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China's Innovation Policy Is All Wrong

July 20, 2011 |
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Will it be able to come up with a new one? Here is a story that Robert O’Brien tells in a recent paper in the journal China Security. In 2005, China’s National Development and Reform Commission, which had the power to set government procurement policies, said that state-owned wind farms could only buy turbines that had 70 percent of their parts made in China.

China, starting around that time, has become a major force in wind power, growing in the last 5 years at a dramatic pace: Chinese producers now control about 85 percent of the Chinese market, and half of the market globally, according to the New York Times, as O’Brien points out.

In 2005, Gamesa, a thirty-five year old Spanish company and one of the world’s largest producers of wind turbines, controlled about a third of the Chinese market. In response to the new rules, Gamesa started teaching local suppliers how to make parts of its turbines. But the suppliers then started to abandon it, and Gamesa’s market share is now only 3 percent. Up to now, China’s growth has been dramatic enough that no one complains–that 3 percent of today’s market is double what Gamesa was selling in 2005. This bonanza-like atmosphere has given the Chinese government license to act with license.

Besides the preferential procurement regulations, the Chinese government was also explicitly subsidizing Chinese industry to the order of several hundred million dollars. Those subsidies ended in June of this year after the U.S. government challenged them at the World Trade Organization (WTO) in February. And on July 5th, China lost another dispute at the WTO centered on restrictions of exports of minerals like bauxite, magesium, zinc, and silica.

The impetus on the Chinese government to encourage innovation was formalized in a 2006 strategy called the “Medium to Long Term Science and Technology Development Plan”. Though the Chinese government increased its R&D spending by 54 percent from 2006 to 2008, O’Brien says that the core of the strategy was industrial policy–such as the wind turbine procurement rules and mineral export restrictions. As part of the plan, products could apparently be designated as “indigenous innovation products” if they:

- Were made by a company that had full ownership of the intellectual property (IP) in China

- Had a trademark that is owned by a Chinese company

- Featured a high degree of innovation

- Were of dependable quality

These “indigenous innovation products” would then be given preference in government procurement, even if they were up to five or ten percent more expensive, in some cases. In December 2010, China relaxed these conditions in response to US government demands, removing the IP restrictions, and saying that Chinese subsidiaries of foreign companies would count as Chinese.

The problem with a supposed “innovation” strategy such as China’s is that it is not really a strategy for coming up with new ideas–the core of what we mean, or should mean, by innovation. It is instead just a means for choosing one’s compatriots over other comparable providers of like ideas and products.

Now, although on the face of it protectionism isn’t a good idea, one could make the contrarian’s case that it makes economic sense for China, as Chinese industry diversifies from manufacturing and assembly to a broader set of tasks. But industrial policy is industrial policy, and innovation is innovation. Preferential purchasing requirements (in China, as in U.S. “Buy American” campaigns) lead to market distortions more often than they actually encourage domestic innovation. To date, China’s indigenous innovation policy has been a procurement policy in disguise. This will have to change if China wants to compete in coming up with new ideas, instead of just boosting domestic industry. And there is every reason to believe that China does want to actually innovate.

The means: the dramatic increase in R&D spending over the last decade. The motive: the size of the workforce in China is likely to start to decline within the next five years. This will cause wages to rise, which means China may lose low cost manufacturing to southeast Asia (in the near term) or even a rising Africa (in the longer term). Even today, a focus on manufacturing means that little of the profit involved in creating, say, an iPod (in the most famous example) is realized in China. China’s phenomenal economic success, both in reality and in the eyes of the drafters of the “indigenous innovation policy”, is not sustainable. The WTO rulings of this month and last should act as a signal to China’s policymakers that the international community will push back at protectionism.

Some will argue that cultural and political factors mean the Chinese government will remain stuck in a mentality that ultimately stifles innovation, as Adam Segal has said in these pages. But this is far from apparent. Gustave Flaubert once wrote in a letter, recommending that his correspondent, "be regular and orderly in your life like a bourgeois, so that you may be violent and original in your work." Scientific research, in its way, is just as much of a creative endeavor as writing a novel. There is no fundamental reason why a scientist in China cannot be “regular and orderly” as a political figure, and yet “violent and original” in science. China’s to date fumbling attempts to recruit scientific luminaries illustrate a desire to cultivate such violent originality. Though that desire has been heretofore haphazard, there is no reason to believe it will inevitably remain so.

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