China Will Become The Number One Global Economic Force

Week after week we read headlines pronouncing that China is about to overtake the U.S. and other advanced economies and become the number one global economic force. Recently there have been a number of high profile announcements that China will also overtake the U.S. and other countries in the area of innovation. China pundits tell us that patent filings in China are at an all-time high. China is exporting high-tech goods that owe their existence to Chinese ingenuity. In essence we are being told that the West is doomed to become a mere follower of China. Our day in the global spotlight is over. Really?
 

 

Personally, I have a great deal of confidence in China's ability to become a more prevalent global player. However, I have serious doubts about China becoming the global leader in the area of innovation. To me, the question that should be asked is, "Can any country really assume the position of 'number one' in the world economy if they are not also number one as a global innovator?" Obviously, China's leaders feel that they are the great innovator. As proof they refer us to their patent history with the implication that it is the number of patents generated by a country that defines true innovation.

China's State Intellectual Property Office (SIPO) officially announced that the number of patents granted in China in 2010 was 40 percent higher than in 2009, receiving over 1.2 million patent applications and approving 814,825 requests among them. The application number for 2010 was over 25 percent more than that in 2009. Using this strong 2010 position China became the world's top patent filer in 2011, surpassing the United States and Japan as it steps up efforts to improve its intellectual property rights track record. The number of patent applications filed to SIPO in 2011 surged 33.63 percent from 2010 to 1.63 million, according to data released by SIPO. The SIPO data indicates that it granted 961,000 patents last year, up 17.91 percent from a year earlier.

It should be noted that China offers incentives to businesses to prepare and file patent applications in an effort to increase the total number of patent applications. The idea of subsidizing patents is not all that bad, however it does distort the truth about what's going on in this area. You get high figures for filings, but that does not tell you anything about the quality of the patents filed. Although volume is a recognized metric that can be used to measure innovation progress, quality is quite another matter. The percentage of approved patents is still not as high in China as, say, in the U.S., Japan or some places in Europe. There is also the issue of patent classification. Before we hand over the Innovator of the Year Award to China it's important to remember that China has three types of patent applications: invention patents; utility model patents; and design patents.

Invention patent applications are equivalent to U.S. non-provisional patent applications, while utility model patent applications (aka "petty patent" applications) do not undergo substantive examination. According to SIPO's statistics, utility model patents and design patents together outnumber invention patents by a 5-to-1 ratio. So much for using the number of patents to signal innovation excellence. As an example, on the China-vs.-foreign front, invention patents accounted for over 85 percent in each year's foreign applications since 2005, while China applications for invention patents accounted for 26 percent during the same period.

A review of the data indicates that intellectual property (IP) filings worldwide rebounded in 2010/2011 after experiencing a considerable drop in 2009. The recovery in IP filings was stronger than overall economic recovery. Patent and trademark filings worldwide grew by 7.2 percent and 11.8 percent, respectively, in 2010 compared to a 5.1 percent increase in global gross domestic product (GDP).

China and the US—the two offices that accounted for the majority of worldwide growth—saw higher IP filing growth than GDP growth in 2010/2011. In the case of China, IP growth rates were more than double its GDP.

While China patent details are sketchy, it would appear that the number of foreign applications in China for invention patents in 2011 rose about 20 percent from 2010, although the number of approved foreign applications dropped. However, domestic applications experienced a large leap—Chinese applications were the majority of all invention patents granted in 2010 and 2011.

There is little doubt that today China is pursuing a national plan to become an economy based on innovation rather than imitation. To that end, China has in recent years, become the most prolific patent filer in the world. The Chinese plan calls for its corporations and individual investors to file two million patents by 2015. If achieved, this number of patent filings would dwarf the current filing rate in the United States.

To support this robust patent target China has increased R&D expenditure from 1.1 percent of GDP in 2002 to 1.4 percent of GDP in 2011. China's goal is to invest 2.5 percent of GDP by 2020. The U.S. R&D expenditure for 2011 was 2.7 percent of GDP. China's current share of the global R&D expenditure was 12.3 percent in 2010, which was tied with Japan for second to the U.S. whose share was 34.4 percent. In 2011 we saw the US share decline to 34 percent, while China increased its share to 12.9 percent (see Table 1).


You might ask, "What is driving China to become the great innovator"?  Perhaps that answer can best be described as success. China's journey from a seriously poor, lack of self-sufficiency economy to the "supplier of the world," took a bit more than two decades to achieve.

Today, less than a decade after achieving this feat we see China struggling with the fallout from having achieved this high degree of success. With the emergence of a genuine middle class China is experiencing the end of cheap Chinese labor. Blue-collar labor costs in areas such as Guangdong and other coastal hubs have been rising at double-digit rates for a decade with no letup in sight. Even workers in remote areas of China are demanding and receiving huge pay increases. 

Foreign companies are discovering that China is no longer a place where manufacturers can go to find ultra-cheap labor. Today, other countries, such as Vietnam, are proving to be much cheaper in regards to labor cost. In case you might be wondering, this labor cost trend does not mean that foreign companies will close their China-based factories and stampede to other, lower labor cost countries. Obviously some will but most won't. As it turns out, China is still a terrific place to make things. Labor may be cheaper elsewhere, but it is only one element in a basket of cost items. Unlike its lower-paying rivals, China has developed reasonable infrastructure, highly sophisticated supply chains and the advantage of scale. Unlike experiences with other countries, when demand surges for a particular product, the larger, more sophisticated firms in China can add thousands of extra workers to a production line in a matter of hours, a feat that even the U.S. cannot accomplish. 

The bottom line is that China is not about to bow out of the global manufacturing scene. However, if it is to keep growing as it has in the past, China must become more innovative, it must work smarter, not harder. The question to ask is, "Can China become a true innovator and distance itself from the role of imitator"?

Obviously, China's current leadership feels it can and that an important measure would be the number of patents filed as described earlier in this article.  But is this really a true measure of innovation? In the past, China's innovation gave the world silk, printing, paper, gunpowder, the compass, etc. These were fresh, novel ideas that the Chinese developed and exploited value from with the rest of the world. Literally, the world was beating a path into China to access its wonders.

Unfortunately, China's leaders appear to have chosen to follow a model that is being pursued by current U.S. leaders of having the state pick and choose winners and losers. So far the Chinese results from this policy have fared no better than the U.S. in this pursuit. There are very few winners but a lot of losers. 

Governments mandating the rate of inventive activity will only get you so far. Telling scientists to innovate without providing a culture and an atmosphere for such a happening has proven over time to be ineffective. In order to make it big on the global stage, China's indigenous firms need to be able to capture the economic value associated with their innovative activity. This means changing the way that they have conducted traditional business activities. They must make an investment into organizational design on a global scale including the establishment of brand visibility, constructing worldwide supply chains and building channels of distribution, and all of the rest of the complex set of activities that go into making a successful multinational corporation. If they are unwilling or unable to do this then they will relegate themselves to their own domestic market with few sales overseas.

There is no doubt that China has the manpower and the brainpower to become a serious innovator on the world stage. There are more than 100 million registered private enterprises in China all trying to become something bigger and better than they are today. Surely, within all this infrastructure and mass of humanity there exists at least one Steve Jobs. Unfortunately there are numerous reasons why the Steve Jobs of China may never be found.

Following years of complaints from foreign and domestic companies China is still beset by continuing intellectual property (IP) theft. On paper there are good IP laws in China but enforcement is another story altogether. In some instances various parts of the government have even been seen as being complicit in the taking of technology from one company and placing it in another company that is felt to have a better chance of developing that technology. Even the banks, with guidance from government leaders, tend to place extremely attractive, low cost loans with certain companies that they feel will be the ultimate winners thus starving true entrepreneurial development in smaller, less likely to succeed firms. Based on current and past practices, Steve Jobs would have never succeeded had he been born in China.

This practice by the Chinese leaders has led to many foreign companies deciding not to venture into China and thus not to expose or share their most valuable IP. China's leaders know this, and are now pouring billions of dollars into research and development. The current five-year plan calls for "indigenous innovation", which the government thinks it can foster by subsidizing strategic industries and strong-arming foreign firms to transfer intellectual property to selected national champions, or state chosen winners. The tried and proven system of state capitalism worked well when the objective was to simply copy and adapt other people's ideas in the cheapest way possible. But can new ideas truly be created by decree? Around the globe governments have tended to run into two problems: the state is not a good innovator, and it always gets in the way of others who are. We are seeing this happen in the U.S. today proving that China leaders are not alone in the belief that they know best.

Although the Chinese government invests a fortune in research and development, analysis of this expenditure indicates that much of this investment is wasted. Based on published data it appears that most of it goes into the development arena with the result that not enough finds its way into research. It appears that often it is far too difficult for new Chinese ideas to move from the laboratory to the marketplace. Since the middle class consumer is a fairly recent happening inside China very few Chinese firms really understand the need to get close to their ultimate customer and learn what the market really wants and needs. In this area, the Chinese could learn a lot from their Japanese neighbors.

China leaders also have the opinion that to become the great innovator you must have a huge bevy of PhDs available. Unfortunately this position can often stifle innovation unless it's tied to other interlocking factors. True, you need highly qualified scientist but you also need talented people who are entrepreneurial thinkers who have other attributes to offer such as a connection with other companies, governments, universities, suppliers and customers; an ability to work across multiple disciplines; able to think outside of the box, etc.

Unfortunately, these interlocking factors don't seem to exist within the normal Chinese culture. In fact, the very structure of Chinese society often presents inherent barriers to innovation. China has a rather monolithic culture, growing from a predominantly (92 percent) Han-Chinese population content and a deep tendency toward strong hierarchies. These factors do not encourage or favor thinking in new ways or including outsiders. This makes it difficult for Chinese scientists to understand new markets, to think creativelyor to accept eccentrics.

In the U.S. we often see the strong, entrepreneurial, stand-alone, risk everything persona such as a Steve Jobs. Unfortunately, this trait is not found in China. As a general rule, Chinese have a strong group focus, and prefer to work, communicate and share information with people they know and trust, someone from within, not from outside. They often exclude personnel from another department or division even within the same company or university, even more so if the individual is from outside the organization.

All these long established habits discourage appreciation of different types of thought, behavior or actions. This often stifles the kind of cross-fertilization and cooperation that successful multinationals tap to boost innovation. There is an old, traditional Chinese saying that sort of sums up the position of a number of Chinese companies: "Do less, make fewer mistakes, do nothing, make no mistakes." 

China's leaders have not fostered a risk-taking atmosphere or made it clear that failure isn't a bad thing. They most assuredly have not fostered a concept of rugged individualism or a hero culture. As a result most of the scientists assigned to R&D tend to work on projects that have limited risk associated hence as the data has shown, we see a preponderance of utility patents versus true invention patents. As such, most of the work going on in China involves low risk "Process Improvements".  The new, novel ideas/concept type of R&D that can change the world is still a rarity.

In the end, innovation capability depends on economic flexibility. The U.S., with its entrepreneurial culture, relaxed labor markets and free capital flows, at least for the moment, continues to be the most innovative economy in the world. China needs such an environment to bridge the growth and productivity gap between emerging markets and the developed world and to truly transform them into the innovative, energetic economy that they feel is required to be a true global leader.

Nobody expects the Chinese government to let the reins go completely, but it needs a less top-down approach that gives its citizens more space to experiment. It must let private investors risk money on ideas they think might work, and bear the consequences of failure. An obvious place to start would be to let firms expand on what they already do well, such as process innovation. China leaders, like current U.S. leaders, need to back out of the R&D, picking winner's process and let nature take its course.

Although I am a bit suspect of China's ability to truly become an innovation power house, the world should not underestimate China's capacity to innovate. From gunpowder on, the history of Chinese innovation is strong. Chinese society is highly competitive. When the Chinese can no longer make easy money imitating most China experts feel that they will finally start innovating.
Homegrown innovations will eventually motivate tougher enforcement of intellectual property regulations, or so one would hope. Until then China will continue to play the patent numbers game and claim victory when they achieve their two million patent applications. Such an achievement will not make them number one.