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China is facing an innovation imperative

Given the structural impediments to growth facing the PRC economy, new sources of productivity must be generated. But how?  In the past, technology acquisition was an important pathway for introducing greater efficiencies within the PRC economic model.  In general, there are three methods by which a country can acquire technology—“transacting”, “taking”, and “making”—and China has used all of them to spur productivity gains and greater innovation. For much of its economic rise since the 1980s, China has relied on the first two methods. Only recently has the country begun to achieve the third by developing a greater capacity for home-grown technology development. “Transacting” and “taking” can still make an important contribution to China’s economic development. However, over the course of the Xi Jinping era, these well-worn pathways have become increasingly strewn with obstacles and risk, particularly in the most advanced technological fields.

In response, industrial policy under Xi Jinping has intensified efforts to leverage both the public and private sector in the cause of indigenous or “independent innovation” (自主创新). According to the PRC State Council, this means “starting from enhancing the national innovation capacity, strengthen original innovation, re-innovation, and absorption of imported innovation.” As this definition suggests, China already has significant “national innovation capacity”, including within the state-owned sector. For example, CRRC Group, the world’s largest producer of railway equipment, is best known for its development of world-leading high-speed trains. Other companies in the private sector such as Alibaba, have transformed the world of e-commerce by leapfrogging from cash to cashless payment systems. Alibaba, Baidu, and other PRC firms are also active in cutting-edge artificial intelligence research.

However, much of the intellectual property of what China has produced and exported over the past several decades was not indigenously developed nor a result of domestic investment. According to one of the leading analysts of the PRC economy, Arthur Kroeber, beginning in the 1990s, about one-third of PRC exports on average have been manufactured by foreign-invested companies (a figure which topped out at nearly 60 per cent in 2005). For exports designated as “high-tech”, the proportion owing to foreign firms is even higher—persisting at around two-thirds even in 2020. As Xi Jinping declared to a high-profile conference on cyber security in 2016:

Our dependence on core technology is the biggest hidden trouble for us…  Heavy dependence on imported core technology is like building our house on top of someone else’s walls: No matter how big and how beautiful it is, it won’t remain standing during a storm.

Xi has good reasons for concern. China is far from technological self-sufficiency and remains dependent on foreign technologies and market-access, especially in certain foundational technologies, such as semiconductors, which will be crucial to the development of other advanced industrial sectors. China scholar Mathieu Duchâtel points out that the value of PRC imports of semiconductors is higher than its total imports from the European Union and more than its oil imports, and that the country only produces about 15 per cent of its domestic requirements. He writes, “The world’s largest consumer market for semiconductor and integrated circuits depends on foreign suppliers not only for finished processors and other chips, but also for critical equipment and software at each stage of the value chain.” In this critical sector and others, the intensifying and more protectionist technological competition between China and other major economies—such as the United States, Japan, and Germany—will complicate Beijing’s pursuit of greater productivity, innovation, and self-sufficiency.

As a result, China’s pursuit of technological innovation—whether through foreign acquisitions or home-grown efforts—faces a range of potential chokepoints both at home and abroad. U.S.-China economic competition intensifies this challenge as it moves beyond trade to encompass technology and financial markets. U.S. actions have included the restriction of exports to key PRC technology firms, banning investments in Chinese companies deemed to have links with the PLA, delisting major PRC companies from U.S. stock exchanges, trying to compel the sale of PRC companies to U.S. competitors, ordering the possibility of sanctions against financial institutions doing business in Hong Kong, stemming the flow of PRC scientists and technical experts seeking to work and study in the United States, and stepping up scrutiny of PRC talent recruitment programs. If and as other advanced economies take up similar measures, China’s access to foreign technology, capital and expertise will be increasingly constrained, especially in cutting-edge fields.

 

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