Research and Development (R&D) is the backbone of innovation. It supports the development of new products and services, which have the potential to touch all aspects of modern life in the ways that personal computers and smartphones have and that artificial intelligence and robotics are expected to in the near future. In a global community built on technology, how countries leverage their R&D efforts has a profound impact on their economic prosperity and the quality of life enjoyed by their citizens.
China has leaned on its manufacturing prowess for decades to support economic development, but it is increasingly seeking to contend with countries whose economies are deeply rooted in innovation-based growth. China has made considerable progress in establishing itself as a pioneer in emerging industries and its leaders are increasingly looking toward innovation as a driver of its economic growth.
R&D Spending Around the World
Decades of rapid economic growth have enabled Chinese leaders to dedicate more resources to R&D. According to the Organization for Economic Co-Operation and Development (OECD), China’s R&D spending accounted for just 0.72 percent of its GDP in 1991. At the time, China’s economy was the 10th largest in the world, just behind Canada, which contributed 1.53 percent of its GDP to R&D in the same year. Economic leaders during the early 1990s, such as the US and Japan, averaged higher R&D to GDP ratios, at 2.5 and 2.7 percent, respectively.
By 2015, China’s R&D expenditure had surged to 2.06 percent of its GDP. This shift was propelled in part by government measures. For instance, China’s 12th Five Year Plan (2010 – 2015) set an R&D spending target of 2.2 percent of GDP by 2015, a mark it narrowly missed by 0.14 percent. Beijing has since renewed its support for R&D through the 13th Five Year Plan (2015 – 2020), which targeted spending 2.5 percent of GDP on R&D by 2020. China’s spending on R&D continues to grow, but likely fell short of the 2.5 percent goal in 2020. According to the OECD, China’s R&D expenditure reached 2.14 percent of GDP in 2018, and Chinese government figures show R&D spending at 2.23 percent of GDP in 2019.
While China may narrowly miss these goals, China’s nominal spending on R&D is rapidly growing. China’s R&D expenditure witnessed a more than 35-fold increase from 1991 to 2018 – from $13.1 billion to $462.6 billion. In 2018, China spent as much on R&D as the next four countries – Japan, Germany, South Korea, and France – combined, and China’s spending accounted for nearly one-quarter of global R&D expenditure.1 Chinese R&D spending still lagged that of the US by nearly $89 billion in 2018, but the gap between the two countries is rapidly narrowing.
Breaking Down the Sources of R&D Financing
The OECD delineates four sources of R&D financing: business, government, foreign funding from the rest of the world (ROW), and other national-level sources. In developed economies, business typically finances a substantial portion of R&D initiatives. The average amount of R&D financed by business in OECD countries was 62.5 percent in 2018. Japan, South Korea, and Taiwan all had ratios well over 75 percent.2
|R&D Financed by Business and Government for Key Countries (2018)|
|Country||Business (%)||Government (%)|
|Source: OECD Main Science and Technology Indicators|
This trend is mirrored in China, with its businesses financing 76.6 percent ($354.4 billion) of the country’s gross expenditure on R&D in 2018. However, this high concentration of business financing has not always been the case. In 1994, business contributed only 32.4 percent of China’s R&D spending. This uptick can partially be attributed to the growing number of Chinese enterprises. According to the World Bank, the number of domestic listed companies in China more than tripled from 1,086 in 2000 to 3,777 in 2019.
However, analyzing trends in business funding is muddled by the importance of state-owned enterprises (SOEs) in the Chinese economy. SOEs are subject to orders from “government officials functioning as representatives of ownership,” which in some cases makes the R&D initiatives financed by SOEs akin to government funding. SOEs also have preferential access to bank loans from China’s state-owned banks, which reduces the cost of borrowing and provides SOEs with stronger financial backing compared to private companies. Unlike their counterparts in the United States and Europe, which commonly rely on venture capital to finance R&D, private firms in China often fund their own innovation efforts, which further widens the financing gap.
Analyzing trends in business funding is muddled by the importance of state-owned enterprises (SOEs) in the Chinese economy.
In contrast to financing from business, direct funding from the government is on the decline. From 2000 to 2018, the percent of R&D financed by the government in China dropped from 33.4 percent to 20.2 percent. This places China on a level comparable to the United States (23 percent) and South Korea (20.5 percent), but significantly below that of Mexico (76.9 percent) and Russia (67 percent).
This trend, however, may soon shift as Beijing works to implement policies aimed at increasing government-led innovation. In 2015, Beijing launched “Made in China 2025,” a plan to increase manufacturing capability and technological innovation within key industries. As part of this push, 901 government guidance funds were launched with the goal of raising $347 billion to help lessen the burden on Chinese firms of financing R&D. Lucrative tax breaks are also being provided to firms to further incentivize investment in R&D.
As a result of domestic restrictions that limit inbound investment flows from overseas, R&D paid for by ROW represented only a small fraction of China’s R&D financing in 2018 (0.36 percent). This rate is much less than that of the United States (7.3 percent), but is on par with other countries in East Asia, including South Korea (1.9 percent) and Japan (0.6 percent). Importantly, these figures do not capture the role of R&D centers operated by multinational corporations. For instance, data from China’s Ministry of Commerce show that as of October 2020 MNCs had established 477 R&D centers in Shanghai alone.
How China utilizes its R&D financing
It is also necessary to consider the users of R&D financing, as those conducting R&D are not always the same as those funding such endeavors. The OECD delineates four main users of R&D funds: government, business, higher education institutions, and private non-profits. The amount of R&D performed by each of these actors varies considerably by country. In the case of China, the share of R&D conducted by nonprofits is practically nonexistent. The other three users are analyzed below.
Over the last several decades, Beijing has worked to boost the role of business enterprises in driving innovation forward. This effort has seen the transfer of government research capacities to SOEs. For example, in 1999, over 11,000 government laboratories were transferred to SOEs as part of an effort to better connect manufacturers with innovation centers. Moves such as these have contributed to the marked growth in the amount of R&D pursued by Chinese firms. In 1991, a mere 39.8 percent of all R&D in China was performed by business enterprises. By 2018, that number had soared to 77.4 percent, which was greater than that of both the United States (72.6 percent) and the average for OECD economies (70.6 percent).3
Similar to the issue of distinguishing the sources of R&D funding, SOEs complicate how Chinese firms utilize R&D. According to China’s National Bureau of Statistics, R&D spending by SOEs and companies with mixed ownership made up 67.6 percent of enterprise R&D expenditure in 2019. Private enterprises, meanwhile, only constituted 32.3 percent.
Nonetheless, private firms are playing an increasingly important role. Since 2011, the percentage of R&D performed by private companies increased by 16.6 percentage points.4 In 2019, privately owned Chinese technology giant Huawei invested $19.3 billion in R&D. This accounted for about 6 percent of China’s national total and surpassed the total amount of R&D spending that took place in 25 of China’s 31 provinces and regions. This shift could prove promising for China. Some research has shown that when compared to SOEs, private companies dedicate higher portions of their revenue to R&D and often yield higher returns on investment.
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Expenditures by the Chinese government stood at 15.2 percent of total R&D usage in 2018. This ratio is similar to that of advanced economies, such as the United States (10.4 percent) and Germany (13.5 percent), but significantly lower than that of Russia (32 percent) and Mexico (34.4 percent). In nominal terms, the Chinese government spent $70.2 billion in 2018, more than any other country in the world.5 Government-driven expenditure has contributed to the development of highly visible technological advancements, particularly those made by the China National Space Administration. The Tiangong-2 space station and the “Micius” quantum satellite – the first of its kind – are just two such examples. More recently, China’s Chang’e 4 lander became the first spacecraft to land on the far side of the moon.
Institutions of higher education perform only a small portion of China’s R&D – about 7.4 percent of the total in 2018. This is considerably less than that of Japan (11.6 percent), Germany (17.6 percent), and Finland (25.2 percent). Several factors are at play when considering the role of academic institutions in China. The country’s restrictions on intellectual freedom, coupled with a focus on the graduate employment rate over scientific output, have impeded innovation within China’s universities.
President Xi Jinping specifically called on China to “strengthen basic research, and make major breakthroughs in pioneering basic research and groundbreaking . . . innovations” in his speech at the 19th Party Congress.
China also lacks well-established linkages between businesses and universities, which significantly limits knowledge transfers. Although this relationship is difficult to quantify, Times Higher Education examined how universities collaborate with industry on research, and noted that in 2016 over “6 percent of US publications [were] joint efforts between the academy and industry, compared with just 2.7 percent in China.”
Additional insight can be gleaned by considering the industries targeted by R&D initiatives. Official government figures show that the manufacturing of electronics, including computers and communication equipment, attract the most funding from government, business, and academic institutions – totaling some $35.4 billion in 2019.
This focus on information and communication technology has helped pave the way for breakthroughs like the Sunway Taihu Light, the world’s fourth-fastest supercomputer in 2020. It has also led to commercial success in niche markets. Chinese drone manufacturer DJI, for instance, is reported to control up to 74 percent of the global drone market. Huawei has emerged as one the leading companies working on next generation mobile communications technology, including the roll-out of 5G networks, which are expected to be 50-100 times faster than 4G.
China is also a leader in surveillance technology, with Hangzhou Hikvision Digital Technology controlling over 20 percent of the global market share. Its newer products, such as the DeepinView Camera, are purportedly outfitted with facial recognition capabilities that can not only identify known individuals, but also estimate the age, ethnicity, and gender of unrecognized persons. Hikvision products have been exported to a number of countries, including the UK and the US, where they have reportedly been put to use by private enterprises and local governments.6
China’s R&D priorities
Research and development can also be distinguished by its desired outputs into three areas: basic, applied, and experimental development research. Definitions for these areas are outlined in the table below.
|Basic Research||Expanding scientific knowledge or answering questions without a specific or immediate application||
|Applied Research||Solving practical problems that can improve the human condition||
|Experimental Development||Using acquired knowledge to produce or improve products and processes||
|Sources: Boston Consulting Group, Lawrence Berkeley National Laboratory|
Beijing has consistently poured the largest share of its R&D resources into experimental development, averaging roughly 80 percent from 2000 to 2019. According to an OECD report, this has contributed to a growing output from “engineering-oriented domains,” which has made it easier for manufacturers to quickly adapt products and services to the domestic market. China’s preference for experimental development research far outstrips that of other leading economies. Innovation powerhouses like the United States and Japan devoted just over 62 percent of R&D on experimental development research.
Conversely, China’s R&D spending on basic and applied research, which are critical to the development of new scientific ideas and cutting-edge technologies, proportionally lags that of other major powers. Basic research in China averaged around 5 percent of total R&D expenditure between 2000 to 2018, while the share of applied research dropped from 17 percent to 11.1 percent. Over the same period, the US poured 17.3 percent of its R&D funding into basic research and 20.4 percent into applied research. In nominal terms, China’s basic and applied expenditure was $77.1 billion in 2018, more than that of South Korea ($34.5 billion) and Japan ($54.7 billion), but less than half that of the US ($200.5 billion).
To supplement the prevalence of experimental research, Chinese leaders are promoting the importance of basic and applied research. President Xi Jinping specifically called on China to “strengthen basic research, and make major breakthroughs in pioneering basic research and groundbreaking . . . innovations” in his speech at the 19th Party Congress. This is likely to be difficult as regulatory hurdles, insufficient IP protections, inefficient government funding, and underinvestment by private-sector players continue to stifle China’s endeavors to promote science-based innovations. However, it is worth noting that in 2019 basic R&D expenditure grew by 22.5 percent year-over-year, while applied and experimental R&D grew by 14 percent and 11.7 percent, respectively.