Books and Reviews

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China’s Path to Innovation

China's economic development is one of the great stories of our time. Today (July 28, 2015) we are starting our special focus on China with a review new book on the development of China's innovative capacity. China's Path to Innovation written by the Oxford Professor Xiaolan Fu. Although a new trade press book seems to come out almost every week on China's innovative capacity, there are relatively few scholarly treatments on the subjects. For this reason, Xiaolan Fu’s book China's Path to Innovation (Cambridge University Press, 2015) is a welcome addition to the literature.

Review by Johann Peter Murmann

China’s economic growth over the past four decades is nothing but spectacular, as these comparative figures show.

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Source: Worldbank

Until recently, Chinese firms have conquered world markets largely by imitating western products and making them a lot a cheaper. Solar panels are an important example of this strategy.  Alternatively, they conquered global markets by contracting for firms like Apple to manufacture the electronic gadgets that we all hold in on our hands.  Even though China manufactures all iPhones, Apple makes the vast majority the profits in the value chain (Kraemer, Linden and Dedrick 2011

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But what if Chinese firms move up the value chain? What if China is able to create more firms like Apple that innovate entirely new product classes? What will this mean for the competitive position of western firms? How soon is this likely to happen?

Corporate strategists and policy makers in western countries worry deeply about these questions. Not surprisingly, significant interest in writings on China’s current and future innovation capacity has built up during the past few years.

To satisfy this thirst for more knowledge about innovative Chinese firms, a new trade press book seems to come out almost every week. Here are three that I found stimulating:

  • Between the Eagle and the Dragon - Who is winning the innovation race? by T. Barlow
  • The End of Copycat China: The Rise of Creativity, Innovation, and Individualism in Asia by S. Rein
  • China’s Disruptors: How Alibaba, Xiaomi, Tencent, and Other Companies are Changing the Rules of Business by E. Tse

  • These trade books are typically written by consultants who have worked with many of the companies covered in the books. They do a good job in describing how some companies are breaking the stereotype of imitative Chinese firms. In the case of Rein’s book, for example, one learns a lot about changing consumer preferences in China because his consulting firm does a lot of market research for global consumer companies. Tse focuses on describing just how entrepreneurial the now-famous Chinese firms are and how they excel in business model innovations.

    But to date there are few research monographs that go beyond picking out striking cases of innovative companies. We clearly also need systematic analyses of China’s growing innovative capacity. For this reason, Xiaolan Fu’s book China’s Path to Innovation (Cambridge University Press, 2015) is a welcome addition to the literature. Fu is Professor of Technology and International Development at Oxford and has written about innovation in China for more than ten years. China’s Path to Innovation has 16 chapters ([/url]Table of Contents[/url). Most of the chapters are revisions of articles that previously appeared in academic journals. If you have already read all of Professor Fu’s published papers, the book will not break much new ground with the exceptions of chapters 2, 8, 11, and 12. However, for scholars like myself who have not read her previous work, the book is a very convenient access to her writings and new insights. It also provides an excellent overview of scholarly literature on the development of Chinese innovative capacities. For this reason, it deserves to be in the library of anyone working on China’s innovative capacity.

    For those readers who want to know more about the book, let me describe briefly each chapter. After a brief introduction, Chapter 2 provides a useful overview of innovation in China since 1978. Many useful graphs and figures (there are about at 100 of them throughout the book) demonstrate how much more China is spending on R&D, how much patenting has increased, how many more students are graduating from university, how many more journal articles are published in China, what regions host most of R&D, etc. The increases in the inputs to innovation are nothing but stunning. If you know nothing about innovation in China, this is an excellent one stop introduction to the subject.

    China’s Path to Innovation is arranged in three major parts. Part 1 (Chapters 2 to 5) deals with “international knowledge transfer and technological takeoff”. Chapter 3 examines the impact of Foreign Direct Investment (FDI) on regional innovative capacity. The chapter shows that most FDI has been concentrated in a few coastal regions in China and that the positive impact of FDI on regional innovative capacity depends on adaptive capacity of the region, proxied here by R&D intensity and labor force skills. In coastal regions with sufficient absorptive capacity, FDI increases regional innovative capacity. This was not the case, however, in central regions for the period from 1998 to 2004. An important observation made in the chapter is that foreign firms because of the lack of sufficient patent protection in China did not bring their most advanced technology to China and did not invest more into innovation (p. 73).

    Chapter 4 is an elaborate econometric study examining technological and information spillovers from FDI in Chinese technology-intensive from 2000 to 2007. The study reveals that there are no sizable technological spillovers, but that local firms learn about exporting and market opportunities from the presence of foreign companies. Just how important foreign technology firms are in the Chinese economy in the period until 2007 is summarized in this statement: “On average, foreign invested firms produce 89 per cent of China’s total exports in high technology products” (p. 92), writes Fu. It would be useful for someone to update these figures for the past 8 years to see whether the numbers have come down.

    Chapter 5 is devoted to teasing out to what extent the technological upgrading of Chinese firms is due to indigenous innovation versus the importation of foreign technology. Again the analysis is based on a large econometric study that estimates the sources of total factor productivity growth for for 53,981 firms. The key findings are that in low-tech and medium-tech industries, Chinese firms have experienced sizable productivity growth not because of foreign technologies but because of collective indigenous innovation. In high-tech sectors, foreign firms dominate the technological frontier and very little technological spillover to domestic firms seems to have taken place. This leads Fu to conclude that industrial policy needs to be tailored to specifics of each sector and its particular state of development. Just how easy this is for policy makers is certainly a fundamental question that deserves more of our attention.

    Part II (Chapters 6 to 10) takes a much closer look at China’s ability to develop indigenous innovation capacities and catch up with leading western countries. Chapter 6 examines The role of state policy in shaping innovation practices with a focus on open innovation. I had not seen anyone apply the concept of open innovation to an entire country, and it is important to note that “open innovation” is here meant metaphorically as relying on other parties to get innovation done. Recall that Deng’s opening of China in 1978 was based on the realization that China technologically was woefully behind the West and that to raise the standard of living China needed to get access to advanced technology. Fu presents data that show how important open innovation is important in China: More than a third of 1408 manufacturing firms responded in a 2008 survey that they partnered with other firms both for product and process innovations. For me the most valuable part of the chapter was to bring into one place a review of the main public policies for open innovation in China from 1986 to 2009. While the government policies initially were focused on getting foreign companies to share their technologies and expertise with Chinese firms through joints ventures and licensing (called inbound open innovation), the Chinese government has in recent years focused on making it easier for domestic firms to acquire foreign companies and thereby gain access to cutting-edge technologies (this is called outbound open innovation). The reason for this is that foreign firms are more and more unwilling to share their leading technologies due to limited intellectual property right protection in China. Hence Chinese firms can only get access to foreign technology by buying foreign firms or setting up their own R&D laboratories in foreign countries, where they can hire scientists and engineers who have knowledge and connections that are not available in China. ZTE, Huawei and Haier are prominent examples of this trend.

    Chapter 7 examines drivers of open innovation for firms in emerging economies, using the case of China. The idea is to examine to what extent firms are responding to technological, financial or institutional constraints and risks in choosing or avoiding open innovation strategies. Replicating the European Community Innovation Survey, the study is based on again on the 2008 survey of 1408 Chinese manufacturing firms, representing 18.2% of the total R&D spending in China. Only 625 made it into the econometric analysis, and large firms are over-represented. Nonetheless, the results show that large firms are more likely to engage in open innovation. The strongest finding perhaps is that without considerable R&D expenditures proxying for the absorptive capacity, firms do not engage much in open innovation. Consistent with many other studies, the different types of firms engage in different amounts of open innovation. Private enterprises do more than state-owned enterprises and foreign-invested firms. Once again, the study underlines how important private enterprises for China catching up with the advanced countries.

    Chapter 8 is one of the most exciting chapters for students of universities and their role in economic development. Even under communism, Chinese universities had the role of solving practical problems of society. Fu reports something that I did not previously know: To stimulate industrial development and to force universities and research institutes to work on use-driven problems and push them into the market, the government cut funding for research from 1986 to 1993 by an annual rate of 5%. This led research institutes and universities to create their own enterprises to make money. The core of the chapter examines an interesting hypothesis regarding the role of universities in developing economies in contrast to their role in advanced economies. Is it the case that universities in China have an important role in helping Chinese firms absorb and diffuse technology from the most advanced countries rather then helping local firms develop new-to-the-world products? Drawing on the aforementioned innovation survey and benchmarking against a sample of the UK firms that filled out a similar survey, Fu finds that Chinese universities indeed helped firms to absorb foreign technology and develop products that are new to China rather than new to the world. The opposite is true for UK universities: They helped British firms to develop new-to-world-products but not diffusing innovations. Those companies in China that work on new-to-world-products benefit not only from domestic universities but from foreign universities, and most interestingly from those that are not in the most advanced countries but countries that are more on the development level of China. Fu is careful to point out that we need further studies to confirm the conclusions with data that are not based on the subjective evaluations of firm managers.

    Chapter 9 examines the Chinese optical fibre and cable industry. Fu acknowledges that there are additional problems with the reliability of the survey data in this study. The dependent variable is very subjective. Firm managers were asked to rate whether they are leaders in the industry. You can skip this chapter.

    Anyone who travels in China realizes that if “necessity is the mother of all inventions” China should become a leader in environmental innovations to deal with the widespread pollution of air, land and water. Chapter 10 offers a comparison of the efforts of China and India to build an indigenous solar and wind industries. Such a chapter could have been effective if detailed scholarly histories of the industries in China and India had already been written. I have done quite bit of research on the solar industry of China, and for me the treatment of development of the Chinese solar industry was too coarse-grained. What I found most rewarding about this chapter was Fu’s discussion of the environmental pollution caused by so-called green technologies. Dominating global solar production, China exports this green technology while keeping the pollution created during the production processes in the country. Fu here reminds us that we need to assess the total environmental impact of producing and using green technologies.

    Part III (Chapters 11 to 14) focuses on China becoming a global innovative leader. Chapter 11 offers an exploratory case study of how Huawei and ZTE became global players in the telecommunications industry.  Huawei is the top patent filer in the world and ZTE is No.3.

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    To get a deeper understanding how these two firms upgraded their capabilities to beat Western firms in many markets, Fu and her co-author Zhonghuan Sun interviewed 17 leading executives of the two firms. In essence, the chapter offers an account of the cognitive maps that senior executives have to explain how their firms became successful. Here are the key reasons cited: The first step in the success of the two firms was to initially go after markets that the incumbent players did not care about, be this the country side of China rather than big cities or later developing countries rather than developed countries. With a foot in the door and some scale economies built up, the firms could then attack incumbent western firms in their core markets. Second, the two firms listened closely to their customers and concentrated their research and development efforts on what the customers wanted. (This strategy does not work always work, as Clay Christensen pointed out in his book on the hard drive industry.) Third, both firms engaged in alliance and JV with leading firms in the industry and through this learned to upgrade their own capabilities. (Why the leading firms when they were not customers would enter these JVs in the first place is not made clear.) Fourth, both firms built country-level organizations all around the world and then set up organizational processes to transfer knowledge not only from headquarters to foreign subsidiaries but also from foreign subsidiaries to HQ. Fifth, the firms set up R&D laboratories in many places in the world to tap knowledge.

    Future research can build on this chapter and bring into the comparison leading incumbent firms from which Huawei and ZTE grabbed market share.  Are we dealing with short-cycle technologies (Lee, 2013) where it is easy to catch up with incumbents because those technologies rely less on existing technologies? Further, did ZTE and Huawei have unbeatable cost advantages over their western rivals in the 1990s and early 2000 mixed with economies of scale? Was the cost advantage also in R&D? If most of the patents of the firms came out of the Chinese laboratories rather than the foreign laboratories, this could be the case. Clearly ZTE and Huawei are leading examples of Chinese firms becoming innovative. I hope other researchers will continue to dig into these key Chinese firms and unravel more details about how they became innovative.

    Chapter 12 returns to the dataset that was already used in Chapter 8 and presents data that is consistent with the case study of Huawei and ZTE. The chapter analyzes what types of collaborations help firms to achieve more radical innovations measured in terms of the percentage of novel new sales. The results are very interesting. It turns out there is only one type of collaboration that matters after controlling for all other types of collaborations. It is not collaboration with a foreign subsidiary; it is not collaboration with a foreign supplier, or foreign private research institute or collaboration with foreign university or public research institute. It is not collaboration with domestic partner. No, the only thing that helps is collaboration with a foreign customer. If ever there was very specific and actionable advice to Chinese companies on how to develop more innovative products, this is it.  I think this finding is one of the most important insights of the entire book.

    Chapter 13 examines how efficient China is in creating innovations by comparing China with a number of other developing and developed countries. The econometric exercises underpinning this analysis involves stochastic frontier analysis (SFA). First, a few words about what is meant by innovation efficiency. Fu explains that innovation efficiency “reflects a nations intangible capability for transforming direct, tangible inputs—Investments in R&D, the stock of engineers, scientists, and skilled labor, and investments in education— into final commercially successful innovation outputs” (p. 331). Think about this intangible capability as the social, cultural, legal and economic infrastructure of a country. The degree of patent protection would be one element. Trusting that the government will not take away the fruits of your innovation would be another. The good news for China is that in 2011, with a benchmarked score of .22 , China was more efficient in creating innovations than France (.20), Spain (.09), Russia (.08), and Argentina (.06). But compared to Japan (1.0), which is the most efficient country, South Korea (.85) and the US (0.80), China is still far from the efficiency frontier.

    Chapter 14 lays out an agenda for how the Chinese government can improve the innovation efficiency of the country. A wide range of policy measures are discussed. Fu sees as the most important goal to stimulate the private sector to take a higher share in the Chinese economy and to subject the state-owned enterprise sector to more competition. She is against the state targeting particular industries for special support and instead wants the government to focus on “horizontal policies” that apply to all sectors. The government should continue to increase its spending on R&D to catch up with more advanced countries, but not focus on particular sectors in the economy. One interesting proposal Fu makes I had not encountered before: She recommends that the government should set up a Central Innovation Leading Group (CILG) led by the prime minster. The idea is to achieve a better coordination among the various ministries and local governments whose policies impact China’s innovation capability.

    The concluding sector recapitulates the key findings of the book and provides suggestions for future research. In my view, Fu’s call to do more research on the role of the state is the single most important one among her many suggestions. Aside from the aforementioned proposal (CILG), throughout the book there is very little discussion about the role of the state and the machinery of government. The only place where different levels of government in China appear explicitly is in Fu’s discussion of the solar industry. Once the solar industry took over, many different regional and city governments sponsored solar companies in their territories, only to lead to a massive oversupply of solar panels, dramatic price declines and bankruptcies. The Communist Party as far as I can remember does not appear at all in the book. It seems to me that future research on the role of the state in China needs to grapple with the organization and the competition among factions without the Communist Party. We in the innovation studies community often pay too little attention on the political process through which any science and technology policy is made. This is why we have too little sense what policies are politically easy or difficult to implement. Someone should write a study about how science and technology policy is made in China similar to the wonderful study of Victor Shih (2009) about the political struggles within the Communist Party and with government technocrats to keep inflation under control in China.

    In the meantime, I recommend that any scholar interested in China’s innovation capacity read China’s Path to Innovation.

    —Johann Peter Murmann                                                                           Published: July 28, 2015

     

    References

    Barlow, T. 2013. Between the Eagle and the Dragon: Barlow Advisory.

    Christensen, C. 1997, 2013. The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail: Harvard Business Review Press.

    Fu, X. 2015. China’s Path to Innovation: Cambridge University Press. (Your university may provide free electronic access).

    Kraemer, K. L., G. Linden and J. Dedrick (2011) “ Value in Global Networks: Apple’s iPad and iPhone” accessed on April 12, 2014.

    Lee, K. 2013. Schumpeterian Analysis of Economic Catch-up: Knowledge, Path-Creation, and the Middle-Income Trap. Cambridge, UK: Cambridge University Press.

    Rein, S. 2014. The End of Copycat China: The Rise of Creativity, Innovation, and Individualism in Asia: Wiley.

    Shih, V. C. 2009. Factions and Finance in China: Elite Conflict and Inflation: Cambridge University Press.

    Tse, E. 2015. China’s Disruptors: How Alibaba, Xiaomi, Tencent, and Other Companies are Changing the Rules of Business: Penguin Publishing Group.

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