

Third, in areas where the Chinese economy appears to enjoy a certain level of competitiveness, much of it has come from foreign-invested enterprises (sanzi qiye). Over the years, for example, most of the computer systems and mobile communications equipment have been exported by foreign-invested enterprises. Wholly-owned foreign enterprises have contributed a significant portion of China’s high-tech exports – some 90% in recently years, while state-owned enterprises have seen their share decline year over year (NBS/NDRC/MST, 2006, pp.447-8).

In a word, it is high-tech multinationals that have benefited from China’s increasing high-tech exports. In the meantime, China’s high-tech industry remains structurally weak – emphasizing processing and assembly of low-end products with low value-added and led by foreign-invested enterprises. Because of this, China may make and export “high-tech” products in large quantity, but does not enjoy the benefits and profits that come from leveraging its own technology to produce higher value-added items. All this points to a pattern of its high demand for and reliance upon advanced foreign technology, a shortcoming that the plan explicitly wants to eradicate. And given path dependence, the domination of foreign-invested firms in China’s high-tech exports poses difficulties for its domestic high-tech firms to become innovative. This is one of the reasons that the plan places so much emphasis on the building up of indigenous innovation and alleviating the dependence on foreign technology.

Strengthening intellectual property rights protection

One last point worthy of attention is the focus of the plan on strengthening intellectual property rights protection in China. This is one of the critical initiatives within China’s S&T development strategy adopted in the new century – the other two being the focus on talent and technical standards – because China has paid an enormous price for overindulgence in imported technology while it has yet to establish sources of competitive advantage based on Chinese-created and -owned intellectual property rights. Furthermore, China has encountered various trade-related intellectual property rights barriers. According to a recent report in the Financial Times, China is increasingly the main target of litigation at the International Trade Commission, with the number of claims against mainland Chinese companies multiplying rapidly since 2000; foreign patent owners have won in about half of the cases against China over the past 10 years (Waldmeir 2006). Even though the Chinese have recognized the strategic value of intellectual property rights in today’s global economy, they have paid a steep financial price for not understanding this point much earlier.

Protecting intellectual property rights effectively and rigorously will spur the expanded introduction of advanced technologies and especially the manufacturing of new products in China earlier in their life cycle. More importantly, intellectual property rights protection will give domestic firms incentives to invest in R&D and introduce innovative products to the market. Only when domestic entities start to be innovative is it possible for the nation to turn itself into a truly innovation-oriented society.

Conclusion

As a new, strategic S&T and innovation policy manifesto, the Medium and Long-Term Plan for the Development of Science and Technology (2006-2020) reinforces China’s ambition to become a global technological power. China consciously is trying to transition from a manufacturing-based economy to an innovation and knowledge-based economy; progress towards this goal is already in evidence. Take the OECD statistics on China’s R&D expenditures as an example. Regardless of whether they are $136 billion or $37 billion or, probably and more accurately, somewhere in between, there has been a trend of rising spending on R&D, and this trend will have positive implications for China’s economic transition away from a heavy natural-resource-and-energy-using, environmentally destructive model of economic development. This suggests that the transition to a knowledge economy is not only good for China, but also for the rest of the world.

The plan’s emphasis on indigenous innovation is not as protectionist as it seemed to some at first sight. Chinese leaders understand that in today’s globalized world economy, lone ranger strategies will likely not be successful. Along with strengthening its own innovative capabilities, China also must become more adept at collaboration and cooperation. Obviously, for a range of economic, political, and national security reasons, China is eager to become a more innovation-oriented society, but only can achieve this goal by becoming more integrated into the global economy and transnational knowledge networks. The real challenge for China is how to effectively access and utilize global resources rather than to worry about becoming overly technologically dependent.

References:

OECD (2006), OECD Science, Technology and Industry Outlook (Paris).

National Bureau of Statistics (NBS), China Statistical Yearbook (Beijing: China Statistics Press, various years.

National Bureau of Statistics and Ministry of Science and Technology (NBS/MST), China Statistical Yearbook on Science and Technology (Beijing: China Statistics Press, various years).

National Bureau of Statistics (NBS) (2006), “Statistical Communiqué on the 2006 National Economy and Social Development of the People’s Republic of China,” available online athttp://www.stats.gov.cn/english/newsandcomingevents/t20070301_402388091.htm
(accessed March 1, 2007).

National Bureau of Statistics and Ministry of Science and Technology (NBS/MST) (2006), 2006 China Statistical Yearbook on Science and Technology (Beijing: China Statistics Press), p. 107.

National Bureau of Statistics, National Development and Reform Commission, and Ministry of Science and Technology (NBS/NDRC/MST, 2006), 2006 China Statistical Yearbook on High Technology Industry (Beijing: China Statistics Press).

Serger, Sylvia Schwaag (2006), “China: From Shop Floor to Knowledge Factory?” In Magnus Karlsson (ed.), The Internationalization of Corporate R&D: Leveraging the Changing Geography of Innovation(Östersund, Sweden: IPTS), pp. 227-266.

Waldmeir, Patti (2006), “China Asserts Patent Rights in U.S. Court,” Financial Times, October 22.

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