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Government-Led Innovation: China’s Path to the First World

The phrase “Made in China” may not refer to cheap products for much longer. China is rapidly transitioning from a manufacturing-based economy to one fueled by innovation and technological advancement. China may no longer be known as the “world’s factory” due to changes including increasing wages and population aging that are pushing the manufacturing industry to countries in Southeast Asia and Africa. To maintain growth rates and effectively compete with the United States and the EU, China feels the pressure to transition from a low-tech manufacturing to innovation-driven development. Rather than looking towards Silicon Valley for the newest technology, China wants the world to look towards one of its 17 technology hubs, including Beijing and Shenzhen.

Image courtesy of Michael Schwarzenberger © 2014

Local governments turn the central government’s goals into reality through a multitude of different incentives including loans, subsidies, and grants for educational institutions and private firms aligned with national goals. Some incentives encourage technology transfers and the acquisition of foreign technology, while others encourage universities to create specific programs that promote innovation and technological advancement amongst its student body. They also help direct the creation of massive entrepreneurship zones intended to mimic Silicon Valley such as the one currently being built in Nanjing. Local governments are motivated to implement national goals because the Chinese government is largely meritorious and implementing projects tied to national goals is key to advancing bureaucratically. Equivalently strong incentives at the governmental level are rare in the United States. As a result of these policies, it is predicted that China will overtake the United States in its innovative capacity in the next decade. In crucial categories ranging from R&D spending to science and engineering graduates, China continues to grow at exponential rates, largely because of government campaigns and policies.

The key difference in China’s development is that innovation is government-led whereas in the rest of the world, innovation is largely market-led. In the United States, Adam Smith’s invisible hand guides the market, albeit with some governmental input. In China, it is the hand of President Xi Jinping. Xi and party leadership draft plans and set economic development goals to push China on the road to development. A 2014 speech on innovation from Premier Li Keqiang, second in power to Xi, ignited a raging fire in the technology industry. Li coined the phrase “mass entrepreneurship and mass innovation,” which would then become a popular government slogan. Comparatively, Silicon Valley is often suspicious of government intervention and often shrugs off government guidance. A 2016 report on national AI goals from the Obama administration, similar to Li’s speech, received negligible media attention. No other powerful country has a government as involved in directing the economy as China, but the statistics suggest that their strategy is working.   

Market-led innovation is slower and is largely based on lower-level trial and error, so mistakes are less costly. Conversely, a mistake by the Chinese government in the arena of innovation can be extremely costly and difficult to undo, though the risks can be extremely rewarding. Sweeping policy changes in China means mistakes are on a much larger scale. Venture capitalist and AI expert Kai-Fu Lee writes that when potential benefits are monumental, it is worth overpaying in the short term. Although every dollar (or yuan) maybe be spent less efficiently in government-led innovation, market-led innovation could take decades. Kai-Fu Lee describes China’s current strategy as “brute-forcing” progress. China is more interested in quick results than in setting a sustainable foundation for innovation.

Western economists typically reject government-led innovation and assert that government cannot outsmart the market. Some economists point to the fact that one-fifth of housing in China is empty due to failed development projects and that money was poured into production in sectors without adequate demand. Economist Anne Stevenson-Yang refers to the Chinese economy as the “ultimate Ponzi-scheme,” citing the Chinese solar industry which ballooned with state funding, flooded the global market with cheap products, killed off competitors, and then largely collapsed when China cut subsidies. Some analysts say that, despite what the statistics indicate, China is not innovative at all, but instead is a master at making millions of infinitesimal improvements on stolen intellectual property. For China, though, the reality that the government can never be as “smart” as the market does not matter because outsmarting the market is not the main goal. The goal is to rapidly transition out of low-tech manufacturing.

China is determined to become a powerhouse in technology, and letting the market lead the course simply is not fast enough. Instead, the government has opted to use central planning as a means to push itself into the future faster than its global competitors. Of course, important exceptions to this innovation model exist, including massive internet firms such as Baidu, Alibaba, and Tencent, which each have their own innovation ecosystems. China still lags behind the U.S. in innovative capacity, but they are quickly catching up. To counter this, the United States must work quickly to develop a strategy to adapt to its new competitor as China takes on the role of a global leader.  


Emma Robinson

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