Promoting Innovation at the Expense of Indigenous Firms?

On April 9th, the Chinese Ministry of Science and Technology (MoST) website announced a new draft plan for accrediting “indigenous innovation products”, covering a range of high-tech sectors including computers, telecom equipment, automatic office equipment, software, new energy, and energy efficiency devices. These accredited products will enjoy priorities in Chinese government procurements. After being excluded in the initial accreditation plan issued in 2009, foreign companies had been complaining ever since. This time, however, there are two significant changes in favor of multinationals: the accredited products must possess “intellectual property rights” and a “registered trademark” in China rather than the previous accreditation criteria of “indigenous intellectual property” and “indigenous brand”.

The draft plan is complementary to the State Council 2010 Circular No. 9 issued on April 6th, which aimed at encouraging R&D investment of multinationals in China through series of favorable polices including cheap land, tax holidays, and financial liberalization. MoST’s latest accreditation plan is, however, a major setback for many Chinese indigenous companies in the growing government procurement market for high-tech products, estimated to be over one billion dollars per year. Since multinationals are more competent in the market of technology-sophisticated products, the 2009 accreditation plan intended to expand the market share of local firms by giving them privileged access to government procurement contracts. So far, it is not clear whether multinational corporations have directly influenced this year’s draft plan, or whether MoST is pursuing a deliberate strategy that de-emphasizes indigenous innovation for the sake of leveraging access by multinationals to the Chinese market in exchange for technology.

What is clear is that the Chinese state is inclined to abandon government procurement as a policy tool to promote indigenous innovation. That having been said, the Chinese government has spent billions buying underdeveloped products from local firms such as CPU, office software, etc, which still remain commercially uncompetitive and technologically backward. There were even worse scenarios in which large local PC vendors acted as middlemen between the Taiwanese OEMs and the Chinese government, with their huge profits from the procurement market only resulting in diminished productive capabilities. Nevertheless, procurement money can be of great importance for financing innovative firms; prime examples are Huawei and ZTE in the Chinese telecommunication industry. Procurement money provides possibilities for firms to endure the high fixed costs of technological catch-up until they can succeed in generating the high quality products at low unit costs that define innovative success. But such possibilities may be about to disappear.

This article has aslo been published on the ChinaAnalysis Monthly Newsletter Issue 22, May 2010.