Innovation is the process by which new knowledge and ideas are created. Global leaders in innovation produce the scientific discoveries and technological advances that shape the modern world, making it critical to national power. An economy’s capacity to innovate is dependent on a variety of factors, including its commitment to research and development, the quality of its workforce, and the effectiveness of government institutions. As China works to upgrade its economy, its innovative strengths and weaknesses will shape its long-term economic competitiveness and prospects for global leadership.
Global Innovation Index
China’s Strengths in Innovation
Decades of rapid economic growth have enabled China to invest in key areas that drive innovation, such as research and development and the creation of new intellectual property. These investments have improved China’s GII ranking and enabled it to compete with advanced economies, such as the United States and Sweden.
Research and development (R&D) is the backbone of innovation. It supports the development of new products and services, which can boost growth and productivity. In recent decades, China has increasingly prioritized R&D, with spending as a percent of GDP rising from 0.72 percent in 1991 to 2.13 percent in 2017. Although this is less than the OECD average of 2.37 percent, the immense size of China’s economy means that its R&D expenditure is now second only to the United States at $442.7 billion (in 2010 USD).
Advancements in R&D have contributed to China’s improved position in the GII, where it places 9th globally in Business Sophistication, just behind the US and ahead of Ireland.1 In developed economies, businesses typically finance a substantial portion of R&D initiatives. For instance, businesses in OECD countries on average finance around 60 percent of R&D. In countries like Japan and South Korea, however, this ratio is over 75 percent. This trend is mirrored in China, where businesses financed 76.5 percent ($338.8 billion) of the country’s gross expenditure on R&D in 2017.
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Assessing the role of business in funding R&D in China is muddled by the importance of state-owned enterprises (SOEs). Many SOE executives have positions within the government and Chinese Communist Party, meaning R&D initiatives financed by SOEs often align with those funded by the government. SOEs also have preferential access to bank loans from state-owned banks, which reduces the cost of borrowing and provides SOEs with stronger financial backing compared to private companies.
Much of China’s R&D usage is geared toward commercial applications, which has left higher education performing a smaller portion of R&D in China than elsewhere. Between 2008 and 2017, an average of just 7.5 percent of China’s R&D was performed at universities and academies. This is well below top innovation leaders like the Netherlands (33.9 percent), Sweden (26.2 percent), and the United Kingdom (26.0 percent), and considerably less than the OECD average (17.9 percent).
| R&D Performed by Sector for Key Countries (2017) | |||
|---|---|---|---|
| Country | Business (%) | Government (%) | Higher Education (%) |
| China | 77.6 | 15.2 | 7.2 |
| United States | 73.1 | 9.7 | 13.0 |
| Japan | 78.8 | 7.8 | 12.0 |
| Germany | 69.3 | 13.4 | 17.3 |
| United Kingdom | 67.6 | 6.5 | 23.7 |
| Source: OECD Main Science and Technology Indicators | |||
Intellectual property (IP) protections, such as patents, are likewise critical for innovation. They provide legal safeguards for innovators and serve as a helpful measure of a country’s innovative capacity. For decades, China has leaned on foreign IP. In 2012, the World Bank Enterprise Surveys found that 18 percent of Chinese firms reported using technology from foreign businesses, which is higher than the global average of 14.8 percent, and nearly twice the OECD average of 9.3 percent.
Beijing has implemented several measures to improve China’s patent system. In 2008, the Chinese government launched a national IP strategy and passed revisions to its existing Patent Law. The National Patent Development Strategy was unveiled in 2010. The plan provides incentives to bolster the number of domestically filed patents, but it has resulted in patents being awarded for small design tweaks and incremental changes rather than entirely new inventions. New amendments to the Patent Law were proposed in January 2019.
Government efforts have had an impact. China has rapidly become the world leader in patent applications. According to the World Intellectual Property Organization, China filed roughly 161,000 patent applications in 2007, accounting for just 8.5 percent of the global total. A decade later, China filed more than 1.3 million patent applications, accounting for 40 percent of all applications in 2017. This high output has propelled China to the top five in the Knowledge and Technology Outputs pillar of the GII.
Despite significant growth in patent output, Chinese patents still suffer from qualitative weaknesses, leading to continued reliance on foreign patents. Between 2008 and 2017, China paid $185.2 billion to purchase IP rights from foreign entities, but Chinese IP only generated $12.2 billion from overseas sales. Over a third of these earnings came in 2017 alone, when annual revenue skyrocketed to $4.8 billion. While Chinese IP is becoming more valuable, it is still outperformed by several competitors. American IP raked in an incredible $128.4 billion in 2017; Japanese IP earned $41.7 billion in the same year.
China’s relatively small contribution to the total number of triadic patents is also notable. These patents – filed jointly in Japan, the United States, and the European Union – are considered the gold standard among patent families. Triadic patents are difficult to obtain, but generally generate more revenue than other patent types. In 2016, China was the fourth largest contributor to triadic patents at 6.9 percent, behind Japan (31.0 percent), the United States (25.4 percent), and Germany (8.1 percent).
Competing but not Leading in Innovation
In other aspects of innovation, China is progressing but still lags advanced economies. Improvements in primary and secondary education and increased funding for startups have helped promote Chinese innovation, but issues with tertiary education, business environment, and work culture persist.
Government initiatives, backed by significant funding, have enabled China to attain near-universal primary and secondary enrollment and literacy rates. Disparities continue to exist in China’s poorer regions, but noteworthy improvements in education have boosted its capacity to innovate.
At the tertiary level, however, China falls short.2 In 2017, only 51 percent of college-age Chinese were enrolled in institutions of higher education. Although this represents a steep jump from 5.5 percent in 1997, it is well below the 77 percent average of high-income countries, and even below the 52 percent average of upper-middle income countries. The quality of higher education in China also trails that of other countries, with only three Chinese universities listed in the top 100 of the 2019 Times Higher Education World University Rankings.
To meet growing demand for skilled workers, China has prioritized tertiary vocational education. The Ministry of Education spent nearly $30 billion on tertiary vocational schools in 2017, a 10.2 percent increase from the previous year. In February 2019, Beijing unveiled two new national education plans designed to boost access to and the quality of vocation centers across the country.3
China’s business environment exhibits both strengths and weaknesses. Startups in urban hubs are attracting more venture capital than ever before, but problems with business regulations and workplace culture inhibit innovation. These factors have contributed to China’s lackluster performance in the GII’s Market Sophistication pillar, where China sits at 25th globally, just behind Latvia and ahead of Azerbaijan.
Urban hubs like Beijing, Shanghai, and Hangzhou have begun to challenge Silicon Valley’s dominance in fostering startups. These three cities were responsible for more than 30 percent of global growth in venture capital investment during 2010-2012 and 2015-2017. They are also home to 75 percent of China’s “unicorns,” or startups with a value of at least $1 billion dollars.
Nevertheless, Chinese companies face considerable hurdles that make it difficult to operate and innovate. Although government measures have helped reduce red tape, which has decreased the average time to start a business from 22.9 days in 2017 to 8.6 days in 2018, the World Bank rated China 46th out of 190 economies in ease of doing business. Contributing factors include legal roadblocks and problems with the credit system.
Workplace culture presents additional challenges for China. The 2018 Global Competitiveness Index (GCI) ranked China 77th out of 140 economies in terms of workforce diversity. As a softer driver of innovation and entrepreneurship, workplace diversity can position firms to creatively solve problems and capture new markets.
The Chinese technology industry is also notorious for encouraging a “996” culture – working from 9 am to 9 pm 6 days per week. Some prominent CEOs, including Richard Liu of JD.com and Jack Ma of Alibaba, have gone so far as to defend the practice. E-commerce platform Youzan even demands employees abide by 996. While overworking is a problem that China shares with countries like the United States and Japan, there is growing evidence that sustained overworking is both counter-productive and detrimental to employee health.
China’s Enduring Weaknesses in Innovation
One of the most significant hindrances to Chinese innovation is a lack of institutionalization – the rules, processes, and organizations that help foster healthy public-private collaboration, economic growth, and innovation. While China has taken steps to strengthen its institutions, the GII places them 70th globally.4
Weak institutions have left China susceptible to widespread corruption, which has contributed to economic inefficiency and loss. In recent years, the Chinese government has taken several steps to reduce corruption. The most visible push is the national anti-corruption campaign spearheaded by President Xi Jinping. The campaign, which has resulted in hundreds of arrests, has helped reduce corruption in the allocation of government R&D subsidies.
Beijing has also established local bankruptcy courts, which are modeled on US courts and staffed by insolvency professionals. These specialized courts were set up primarily to stop local politicians from propping up inefficient state-owned enterprises (SOEs). Between 2014 and 2017, the number of specialized bankruptcy courts increased to 97, leading to a more than six-fold increase in bankruptcy cases and increased closure of underperforming SOEs.
| Bankruptcy Cases | |
|---|---|
| Year | Number of Cases Accepted |
| 2017 | 9,542 |
| 2016 | 5,665 |
| 2015 | 3,568 |
| 2014 | 2,031 |
| 2013 | 1,919 |
| 2012 | 1,521 |
| Source: Li and Ponticelli, “Going Bankrupt in China” | |
Notwithstanding such efforts, corruption remains a challenge for China. In the 2018 Corruption Perceptions Index (CPI), China and Serbia shared a middling score of 87th out of 180 countries. China maintained an average position of 84th in the CPI between 2013 and 2018. This is well below robust democracies like Denmark, New Zealand, and Finland, which took the top three spots in 2018. Compared with other BRICS members, China is just behind South Africa (73rd) and India (78th) but ahead of Brazil (105th) and Russia (138th).
High levels of corruption in China are linked to the weak rule of law. Economies supported by a strong rule of law are more stable and better capable of protecting key elements of innovation, such as IP rights. The United States and the European Union have long called for China to strengthen the rule of law, especially regarding IP protections. In January 2019, China’s Supreme People’s Court began hearing IP appeals cases, a move aimed at protecting foreign and domestic innovation.
Similar measures could help better protect innovators, but China will need to undertake fundamental reforms to match the strong rule of law in leading nations. The World Bank’s 2018 Worldwide Governance Indicators (WGI), which scores countries based on scale between 0 (worst) and 100 (best), gave China a percentile rank of 45. This was far below the OECD average of 87, but on par with other BRICS economies, which averaged 43.
The challenges that China faces regarding corruption and the rule of law likely require systemic institutional reforms. Legal adjustments in areas like bankruptcy and IP can help enhance innovation, but if these are not matched with a more comprehensive push from Beijing, China may never ascend to the heights of the elite innovating nations. 