Growth Challenges

Innovation Squared in China: Empty Patents and Hollow R&D?

Before Xi Jinping and Li Keqiang’s appointment to the top of the CPC, few noticed the changing signage on the streets of Beijing and around China. For decades the Communist Party has directed its people with slogans, placed on bridges, public transport, and various public locations. Where in the past these signs focused on transforming the economic basics, today they focus on: Patriotism (爱国), Innovation (创新), Tolerance (包容) and Virtue (厚德). Similarly, the square outside the Chinese Academy of Sciences in Beijing’s Haidian District has recently been formally named “Innovation Square.”

The chronic imbalances in China’s economy due to the high percentage of GDP accounted for by state investment, has led to a re-enlivened push to increase consumption. A key issue of this economic rebalancing has been a strong focus on driving domestic innovation. As the Xinhua report says:


“The guideline also sets a goal of establishing a market-oriented ‘technology innovation system’ inside enterprises by 2015 that combines research, development and production.

 

The guideline calls on enterprises to invest more in research and development, with money spent on research by large- and medium-sized industrial enterprises to be increased to 1.5 percent of their main business revenues.

 

Leading enterprises should reach the level as their international peers and double the amount of patent applications they file, the guideline says.”

 

One of the problems with this policy announcement is its focus on “large- and medium-sized industrial enterprises,” and a lack of policy support for new emerging businesses, which are far greater drivers of innovation and job creation (). The other major issue is the focus on patent filings and R&D spending, metrics that are correlated with innovation, but are certainly not causes of innovation. This overt reliance on non-causal metrics runs the serious risks of Campbell’s Law, which states:

 

“The more any quantitative social indicator is use for social decision-making, the more subject it will be to corruption pressures and the more apt it will be to distort and corrupt the social processes it is intended to monitor.”

 

Whilst coined as a criticism against the over-reliance on the metrics of standardised testing, it is equally relevant to the metrics that measure cadre promotion in the CPC (the huge debts racked up by Bo Xilai in Chongqing and Zhang Gaoli in Tianjin that drove record-breaking GDP numbers in their bid for PBSC seats are cases in point). The central government can dictate projected increases in R&D spending and patent filings, and SOEs may well be incentivised to hit those targets on paper, but this does nothing for the quality of innovation. The Economist has shown quite clearly that even though China has now surpassed US in patent filings, only 5% of those patents were also filed in other countries, which is a clear indication of a genuinely valuable idea and compares with 27% in the US and over 40% in the EU.

 

If China is really serious about innovation, and not about further subsidizing its SOEs in another name, its policy focus should be on nurturing emergent private sector companies. And there are plenty of interesting policies being adopted around the world, and influential studies like the Startup Genome Project documenting the characteristics and policies adopted in different startup ecosystems around the world.

 

In this regard the UK has been a leader in pushing through reforms heavily supported by entrepreneurs. They have instituted the Seed Enterprise Investment Scheme, which gives a tax deduction up to 100% if the startup fails for investments into startups up to £200,000, lowering the amount of invested capital in a startup to £50,000 to qualify for and entrepreneur visa, as well as a whole range of other policies including a 50 million investment to create Tech City, “Europe’s largest indoor civic space, dedicated to start-ups and entrepreneurs in East London”.

 

In the US they have passed the JOBS Act, which allows crowdfunding (including equity stakes) and lowers SEC restrictions on fund raising. In Berlin, there are low interest startup loans available from the government up to $250,000, and for those in innovative technologies there is also $500,000 available for seed capital as part of the High-Tech Founders Fund. In Singapore, SPRING, an agency under the Ministry of Trade, runs the Startup Enterprise Development Scheme (SPRING SEEDS) an equity-based co-financing scheme where they will match the sum invested be any third-party in a startup up to $1 million. Singapore also has very low requirements for their entrepreneur visa (EntrePass), only requiring $50,000 in paid up capital to qualify.

 

Whilst politically it may be very difficult to get these policies passed in China, and one could debate some of their applicability to China’s stage of development, it is pretty clear that greater policy focus on supporting emergent private businesses is relatively lacking in much of the discussion about innovation in China. The huge private sector success story in Wenzhou has shown what can happen when the natural Chinese entrepreneurial skill is combined with easy access to capital. Reforming the banks to give out more loans to emerging businesses would do far more for innovation than top-down orders to hit R&D and patent filing targets. Funnily enough the best hope for these sorts of reforms are not coming from the government, but from Alibaba. Alibaba is using the credit data obtained from its Taobao and Tmall subsidiaries to give small business loans. While it doesn’t publish financials “the firm loaned more than 26 billion yuan to more than 129,000 small and family-owned businesses through company-related website platforms between April 2010 and July 1.” It is a significant bright spot for future capital allocation reforms.

 

Undoubtedly, there will be a whole slew of powerful and innovative private companies coming out of China in the future, but if the government is serious about speeding up their pace of development they would do well to closely analyse what policies will actually help real innovation and not just achieve hollow targets.

Lauren has worked in economic policy and research at the World Bank, World Economic Forum, EIU and for the governments of Sierra Leone and Guyana. She has learned Chinese since 1995, and lived in Beijing for almost six years, on and off since 1997. Lauren has a PhD in Economics from Peking University, an MSc in Development Economics from the School of Oriental and African Studies (SOAS) and a B.A/B.Com from the University of Melbourne.

Leave a Reply

Your email address will not be published. Required fields are marked *