China’s New R&D Path

Moving from imitation to innovation is a main pillar of China’s effort to develop its economy. The five-year plan just ended had targeted 2% of GDP to be spent on research and development. It probably fell short of that; 1.5% of GDP in 2008 is the most recent number available. But still that accounts 12% of global R&D spending.

More significantly, says management consultancy McKinsey’s Gordon Orr in a newly published article in the McKinsey Quarterly, China’s R&D spending is shifting from government-controlled research institutes to large and medium-sized enterprises, which now account for 60% of it (though given the dominance of state-owned enterprises in the economy that may represent less of shift than it first appears). However, one-thirteenth of the non-government R&D is accounted for by companies with foreign investors. China is now home to nearly 1,500 R&D centers set up by multinationals.

Orr also says that beyond industrial innovation, “much of the best innovation in China today is built around developing creative business models”.  Examples:

Broad Air Conditioning developed a way to commercialize gas-powered air conditioning systems for large buildings. Alibaba built a new business around an online platform to connect smaller Chinese producers with buyers abroad.

Chinese policy makers have learned some important lessons from earlier innovation failures, Orr says, “the biggest being that it’s hard to impose innovation from the top down”. So Beijing is focusing on identifying opportunities earlier and creating incentives for companies to innovate. Electric vehicles are his case in point, with government underwriting future demand through promises to buy for official fleets and incentives to consumers.

Undoubtedly, China’s innovation record is mixed. It is easy to spot areas such as financial services and consumer electronics where the record is poor, just as there are areas such as pharmaceuticals and telecoms where it is much better. And for many of China’s emerging multinationals, expanding market share through lower-cost rather than innovative new products is still their business model.

For all the shifts in R&D that Orr identifies, China’s policymakers won’t be getting out of the business of picking winners anytime soon, even if they want companies to do more of the donkey work of actual innovation. How good they prove to be at winner-picking, and how deftly they manage to let the market drive more innovation while still encouraging it to go broadly where they want it to for national policy reasons, will shape how fast and successfully China moves to the next phase of its development — two challenges that apply more broadly to the economy as a whole, too.

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