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News : Innovation Last Updated: May 14, 2014 - 12:04 PM

China's bumpy road to a world-class knowledge economy
By Michael Hennigan, Finfacts founder and editor
May 12, 2014 - 5:29 PM

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State-owned enterprises (SOEs); domestic private-owned enterprises (POEs) and foreign-invested enterprises (usually with a local joint venture partner)

We wrote in 2011 on China's 'indigenous innovation plan' of 2006 to reduce its dependence on the technology of foreign-owned firms and set the country on the road to become a world-class knowledge economy.

The challenge facing China can be illustrated by Apple's iPhone and the statement on the rear: 'Designed by Apple in California. Assembled in China' but that doesn't tell much of the story.

While the iPhone 5 retails for about $500 across the world, the value added in China per unit is less than $10 and is mainly labour with most of the materials coming from other Asian countries.

China's 'National Medium- and Long-Term Plan for the Development of Science and Technology (2006-2020)' report, says China will build its dominance by "enhancing original innovation through co-innovation and re-innovation based on the assimilation of imported technologies." This key report is known as 'MLP.'

Also in 2006 another economy with a significant foreign-owned sector set itself a target to be recognised as a "world class knowledge economy by 2013" - - that was Ireland and 2013 came and went with official Ireland including the mainstream media tacitly ignoring that there was ever a target.

A recent paper [pdf] by Seamus Grimes, emeritus professor of geography, at the Whitaker Institute for Innovation and Societal Change, National University of Ireland Galway, and Dr Yutao Sun, School of Contemporary Chinese Studies, at the University of Nottingham UK and a member of the Faculty of Management and Economics, Dalian University of Technology, Dalian, China, examines the on-going high level of dependency of China’s economy on foreign sources of technology during the period since accession to the World Trade Organisation (WTO). Because this dependency is a major cause of concern for China’s leaders and policymakers, they have sought to shift the direction of the economy particularly since 2006 towards a greater focus on indigenous innovation.

The authors say that achieving such a major transformation, however, in an era when much of China’s economic activity has become integrated within the global value chains of major corporations, is very challenging, and the evidence to date suggests only a modest level of success on the part of Chinese companies to substitute for the on-going dominant position of foreign companies particularly in China’s high technology sectors.

They say that some progress has been made, however, in the private sector’s share of economic activity in contrast to the declining share of State Owned Enterprises (SOEs).

Last December, in its annual global R&D forecast, the US Batelle Foundation forecast that China's R&D spending would surpass the US, the current leader, by about 2022.

Batelle said that this year would see 10 countries spending about 80% of the total $1.6tn invested on R&D around the world; the combined investments by the US, China and Japan would account for more than half of the total.

Together, the US, China, Japan and Europe account for about 78% of 2014’s $1.6tn total.

In 2014, China will continue its two-decade trajectory in R&D investment, consistent with the current Five-Year Plan (FYP 2011 to 2015). According to Batelle, China’s research intensity will increase to 1.95% of GDP in 2014.

China’s FYP is aimed at achieving 2.2% of GDP by 2015 and the foundation says this rate of growth is expected to continue through the end of the decade as China strives to transition from a manufacturing economy to being “innovation-driven” by 2020.

At current rates of R&D investment and economic growth, China could surpass the U.S. in total R&D spending by about 2022.

Grimes and Sun say that a distinction should be made between a relatively small number of highly successful, innovative Chinese companies in high technology sectors, and many state enterprises (SOEs) which are still undergoing transformation from the earlier command economy (Boeing and Sandner, 2011).

While Chinese leaders and policymakers realise the urgency of moving China’s development model more towards knowledge exploitation, they appear to be still struggling to find the most effective way forward. Although always strongly influenced by political considerations, China shows evidence of adopting a pragmatic approach which is often based around hard bargaining with foreign investors. Experience of other Asian countries provide some lessons for China’s future, but the challenges of achieving significant industrial upgrading during a more globalised era may prove quite daunting, particularly when Chinese policy is so focused on its own domestic economy. While China’s primary influence is within its own borders, the complex integration of both foreign and Chinese companies in China into global networks requires an approach which can improve China’s competitiveness within these networks rather than one which seeks to contain innovation within China.

The authors says that a distinction can be made between the political objective of the Chinese state to achieve technological autonomy and the pragmatic approach of many Chinese companies who, rather than cutting themselves off from global markets have considerable cooperation with companies in Japan, Korea and Taiwan. Some of China’s leading firms such as Huawei have called for a more open innovation policy which would allow them more easily to cooperate with foreign firms

The paper says that an analysis of the changing profile of China’s top exporting companies between 2001 and 2012, indicate a dominant, if decreasing role of foreign invested firms and the beginnings of an emergence of the private sector. It is clear, however, that despite their falling numbers and increased scaling, that SOEs continue to play a significant role more generally in China’s exports. It is clear that major challenges remain for China to transition from playing a relatively subordinate role within global value chains, and rather than focusing on developing a more innovative and globally competitive development model, there are some signs that China’s progress could be delayed by opting for a more inward model of technology autonomy within a relatively protected large domestic market.

Lessons from Japan and South Korea

McKinsey, the management consultants, asks: Why are General Motors and Volkswagen more successful in China than Honda and Toyota? Why are LG and Samsung bigger in India than Panasonic and Sony? Why is IBM larger in Japan than Fujitsu is in the United States?

McKinsey says in future, building a globalized company will require many Japanese executives to think in new and unfamiliar ways about organization, marketing, and strategy. The approaches that proved successful in the past - - for example, replicating practices from the Japanese market in foreign operations - - have outlived their usefulness.

Japan’s biggest companies have been losing relative market share over the past decade: their proportion of the Fortune Global 500’s total revenues decreased to 13%, from 35%, between 1995 and 2009. One of Japan’s longtime strengths is electronics, for example, but its share of the world’s export value of electronic goods has fallen from 30% in 1990 to less than 15% today, according to the Japanese Ministry of Economy, Trade, and Industry. Many Japanese companies have no alternative to globalization if they hope to continue growing.

Japanese companies have a global presence and reputation, but most remain surprisingly dependent on Japan’s domestic market for revenue, while struggling to capture a reasonable share of dynamically growing emerging markets. The analysis shows that Japanese high-tech companies, as a group, still generate more than 50% of their sales in the home market, growing by a mere 1% annually, compared with growth of 5 to 10% in the developing world and 2 to 3% in other developed markets.

Typically in western multinationals, the worldwide company language is English, overseas experience is essential for career progression and there is a unified global structure.

In 2009 Japan had the lowest score of any of the International Monetary Fund’s advanced economies on the Test of English as a Foreign Language, administered to foreign students who want to study in the United States. It had the second-lowest score among Asian nations, outperforming only Laos.

South Korea now dominates in mobile phones and television technology.

In common with Japan, deference to bosses is common in China, while innovation thrives in flat limited hierarchy organisations.

Warren Buffett, the renowned American investor, often says that nobody ever won by betting against the USA.

China's road to a world-class knowledge economy will be bumpy but it will get there.

Crucially, Chinese companies are developing overseas trading experience in developing country markets before taking on western multinationals in their own markets.

Chinese foreign direct investment (FDI) in Europe also reflects a desire to co-opt the local model -  - for example usually Chinese investment involves acquiring companies, including German Mittelstand firms, rather than developing greenfield operations from scratch.

Finfacts reports:

2013: Nokia, Europe and Japan's old companies versus US young champions

2010: Globalization and Asia’s return to economic supremacy

2011: China remains a 'workbench' economy

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© Copyright 2011 by Finfacts.com

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