Can China innovate?

Yu Zhou
Professor of Geography, Vassar College

We know that China can manufacture at low costs, but can Chinese companies innovate? With many of China’s exporting markets face prolonged recession, the question is becoming more urgent. For China to become a worthy global economic engine, it has to move beyond specializing in cheap-labor exports. Evidence is mounting on both sides. On the one hand, China claims the world’s largest number of engineering graduates and the second highest amount of R&D spending. Its registered patents exceeded those of Germany in 2007. On the other hand, China’s rigid political and educational systems are seen as crippling creativity. Chinese enterprises sit low in the global production chain so they have low profit margins with little room for long-term R&D investment. China’s weak intellectual property rights protection is another popular explanation for lack of innovation. Debates also rage on who will lead Chinese technological changes. Some believe that multinational corporations (MNCs) are the leaders. Others believe that China has become too dependent on Western technology. The Chinese government stresses “indigenous innovation” as a national priority.

I argue in my book, “Inside Story of China’s High-tech Industry: Making Silicon Valley in Beijing“, that Chinese domestic companies can become technology leaders, but only when they successfully collaborate with foreign MNCs. My research traces the emergence and development of China’s high-tech industry since the mid-1980s in Beijing’s Zhongguancun–the so-called China Silicon Valley. By detailing the stories of the region, collected over six years through interviews, I argue the following:

1. MNCs have limitations in bringing technological transformation to China. Chinese firms have a competitive edge in the home market, which may serve as a launching pad for their international ambitions in the long run.

Foreigners often assume that if a large multinational company, say HP or Google, is successful in the United States and elsewhere, it should also be successful in China. If it is not, the Chinese government is blamed for unfair treatment. But the reality is that China is a vast, regionally fragmented, rapidly evolving and largely low-income market. It is challenging for MNCs to reach beyond China’s affluent core. In contrast, Chinese domestic firms understand their home court better, and have greater commitment and flexibility. Successful Chinese companies have served the Chinese market with their access to competitive, reliable, and high-quality component suppliers—the same suppliers that MNCs use for exports. The Chinese companies then target the Chinese market with special designs, pricing and marketing that enable them to beat foreign-brand competition. This is the story of Lenovo, Huawei and many other successful Chinese high-tech companies. Though they are not at the cutting-edge of technology at the beginning, they have always been extraordinarily effective in bringing new technology to the Chinese market at an affordable price.

2. The key constraint for Chinese companies to produce cutting-edge innovation is the Chinese market, but this will change.

Many believe that the lack of innovation by Chinese companies has to do with their low R&D capacity. This is only partly true. It is worthwhile to remember that almost all Chinese technology companies were established after the mid 1980s, and also that most have emerged only in the 1990s. This short history sets them apart from business power houses in Japan, South Korea and even India.

But beyond their inexperience, capital capacity, and technological lag, the key constraint for the Chinese companies to innovate is the Chinese market. Michael Porter in his book The Competitiveness Advantage of Nations argues that it is the quality of the domestic market that is critical for national competitiveness. A technologically sophisticated market pushes innovation by forcing the companies to constantly upgrade their products. Yet Chinese consumers value low-price and lack experience with many products. Most have yet to attach the same importance to the quality, design, and newness of products that consumers in advanced economies do. This provides little incentive and reward for cutting-edge innovation by domestic companies. It is not surprising, indeed it should be expected, that most Chinese companies would concentrate on following the MNCs’ lead in making products cheaper and better suited to Chinese customers rather than blazing their own paths. But as the market evolves with sustained higher income and more sophisticated consumer tastes, one can bet that Chinese companies will evolve with it by offering more innovative products.

3. The competition between Chinese indigenous firms and MNCs is not a zero-sum game.

The growth of Chinese companies does not crowd out foreign companies. It is tempting to view the competition between MNCs and domestic firms as one side trying to eat the other’s lunch. But the prevailing pattern is actually a relationship of collaboration. Virtually none of the Chinese products are made without MNCs’ components. This is true for both hardware and software. China’s most popular enterprise management software by UFIDA, a domestic company, uses an Oracle database. As domestic companies cultivate and expand the market, MNCs have an enlarged consumer base for their products.

Some critics from China lament the lack of innovation in China, and imagine that if only Chinese scientists put their minds to innovation with ample state funding, innovation would take place. The truth is that domestic companies cannot generate globally significant technology unless they work with MNCs. Chinese companies are actively learning from MNCs how technologies, markets, and human resources are managed in the modern world.

In turn, MNCs have learned from local firms’ marketing expertise to enhance their market performance. For example, when Nokia and Motorola suffered setbacks in marketing cell phones in China in 2002-2004, they managed to regain the market by adjusting marketing strategies in part modeled after local competitors’ regional distribution channels. Overall, the increased involvement of MNCs in China in the past 20 years has been accompanied by, and indeed dependent upon, the growing competence of local Chinese companies. By partnering with Chinese companies, MNCs can penetrate far larger markets than would be possible relying on their own work force. The interdependence of Chinese and foreign firms can be seen regionally. The regions with more advanced development of indigenous companies are the same regions where one can find a greater presence of MNCs in more diverse fields, not the other way around. It is uncommon to find foreign technology firms work alone very successfully in the Chinese market without major Chinese business partners.

Innovation is a long term process, and can only be approached step by step, not just by a few strong companies in China but by succeeding generations of them, collaborating with foreign companies. My research in Beijing’s Zhongguancun has found that there have been rapid generational successions in the region, from a first generation of competitive Chinese personal computer makers in the 1980s, to an entrepreneurial Internet generation in the 1990s to current overseas returnee-founded high-tech companies in the 2000s. In the last two decades, Chinese indigenous companies have moved a long way in capital capacity, management expertise and technological sophistication. In the end, it is the development of these indigenous companies, not MNCs or the Chinese government, that will ultimately determine the extent to which China controls its technological destiny, and how much China can contribute to the world economy.