Exploring China’s innovation potential

China has dramatically increased its budget for innovation and increased its participation in international bilateral research partnerships. Its strategy emphasises home-grown innovation, joint ventures with foreign companies, and modifications to existing Western technology. All of these approaches often entail risks for partners. Joint ventures result in a progressively diminished role for foreign businesses. Foreign technology is taken over and separately marketed by Chinese partner companies. Foreign entities entering into Chinese partnerships must exercise due diligence and agree on clear rules of engagement.

Is the People’s Republic of China (PRC) an emerging technology superpower, as some observers have suggested? Certainly China’s leadership would like the country to be seen in that light. So what do the facts say? The country is not close yet, but at its current rate of investment in innovation it will be approaching that status within the next decade. The 2017 Global Innovation Index puts the PRC at 22, with the US at 4 and Canada at 18. But its trajectory is going in the right direction. It is up three positions from 2016. Beijing’s own 2016-17 national innovation Index puts the PRC at 17, up one from the previous year.

So China certainly is not in the top 3, or even the top 10, but its spending on research and development (R&D) exceeds that of all countries except for the US. Its spending was up 11.6 per cent in 2017, reaching USD 280 billion. It has a target for gross expenditures on R&D-to-GDP of 2.5 per cent by 2020 and is now sitting at 2.12 per cent compared to the most recent statistics for the United States at 2.7 per cent and Canada at 1.67 per cent. Foreign researchers and companies have taken note of recent huge investments in laboratories, talent programs, industry R&D and start-ups: they see an innovative China as a desirable collaborator now but perhaps as a competitor in the medium to long term. Therefore, identifying how to engage with China for long-term success is critically important.

Reaching for the top

Beijing’s comprehensive strategies and plans are clearly mapping out a future for China to move into the vanguard of world innovation. The broad targets set by Its Strategy for Innovation-driven Development are described below.

• 2020: be an innovative country with a full national innovation system;
• 2030: be a leading global innovative country; and
• 2050: be a major global hub for science, with innovation the key factor in policy-making and institutional planning.

Beijing’s 13th Five Year Plan for Science, Technology and Innovation is a comprehensive plan that covers specific technology and sectorial priorities; it provides clear and detailed direction to all players in China’s innovation system. These top-down strategies, along with Made in China 2025 and the Next Generation Artificial Intelligence Plan, provide policy guidance for funding agencies, companies and researchers. Consistent messaging from China’s President and Premier has put innovation at the forefront of the government’s agenda.

In addition to its aggressive targets and massive spending, the PRC has implemented major reform of all aspects of China’s innovation system, starting with the country’s competed R&D programs. In the past three years, the programs of all Chinese ministries and agencies that fund industry R&D have been wound up and replaced with five program areas and seven arms-length professional agencies managing the new peer-review process. This has resulted in a much fairer and more transparent system of decision-making.

The cross-government coordinating committee for these massive changes is led by Vice-Minister Wang Zhigang of the Ministry of Science and Technology (MOST) and is supported by the powerful National Development Reform Commission (NDRC) and the Ministry of Finance. In addition to his ministerial responsibilities, Vice-Minister Wang is the Secretary of the Chinese Communist Party’s (CCP) Leading Group and Party Secretary-General of MOST, reflecting the importance that the Party is placing on these reforms.

Reforms are also occurring in universities and national laboratories. The salaries of scientists have been increased, plagiarism is being dealt with more aggressively, and talent programs have been upgraded to attract the best and brightest researchers from around the world with promises of sparkling new facilities and lots of bright post-doctoral staff. Other reforms include three new intellectual property courts in Beijing, Shanghai and Shenzhen, and a full range of incubators and accelerators for start-up companies.

With these very focused, top-down signals, will there be pick-up and implementation at the bottom of the innovation system? Certainly the culture of innovation is not deeply engrained in Chinese organisations, including universities. For example, while they have been directed to allow professors to set up start-up companies based on their research and return to their teaching positions later if they wish, university faculties may be reluctant to allow university innovations to be used in the private sector for fear of being criticised at a later date for wasting university resources.

Clearly Beijing is taking major steps to position its researchers and companies to contribute to China’s innovation-driven economy. In addition, it has mandated increased international collaboration, including participation in joint-research projects around the world and joint R&D centres. It is also seeking to be involved in and take on a leadership role in prominent international standards initiatives, including for space, the polar regions and the Internet. The PRC’s openness to international science is also an opportunity for Western researchers. For example, China is investing in world-class ‘big science’ projects that are bigger than those of other countries. It has stellar scientists undertaking fundamental science research in advanced laboratories in areas that could win them the Nobel Prizes they covet. Researchers from all over the world should be engaged in research at these facilities.

Australia has deepened and broadened its innovation relations with China in the period leading up to and since the conclusion of the China-Australia Free Trade Agreement. There is evidence, however, that some of the Australian government’s R&D funding has gone to research associated with the People’s Liberation Army. The PRC’s new policy mandates the integration of military and civilian R&D, so this is a dynamic that other countries can expect to see in the coming years as their researchers increasingly collaborate with those in China. Australia also has found that the joint R&D is most often not commercialised in that country, Chinese-Australian researchers preferring to return to the PRC and commercialising their innovations there.

Serious strategic challenges for foreign companies

So how have Western companies been performing in this new dynamic Chinese market? One of the most significant policies affecting Western companies is the PRC’s Indigenous Innovation Policy, which has as its target reducing foreign technology in the Chinese market to less than 30 per cent by 2025. The three-pronged strategy calls for the development of indigenous Chinese innovation, the integration of foreign companies’ technology into Chinese firms through joint ventures (JVs), mergers and acquisitions (M&As), as well as “re-innovation”, by modifying Western technology to make it Chinese.

Foreign firms are seeing increasing efforts by Chinese companies to acquire their technology in ways that may threaten their firms’ own viability in the longer term. Companies such as Hewlett-Packard, Cisco and Microsoft, which once had a formidable China business that was 100 per cent foreign-owned, have been forced to sell a majority stake in their Chinese business to a Chinese partner, or get out of China completely. There are cases of forced technology transfers to a Chinese firm as well as the ‘re-innovation’ of Western technology for the Chinese market, and in some cases for sale in foreign markets as well: CRRC, Siemens and Bombardier’s Chinese partner is now selling their rail designs in Europe and North America. And massive investments can skew technology sectors, such as the USD 150 billion that China announced it would spend between 2016 and 2025 in the semiconductor sector to reduce the foreign share of China’s market from 91 per cent to below 30 per cent.

Joint ventures present an interesting case. While continuing to talk about win-win business deals, Beijing has moved since 2016 to a model where the Chinese company partnering with a foreign firm must have more than a 50 per cent ownership of the joint venture; the Chinese share can often reach 70, 80 or 90 per cent. There are still legacy 50-50 joint ventures in place with Western companies that have been in China for many years, or in a technology sector that China clearly needs. New joint-ventures, however, are majority Chinese-owned and often carry other conditions: manufacturing must take place in the PRC; branding must use a Chinese name; the Chinese joint-venture may sell to third countries; the product sold has lower quality parts (which may impact the foreign partner’s reputation for quality); and the Western firm’s core intellectual property (IP) must be shared but not that of the Chinese partner.

What do these arrangements look like in the medium to the long term? We have seen cases where the Chinese partner presses for a higher and higher share of the joint venture, until the foreign firm has little or no remaining equity in the deal, but the Chinese joint venture is continuing to make use of that firm’s technology and pocketing the profits. While this is particularly acute in the case of technology firms as a result of the Indigenous Innovation Policy, other sectors are seeing a similar dynamic, with in the foreign firm retaining only a fraction of what was once a 100 per cent foreign-owned business in China. For example, fast-food restaurant chain McDonald’s now owns only 20 per cent of its business in mainland China, Hong Kong and Macao.

In some cases, the foreign company has negotiated special arrangements. This could involve manufacturing a key component in the West and shipping it to China to be inserted in the technology product being manufactured there, or arranging ‘super minority voting rights’ on the board of the joint venture in order to have a greater say on important decisions, if important can be agreed upon. Firms, especially small- and medium-sized ones, need guidance to understand how they can access the promises of the Chinese market while not falling victim to aggressive negotiations. They must have the full picture as to what to expect and how best to ensure that they achieve short-term success and protect themselves for a longer term presence in China.

US technology firms in particular have been vocal about the pressures they have been under in the China market. The US Trade Representative’s Section 301 investigation into whether China’s policies and practices on technology transfer, IP and innovation are unreasonable, discriminatory and burden or restrict US commerce will be an important measure. The open question is what actions will be taken based on the findings.

Foreign governments are facing decisions about whether and when to intervene in Chinese investments in foreign technology companies that bring in much needed capital, but may have an impact on jobs and national security down the road. The sale of Kuka Robotics to Chinese interests for USD 3.7 billion was a wake-up call for Germany and Europe more generally, especially because the sale provided access to the data of all Kuka’s customers around the world. Concerns have also been voiced in Europe about the Chinese takeover of the Swedish chip-maker Silex Microsystems and Germany’s Aixtron Semiconductors. And the US blocked the sale of Lattice Semiconductors to Chinese interests.

Some have called for the principle of reciprocity to act as an investment guide in the technology sector particularly in the light of China’s Negative List, issued by NDRC and the Ministry of Commerce. This list itemises “restricted industries for foreign investment”, including exploration and exploitation of oil and natural gas, telecommunications, automobiles, ships and insurance. Foreign investments in some of these sectors are permitted if the non-Chinese company is in a contractual joint-venture and the Chinese party has a majority stake. A separate list covers sectors where foreign investment is forbidden outright, such as the breeding of genetically modified crops, stem cell development, genetic diagnosis, exploration and exploitation of numerous minerals, production of nuclear fuels, manufacture of weapons, surveying of any kind, and all aspects of books, audio, video, radio, television, satellites, film production, Internet news and online publishing, as well as ‘humanities and social sciences research institutes’. There are 63 restricted and forbidden sectors in total.

Even with the concerns identified above, multiple mechanisms exist for researchers and companies to engage safely in science, technology and innovation with China. The development of long-term trusted relationships, clear parameters for collaboration, the involvement of trusted Chinese-speaking staff, and expert legal and strategic advice are all critical. Governments can support this by developing clear rules of engagement in bilateral and multilateral trade and commercial negotiations.