The Oxford Handbook of China Innovation 9780190900533, 9780190900564, 9780190900540, 9780190900557, 0190900539

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The Oxford Handbook of

CHINA INNOVATION

The Oxford Handbook of

CHINA INNOVATION X IAO L A N F U, B RU C E M C K E R N , and

JIN CHEN

1

3 Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide. Oxford is a registered trade mark of Oxford University Press in the UK and certain other countries. Published in the United States of America by Oxford University Press 198 Madison Avenue, New York, NY 10016, United States of America. © Oxford University Press 2021 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, by license, or under terms agreed with the appropriate reproduction rights organization. Inquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above. You must not circulate this work in any other form and you must impose this same condition on any acquirer. Library of Congress Cataloging-in-Publication Data Names: Fu, Xiaolan, 1967- editor. | Chen, Jin, editor. | McKern, Bruce, editor. Title: The Oxford handbook of China innovation / [edited by] Xiaolan Fu, Jin Chen, and Bruce McKern. Description: New York : Oxford University Press, 2021. | Series: Oxford handbooks series | Includes bibliographical references and index. | Identifiers: LCCN 2021002732 (print) | LCCN 2021002733 (ebook) | ISBN 9780190900533 (hardback) | ISBN 9780190900564 | ISBN 9780190900540 | ISBN 9780190900557 (epub) Subjects: LCSH: Economic development—China. | China—Economic policy—21st century. | Technological innovations—Economic aspects—China. | International business enterprises—Technological innovations—China. | Information technology—Management—China. | Organizational change—China. Classification: LCC HC427.95 .O94 2021 (print) | LCC HC427.95 (ebook) | DDC 338/.0640951—dc23 LC record available at https://lccn.loc.gov/2021002732 LC ebook record available at https://lccn.loc.gov/2021002733 DOI: 10.1093/oxfordhb/9780190900533.001.0001 1 3 5 7 9 8 6 4 2 Printed by Sheridan Books, Inc., United States of America

Contents

Contributors Acknowledgement

ix xvii

Introduction: China’s Journey to Innovation Xiaolan Fu, Bruce McKern, and Jin Chen

1

PA RT I . T H E DE V E L OP M E N T OF I N N OVAT ION I N C H I NA : T H E ORY, P OL IC Y, A N D P R AC T IC E 1.1. Capabilities Accumulation and Development: What History Tells the Theory Giovanni Dosi and Xiaodan Yu

29

1.2. China’s Industrial Development Strategies and Policies Justin Yifu Lin and Jianjun Zhou

56

1.3. The Development of Innovation Studies in China Rongping Mu, Jin Chen, and Rebecca Wenjing Lyu

73

1.4. China’s Science and Technology Progress through the Lens of Patenting Gary H. Jefferson and Renai Jiang

90

PA RT I I . BU I L DI N G C H I NA’ S I N N OVAT ION C A PA B I L I T I E S 2.1. China’s National and Regional Innovation Systems Lan Xue, Daitian Li, and Zhen Yu

115

2.2. The Great Dialectic: State versus Market in China Loren Brandt and Eric Thun

135

2.3. Entrepreneurship and Innovation of Small and Medium-Sized Enterprises in China Jin Chen and Liying Wang

156

vi   Contents

2.4. Financing for Innovation in China Changwen Zhao and Xiheng Jiang 2.5. Innovation and Entrepreneurship Education and Its Implications for Human Capital Development in China Fang Lee Cooke

168

187

PA RT I I I .   NAT IONA L I N C E N T I V E S F OR A N I N N OVAT ION -​DR I V E N E C ON OM Y 3.1. System Reform, Competition, and Innovation in China Weiying Zhang

205

3.2. Reforms of the Science and Technology Management System Zhijian Hu, Zhe Li, and Xianlan Lin

241

3.3. Mass Entrepreneurship and Mass Innovation in China Jian Gao and Rui Mu

254

PA RT I V.   DE V E L OP I N G I N N OVAT ION - ​F AVOR I N G I N ST I T U T ION S A N D E C O SYS T E M 4.1. The Role of Clusters in the Development of Innovation Capabilities in China Tuoyu Li and Jiang Wei

275

4.2. China’s Science-​Based Innovation and Technology Transfer in the Global Context Jizhen Li, Ximing Yin, and Subrina Shen

315

4.3. Science Parks and High-​Tech Zones Susan M. Walcott 4.4. Venture Capital, Angel Capital, and Other Finance, IPOs, and Acquisitions Lin Lin

337

354

4.5. Intellectual Property Rights Protection Can Huang and Naubahar Sharif

370

4.6. Innovation Elements in Traditional Chinese Culture Jin Chen and Qingqian Wu

384

Contents   vii

PA RT V.   OP E N N E S S A N D T H E AC Q U I SI T ION OF T E C H N OL O G Y A N D C A PA B I L I T I E S 5.1. Innovation Strategies of Multinational Corporations in China and Their Contribution to the National Ecosystem Bruce McKern, George S. Yip, and Dominique Jolly

397

5.2. Foreign Technology Transfers in China Xiaolan Fu and Jun Hou

415

5.3. China’s International Migration: Status and Characteristics Huiyao Wang

441

5.4. Chinese Outward Foreign Direct Investments and Innovation Vito Amendolagine, Xiaolan Fu, and Roberta Rabellotti

467

5.5. Internationalization of Chinese Research and Development Max von Zedtwitz and Xiaohong Iris Quan

486

5.6. International Innovation Collaboration in China Kaihua Chen, Ze Feng, and Xiaolan Fu

502

5.7. Open Innovation for Development in China Jin Chen and Yufen Chen

525

PA RT V I .   I N N OVAT ION W I T H C H I N E SE C HA R AC T E R I S T IC S 6.1. Chinese Cost Innovation, the Shanzhai Phenomenon, and Accelerated Innovation Peter J. Williamson 6.2. Global Supply Chains as Drivers of Innovation in China Michael Murphree and Dan Breznitz 6.3. Market Demand, Consumer Characteristics, and Innovation in Chinese Firms Hengyuan Zhu and Qing Wang 6.4. Chinese Firms’ Move to the Forefront in Digital Technologies Jiang Yu and Yue Zhang

539 554

573 593

viii   Contents

6.5. China’s Financial Innovation: Process, Drive, and Impacts Liqing Zhang 6.6. The Puzzle of the Underdog’s Victory: How Chinese Firms Achieve Stretch Goals through Exploratory Bricolage Peter Ping Li, Shihao Zhou, and Monsol Zhengyin Yang

610

625

PA RT V I I .   I N N OVAT ION C A PA B I L I T Y T R A N SI T ION A N D U P G R A DI N G F OR A N I N C LU SI V E A N D SU S TA I NA B L E I N N OVAT ION SYS T E M 7.1. Green Innovation in China Ping Huang and Rasmus Lema 7.2. Innovating for the Poor: The Inclusive Innovation System in China Xiaobo Wu and Linan Lei 7.3. Manufacturing Power Strategy: Advanced Manufacturing Jörg Mayer and Huifeng Sun 7.4. Facing the Future of China’s Science and Technology Development Jiaofeng Pan, Guanghua Chen, and Xiao Lu

649

675 696

714

PA RT V I I I .   C ON C LU SION A N D I M P L IC AT ION S F OR P OL IC Y 8.1 Conclusion: Innovation in China: Past, Present, and Future Prospects Xiaolan Fu, Bruce McKern, Jin Chen, and Ximing Yin

735

8.2 Policy and Managerial Implications for China and Other Countries 759 Xiaolan Fu, Bruce McKern and Jin Chen Index

777

Contributors

Vito Amendolagine  Department of Economics University of Foggia Foggia Italy Loren Brandt  Department of Economics University of Toronto Toronto ONT Canada Dan Breznitz  Munk School University of Toronto Toronto ONT Canada Guanghua Chen  Institutes of Science and Development, Chinese Academy of Sciences Beijing China Jin Chen School of Economics and Management Research Center for Technological Innovation Tsinghua University Beijing China Kaihua Chen  Institutes of Science and Development, Chinese Academy of Sciences Beijing China Yufen Chen School of Statistics and Mathematics, Zhejiang Gongshang University, Hangzhou, China

x   Contributors Fang Lee Cooke  Department of Management Monash University Melbourne VIC Australia Giovanni Dosi  Institute of Economics Sant’Anna School of Advanced Studies Pisa Italy Ze Feng  Department of Public Policy and Management University of the Chinese Academy of Sciences Beijing China Xiaolan Fu  Technology and Management Centre for Development, Department of International Development, University of Oxford, Oxford, UK Jian Gao  Department of Innovation, Entrepreneurship and Strategy Tsinghua University Beijing China Jun Hou  Lincoln Business School University of Lincoln Lincoln United Kingdom Zhijian Hu  Chinese Academy of Science and Technology for Development Beijing China Can Huang  Department of Innovation, Entrepreneurship and Strategy, School of Management Zhejiang University Hangzhou China

Contributors   xi Ping Huang Center for International Environment and Resource Policy, The Fletcher School, Tufts University, Boston, United States Gary H. Jefferson  Department of Economics Brandeis University Waltham MA United States Renai Jiang  School of Economics and Finance Xi’an Jiaotong University Xi’an China Xiheng Jiang  China Center for International Knowledge on Development Beijing China Dominique Jolly  Webster University Geneva Geneva Switzerland Linan Lei  Zhejiang University, International Business School Hangzhou China Rasmus Lema  Department of Business and Management Aalborg University Copenhagen Denmark Daitian Li  School of Management and Economics University of Electronic Science and Technology of China Chengdu China Jizhen Li  School of Economics & Management Tsinghua University Beijing China

xii   Contributors Peter Ping Li IBM, Nottingham University Business School (NUBS) University of Nottingham Ningbo China Ningbo China Tuoyu Li  Institute of China’s Science, Technology and Education Policy Zhejiang University Hangzhou China Zhe Li  Chinese Academy of Science and Technology for Development, Beijing, China Lin Lin  Faculty of Law National University of Singapore Singapore Justin Yifu Lin  Institute of New Structural Economics Peking University Beijing China Xianlan Lin  Department of Public Management Hubei University Wuhan China Xiao Lu  Institutes of Science and Development, Chinese Academy of Sciences China Jörg Mayer  Division on Globalization and Development Strategies United Nations Conference on Trade and Development Geneva Switzerland Bruce McKern  UTS Business School University of Technology Sydney Sydney Australia

Contributors   xiii Rongping Mu School of Public Administration University of Chinese Academy of Sciences Beijing China Rui Mu   Entrepreneurship Research Center on G20 Economies Tsinghua University Beijing China Michael Murphree  Sonoco International Business Department University of South Carolina Columbia SC United States Jiaofeng Pan  Institute of Sciences, Chinese Academy of Science Beijing China Xiaohong Iris Quan  Lucas College and Graduate School of Business San Jose State University San Jose CA United States Roberta Rabellotti  Department of Political and Social Sciences University of Pavia Pavia Italy Naubahar Sharif  Division of Public Policy Hong Kong University of Science and Technology Hong Kong Subrina Shen Department of Management McCombs School of Business, The University of Texas at Austin Austin TX United States Huifeng Sun  General Manager of CCID Consulting Company Limited, Beijing, China

xiv   Contributors Eric Thun Saïd Business School University of Oxford Oxford United Kingdom Max von Zedtwitz  Department of International Economics, Government, and Business Copenhagen Business School Frederiksberg Denmark Susan M. Walcott  Geography, Environment, and Sustainability University of North Carolina at Greensboro Greensboro SC United States Huiyao Wang  Department of Development Studies Center for China and Globalization Southwestern University of Finance and Economics Beijing China Liying Wang  China Institute for SMEs in Zhejiang University of Technology Hangzhou China Qing Wang  Warwick Business School The University of Warwick Coventry United Kingdom Jiang Wei  Department of Innovation, Entrepreneurship and Strategy Zhejiang University Hangzhou China Rebecca Wenjing Lyu Initiative on the Digital Economy Massachusetts Institute of Technology Cambridge MA United States

Contributors   xv Peter J. Williamson  Judge Business School University of Cambridge Cambridge United Kingdom Qingqian Wu  School of Economics and Management Tsinghua University Beijing China Xiaobo Wu  Department of Innovation, Entrepreneurship and Strategy Zhejiang University Hangzhou China Lan Xue  School of Public Policy and Management at Tsinghua University Beijing China Monsol Zhengyin Yang   Shantou Development and Planning Institute Shantou China Ximing Yin  School of Management and Economics Beijing Institute of Technology Beijing China George S. Yip  Imperial College Business School London, and D’Amore-McKim School of Business, Northeastern University Boston, MA United States Jiang Yu  Institutes of Science and Development, Chinese Academy of Sciecnes Beijing China Xiaodan Yu  LUISS, Rome and Nottingham University Business School, University of Nottingham Ningbo China Ningbo China

xvi   Contributors Zhen Yu  School of Public Policy and Management Tsinghua University Beijing China Liqing Zhang  School of Finance and Center for International Finance Studies Central University of Finance and Economics Beijing China Weiying Zhang  National School of Development, Peking University Beijing China Yue Zhang Institutes of Science and Development, Chinese Academy of Sciecnes Beijing China Changwen Zhao  Department of Industrial Policies Development Research Center of the State Council Beijing China Jianjun Zhou  Renmin University of China Beijing China Shihao Zhou  Department of Marketing and E-​Commerce Nanjing University Nanjing China Hengyuan Zhu  Department of Innovation, Entrepreneurship and Strategy School of Economics & Management Tsinghua University Beijing China

Acknowledgement

The book is the collective outcome of more than two years of work by some eighty outstanding scholars, specialised in the economics of innovation, innovation policy and management. We would like to thank all the authors for their efforts and their contributions. It has been a great privilege for us to work with so many leading scholars in the field. We also would like to thank the editors of Oxford University Press, particularly David Pervin for inviting us to start this important and interesting journey, and James Cook, Macey Fairchild for their continued support and patience. We also wish to acknowledge the excellent editorial assistance provided by Brandon Chye Zhi Han and Shaomeng Li in helping us communicate with the authors and for organising all the manuscripts; and to Brandon and Patricia Dudman for proofreading several of the manuscripts. We are also grateful to the Bank of China (UK) and the Oxford Department of International Development for their financial support to the editorial process. We would like to express our thanks to colleagues at the Technology and Management Centre for Development (TMCD) at the University of Oxford for their support in this endeavour. Finally, we would like to thank our families for their continued support to our research and to the editing of the book. Xiaolan Fu in particular would like to dedicate the book to her parents, Baisong and Hualin, for their guidance and love which enlightened her life. Bruce McKern gives his thanks to Cathryn, dear critic and constant companion. Chen Jin thanks his Father and Mother for their encouragement and support.

Introdu c t i on

China’s Journey to Innovation Xiaolan Fu, Bruce McKern, and Jin Chen The development of China’s economy since the market-​oriented opening after 1978 has been a phenomenon of extraordinary historical significance. The pattern of China’s development and the forces driving it have been of profound interest to policymakers and scholars alike, and research has been undertaken from a number of perspectives. Explanations of the nation’s economic growth path during the years subsequent to the adoption of the reforms have been largely concerned with the macroeconomic and political environment. The perspectives of this work range from the historical to the economic, social, cultural and, to a lesser extent, business. Only recently have scholars looked into the microeconomic factors in China’s growth, of which a critical force has been the steady drive for innovation, recognized by its government early as a necessary condition for economic development. In its early days China’s development path followed the well-​established shift of underemployed labor from agriculture to more productive manufacturing, a sequence well documented for other countries, particularly the nations of Southeast Asia. In shifting away from state ownership of the means of production, China implemented market-​oriented microeconomic policies through a pragmatic process of trial and error. Its national government has maintained the direction of development through taxation and spending policies, supported by a high level of savings and by allocating funds according to key priorities expressed in a series of five-​year plans. Adopting market reforms from 1978 was an important step and it was recognized over time that the state-​owned enterprise (SOE) sector needed to yield space to the private sector for the markets to function efficiently. Although SOEs still account for some 26% of output and 42% of assets,1 the implementers of innovative services and products have increasingly been private sector firms. From a few years after the beginning of the reforms, a leading official priority has been the creation of a national innovation ecosystem.

1  Fan Gang and Nicholas C. Hope, “The Role of State-​Owned Enterprises in the Chinese Economy,” in US China Relations in the Next 10 Years: Towards Deeper Engagement and Mutual Benefit, chap. 18. Hong Kong: China-​United States Exchange Foundation, 2013.

2    Fu, McKern, and Chen Academic interest in the role of national innovation systems in a country’s economic growth and its competitiveness in international trade originated in the developed world, especially the United States and Europe.2 In this work, academic attention was paid to both the macroeconomic and the microeconomic environment, the latter including the interaction of government policies with the development of both SOEs and the private sector.3 These ideas have been useful in understanding the important role of innovation systems in the growth of developing countries and specifically in China. Even more recently, serious academic attention has been paid to the development of innovation and entrepreneurship in China and the important role of business sector innovation in productivity and economic growth. This work includes a good number of journal articles but surprisingly few serious volumes. Among those with a specific microeconomic focus on China are Zeng and Williamson (2007),4 Breznitz and Murphree (2011),5 Fu (2015),6 and Yip and McKern (2016).7 It is important, however, to explain China’s much faster innovative success relative to other large countries, such as India. Are there factors specific to the Chinese context that explain this phenomenon?8 China employed well-​established policies to facilitate the shift from agriculture and to encourage savings and capital formation. But the shift from a state-​ owned system of production to a market-​based system was a critical step in creating private sector incentives. These interacted with cultural factors to liberate a wave of entrepreneurship in a rapidly expanding private sector, but to a much lesser extent in the state-​owned sector. While the impact of the microeconomic and business elements in fostering innovation are the main concern of this Handbook, they can be properly understood only in the context of the institutional environment and government policy framework underlying China’s economic development. Although innovation is undertaken primarily at the level of the business firm, it cannot be isolated from the Chinese government’s long-​term vision for the country, its growth-​oriented macroeconomic policy, and its indispensable role in establishing the physical infrastructure and the innovation ecosystem, which together underpin the country’s economic strength today. Also, since innovation depends on entrepreneurship and human capabilities, it is also essential to address other “soft”

2  Richard R. Nelson (Ed.), National Innovation Systems:  A Comparative Analysis. Oxford:  Oxford University Press, 1993. Lundvall, B-​Å. (Ed.), National Innovation Systems:  Towards a Theory of Innovation and Interactive Learning. London: Pinter, 1992. Freeman, C. 1995. The National Innovation Systems in historical perspective. Cambridge Journal of Economics, 19(1): 5–​24. 3  Porter was one of the pioneers of postclassical microeconomic explanations of national competitiveness between countries. Porter, however, placed little emphasis on the role of government. See Michael E. Porter, The Competitive Advantage of Nations. New York: Free Press, 1990. 4 Ming Zeng and Peter J. Williamson, Dragons at Your Door:  How Chinese Cost Innovation Is Disrupting Global Competition. Boston: Harvard Business School Press, 2007. 5  Dan Breznitz and Michael Murphree, Run of the Red Queen: Government, Innovation, Globalization, and Economic Growth in China. New Haven, CT: Yale University Press, 2011. 6  Xiaolan Fu, China’s Path to Innovation. Cambridge: Cambridge University Press, 2015. 7  George S. Yip and Bruce McKern, China’s Next Strategic Advantage: From Imitation to Innovation. Cambridge, MA: MIT Press, 2016 8  We are grateful to one of the reviewers of the book outline for stressing the importance of this issue.

Introduction   3 factors that contribute to the development of an innovative society, including education, culture, and demographics. Recognizing the potential relevance of this Handbook for other countries, we have attempted to address in several chapters the interaction of these contextual factors, both cultural and institutional, in stimulating the role played by private firms. Equally important is explaining the rapid development of the private sector in response to the opportunities presented by burgeoning demand, in turn stimulating the creation of innovative capabilities in private sector companies. With the private sector today far more significant in China’s economy than when the shift to a market-​oriented system was begun, the balance between the roles of the private sector and the state-​owned sector has tilted substantially. We cover the evolution of the private sector role, its future prospects, and the changing balance between the state and the market. The Handbook includes discussions of the research dealing with all of these elements of the national innovation ecosystem in China. It includes a review of China’s development policies, the place of innovation within national priorities, the specific components of the national innovation system, and the resources required for effective innovation. It gives detailed attention to the elements of the system that provide incentives and support for companies in China. Since innovation in the modern age depends to a great extent on science and technology (S&T), we put emphasis on the factors contributing to a technologically sophisticated society—​the consistently expressed goal of Chinese administrations since the 1980s. Openness to foreign influence and investment has also been a distinguishing characteristic of China’s development in the early era of reform. This important influence is also addressed, along with the evolution of policy toward foreign know-​how, patent protection, open innovation, and foreign direct investment. Further, since sectoral differences are significant (as addressed in an earlier volume, The Oxford Handbook of Innovation),9 we include attention to important sectors that demonstrate China’s specific approach to development. These include digital technology, “green” technology, financial innovation, advanced manufacturing (the latter relevant to many sectors), and China’s private and public policies toward automobiles, construction equipment, and machine tools. In a chapter concerned with the role of clusters and regional agglomerations, a contrast is drawn between two clusters, one traditional (textiles) and one new (software). China’s business enterprises have developed capacities for innovation that provide the basis for competitive success, not only in their own country, but also increasingly outside China. Awareness of their capabilities and strategies is of critical importance to firms operating in the Chinese market, to scholars of China’s economy and business, and to policymakers worldwide. Several of the chapters include examples of those successful business corporations that have become world-​class innovators. In conceiving the Oxford Handbook of China Innovation, we were motivated by the belief that it should provide comprehensive and authoritative views of state-​of-​the-​art research on the role of innovation in China’s rise, including the broad range of topics outlined earlier.

9  Jan Fagerberg, David C. Mowery, and Richard R. Nelson (Eds.), The Oxford Handbook of Innovation. Oxford: Oxford University Press, 2004. This provides a thorough discussion of innovation in general and is recommended background for readers of the Handbook of China Innovation.

4    Fu, McKern, and Chen Accordingly, the Handbook consists of chapters written by experts from universities and research institutions who were asked to provide an exposition of the state of the art in a particular area, with criticism and suggestions for further research. New research was not specifically requested, but some of the authors have chosen to present new work, and all the authors have provided original viewpoints on their topics.

Outline of the Handbook The work is in seven sections, beginning with macroeconomic development strategy and theory and progressing to microeconomic policies, followed by institutions and enabling policies and other factors; external openness; China-​specific characteristics of indigenous innovation; recent policy shifts; environmental, social, and demographic challenges; and the likely future trajectory of science, technology, and innovation in China. The seven sections are as follows: Part I. The Development of Innovation in China: Theory, Policy, and Practice Part II. Building China’s Innovation Capabilities Part III. National Incentives for an Innovation-​Driven Economy Part IV. Developing Innovation-​Favoring Institutions and Ecosystem Part V. Openness and the Acquisition of Technology and Capabilities Part VI. Innovation with Chinese Characteristics Part VII. Innovation Capability Transition and Upgrading for an Inclusive and Sustainable Innovation System In what follows we provide a short overview of each section and an outline of the chapters. These short statements are not meant to discuss the authors’ ideas in depth; rather, they are intended as a reader’s guide to the issues considered in each chapter.

Part I.  The Development of Innovation in China: Theory, Policy, and Practice This section outlines the themes of the Handbook and provides a theoretical introduction to the concept of innovation, emphasizing the necessity to view innovation as a multidimensional phenomenon. This is followed by a historical view of the importance of innovation in China’s recent industrialization and its impact on the country’s growth, by comparison with its former world leadership in many fields of science and technology (S&T) during the dynastic era. It describes the evolution of the country’s macroeconomic and microeconomic development strategy and the key elements of policy. The evolution of innovation studies as a field of investigation is also examined. The current position of China relative to other countries and its efficiency in innovation are considered, by evaluating China’s remarkable performance in patenting.

Introduction   5

1.1. Capabilities Accumulation and Development: What History Tells the Theory Giovanni Dosi and Xiaodan Yu In this chapter, the authors provide a theoretical basis for understanding concepts of innovation as a key factor in economic development, in terms of capabilities. They consider the historical lessons of economic development, of which China, in their view, is the most striking. They describe its development as a Great Transformation, which entails a process of accumulation of knowledge and capabilities, at the level of both individuals and organizations. They see this as a major shift of the technological paradigm; they explain that concept and ascribe crucial importance to “ensembles” of industrial policies and institution-​ building efforts that nurture capabilities accumulation and industrial development. The authors see the evolution of a paradigm in a nation in terms of three co-​evolving sub-​systems or “domains”: 1. The system of scientific knowledge and technologies 2. The “economic machine,” comprising the mechanisms determining production, investment, income distribution, and structural change 3. The system of social relations and institutions, including those governing labor, financial and goods markets, and public agencies and policies This implies path dependence for national innovation systems, and difficulty for any country seeking to make significant and rapid paradigm shifts. The authors raise an important question for our understanding of China: given these constraints, how was China able to shift to a new paradigm of technological change, and how did these three domains interact in that transformation? The authors agree that such capability creation builds partly on education and formally acquired skills. However, they consider that capabilities have to do with problem-​solving knowledge that is embodied in organizations—​such as production technologies, the technical and social division of labor, labor relations, and “dynamic capabilities” of search and learning. The authors develop the concept of the technological paradigm and that of a prevailing paradigm of “best practice.” They illustrate the concept with graphical examples depicting the shifts in the distribution of labor productivity in China as compared to France and Italy (as relatively advanced economies). These illustrate their view that the theory predicts persistent asymmetries among countries in the production processes that they are able to master. Further, the process of development and industrialization in a country is strictly linked to the inter-​and intra-national diffusion of “superior” techniques. At any point in time, there is likely to be only one or very few best-​practice techniques of production that correspond to the technological frontier. In the case of developing economies, the process of industrialization is thus closely linked with the acquisition, imitation, and adaptation of established technologies from more advanced economies. These asymmetries are reflected in differences in the abilities of countries to copy new products and in different time lags in producing them and catching up. The authors describe the mechanisms and institutions

6    Fu, McKern, and Chen that have been used historically by other nations in the catchup process, some entailing altering market signals to promote one sector over another. The authors consider the specific case in China in relationship to their theoretical approach. They provide interesting views on where China’s development appears consistent with that approach and where its experience appears to be exceptional. They pose interesting challenge for the future, noting that “catching up is quite different from maintaining and exploiting technological leadership.”

1.2. China’s Industrial Development Strategies and Policies Justin Yifu Lin and Jianjun Zhou In this chapter, the authors address an issue of central importance: compared with the industrialization efforts undertaken by China before 1949, what were the actions China adopted toward its industrialization after 1949, especially after the reform and opening up in 1978? They point out that China did not suffer from a systemic crisis as did the former Soviet Union and Eastern Europe economies during their transition from centrally planned economies to market economies. This was primarily due to the pragmatic reform approach that China adopted. The authors provide an overview of China’s economic development and the evolution of its policy approach, with emphasis on the post-​ 1978 period. They describe the market-​oriented opening and the early role of foreign direct investment, industrial policy and learning by doing, the challenges to the process, and the policy responses. The authors argue that industrialization was essential to the country’s ambition to develop from a low-​income nation to a moderately prosperous one, especially in the upgrading of industrial structure and the advancement of industrial technology. This view is consistent with the theoretical approach put forward by the authors of the previous chapter. They are critical of the Washington Consensus prescription for transition policy, which in their view caused Russia and the Eastern European countries to fall into the “middle-​income trap.” China adopted market liberalization, but not political liberalization, and the authors note that China’s approach allowed the market system to flourish without social upheaval. They explain the cautious and incremental approach employed by China, in which reforms could be applied, tested, and revised based on experience gained. Industrial policies were widely used by the government from the 1980s as a means of moving toward market-​oriented activities. The industrial strategy of the “Five-​Year Plans” and the research and development (R&D) support of specific industries were integral parts of its industrial policy. The authors provide a detailed account of the policies used and their impact, not least in the creation of the innovation ecosystem. They note that the use of industrial policy is not unique to China: it has been widely used at various times by both developed and developing countries. They conclude that China’s controlled and gradual approach to adoption of a market economy has minimized the risks of its transition.

Introduction   7

1.3. The Development of Innovation Studies in China Rongping Mu, Jin Chen, and Rebecca Wenjing Lyu This chapter is a discussion and review of the scholarly approaches to innovation studies in China and their contribution to the understanding of China’s social and economic development policies since the early 2000s. The authors argue that due to the unique cultural and social context in China, managerial and innovation practices in domestic firms cannot be understood simply in terms of Western innovation theories. Thus, starting from “Chinese-​ specific” innovation theories, Chinese scholars have been attempting to make contributions to innovation studies, some of which are less “Chinese specific” than “Chinese contextual.” However, they note that none of this research is yet ground-​breaking, and they provide a comprehensive framework for the field, ranging in scope from the systemic or macro level, through the sectoral and regional (meso) level, to the level of the firm and individual creativity.

1.4. China’s Science and Technology Progress through the Lens of Patenting Gary H. Jefferson and Renai Jiang This chapter focuses on the significance of innovation in China by reference to patenting activity, with the view that patent statistics are meaningful indicators of innovation performance. The chapter brings together and analyzes extant research on appropriate measures of China’s technological innovation capabilities and performance. The authors carefully survey the existing research and investigate the following fundamental questions: • What accounts for China’s patent surge and what are its implications for patent quality? • Does the nature of patenting reveal China’s S&T direction and its comparative advantage? • How has the international sector affected China’s patent production? • What has been the role of the government—​the central, provincial, and local governments—​ in shaping patent production? • How heterogeneous is China’s regional patent production, and are patenting capabilities diffusing across China? The authors provide a detailed examination of China’s patenting activity and the reasons for the surge in recent years. They evaluate patent quality by examining citations and patenting in specific sectors, as well as the international dimension (Chinese patent filing in foreign offices and international research collaboration). They analyze the role of local universities and the government and assess the impact of patenting on regional disparities and technological diffusion.

8    Fu, McKern, and Chen

Part II.  Building China’s Innovation Capabilities This section considers in more depth the factors that have been instrumental in the development of the innovation ecosystem in China, beginning with the role of the state in shifting the nation from a centrally planned economy to a market-​oriented one. It includes the government’s role in creating the national physical infrastructure and its innovation system, along with its evolving S&T policies. It also considers the all-​important role of China’s rapidly expanding domestic market in stimulating the development of small private sector enterprises. Two key contributing factors, education and finance, are also addressed. (These topics are addressed in greater depth in later chapters of the Handbook.)

2.1. China’s National and Regional Innovation Systems Lan Xue, Daitian Li, and Zhen Yu The authors of this chapter describe in detail the evolution of the Chinese national innovation ecosystem from the pre-​reform period to the present era of innovation-​driven development. They detail the difficulties of making substantial changes to S&T policy as the country adopted a market-​oriented development strategy. They explain the changing roles of the central government ministries and the various provincial, municipal, and city governments, as well as the public research institutions, universities, and corporations, both state-​owned and private. The authors provide a critical assessment of China’s progress today in S&T, and in considering the future, they raise issues for improvement in its administration, as well as the need for a greater international role for China in issues of S&T governance.

2.2. The Great Dialectic: State versus Market in China Loren Brandt and Eric Thun In this chapter, the authors raise an issue that is central to the themes of this Handbook: should the state play the dominant role in directing and shaping innovation efforts, or should market forces be the main drivers? As discussed in many of the chapters in this book, in China the role of the state has been regarded by most scholars as critical. This chapter analyzes the track record of economic reform in China with the objective of understanding how and where the most growth has occurred. The authors then seek an explanation of why sectors that have been more open to competition have produced more vibrant and innovative Chinese firms. They focus on the role of China’s domestic market, contrasting various sectors with differing conditions. They note that in the 10 to 15 years prior to the global financial crisis, total factor productivity improvements in Chinese firms contributed half of the total national increase in output and value. The authors examine factors that contributed to these differences, including the prevalence of private companies versus SOEs, the domestic versus foreign market focus, and supply-​side factors such as finance. Contrasts between sectors are also considered. For

Introduction   9 example, the automobile and the construction equipment industries provide contrasting examples of success and failure. The wind turbine and mobile phone sectors provide additional examples of contrasting industry structures and their performance. In the later sections of the chapter, the authors consider China’s recent focus on independent capabilities in light of the research evidence discussed earlier, offering interesting conclusions for policy.

2.3. Entrepreneurship and Innovation of Small and Medium-​Sized Enterprises in China Jin Chen and Liying Wang This chapter brings together the existing research in what has been a somewhat neglected area—​innovation in Chinese small and medium-​sized enterprises (SMEs)—​and outlines areas for further investigation. It covers in detail the extent of new SME formation in China, emphasizing their importance for employment. The chapter covers the policies developed for fostering SMEs and their contribution to stimulating SME growth; SME innovative capacity; and SME success rates and contributions to the economy. The chapter makes a careful analysis of the policies developed to strengthen the intellectual property (IP) of SMEs and concludes with suggestions for further improvement.

2.4. Financing for Innovation in China Changwen Zhao and Xiheng Jiang This chapter is concerned with the Chinese financial system, specifically the role of state and private financing for innovation, the traditional dominance of the state banks, and the development of new institutions and financing mechanisms. The chapter provides a detailed description of Chinese financial entities, both public and private. As the authors note, S&T innovation is underpinned by a combination of public and commercial finance, as well as a hybrid of fiscal, taxation, and financial policies. The authors consider the wide range of Chinese fiscal policies, instruments, and new financial institutions such as venture capital and private equity and explain the role of each in promoting the development of S&T and innovative new enterprises. They argue that by combining fiscal and taxation policies with market capital, China has put in place its own investment and financing system for S&T innovation and in so doing has effectively improved the risk-​return structure in traditional financial services.

2.5. Innovation and Entrepreneurship Education and Its Implications for Human Capital Development in China Fang Lee Cooke In this chapter the author explores the question of how China’s education system is responding to the country’s need for entrepreneurship and creativity. The chapter discusses

10    Fu, McKern, and Chen the development of education policy as a component of the innovation-​driven development path and details the changes of approach over time. She considers the important issue of creativity in education, explaining the approaches to “creativity education” in primary and secondary schools, and “innovation education” and “entrepreneurship education” in higher education institutions. A thorough exposition and critique are provided of the “maker” movement in Chinese primary and secondary education, with its emphasis on practicality, as well as entrepreneurship and the “mass entrepreneurship and innovation” strategy at the university level (addressed further in Chapter 3.3). The chapter concludes with questions and suggestions for policy improvement.

Part III.  National Incentives for an Innovation-​Driven Economy This section examines the current incentives for innovation in China in terms of both a top-​down and bottom-​up process. It is concerned mainly with the role of the state in establishing the microeconomic infrastructure and ecosystem for an innovative society. It also explores the institutional context in which the twin alternatives of market-​based incentives and government-​directed economic and social policies operate. It evaluates their relative effectiveness as the economy has become increasingly complex, with consideration of recent reforms, competition policy, industrial and sector policies, and strategies for encouraging wider participation.

3.1. System Reform, Competition, and Innovation in China Weiying Zhang This chapter examines how the adoption of a market economy has transformed the incentives for, and adoption of, innovation in China. The chapter opens with a brief description of China’s economic reform process and then assesses the measurement of competition, how the economic system reforms have improved market competition in China, and what kind of progress China has made according to a variety of performance measures. Using a cross-​regional comparison, the author demonstrates that innovation is positively and significantly correlated with market adoption and competition. He concludes the chapter with an evaluation of the state of innovation to date, including industrial policy, and makes suggestions for reforms.

3.2. Reforms of the Science and Technology Management System Zhijian Hu, Zhe Li, and Xianlan Lin This chapter focuses on government micro-​level policies toward management and adaptation of the S&T ecosystem. The authors describe the various institutions and programs that

Introduction   11 are intended to foster S&T. They detail the reforms made to the management of state-​owned research institutions and universities, including incentives for researchers and institutions, especially to promote the commercialization of R&D discoveries. Three areas of success are outlined: optimizing the allocation of scientific and technological resources, mobilizing the enthusiasm of researchers, and improving the governance system. The authors conclude that reforms of the S&T management system have achieved substantial breakthroughs, but see opportunities for further change.

3.3. Mass Entrepreneurship and Mass Innovation in China Jian Gao and Rui Mu The concept of “mass entrepreneurship and innovation” was first proposed by Chinese premier Li Keqiang in 2014 at Summer Davos, with the intention to create a more attractive environment for widespread entrepreneurship. This chapter reviews the literature on entrepreneurship in China, as well as the socioeconomic background to the concept of mass entrepreneurship and innovation. The authors outline the substantial changes in the institutional context for small business in China, from a relaxation of constraints to proactive encouragement. They elaborate on the policies and measures implemented by the Chinese government to promote mass entrepreneurship and analyze these measures and polices from the perspective of the entrepreneurial ecosystem. They conclude that the mass innovation concept is an important evolution in institutions and mechanisms, and that significant changes have been made since its recent implementation.

Part IV.  Developing Innovation-​Favoring Institutions and Ecosystem This section examines in more depth the key elements of the innovation ecosystem and the factors leading to effective implementation. It covers industry clusters and agglomerations, linkages between sources of scientific and technological knowledge and industry, the impact of high-​technology parks and industry zones, nontraditional sources of funding, IP protection, and the role of Chinese culture in promoting entrepreneurship.

4.1. The Role of Clusters in the Development of Innovation Capabilities in China Tuoyu Li and Jiang Wei Industrial clusters have long been recognized as important elements of an innovation system and they are very prevalent in China, where the three major urban and regional agglomerations, composed of 360 million people, account for over 40% of national gross domestic product. This chapter is focused more precisely on industry clusters rather than

12    Fu, McKern, and Chen regional agglomerations, and examines them from two perspectives: the value chain—​ the role of suppliers, customers, and other resources in a region—​and “communities of knowledge and practice” extending from within firms to adjacent companies in related industries. The chapter looks at the development of clusters in China, the forces facilitating their success and their contribution to the economy, and their contribution to the long-​term enhancement of innovation capability. Through empirical studies of specific clusters, the authors describe the main features of a functioning cluster and observe the need to enhance the learning capabilities of clustering enterprises. They conclude with a conceptual framework for an innovation system designed to capture linkages within industrial clusters.

4.2. China’s Science-​Based Innovation and Technology Transfer in the Global Context Jizhen Li, Ximing Yin, and Subrina Shen This chapter assesses China’s policies and experience in motivating and facilitating the diffusion of science-​based innovations in universities into industry in the context of globalization. The authors pose three questions: • First, how well do Chinese companies, and China as a whole, innovate? • Second, what is the current state of science-​based innovation, especially with regard to university technology transfer and innovation commercialization? • Third, what factors led to the progress in innovation and technology transfer as China entered the 21st century, and what challenges and opportunities remain for China to become a main power of innovation in the world? The authors begin by making an assessment of China’s current global ranking in S&T relative to other countries on a number of dimensions, and they note the rapid improvement of its ranking in recent years. They next consider the national technology transfer system from universities (the main players in R&D) to the marketplace, the earlier weaknesses of the system, and the changes in approach designed to make it more effective. They assess the local university commercialization record against that of several foreign universities. They provide further analysis about five main drivers that, in their view, will contribute to China’s future success in commercialization. They conclude by offering new perspectives on the future direction of technology and innovation transfer in China.

4.3. Science Parks and High-​Tech Zones Susan M. Walcott This chapter reviews the development of science parks and high-​technology zones (SPHZs) in China and their impact on regional and national innovation. The author

Introduction   13 begins with a discussion of the role of SPHZs as economic development institutions and their costs and benefits. The author then describes the evolution of policy toward the development of SPHZs in China after 1978, the approaches taken, and the rationale. She also puts emphasis on geographic and scientific specialization and classifies the major SPHZ programs on these two dimensions. In the third section she gives specific examples of many well-​known SPHZs, providing useful empirical evidence of the variety of approaches taken. The author raises a key question: do Chinese SPHZs produce what they are designed to do? This chapter offers a number of criteria for assessing suitability but notes the difficulty of answering the question in a scientific manner. The chapter concludes with a number of issues for consideration.

4.4. Venture Capital, Angel Capital, and Other Finance, IPOs, and Acquisitions Lin Lin This chapter focuses on the development of non-​bank financial institutions, particularly venture capital, and their role in funding entrepreneurial new ventures. It covers the rationale for their development in China, the roles of private equity and foreign funding sources, as well as the market for liquidation through initial public offerings (IPOs) and acquisitions. It evaluates institutional changes and policy actions for reforming access to funds for small enterprises, including the launch of ChiNext, and other mechanisms for financial support. The author starts with an introduction to the concept of venture capital, in contrast to private equity, and then discusses the evolution of venture capital in China. She explains the legal framework, regulation, and corresponding market responses. After covering the role of foreign venture capital, she provides a discussion on various forms of exit, from IPOs to mergers and acquisitions (trade sales). Here she describes the roles of the various exchanges, including the ChiNext Board of the Shenzhen Stock Exchange (SZSE) and the National Equities Exchange and Quotation (NEEQ), an over-​the-​counter market. In concluding, the author notes that there remain institutional impediments within the stock market that may hinder the development of the venture capital industry in China.

4.5. Intellectual Property Rights Protection Can Hunag and Naubahar Sharif This chapter is concerned with the development of IP rights in China and their role in stimulating innovation by indigenous companies, as well as the effects of IP rights on the transfer of knowledge from multinational corporations (MNCs) into China. The authors describe the evolution of the IP protection regime in China and the eventual promulgation in 2015 of four major changes in the regulations, designed to protect IP

14    Fu, McKern, and Chen and encourage its transfer. In reviewing the early results of these changes, they note that the technology transfer offices of universities and public research organizations have not yet taken on the commercialization role that is common in Western institutions. On the other hand, the authors provide evidence that the prosecution of legal cases in the new special patent courts has improved considerably, and that foreign patent holders appear not to suffer discrimination in those courts. They conclude that the system has been considerably enhanced in recent years, although challenges remain regarding IP management and patent licensing in Chinese universities and public research organizations.

4.6. Innovation Elements in Traditional Chinese Culture Jin Chen and Qingqian Wu This chapter thoughtfully examines the question, rooted in Chinese history and philosophy, of whether Chinese society has the cultural preconditions to become an innovation leader. The authors begin by contrasting the “partial, static, analytical, and reductive mode of thinking,” which they note characterizes the culture of contemporary Western science, with traditional Chinese culture, which features “dynamism, balance, comprehensiveness, and holism.” A holistic mode of thinking, they argue, is contributing to an independent and comprehensive approach to Chinese innovation management. Drawing on Confucian, Buddhist, and Taoist perspectives, the authors show those values and precepts to be the foundation elements in many aspects of Chinese society and leadership, including science and innovation. In relation to the major emerging scientific and technological questions, their view is that holistic thinking will prove an advantage to China. In a world of complex problems, which are increasingly characterized by technological interrelatedness, a systemic, holistic approach will be advantageous. As they conclude, “The road of modernization is diverse in nature, encompassing traditional ‘cultural genes’ with a far-​reaching impact. . . . Chinese culture and innovative resources will no doubt contribute significantly to the assimilation of Eastern wisdom and Chinese cultural elements . . . to make more and better contributions to world technology.”

Part V.  Openness and the Acquisition of Technology and Capabilities This section of the book is concerned with China’s openness to technology and innovation flows from and to the rest of the world. It considers first the role of MNCs in the transfer of technology to China through direct investment and other means of inward technology transfer. An important source of knowledge and experience is then discussed, namely foreign education and experience as transmitted to China by returnees. The policies and practices regarding Chinese firms’ global expansion are next evaluated, with emphasis on their impact on innovation capacity in China. In the same vein, the section reviews

Introduction   15 a relatively recent strategic direction of Chinese firms—​establishing R&D centers outside China. The authors then look at international collaboration in technology and China’s rapid rise in international institutional collaboration in S&T. Finally, the authors consider a more recent form of inter-​institutional collaboration—​ open innovation—​a phenomenon that China has embraced rapidly.

5.1. Innovation Strategies of Multinational Corporations in China and Their Contribution to the National Ecosystem Bruce McKern, George S. Yip, and Dominique Jolly This chapter reviews the role of MNCs in the creation of foreign intellectual capital in China and its transfer to China, including incentives and policy implications for indigenous innovation. It also discusses the evolution of MNCs’ R&D strategies in China and China’s policies toward foreign R&D activities and foreign IP. The chapter concludes with suggestions for changes in policies to enhance the attraction of foreign intellectual capital.

5.2. Foreign Technology Transfers in China Xiaolan Fu and Jun Hou In this chapter the authors examine in depth the role of international technology transfer in China with a focus on its role in technological upgrading and its interactions with indigenous innovation. Foreign technology’s effects on the local economy are carefully explored through several processes: openness in terms of import and export trade, foreign inward direct investment, and outward direct investment by Chinese firms. The authors conclude that China’s integration into the global economy has allowed Chinese firms access to both tangible and intangible knowledge assets. While each of these is important, the authors argue that they must be complemented by indigenous innovation, to enhance the national technological capacity. The Chinese model of relying on dual sources is a strategy to maximize the benefits for the developing country.

5.3. China’s International Migration: Status and Characteristics Huiyao Wang This chapter deals with China’s policies for attracting overseas Chinese to return as a process for IP transfer and absorption, as well as a stimulus for innovation and new business. The author addresses in detail the patterns of migration in and out of China, discussing the status, numbers, and characteristics of outward and inward migrants, with international comparisons. The comparison data demonstrate that China is a major source of migrants going to other countries, with concomitant foreign remittances to China (the second-​largest

16    Fu, McKern, and Chen receiver of remittance payments globally), but that China itself is a very minor destination for inward migration. The author notes that there are now decreasing numbers of Chinese migrants going abroad, at the same time as more and more overseas Chinese are returning to make their lives in China. The latter trend is helpful for China’s technologically advanced workforce. However, only 0.07% of China’s population is foreign born, the lowest proportion in the world. The author notes that China recognizes the potential for foreigners to add to its pool of high-​quality talent and has taken a number of policy steps in this direction. He makes suggestions for further improvement.

5.4. Chinese Outward Foreign Direct Investments and Innovation Vito Amendolagine, Xiaolan Fu and Roberta Rabellotti This chapter examines China’s policies and firm practices in expanding globally and their impact on innovation in indigenous firms. It provides a thematic structure that leads from data explaining the nature of the OFDI phenomenon and its recent geographic and sectoral impact to the specific topic of asset-​seeking foreign direct investment. It then considers the important question of the impact of OFDI on Chinese companies’ innovation capabilities. It provides links to and assessments of the relevant existing research, with an evaluation of its significance and areas where uncertainty remains. The authors explore the important question of the extent to which OFDI enhances the innovation capabilities of Chinese companies. They conclude with a summary of the research on this issue and make recommendations for further research.

5.5. Internationalization of Chinese Research and Development Max Von Zedtwitz and Xiaohong Iris Quan Seeking new knowledge is one motive for OFDI by more advanced companies. This chapter reviews this recent strategic direction among Chinese firms, specifically in establishing R&D centers outside China. The authors note that what makes the rise of international Chinese R&D remarkable is that it is—​alongside India—​one of the first such endeavors by a developing country, which has quickly established one of the most substantial global R&D footprints, in over 450 known foreign locations. The chapter surveys the relatively few research articles concerned with this phenomenon and explains the motivations for Chinese firms in setting up R&D centers outside China. In terms of established ownership, location, and internalization (OLI) theory, they see parallels to the spread of foreign R&D centers by MNCs from developed countries in the past and the more recent experience of Japan in following that path. The authors discuss the obstacles Chinese firms have encountered in this process, the impact on firm capabilities, Chinese national policies, and the reactions of host countries.

Introduction   17

5.6. International Innovation Collaboration in China Kaihua Chen, Ze Feng and Xiaolan Fu Collaborating internationally in research has had an important role in developing China’s S&T capabilities, and this activity has grown exponentially over the last 20 years. Although there are distinctive characteristics of international innovation collaboration that differ from domestic research collaboration, this important field of inquiry has not been extensively researched. In this chapter the authors discuss the necessity of international innovation collaboration, providing a detailed view of China’s policies toward collaboration, its experience with collaboration agreements, its evolving approach, and the current status. They show the leading scientific fields that have been involved and the dramatic increase in collaborative activities between China and its main collaborators, led by the United States. They note that scientific publications arising from international collaboration now account for 25% of all Chinese research papers. The authors give practical suggestions on dealing with current problems and make suggestions about areas for future research.

5.7. Open Innovation for Development in China Jin Chen and Yufen Chen Open innovation in firms involves seeking new ideas from outside the firm’s own resources among the many other actors in the value chain and the broader environment. These include firms’ suppliers and customers, local and foreign companies, government agencies, universities, institutes, and consulting companies. Open innovation in China is well developed, and in this chapter the authors detail its scope through data on sources of technology among companies, together with specific examples of companies using such sources. They argue that an open vision to integrate global R&D resources and market resources has greatly enhanced Chinese firms’ innovation capabilities. They conclude that open innovation is an inevitable choice for Chinese firms to adapt to globalization and that it is a valuable stimulus to innovation.

Part VI. Innovation with Chinese Characteristics In this section the Handbook addresses the distinctive nature of innovation strategies and practices in Chinese firms. The section provides evidence on the question of whether China’s experience in creating its innovation ecosystem has been unique and to what extent other rapidly developing economies (as well as advanced nations) can learn from it. The first chapter explains how Chinese firms’ capabilities have evolved from the early reliance on the country’s labor cost advantage and copying of foreign ideas, by way of Shanzhai and “accelerated innovation” business models, to today’s world-​class digital businesses.

18    Fu, McKern, and Chen The authors consider these topics from a number of perspectives concerned with firm creation in the marketplace. They discuss the critical early role of global supply chains in influencing the capabilities that were most suited to success in China, as well as subsequent intense domestic competition under the pressure of large-​scale and rapidly evolving customer demand. The demand variable is seen as an important but neglected factor in innovation research, often in second place to supply factors. A central question is the role of the Chinese state versus the private sector in fostering innovative companies. One chapter details the structure and performance of several specific sectors in terms of domestic versus foreign participation and provides interesting evidence on the role of SOEs. Digital technology has emerged as one of China’s commercial strengths, due in part to its rapid market adoption and newness, where China was not greatly disadvantaged relative to foreign innovators. This is addressed in depth in a chapter explaining the rise of digital business in China to the forefront of global competition. Financial reform was a critical factor in the development of a vigorous private sector in China, and the changes made in policies, institutions, instruments, and markets greatly influenced the transition. The reasons for this evolution, its progressive unfolding, its impact on firms, and its future are addressed. Finally, the section deals with another intriguing question—​the creation of new firms in the resource-​constrained environment of China’s early reforms. This apparently paradoxical question is addressed in terms of the concept of “bricolage.”

6.1. Chinese Cost Innovation, the Shanzhai Phenomenon, and Accelerated Innovation Peter J. Williamson This chapter explains the evolution of Chinese innovation strategies over three phases, described by the author as moving from an initial focus on comparative advantage in low-​ cost labor, to copying foreign consumer products and services, to an emphasis on rapidly changing new product introductions—​the Shanzhai phenomenon and “accelerated innovation.” The author’s discussion of each phase includes many examples of Chinese firms using a variety of approaches based on their cost advantage. As their labor cost advantage eroded, firms looked to increase the speed of innovation while simultaneously reducing costs, a strategy the author calls “accelerated innovation.” The author explains the many innovations in design and development that Chinese firms invented in introducing accelerated innovation, challenging accepted Western conventions. These extended to organization and decision making, resulting in new approaches to the whole innovation process. In addressing the most recent phase, the field of digital innovation, the author explains how Chinese companies have applied the accelerated innovation strategy, supported by government policies and a large and burgeoning domestic market. He sees digital innovation as the leading edge of Chinese innovation today.

Introduction   19

6.2. Global Supply Chains as Drivers of Innovation in China Michael Murphree and Dan Breznitz An important initial driver of innovation in China’s companies has been their participation in global supply chains. This chapter details the growth of their capabilities based on integration into the supply chains of multinationals, with detail on their early development, the specific kinds of firms, and their subsequent evolution. The chapter opens with a survey of research on the phenomenon of global value chains (GVCs) and then discusses more recent studies that emphasize the role GVCs play in the transfer and dissemination of knowledge and technology. The authors place considerable emphasis on “structured uncertainty” in the Chinese environment, which they see as the primary influence on what kinds of innovation capabilities were developed in China. This “Knightian” uncertainty had a profound impact on the type of innovation local firms produced (in which overseas Chinese firms had an important early role) and their profitability. The result is an entrepreneurial business culture that emphasizes speed, rapid returns, and political connections to protect against risk. There remains today a focus on short-​and medium-​term returns and practices. The implication of the chapter is that firms have difficulty in evolving from innovations that, while incremental and responsive to the domestic market, are not often radical or pathbreaking. Although that critique echoes the conventional criticism of Chinese firms as copycats, the authors agree that many Chinese firms have moved well beyond that earlier state of innovative capability.

6.3. Market Demand, Consumer Characteristics, and Innovation in Chinese Firms Hengyuan Zhu and Qing Wang This chapter addresses the question of market demand as a major stimulus for innovation, as distinct from the traditional, more narrow view of the supply side being the prime driver (emphasizing technology). The authors’ aim is to explain consumer heterogeneity and market dynamics as a source of value creation and a key influence on Chinese firms’ innovation decisions and capabilities. In spite of the crucial role of domestic market demand in China’s economic growth, there is an absence of a consistent and well-​developed demand-​side approach to studying innovation in China. The authors address the question of how the size, diversity, and growth rate of the domestic market influence innovation capabilities and performance. They use “diffusion of innovation” theory to examine the characteristics of Chinese consumers and their changing demands over time. A  case study of a well-​known firm illustrates these concepts. The authors go beyond the general question of demand and supply as motivators of innovation into the important question of how firms from developing countries can develop the capabilities to compete against established multinational enterprises (MNEs) in global

20    Fu, McKern, and Chen markets. This discussion critiques the limitations of the traditional notion of firm-​specific advantages in explaining the rise of emerging market multinational enterprises (EMMEs), noting that there are context-​specific advantages such as consumer demand that enable EMMEs to turn local factors into sources of competitive advantage. The authors’ conclusions provide evidence in support of this assertion and throw more light on the ability of Chinese firms to become global players. The authors provide suggestions for further research on the importance of market demand.

6.4. Chinese Firms’ Move to the Forefront in Digital Technologies Jiang Yu and Yue Zhang The authors of this chapter note that China’s leading corporate strategists are now seeking ways to move beyond the “global factory” model. As several of the authors of this Handbook acknowledge, China intends to minimize its dependence on foreign technologies and IP and cultivate its own technology-​intensive industries and indigenous innovation expertise. A number of Chinese companies have reached global standards, and in several sectors they are at the frontier of the technology, a leading example being the information and communications technology (ICT) industry. This chapter provides a detailed overview of the past, present, and future of digital innovation in China and investigates the causes of this impressive evolution, paying particular attention to the role of government. It explores the topics of institutional support, key technological fields and related industries, the global market and competition, and policy issues. The authors investigate several key factors, such as technological capabilities, cooperation and alliances, competition, entry and exit strategies, ecosystem building and governance, and macroenvironmental factors, such as regulation, policy, and standardization. The mechanism facilitating the strategic transition from survival to innovation and market leadership is also discussed. Finally, the authors offer advice regarding potential challenges for China’s future digital innovations.

6.5. China’s Financial Innovation: Process, Drive, and Impacts Liqing Zhang Since 1978, the strong demand for modern financial services by governments, corporations, and individuals has been, in the view of the author of this chapter, the most important driving force in China’s rapid economic growth and its transition to a market-​oriented economy. The delay in liberalizing financial controls, as well as the extensive application of internet and other advanced information technology, has played an important role in triggering financial innovations. The author summarizes in the first section of the chapter the contributions of 40 years of changes in policies, institutions, instruments, and markets in the creation of a modern

Introduction   21 financial system in China, beginning with the transformation of the People’s Bank of China into a modern central bank. This section deals with the reform of the domestic banks, development finance, internet finance, shadow banking, internationalization of the renminbi (RMB), monetary policy instruments, and financial regulation. In the second section of the chapter, the author explains the driving forces for these changes, beginning with the shift initiated in the late 1970s in China’s development model. He details the main demand and supply forces that necessitated change. In the third section, he considers the impact of these changes and explains how the modern financial system has changed the way that financial resources are allocated and the impact on financial efficiency, growth, and social welfare. The chapter concludes with suggestions for further research on several topics where important questions remain.

6.6. The Puzzle of the Underdog’s Victory: How Chinese Firms Achieve Stretch Goals through Exploratory Bricolage Peter Ping Li, Shihao Zhou and Zhengyin Yang In this chapter the authors address a significant question about the development of innovative Chinese companies: how is it that some new companies facing resource constraints in a developing country are nevertheless able to develop strategies and capabilities that enable them to succeed against competitors in their own country, and sometimes outside? The authors set the question in a framework of the concept of bricolage, or “making do with limited resources,” and to this they add the influence of stretch goals. The authors argue that, according to traditional innovation theory, firms can’t achieve stretch goals using local search or resources, because they need unfamiliar resources from outside their current domain to produce breakthrough innovations—​necessitating non-​ local search, which is costly and difficult. Also, the goals that small firms in developing countries consider attainable arise out of their perceptions of the resource constraints. So such firms cannot have stretch goals, since the resource constraints are perceived as too limiting. This chapter challenges that view and argues that some newcomer firms are able to find ways to meet stretch goals in a limited resource environment through local search. The authors explore the issue through four case studies of Chinese companies. They argue that “bricolage” uses local resources, but in novel ways. Such firms use an exploration strategy rather than an exploitation strategy. The four case studies lend support to their argument and also raise questions for further research. The authors address the question of which factors or processes make bricolage successful in such a context. Consistent with the strategy literature, they focus on a number of organization and leadership issues, which they see as moderating variables. In further research, these variables will be very important in helping to explain the somewhat paradoxical nature of innovation based on bricolage and determine if it has general applicability.

22    Fu, McKern, and Chen

Part VII.  Innovation Capability Transition and Upgrading for an Inclusive and Sustainable Innovation System This section looks to the future and is concerned with emerging social, demographic, and economic challenges that influence the need for different approaches to the organization of innovation in China. These challenges are driven in part by rapid growth and demography—​the aging population and the shrinking workforce—​as well as by the shift toward greater domestic consumption and the recent urgent emphasis on poverty elimination and inclusiveness. The section addresses China’s embrace of green technologies, particularly renewable energy, as a solution to the environmental impact of its past energy mix. The section also addresses support for “inclusive innovation” to address persistent income inequality, especially the rural-​urban divide, through small-​scale entrepreneurship. Economists and officials in China have expressed concern for some time over the risk of the middle-​income trap, raised also in several preceding chapters. With an aging population and shrinking workforce, the solution to stagnant incomes in China is seen to lie in shifting its industrial base toward higher-​value manufacturing based on advanced technologies. The “Made in China 2025” initiative, now more generally called “Manufacturing Power Strategy”, represents a series of policies under way to change radically the basis of industry and innovation. We discuss these policies and actions and the reactions of advanced countries. At the end of the section we look forward to the promise of future technology advances for China, with a view of the probable trajectory of China’s scientific and technological capabilities over the next years to 2050, when China intends to be the world’s leading technological power.

7.1. Green Innovation in China Ping Huang and Rasmus Lema China’s large population compounds the problems of its rapid growth, which have led to well-​known environmental concerns and in particular the need for efficient and sustainable energy sources. This chapter addresses the transition to sustainable energy sources in China. It shows how the Chinese response to the sustainability challenge has depended on both “hard” (technological) and “soft” (institutional) innovations, as other authors have noted in describing China’s innovation transformation. The authors also show how that challenge has presented a window of opportunity for industrial development and global competitiveness in a green economy. Finally, they discuss the global implications of China’s mounting innovation capabilities in these new fields. The authors agree with other authors of the Handbook on the importance of all of the elements of the country’s innovation ecosystem in developing its capabilities. The Chinese

Introduction   23 approach has built an extensive ability to respond to local environmental pressures, while at the same time forming the basis for global leadership in a new industry. The authors describe the factors leading to China’s “green turn” and the policies initiated by the government. They provide considerable detail about the actions taken, the capabilities created, and the investment involved. Their discussion includes wind energy, solar voltaics, solar thermal energy, and bio-​energy, and they provide comparisons with other countries. New energy technologies are also discussed, including new energy vehicles, concentrating solar power, smart grids, and efficient buildings. The chapter is concerned not only with innovation but also with diffusion of the outputs into the economy. Discussion of specific sectors explains the differences in the local demand and the innovations that arose in response—​influenced by the context of market demand and government policy. And consistent with that perspective, the authors also explain the impetus to innovate as well as the factors influencing diffusion across the country. Impressive as China’s energy initiatives have been, the authors raise important questions for the future.

7.2. Innovating for the Poor: The Inclusive Innovation System in China Xiaobo Wu and Linan Lei Improving the incomes of the large numbers of the Chinese population who are not yet participating in the middle class is an important priority for China, as emphasized by the President, Xi Jinping. This chapter addresses the role of innovation in the improvement of the standard of living of the poor, particularly in the rural population, through opportunities for using digital technology to start small businesses. The authors show the disparity in average incomes between the urban population and the rural population of China, noting that while the ratio of urban to rural incomes has declined, it is still high. Similar differences exist between the eastern parts of the country and the western provinces. The authors also find, as might be expected, income differences between employment in high-​technology industries relative to more labor-​intensive low-​ technology industries. The gradual shift toward tertiary industry from secondary industry should create some reduction of these differences, but that will take time. The authors discuss the concepts of social exclusion and inclusive growth and the difficulties faced by people at the bottom of the income pyramid. They focus on entrepreneurship at low-​income levels as one of the ways to improve income and social inclusion. An impressive example is the enabling of many small Chinese rural businesses through Alibaba’s Taobao website. Over 3,200 “Taobao Villages” or communities of small entrepreneurs were established through this system, with more than 1.8  million people employed. Because information technology is widely deployed across China, new entrepreneurship ideas based on digital technology have considerable promise. The authors describe the policies developed in recent years to stimulate small-​scale entrepreneurship, particularly in rural society, and they discuss the complexities to be overcome to achieve more widespread adoption.

24    Fu, McKern, and Chen

7.3. Manufacturing Power Strategy: Advanced Manufacturing Jörg Mayer and Huifeng Sun In this chapter, the authors reflect on China’s successful structural transformation, which, as noted earlier, entailed a large-​scale shift of labor from agriculture to manufacturing and services, guided by policies that focused on investment-​driven and export-​oriented growth. With the success of that strategy, today there is a concern to avoid falling into the middle-​ income trap. As the basis for growth toward advanced economy status, China has adopted a new and more balanced strategy, which assigns a greater role to domestic demand and to improvements in indigenous innovation capacity through a focus on strategic industries with a high content of local technology. “Made in China 2025” more generally known as “Manufacturing Power Strategy” and other initiatives incorporated in the 13th Five-​Year Plan, such as Internet Plus, are the strategic components of China’s new innovation-​focused industrial policy. The authors present the Manufacturing Power Strategy and other recent measures for strengthening indigenous innovation in detail and examine the extent of progress to date. They explain these initiatives in the context of China’s overall development strategy, now faced with a more challenging external environment. After presenting China’s past growth path, including the recent slowing, they provide a variety of views on the likelihood of China’s escaping the middle-​income trap. The authors also provide an account of the perceptions of its advanced manufacturing initiative by other countries and its part in the recent trade dispute with the United States. As trade matters have broadened into issues of protectionism, foreign access to the China market, and IP, the trade frictions, in their view, have been subsumed into a “contest for technological supremacy.” They provide viewpoints from China regarding the purpose of the initiative and how it is managed, noting that perhaps the greatest challenge will be finding the right mix between state guidance and private sector involvement.

7.4. Facing the Future of China’s Science and Technology Development Jiaofeng Pan, Guanghua Chen, and Xiao Lu This chapter looks forward, with a detailed summary of the priorities and probable evolution of China’s scientific and technological capabilities in the future, as far as 2050. The authors state that China’s scientific and technological strength is in a critical period of transition, from quantitative accumulation to a qualitative leap forward, and from “point breakthroughs” to system-​wide capacity improvement. By 2050, they predict, China will be the world’s leading technological innovation power. The chapter systematically describes in three sections the goals and plans for China’s future scientific and technological innovation development; eight socioeconomic foundations and strategic systems for China’s technological growth; and the features of China’s organization and governance of a modern S&T innovation system.

Introduction   25 The authors give a brief summary of the country’s overall scientific development since the opening up after 1978 and a detailed statement of the major goals ahead and the specific industrial areas of focus. The plans for each of the focal areas provide a comprehensive picture of the future priorities. An important feature of this section is its emphasis on overarching goals and the organizational and institutional priorities. The authors consider that China faces severe challenges in energy resources, ecology and the environment, population health, air and sea, and security. They place emphasis on eight socioeconomic foundations and strategic systems that will be the foundations for the future, and they give specific detail of scientific priorities in each of these areas. For example, in the field of agriculture, they expect that by 2050 the whole animal or plant genome will be able to be optimized and assembled, and the digitalization and precise management of animal and plant production processes will be realized. The third section presents a discussion of important changes that the authors believe will need to be made to the innovation ecosystem, in terms of government, SOEs, and the private sector. They discuss in detail a range of reforms needed in IP protection, anti-​monopoly law, stimulating basic research, encouraging firms to undertake more R&D, attracting foreign R&D, scientific education, and others. They consider that the many elements of the ecosystem need to be in harmony to promote innovation, a view that fits with that of other authors in this Handbook. The chapter concludes with recommendations for improving the organization, management, incentives, and resources of the innovation ecosystem.

Conclusion Xiaolan Fu, Bruce McKern and Jin Chen Our conclusions to the Handbook are presented in two chapters. In the first of these, 8.1 Conclusion: Innovation in China: Past, Present, and Future Prospects, we summarize common themes in the collective thinking of the authors. We hope that readers will find their understanding of China’s march toward technological and innovation leadership expanded and that they will have acquired a foundation for informed conjecture regarding the challenges ahead. In the second chapter, 8.2 Policy and Managerial Implications for China and Other Countries, the editors put forward a set of ideas arising from the analysis in the Handbook and other research, to draw implications and suggest policies and actions oriented towards positive developments in innovation for China and other countries.

Pa rt   I

T H E DE V E L OP M E N T OF I N N OVAT ION I N C H I NA :   T H E ORY, P OL IC Y, A N D P R AC T IC E

Chapter 1.1

Capabili t i e s Ac cum u l at i on a nd Devel opme nt What History Tells the Theory

Giovanni Dosi and Xiaodan Yu This work significantly draws upon Cimoli and Dosi (1995), Cimoli et  al. (2009), Dosi (1984), Dosi and Nelson (2010), and Yu et al. (2015, 2017), to which the reader is referred for further details.

Introduction: The Drivers of Great Industrial Transformation Development, catching up, and possibly forging ahead have to do with the technological, institutional, and policy dynamics associated with the great transformation—​borrowing Karl Polanyi’s (1944) expression—​leading from traditional, mostly rural economies to economies driven by industrial activities (and nowadays also advanced services), able to systematically learn how to implement and eventually how to generate new products and new ways of producing under conditions of dynamic increasing returns (Brandt and Rawski, 2008, use the same expression with reference to the Chinese miracle). Such a “great transformation” entails a major process of accumulation of knowledge and capabilities, at the levels of both individuals and organizations. Certainly, part of such capabilities builds on education and formally acquired skills (what in economists’ jargon often goes under the heading of “human capital”). However, at least equally as important, capabilities have to do with the problem-​solving knowledge embodied in organizations—​ concerning, for example, production technologies, the technical and social division of labor, labor relations, and “dynamic capabilities” of search and learning (see, among others, Amsden 2001; Bell and Pavitt 1993; Chang 2002; Chang et al. 2002; Cimoli and Dosi 1995; Cimoli et al. 2009; Dosi et al. 1990; Mytelka 2007; Nelson 1982, 2004; Reinert 2007).

30   Dosi and Yu In turn, the rates and directions of knowledge accumulation during the catch-​up process and the ensuing effects upon the patterns of production and trade are shaped by the economic and institutional framework in which such processes are embedded. Simplifying enormously the nuances of actual history, but much less than the “representative economists” do, let us distinguish three partly independent but co-​evolving subsystems or domains (Dosi 1984): 1. The system of scientific knowledge and technologies 2. The “economic machine,” comprising the mechanisms determining production, investment, income distribution, structural change, etc. 3. The system of social relations and institutions, including those governing labor, financial and goods markets, and of course public agencies and policies1 While we maintain that technological and organizational learning is a sort of primus inter pares, a necessary albeit not sufficient ingredient, it is the matching or mismatching between the foregoing three coupled domains that is at the root of the early industrial revolution in England and also of later episodes of catching up, falling behind, and forging ahead. Hence, we suggest, what explains earlier and more recent dynamics is not one single factor but the patterns of consistency, or lack thereof, among them.2 So, just to name a few pertinent examples, Northern Italy in the 14th century had higher gross domestic product (GDP) per capita, more sophisticated financial institutions, etc., but it fell strikingly behind the Low Countries and England; China was plausibly technologically (and possibly even scientifically) more advanced than Europe for nearly a millennium, but the Industrial Revolution did not happen there; nowadays oil-​rich countries in the Middle East are very rich in terms of capital and wealth but backward in terms of technologies they can master. Of course, the three domains interact with each other. Our analysis, however, will be rooted in the following hypotheses: 1. Despite powerful interactions, each of these three domains has rules of its own that shape and constrain every inducement and adjustment mechanism between them. 2. There is a limited number of configurations of these three domains, which allows a relatively “well-​regulated” and smooth consistency between them. These define, so to speak, the “possible worlds.” 3. Unbalanced, stagnating, or “crisis” configurations do not necessarily also embody the necessity of the transition to other (more balanced or “smoother”) ones. Let us clarify these points in relation to the interaction between the “system of techno­ logies” and the other two.

1  This closely resonates with Freeman (1995), who further distinguishes between science and technology, and between institutions and culture, in his insightful interpretation of the first and subsequent industrial revolution. See also later. 2  The general conjecture is well in tune with the mainly French Regulation School (see Boyer 1988b, 1988a; Boyer and Petit 1991).

Capabilities Accumulation and Development    31

Some Properties of Technical Change We firmly believe that the standard ideas of “production possibility sets” or “production functions,” with their corollary of technology as a malleable and reactive black box, to use Rosenberg’s terminology (Rosenberg 1982), has been one of the most poisonous tools economic theory has offered the students of the development process, in that it has deprived the analysis of any lens related to knowledge and to problem-​solving procedures—​which on the contrary are the core of what technology is and how it evolves. Indeed, the view of technology we propose comprises (1) a specific body of practice—​in the form of processes for achieving particular ends—​together, of course, with an ensemble of required artifacts on the “input side”; (2)  quite often some distinct notion of a design of desired “output” artifacts; and (3) a specific body of understanding, some relatively private, but much of it shared among professionals in a field. These elements, together, can be usefully considered as constituent parts of a technological paradigm (Dosi 1982, 1988), somewhat in analogy with Kuhn’s (1962) scientific paradigm.3 A paradigm embodies an outlook, a definition of the relevant problems to be addressed, and the patterns of inquiry to address them. It entails a view of the purported needs of the users and the attributes of the products or services they value. It encompasses the scientific and technical principles relevant to meeting those tasks and the specific technologies employed. A  paradigm entails specific patterns of solution to selected techno-​economic problems—​that is, specific families of recipes and routines—​ based on highly selected principles derived from natural sciences, jointly with specific rules aimed at acquiring related new knowledge. Together, the paradigm includes a (generally imperfect) understanding about just how and (to some extent) why prevailing practice works. An important part of paradigmatic knowledge takes the form of design concepts that characterize in general the configuration of the particular artifacts or processes that are operative at any time. Shared general design concepts are an important reason that there is often strong similarity among the range of particular products manufactured at any time—​such as the large passenger aircraft produced by different aircraft companies, the different television sets available at the electronics stores, etc. Indeed, the establishment of a given technological paradigm is quite often linked with the emergence of some dominant design (see Abernathy and Utterback 1978; Henderson and Clark 1990; Rosenbloom and Cusumano 1987; Suárez and Utterback 1995; Utterback and Suárez 1993; and the critical review of the whole literature in Murmann and Frenken 2006). A dominant design is defined in the space of artifacts and is characterized both by a set of core design concepts embodied in components that are essential to the major functions performed by the product and

3  Here as well as in Dosi (1982), we use the notion of paradigm in a microtechnological sense: for example, the semiconductor paradigm, the internal combustion engine paradigm, etc. This is distinct from the more “macro” notion of the “techno-​economic paradigm” used by Perez (1985, 2010) and Freeman and Perez (1988), which is a constellation of paradigms in our narrow sense: for example, the electricity techno-​economic paradigm, information and communications technologies (ICTs), etc. The latter broader notion overlaps with the idea of “general purpose technologies” from Bresnahan and Trajtenberg (1995). Moreover, the notion of paradigm used here overlaps a good deal with that of “regimes” put forward in Nelson and Winter (1977).

32   Dosi and Yu by a product architecture that defines the ways in which these components are integrated (Murmann and Frenken 2006; drawing upon Henderson and Clark 1990). However, sometimes the establishment of a dominant paradigm is not associated with a dominant design. A revealing case to this point is pharmaceutical technologies that involve specific knowledge basis, specific search heuristics, etc.—​that is, the strong mark of paradigms—​without, however, any hint at any dominant design. Molecules, even when aimed at the same pathology, might have quite different structures: in that space, one is unlikely to find similarities akin to those linking even a Volkswagen Beetle 1937 and a Ferrari 2000. Still, the notion of “paradigm” holds in terms of underlying features of knowledge bases and search processes. So, in pharmaceuticals the process of creating new drugs has undergone a paradigm shift, from testing large numbers of molecules for potential efficacy to designing molecular structures with the likely useful properties—​not a change in dominant designs but a change in the dominant processes for developing drugs. Whether the establishment of a dominant paradigm entails also the establishment of a dominant design or not bears a lot of importance in terms of the dynamics of industry structure along the life cycle of the industries to which a particular paradigm is associated. So, the emergence of a dominant design in, for example, cars or TVs is linked to a major shakeout of the industry and the inception of a relatively tight oligopoly. Conversely, this does not happen in the machine tool or laser industries (more in Klepper 1997; Dosi and Nelson 2010). More generally, the cognitive frames shared by technological professionals in a field orient what they think they can do to advance a technology (Constant 1980). Technological paradigms also encompass normative aspects, like criteria for assessing performance, and thus provide ways of judging which approach is better and determining goals for the improvement of practice. Each paradigm involves a specific “technology of technical change,” that is, specific heuristics of search. So, for example, in some sectors such as organic chemicals, these heuristics relate to the ability to couple basic scientific knowledge with the development of molecules that present the required characteristics, while in the pharmaceutical field an additional requirement is the ability to match the molecular knowledge with receptors and pathologies. In microelectronics, search concerns methods for further miniaturization of electrical circuits, the development of the appropriate hardware capable of “writing” semiconductor chips at such a required level of miniaturization, and advances in the programming logic to be built into the chip. The examples are many: a few are discussed in Dosi (1988). Here, notice in particular that distinct (paradigm-​specific) search and learning procedures imply first, diverse modes of creating and accessing novel technological opportunities, and second, different organizational forms suited to such research procedures. Together, the foregoing features of technological paradigms both provide a focus for efforts to advance a technology and channel them along distinct technological trajectories, with advances (made by many different agents, which are mainly business firms) proceeding over time in certain relatively invariant directions, in the space of techno-​economic characteristics of artifacts and production processes. As paradigms embody the identification of the needs and technical requirements of users, trajectories may be understood in terms of the progressive refinement and improvement in the supply responses to such notional demand requirements. A growing number of examples of technological trajectories include aircraft, helicopters, various kinds of agricultural equipment, automobiles, semiconductors, and a few other technologies (Dosi

Capabilities Accumulation and Development    33 1984; Gordon and Munson 1981; Grupp 1992; Sahal 1981, 1985; Saviotti 1996; Saviotti and Trickett 1992; and the discussion in Dosi and Nelson 2010). So, for example, technological advances in aircraft technologies have followed two quite distinct trajectories (one civilian and one military) characterized by log-​linear improvements in the tradeoffs between horsepower, gross takeoff weight, cruise speed, wing load, and cruising range (Frenken and Leydesdorff 2000; Frenken et al. 1999; Giuri et al. 2007; Sahal 1985; and more specifically in aircraft engines Bonaccorsi and Giuri 2000). Analogously, in microelectronics, technical advances are accurately represented by an exponential trajectory of improvement in the relationship between the density of electronic chips, speed of computation, and cost per bit of information (see Dosi 1984; the trajectory has persisted since then). We could say that the paradigmatic, cumulative nature of technological knowledge provides innovation avenues (Sahal 1985)  that channel technological evolution, while major discontinuities tend to be associated with changes in paradigms. Indeed, here and throughout we shall call “normal” technical progress those advances occurring along a given trajectory—​irrespectively of how “big” they are and how fast they occur—​while we reserve the name of “radical innovations” for those innovations linked with paradigm changes. A change in the paradigm generally implies a change in the trajectories. Together with different knowledge bases and different prototypes of artifacts, the techno-​ economic dimensions of innovation also vary. Some characteristics may become easier to achieve, new desirable characteristics may emerge, and some others may lose importance. Relatedly, the engineers’ vision of future technological advances changes, as does emphasis on the various tradeoffs that characterize the new artifacts. So, for example, the technological trajectory in active electrical components based on thermionic valves had as fundamental dimensions heat-​loss vacuum parameters, miniaturization, and reliability over time. With the appearance of solid-​state components (the fundamental building block of the microelectronic revolution), heat loss became relatively less relevant, while miniaturization increased enormously in importance. Similar examples of change in the dimensions of the design space can be found in most transitions from one paradigm to another. Of course, one does not always observe clear-​cut paradigmatic “revolutions.” It is sometimes the case that “normal” advances on established knowledge bases are intertwined with new sources of knowledge. This appears to be the case nowadays in electronics-​based industrial automation converging with artificial intelligence, and might apply also to drugs and biotech (cf. Hopkins et al. 2007).

Technological Dominance, Microheterogeneity, and Nonsubstitution The notion of paradigms contains elements of both a theory of production and a theory of innovation and bears straightforward implications for the interpretation of the processes of catching up. Concerning the theory of production, we suggest the following: 1. In general, there is at any point in time one, or very few, best practice techniques that dominate the others irrespective of relative prices.

34   Dosi and Yu 2. Different agents are characterized by persistently diverse (better and worse) techniques. 3. Over time the observed aggregate dynamics of technical coefficients in each particular activity is the joint outcome of the process of imitation/​diffusion of existing best-​practice techniques, of the search for new ones, and of market selection among heterogeneous agents. 4. Changes over time of the best-​practice techniques themselves highlight rather regular paths (i.e., trajectories) both in the space of input coefficients and in the space of the core technical characteristics of outputs (see the earlier example on aircrafts). Let us further illustrate the previous points with a graphical example (Figure 1.1.1). Start from the notion that each technical coefficient observed at the micro level is the outcome of codified information (something resembling blueprints), but also of more tacit and firm-​specific forms of knowledge. Suppose that, for the sake of simplicity, we are considering here the production of a homogeneous good under constant returns to scale with two variable inputs only, x1 and x2.4 A paradigm-​based theory of production predicts that, in general, in the space of unit inputs, microcoefficients are distributed somewhat as depicted in Figure 1.1.1. Suppose that at time t the coefficients are c1, . . . , cn, where 1, . . ., n are the various techniques labeled in order of decreasing efficiency at time t. It is straightforward that technique c1 is unequivocally superior to the other ones no matter what relative prices are: it can produce the same unit output with fewer inputs of both x1 and x2. The same applies to the comparison between c3 and cn, etc.

x2

I

I'

cn

c'm c2

C'

c'1

c3

C

c1 I

c'2 c'3

I'

x1

Figure 1.1.1  Microheterogeneity and technological trajectories. Source: Cimoli and Dosi (1995)

4 

Note that fixed inputs, vintage effects, and economies of scale would just strengthen the argument.

Capabilities Accumulation and Development    35 Let us call this property technological dominance and call some measure of the distribution of the coefficients across heterogeneous firms the degree of asymmetry of that industry (e.g., the standard deviation around the mean value C). We shall discuss some empirical evidence below. The first question is why doesn’t firm n adopt technique c1? To simplify a more articulated argument (see Freeman 1982; Nelson and Winter 1982; Dosi 1988; Dosi et al. 1990, 2008), the answer is “because it does not know how to do it.” That is, even if it is informed about the existence of c1, it might not have the capabilities of developing or using it. Remarkably, this might have little to do with the possibility for c1 to be legally covered by a patent. The argument is much more general: precisely because technological knowledge is partly tacit, also embodied in complex organizational practices, etc., technological lags and leads may well be persistent even without legal appropriation. The opposite also holds: if the two firms have similar technological capabilities, imitation might occur very quickly, patent protection notwithstanding, by means of “inventing around” a patent, reverse engineering, etc. We are prepared to push the argument further and suggest that even if firm n were given all the blueprints of technique c1 (or, in a more general case, all the pieces of capital equipment associated with it), performances and thus revealed input coefficients might still widely differ. It is easy to illustrate this by means of a gastronomical metaphor: despite readily available cooking blueprints and, indeed, codified rules on technical procedures, which are not available in most economic representations of production, (“first heat the oven, then after around 10 minutes introduce some specified mixture of flour and butter, etc.”), one obtains systematically asymmetric outcomes in terms of widely shared standards of food quality. This applies to comparisons among individual agents and to institutionally differentiated groups of them: for example, we are ready to bet that most eaters randomly extracted from the world population would systematically rank samples of English cooks to be “worse” than French, Chinese, Italian, Indian, etc., ones, even when making identical recipes! If one accepts the metaphor, this should apply, much more so, to circumstances whereby performances result from highly complex and opaque organizational routines (incidentally, Leibenstein’s X-​efficiency is a reflection of this widespread phenomenon). Suppose now that at some subsequent time t’, we observe the distribution of microcoefficients c’1,…, c’m, denoting the new or improved technology of firm c1, c2, etc., at time t’. How do we interpret such a change? The paradigm-​based story would roughly be the following. At time t, all below-​best-​ practice firms try with varying success to imitate the technological leader(s). Moreover, firms change their market shares, some may die, and others may enter: all this obviously changes the weights (i.e., the relative frequencies) by which techniques/​firms appear. Finally, at least some of the firms try to discover new techniques, prompted by the perception of innovative opportunities, irrespective of whether relative prices change or not. For the sake of illustration, in Figure 1.1.1, firm-​3 succeeds in leapfrogging and becomes the technological leader while firm-​m now embodies the marginal technique. How do relative prices fit into this picture? In a first approximation, no price-​related substitution among firm-​known blueprints occurs at all. Rather, changes in relative prices primarily affect both the direction of

36   Dosi and Yu imitation and the innovative search by bounded-​rational agents. However, the paradigm-​ based story would maintain that, even if relative prices change significantly, the direction of innovative search and the resulting trajectories would remain bounded within some relatively narrow paths determined by the nature of the underlying knowledge base, the physical and chemical principles it exploits, and the technological systems in which a particular activity is embodied. Still more importantly, persistent shocks on relative prices, or, for that matter, on demand conditions, are likely to exert irreversible effects on the choice and relative diffusion of alternative technological paradigms, whenever such an alternative exists, and, in the long term, to focus the search for new ones. In an extreme synthesis, a paradigm-​based production theory expects as the general case, in the short term, fixed-​coefficient (Leontief-​type) techniques, with respect to both individual firms and industries, the latter showing rather inertial averages over heterogeneous firms. In the longer term, we should observe quite patterned changes—​that is, changes along rather distinct trajectories—​often only loosely correlated with the dynamics of relative prices. In fact, all the available evidence robustly supports these conjectures:  there appear to be wide and persistent asymmetries in efficiency among firms within the same industry (surveys and discussions include Nelson 1981; Bartelsman and Doms 2000; Dosi 2007; Dosi and Grazzi 2006; Syverson 2011). Let us now expand the space over which technologies are described and include, in addition to input requirements, the core characteristics of artifacts, hinted at earlier:  for example, wing load, takeoff weight, etc., in airplanes; circuit density and processing speed in semiconductors; acceleration and fuel consumption in automobiles; etc. Growing evidence suggests that in this higher-​dimension space, trajectories appear and discontinuities are associated with changes in knowledge bases and search heuristics. Indeed, the evidence shows remarkable regularities in the patterns of change within the space of core product characteristics: for example, in commercial aircraft, one can observe a well-​defined trajectory leading from the DC-​3 to contemporary models. More on this evidence can be found in Dosi and Nelson (2010).

Technical Change, International Asymmetries, and Development Naturally, there is an alternative interpretation of all the evidence discussed so far drawing on standard production theory. Let us consider once more Figure 1.1.1. Take, for example, the average technical coefficient C at time t by reading it from published industrial statistics. Indeed, this is what any statistical office publishes. Assume—​by definition, if one believes in the standard formal narrative—​that C is the equilibrium technique (whatever that means, as average and best-​practice techniques are quite different). Relatedly, draw some generic and unobservable downward-​sloped curve through C (say, in Figure 1.1.1, the II curve) and also the observed relative price ratio. Do the same with point C’ corresponding to the average values at t’ and again with the subsequent average observations. Next assume a particular functional form to the unobserved curve postulated to pass through C, C’ , . . . , etc.,

Capabilities Accumulation and Development    37 and call it the isoquant of a corresponding production function. Finally, interpret the relationship between the values of the estimated coefficients in terms of elasticities of substitution (i.e., some notional movement along the II curve, as equilibrium responses to relative price changes) and attribute the residual variance to a drift in the technological opportunity set, as represented by the movement across “isoquants.” For the purpose of this argument, one can neglect whether such a drift is meant to be an exogenous time-​dependent dynamic, as in Solow-​type growth models, or is in turn the outcome of some higher-​level production function of blueprints, as in many new growth models. In any case, if, for whatever reason, relative prices present some intertemporal regularity and so do patterns of technological search (e.g., because they follow paradigm-​ driven trajectories), then one is likely to find a good statistical fit to the postulated model, even when no causal link actually exists between distributive shares and factor intensities. This is a well-​established point, convincingly argued in different perspectives by F. Fischer, R.  Nelson, L.  Pasinetti, A.  Shaikh, and H.  Simon:  see the discussion in Dosi and Grazzi (2006). Take the illustration of Figure 1.1.1 and suppose that the evidence does not refer to two distributions of microtechnical coefficients over time within the same country, but instead to two countries at the same time. After all, paraphrasing Robert Lucas, we only need informed tourists to recognize that most countries can be ranked in terms of average technological gaps. With some additional assumptions on the nature of the production function, one can still claim that C, C’, etc., remain equilibrium realizations of country-​specific allocation processes. Conversely, in the context of an evolutionary approach, one would suggest, as we do, that optimizing choice among technical alternatives commonly shared by all agents in the two countries has little to do with all this, and that one should rather look for an explanation of such international differences within the process of accumulation of technological competence and within the institutions governing market interaction and collective learning. The contrast between (imperfect) learning and optimal allocation of resources as the fundamental engine of development has indeed been repeatedly emphasized by Kaldor, Pasinetti, and, earlier, Schumpeter, but to our knowledge, no one has yet fully explored its consequences for the theory and policy of development. Needless to say, we are dramatizing the differences. After all, learning is intertwined with the process of resource allocation. Still, it is useful to distinguish between what is assumed as having first-​order or second-​order effects. All this has also an empirical counterpart:  indeed, the economics discipline has undertaken far too few exercises at the highest available disaggregation on international comparisons among sectoral technical coefficients. Our conjecture is that, at this level, one could observe a good deal of evidence conflicting with the standard theory of production. Less developed countries may well show higher utilization of all or most inputs per unit of output and perhaps even higher relative intensity of those inputs that the theory would consider to be more scarce (i.e., some loose equivalent of what surrealistically the economic profession calls in international trade the Leontief “paradox”!). Conversely, an evolutionary interpretation is straightforward: unequivocal technological gaps account for generalized differences in input efficiencies. Moreover, if technical progress happens to involve high rates of saving in physical capital and skilled labor inputs, one may also observe less developed countries that use not only more capital per unit of output but also more capital per unit of labor input as compared to technological leaders (Figure 1.1.1 illustrates a similar case: compare, for example, techniques c’3 and cn).

38   Dosi and Yu

Figure  1.1.2  Empirical density of labor productivities, whole manufacturing of China, France, and Italy, years 1998, 2002, and 2006. Note: The first row: constant 2000 prices and exchange rates (IMF source); the second row: Purchasing Power Parity adjusted price (World Bank source). Source: Yu et al. (2015)

Some important implications emerge from this approach. First, the theory predicts persistent asymmetries among countries in the production processes they are able to master. This, of course, also shows up in terms of different input efficiencies: see Dosi et al. (1990). Thus, at any point in time, one can draw two major testable conjectures: (1) different countries might well be unequivocally ranked according to the efficiencies of their average techniques of production and, in the product space, of the (price-​weighted) performance characteristics of their outputs, irrespective of relative prices, and (2) there is the absence of any significant relationship between these gaps and international differences in the capital/​output ratios. In a fundamental sense the process of catching up concerns the shortening of the gap between the distributions of the coefficients in the “advanced” and “catching up” country. As a vivid illustration, consider Figure 1.1.2, which depicts the dynamics in the distributions of labor productivity in China as compared to France and Italy, taken as examples of relatively advanced economies. Second, wide differences apply to the capabilities of developing new products and to different time lags in producing them after they have been introduced into the world economy. Indeed, the international distribution of innovative capabilities regarding new products is at least as uneven as that regarding production processes. For example, if one takes international patents or the number of discrete innovations as (noisy) proxies for innovativeness, the evidence suggests that the club of innovators has been restricted over the whole past century to a dozen developed countries with only three major new entries, Japan (more on the evidence in Dosi et al. 1990), later Korea, and now China. Indeed, the progressive entry into such an exclusive club is the other side of catching up.5 China should

5 

For thorough discussions of catching-​up processes see Lee and Malerba (2017) and Lee (2018).

Capabilities Accumulation and Development    39 be considered a full member of the club with more international patent applications than any other country in the world. More generally, the process of development and industrialization is strictly linked to the inter-​and intranational diffusion of “superior” techniques. Relatedly, as already mentioned, at any point in time, there is likely to be only one or, at most, very few “best practice” techniques of production that correspond to the technological frontier. In the case of developing economies, the process of industrialization is thus closely linked with the borrowing, imitation, and adaptation of established technologies from more advanced economies. These processes of adoption and adaptation of technologies, in turn, are influenced by the specific capabilities, in primis, of domestic firms of each economy. In this context, evolutionary microtheories are well apt to account for the processes by which technological gaps and national institutional diversities can jointly reproduce themselves over rather long spans of time. Conversely, in other circumstances, it might be precisely this institutional and technological diversity among countries that may foster catching up (and, rarely, leapfrogging) in innovative capabilities and per-​capita incomes. We shall briefly come back to this issue later, when looking at some lessons from China. Here let us just emphasize that systematically different rates of learning may have very little to do with “how well markets work.” Rather, the incentives and opportunities that agents perceive in a particular context are themselves the result of particular histories of technologies and institutions. The importance of the institutional dimension for evolutionary theories of production and innovation should come as no surprise: after all, at the micro level, technologies are to a fair extent incorporated in particular institutions and the firms whose characteristics, decision rules, capabilities, and behaviors are fundamental in shaping the rates and directions of technological advance. In turn, firms are embedded in rich networks of relations with each other and with other institutional actors—​ranging from government agencies to universities to banks. China is no exception. Its impressive growth “miracle” emerged through profound processes of “creatively restructuring” a largely centrally planned incumbent industrial structure (Yu et al. 2015), under a progressive but regulated “invasion” by market mechanisms, always guided and vigilated by the central government, which sets the broad collective strategies and “visions” of the future.

Paradigms, Routines, Organizations A locus classicus in the analysis of the profound intertwining between technological learning and organizational change is certainly Alfred Chandler’s reconstruction of the origins of the modern multidivisional (the M-​form) corporation and its ensuing effects on the American competitive leadership over several decades (Chandler 1990, 1992a, 1993). As Chandler himself has recently argued, there are strict links between his story and evolutionary theories (Chandler 1992b). While it is not possible to enter into the richness of the Chandlerian analysis here, let us just recall one of the main messages: It was the institutionalizing of the learning involved in product and process development that gave established managerial firms advantages over startups in the commercialization

40   Dosi and Yu of technological innovations. Development remained a simple process involving a wide variety of usually highly product-​specific skills, experience and information. It required a close interaction between functional specialists, such as designers, engineers, production managers, marketers and managers. . . . Such individuals had to coordinate their activities, particularly during the scale-​up processes and the initial introduction of the new products on the market. . . . Existing firms with established core lines had retained earnings as a source of inexpensive capital and often had specialized organizational and technical competence not available to new entrepreneurial firms. (Chandler 1993, 37)

As thoroughly argued by Chandler himself, these organizational dynamics can be interpreted as an evolutionary story of competence accumulation and development of specific organizational routines (Chandler 1992b). Did seemingly superior organizational forms spread evenly throughout the world? Indeed, the Chandlerian enterprise diffused, albeit rather slowly, in other Organisation for Economic Cooperation and Development (OECD) countries (Chandler 1990; Kogut 1992). However, the development of organizational forms, strategies, and control methods has differed from nation to nation, because of the differences between national environments (Chandler 1992b, 283). Moreover, the diffusion of the archetypical M-​form corporation has been limited to around half a dozen already developed countries (and even in countries like Italy, it involved very few companies, if any). Similar differences can be found in the processes of international diffusion of American principles of work organization, for example, Taylorism and Fordism (for an analysis of the Japanese case, see Coriat 1990). For the purposes of this work, it is precisely these differences and the diverse learning patterns they entail that constitute our primary interest. So, for example, a growing literature identifies some of the roots of the specificities of the German, Japanese, or Italian systems of production in their early corporate histories, which carried over their influence up to the contemporary form of organization and learning (see Chandler 1990; Coriat 1990; Kogut 1993; Durleifer and Kocka 1993; Dosi et al. 1993). Even more so, one observes quite different organizational initial conditions, different organizational histories, and different patterns of learning across emerging countries. However, some pattern appears. (Here we refer essentially to some examples, excluding the Chinese miracle to which this whole book is dedicated: we shall just make some comments at the end.) In particular, one can identify some relatively invariant sequences in the learning processes, conditional on the initial organizational characteristics of the firms and the sectors of principal activity. A first set of regularities regards the varying combinations between acquisition of outside technologies and endogenous learning.6 As is well known, the transfer of technology to developing economies is a common source for the subsequent development of learning capabilities at the firm and sectoral levels. Amsden and Hikino (1993), possibly with

6  The

technology flows to developing economies show a rapid expansion in the 1960s and 1970s; during the 1980s this process decreased its intensity. During the whole period the Asian countries show an increasing role as the major recipients of foreign direct investment and capital goods. The flow of capital goods to Latin American countries remains stable during this period.

Capabilities Accumulation and Development    41 too extreme an emphasis, identify the ability to acquire foreign technology as a central characteristic of late industrialization at the core of which is borrowing technology that has already been developed by firms in more advanced countries. Whereas a driving force behind the First and Second Industrial Revolutions was the innovation of radically new products and processes, no major technological break-​ through has been associated with late-​ industrializing economies. The imperative to learn from others, and then realize lower costs, higher productivity, and better quality in mid-​tech industries by means of incremental improvements, has given otherwise diverse 20th century industrializers a common set of properties. (Amsden and Hikino 1993, 37)7

At a general level, learning patterns can be taxonomized according to the relative importance of the corporate activities involved,8 namely (1)  the acquisition of an existing technology associated with the paradigm prevailing in the developed world, (2) its adaptation and modification in the local environment, and (3) the creation of new innovation capabilities with respect to products and processes. The three learning regimes often follow a temporal sequence. Already the modification of the adopted technology implies learning of new production skills, which grows through the adaptation of these capabilities to local specificities. Note, however, that there is no inevitability in the learning-​by-​doing process, which, on the contrary, requires adequate organization conditions, both within each firm and within each environment. Interestingly, the initial characteristics of corporate organizations appear to exert a strong influence on subsequent dynamics. For example, evidence on the four decades (1950–​1990) following World War II concerning Latin American countries (Argentina, Brazil, Colombia, Mexico, and Venezuela) indicate that the evolutionary sequence of organizational and technological learning can be distinguished among four types of firms, classified mainly in terms of the nature of ownership: subsidiaries of multinational corporations (MNCs), family firms, large domestic firms, and public firms.9 The family firm appears to be characterized by a high “propensity to self-​sufficiency and self-​financing” and the “mechanical ability of an individual,” which frequently stems from immigrant entrepreneurs.10 The technology acquired is related to the technical background of the entrepreneur, and the initial phase is characterized by the adoption of discontinuous modes of production.11 At the beginning, production is characterized by low economies of 7 Although we share their view on the current importance of technological assimilation of outside technologies, one should not underestimate the degree to which this occurred also in the past experiences of late-​coming industrialization and catching up, for example, in the case of the United States or Continental Europe vis-​à-​vis Britain. 8  On a similar point see Teitel (1987). 9  Information on the different phases of the technological accumulation of firms has been taken from the case studies of the Economic Commission for Latin America and the Caribbeans of the United Nations (ECLAC), and the United Nations Development Program (UNDP) and from the overviews of the research findings in Katz (1983, 1984a, 1984b, (1987), Berlinski et al. (1982), Teitel (1984, 1987), and Teubal (1987). 10  See Katz (1983). 11  Two alternative modes of production, namely continuous and discontinuous, appear to be relevant for the analysis of learning patterns. Continuous methods imply (1) specialization of production along precise product lines, (2) production planning for each line of business, (3) relatively high-​scale

42   Dosi and Yu scale (also as a consequence of the limitations of the domestic market and the difficulties in exploiting export possibilities). A sort of ideal learning trajectory for a South American family-​stabilized firm that is technologically progressive (which is not by any means a general characteristic of the whole population) would run more or less as follows. First, the effort is concentrated on product design activities (most likely due to the incentive provided in the past by import substitution policies) and, increasingly, on quality improvements and product differentiation. Next, attention is focused on process engineering, the organization of production, and the exploitation of some economies of scale, until (in some empirically not too frequent cases) highly mechanized production is achieved. Along the process, it might happen (again, not too often) that the organization is developed beyond the original family hierarchy and “managerialized.” The story concerning subsidiaries of foreign firms that emerges from the set of case studies cited earlier is quite different. The bulk of competences and technologies derives from the parent company, and learning mainly concerns the adaptation to the local environment, adjustments in product mixes, and rescaling of production lines. In some cases, this holds throughout the history of the subsidiary, while in others an autonomous capability in product and process design is developed. (Note also that in Latin America foreign subsidiaries tend to be concentrated in mass production activities like vehicles, consumer durables, food processing, etc.) State-​owned firms display yet another archetypical learning story. First, they have been concentrated in sectors that have tended to be considered “strategic” and often happened to be continuous process industries such as bulk materials, steel, and basic petrochemicals, in addition—​in some countries—​to aerospace and military production. Second, the strategies have generally been dictated by political considerations. Third, learning has often started via agreements with international suppliers of equipment. In the “healthy” scenario—​which is not the rule—​international technology transfer agreements became more sophisticated, involving adaptation of plants and technologies to local circumstances, while the emphasis was kept on personnel training and learning by doing and by using. Finally, autonomous capabilities of plant upgrading and process engineering were sometimes developed. As regards large domestic firms, it is hard to trace any modal patterns. In the case studies, they sometimes appear to follow patterns not too different from the family firms, in other cases they seem to perform like East Asian business groups (see later), and yet in other cases learning appears to be much more directed toward the exploitation of political rents and financial opportunities rather than technological accumulation.

economies, and (4) relatively low complexity of products and low flexibility in the rates of throughput. Conversely, discontinuous methods involve (1) the possibility of lower standardization of production, (2) relatively lower economies of scale, (3) the organization of production into multiproduct “shops,” and (4) general purpose, machinery. It is remarkable that in many Latin American examples (but not in Far Eastern ones), at least until the 1980s, incremental learning appeared to be more successful in discontinuous batch production as compared to continuous and mass-​production activities (such as chemicals, many consumer durables, etc.).

Capabilities Accumulation and Development    43 It is interesting to compare these sketchy Latin American “corporate trajectories” with other experiences, such as the Korean (and the earlier Japanese) ones.12 To make a long and variegated story very short, in Korea it seems that the major actors in technological learning have been large business groups—​the chaebols—​which were able at a very early stage of development to internalize skills for selection of technologies acquired from abroad and for their efficient use and adaptation and, not much later, have been able to grow impressive engineering capabilities. Conversely, the Taiwanese firms’ organizational learning has rested much more in large networks of small and medium firms very open to the international markets and often developing production capabilities that complement those of first world companies (Dahlman and Sananikone 1990; Ernest 1989). This impressionistic list of stylized organizational patterns of learning could be, of course, very lengthy. For our purposes, it should be understood only as an illustration of the multiplicity of evolutionary paths that organizational learning can take. The fundamental point here is that the rates and directions of learning are not at all independent from the ways corporate organizations emerge, change, develop particular problem-​solving capabilities, diversify, etc. Indeed, as already mentioned and thoroughly discussed in Yu et  al. (2015), different forms of corporate governance have powerfully influenced the evolution of Chinese manufacturing and the dynamics of productivity thereof.

Institutional Development of Technological Capabilities, Organizations, and Incentive Structures: Coevolutionary Dynamics A fundamental element in countries that successfully caught up with the leaders during the 19th and 20th centuries was active government support of the catch-​up process, involving various forms of protection and direct and indirect subsidy. The guiding policy argument has been the need to protect domestic industry, in the industries judged critical in the development process, from advanced firms in the leading nations. Alexander Hamilton’s argument (1791) for infant industry protection in the new United States was virtually identical to that put forth decades later by Friedrich List (1841) regarding Germany’s needs. Gerschenkron’s (1962) famous essay documents the policies and new institutions used in Continental Europe to enable catch-​up with Britain. The same story also fits well with the case of Japan, and of Korea and Taiwan somewhat later. In many countries these policies engendered not successful catch-​up, but a protected inefficient home industry. However, they also were the hallmark during the 20th century of all the countries that have achieved

12  As discussed at greater depth in Amsden (1989), Amsden and Hikino (1993, 1994), Enos and Park (1988), Bell and Pavitt (1993), and Lall (1992).

44   Dosi and Yu their goals of catching up. We need to learn more about the circumstances under which infant industry protection leads to a strong indigenous industry and the conditions under which it is self-​defeating, and indeed several contributions to this project shed new light on the issue. These policies obviously angered companies in the leading countries and their governments, particularly if the supported industry not only supplied its home market but also began to invade the world market. While the case made after World War II for free trade was mostly concerned with eliminating protection and subsidy among the rich countries, with some sympathy for the argument that infant industry protection was useful for developing countries, the more recent international treaties increasingly have been used against import protection and subsidy in less developed countries seeking to catch up from far behind. Our belief is that Hamilton and List were, and continue to be, right that successful catch-​ up in industries where international trade is considerable requires some kind of infant industry protection or other modes of support. Moreover, during the 19th and early 20th century, many developing countries operated with intellectual property rights regimes that did not restrict seriously the ability of their companies to copy technologies used in the advanced countries. There are many examples where licensing agreements were involved, but we believe that for the most part these were vehicles through which technology transfer was effected for a fee or other considerations, rather than instances of aggressive protection of intellectual property by the company in the advanced country. Like infant industry protection and subsidy, conflicts tended to emerge largely when the catching-​up company began to encroach onto world markets, or even to export to the home market of the company with the patent rights. Increasing instances of this clearly were a major factor in establishing the treaty on Trade-​Related Intellectual Property Rights (TRIPS). But this treaty makes vulnerable to prosecution not just companies in developing countries that are exporting, but also companies that stay in their home markets. Given that, what are the different domains of policy intervention and how do they map into different policy measures and related institutions? Table 1.1.1 summarizes an exploratory taxonomy of the interactions between these variables. In the last resort, policies and other activities of “institutional engineering” affect together (1) the technological capabilities of individual and corporate organizations and the rate at which they actually learn, (2)  the economic signals that they face (including, of course, profitability signals and perceived opportunity costs), and (3) the ways they interact with each other and with nonmarket institutions (e.g., public agencies, development banks, training and research entities, etc.). It happens that all major developed countries present relatively high degrees of intervention—​whether consciously conceived as industrial policies or not—​that affect all the aforementioned variables. And this applied, even more so, to the period when today’s developed countries were catching up with the international leader. What primarily differentiates the various countries are the instruments, the institutional arrangements, and the philosophy of intervention. In another work, one of us considers the case of Japanese policies, especially in relation to electronic technologies, after World War II, as a paradigmatic example of catching-​up policies (Dosi 1984).

Capabilities Accumulation and Development    45 Table 1.1.1. A Classification of the Variables and Processes That Institutions

and Policies Act Upon (in General and with Particular Reference to Technological Learning) Domain of Policy Intervention

Policy Measure

Related Institutions

(1) Opportunities of scientific and technological innovation

Science policies, graduate education, “frontier” technological projects

Research universities, public research centers, medical institutes, space and military agencies, etc.

(2) Socially distributed learning and technological capabilities

Broader education and training policies

From primary education to polytechnics to US-​type “land-​grant colleges,” etc.

(3) Targeted industrial support measures affecting, e.g., types of firms, etc.—​in primis the structure, ownership, and modes of governance of business firms (e.g., domestic vs. foreign, family vs. publicly owned companies, etc.)

From the formation of state-​owned firms to their privatization, from “national champions” policies to policies affecting MNC investments, all the way to the legislation affecting corporate governance

State-​owned holdings, public merchant banks, public “venture capitalists,” public utilities

(4) The capabilities of economic agents (in the first instance business firms) in terms of the technological knowledge they embody, the effectiveness and speed with which they search for new technological and organizational advances, etc.

Cf. especially points (2), (3), and also R&D policies; policies affecting the adoption of new equipment, etc.

(5) T he economic signals and incentives profit-​motivated agents face (including actual and expected prices and profit rates, appropriability conditions for innovations, entry barriers, etc.)

Price regulations; tariffs and quotas in international trade; intellectual property rights regimes, etc.

Related regulatory agencies, agencies governing research and production subsidies, trade-​controlling entities, agencies granting and controlling IPRs

(6) S election mechanism (overlapping with the above)

Policies and legislation affecting antitrust and competition; entry and bankruptcy; allocation of finance; markets for corporate ownership; etc.

Antitrust authorities, institutions governing bankruptcy procedures, etc.

(continued)

46   Dosi and Yu Table 1.1.1. Continued Domain of Policy Intervention

Policy Measure

(7) Patterns of distribution of information and of interaction among different types of agencies (e.g., customers, suppliers, banks, shareholders, managers, workers, etc.)

Governance of labor markets, product markets, bank-​ industry relationships, etc., all the way to collectively shared arrangements for within-​ firm information-​sharing mobility and control, forms of cooperation and competition among rival firms, etc. (cf., e.g., the historical differences between Japanese and Anglo-​ Saxon firms)

Related Institutions

Interestingly, Japan appears to have acted comprehensively upon all the variables categorized in our aforementioned taxonomy. A heavy discretionary intervention upon the structure of signals (also involving formal and informal protection against imports and foreign investments) recreated the “vacuum environment” that is generally enjoyed only by the technological leader(s). However, this was matched by a pattern of fierce oligopolistic rivalry between Japanese companies and a heavy export orientation that fostered technological dynamism and prevented any exploitation of protection in terms of collusive monopolistic pricing. The export orientation also exposed these firms to the discipline of competition with foreign firms, but in foreign markets. It is tempting to measure this successful Japanese experience—​notwithstanding recent, mostly macroeconomic difficulties—​with, on average, less successful others, such as the European ones, which heavily relied upon one single instrument, financial transfers (especially research and development [R&D] subsidies and transfers on capital account), leaving to the endogenous working of the international market both the determination of the patterns of signals and the response capabilities of individual firms. Let us simplify the point to the extreme. Take, say, a Japanese electrical firm in the 1950s. Should it have entered into semiconductor production? Given incumbent international prices and a reasonable self-​appreciation of its own production capabilities, no reasonable profit-​motivated firm would have given a positive answer. And for religious believers in the “market magic” that ought to be the end of the story: as potato chips are identical to computer chips, comparative advantages ought to rule. However, if the two types of chips are different in terms of innovative opportunities, then the policy task is indeed to distort international market signals to make (eventually) the commitment to computer chips instead of potato chips profitable for any profit-​motivated firm (on the implications of intersectoral differences in technological opportunities for the ensuing pattern of industrialization, see Dosi et al. 2021). Certainly, there are country-​specific features of the Japanese example that are hardly transferable. However, that case, in its striking outcome, points at a general possibility of reshaping the pattern of “comparative advantages” of a country differently from the endogenous evolution of the international markets.

Capabilities Accumulation and Development    47 The comparison between the experience of Far Eastern countries and Latin American ones is equally revealing (cf. Amsden 1989, 2001; Wade 1990; Kim and Nelson 2000; Dosi et al. 1994; among others). In a nutshell, Korea—​as well as other Far Eastern economies—​has been able to “twist around” absolute and relative prices and channel the resources stemming from “static” comparative advantages toward the development of activities characterized by higher learning opportunities and demand elasticities (Amsden 1989). And they did that in ways that penalized rent-​seeking behaviors by private firms. This process has been further supported by a set of institutions and networks for improving human resources (Amsden 1989). All this sharply contrasts with the Latin American experience, where the arrangement between the state and the private sector has often been more attentive to inefficiencies and rent accumulation and less attentive to the accumulation of socially diffused technological capabilities and skills. Ultimately, success or failure appears to depend on the combinations of different institutional arrangements and policies, insofar as they affect learning processes by individuals and organizations on the one hand, and selection processes (including, of course, market competition) on the other. Certainly, the historical experience shows a great variety of country-​and sector-​specific combinations between the types of policies illustrated earlier. Some subtle regularities nonetheless emerge. First, a regularity, holding from 19th-​century Europe and the United States all the way to contemporary times, is the centrality of public agencies, such as universities, and public policies in the generation and establishment of new technological paradigms. Second, and relatedly, incentives are generally not enough. A crucial role of policies is to influence the capabilities of the actors, especially in the foregoing case of new technological paradigms, but also in all cases of catching up in which no reasonable incentive structure might be sufficient to motivate private actors to surmount big technological lags. Third, market discipline is helpful insofar as it weeds out the low performers and rewards the high performers within particular populations of firms. However, nothing guarantees that selective shocks that are too high will not wipe out an entire firm population, thus also eliminating any future learning possibility. Fourth, policies—​especially those aimed at catching up—​generally face the need to balance measures aimed at capability building (and also at protecting the “infant learner”) with mechanisms curbing inertia and rent-​seeking. For example, the latter are indeed two of the major elements missing in the old Latin American experience of import substitution, while the former are what is lacking under many more recent “liberalization” policies. Fifth, historically, a successful catching-​up effort in terms of per-​capita income and wages has always been accompanied by catching up in the new and most dynamic technological paradigms, irrespective of the initial patterns of comparative advantage, specialization, and market-​generated signals. Our conjecture is that, ceteris paribus, the structural need for policies affecting the economic signals (including relative prices and relative profitability) as they emerge from the international market will be higher the greater the distance of any one country from the technological frontier. This is what Amsden (1989) has provocatively called policies of deliberately “getting the prices wrong.” Conversely, endogenous market mechanisms tend to behave in a “virtuous” manner for those countries that happen to be on the frontier, especially in the newest or most promising technologies. This is

48   Dosi and Yu broadly confirmed by historical experience: unconditional free trade often happened to be advocated and fully exploited only by the technologically and politically leading countries.

Some Remarks on the Chinese Transformation, by Way of a Conclusion The spectacular success of China in its Great Transformation is also, we suggest, a striking vindication of a coevolutionary view linking technological learning, organizational transformation, and institutional change ubiquitously, characterized by widespread dynamic increasing returns (see Myrdal 1957; Kaldor 1972; Cimoli et al. 2009, among many unorthodox others). In fact, the accumulation of knowledge and capabilities at the levels of individuals, organizations, and countries is at the core of increasing returns. The “unbound Prometheus” systematically accumulating and improving technological and organizational knowledge has been a crucial deus ex machina of the early industrialization of almost three centuries ago, as well as of subsequent episodes of development (Landes 1969; Freeman 1995; Freeman and Soete 1997). The rapid economic catch-​up and industrialization in China are no exception. Its institutional setups in fact have entailed more of learning and “creative restructuring” of domestic firms rather than sheer “creative destruction,” and even less so a multinational corporation-​led drive (Yu et al. 2015). Contrary to common belief, we think there is not much evidence on the role of foreign investment as an early driver of technology transfer (this is possibly a point of disagreement with Chapter 6.2 by Breznitz and Murphee in this Handbook). For sure, later joint domestic-​foreign ventures have been a major vehicle of domestic learning. But all this happened under a good deal of “political moral suasion,” which could not have happened, for example, under Yeltsin’s “opening”: selling out the whole of Russian industry and mining. Points often forgotten are, first, that the rapid catching up since 1978 has been characterized by mobilization of the technological and organizational capabilities accumulated in the preliberalized stage. It is often forgotten that China, even in 1949, had already a share of “heavy industry” in the total industrial output of 26.4%, and after the revolution it increased to 53.5% in 1962, notwithstanding the failures of the “Great Leap Forward” (Campbell 2013). The 1950s were a period of intensive and quite successful “Soviet-​based” learning, leading, despite the Soviet-​Chinese schism, to a Chinese atomic bomb (1964), largely domestic-​built intercontinental ballistic missiles (late 1960s), and a very ambitious space program. The ratio of R&D to national income (a measure smaller, but not too much, than the Western measure of GDP) was 2% in 1961, that is, higher than Italy today! China arrived at Deng’s reforms grounded on quite mature industrial capabilities and under continuing political guidance. “Market opening,” without other qualifications, leads to all dramatic International Monetary Fund (IMF)-​led failures. For more on the early importance of the heavy industries, on the one hand, and on the construction of a Chinese national system of production and innovation, on the other, see Campbell (2013), Gu and Lundvall (2006), Hsueh and Woo (1986), and Wang and Hong (2009), among others. Second, but relatedly, Chinese industrialization has certainly involved catching up of all sectors by means of big and coordinated investment and capital accumulation, in the

Capabilities Accumulation and Development    49 spirit of that suggested by the founding fathers of development economics (Nurkse 1953; Gerschenkron 1962; Rosenstein-​Rodan 1943, 1961; Hirschman 1958; Prebisch 1949). Third, note that, more importantly, the catching up has been associated with learning effects well beyond the sheer accumulation of capital, involving the improvement of technological and organizational capabilities and the more efficient use of both capital and labor (Cimoli et al. 2009; Lee 2013), together, of course, with the general improvement in formal education and skills. Last but not least, the “Chinese miracle,” as basically all other modernizing miracles following the First Industrial Revolution, begins with the painstaking formation of a working class, with all the changes in the whole anthropology of perception of time, discipline, skillfulness, and obedience (possibly with some solidarity and rebellion).13 In our view there is little doubt about the historical lessons, of which China is by far the most striking one, pointing out the crucial importance of various ensembles of industrial policies and institution-​building efforts in nurturing capability accumulation and industrial development. However, we face three interrelated questions. The first concerns whether what applied to the past will apply to the future: whether the magic, that was not brought about by the Washington Consensus policy medicines, is going to occur nonetheless as a natural by-​product of “globalization.” Our major message here is that divergence and heterogeneity have been and continue to be the dominant tendencies in the world economy. In fact, it could well be that under conditions of dynamic increasing returns, more international openness of capital and trade flows might well “naturally” induce divergence across regions and countries (more in Dosi et al. 2017), hence, in our view, the continuing importance of measures of discretionary policy intervention able to trigger and fuel what we have called the “great industrial transformation.” Clearly, the international conditions have changed compared to when, say, the United States was taking its first steps toward catching up, and even compared to when Korea or Taiwan were entering the international scene. The World Trade Organization (WTO) and the TRIPS agreements have been putting novel constraints on what policies can and cannot do with respect to both domestic industry and trade flows (with a caveat regarding the noise shocks from some contemporary presidents). First-​world companies are as aggressive as ever before in the defense of their proprietary technologies. But it is the very emergence of China as a major industrial player that has profoundly changed the patterns of opportunities and constraints facing other actual or would-​be industrializers. However, the processes of knowledge accumulation and industrial development will continue to require relatively massive doses of public policies and institution building, molding a national political economy friendly to technological and organizational learning. This leads to our second major question. Put provocatively, how long will it take before China “throws away the ladder”—​as Chang (2002) puts it—​and moves to the club of the winners, praising Ricardo the free trader and dismissing List the theorist of capability accumulation? This has been a robust secular pattern. All countries achieving world industrial leadership tend to rewrite history, reconstructing their free trade

13  As

Gerschenkron (1962) puts it, “industrial labor, in the sense of stable, reliable and disciplined group that has cut the umbilical connecting it with the land and it has become suitable for utilization in factories, is not abundant but extremely scarce in a backward country. Creation of an industrial labor force that really deserves its name is a most difficult and protracted process” (p. 9).

50   Dosi and Yu virginity: it happened to England and next to the United States, and we would be surprised if it did not happen to a winning China. No matter, third, as soon as China joins the “club of innovators,” the coevolutionary processes we were talking about at beginning of this chapter are bound to profoundly change. Catching up is quite different from maintaining and exploiting technological leadership. Institutions and relations among them are bound to change too, for example, among science, technology, and industry, or the mechanisms governing income distribution. But this is the subject of an entirely different essay.

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Chapter 1.2

China’s Indu st ria l Devel opm ent St rat e g i e s and P ol i c i e s Justin Yifu Lin and Jianjun Zhou The year 2018 was a year worthy of celebrating in China. It had been 40 years since the reform and opening-​up policies in China started in 1978. At that time, China was one of the poorest countries in the world. According to World Bank statistics, in 1978, China’s per capita gross domestic product (GDP) was only $156, less than one-third of the per capita GDP of $495 in sub-Saharan Africa, and 30% lower than $204 in India. Meanwhile, 81% of China’s population lived in rural areas, and 84% of the population had their consumption expenditure below the international poverty line of $1.25 a day. China’s exports accounted for only 4.1% of GDP, while imports accounted for only 5.6%, which together accounted for only 9.7%. Moreover, more than 75% of the exported products were either agricultural products or agricultural processed products. On the basis of such a weak economy, from 1978 to 2018, the Chinese economy achieved an average annual growth rate of 9.4% for 40 consecutive years. In human history, no other country or region has ever achieved such a high growth rate for such a long time. The average annual growth rate of China’s foreign trade reached 14.5% in this period, becoming the world’s largest exporter in 2010 and the world’s largest trading country in 2013 with more than 95% of its exports from manufacturing sectors. China gained the name of the “factory of the world,” following the United Kingdom after the Industrial Revolution, the United States after the 19th century, and Germany and Japan after World War II. In 2014, China overtook the United States as the world’s largest economy measured in purchasing power parity. In 2018, China’s per capita GDP reached $ 9,780. In this process, more than 700  million Chinese people have been lifted out of poverty. This is not only a great improvement in the welfare of the Chinese people but also a great contribution to poverty alleviation in the world. It is worthwhile to note that China’s extraordinary performance was the result of structural transformation from an agrarian economy to an industrialized economy. The large-​scale industrialization involving 1.3 billion people, especially the strategies and policies behind this large-​scale industrialization, is the key to the success of the economic development in

China's Industrial Development Strategies and Policies    57 contemporary China. Compared with several industrialization efforts before 1949, what was the right thing China did with industrialization since 1949, especially after the reform and opening up in 1978? This is the subject to which this chapter hopes to make a contribution.

The Reform Approach: Proceeding from Reality Pragmatically There are many explanations for the miracle of China’s economic development. In the past four decades, China did not suffer from a systematic crisis as other transition economies in the former Soviet Union and Eastern Europe did during their transition from a plan economy to a market economy. This is primarily due to the pragmatic reform approach that China adopted. As far as the approach is concerned, China has always formulated its development strategies and policies based on China’s own economic reality while learning from the experience and lessons from other countries, developed and developing. This means that China learned the mainstream economic theory selectively and rejected the neoliberal policies package that the “Washington Consensus” advocates and many other transition economies have implemented. Practice shows that most countries guided by mainstream economics to form their development and transition policies are not very successful, while the path for transition and development of a few successful countries goes against mainstream economics (Lin 2011). The problem of huainan weiju huaibei weizhi (transplanting the orange in the south to the north becomes a trifoliate orange, meaning a valid theory in one place may not be valid in other places due to differences in conditions) often arises when Western mainstream economic theories are applied to developing countries. Particularly, the neoliberalism reforms have not brought economic prosperity but economic collapses, stagnation, and crises to developing countries. Some neoliberal economists argued that the failures arose from the government agencies’ and officials’ lack of training in Western economics and their inability to cope with the challenges of economic reform. Looking back on history, the argument may confuse the cause with the consequence. On the one hand, the success or failure of economic reform can only be judged by the results, and the applicability of any economic theory depends on its preconditions; on the other hand, common sense and experience will be more important than advanced theories for economic reform due to the complexity of reform. Those fast-​growing countries such as China, Japan, and South Korea always combined theories selectively with their national conditions and real needs, rather than apply the theories directly. For example, the East Asian dragons adopted an export promotion strategy instead of the prevailing structuralist import substitution strategy during their take-​off period after World War II, and China, Vietnam, and Cambodia adopted a gradual, piecemeal transition strategy instead of the neoliberal shock therapy (Lin 2009). The Washington Consensus, with marketization, stabilization, and privatization as its main contents, has brought hyperinflation and large-​scale embezzlement of state-​owned assets to Russia and some Latin American countries (Hausmann, Rodrik, and Velasco 2008). Excessive liberalization has led to a loss of financial control, a sharp decline in the

58   LIN and Zhou savings rate, uneven income distribution, and private oligopoly to these countries, which in turn has caused them to fall into the “middle-​income trap.” As a result, many reforms of the Washington Consensus are counterproductive. In many countries affected by the Washington Consensus, the privatization of state-​owned enterprises has not led to the reduction of subsidies and efficiency improvement to enterprises, but has brought “de-​industrialization” to these countries (MacMilland and Rodrik 2011). The proportion of industry in the national economy is getting lower, economic performance is getting worse, and economic crises are frequent. The reason for the failure of neoliberalism or the Washington Consensus is that it takes the institutional system and development model of developed countries as the standard. It advocates that if the late-​developing countries want to achieve economic development and modernization, they must imitate the economic system and policy arrangements in the developed countries, and thus implement comprehensive, thorough, and even excessive liberalization, privatization, and stabilization reforms. However, this policy package neglected the fact that many firms in the transition economies were nonviable and many policy interventions before the transition were endogenous to the need for protecting those nonviable firms (Lin 2012). Facing the transition failures, the World Bank and the International Monetary Fund (IMF) have begun to rethink the Washington Consensus in recent years. Zoellick (2010) pointed out that the Washington Consensus is fading out of the historical background, and there is no possibility for one political economic consensus that can be applied from one city to the whole world. Strauss-​Kahn (2011) claimed that the Washington Consensus, which advocates the free flow of capital, has already become history. He insists that the international flows of “hot money” should be taxed and regulated, and also emphasizes the increase of social cohesion and inclusiveness to consolidate the foundation of sustainable economic and social development. Advocates of the Washington Consensus also ignore the large number of industrial policies and regulations in advanced industrialized countries. Law and Kim (2011) argued that although the United States claims to be the world’s largest free-​market economy, government regulation is still a main feature of its economic activity. In contrast, China’s approach to seeking truth from facts and choosing the development path independently is crucial for its success. The World Bank representative in China believes that such a development approach is an important difference between China and other developing countries and praises China for always controlling its own reform agenda (Lin and Wang 2017). In this sense, China’s self-​determined and gradual reforms based on China’s own reality have universal significance for the economic transformation and social development of developing countries.

Incremental Reform and the Viability of Enterprises Since the founding of the People’s Republic of China in 1949, China’s economic system has undergone a long process of transition. After 1949, China made a lot of efforts to build an independent and complete industrial system. For a newborn country, being subjected to

China's Industrial Development Strategies and Policies    59 various political and economic factors, it is not practical to be critical of its industrialization achievements. Compared with several industrializations in modern history, the capacity of the new Chinese government to implement industrialization is constantly improving. History cannot be easily separated. The government’s capacity to lead industrialization, a complete industrial system, and various public-​owned enterprises is the premise and basis for China’s industrialization since the reform and opening up. From a historical point of view, some of the private enterprises that developed rapidly during the period of reform and opening up were born out of the early township enterprises, and some were evolved from the transformation of state-​owned enterprises. The technology of many newly built private enterprises also relied on the skilled workers or engineers of state-​owned enterprises. At the beginning of reform and opening up, there were many heated discussions about what kind of economic system to adopt in China. In the face of various debates, Chinese leaders adhered to the principle of pragmatism and transformed the economic system from the planned economy to the current socialist market economy in a gradual piecemeal approach. In this process, the relationship between government and market  also underwent profound changes. China has adopted a strategy of combining effective markets with facilitating government, effectively playing the role of the market in economic development and optimizing the role of the government. Since market failures in the process of economic transformation and industrial upgrading are widespread and inevitable, the government has to play a role in overcoming market failures and promoting market effectiveness. While the goal of facilitating government is making the market effective, the market’s effectiveness should be based on the premise of facilitating government. In summarizing the development practices of successful and unsuccessful countries, the most significant difference is that unsuccessful countries always have a one-​sided focus on the role of the government or market (Lin 2011). Successful development experience has proved that the government and the market have to play their respective roles in economic activities. This is because, in the process of economic development, market failure is inevitable. When the market fails, the role of the government in overcoming market failures is necessary.1 It is worth noting that the government must be proactive in economic and social development and avoid failing to act and acting irresponsibly. An appropriate relationship between the government and the market has also become the reason for the success of China’s economic reform. According to the report of the Commission on Growth and Development (2008), the reason for the rapid and sustainable growth of 13 economies including China after World War II is that these economies have effective, proactive governments and allocate resources through the market. Proactive governments can implement economic development strategies through industrial policies, public investment, and capital account control to provide guidance and support for the development of the market economy. Under the guidance of such economic development thinking, China has proceeded from the realistic situation of the country to promote reform through a gradual, dual-​track, and incremental approach. Starting from rural areas and agriculture, China launched its own

1  Nolan (1995) argued that even in the extreme cases of “free markets,” such as Hong Kong since 1949, Britain in the Industrial Revolution, and the United States in the 19th century, government intervention turns out to be involved much more than is commonly supposed.

60   LIN and Zhou market economy reform. Through the “Household Responsibility System,” the peasants’ enthusiasm is widely mobilized when the state retains ultimate ownership of the land and grants farmers the right to cultivate the land and the right to dispose of the produce. The reform of state-​owned enterprises always focused on the decentralization of enterprises and the improvement of the viability of enterprises. This reform has promoted the enterprises’ development as independent players in the market. From the perspective of ownership, China has developed a multicomponent economy, such as the private economy and the foreign economy, rather than privatizing large and medium-​sized state-​owned enterprises. This is because the principal-​agent problem exists not only in state-​owned enterprises but also in large private enterprises with separation of ownership and control rights. In terms of sequence, China’s reform of state-​owned enterprises in the 1990s was behind the development of the private economy in the 1980s. From the perspective of the industrial sector, on the one hand, China has given transitional subsidies to the capital-​intensive industrial sectors that were prioritized in the plan economy and were not consistent with China’s comparative advantages, and on the other hand, it has liberalized access to the labor-​ intensive sectors that were previously suppressed and were consistent with China’s comparative advantages. From the perspective of technological progress, as a latecomer, China has adhered to combine technology’s import for the sectors for which China is in the process of catching up and indigenous research and development (R&D) for strategic sectors that are essential for national and economic security (Lin 2017). China’s gradual and incremental economic reform has recognized the interests of enterprises and individuals as microagents, mobilized the enthusiasm of market players such as workers and farmers, adjusted the price system and resource allocation methods, achieved the common development of the multiple ownership system, and maintained a smooth transition of China’s economy and society. More importantly, this reform is not a shock therapy. It does not eliminate all distortions in one stroke, but allows the coexistence of the plan and the market. This reform approach can gradually develop the market with the government’s guidance to realize a transition from the dual-​track system to a market system, and explore a development path of the socialist market economy. Western mainstream economic theory once believed that the gradual dual-​track system adopted by the Chinese government was the worst approach for economic transition. However, the practice of China’s reform and opening up has proved that a pragmatic and gradual dual-​track system is an important reason for China’s economic stability and rapid development in the transition from a plan economy to a market economy. In addition, a few successful developing countries such as Vietnam, Cambodia, and Mauritius have implemented a gradual dual-​track system similar to China (Lin 2014).

The Historical Evolution of Industrial Policies in China With the reform and improvement of the socialist market economic system, China has gradually established a market-​driven, open, and inclusive industrial policies system. Industrialization was a process of continuous market creation and industrial capacity

China's Industrial Development Strategies and Policies    61 improvement, which requires long-​ gestation cultivation and learning (Wen and Fortier 2016). Since the 1980s, as a means of promoting economic development by the government in market economic activities, industrial policies have been widely used in China. The industrial strategy of the “Five-​Year Plan” and the R&D support of specific industries can all be regarded as an integral part of industrial policy. In 1988, the Chinese government set up a number of institutions responsible for industrial policies within the National Planning Commission and other institutions to carry out the formulation of industrial policies. The Ministry of Industry and Information Technology and the Ministry of Science and Technology, which were established afterward, also participated in the formulation of industrial policies under the unified leadership of the state council. In 1989, the State Council of China issued the “Decision on the Key Points of Current Industrial Policies,” which was the first time a national-​level policy outline was formulated in the name of industrial policy. This industrial policy focused on the imbalance between supply and demand and the inappropriate industrial structure. It was committed to cultivating the effective supply capacity of enterprises. According to this document, the central government was responsible for formulating industrial policies, and various ministries and provincial governments were responsible for formulating implementation measures, which could not deviate from the central government’s policy (State Council 1989). Therefore, this document highlighted the original intention and principle of the Chinese government to formulate industrial policies. In 1994, after entering the period of the socialist market economy, the State Council of China promulgated the “Outline of the National Industrial Policies in the 1990s.” This document clearly stated that under the state’s macroeconomic regulation and control, industrial policies should be formulated to give full play to the fundamental role of the market in resource allocation. It also formulated a series of industrial policies in communication, construction, electronics, machinery, petrochemical, and other sectors (State Council 1994). After the international financial crisis in 2008, developed countries implemented a “re-​industrialization” strategy. Under this background, the Chinese government also formulated industrial development initiatives to solve the problems in Chinese manufacturing such as “large but not strong” and weak innovative capability. China’s industrial policies, including structural policies, technological policies, organizational policies, and regional policies, play a role in promoting industrial structure upgrades, technology advancement, and industrial organization efficiency. With the upgrade in economic development and industrial structure, the contents and focus of China’s industrial policies have undergone many changes. At the beginning of reform and opening up, industrial restructuring was one of the important goals of China’s economic development. At that moment, the industrial structural policy paid more attention to the balance between light industries and heavy industries. In the 21st century, China’s industrial structure policies focus on balancing agriculture and industry, while paying attention to the development of the tertiary industry. In addition to focusing on specific industries, infrastructure has always been an important area in China’s industrial restructuring. China’s industrial technological policies have always been concerned with the improvement of industrial technological capabilities, especially those that are capital intensive with strong externalities and insufficient private investment. Hence, government R&D expenditure has been greatly increased in recent years. Due to issues such as enterprise size and repeated investment,

62   LIN and Zhou the excessive competition of Chinese industries was very serious. Industrial organizational policies have also made many efforts to improve the efficiency of industrial organization. From the revitalization in the northeast, development in the west, and rise of the central region, China’s regional industrial policies have been trying to release the advantages of each region to narrow the gap between regions. As indispensable participants in China’s economic development, China’s local governments (especially provincial governments) played an important role in R&D support and industrial cluster cultivation. Industrial policies promoted by local governments have been an important part of China’s industrial policies, although there are different views on local governments in terms of redundant construction and excessive competition. Even in economically advanced cities such as Shanghai and Shenzhen, the government’s industrial policies also play an active role. These industrial policies are reflected in the provision of infrastructure, attracting talent, R&D funding, credit discounts, and venture capital to reduce costs and promote industry incubation and development. The effective formulation of industrial policies depends on the cognition and understanding of industrial development between the appropriate roles of government and enterprises. The effective implementation of industrial policies requires the mutual cooperation and support of the government and enterprises. Local governments have greater policy space in this regard, especially for industries that are in line with local comparative advantages. High-​tech industries such as high-​speed railway manufacturing and liquid crystal displays, which have been successfully pursued in recent years, are typical examples of China’s industrial policies. As a broad form of industrial policies, the planning for economic development has always played an important role in China’s industrial policy system. The five-​year plans in the early stage of the founding of the People’s Republic of China and those in the period of reform and opening up all played an important role in establishing a relatively complete industrial system and the national economic system. In particular, planning for important historical nodes such as the First Five-​Year Plan and the Sixth Five-​Year Plan played an active role in specific historical periods and was widely recognized (Liu and Yang 2009, 432–​435). In the new era, the formulation of economic and social development plans is a process not only of policy research but also of social consultation and extensive mobilization. Through such research and mobilization, the government, enterprises, and public have more consensuses on the goals and paths of economic and social development than before. However, unlike the plans in the planned economy period, industrial policy is no longer mandatory and serves as the guidance and regulation of market activities. In this sense, the current Chinese industrial policies, especially development plans, are mostly guiding and visionary documents. As a developing country, the formulation of such industrial policies is also based on the development experience of developed countries such as the United States and Japan. In terms of R&D, especially for basic research, the total amount of R&D investment of the Chinese government and the proportion of R&D expenditures in the whole society are still lower than those of the US government. According to science and engineering indicators by the National Science Board, the total R&D expenditure in the United States and China in 2015 was $499.6 billion and $408.8 billion (according to purchasing power parity), and the proportion of government expenditure on total R&D expenditure was 25.5% and 21.3%, respectively. Although China’s industrial policy does not necessarily coincide with the industrial policies of Western countries, the objectives of China’s industrial policies and Western

China's Industrial Development Strategies and Policies    63 countries’ industrial policies are generally convergent. Similar policy objectives aim to compensate for market failures and improve the technological capabilities of domestic enterprises. Especially for enterprises in developing countries, industrial policy is one of the necessary conditions for economic development and industrial upgrading, despite the risk of failure (Stiglitz and Greenwald 2014). Although the industrial policies fail in many countries, there are no developing countries that have successfully caught up to developed countries without industrial policies (Chang 2003). Also, there are no developed countries that do not use industrial policies to maintain the leading edge (Mazzucato 2013). As a complex system, China’s industrial policy implementation has been achieving great success and facing challenges as well. To improve the efficiency of the industrial policy implementation, China has been learning and drawing on the practices and experiences of countries around the world to make industrial policies more efficient and transparent and to make Chinese enterprises more innovative and dynamic. Historically, industrial policies have been widely used to achieve industrialization and economic development goals by developed countries such as the United Kingdom, Germany, the United States, Japan, and South Korea (Chang 2003). UNCTAD (2018) shows that industrial policies have become popular again over the past decade. In the past five years, 84 countries have formulated clear industrial development strategies, and their GDP accounts for about 90% of the global GDP. For example, after the financial crisis, the United States formulated a series of industrial policy documents, such as the Advanced Manufacturing Partnership Program, which involved both horizontal industrial policies and selective industrial policies. Over the past 60  years, the US government has invested more than $4 billion in R&D activities and has promoted the technology development and commercialization of US companies through the US Small Business Administration and the US Department of Commerce’s Advaned Technology Program. Some studies have shown that effective industrial policies in the United States provide important support for economic growth (Block 2008; Mazzucato 2013).

The Increasingly Diversified and Fair Competition of Market Players Recalling the road of economic development for 40 years, China’s reform and opening up adheres to the goal of a socialist market economy, adheres to the enthusiasm of various market entities based on a multiownership economy, and actively participates in international division of labor and cooperation. Since the reform and opening up, the coexistence and development of multiple ownership economies has promoted competition and technological innovation of Chinese enterprises. In general, China’s current state-​owned economy and private economy are already playing to their respective advantages, complementing, integrating, and promoting each other. At present, the ownership of Chinese enterprises has become increasingly diverse. According to statistics from the National Bureau of Statistics on industrial enterprises above designated size, there were 19,022 state-​owned industrial enterprises, 214,309 private industrial enterprises, and 49,554 foreign industrial enterprises in China by the end of 2016,

64   LIN and Zhou accounting for 5%, 56.5%, and 13% of the total number of industrial enterprises above designated size, respectively. The corresponding main business income was 238,990.23 billion RMB, 410,188.06 billion RMB, and 250,392.99 billion RMB, accounting for 20.6%, 35.4%, and 21.6% of the total business income of all industrial enterprises, respectively, as shown in Figure 1.2.1. It can be seen that the development environment of China’s economy is improving, and the market entities are more diversified. China has gradually moved toward an open, transparent, inclusive, and nondiscriminatory market economy. Over the past 40  years, China’s private enterprises have grown from small to large, from large to strong. Different from the practice of the former Soviet socialist countries, China allows and encourages the development of non-​state-​owned enterprises while retaining state-​owned enterprises. Since the 1980s, private capital and foreign capital have entered more and more industrial sectors and have experienced unprecedented rapid growth. Especially in the industrial sector, the current situation has changed a lot compared with the beginning of the reform and opening up. In the manufacturing sector, most of the current fixed asset investment comes from private enterprises. According to the latest data released by the People’s Daily in November 2018, about 80% of China’s manufacturing fixed-​asset investment comes from private companies. In general, although the state-​owned economy is growing, the private economy and the foreign economy are growing faster. At present, China’s private economy has accounted for half of the Chinese economy and has been an important part of the national economy (Lardy 2014). Leading companies in the manufacturing and service industries are also private enterprises. Over the past 40 years, China has attracted a large amount of foreign direct investment (FDI). In 2014, China was even the largest recipient of FDI in the world. Benefiting from

450000 400000 350000 300000 250000 200000 150000 100000 50000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

0

State-owned Industrial Enterprises Private Industrial Enterprises Foreign Industrial Enterprises

Figure 1.2.1  Comparison of main business income of Chinese industrial enterprises with different ownership structures from 2000 to 2016 (unit: 100 million RMB). Source: National Bureau of Statistics

China's Industrial Development Strategies and Policies    65 China’s huge market, well-​trained labor force, and transparent market environment, many foreign enterprises have achieved huge returns in their investment in China. China has become an indispensable part of the global production, trade, and R&D network of many multinational enterprises. As far as industry is concerned, foreign-​funded enterprises have gained a large market share in China’s capital-​and technology-​intensive industries such as communications and electronic equipment, automobile manufacturing, instrumentation and metal products, machinery, and equipment repair. Taking the main business income as a statistical indicator, in 2016, the market share of foreign enterprises in communication and electronic equipment and automobile manufacturing reached 57% and 45%, respectively. From the perspective of international trade, foreign-​funded enterprises once occupied a dominant share of China’s high-​tech product exports. Regarding the role of foreign-​funded enterprises in the development of the country’s economy, such as “market for technology,” relevant research has always been controversial. However, there is no doubt that foreign-​invested enterprises are a double-​edged sword for any country, and the positive externalities brought by foreign-​invested enterprises still depend on many influential factors. At present, state-​owned enterprises still exist in important industries and fields that are related to the national economy, such as automobile, railway, shipbuilding, aerospace, and other industries related to national security. As an important engine of economic development, state-​owned fixed asset investment has always played a leading role in the most important industrial fields. Before the reform and opening up, China’s state-​owned capital stock exceeded 500 billion RMB, which laid a good foundation for China’s industrialization (Hu 2008, 525). Since 2008, state-​owned fixed asset investment has always maintained a share of more than 30% in the total fixed asset investment. In addition, state-​owned enterprises are still an important source for tax revenue of the Chinese government. From 2008 to 2017, taxes paid by state-​owned and state-​holding enterprises (excluding financial enterprises) increased from 1.71 trillion RMB to 4.23 trillion RMB, accounting for about 30% of the government’s tax revenue. With the deepening of reforms, China’s state-​owned enterprises, especially commercial state-​owned enterprises, have been continuously integrated with the market economy system, and there have been many innovative enterprises that can participate in global competition. In addition to state-​owned enterprises, state-​owned banks are one of the characteristics of China’s socialist market economy. State-​owned development banks and commercial banks are the main sources of corporate credit in China and provide important support for China’s industrialization. In addition, the Chinese Constitution clearly defines the public attributes of land and natural resources. Land and natural resources are important capital goods as well as natural gifts, not relying on the efforts of individuals. The public nature of the land provides a convenient condition to carry out large-​scale infrastructure in China. The public nature of natural resources is the basis for obtaining stable and cheap energy and mineral resources, which are also closely related to industrialization. In general, the existence of Chinese state-​owned enterprises does not crowd out private investment in the competitive field, but also plays a role in enhancing the relationship between the upstream and downstream of the industrial chain. Compared with the leading manufacturing multinationals in the Western countries, there is still a significant gap in the competitiveness of Chinese enterprises, regardless of whether they are state-​owned or private companies.

66   LIN and Zhou

Latecomer Advantage, Technology Import, and Indigenous Innovation History and statistics have indicated that industrialization, especially industrialization via manufacturing, is an important driving force for economic growth and employment, and also a necessary way for late-​developing countries to catch up with developed countries. Since the British Industrial Revolution, many countries have seized the opportunity to transform and ascend into manufacturing powers. Even during economic development, there have been cases where a small number of latecomer countries have surpassed leading countries. The case of such latecomer countries surpassing leading countries is known widely by economists as the “latecomer advantage” (Gerschenkron 1962). Indeed, the late-​developing countries can upgrade their technological capacity at a lower cost and increase their speed by means of existing technologies from developed countries through technology import, imitation, or patent purchase. This is a path that some developed and developing countries have taken since the Industrial Revolution. After World War II, countries such as Japan and South Korea experienced fast economic growth. Since the 1980s, China has actively introduced technology and foreign capital. Starting from exporting labor-​intensive products based on comparative advantage, China has gradually accumulated capital and technology to enhance its comparative advantage, by promoting industrial upgrading and participating in the international economic cycle. It should be emphasized that as the technological learning capacity of Chinese enterprises continues to increase, the composition of Chinese exports also continues to advance. New structural economics argues that labor intensive and capital intensive are relative concepts, and endowments and comparative advantages can also change dynamically (Lin 2011). Now, after decades of rapid growth and capital accumulation, unlike the early days of reform and opening up, China has the comparative advantage of most capital-​intensive industries. Since joining the World Trade Organization (WTO) in 2001, in the new international political and economic environment, the share of the Chinese economy in the world economy and international trade has gradually increased. The East Asian economies, including China, based on the export orientation strategy, are considered to have “the fastest and most sustained record of catch-​up development in the modern era” (UNCTAD 2016). It is undeniable that since reform and opening up, the low cost of imported technology and the rapid pace of technological change are reasons for the rapid growth of the Chinese economy. Meanwhile, it should be realized that the latecomer advantage of late-​developing countries cannot be realized spontaneously; rather, it depends on a series of dynamic adjustments of internal and external environments, involving the government’s industrial policies, learning capabilities of the enterprises, and will and efforts of indigenous innovation. Limited by the learning ability of later-​developing countries, the import of technology is not equal to the absorption of technology, and the import of technology does not necessarily lead to the improvement of technological capabilities. This means that although late-​ developing countries can import technology, if there is no indigenous development strategy and learning capacity in the late-​developing countries, the space for improving their own capabilities will be very limited. Moreover, the technology introduced is not always up to date. Fu (2015) argues that although foreign technology transfer may facilitate technology

China's Industrial Development Strategies and Policies    67 development at an early development stage and may assist the diffusion of second-​tier technology, developing countries have to rely on collective indigenous innovation at the industry level in their catch-​up with the world technology frontier. In response to the catch-​up of the late-​developing countries, Gerschenkron (1962) argued that the more backward a country’s economy is, the more important the role of special institutional arrangements (governmental institutions, banks) in increasing the capital supply to new industries will be. In terms of China’s special institutional factors, China has developed a variety of ownership economies and has actively mobilized the enthusiasm of market entities. The enthusiasm of enterprises and individuals has been supported by industrial policies and guided by indigenous innovation strategies, enabling China to adhere to indigenous innovation through multiple channels. In 2006, the Chinese government formulated the Science and Technology Development Plan, clearly proposing to enhance the indigenous capability of innovation and build an innovative country. In recent years, China has paid more attention to indigenous innovation, and its expenditure for R&D and number of patent applications have increased substantially. In 2017, China’s R&D expenditure reached 1.77 trillion RMB, accounting for 2.13% of GDP; R&D expenditures in Guangdong, Jiangsu, Shandong, Beijing, Zhejiang, and Shanghai exceeded 100 billion RMB (National Bureau of Statistics et al. 2017). As a middle-​income latecomer, China is trying its best to overcome the “middle-​income trap.” From the old industrial bases in northeast China, manufacturing centers such as the Yangtze River Delta and the Pearl River Delta, to the less developed provinces in central and western China, the internal differences in China are still very large. Resource endowments vary across regions, and the path of the import of technology and indigenous innovation will also be different. For the developing countries like China that have reached middle-​ income levels with great internal differences, Lin (2011, 2012) argues that the industrial development of each region needs to identify the bottlenecks for industrial upgrading in its own region. According to the gap between the technical level of the existing industry and the frontier of technology, governments must differentiate their industrial policies to make the most of their effectiveness. Industries can be classified into five different types: catching-​ up industries, leading-​edge industries, comparative advantage–​losing industries, short innovation cycle industries, and strategic industries. Catching-​up industries, leading-​edge industries, and short innovation cycle industries are usually in line with this region’s latent comparative advantage. The responsibility of the government lies in overcoming the externalities of industrial upgrading and the bottlenecks of development such as hard and soft infrastructures. In this way, the enterprises can turn a comparative advantage into a competitive advantage. The comparative advantage–​losing industries have lost their comparative advantage, and thus the government has to create conditions for some enterprises to shift toward higher value-​added activities, such as branding and marketing, and also to help most of the production enterprises transfer to areas with lower labor costs. Due to the capital-​intensive and long-​term research cycles, strategic industries generally do not conform to China’s current comparative advantages. The enterprises lack viability in competitive markets, but such industries are related to national defense and economic security, and hence require government’s financial support to sustain themselves and develop (Lin 2017). Supporting the development of the first four types of industries is the responsibility of local government’s industrial policy, while the industrial policy of strategic industries requires the central government to assume the main responsibility. Since strategic industries can

68   LIN and Zhou generate positive externalities to the local industrial development, local governments should take some responsibility to provide land, good living environments, medical care, and children’s education for the staff of strategic industries, etc. In this sense, for the formulation of China’s economic development strategies and industrial policies, the diversity and differences within the country (not a strategy of “one size fits all”) should be taken into consideration. Within a fast-​moving economy, there will be several industrial development strategies, not just one. The development of most industries should follow the principle of comparative advantage. Although some industries (such as strategic industries) do not have comparative advantages, they should be supported due to considerations of national defense, economic security, and dynamic interests. The role of industrial policies will also vary in different industries.2

The Challenges to Overcome the “Middle-​Income  Trap” Since the term “middle-​income trap” was coined by Gill et al (2007), government agencies and economists have paid a lot of attention to this issue. According to the World Bank, from 1960 to 2012, only 13 economies among the 101 middle-​income economies successfully transformed from a middle-​income to a high-​income level (Agénor, Canuto, and Jelenic 2012). Most economies have been stagnated at middle-​income levels and have failed to achieve a leap from middle-​income to a high-​income level. In 2017, China’s per capita income had reached $8,640 and had reached the level of the upper-​middle-​income countries. However, there is still a big gap from the developed countries such as the United States and the European countries. It is understood that middle-​income economies are often trapped in sociopolitical problems caused by innovation and inequality. Innovation-and-inequality related problems can affect both the quality of economic development and the distribution of development outcomes. For China, to achieve the leap from middle-​level income to high-​level income, it is necessary to promote innovation-​driven economic development and the sharing of development results. In China, there are many factors that influence and restrict technological innovation and inequality, such as regional disparities, urban-​rural disparities, income disparities, the relationship between real economy and finance, the lack of leading enterprises, the lack of research input, the quality of education and research, governance capabilities, etc. In the early days of reform and opening up, issues such as regional disparities, urban-​ rural disparities, and income disparities were not as prominent as they are now. According to the World Bank, the Gini coefficient measuring China’s income gap rose from 0.31 in 1981 to 0.42 in 2005, close to the gap between the rich and the poor in Latin America. China is 2  Stiglitz,

Greenwald, and Yu further discussed the issues related to comparative advantage. Stiglitz emphasized the importance of learning capacity for dynamic comparative advantage (Stiglitz and Greenwald 2014, 25), In a Chinese paper, Yu emphasized that a big country with a fast growth rate has to develop a variety of development strategies to cope with the changing situation (Yu 2013).

China's Industrial Development Strategies and Policies    69 also one of the countries with the largest urban-​rural gap in the world. In terms of the relationship between real economy and finance, the excessive expansion of finance has had an impact on the development of the real economy, especially the manufacturing industry. The chairman of China’s largest commercial bank even argued that the proportion of China’s financial sector’s output to GDP had risen from 4.4% in 2005 to 8.3% by the end of 2016, exceeding the proportion of developed countries (Yi 2017). In terms of leading industries in China, enterprises’ innovative capability is still very limited. The average size of Chinese companies is also far from the average size of companies in the United States and other developed countries. It is generally believed that Chinese industries, especially manufacturing industries, are “large but not strong.” As far as research expenditure is concerned, even if the expenditure of research and development in China has increased in recent years, the expenditure for basic research and applied research is still insufficient. Basic research and applied research will affect the potential of innovation. The improvement of the quality of education in China and the cultivation of high-​level talents are also very important. These problems are closely related to the governance capacity of the Chinese government. In the new era, the Chinese government has proposed to improve governance capacity. The improvement of governance capacity will be helpful for solving these problems that affect technological innovation and inequality and in overcoming the “middle-​income  trap.”

Summary and Outlook Forty years have passed since China’s reform and opening up. China’s economy and society have undergone tremendous changes. Reviewing the achievements, experiences, and challenges of China’s economic development is of great significance to China itself and other developing countries. By adhering to the nation’s actual conditions and gradual and incremental reforms, China has gradually transitioned from a planned economy to a market economy. Different from the neoliberal Washington Consensus prescription, China adheres to the independence of the development policy while reforming the market economy, and always controls its own reform agenda. Thus, China can minimize the transition loss and risk to the greatest extent and accomplish today’s achievements. The relationship between the government and market and the relationship between state-​owned enterprises and private enterprises have always been the core issues of China’s economic reform. After 40 years of reform and opening up, the role of the Chinese government in economic activities has undergone great changes. Unlike the role of the omnipotent government in a planned economy, the direct intervention from the Chinese government has been greatly reduced. The Chinese government has clearly stated recently that it must let the market play a decisive role in economic activities while the government plays a better role. This is the clear positioning of the Chinese government on the relationship between the government and the market, and it has also pointed out the direction for China’s future reforms. China’s industrial policy has indeed played an important role in China’s economic development, especially in the upgrading of industrial structure and the advancement of industrial technology. Industrial policy is an indispensable means for development even though

70   LIN and Zhou it may face some challenges. Historically, industrial policies have been widely used by both developed countries and developing countries. Benefiting from the learning capacity of the Chinese government, industrial policies have generally played a beneficial role in the Chinese economy. From the perspective of ownership, China has become increasingly diverse. State-​owned enterprises exist in strategic industries and fields that are important to national and economic security. Private and foreign-​invested enterprises accounted for the largest market share in competitive manufacturing. It can be observed that China’s market is open, transparent, and even highly competitive. China’s market economy status should be widely recognized and treated equally. From the perspective of technological learning, China has taken advantage of being a latecomer. China has always adhered to indigenous innovation and has been actively importing and learning advanced technologies. China is a large developing country with great internal differences. The development strategies of each region and industry should also be identified carefully and made in a classified way. Both resource endowment and comparative advantage should be dynamically adjusted. Learning capacity has been one of the most important endowments and comparative advantages of the Chinese government and enterprises. With good learning capacity, the government and enterprises can take advantage of the existing factor endowments and convert latent comparative advantages into competitive advantages to promote continuous transformation, upgrading, and sustainable development of the industry. This chapter reviews the achievements, experiences, and challenges of China’s economic development. As a major economy in transition, China still faces many challenges and problems in its development. This requires constantly reviewing and summarizing its successes and failures to make more progress. Meanwhile, other developing countries may also have similar opportunities and challenges. Nowadays, globalization is prevalent, and exchanges of ideas and knowledge among nations should be encouraged. Such exchanges are not only at the level of trade in goods but also at the ideological level. Therefore, the Chinese experience will help other developing countries overcome the obstacles to development and work together to achieve prosperity.

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China's Industrial Development Strategies and Policies    71 Gill, I., Kharas, H., Bhattasali D., et al. (2007). An East Asian Renaissance: Ideas for Economic Growth. Washington, DC: World Bank. Hu, A.G. (2008). Historical Review on China’s Political Economy. Beijing:  Tsinghua University Press. Hausmann, R., Rodrik, D., and Velasco, A. (2008). “Growth Diagnostics.” In N. Serra and J. E. Stiglitz (eds.), The Washington Consensus Reconsidered: Towards a New Global Governance. New York: Oxford University Press. Lardy, N. R. (2014). Markets over Mao:  The Rise of Private Business in China. Washington, DC: Peterson Institute for International Economics. Law, M. T., and Kim, S. (2011). “The Rise of the American Regulatory State:  A View from the Progressive Era.” In David Levi-​Faur (ed.), Handbook on the Politics of Regulation, Chapter 8. Cheltenham, UK: Edward Elgar Publishing. Lin, J. Y. (2009). Economic Development and Transition:  Thought, Strategy and Viability. Cambridge, UK: Cambridge University Press. Lin, J. Y. (2011). “New Structural Economics:  A Framework for Rethinking Economic Development.” World Bank Research Observer, 26 (2): 193–​221. Lin, J. Y. (2012). New Structural Economics:  A Framework for Rethinking Development and Policy. Washington, DC: World Bank. Lin, J. Y. (2014). “The Washington Consensus Revisited:  A New Structural Economics Perspective.” Journal of Economic Policy Reform, 18 (2): 96–​113. Lin, J. Y. (2017). “Industrial Policies for Avoiding the Middle-​Income Trap: A New Structural Economics Perspective.” Journal of Chinese Economic and Business studies, 15 (1): 5–​18. Lin, J. Y., and Wang, Y. (2017). Going beyond Aid:  Development Cooperation for Structural Transformation. Cambridge: Cambridge University Press. Liu, H., and Yang, W. M. (1999). China’s Industrial Policy: Theoretical Thinking and Practice. Beijing: China Economic Publishing House. Mazzucato, M. (2013). The Entrepreneurial State: Debunking Public vs. Private Sector Myths. New York: Anthem Press. McMillan, M., and Rodrik, D. (2011). Globalization, Structural Change and Productivity Growth. Cambridge, MA: Kennedy School of Government, Harvard University. National Bureau of Statistics, Ministry of Science and Technology, and Ministry of Finance. (2018). “Statistical Bulletin on National Science and Technology Funds in 2017.” Available at http://​www.stats.gov.cn/​tjsj/​zxfb/​201810/​t20181009_​1626716.html. Nolan, P. (1995). China’s Rise, Russia’s Fall, Politics, Economics and Planning in the Transition from Stalinism. Basingstoke: Palgrave Macmillan. State Council. (1989). “Decisions on Key Points of Current Industrial Policies.” Available at http://​www.people.com.cn/​item/​flfgk/​gwyfg/​1989/​112501198902.html,2018-​08-​05. State Council. (1994). “Notice on Printing and Distributing the Outline of the National Industrial Policy of the 1990s.” Available at http://​www.people.com.cn/​item/​flfgk/​gwyfg/​ 1994/​112105199404.html,2018-​08-​05. Stiglitz, J. E., and Greenwald, B. (2014). Creating a Learning Society:  A New Approach to Growth, Development and Social Progress. New York: Columbia University Press. Strauss-​ Kahn, D. (2011). “Global Challenges, Global Solutions.” An Address at George Washington University, Washington: International Monetary Fund, April 4, 2011. Available at http://​www.imf.org/​external/​np/​speeches/​2011/​040411.htm. UNCTAD. (2016). Trade and Development Report 2016. New York and Geneva: United Nations. UNCTAD. (2018). World Investment Report 2018. Geneva: United Nations.

72   LIN and Zhou Wen, Y., and Fortier, G. E. (2016). “The Visible Hand: The Role of Government in China’s Long-​ Awaited Industrial Revolution.” Review Federal Reserve Bank of St. Louis, 98 (3): 189–​226. Yi, H. (2017). Chairman of the Industrial and Commercial Bank of China, Speech at the 2017 China Economic Summit. Yu, Y. D. (2013). “Restructure Development Economics.” China Economic Quarterly, 12 (3): 1075–​1078. Zoellick, R. (2010). Democratizing Development Economics. Presented at Georgetown University, Washington, DC, September 29, 2010.

Chapter 1.3

T he Devel op me nt of Innovation St u di e s in Chi na Rongping Mu, Jin Chen, and Rebecca Wenjing Lyu Introduction Innovation as a scientific field has been receiving increasing attention in research and is increasingly being recognized as an important phenomenon that plays an essential role in modern society and economy. Thousands of researchers have contributed tremendously to the evolution of the field of innovation studies (IS), which is more than half a century old (Martin, 2016), with remarkable achievements, but also challenges. It is therefore timely to review major advances and prospect directions for future studies. IS builds upon understanding of the nature, sources, and outcome of innovation (Dodgson, Gann, & Phillips, 2014) and observing innovation practices in management. The overall aim of this chapter is to systematically review the evolutionary history of IS, to identify influential research works, and to propose a comprehensive research framework for IS to better face its challenges, as well as to figure out potential future directions for the development of the IS community. To realize these objectives, however, we first need to construct an evolutionary and historic overview of the field, as innovation itself is an “interactive” process that is evolving all the time (Lundvall, 1992). Thus, the rest of this chapter is organized as follows. We first clarify the definition of innovation and discuss the interdisciplinary nature of IS. We then review the evolution of IS in China, focusing on the main Chinese researchers’ theoretical contributions. After that, we propose an integrated innovation research framework by reviewing innovation systems. Finally, we conclude with a discussion section in which we point out several challenges that IS is facing and propose future directions for IS.

74    Mu, Chen, and Lyu

Definition of Innovation and the Nature of Innovation Studies Innovation as a scientific discipline emerged in the late 1950s and has been developing rapidly, with thousands of researchers now in this community (Fagerberg & Verspagen, 2009). As innovation involves various types of changes that occur in different places, such as new products, new production processes, new markets, new resources, new materials, and new organization forms (Schumpeter, 1912/​1934), innovation is of interest to researchers and practitioners across a wide range of disciplines, and thus has been defined by various scholars from different discipline perspectives (Damanpour & Schneider, 2006). However, these various definitions of innovation fail to reach widely accepted, clear and authoritative agreement (Baregheh, Rowley, & Sambrook, 2009), which, according to several researchers, hampers the understanding of the nature of innovation (Cooper, 1998; Zairi, 2006). Thus, a general multidisciplinary definition of innovation that could cover different aspects of innovation and be applicable to various disciplines is needed (Adams, Bessant, & Phelps, 2006). Starting from Schumpeter’s (1912/​1934) definition of innovation as a “recombination of current resources to create a new production function,” almost 60 definitions of innovation were proposed from various disciplines, such as business and management, economics, organization studies, innovation and entrepreneurship, technology, science and engineering, knowledge management, and marketing (Baregheh et al., 2009). For example, Thompson (1971) defines innovation as “the generation, acceptance, and implementation of new ideas, processes, products or services” (p. 2); this definition has been widely accepted and simplified as the successful application of new ideas (Dodgson et al., 2014). Kimberly (1981), however, stresses innovation’s different forms and stages including process, discrete item, and attributes of organizations. Most of these definitions mention “newness” in innovation, but researchers with different discipline backgrounds tend to define innovation from different aspects. For instance, Nord and Tucker (1987) define innovation as product relating to new technology, from the aspect of technological innovation; Plessis (2007) defines innovation as knowledge and new idea creation, from the aspect of knowledge management. To get a whole picture of the definition of innovation and grasp its key points, after performing a content analysis of all these definitions and reviewing the nature, type, stages, social context, means, and aim of innovation, Baregheh et al. (2009) proposed a diagrammatic definition of innovation, which proposes that Innovation is the multi-​stage process whereby organizations transform ideas into new/​ improved products, services or processes, in order to advance, compete and differentiate themselves successfully in their marketplace (p. 1334).

This definition of innovation emphasizes the “novel and improve/​change” nature of innovation and involves different types of innovation, such as product innovation, service innovation, process innovation, and technical innovation; most importantly, it stresses the multistage process of innovation (from creation to adoption), and thus could be adaptable to various disciplines and different types of innovation. We adopt this multidisciplinary definition of innovation in this article.

Development of Innovation Studies    75 The field of IS, defined as the scholarly study of the emergence of innovation and the theoretical model of innovation, including the influencing factors and economic and social consequences of innovation (Fagerberg, Fosaas, & Sapprasert, 2012), has become a fashionable research area. After about a half century’s development in the context of economic progress, IS today mainly involves the economic, management, and policy study of innovation as its major subject foundation (Fagerberg & Verspagen, 2009); IS also benefits from other various disciplines that act as its supplementary subject foundation, which makes IS itself an interdisciplinary scientific field (Godin, 2013). Based on its interdisciplinary nature, various factors need to be considered in IS; for example, institutions, technology, economy, geography, and other industry-​related or sectoral factors would play different roles in innovation. Thus, our research methods in IS also need to be diversified and take a systematic perspective (Fagerberg, 2005). In short, innovation itself is a multistage process of transforming new ideas into business; IS therefore is a multidisciplinary scientific field that needs diversified research methods and systematic views.

The Evolutionary History of Innovation Studies in China Innovation-​driven development has been set as a national strategy in China’s 13th Five-​Year Plan, with a three-​step goal to realize China’s aim of becoming a leading power in innovation. The three-​step goal is, first, becoming an innovative nation in 2020; second, becoming a major leading innovative nation in 2030; and third, becoming the world’s leading power in science and technology (S&T) in 2049, which is the 100-​year anniversary of the People’s Republic of China. Consequently, IS starts to emerge as a prominent research field in China. Meanwhile, due to the unique cultural environment and social context in China, managerial and innovation practices that occur in domestic firms cannot be perfectly explained or guided by Western innovation theories. Thus, starting from developing “Chinese-​specific” innovation theories, Chinese scholars have been trying to make contributions to the IS community by exploring “Chinese-​contextual” research questions (Tsui, 2012). We select representative research and examine theoretical links among them. Meanwhile, as the major driver of national competency, innovation has been set up as a national strategy by the Chinese government; especially after the “independent/​indigenous innovation strategy” put forward in 2006, Chinese technology innovation has developed rapidly and enormously. Undoubtedly, China has accomplished great achievements in technology development, such as the technological capabilities expressed in high-​speed railway, manned space flight, ultra-​high-​speed computers, deep sea engineering, West-​East natural gas transmission, South-​to-​North water transfer, and other mega projects. China also has witnessed contributions to S&T research, such as breakthroughs in discovering the quantum anomalous Hall effect, artemisinin, Chemically induced Pluripotent Stem (CiPS) cells, and development in dark matter particle detection satellites; ultra-​high-​voltage transmission and transformation; and other key technologies. During this process, Chinese innovation scholars have formed and developed specific IS, based on Chinese innovation

76    Mu, Chen, and Lyu practice, and modified Western innovation theories, contributing to China’s economic and society development. Therefore, it is also timely to summarize Chinese IS and evaluate its contribution to the community of IS. Chinese IS will face the following challenge: can it really provide a set of theories and methods with Chinese characteristics that are comparable to the Western innovation theory? China’s IS initially devoted itself to the construction of internal disciplines. It developed for the main purpose of recognizing national conditions, meeting national needs, and promoting national development. It applied the theoretical research results in the field of innovation to China’s national development, focusing on links with economy, management, policy formulation, and systematic methodology. In addition to the introduction, application, and modification of Western innovation theories, Chinese IS scholars also strive to build Chinese-​contexual theories based on some unique findings in China. This is the logical premise of how Chinese IS can be possible. The development of China’s reform and opening up in the past 40 years has witnessed the development of Chinese IS. In the development of Chinese IS, innovation economics, innovation management, innovation policy, and innovation system methodology can be seen as four streams of research (as shown in Figure 1.3.1). These streams not only are the reflection of theoretical prosperity of Chinese innovation research but also act as practical guidance for China’s innovation development. Take innovation management as an example. The first influential innovation theory proposed by Chinese scholars is the “3I pattern” (Xu, Chen, & Guo, 1998), which summarizes the “introduction, digestion, absorption, and then innovation” process as the “imitation-​ improvement-​innovation” pattern, which is the most common innovation pattern adopted in Chinese firms, especially in the last century. Some firms have successfully realized innovation through this pattern, whereas some firms have failed. The first step in the “3I pattern,” imitation, is a reasonable response of Chinese firms that lack technology, and thus was widely encouraged by the government in the 1980s. Through acquiring technology, importing machinery, and introducing advanced technologies (Levitt, 1966), imitation enables Chinese firms to quickly reach production demands and meet domestic customer needs. However, many firms stop at that stage and fail to reach the next stage, improvement, which requires technology improvement through digestion and absorption. Those firms that successfully understand and transfer “tacit knowledge” in imported technologies into explicit knowledge of their own, and thus develop localized products for the domestic market and improve technology, can enter into the last stage, innovation. Through the 3I pattern, lots of Chinese firms have utilized their “latecomer advantages” (Lin, Cai, & Li, 1997) and developed medium-​level or even high-​level self-​design technologies. Based on the 3I pattern, integrated innovation, which is composed of technology integration, knowledge integration, and organization integration (Jiang & Chen, 2000), proposes that to realize self-​development in technologies, Chinese firms need to integrate resources, instruments, and solutions through organizations. This view is based on Iansiti’s thoughts about technology integration (Iansiti, 1998) and emphasizes the role of knowledge and organization in realizing “effective communication” among different departments of firms (Chen, 2002). Neither the 3I pattern nor integrated innovation considers the role of the environment, which is not very appropriate in a global collaboration era. Thus, to guide innovation and managerial practice in the new century, Xu, Zheng, and Yu (2003) developed

Figure 1.3.1  Knowledge genealogy of Chinese innovation studies.

78    Mu, Chen, and Lyu total innovation management (hereafter TIM), emphasizing outsourcing knowledge and environmental factors in innovation. According to TIM, innovation should be taken and managed (1)  all the time, (2)  in the whole process, (3)  among all actors, (4)  in the total value chain, and (5) through globalization. Thus, in TIM, everyone could act as innovation engines on everything, everywhere, at any time. To realize the endogenous growth of Chinese firms, Chen (1994) first proposes “indigenous innovation” and then further develops indigenous innovation into an evolutionary process, which develops from the 3I pattern and integrated innovation, through portfolio innovation, and eventually realizes total innovation, which is the nature of indigenous innovation (Chen, Yu, & Wang, 2010). Indigenous innovation is now set as China’s national strategy, due to its clear goal to (1) realize major technology breakthroughs, (2) stimulate technology inventions and products with indigenous property rights, (3) achieve original scientific and technological achievements through independent research and development (R&D) efforts, and (4) create significant economic and social value for national development (Chen et  al., 2010). Indigenous innovation also integrates the afore-mentioned innovation theories by emphasizing absorbing foreign advanced technology through the 3I pattern, utilizing integrated innovation, and then, based on the platform of portfolio innovation, further including external actors in TIM. Now, innovation-​driven development has been set as a national strategy in China’s 13th Five-​Year Plan, with a three-​step goal to realize China’s aim of becoming a leading power in innovation. Consequently, IS has started to emerge as a prominent research field in China. Meanwhile, due to the unique cultural environment and social context in China, managerial and innovation practices that occur in domestic firms cannot be perfectly explained or guided by Western innovation theories. Thus, starting from developing “Chinese-​specific” innovation theories, Chinese scholars have been trying to make contributions to the IS community. As a conclusion, Chinese scholars have made distinctive achievements in IS, not only in theory development but also in guiding innovation and managerial practice in the industry. However, IS in China is still relatively rough and superficial, without groundbreaking theoretical contributions. We hope this situation will change in the coming years, especially with the rapid development of the IS community and the essential role of innovation in China. In the last section, we will point out several challenges that IS is facing, which are promising directions especially for Chinese researchers.

Research Framework of Innovation Studies The notion that “innovation is an interactive process” is most widely adopted in the literature on innovation systems (Malerba & Adams, 2014). Moreover, it is always alleged that the innovation process is systematic. That is, although acting as the major player in innovation, firms cannot innovate independently, without collaboration with other firms, research institutes, or governments (Fagerberg, Mowery, & Nelson, 2005). Besides, the holistic, interdisciplinary, and evolutionary view in innovation systems (Edquist, 2005) also makes it is easier to understand innovation starting from reviewing innovation systems.

Development of Innovation Studies    79 Thus, to examine IS in a comprehensive research framework, studying innovation systems thoroughly is the primary task. However, to grasp the nature of innovation through a framework, just focusing on innovation systems is not enough. One reason is that cross-​national, national, or subnational innovation systems are all interdependent and complementary, rather than substitutable or contradictory, which indicates that the innovation research framework needs to take all of these innovation systems into consideration. The other reason is that the role of the individual innovator is always neglected in IS, especially in innovation systems. However, the two most important factors in innovation systems, organizations and institutions (Edquist, 2005), both depend on individual innovators, and thus ignoring the role of the individual in innovation is illogical, as well as unreasonable. Besides, to encourage the stimulating and promoting effect of innovation on the economy (Schumpeter, 1912/​1934), understanding which factors influence innovation itself is essential. But influencing factors in innovation systems are not only evolutionary in time and space but also interrelated. Meanwhile, influencing factors in different types of innovation are also different. Thus, in addition to macro-​level analysis in innovation systems, meso-​level and micro-​level explanations are also needed in the innovation research framework. In this section, we first discuss thoroughly the literature on innovation systems from the macro level (national innovation system [NIS]) to the meso level (regional/​sectoral innovation system, firm innovation system [FIS], and China’s practices in innovation systems building); we then turn to examine the microfoundation of innovation, that is, individuals’ creativity (Anderson, Potočnik, & Zhou, 2014), and further explore its internal mechanism through discussing neuroscience as well as psychology; we finally develop an integrated comprehensive research framework based on these reviews and discussions.

Macro Level: National Innovation System The NIS is the starting point of innovation systems. It was proposed by Freeman (1987); Lundvall’s (1992) pioneering work focused on the interactive nature of innovation and initiating transfer from user-​producer interactions to national systems of innovation, while Nelson’s (1993) comprehensive work noted that national specificity of user-​producer relationships counts in innovation and thus a focus on national rather than regional or global innovation systems needed to be adopted. The NIS might be the broadest approach to examine national differences in economic performance at the country level (Acs, Audretsch, Lehmann, & Licht, 2016) and still is the source of the regional innovation system (RIS). As stated in the literature, the NIS “is a set of institutional factors that, together, plays the major role in influencing innovative performance” (Nelson & Rosenberg, 1993, 4–​5); this institutional perspective can still be inherited in the RIS and sectoral innovation system (SIS). Meanwhile, context is also emphasized in the NIS, by clarifying that the knowledge-​ creating and accumulation process is embedded in a national context. China’s practice in the NIS can be divided into three periods: traditional administrative system period (1949–​1978), transitional period (1979–​1992), and market-​oriented economy period (after 1993). During the first period, a planning economy dominated China, and thus innovation mainly relied on government administration; meanwhile, China’s NIS is also planning dominated, which changes dramatically after the reform and opening up initiated

80    Mu, Chen, and Lyu in 1978. As a result, during the second period, the government administrative NIS gradually converted into government guidance, and the planning economy gradually changed into a market economy. Meanwhile, the scientific and technological system reform had been carried out, with the NIS totally reshaped. Scientific research institutions and universities were encouraged to take different forms of ownership and actively enter into the economy, promoting steady economic growth. After Deng Xiaoping’s southern tour speeches in 1992, S&T has been experiencing rapid growth in China, with more attention being paid to market and social needs. During this period, China’s NIS policy and direction was unequivocal, and thus the S&T strategy and innovation-​driven development strategy were successfully implemented. Meanwhile, the role of enterprise also has been emphasized in China’s NIS, to promote industrialization of innovative achievements. As for now, China is reforming its NIS under several principles: (1) regarding innovation policy, improving the policy system and legal institutions to protect and encourage innovation, and constructing an innovation-​friendly social environment and stimulating the vitality of the whole society; (2) regarding innovation subject, constructing an efficient and open innovation network, with clear and definite orientations and roles for all kinds of innovation subjects, and building a collaborative innovation platform integrating the military with the civil sector; and (3) regarding innovation governance, improving the management of innovation, clearing the division of the government and market, and constructing the allocation mechanism of innovative resources.

Meso Level: Sectoral Innovation System and Regional Systems of Innovation Sectoral systems of innovation, first proposed by Breschi and Malerba (1997), focus on innovation in specific sectors and firms inside these sectors and adopts a multidimensional, integrated, and dynamic approach (Malerba & Adams, 2014)  to examine the influence of sectoral characteristics, rather than geographic boundaries, on innovation. In sectoral systems of innovation, three major elements build the framework: knowledge and technological domains, actors and networks, and institutions. As emphasized as a major driving force in sectoral systems of innovation, knowledge stimulates more actors to join in, and more institutions emerge in sectoral systems of innovation and change the boundary of sectors. However, knowledge is always neglected in management studies (Malerba & Adams, 2014). Sectoral systems of innovation are also of practical importance in China, especially in catching-​up strategies in specific sectors, such as telecommunications, auto, and transportation (Malerba & Adams, 2014). As stressed in sectoral systems of innovation, knowledge, as well as learning and capabilities, plays the decisive role in firms’ catching-​up processes (Lee & Lim, 2001). Although in different sectors, the influencing factors of innovation and catching up vary from country to country (Malerba & Nelson, 2012), it is beneficial to study sectoral innovation and its influencing factors in a systemic framework. The RIS was first introduced in the early 1990s (Asheim & Isaksen, 1997, 2002; Cooke, 1998, 2001), based on previous research on the NIS (Freeman, 1987; Lundvall, 1992; Nelson, 1993)  and origins from technological trajectories and knowledge creation organizations

Development of Innovation Studies    81 (Asheim & Gertler, 2006). As a major direction in meso-​level IS, the RIS consists of regional institutions and infrastructures that support innovation, including territorially embedded innovation systems or grassroots RISs, regional industry clusters or network RISs, and regionalized NISs or dirigiste RISs (Asheim & Isaksen, 1997, 2002; Cooke, 1998). China’s practice in the RIS is highly effective. In the United States, both Silicon Valley and Route 128 of Massachusetts could coexist under the same national institutions (Saxenian, 1994, 1995); however, the situation is different in China. Zhongguancun Science Park, always seen as “Chinese Silicon Valley” and a representative RIS in China, adopts an “up-​ down” evolutionary path, which is more like Route 128 than Silicon Valley (Saxenian, 1994). However, as Route 128 evolved in the late 1990s to become more open and proximal to Silicon Valley (Best, 2001; Kenney & Burg, 1999; Saxenian, 1999), it seems that a more flexible, mobile, and open RIS would be more competitive in the new century (Asheim & Gertler, 2006). Nowadays, China is prompting the RIS through “mass entrepreneurship space” in lots of cities but has only been successful in a few.

Micro Level: Firm Innovation System Based on the innovation ecosystem (Autio & Thomas, 2014) and evolutionary history of technology innovation (Rothwell, 1992), we propose the FIS in this chapter and review the evolutionary pattern of the FIS, focusing on a focal firm’s innovation process and innovation capabilities. The first generation of the FIS emerged during 1950s to 1960s and focused only on internal R&D. Bell Labs at AT&T, the Palo Alto Research Center of Xerox (PARC), and the T.  J. Watson Lab at IBM are all representative of first-​generation FISs. This kind of FIS tries to realize production and launch of new products through internal R&D efforts and neglects the importance of external cooperation in innovation. The second generation of FISs emerged in the late 1960s. With fierce market competition and increasingly higher productivity, firms recognized the essential role of the market in innovation systems; thus, based on synergy and integration, the second FIS emerged to acquire potential ideas from multiple sources (Mowery & Rosenberg, 1979) and develop complementary assets such as production and marketing capabilities (Teece, 2007). Compared to the first-​generation internal R&D-​centered FIS, the second-​generation FIS integrates not only marketing, production, and other internal resources but also external innovative resources such as dominant customers, research institutes, and other players to realize synergy innovation. Haier’s initiative is an example of a second-​ generation synergy/​integration-​based FIS. Haier utilized five worldwide R&D centers to strategically cooperate with world-​class universities, research institutes, and suppliers to realize an integrated open innovation system and exploit both internal and external innovative resources. In the late 1980s, with the emergence of strategy as a scientific field (Hambrick & Chen, 2008), strategy management was also emphasized in the FIS, which led to the third-​ generation strategy management–​guided FIS that dominated during the 1980s to 1990s, focusing on corporate governance and strategic management in innovation. In the late 1990s, the innovation ecosystem was proposed and then applied in various contexts (Moore, 1996, 1999). It was defined as a dynamic network that consists of

82    Mu, Chen, and Lyu interconnected organizations such as customers, suppliers, partners, governments, and other stakeholders around a focal firm or platform (Iansiti & Levien, 2004; Moore, 1999; Teece, 2014). Since then, the innovation ecosystem has dominated in managerial practice and is regarded as the fourth-​generation FIS. In the innovation ecosystem, not only the interfirm ecosystem but also internal innovation is considered. For example, Baosteel Group Corporation (hereinafter referred to as Baosteel) encourages internal R&D departments to join in technology cooperation with external research institutes and technology departments. Rather than regarding itself as a member of the steel industry, Baosteel sees itself as part of a “business ecosystem” and actively participates in value co-creation (Adner & Kapoor, 2010) through jointly building labs with other steel firms and cooperating with national engineering research centers on R&D. In conclusion, the development of the FIS is an evolutionary process. In the first-​ generation FIS, internal R&D is seen as the most valuable strategic asset and core competence; however, this closed innovation pattern is not fit for an open economy. However, in the second-​generation FIS, integrated internal R&D efforts as well as open external relationships enable firms to be more interactive in innovation. In the third-​generation FIS, governance structure plays the major role in innovation. In the fourth-​generation FIS, firms’ internal core competence is emphasized in the innovation ecosystem, which guides the strategy design and implementation in an open economy (Iyer & Venkatraman, 2006) and will be the future direction for enterprises, guiding FIS transfer from linear innovation to adaptive innovation to meet demands in the new era.

Individual-​Level Innovation, Creativity, Psychology, and Neuroscience Individual-​level innovation and creativity in the workplace are both essential determinants of organization performance and other dependent variables. Defined as the generation of novel and useful ideas, creativity is always seen as the first step of innovation, as innovation itself includes both the first-​step production of ideas and the second-​step implementation (Anderson et al., 2014; West, 2002). As a related construct, creativity has many overlaps and similarities with innovation; thus, integrating creativity (idea generation) and innovation (idea implementation) needs to be considered, especially when proposing a comprehensive research framework of innovation. Although creativity is mostly studied at the individual level, it is alleged that team-​level, organization-​level, and even multilevel research are needed in creativity studies in order to better integrate with IS (Anderson et al., 2014). Besides recognizing creativity as one microfoundation of innovation, we also need to further take account of the subject foundation of creativity itself, that is, psychology (Amabile, 1980, 1996, 2003; Gruber & Bödeker, 2005)  or even neuroscience (Fink, Benedek, Grabner, Staudt, & Neubauer, 2007; Panksepp, 2000). As a multifaceted complex process, innovation involves a wide variety of factors at various levels and thus needs to be studied through an integrated view. Regarding psychology, creativity needs to be measured from individual thinking characteristics; therefore, the novelty, flexibility, and uniqueness of thinking play an essential role in creativity, and thus divergent thinking

Development of Innovation Studies    83 stimulates creativity (Guilford, 1967). Regarding neuroscience, examining the mechanism of humans’ brains and the source of creative thinking is of interest in IS (Sawyer, 2011). We have discussed that all kinds of innovation phenomena are initiated by individual innovators; nevertheless, individuals’ behaviors in turn are administered by the human mind and brain. This is the reason that neuroscience, or so-​called neuro-​innovation, needs to be seen as the core foundation of individual-​level innovation, and thus is of importance in our research framework for IS.

Summary: An Integrated and Comprehensive Research Framework for Innovation Studies In summary, individual-​level innovation research offers the microfoundation for IS, and based on that, the FIS should also be noted in IS, as firms are more and more important in the innovation process. The sectoral innovation system, which consists of all stakeholders in a specific sector, as well as the RIS, which consists of all actors in a specific region, both act in the innovation research framework at the meso level in analysis. Finally, the NIS or cross-​national innovation system, as the macro level in IS, is based on all of the aforementioned innovation systems. Thus, from the aspect of innovation systems, we propose an integrated and comprehensive research framework for IS (see Figure 1.3.2).

NIS RIS FIS Individual Creativity Brain Psycholog Firm Innovation System Regional Innovation System National Innovation System

Figure 1.3.2  An integrated research framework for innovation studies.

84    Mu, Chen, and Lyu

Conclusions, Challenges, and Future Prospects As innovation plays an essential role in the modern economy, “innovation-​driven” development is also regarded as a basic guideline in various countries, such as in the United States, the United Kingdom, China, Israel, Korea, Japan, and other major economies (OECD, 2016). Enthusiasm for IS is increasingly rising. As a relatively young field, IS has experienced rapid growth with lots of remarkable achievements (Martin, 2016). Yet, with an over 50-​year evolutionary history, IS still needs continuous refinement to become a respectable discipline. In this chapter, we review the evolutionary history of IS to get a “whole picture” of the development of the IS community and develop a comprehensive research framework based on integrating innovation systems research. However, before prospecting future research directions in IS, let us first point out several challenges that IS is facing.

Exploring Previously Overlooked Areas and Topics There have been tremendous achievements in IS, yet there are still some gaps that have been overlooked. For example, overemphasis on technology innovation, R&D-​based innovation, and high-​tech sectors while neglecting service innovation, financial innovation, business model innovation, low-​tech innovation, or other types of innovation is repeatedly criticized by several researchers (Fagerberg, Martin, & Andersen, 2013; Martin, 2016; Nelson, 2013; Salter & Alexy, 2014). Meanwhile, in terms of innovation output, overemphasis on measurable and visible innovation performance such as patent counts and new products (Salter & Alexy, 2014) while neglecting “dark innovation” is another challenge the IS community is facing (Martin, 2016). This hysteria regarding countable and visible innovation output may be the source of focusing only on innovation quantity without considering the quality and novelty of innovation. However, as innovation for sustainable development, well-​being, and fairness for all is increasingly raised in both research and practice, it would be beneficial to explore these previously overlooked topics and areas. Moreover, there are several changes in managerial practices, and IS needs to renew and evolve in a timely manner to reflect and explain these practices. For example, rather than only focusing on individuals and big firms, environmental factors and the social context are increasingly being emphasized in innovation practice. Moreover, with the emergence of open and distributed innovation (von Hippel, 1988), it is clear that the innovation ecosystem and interconnected organizations will dominate, which puts forward new requirements for IS.

Theory-​Driven Research and More Theoretical Contributions Although IS has contributed new insights into the study of economic development and other research areas (Castellaci, Grodal, Mendonca, & Wibe, 2005), as a scientific field,

Development of Innovation Studies    85 it still lacks research synergy and academic influence. Despite borrowing concepts from related disciplines as other young and emerging fields always need to do, there are very few theories and little research in IS that could be popularized to other related disciplines. The interdisciplinary and relatively young nature of IS may partly explain that, but it is not the major reason. A lack of theory-​driven research and studies that have theoretical contributions is the true cause.

Guiding and Forecasting Innovation Practice IS was born to be a problem-​solving field that deals with social change and economic development. Actually, that is the reason that innovation enjoys an essential role in our society and economy and that IS has attracted attention from policymakers and managerial practitioners from the very beginning (Fagerberg et  al., 2013). Therefore, it is innovation researchers’ mission to maintain the certain role of IS not only in academic research but also in leading S&T policymaking. Meanwhile, as a dynamic, nonlinear, and systematic process (Dosi, 1982), innovation needs to be studied through a nonlinear evolutionary process to better reflect and predict innovation practices in enterprises. Our list of challenges that IS is facing is neither exclusive nor exhaustive, but a reflection of the innovation journey and IS community. Future research should continue to explore promising topics and contribute to general management besides IS. As illustrated in this chapter, innovation plays an essential role in the economy and society; therefore, it is our IS scholars’ duty to push the endless frontier of innovation and make our research generates significant impact. Note. Some part of this chapter has been published as Chen, J., & Lyu, W.  J. (2018). Innovation studies: Evolution and contribution of China. Technology Economics, 37(5), 1–​13 (in Chinese).

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Chapter 1.4

China’s Sci e nc e a nd Technol o gy Pro g re s s throu gh th e L e ns of Paten t i ng Gary H. Jefferson and Renai Jiang Introduction Accompanying the surge in Chinese patenting has been an equally impressive surge in published papers researching and analyzing the many causes and implications of China’s historic embrace of technological innovation. The purpose of this chapter, within the prescribed length limit, is to integrate and analyze this literature with a view toward gaining insight into the extent to which China is transforming from an imitation economy to an innovation economy. Such a transformation raises issues regarding its drivers, including public policy and international factors, and its consequences with implications for patent quality, technical specialization, and regional patenting capabilities. Since 1990, the number of invention patents granted by China’s State Intellectual Property Office (SIPO) to residents of China has exploded from around 1,100 to more than 325,000 per year.1 A relatively small but now rapidly growing proportion of these patents are being granted by the US Patent and Trademark Office (USPTO). The literature we review largely focuses on data garnered from these two patent offices, with the SIPO being the destination for all patent applications from Chinese residents and the USPTO, which provides a uniform measure of the relative capacities of nations to contribute to the world’s top inventions. That SIPO patent grants are also a measure of China’s technological 1 

While SIPO has been replaced by the China National Intellectual Property Administration (CNIPA), because virtually all of the patent reviews and approvals documented in this paper were administered by SIPO, we retain the reference to the State Intellectual Property Office (SIPO) throughout.

S&T Progress and Patenting    91 Table 1.4.1 Characteristics of Expired Patents

Claims Forward citations

All Unexpired Patents

Patents Expired in Patents Expired 12 Years in 8 Years

Patents Expired All Expired in 4 Years Patents

13.27 7.13

12.63 5.49

11.44 4.03

11.95 4.67

12.01 4.73

Source: Moore (2005).

advance is shown by Dang and Motohashi (2015), who employ a merged dataset of SIPO patent data and China’s large and medium-​sized enterprises; their empirical results show robust correlations between patent counts, research and development (R&D) input, and financial output, suggesting that patent statistics are meaningful indicators of innovation performance. In addition to patent counts, many of the papers reviewed herein examine the quality of Chinese patenting. For the purpose of measuring patent quality, we particularly focus on two widely used measures:  claims and forward citations. Explaining that the number of claims awarded to a patent measure its breadth, Hall, Jaffe, and Trajtenberg (2001, 23–​24) assert: “The claims specify in detail the ‘components’, or building blocks of the patented invention, and hence their number may be indicative of the ‘scope’ or ‘width’ of the invention.” The breadth of a patent relates to the number of technology classifications that it spans; hence, the wider the breadth, the greater the number and variety of technologies over which the holder is able to exercise monopoly control for the duration of the patent. One study that assesses the importance of patent claims, as well as forward citations, is Moore (2005), which uses the set of USPTO utility patents that were granted in 1991, of which there was a total of 96,713 issued that year, to examine the relationship between claims and citations and the life of the patent. Table 1.4.1 shows that, controlling for the grant year, the number of both claims and forward citations declines monotonically as the duration of the patent becomes shorter. Hence, Table 1.4.1 confirms that patents with more claims and citations enjoy longer patent longevity. A wide range of research demonstrates the relationship between forward citations and patent value, including measures of their technological importance (Albert, Avery, Narin, & McAllister, 1991), renewal fees paid (Harhoff, Narin, Scherer, & Vopel, 1999), social value (Trajtenberg, 1990), and market value (Hall, Jaffe, & Trajtenberg, 2005). Studies also use citation-​weighted patent counts as a more precise indicator of innovation output (Bloom & Van Reenan, 2002; Hall, Thoma, and Torrisi, 2007). The study by Hall, Jaffe, and Trajtenberg (2005) uses a sample of US publicly traded firms to test the economic significance of forward citations for Tobin’s q, the ratio of the firm’s market value to the replacement cost of its physical capital. The firm-​specific innovation-​related characteristics they examine are (1) R&D intensity, (2) R&D productivity measured as the ratio of the firm’s patent count to its R&D stock, and (3) the average number of forward patents for the firm’s patent portfolio. The authors find that each of these measures, forward citations included, has a positive and significant impact on the firm’s Tobin q.

92   Jefferson and Jiang Specifically, to assess China’s science and technology (S&T) progress, we review the relevant patent literature by investigating the following questions:2 ➢ What accounts for China’s patent surge? ➢ What are the implications of the surge for patent quality? ➢ Does the nature of patenting reveal China’s S&T direction and comparative advantage? ➢ How has the international sector affected China’s patent production? ➢ What has been the role of the government—​the central, provincial, and local governments—​ in shaping patent production? ➢ How heterogeneous is China’s regional patent production; are patenting capabilities diffusing across China? After presenting an overview of China’s patent production over the past 25 years, we dedicate a section of the chapter to each of these questions.

Overview of China’s Patent Production Tables 1.4.2 and 1.4.3 show the surge in China patents granted by both the SIPO and USPTO from 1990 to 2017. Before reviewing the tables, it will be useful to distinguish between three types of patents that the SIPO issues. China’s “invention” patent is subject to the highest review standards and receives 20 years of protection. In addition to the invention patent, China issues utility patents and design patents that each receive 10 years of protection. For the USPTO, the highest-​quality patent, the “utility” patent, receives 20 years of protection. In addition, a relatively small portion of the grants it assigns are design patents with a maximum lifespan of 14 years and plant patents for 20 years. A review of the SIPO data in Table 1.4.2 shows the following highlights: ➢ The total number of patents granted by the SIPO rises from 22,588 in 1990 to 214,003 in 2005 and 1,836,434 in 2017. The numbers in parentheses show the average annual rates of growth in patent grants from the previous reported year. For total patents, the table shows from 2005 to 2010 an increase of nearly 60% per annum. The data show a substantial slowdown in the patent growth from 2005–​2010 to 2010–​2015 and again during the recent full two-​year period, 2015–​2017. ➢ The data in Table 1.4.2 also show the comparative rate of growth of invention patents. Whereas from 2000 to 2017 the number of total patents grew by a factor of 17, the number of invention patents grew by a factor of 33, nearly twice the rate of overall patenting. ➢ From 2000 to 2005, coinciding with China’s entry into the World Trade Organization (WTO) in 2001, Table 1.4.2 shows a remarkable surge—​an annual 80% rate of growth—​of foreign invention patent grants. Thereafter, from 2005 to 2017, the annual rate of growth 2  The papers reviewed herein are those that we located through a good-​faith search. Our apologies to the authors of papers that we might have inadvertently overlooked.

S&T Progress and Patenting    93 Table 1.4.2 SIPO Patents and Grants (Average Annual Growth Rate from Prior

Period, %) Patent Type

1990

2000

2005

Invention Domestic Foreign Utility Design Total

3,838 1,149 2,689 16,952 1,798 22,588

12,683 (23) 53,305 (64) 6,177 (44) 20,705 (47) 6,506 (14) 32,600 (80) 54,743 (22) 79,349 (9) 37,919 (201) 81,349 (23) 105,345 (37) 214,003 (21)

2010 135,110 (31) 79,767 (57) 55,343 (14) 344,472 (67) 335,243 (62) 814,825 (56)

2015 359,316 (33) 263,436 (46) 95,880 (15) 876,217 (31) 482,659 (9) 1,718,192 (22)

2017 420,144 (9) 326,970 (12) 93,174 (-​1) 973,294 (6) 442,996 (-​4) 1,836,434 (3)

其中，2017年的专利数据来源于国家知识产权局；1990年的专利数据来源于《中国科技 统计年鉴1991》；其他年份的专利数据来源于《中国科技统计年鉴2017》。Source: The patent data for 2017 came from the State Intellectual Property Office; the patent data for 1990 came from the China Science and Technology Statistics Yearbook 199; and the patent data for other years came from the China Science and Technology Statistics Yearbook 2017.

Table 1.4.3 Patent Counts (USPTO) 2015: US = 146,883; non-​US = 142,981 Year

1990

2000

2010

2015

2017

China

26 (0.0%) 37,536 18,898 163 6,520 9,807

95 (1.1%) 80,313 32,787 3,285 9,530 17,796

2,355 (2.2%) 109,152 47,731 12,519 12,431 26,808

7,450 (5.1%) 146,883 55,110 20,305 16,220 39,169

12,309 (7.1%) 162,092 53,110 23,116 16,927 42,122

US Japan S. Korea Germany Other OECD

of foreign invention patent grants falls to 15% or less, such that in the recent two years the number stabilizes to somewhat under 100,000 per year, less than one-​third the number of invention patent grants to Chinese residents. As a portion of total invention patent grants, the share granted to foreign residents fell from about one-​half in 2000 to 22% in 2017. Comparative USPTO patent grant levels and trends for key countries shown in Table 1.4.3 include the following highlights: ➢ In 2000, only 95 patents were awarded to Chinese residents, accounting for a negligible portion of total USPTO patent grants. By 2017, USPTO-​granted patents rose to 12,309, to 3.5% of total USPTO patent grants in that year. ➢ As the home country, we would expect the United States to account for the largest portion of USPTO patent grants. Other countries in proximity to the international frontier

94   Jefferson and Jiang include Japan (53,110), South Korea (23,116), and Germany (16,927). By this measure, by 2020 the China USPTO patent count should overtake that of Germany. We review the reasons advanced in the literature for this Chinese patent surge.

Factors Causing the Surge One of the earlier articles, “A Great Wall of Patents: What Is behind China’s Recent Patent Explosion?,” by Hu and Jefferson (2009), uses 1995–​2001 firm-​level data for the population of China’s large and medium-​size industrial enterprises to explore the factors that account for China’s rising patent activity. While R&D in China’s economy tracks with patenting activity, the authors find that R&D accounts for only a fraction of the patent explosion. Of nearly equal significance has been the growth of foreign direct investment (FDI), having enabled and/​or prompted Chinese firms to file for more patent applications. Amendments to the patent law that favor patent holders and enterprise ownership reform clarifying the assignment of property rights also emerge as significant sources of China’s patent boom. Thus, a key finding of this article is that no single factor, such as R&D spending, has driven China’s patent surge;3 rather, a combination of factors—​R&D effort, FDI, the expansion and strengthening of the patent system, and ownership reform—​account for aspects of the surge.4 In “Behind the Recent Surge of Chinese Patenting: An Institutional View,” Li (2012) uses SIPO data to account for differences in provincial-​level conditions that have contributed to the patent surge. The author formulates a measure of each province’s legal environment that robustly correlates with the patent performance of local universities and research institutes. Furthermore, controlling for the legal environment, Li finds that patent subsidy programs significantly augment the patenting propensities for large and medium-​size enterprises and for universities; while not to the same degree, research institutes and individual inventors also respond to subsidies with greater patenting activity. Finding that a larger fraction of applications have been granted since the provincial-​level initiatives, Li posits that unless the criteria used for patent examinations have been lowered, a reduction in patent application quality may not be a serious concern. In “Is the Dragon Learning to Fly? An Analysis of the Chinese Patent Explosion,” Eberhardt et al. (2017) match 374,000 firms from Chinese manufacturing census data with

3  In “Patent Laws and Innovation in China,” Yueh (2009) uses provincial-​ level data to estimate a model that concludes that the main determinants of patent production are R&D expenditure and FDI, but not the number of researchers. By implication, the level of human capital matters more than the sheer number of researchers. 4  Liu et al. (2013) offer further support to this view that a wide range of factors account for China’s patent surge. Specifically, the institutional factors they cite include the national patent system, patent subsidies, high-​tech enterprise certification, patent intermediary services, patent financing, management of governmental S&T programs, and intellectual property pilot and demonstration projects. They further conclude that the growth of capital (R&D fund) and labor (scientists) are highly endogenous as they respond to these institutional conditions.

S&T Progress and Patenting    95 patent applications both in the SIPO and USPTO from 1999 to 2006. Their key finding is that in both patent offices, the Chinese patent explosion is accounted for by “a tiny, highly select group of Chinese companies in the ICT [information and communications technology] equipment industry” (p. 1). The authors also conclude that SIPO patent filings have been substantially driven by subsidies that directly encourage patent filings. More recent data suggest a broadening of China’s patent applicant pool. Using SIPO data, Hu et  al. (2017) find that most of the growth in Chinese patenting has come from new patent entrants, that is, firms that were not actively applying for patents in the past, thereby updating the finding of Eberhardt et al. (2017) for 1999–​2006. To further test the persistence of the “tiny” numbers hypothesis, we use USPTO data to analyze the preponderance of patents sourced by various Chinese inventors. While the large firm concentration may be higher in the SIPO than in the USPTO, we find that in 2010 the proportion of USPTO-​ granted Chinese patents originating from the 10 largest Chinese firms was 6.6%; by 2017, that proportion had fallen to 4.4%. Hence, within the USPTO, the contribution of Chinese firms beyond the largest 10 patenting firms is substantial and growing. In “China’s Shifting Patent Landscape and State-​Led Patenting Strategy,” Prud’homme (2015) focuses on the decrease in the annual rate of domestic invention patent filings reported in the 2014 data and recent negative rates of the growth of filings of utility and design patents. Prud’homme suggests that China’s technological catch-​up strategy had at first focused on production quantity but has recently shifted toward emphasizing patent quality. Specifically, Prud’homme points out that Chinese authorities have moved away from targets for overall patent filings and grants to targets for invention patents granted. Having previously only specified “patents” as a plan target, China’s National IP Strategy (2014–​2020) promulgated by the State Council on December 29, 2013, now targets 14 invention patents granted per every 10,000 people in 2020, a quality shift as well as quantity upgrade from earlier targets. According to Prud’homme’s assessment, the National IP Strategy (2014–​2020) reflects a more sophisticated approach to state-​led patenting by stimulating patents that can be commercialized, sustain longer patent lives, generate export income from royalties and franchise fees, and result in Patent Cooperation Treaty (PCT) applications.5 Using patent and R&D data from the China High-​Tech Industry Yearbook, Jefferson et al. (2018) compute levels and changes in the marginal product (cost) of patent production for China’s high-​tech industries. Over the periods 1999–​2005 and 2005–​2012, the authors find a significant reduction in patent production cost measured in terms of both R&D expenditure and R&D personnel from the earlier to the later period. Jefferson et al. do not directly control for quality, although they do obtain a similar result for invention patents only and note that the grant rate for invention patent applications rose from the earlier to the later

5  SIPO’s

Several Opinions on “Further Improving Quality of Patent Applications,” promulgated on December 18, 2013 (“the Opinions”). The Opinions recommend a number of important initiatives, for example, (1) search reports should be provided along with applications for utility model subsidies, (2) funding should only be given to authorized utility models, (3) the level of funding a subsidy recipient can obtain is not greater than the sum of all official charges and patent agency service fees that the recipient pays, (4) patent targets and performance evaluation systems better reflect patent quality, and (5) bad-​faith disincentives should be strengthened.

96   Jefferson and Jiang period. Their most robust result is that much of the surge in patenting can be accounted for by increases in patent production efficiency as well as R&D spending. A source of efficiency gains may be the creation of a nationwide communications and transport network. In their article “Roads to Innovation: Firm-​Level Evidence from People’s Republic of China (PRC),” Wang et  al. (2018) focus on the role of infrastructure investment in driving patent production. Using a matched patent database at the firm level and road information at the city level to examine the impact of road density on firm innovation, their empirical results show that a 10% improvement in road density increases the average number of approved patents per firm by 0.71%. The authors speculate that road development spurs innovation by facilitating knowledge spillover and enlarging market size. Two articles attempt to put China’s patent surge in a broader historic and institutional context. Peng et al. (2017) document the fact that during the 19th century, the United States was not a leading intellectual property rights (IPR) advocate, but rather a leading IPR violator. Only when indigenous inventors, authors, and organizations within the United States emerged, demanding protection of their own IPR in foreign countries in the late 19th century, did the US Congress in 1891 pass the International Copyright Act to extend IPR protection to foreign works. The clear implication of Peng et al.’s historical analysis is that, as with the United States in the 19th century, as China builds its indigenous innovation capability, political pressure will grow for the more robust enforcement of IPR. In “Exploring the Worldwide Patent Surge,” Fink et al. (2016) put China’s patent surge into global perspective, where, apart from China’s surge, worldwide patent filings have risen to historically unprecedented levels. The authors point out that the worldwide patent surge may indicate faster technological progress and new innovation models, may reflect strategic shifts in how companies exploit the patent system, or may result from both of these conditions. Seeking to evaluate these alternative hypotheses, Fink et al. find that subsequent patent filings—​the creation of patent families involving filings of the same invention in additional countries—​contributed considerably to the growth in filings worldwide, pointing to globalization as one important driver of filing growth. In conclusion, a wide range of factors accounted for China’s post-​1995 patent surge. These include the surge in R&D spending and FDI, accession to the WTO, patent law amendments, enterprise reform, subsidies, transportation and communication improvements, efficiency improvements, and the globalization of patenting.

Quality Given the remarkable surge in the sheer quantity of Chinese patents, both SIPO grants and USPTO grants, it is not surprising that much of the literature questions the quality implications of the rapid growth of Chinese patenting. Using SIPO data, Hu et al. (2017), while finding a relationship between patents and R&D, as well as between patents and labor productivity, conclude that the relationships have statistically weakened. Indeed, given the surge in patenting—​and the substantial broadening of the base of inventors and assignees—​ it is not surprising that the quality of the average or median SIPO patent has stagnated or declined.

S&T Progress and Patenting    97 Table 1.4.4 Patent Claims, USPTO Data

China US Japan S. Korea Germany Other OECD

1990

2000

2010

2015

2017

11.73 14.31 10.25 8.60 11.44 11.23

9.29 17.49 13.81 12.97 13.22 14.59

12.22 18.08 11.70 14.52 15.28 15.91

12.42 17.61 11.42 13.26 14.56 15.67

12.73 16.83 11.34 13.35 14.20 15.33

Other researchers also document and analyze the appearance of low-​quality patent production. Schmid and Wang (2017) find that “ill-​structured innovation incentives and the preoccupation of officials with quantity-​based goals (guan benwei)” together work to create lower-​quality patents in the PRC. Numerous others, including studies reviewed in the previous section, cite the provincial-​level patent subsidy and reward schemes that result in the filing with the SIPO of lower-​quality patents and granting of more narrow patents with fewer claims. Still others argue that notwithstanding these incentives, the quality of Chinese patenting has been respectable and improving, specifically those relating to agricultural innovations. While these studies are clearly relevant and important, a central interest of this study is to determine the extent to which China’s patenting frontier may be closing the distance between that of the United States and other Organisation for Economic Development (OECD) economies. Again, this emphasis recommends that we give particular attention to USPTO-​approved Chinese patents. To follow, using USPTO data, we review the data and research relating the patent data on claims and forward citations. Claims: Table 1.4.4 shows the average number of claims for USPTO-​granted patents for a range of countries.6 In 1990, with only 26 patents, the average for Chinese patent grants was 11.73, less than the United States but more than the other included countries. In 2000, with 95 patents, the number of average claims dipped to 9.29. Ten years later, in 2010, the average rose to 12.22, somewhat better than Japan but lagging relative to the other countries. In 2015, the relative ranking was essentially unchanged. The literature offers various ways of measuring patent claims and patent breadth. Malackowski and Barney (2008) propose using the word count of the patent as a rough measurement of claim breadth. They argue that because each word in a claim introduces an additional legal limitation upon the scope of a patent, with a sufficiently large sample, as with USPTO patents, the average number of words per independent claim serves as a proxy for the effective scope of the patent. Malackowski and Barney find that in 2007, USPTO patents granted to Chinese residents had an average word count of 160.1 per independent patent, a 4.4% increase over the average word count in 2003. As a point of reference, the

6  Dang and Motohashi emphasize the necessity of adjustments and provide a novel method of using the number of nouns in claims to quantify the claim scope, thereby overcoming the shortcomings of Chinese patent data that have no citations or lack well-​documented patent claim information.

98   Jefferson and Jiang Table 1.4.5 Forward Citations, USPTO Data

China US Japan S. Korea Germany Other OECD

1990

2000

2010

2015

2017

22.15 25.70 15.89 11.27 11.44 15.13

7.47 31.45 16.18 14.41 12.12 17.92

4.52 9.23 3.75 4.24 4.26 5.86

0.80 1.60 0.56 1.33 0.62 0.86

0.07 0.09 0.03 0.08 0.03 0.05

authors find overall, among all patents filed in the USPTO over this period, that examiners were not granting patents with broader claims; they were granting claims of approximately the same scope or slightly narrower scope. Hence, Malackowski and Barney conclude that there is evidence that over the period 2003–​2007, the quality of patent grants appears to have risen marginally. This finding would appear to be consistent with the quantity change in patent claims reported for China for 2000–​2010 in Table 1.4.4. Forward citations: Table 1.4.5 shows that among USPTO-​granted patents in 1990, China ranked second only to the United States in the number of forward citations per patent grant. However, in that year, China had only 26 patents granted. Ten years later, when the number of annual grants had grown to 95, the number of forward citations fell quite dramatically to 7.47%. Over the following 10 years, as the incidence of patent grants surged to 2,355 in 2010 while the citation counts for all countries declined as the patent duration shrunk, China’s relative performance actually improved, achieving a level that was marginally greater than the citation counts for Japan, Germany, and South Korea. In general, the measures of patent claims and forward citations shown in Tables  1.4.4 and 1.4.5 are consistent with having declined from 1990 to 2000; rising from 2000 to 2010; and, with the exception of the United States, remaining near the average of the other four countries (region) thereafter. Many would agree that between the claims and citation data associated with patent office data, the more accurate measure of patent quality is forward citations. However, the truncation of patent counts for newer patents seriously impairs the ability to use cumulative patent counts to assess the evolution of patent quality over time. To compensate for this lag between the publication of the patent and the accumulation of forward citations, another available method is that of the “citation lag,” which is the time elapsed between the publication of the application and a time-​limited forward citation count.7 For example, using the date of the first citation as their measure of citation lag and using patent data between 2000 and 2010, Fisch et al. (2017) employ Cox regressions to show that Chinese patents suffer from a large citation lag in comparison to international patents.8 This is especially true for 7  The citation lag is very similar to forward citations but circumvents the loss of the most recent data points. Also, Cox regressions can be employed that are explicitly able to deal with right truncation. 8  The sample used by Fisch et al. consists of patent data obtained from PATSTAT (November 2013 version). Their final data set contains 10,000 patent families applied for by applicants from each of the five regions, the United States, Europe, Japan, China, and Korea, as well as 10,000 PCT applications, resulting in a total sample of 60,000 patent families.

S&T Progress and Patenting    99 Table 1.4.6 Three-​Year Forward Citations, USPTO Data

2000 2005 2010 2014

CN Only

US Only

0.79 2.32 1.76 1.05

2.77 2.12 2.62 2.84

OECD Only Other Only 1.97 1.54 1.52 1.29

1.77 1.82 1.77 1.67

CN-​US

CN-​OECD CN-​Other US-​Other

n.a. 1.00 2.64 1.50

n.a. n.a. 1.69 1.66

n.a. n.a. 2.11 0.78

2.65 1.63 2.01 1.40

patents filed domestically with the SIPO. However, Fisch et al. find empirical support for an increasing patent value for patents filed later in the 2000–​2010 period, suggesting the possibility of a narrowing of the gap between Chinese patents and international patents thereafter. In the spirit of the citation lag analysis, we construct a citation lag for a three-​year period following the year in which the patent was granted. These measures, based on the USPTO data, reported in Table 1.4.6, show citation lags for Chinese assignee-​only patents as well as those for US assignee–​only, OECD-​only, and other country–​only patents. The first four columns of Table 1.4.6 show beginning in 2005 a steady decline in the three-​year citation lag measure for China, while that for the United States rises to more than twice China’s citation level. Contemporaneously, as with China, the three-​year citation lags for the other OECD and other countries also declined; nonetheless, for the patents granted in 2014, China shows the lowest of the citation lag measures. In conclusion, most of the literature is consistent with the data in Table 1.4.6 that shows a weakening of Chinese patent quality among USPTO-​granted patents. The forward citation data show a steady decline from 2005 to 2017 to a level below that of the United States and the averages of other OECD and non-​OECD countries.

Specific Sectors One might expect that given the rapidity with which China has developed its patent portfolio, R&D and patenting have tended to be specialized in certain technology areas while remaining relatively backward in other areas. In their article, “Technological Diversification in China from 1986 to 2011:  Evidence from Patent Data,” Wang et  al. (2015) confirm the positive relationship between national technology size, measured in terms of the number of patents, population, and gross domestic product, and technology diversification as it applies to China. Appling shift-​share analysis to a dataset of 3.7 million SIPO Chinese patents, the authors identify structural shifts, greater than those predicted by their earlier world model, toward greater technological specialization and away from traditional fields, such as consumer goods like electronics and computing. The authors argue that this transition mirrors the surge of “globalizing” FDI that entered China from 1985 to 2011. In their article “Industry Evolution and Key Technologies in China Based on Patent Analysis,” Zheng et al. (2011) use USPTO patent grants to identify the key technologies of

100   Jefferson and Jiang Table 1.4.7 China. World Citations for Papers and Patents with International

Collaboration versus Total: (CPPFCSm) Year

Papers

Patents

Papers/​Patents

Int’l Collaboration

Total

Int’l Collaboration

Total

2004 2006 2008

1.16 1.19 1.19

0.76 0.80 0.76

0.67 0.56 0.17

0.66 0.54 0.17

If the ratio CPP/​FCSm is above 1.0, the country’s paper/​patent is frequently cited and has brought more influence than the world average. Data compiled from Tables 8 and 11 in Zheng et al. (2012).

Chinese patents. Patents in six industries, including chemical (excluding drugs), computers and communications, drugs and medical instruments, electrical and electronics (E&E), mechanical, and others, are analyzed in this study. Zheng et al. find that in these fast-​growing industries with their associated rapid patent growth, citation rates for these patents have been low and declining. For example, in Table 1.4.7, Zheng et al. report that the citations per patent (CPP) for computers and communications fell from 0.80 in 2003 to 0.41 in 2005, stabilizing at 0.42 in 2008, while for E&E for the same years the CPP declined from 0.57 to 0.50 to 0.43. The decline that the authors find in the six industries is broadly consistent with the erosion of three-​year citation counts shown in Table 1.4.6. Focusing on the E&E industry, which accounts for over one-​third of the total technology patents, Zheng et  al. report that following 2006, 90% of the USPTO-​granted Chinese patents in the U.S. Patent Classification (USPC) 361, electrical systems and devices, have been owned by Foxconn Technology Co., Ltd. These data suggest a highly concentrated R&D environment in China’s E&E industry sector.9 The dominant role that Foxconn plays in China’s E&E sector also underscores the important role that companies headquartered outside of Mainland China play in contributing to China’s patent growth. In “Patent-​Bibliometric Analysis on the Chinese Science—​Technology Linkages,” using USPTO data, Guan and He (2007) explore the linkage between science and technology in China patenting. Specifically, they investigate the relative proportion of forward citations that appear in scientific publications, that is, “nonpatent references” (NPRs). In general, one would expect NPRs to measure the contribution of a patent to science rather than solely to technology. The analysis focuses on the period 1995–​2004, during which Chinese patent grants rose from 29 to 309. While the E&E industry generates the most patent grants, it accounts for only 4.1% of the scientific NPRs, a relatively low level compared with numerous other sectors. Guan and He report that the biotechnology, pharmaceutical, and organic

9  Using our data set to compare these figures with Zheng’s Table 8, we find that the Foxconn patent numbers are somewhat less. For 2007 and 2008, in the USPC 361 classification, our data set identifies 59 and 63 in 2007 and 2008, not 83 (2007) and 126 (2008) as reported by Zheng et al. Based on our data set, as the total Chinese patent number in USPC 361 increases during 2006–​2013, the patent count for Foxconn in this technology classification decreases from 74 in 2010 to 15 in 2013.

S&T Progress and Patenting    101 chemistry subsectors have a much stronger connection to scientific research, whereas—​like E&E—​ICT sectors, semiconductors, and optics are less science-​based domains.

The Role of Universities and Research Institutes Annual editions of the China Science and Technology Yearbook report that while the proportion of China’s total R&D spending accounted for by universities declined from 2000 to 2016 from about 9% to 7%, total university R&D spending rose by approximately a factor of 15. Perhaps more significantly, the university share of spending on basic research rose to 53% of China’s total in 2016. At the same time, China’s research institutes demonstrate a sizeable proportional reduction in both total R&D spending and in basic research, although still accounting for 41% of total basic R&D spending in 2016. The Other category, with nonenterprise entities accounting for only a very small proportion of basic research, shows a rising proportion of total R&D spending, of which the basic research proportion declines. Hence, in China, 94% of the basic research is conducted by the university and research institute sector.10 While over the 2000–​2016 period the enterprise sector’s share of total patents, invention patents included, rose significantly, the shares for the research institute sector declined. While the total number of patents fell only about 2.5%, the share of invention patents declined quite dramatically, from 15% to just 5%. This rapid decline is likely partly accounted for by the restructuring program begun in 1999 that has converted a sizeable number of research enterprises to commercial S&T enterprises, thus significantly reducing the size of the research institute sector. Analyzing the sources of China’s patenting surge, Hu and Matthews (2008) emphasize the strong role played by universities in the building of China’s national innovative capacity over the last 15 years. However, consistent with the analysis in the previous paragraph, the authors find a puzzling lack of contribution of the public research institutes in reinforcing China’s national innovative capacity. They reference the restructuring reforms initiated in 1999, involving the commercialization of a large number of research institutes, while rechanneling government support to a smaller number of nonprofit research institutes. Fisch et al. (2016) use a comprehensive dataset of university patents by 155 leading Chinese universities from 1991 to 2009 to study two issues: the quantity and quality of patents filed by leading Chinese universities and the role of subsidy programs with regard to university patenting in China. Addressing the quantity-​quality issue, their results show that a subsidy program to promote research excellence at selected universities has been a significant driver of patent quantity and quality. In contrast, a subsidy program that decreases the costs of patent applications seems to enhance patent quantity but not patent quality. The authors conclude that innovation policies that aim to stimulate patents of higher quality should

10 Source: China

Science and Technology Yearbook, 2001 and 2017.

102   Jefferson and Jiang focus primarily on increasing university R&D, and to a lesser extent on decreasing the costs of university patenting. In “Restructuring China’s Research Institutes: Impacts on China’s Research Orientation and Productivity,” Jiang, Tortorice, and Jefferson (2016) evaluate the impact of the Chinese government’s 1999 restructuring initiation for the country’s approximately 3,500 research institutes. Using a balanced sample of these institutes, both converted and unconverted, spanning 1998, the year prior to the restructuring initiative, to 2005, their econometric analysis finds that the restructuring program appears to have achieved a fundamental goal of shifting government research subsidies away from the converted commercially oriented S&T enterprises toward the nonprofit research-​oriented institutes. The initial results show modest gains in the efficiency of patent production, but given the lengthy gestation period, a longer duration is needed to assess how the patent production of China’s research institutes will adapt to the shift in their missions and reassignment of government resources. Lei et  al. (2012) use USPTO data to analyze three models of university–​industry–​ government institute (UIG) relations that represent different triple-​helix configurations. Analyzing the grant years for the patents, Lei et al. find that the inventive activities of China have experienced three developmental phases, having transitioned from (1) government to (2) universities and research institutes and then to (3) industry, during which enterprises, especially foreign-​invested enterprises and private-​owned enterprises, account for most of the growth in innovative activity. Of particular relevance for this section, in their analysis of copatenting, the authors find that collaborations between universities and industry are particularly robust and have intensified in recent years, while other forms of UIG collaboration have been weak. In the paper “The Role of Research and Ownership Collaboration in Generating Patent Quality:  China-​U.S Comparisons,” the findings of Jiang et  al. (2018) confirm and elaborate on these results. Their paper on the quality implications of various forms of patent collaborations finds that among Chinese patents that have been granted by the USPTO over the period 1990–​2015, patents involving firm-​university collaboration show the highest-​ quality level. At a somewhat lower-​quality level, firm-​institute collaborations also fare well. However, university–​research institute collaboration and the triple-​helix firm–​university–​ research institute (UIG) combinations fare quite poorly, which may be explained by the fact that the samples for both of these, less than 50 approved patents, is rather small. Of note, Jiang et al. report that the successful firm-​university and firm–​research institute combinations both show high incidences of international collaboration—​72% for the corporate-​university collaborations and 22% for the corporate–​research institute collaborations. As anticipated, China’s universities and research institutes may account for significant technology spillover effects. In their article regarding the interaction of industrial and academic R&D, Zhang and Rogers (2009) use data from the Chinese Patent Abstract database for 1989–​1999 to analyze the spillover effects of university and research institute R&D. Using patent count data, they find that the R&D expenditures of individual firms and spillovers from R&D activities conducted at universities and research institutes within the same region are the two most prominent factors shaping the firm’s innovation performance as measured by the firm’s patent awards. Very likely the tendency for universities and research institutes to specialize in basic research, accounting for 94% of China’s basic research, accounts for much of this spillover effect.

S&T Progress and Patenting    103 Focusing on the university sector, Wang and Guan (2010) find that scientists from universities are becoming more proactive in their efforts to commercialize research results. The authors examine the question of whether patenting adversely affects academic research publications. Their finding, focused on research in China’s nanotechnology sector, generally supports earlier investigations concluding that patenting activity does not adversely affect research output. However, when academic researchers participate with a corporation that is an assignee of a patent or the scientists themselves become assignees, participation in patent research does show negative impacts on both quantity and quality of the university researchers’ publication output. In conclusion, while firms dominate R&D spending and patent approvals in China, as generally elsewhere, research and patenting in China’s university sector have rapidly grown, suggesting a shift in funds and talent from China’s research institutes. By converting commercially oriented research institutes into S&T enterprises, China’s research institute sector is attempting to sharpen its focus on basic research and higher-​quality patenting.

The Role of the International Sector For China, the international sector matters in significant ways; the literature centers on two of these. First, Chinese patenting abroad, particularly in the USPTO, is growing rapidly, more so than domestic patenting within the SIPO. The incidence and quality of Chinese patenting offers a measure of the pace and extent of China’s S&T catchup with the international technology frontier and that of other countries. Second, China exhibits a rapidly increasing propensity for patent collaboration with foreign entities, whether at home, as through FDI, or abroad. Such collaboration is an important pathway for technology transfer. In “International Patenting by Chinese Residents: Constructing a Database of Chinese Foreign-​Oriented Patent Families,” Wunsch-​Vincent et al. (2015) analyze Chinese patenting abroad using WIPO data to construct a foreign-​oriented patent family database (1970–​ 2012).11 Exploring the motivations for overseas patenting, the authors find that the main drivers for this increasing tendency of Chinese firms to file in foreign jurisdictions are the desire to facilitate collaboration, to license intellectual property (IP), and to further the firm’s reputation as a true innovator. In his article “Propensity to Patent, Competition and China’s Foreign Patenting Surge,” Hu (2010) investigates the inverse of Wunsch-​Vincent et al. (2015)—​that is, the motivation for foreign firms to patent in China. The article focuses on competition as a determinant of the patenting decision in the context of the recent foreign patenting surge in China. Using a database composed of all patents granted by the SIPO and USPTO, Hu finds that competition between foreign imports can account for 36% of the annual growth of foreign patenting in China. In their paper “The Role of R&D Offshoring in Explaining the Patent Growth of China and India at the USPTO,” Duan and Kong (2008) document the increase over 1988–​2007 11  WIPO’s patent family database is based on a combination of the European Patent Office’s PATSTAT (April 2013 edition) and the WIPO Statistics Database.

104   Jefferson and Jiang in USPTO-​filed patents for both Chinese and Indian patents with Chinese and Indian inventors including Chinese and Indian assignees. Data show that in both China and India, most USPTO patents involving one or more Chinese or Indian inventors are owned by foreign assignees. Duan and Kong find that these results coincide with the trends of FDI and related foreign-​invested R&D activities in the two countries, suggesting that while foreign firms are expanding their R&D in these countries, resulting in more USPTO-​filed patents, most of these are limited to home country inventor participation, not joint assignee ownership. For nearly the same period, in “Booming or Emerging? China’s Technological Capability and International Collaboration in Patent Activities,” using 1997–​2007 data, nearly identical to Duan and Kong (2008), Ma et al. (2009) also assess the pattern of international collaboration between China and other major industrialized countries or regions and likewise find low assignee-​inventor ratios. Using the USPTO data, Jiang et al. (2018) confirm Duan and Kong’s finding for the earlier period; their Table 3 shows that pre-​2006, 30.6% of Chinese patents included a foreign inventor, while only 3.1% included a Chinese assignee. However, for 2006–​2015, as the foreign inventor share remains virtually unchanged, the proportion including a Chinese assignee rises to 27.3%. This increase would seem to indicate a substantial rise in the proportion of intellectual property created cooperatively with foreign inventors for which at least some portion of its ownership was assigned to a Chinese resident. In “International Scientific and Technological Collaboration of China from 2004 to 2008: A Perspective from Paper and Patent Analysis,” Zheng and colleagues (2012) assess China’s principal international collaborations. The authors show that China’s international technological collaboration (ITC) has been mainly carried out with the United States and Taiwan; Zheng et  al. find that Taiwan has been China’s most significant ITC patenting partner. These results are highly consistent with Zheng et al. (2011), who report a surge in patent collaboration with Taiwan following 2006; the cross-​strait collaboration, such as that with Foxconn, is a major factor in driving overall statistics concerning China’s research and patent cooperation with both inventors and assignees outside Mainland China.

Role of Government The Chinese government actively promotes China S&T development generally and patenting activity specifically through means that include setting nationwide patenting targets, often reflected in provincial planning, directing research funds for innovation and patenting, and, at the local level, offering subsidies and rewards for successful patent outcomes. The patent literature particularly focuses on the patent subsidy or patent promotion policies and programs (PPPs) initiated at the local level. Dang and Motohashi (2015) explain that local governments in China differ in their subsidy programs. Their Appendix 2 describes the provincial and time distribution of subsidy programs. Some governments subsidize only granted patents, intending to promote applications with a good probability of approval. However, such programs may not provide strong incentives for patent filing, because three to four years elapse between the filing and granting of patents, and the examination results are uncertain. Therefore, some governments provide subsidies during the filing and examination stages, allowing the applicants to obtain

S&T Progress and Patenting    105 subsidies immediately after a patent filing or examination request. Applicants are not required to return the subsidies if the applications are rejected by examiners. The amount of the subsidies also differs. Some governments fully subsidize the filing and/​or examination fee, whereas others provide subsidies covering only 50% to 80% of the fees. Grant-​ contingent rewards can vary from 500 yuan (Hebei) to 15,000 yuan (Tibet). By 2008, 80% of the provinces in China had initiated filing fee subsidies, while about half of the provinces offered examination fee subsidies and grant-​contingent rewards. In their chapter “Evaluating Patent Promotion Policies in China: Consequences for Patent Quantity and Quality,” using SIPO patent data at the provincial level from 1985 to 2010, Long and Wang (2015) find evidence that by 2007 PPPs—​namely preferential tax policies, subsidies, and subsidies for patent filing and maintenance fees—​had been adopted by various government agencies spanning 29 Chinese provinces.12 The authors find in response to these PPPs an increase in patent applications, although they find that the supply elasticity of invention patents is less than those for utility and design patents. Whereas the PPPs appear to have somewhat eroded the quality of the average patent application—​notably a reduction in renewal rates—​the adverse-​quality impacts on invention patents have been relatively marginal. Lei et al.’s (2012) “Are Chinese Patent Applications Politically Driven? Evidence from China’s Domestic Patent Applications” investigates the seasonal characteristic of patent filing counts in China from 1986 to 2007. Comparing domestic filings with foreign filings at the SIPO, the authors find a much stronger monthly pattern of domestic filings, which peaks in December every year. This analysis suggests the higher number of filings is likely due to firms breaking up their inventions to create more applications, possibly to qualify at year’s end for more subsidies and rewards resulting from the increase in applications. Using a sample of private Chinese small and medium-​sized enterprises in Zhejiang province and building on an agency-​theoretic framework, Shapiro et  al. (2017) find evidence that firm-​specific incentives exert a positive effect on patent activity. More specifically, their impact is contingent on the nature of the incentive, the employees at whom it is directed, and the measure of innovation employed. Contrary to their initial hypothesis and the evidence from other countries, Shapiro et al. find that pay-​for-​performance measures for managers positively impact patenting activity. Specifically, the authors find that both shareholding and performance-​based pay for managers are positively associated with new patents granted. They conclude that an understanding of the role of innovation incentives may be more complicated than typically assumed; that is, such research must account for the fact that different types of incentives impact the innovation performance of firms through different channels (ownership structure, managers vs. nonmanagers), resulting in incentives having differential effects on innovation.

12  According to Long and Wang, these data regarding PPPs, shown in their Tables 9.1 to 9.3, were collected by searching the relevant provincial-​ level legislation and regulations from Beida Fabao (http://​www.pkulaw.cn), Beida Fayi (http://​www.lawyee.net/​), and the Compendium of Chinese Laws (maintained by the Chinese Court website) (http://​www.chinacourt.org/​law.shtml/​) using keywords including “patent,” “award,” “preferential tax treatment,” and “subsidy.” They report the status of such PPPs prior to and including 2007 for 29 provinces.

106   Jefferson and Jiang In their article “Research-​ Driven or Party-​ Promoted? Factors Affecting Patent Applications of Private Small and Medium-​Sized Enterprises in China’s Pearl River Delta,” Liefner et al. (2016) do as Zhen et al. recommend. They use company survey data for the period 2011–​2012 to examine the influence of firms’ formal ties with the Communist Party of China (CPC) on their patenting behavior. Taking the example of private small and medium-​sized firms in the electronics industry within the Pearl River Delta, the authors establish that the presence of CPC offices can be the strongest single predictor for firm patenting even when controlling for other factors.13 This seems particularly noteworthy because earlier studies found that small and medium-​sized firms in the Pearl River Delta were less susceptible to central government influence than other Chinese firms. This set of papers, combined with earlier reviews in the previous sections regarding the causes of China’s patent surge and its implications for patent quality, strongly suggest that whereas government subsidies have encouraged the growth of patenting in China, the subsidies have generally distorted incentives and eroded patent quality in some degree. It may be, however, that certain carefully crafted and supervised subsidy programs merit attention for seemingly having simultaneously increased China’s patent count without compromising patent quality.

Sectoral and Regional Technology Diffusion A key issue regarding China’s S&T system and its evolution, including patenting, is its impact on regional disparities.14 While not focused on regional disparities per se, in “Effects of Knowledge Capital on Total Factor Productivity in China:  A Spatial Econometric Perspective,” Scherngell et  al. (2014) investigate the use of patent counts as a proxy for knowledge capital for the purpose of measuring total factor productivity (TFP) in China’s manufacturing sector. Their results confirm a shift of Chinese productivity growth to becoming more knowledge based, showing a far more robust impact of knowledge capital, measured in terms of patent counts, on regional TFP after 1998. Guan and Liu also find that the interregional spillovers of knowledge capital become substantially more robust after 1998 than they had been pre-​1998, thus confirming the growing importance of knowledge capital (patents) in China’s economy.

13  Liefner et  al. (2016) report that according to a Xinhua news release, in the year 2010, the CPC maintained offices in 640,000 companies (nearly one-​quarter of China’s 2.77 million firms), including 438,000 private companies. 14 In “A Comparison of the Spatial Distribution of Innovative Activities in China and the U.S. Fengchao,” Liu et  al. compare the spatial distribution of innovative activities between China and the United States. Using invention patents as an indicator gathered from the SIPO and USPTO, their paper compares the spatial distribution of innovative activity in China and the U.S. by methods such as rank-​ frequency, concentration and classification. They find that while innovate activities in both countries are more concentrated toward coastal areas, the spatial diversity of patent distribution in China is more pronounced than in the United States.

S&T Progress and Patenting    107 Using SIPO data, in “A Patent-​Based Evaluation of Technological Innovation Capability in Eight Economic Regions in China,” Chen et al. (2009) analyze the regional distribution of patent applications, during 1999–​2004. Unsurprisingly, this study finds that across the eight regions more than 50% of the Chinese patent applications were filed from the north coast and east coast, where the rates of patent growth, the south coast included, exceeded those of other regions. Most intriguing, the authors find that the disparity between R&D spending among the eight regions is small compared with the large difference in patent applications, thus suggesting higher returns to R&D across China’s coastal provinces. This disparity may result from heightened knowledge spillovers accruing in regions with greater concentrations of universities and with more dense transportation connections. In this vein, using Chinese city data for 224 cities over 2006–​2010, Jiang et al. (2017) explore the factors affecting cross-​city R&D collaborations in China. Using the copatenting data of the Chinese Patent Database as a proxy for R&D collaboration, the article investigates the spatial patterns of R&D collaborations between cities. The study shows that cross-​city collaborative R&D activities mainly occur between advanced municipalities and coastal regions. While the mean collaboration intensity for intraprovincial cross-​city collaborations is 4.74, at 0.69 the incidence of interprovincial collaborations is substantially less. Specifically, it is more likely that R&D collaborations occur among cities that are connected by high-​ speed railways. In “Comparing Regional Innovative Capacities of PR China Based on Data Analysis of the National Patents,” Guan and Liu (2005) argue that the inequality of innovative capacities among regions hinders the harmonious development of China’s overall S&T. By examining the complementarities between and among the range of inputs to patenting, the authors argue that the relevant inputs are inefficiently distributed across regions. Specifically, Guan and Liu conclude that scientists and engineers, government R&D funds for enterprises, bank R&D loans, and enterprise funds for research institutes and universities are all allocated inefficiently to different degrees within China’s regional innovation system. On the contrary, firms’ self-​financed R&D contributes efficiently to regional innovative capabilities, suggesting that more efficient allocations of innovation resources could at once improve the distribution of regional innovative capacities and China’s overall innovation achievement. In their paper, “The Impact of Small World on Patent Productivity in China,” Zhang et al. (2014) use SIPO data to examine the evolution of small world networks, with high densities of enterprises, and their impact on patent productivity in China. The authors confirm their hypothesis, that small networks with larger ratios of state-​owned enterprises (SOEs) confront more cumbersome transmission paths, causing knowledge to flow less efficiently. For example, they find slower technology transmission in Beijing, with a high proportion of SOEs, than in Guangdong, with a lower proportion. Hence, the authors conclude, to speed up knowledge dissemination and innovation, the Chinese government should let the market rather than administrators determine the allocation of innovation resources. Combining SIPO and European Patent Office (EPO) PATSTAT data sources for the period 2008–​2012, Kroll (2016) explores the structure of Chinese patenting from a regional perspective. Kroll’s key conclusions include the following: ➢ The most recent development of China’s technological system gives no indication that any substantial mitigation of geographical disparities regarding technological capacities appears imminent. While there is evidence of an absolute strengthening of many

108   Jefferson and Jiang noncoastal regions’ positions, the continued dynamic of the Greater Shanghai region in particular limits the prospects for regional convergence. ➢ The fact that China has become globally competitive in only a few technological fields creates an imbalance favoring regions with these specializations. However, the degree of concentration of university patents has decreased substantially as actions and policies supporting technological transfer, formerly limited to “islands of innovation,” become more and more prevalent in China’s interior. Not all of the research focuses on the seemingly irreversible divide in relative research capabilities across China’s coastal and interior regions. Using the population of SIPO patents over the period 1986–​2006, Huang (2010) finds that the S&T capabilities across Chinese regions appear to be becoming more uniform. Specifically, Huang finds that various S&T indices measured across 12 technology classifications have systematically diffused inward across the provinces to enhance China’s overall innovative capacity.15 Between 1986 and 2006, the S&T advantages of key regions, including Shaanxi, Guangdong, Shanghai, Tianjin, Beijing, Jiangsu, Shandong, and other coastal provinces, diminished over time relative to the central and interior regions. One way in which to reconcile Huang’s findings with others less sanguine about the extent of and prospects for regional catchup is the possibility that the cutting-​edge technologies in the coastal economies are those other than the 12 technologies for which Huang uses continuous data extending back to 1986.

Conclusions and Discussion In this chapter, we draw on key results of 44 research papers and data from the USPTO to analyze how China’s recent 25-​year patent production offers insight into China’s effort to transform successfully from an innovation economy to an invention economy. Limits to the length of this chapter constrain our ability to integrate and discuss the range of analyses and conclusions summarized earlier. Nonetheless, as shown by the review, which includes six distinct sections ranging across quantity, quality, technological specialization, the roles of the international sector and the Chinese government, and regional disparities, the literature spans a wide range of subjects, with some papers focusing on China’s early patent performance while others update the performance to the recent 5 or 10 years. One focus of the literature that arguably is missing, largely because it is only now becoming feasible as Chinese patents proliferate with international patent offices, is the extent to which China has been closing its technology and patenting gap with the evolving frontier of other countries. Our assessment is that given the rapid accumulation of patent grants, particularly by the USPTO, in addition to patent grants by the SIPO and the patent offices of other countries, a sufficient amount of Chinese and comparative patent data, both country-​wide and across key industries, now allows for careful quantitative analysis of the degree and rate of technology catchup. Given the availability of patent data, including

15  This index is defined here as a region’s share of SIPO patents across the twelve major science or technology classes, divided by that region’s share of SIPO patents across all classes.

S&T Progress and Patenting    109 quality measures, such as claims and citations, the ability to suitably weight patent counts by their quality allows for more nuanced measures of country comparisons. We can look forward to the application of updates of various data sources and analytical methods reviewed in this chapter to analyze the pace, strengths, and weaknesses of China’s effort to close its technology gap with the world’s most innovative economies. Acknowledgments: Project of National Natural Science Foundation of China (71874138, 71302147), the Fundamental Research Funds for the Central Universities (SK2018044), and the International Business School of Brandeis University.

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Pa rt   I I

BU I L DI N G C H I NA’ S I N N OVAT ION C A PA B I L I T I E S

Chapter 2.1

Chi na’s Nati ona l a nd Regional Innovat i on Systems Lan Xue, Daitian Li, and Zhen Yu Introduction The notion of the national innovation system (NIS) was developed by Freeman (1987), Lundvall (1992), and Nelson (1993) at the end of the 20th century. It has become a popular concept among scholars, policymakers, and industry practitioners since the early 2000s. Although some scholars questioned the relevance of this concept and proposed alternative frameworks (e.g., global innovation system [Binz and Truffer 2017], multilevel perspective [Geels  2011]) for addressing the world’s grand challenges today (Schot and Steinmueller 2018), the NIS remains an important framework for governments in many countries to promote innovative capability and competence building within national boundaries (e.g., Ministry of Science & Technology, People’s Republic of China). To understand China’s NIS, the first thing we need is a clear definition of the NIS framework. Despite the fact that different definitions exist (Niosi 2002), we adopt the definition given by Lundvall (1992), according to which the NIS refers to “the elements and relationships which interact in the production, diffusion and use of new, and economically useful, knowledge . . . and are either located within or rooted inside the borders of a nation state.”(p2) Figure 2.1.1 shows the key elements of a typical NIS, which include firms and non-firm actors (e.g., public research institutes [PRIs], government agencies), markets, the science system, the education system, infrastructures, and the macroeconomic and regulatory context (OECD 1999). A  well-​ functioning NIS often requires that different elements interact with each other in virtuous cycles. For example, the education system cultivates talented people, who will enter the science system and produce new knowledge. The knowledge generated from the science system will subsequently be commercialized by firms on the markets. The economic value created by firms will be (partially) redistributed back to the science and education systems by governments in the forms of public funds and infrastructures. However, this does not imply that the NIS is a closed system. Instead, foreign firms often play important roles in

116    Xue, Li, and Yu Macroeconomic and regulatory context Infrastructures

Education system

Firms Networks among different actors

Other research bodies

Science system

Supporting institutions

Product market

Industrial and regional clusters

Factor market

Figure 2.1.1  A typical model of the NIS. Source: Adapted from OECD (1999)

the NIS of latecomer countries (Fu 2015). Access to foreign knowledge is crucial for the catching-​up of emerging market firms, at least in the early stage (Malerba and Nelson 2011). The aforementioned interactions among different actors should be supported by a variety of institutional arrangements (e.g., property rights protection, market-​based transactions). China’s NIS has a unique development path and demonstrates several interesting characteristics. While the concept of the NIS was not introduced into China until the late 1990s, China began to take a systematic approach to build its science and technology (S&T) capabilities following the former Soviet Union’s model since the founding of the People’s Republic of China (PRC) in 1949. From 1949 to 1966, China established the Chinese Academy of Sciences (CAS), over 1,000 applied research institutes, and a comprehensive university system. This S&T system made some remarkable progress in training S&T manpower, performing basic research, and developing strategic military technologies. As a planned economic system, however, Chinese firms (almost all were state-​owned enterprises [SOEs] or collective enterprises) had little incentive for commercial innovation.1 The reform and opening up that started in 1978 had a tremendous impact on China’s NIS. The “market reform” provided abundant opportunities for different types of firms to emerge and prosper. The “opening up” enabled domestic firms to access foreign knowledge and technologies so that they could apply them in the production of their own technological

1 

Unlike “invention,” “innovation” involves the commercialization of something new (Schumpeter  2017).

National and Regional Innovation Systems    117 capabilities. The reforms of universities and PRIs facilitate knowledge creation and knowledge diffusion in the whole society. As shown in the chapters in Part I, after four decades of efforts, the overall innovation capability of China has been greatly improved. For example, in basic research, the total number of scientific papers published by Chinese authors has been ranked No. 1 in the world since 2016.2 China’s rapid catching-​up in high-​tech sectors (e.g., telecommunications, high-​speed trains, internet) has also drawn worldwide attention, which is believed to be one of the key factors triggering the Sino-​US trade war. Following this introduction, we first review the evolution of China’s innovation system. We then look into the current status and characteristics of China’s NIS. Lastly, we discuss the future directions for China’s NIS development.

Evolution of China’s Innovation System Pre-​reform era (1949–​1978). After the establishment of the PRC in 1949, China basically copied the former Soviet Union’s mode of S&T development, which was characterized by a clear division of labor (but little interaction) among PRIs, universities, and industrial enterprises (Sun 2002). PRIs, administered either by the CAS, by central government ministries, or by local governments, were the most important actors in research and development (R&D) and carried out almost all research projects. S&T funding and tasks were centrally planned and allocated by the government (Xue 1997; Zhong and Yang 2007). With few exceptions, universities were only engaged in education, while industrial enterprises focused on production. As China had a very hostile international environment at that time, military-​related S&T activities and industries were disproportionally prioritized by China’s central government. As a result, China witnessed a relatively successful development in strategic military technologies, such as the atomic bomb (1964), hydrogen bomb (1967), and man-​made satellite (1970). However, the civilian industries were largely ignored and poorly managed, with few incentives for developing and adopting new technologies. The end of the chaos and the beginning of a new era (1978–​1985). During the ten-​ year period of the Cultural Revolution (1966–​1976), many intellectuals and researchers were persecuted and many research institutes were eliminated or downsized (Sun 2002). Therefore, the first job after the chaotic period of the Cultural Revolution was to restore China’s S&T and education system to its normal operation. A critical event was in March 1978 when the National Science Conference was held in Beijing. In the conference, Deng Xiaoping, a major figure in the then-​political leadership group in China, articulated several historical judgments: for example, “science and technology is a productive force” (which was later developed into “science and technology is the primary productive force”) and “intellectuals are part of the working class,” which clearly legitimized the role of S&T in economic development and liberated scientists and intellectuals from the fear of the Cultural Revolution. The conference also passed the “1978–​1985 National S&T Program (Draft),”3

2  3 

According to the Scopus database maintained by Elsevier. “Outline of National Science and Technology Development Plan from 1978 to 1985 (Draft).”

118    Xue, Li, and Yu highlighting investment in basic research. For scientists in China, these changes signified the arrival of the Spring of Science. Meanwhile, China’s government agencies related to S&T administration were concerned about how to allocate S&T resources more effectively, in line with the government’s guiding principle that stipulated that S&T research must render services to economic construction while economic development must rely on science and technology.4 In addition, China initiated a wide discussion on the new S&T revolution around the world and issued corresponding policy documents to respond to its challenges, reflecting the role of the international perspective in China’s S&T policymaking and providing a rationale for the coming S&T system reform. The reform of China’s S&T system (1985–​1998). In March 1985, the Central Committee of the Chinese Communist Party (CPC) issued the landmark policy document “The Resolution of the Structural Reform of the Science and Technology System,”5 marking the beginning of China’s systematic reform of its NIS (Xue 1997). The fundamental objectives of the reform were “to apply results from S&T research to production widely and rapidly; to make full use of S&T personnel; to greatly empower science and technology as the driving force for the economy, and to promote the development of the economy and society.” According to the resolution, the operating mechanism, institutional structure, and management of S&T personnel were the three key areas where structural reforms were most needed (Xue 2018). In terms of the operating mechanism, the resolution changed the appropriation system for funding S&T research in PRIs. The government gradually reduced the amount of funding for PRIs, pushing them to acquire funding from industries. Though the government continued to provide some funding to cover basic costs for PRIs engaged in basic research, most PRIs were no longer entitled to receive major research grants automatically but had to compete with other qualified research institutes through a public bidding system. Besides, the resolution called for opening up a technology market where R&D results could be commercialized. In terms of institutional structure, the resolution advocated better coordination and integration between research institutions and industrial enterprises, between civilian and military research, and between research in different industrial sectors and regions. It also encouraged various horizontal linkages among PRIs, universities, and industrial enterprises, including mergers between PRIs and industrial enterprises. In terms of personnel management, many efforts were devoted to building a favorable environment where intellectual work was respected and talent mobility was encouraged. S&T personnel were no longer guaranteed employment within their units (the “iron rice bowl”) and were encouraged to move to industrial and agricultural sectors through various means. In the meantime, a series of new S&T mechanisms were established at the national level, including a national system for the protection of intellectual property, the National Natural Science Foundation to support PRIs’ basic research through a peer-​reviewed grant system.

4 Frist

articulated in the 12th National Congress of the Communist Party of China held in September 1982. 5  “The Decision of the Central Committee of the Communist Party of China on the Reform of the Science and Technology System.”

National and Regional Innovation Systems    119 Various national R&D programs, for example, the Spark Program, Torch Program, High-​ Tech Research and Development Program (the 863 Program), and National Basic Research Program (the 973 Program),6 were developed to better utilize S&T capacities and resources to serve China’s economic development. To accelerate the development of emerging high-​tech industries, the resolution also proposed to develop a number of new high-​tech industry development zones with different characteristics in certain regions that have a high intensity of intellectual resources. The first national high-​tech development zone, Zhongguancun, was established in Beijing in 1988. In 1991, the central government approved 11 policy documents to identify high-​tech enterprises and to provide them with preferential policies. By June 1997, 52 national high-​tech industrial development zones had been established nationwide, providing a comparatively favorable physical and institutional environment for the development of new high-​tech enterprises, and hence promoting China’s high-​tech industry. The scaling-​up of S&T system reform (1998–​2006). With the deepening of S&T system reform since 1985, many research institutes engaged in applied research benefited from participating in economic development through innovation and entrepreneurship. A large number of basic research institutes, however, were confronted with very severe survival challenges (Xue 2018). The first author of this chapter recalls the experience of visiting a geology research institute under the CAS system in 1997, which was trying to participate in the market by establishing a gem authentication service. Linkages among PRIs, universities, and industries were also relatively weak. As China’s market economy reform proceeded, domestic private enterprises grew quickly due to the fast-​growing market, but limited innovation capacity remained a key bottleneck of their development. In contrast, despite possessing a large number of researchers and resources, many SOEs were trapped at a low productive level mainly due to the lack of effective incentives to innovate. While China’s S&T system reform struggled to muddle through, new concepts and theories from the international S&T policy research community offered new stimulation for China’s further reform. In 1997, the concepts of the knowledge economy and NIS were successively embraced by China’s academic community and policymakers. Taking advantage of this momentum, the CAS submitted a petition report titled “Welcome the Era of Knowledge Economy and Build a National Innovation System” to the then national leader, President Jiang Zemin, who soon responded with an important instruction:  “I think we can support them to go ahead with some pilot projects, so as to build our own national innovation system.” In June 1998, the CPC’s Central Committee and the State Council made an important decision to build China’s NIS. The CAS was tasked to initiate a major pilot project on knowledge innovation, aiming to form an efficient national knowledge innovation system and operating mechanism, and to build a batch of internationally renowned national innovation centers of excellence. These initiatives opened up a new round of S&T system reform focusing on building China’s NIS. Accompanying these knowledge innovation projects was the transformation of the PRIs’ institutional structure and status. In 1998, the State Council started an institutional reform

6  The Spark Program, formally launched in 1986, aims to promote economic development in rural areas through the application of scientific and technical knowledge. The Torch Program focuses more on the commercialization, industrialization, and internalization of new and high technologies.

120    Xue, Li, and Yu and restructuring, which eliminated 15 ministries, most of which were specialized in industry administration. Following this effort, 242 applied research institutes administered by these ministries began to experiment in transforming their ownership structure, and 131 of them were then acquired by industrial enterprises, 40 were transferred to local governments, 18 turned into intermediary agencies, 24 transferred to universities or other ministries, and 29 were merged into 12 aircraft enterprises administered by the central government. The reform was then scaled up. By the end of 2003, 1,050 applied research institutes had completed the transformation of ownership structure and become independent market entities, and 99 PRIs were merged into universities or became non-profit organizations. At the same time, a series of measures were implemented to encourage large SOEs to set up R&D centers. Several technological innovation programs were established to support small and medium S&T enterprises for innovation. Local governments were also enthusiastic in attracting multinational corporations (MNCs) to set up R&D centers in their jurisdictional areas by offering various preferential policies. Gradually, China’s local enterprises greatly benefited from MNCs’ knowledge spillover through, for example, joint venture, patent licensing, and talent mobility, and MNCs were increasingly viewed to be an important part of China’s NIS. During this period, China’s higher education system, as an important part of its NIS, also went through several major reforms, including the enlargement of university enrollment and the project of building world-​class universities (the 985 Project). In response to the financial crisis in Asia and the growing unemployment in 1998, China’s universities and colleges began to increase student enrollment at an unprecedented scale. In 1999, the total higher education enrollment number reached 1.6 million, among which 0.5 million were newly added, making the enrollment growth rate 47.4%. Subsequently, enrollment continued to expand at a rate of 38.16%, 21.61%, and 19.46% in 2000, 2001, and 2002, respectively. While the total number of university students exceeded just 10 million in 2003, the number grew rapidly to 37.8 million in 2017, with a gross enrollment ratio (GER)7 for higher education reaching 45.7%. In May 1998, at Peking University’s centennial anniversary ceremony, then-​president Jiang Zemin proposed that “in order to achieve modernisation, we need a number of world-​class universities.” His proposal was implemented in the “Education Revitalization Action Plan for the 21st Century”8 in 1999 by the Ministry of Education, with Peking University and Tsinghua University as the first two candidates. The improvement of the national S&T system (2006–​2013). In 2003, China began to formulate a national medium-​and long-​term S&T development plan in response to the growing international competitive pressure after China’s entry into the World Trade Organization (WTO). The State Council set up a leading group for the planning process led by then-​premier Wen Jiabao and involved 20 ministries under the State Council. This planning process gathered more than 2,000 experts from various fields of natural science, engineering, and social sciences. Over 20 specialized research groups were organized to focus

7 

UNESCO defines GER as the total enrollment within a country in a specific level of education, regardless of age, expressed as a percentage of the population in the official age group corresponding to this level of education. 8  “Action Plan for Invigorating Education in the 21st Century.”

National and Regional Innovation Systems    121 on strategic issues such as the overall strategy of S&T development, S&T system reform, the NIS, and S&T development in the manufacturing sector. In 2006, the planning process was completed with the “Guideline for the Medium-​and Long-​Term National Science and Technology Development Planning (2006–​2020)”9 (hereafter Guideline) officially promulgated. Indigenous innovation, leap-frogging in key areas, supporting economic development, and leading the future became the core themes in China’s S&T development for the next 15 years. The Guideline aimed to build China into an innovative country by 2020. It identified key research tasks in the areas of basic research, applied research, and interdisciplinary research. In addition, 16 mega-​research projects of strategic significance were chosen to receive major government support. The Guideline offers a great opportunity for the comprehensive operations of China’s NIS. In February 2006, the State Council issued a document “Supporting Policies to Implement the Guideline,”10 offering guiding principles for various supporting policies such as S&T input, tax reduction, financial support, government procurement, intellectual property protection, and the talent workforce. Furthermore, China enacted the Science and Technology Progress Law to affirm China’s objectives, guidelines, and strategies in the new medium-​ and long-​term S&T development plan, enhancing the supporting measures to encourage indigenous innovation. Innovation-​driven development (2013–​present). Since 2013, China’s new leadership has attached great importance to S&T system reform, highlighting S&T innovation as the key strategy to promote China’s comprehensive national development and improve the quality of such development. A series of reforms were put forward under the guideline of innovation-​driven development. In 2014, the State Council issued “Plans for Deepening the Management Reform of the Central Fiscal S&T Program (Special Projects, Funds, etc.).”11 In 2015, the CPC’s Central Committee and the State Council together released “Suggestions for Deepening System and Mechanism Reform to Accelerate the Implementation of Innovation-​ Driven Development Strategy.”12 Meanwhile, China amended the law of promoting technology transfer,13 enacted regulations to implement the law, and issued “Action Plans to Promote Technology Transfer,”14 completing the trilogy of policies for promoting technology transfer. In 2016, the CPC’s Central Committee released “Guideline for National Innovation-​Driven Development Strategy,”15 providing top-​level design and systematic planning for China’s future S&T innovation toward 2050. The State Council also promulgated “Suggestions to Promote Mass Entrepreneurship and Innovation,”16 aiming

9 

“National Medium-​and Long-​Term Plan for Science and Technology Development (2006–​2020).” Number of Supporting Policies for the Implementation of the National Medium-​and Long-​ Term Plan for Science and Technology Development (2006–​2020).” 11  “Proposal on Deepening the Management Reform of the Central Financial Science and Technology Plan (Special Funds, etc.).” 12  “Several Opinions on Deepening the Reform of System and Accelerating the Implementation of Innovation-​Driven Development Strategy.” 13  “Law on Promoting the Transformation of Scientific and Technological Achievements.” 14 “Action Plan for Promoting the Transfer and Transformation of Scientific and Technological Achievements.” 15  “National Innovation Driven Development Strategy Outline.” 16  “Opinions on Promoting Several Policy Measures for Public Innovation and Mass Innovation.” 10  “A

122    Xue, Li, and Yu to facilitate S&T innovation and mass entrepreneurship simultaneously. Represented by the co-working space, various new business incubators started to emerge. In 2016, China hosted 17 specialized national co-working spaces, around 4,200 normal co-working spaces, 3,600 S&T enterprise incubators, and 400 enterprise accelerators, forming a coordinated chain of innovation, incubation, and entrepreneurship; providing services to 0.4 million startups; and creating more than 1.8 million jobs. Throughout the four-​decade process of S&T reform, it is clear to see that China followed a gradualism philosophy (Sun 2002). Reforms usually begin with a trial-​and-​error approach by issuing some temporary mandates, which would be modified or supplemented by further mandates, or completely replaced by new laws when enough experience and feedback were accumulated (Xue 1997). Another area of progress is that China increasingly uses legislative means, rather than the traditional administrative directives, as instruments for policy implementation. For a long period of time, the state was heavily involved in R&D activities, “from the drafting of development policies and identification of priority fields, to funding, coordinating, and managing R&D activities” (Sun 2002, 488). This situation has changed dramatically, particularly for research in the industrial sector, which has grown to represent over three-​quarters of China’s R&D activity and is driven mainly by market forces.

Characteristics of China’s Innovation System Although China imported the concept of the NIS from Western countries in 1997, China’s de facto NIS, developed since the founding of the PRC, has its own characteristics that were shaped by the economic and political environment as well as historical events. In this section, we will first illustrate the structure and components of China’s innovation system with a focus on two types of actors and two types of interactions. Then, we briefly review the overall performance and problems of China’s NIS.

Structure and Components Overall Structure China’s NIS consists of different entities and various interactions among these entities. These entities include firms, governments, universities, PRIs, and users. Different types of entities play different roles within the system, in which they learn and develop different types of capabilities through interactions with other players. The overall structure of China’s innovation system is shown in Figure 2.1.2. Here, the “government” includes the central government, ministries, and local governments. All public universities and PRIs are under the administration of either the central government or local governments. Before China’s reform and opening up in 1978, most of the enterprises were state owned or collectively owned. Nowadays, private firms, international joint ventures, and foreign-​owned enterprises are also critical players in the Chinese economy and important components of China’s NIS. The state plays important roles in China’s NIS, setting development plans and

National and Regional Innovation Systems    123 Government Central Government

Ministries

Local Government

Ministry of Education

Research Institutes (e.g., Chinse Academy of Sciences) Universities Research Institutes

Research Institutes

Public research institutes

State-owned enterprises

Universities

Private firms

Other supporting institutions

Universities

Foreign-owned enterprises

International joint ventures

Other types of firms

Firms

Users/Consumers Figure 2.1.2  The overall structure of China’s NIS. Source: Drawn by the authors

launching S&T projects. Beyond involving the NIS through SOEs and PRIs, the state also involves the NIS through other institutional arrangements, such as public-​private partnership (PPP), industry alliances, and standards-​setting organizations.

Firms Before the reform and opening up, China was a planned economy. SOEs conducted production activities under the national planning directives. Product development during this period was carried out in government-​affiliated R&D institutes. At that time, firms did not have the capabilities to develop new technologies, nor did they have such motivations. The reform and opening up that began in 1978 promoted the technological development of enterprises from two aspects: on the one hand, it allowed private enterprises to enter the

124    Xue, Li, and Yu market and to enjoy shared prosperity with SOEs; on the other hand, it allowed foreign-​ owned enterprises to enter the market and to compete with domestic firms. As enterprises from developed countries entered the Chinese market, they also brought a wealth of technologies to China, which generated positive spillovers to Chinese companies. This laid the foundation for Chinese enterprises to acquire technological capabilities and achieve rapid catchup. Since China officially joined the World Trade Organization in 2001, the innovation performance of Chinese enterprises has improved rapidly under fierce global competition. A number of Chinese companies, such as Huawei and Haier, have successfully upgraded their capabilities in terms of technology development, market expansion, organizational structure, and global strategy. Although many Chinese companies started with an “imitative strategy” (Xiao, Tylecote, and Liu 2013)  in the early stages, they were not simply copying the technologies they had imported. Instead, they were conducting independent R&D adapted to their home-​country environments and creating a development path with Chinese characteristics. In more recent years, an increasing number of companies followed the strategy of indigenous innovation and have considered internationalization as a way of enhancing their competitive advantages, as well as widening their customer base. For example, Lenovo became the world’s PC manufacturing giant by acquiring IBM’s R&D capabilities and brand. Geely developed key automotive components (e.g., engines) in China through the acquisition of Volvo. Similarly, in the pharmaceutical industry, many successful Chinese firms used advanced foreign biochemical or pharmaceutical technologies to upgrade traditional Chinese medicines. Meanwhile, they developed many proprietary Chinese medicines, such as San-​ jiu-​wei-​tai, Yunnan Baiyao, and other famous branded products. In the information and communications technologies (ICT) industries, Chinese companies started to migrate from creative imitation to innovation. They invested heavily in R&D, moving from the low-​end market to the high end. Companies such as Huawei and ZTE have launched products that compete with global giants such as Cisco and Ericsson. Hikvision and Dahua have become leaders in the global market of video surveillance. The reason these companies succeed is that they have adopted unique but suitable technology development strategies that allow them to provide customers with products that are “fit for purpose” (Yip and McKern 2016). For example, Huawei adheres to the “needle-​point strategy,” which means that it allocates more resources than its competitors in selected technological areas to achieve comparative advantages in those areas. Subsequently, it migrates such comparative advantages to other related technological areas. After 2009, as globalization intensified, Chinese companies were increasingly relying on open innovation in the global innovation network. Under the paradigm of global open innovation, companies are not isolated individuals, but organisms that interact with the business ecosystem in which they operate, especially for companies that occupy the core positions of the innovation ecosystem. Service-​oriented business ecosystems, represented by Alibaba, Baidu, and Tencent, and manufacturing-​ oriented business ecosystems, represented by Huawei, Xiaomi, and China Commercial Aircraft, are booming. (For further analysis of this phenomenon, see Chapter 5.7 of this Handbook, “Open Innovation for Development in China.”) Despite the fact that a number of globally competitive multinationals (e.g., Huawei, Geely) have emerged in China, most of Chinese firms’ innovation activities are still concentrated at

National and Regional Innovation Systems    125 the engineering level. The majority of Chinese firms have not genuinely developed the capability for original innovation. This urgently requires Chinese firms to upgrade their innovation capabilities. Huawei understands this and established the “2012 Lab” and increased its R&D expenditure in 2016 to RMB 59.6 billion. The main research areas of the “2012 Lab” include next-​generation communication technologies, cloud computing, audio and video analysis, data mining, machine learning, and so on. Similarly, Alibaba established the DAMO Academy (Academy for Discovery, Adventure, Momentum, and Outlook) in 2017, announcing that it would invest RMB 100 billion in the next three years for conducting research on basic science and disruptive technologies. The main research areas of the DAMO Academy include quantum computing, machine learning, basic algorithms, network security, natural language processing, human-​machine interaction, and others. These top-​notch laboratories are independent of their parent companies’ established R&D systems and their mission is to develop future technologies for the next 5 to 10 years.

Universities and Public Research Institutes Universities constitute another building block of China’s NIS with a focus on education, developing talent, and basic research. Most developed countries have world-​class universities, such as Harvard and Stanford in the United States, Oxford and Cambridge in the United Kingdom, and Tokyo University in Japan. These universities have significant influences on the development of their home countries. Having universities with a worldwide reputation is also an important symbol of a country’s comprehensive national strength. Thus, building “first class” universities is a crucial task during China’s innovation system development process. As previously discussed, at the turn of the century, China started a world-​class university program. The latest effort in building first-​class universities is the so-​called Double First-​Class University Plan.

“Double First-​Class” University Plan Building first-​class universities and first-​class disciplines is a major strategic decision made by the central government in recent years. It is aimed at improving China’s education system, strengthening the country’s core competitiveness, and laying the foundation for long-​term development. In October 2015, the State Council issued the “Overall Plan for Coordinating the Advancement of World-​Class Universities and First-​Class Disciplines” (“Double First-​ Class” University Plan). The program aims to support the innovation-​driven development strategy and economic development, in order to achieve the “Two Centenary Goals”17 and to realize the rejuvenation of the Chinese nation. The program proposes that “By 2020, a number of universities and a number of disciplines will enter the world’s leading university list, and several disciplines will be among the world’s leading disciplines; by 2030, more universities and disciplines will enter the world’s leading university list. By the middle of this century, the quality of China’s first-​class universities and first-​class disciplines should

17  Two Centenary Goals:  (1) build a well-​ off society by 2021 (100  years since the founding of the Communist Party of China) and (2) build a rich, strong, democratic, civilized, and harmonious socialist modern country by 2049 (100 years since the founding of the PRC).

126    Xue, Li, and Yu Table 2.1.1. Chinese (Mainland) Universities Listed in the Top 100 of QS

World University Rankings Rank in China

University

Global Ranking

1 2 3 4 5 6

Tsinghua University Peking University Fudan University Shanghai Jiao Tong University Zhejiang University University of Science and Technology of China

25 38 40 62 87 97

Source: QS World University Rankings, 2018, https://​www.topuniversities.com/​university-​ rankings/​world-​university-​rankings/​2018.

have reached the global frontier.” This means “building first-​class faculties, cultivating top-​ notch talents, upgrading scientific research, inheriting innovative and excellent culture, and promoting the industrial application of research output.” In January 2017, the Ministry of Education, the Ministry of Finance, and the National Development and Reform Commission jointly promulgated the “Measures for the Implementation of First-​ Class Universities and First-​ Class Discipline Construction (Provisional).” On September 21, 2017, the Ministry of Education, the Ministry of Finance, and the National Development and Reform Commission announced the list of “Double First-​Class” universities. A  total of 137 universities were shortlisted, among which 42 universities entered the list of “first-​class universities,” and 95 universities entered the list of “first-​class disciplines.” This means that China is initiating a new round of world-​class university development, after 18 years of implementation of the “985 Project.” As shown in Table 2.1.1, China had 6 universities listed in the QS Top 100 ranking by 2018. In addition to universities, PRIs also played an important role in China’s NIS, especially the CAS. From 1998 to 2010, the CAS filed a total of 47,119 domestic patent applications, among which 83.7% were invention patents. Since the Nature Publishing Group released the natural index list for the first time in 2014, the CAS has been consistently ranked No. 1 in the world among academic institutions. Universities and PRIs are important drivers of China’s catching up. This is especially true in emerging technological fields such as artificial intelligence (AI). According to the China AI Development Report 2018 published by the China Institute of Science and Technology at Tsinghua University (CISTP), four Chinese institutions (CAS, Tsinghua University, Harbin Institute of Technology, and Shanghai Jiao Tong University) entered the list of the world’s top 10 institutions in AI paper output (Figure 2.1.3).

Interactions Interactions among different types of actors facilitated learning and competence building within China’s innovation system. The importance of such interactions is discussed in Chapter 1.2 of this volume. Although there are various types of interactions within China’s

National and Regional Innovation Systems    127 Chinese Academy of Sciences System

26176

French National Center for Scientific Research

25728

University of California System

24165

Indian Institutes of Technology

14070

Tsinghua University

13693

Harbin Institute of Technology

11675

University of Texas System

11397

Florida State University

11196

Nanyang Technological University

10673

Shanghai Jiao Tong University

10483 0

5000

10000

15000

20000

25000

30000

Figure 2.1.3  The world’s top 10 institutions in AI paper output. Source: China AI Development Report 2018, http://​www.sppm.tsinghua.edu.cn/​eWebEditor/​UploadFile/​20180712001.pdf

Table 2.1.2. R&D Projects of Higher Education by Sources (2016) R&D Projects (No.)

Input of Personnel (Man-​Year)

National S&T projects

255,744

131,714

3,747,020

Local S&T projects

298,355

112,841

1,160,346

S&T contracts from the industry

190,701

68,683

2,470,087

S&T projects supported by universities’ own funding

131,839

38,732

275,886

3,274

1,219

59,625

Overseas S&T projects Others Total

Input of Funds (10,000 Yuan)

14,366

6,649

59,262

894,279

359,837

7,772,226

Source: China Statistical Yearbook on Science and Technology 2017.

NIS, we will focus on two types of interactions in this chapter due to the limited space. The first type of interactions is the interaction between universities and industries (university-​ industry linkages), whereas the second type of interactions is the interaction between the civilian sectors and the military sectors (military and civilian integration).

University-​Industry Linkages China’s university-​industry linkage in S&T activities has been enhanced in recent years. As shown in Table 2.1.2, the industrial sector has been the second-​largest source of S&T funds for universities, with the percentage of total funds allocated getting near to 32% in 2016.18 This relatively tight linkage between the two sectors can be traced back to the early times when China’s NIS began to take shape in the 1980s. Industrial enterprises at that time were 18 

Source: China Statistical Yearbook on Science and Technology 2017.

128    Xue, Li, and Yu in acute shortage of research resources with backward technologies and equipment, which, along with a lack of trained R&D personnel, largely accounted for their weak capacities in innovation. In this case, it was reasonable for the industrial sector to seek outside assistance to enhance their capacity for technology innovation, and universities have naturally become one of their important options. The rapid growth of China’s economy serves as another main reason universities are cooperating with the industrial sector more than ever. During China’s rise from a low-​ income country to an upper-​middle-​income country, more and more Chinese firms have transformed themselves from imitators to innovators. There is an increasing demand from the industrial sector for obtaining new knowledge. Because the university-​industry linkage is an important vehicle for the commercialization of new knowledge (Mueller 2006), the linkage becomes stronger as China’s economy grows.

Military and Civilian Integration The CPC’s Central Committee, the State Council, and the Central Military Commission issued the “Opinions on the Integration of Economic Construction and National Defense Construction” in 2016, focusing on overall national security and development strategy. It clarified the general idea, key tasks, and policy measures for the integration of military and civilian development under the new situation. It is a programmatic document for coordinating economic and national defense development. In the same year, the State Council and the Central Military Commission promulgated the “13th Five-​Year Plan for the Integration of Economic Development and National Defense Construction” as the top-​level design for the in-​depth implementation of the military-​civilian integration development strategy during the 13th Five-​Year Plan period. The aforementioned documents and the forthcoming “Military and Civilian Integration Development Strategy Outline” (known today as the Military-​Civil Fusion strategy), constitute the top-​level strategic planning for the integration of China’s military and civilian development. Coupled with special plans in various fields and development plans for various regions, China’s military-​civilian integration strategic planning system has basically been established. At present, major demonstration projects have been launched, and a number of projects are being accelerated. For example, China initiated the reform of the first batch of 41 military research institutes and promoted the sharing of large-​scale national defense scientific research equipment for military and civilian dual usage. At present, among the major enterprises that have obtained research and production licenses for weapons and military equipment, civilian enterprises have accounted for more than two-​thirds. Military and civilian integration plays an important role in China’s NIS. Many of China’s mega-​projects such as “BeiDou-​3” (satellite navigation), “Chang’e 3 and Chang’e 4” (moon exploration), “Tiangong No. 2” and Tiangong-​ 3  (Space Laboratory), and “Shenzhou No. 11” (Spacecraft) all involve a certain degree of military-​civilian integration. The BeiDou satellite navigation system that originated from the military sector has been providing navigation services for civilian sectors.

Overall Performance and Problems By following an innovation system approach, China has made impressive progress both on the input side and on the output side of S&T activities. On the input side, China’s full-​time

National and Regional Innovation Systems    129 equivalent of R&D personnel almost tripped, and China’s R&D expenditure increased by five times in the past decade (Figure 2.1.4). On the output side, China’s number of patent applications increased by six to seven times (Figure 2.1.5). After decades of innovation system development, China has made remarkable progress in terms of innovation capabilities. The quantity of China’s innovation output has surpassed

2009

2010

2011

2012

2013

2014

2015

387.8

353.3

324.7

288.3

255.4

229.1

196.5 2008

375.9

2007

371.1

2006

173.6

150.2

(a) Full-time Equivalent of R&D Personnel (Unit: 10000 man-year)

2016

2007

2008

2009

2010

15676.7

14169.9

13015.6

11846.6

8687

7062.6

5802.1

4616

2006

3710.2

3003.1

10298.4

(b) Expenditure on R&D (Unit: 100 million yuan)

2011

2012

2013

2014

2015

2016

Figure  2.1.4  China’s R&D input in the past decade:  (a) full-​time equivalent of R&D personnel (unit: 10,000 man-​years); (b) expenditure on R&D (unit: 100 million yuan). Source: China Statistical Yearbook

130    Xue, Li, and Yu 400 350

(Unit: 10000)

300 250 200 150 100 50 0

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Number of (total) Patents Application Accepted Number of (total) Patents Application Granted Number of (invention) Patents Application Accepted Number of (invention) Patents Application Granted

Figure 2.1.5  China’s R&D output between 2006 and 2016. Source: China Statistical Yearbook

many countries in the world. However, there is still a long way to go before the country can close the gap between itself and leading countries in terms of the quality of innovation. To conclude, we present some of the main problems that hinder China’s high-​quality innovation. First, different government agencies are not well connected with each other in terms of innovation management. This leads to insufficient investment in some areas, but excessive competition in other areas. The reform of China’s S&T system and the reform of China’s economic system lack sufficient overall design and coordination. The reforms in the sectors of finance, real estate, and energy are lagging behind the reform of the S&T system. Currently, the income of local governments relies heavily on real estate–​related taxes and land transaction fees. This leads to excessive growth of the real estate sector. On the one hand, the growing real estate sector absorbs too many resources that could have been invested in other innovative sectors. On the other hand, the rising house prices create pervasive anxiety among the younger generation, discouraging them from conducting (often risky) innovation activities. A promising sign is that China recently established the National Science and Technology Leading Group, which is led by the Prime Minister and involves senior officials from a variety of ministries. We expect to see more coordinated policymaking, which can improve the incentive structure and create stronger linkages among different sectors (Fu and Mu 2014; Fu 2015). Second, the “openness” of China’s NIS is stuck at an unsatisfactory level. On the one hand, China’s innovation system is still not open enough to the outside world. On the other hand, China’s ability to participate in global governance and policymaking remains rather weak. China has not developed sufficient ability to integrate and utilize global S&T resources. The participation of top international personnnel in China’s S&T programs is relatively rare. In addition, China needs to face the more stringent environment toward foreign technology transfer. When China started its reform and opening up 40 years ago, there were abundant foreign technologies for Chinese firms to learn and imitate. But now, as China has caught

National and Regional Innovation Systems    131 up with forerunners in more areas, there is less space for Chinese firms to play such catchup strategies. Third, the services that support entrepreneurial-​innovation activities are still poorly developed. Currently, there are still many institutional obstacles for knowledge transfer and resource mobilization within China’s NIS. The existing service system lacks clear value orientation, making it difficult to serve the needs of entrepreneurs and innovators. Lastly, China’s institutional environment, regulatory environment, business environment, and intellectual property protection environment also need to be further improved. Innovation activities require huge investments and involve high uncertainties. If individuals or companies do not believe that they can appropriate returns from their innovations, they would not make such investments in the beginning. Therefore, China needs to further improve its innovation environment, fostering an innovation culture and promoting the importance of reputation and integrity in scientific research.

Future Directions In the latest 13th Five-​Year Plan for Science and Technology Innovation, China established broad goals for China’s economy to become an “innovative nation” by 2020, an international innovation leader by 2030, and a world powerhouse of scientific and technological innovation by 2050. To achieve these goals, China will need to deepen the reform of the S&T management system and continue to pursue innovation-​driven development by giving a central role to innovation in S&T and a supporting role to the development of talent, closely interacting with innovation efforts by business startups and the general public, and offering greater incentives for first innovators. Specific targets by 2020 have been set, for example, to increase China’s global innovation ranking from 18 to 15 and the share of R&D spending as a percentage of gross domestic product from 2.1 to 2.5 (Table 2.1.3). Looking into the future, it is far from enough for China to simply address the current weaknesses of its NIS (e.g., institutional failure, capacity failure); great efforts should also be made to adapt to the challenges brought by, for example, the aging society, the middle-​income trap, the Fourth Industrial Revolution, and global sustainable development. First, the massive volume of cheap labor has been one of the key driving forces in China’s economic growth in the last four decades. This demographic bonus has begun to decrease as China’s aging population is rapidly growing and the young working-​age population is diminishing. According to the World Health Organization (WHO) (2016), the speed of China’s aging of population is significantly faster than in other middle-​and low-​income countries, and by 2040, 28% of China’s population would be above 60 years old. Meanwhile, China is already suffering from waves of industry relocation to other countries due to its rising labor cost. Though some initiatives under way, such as “Made in China 2025” and “One Belt and One Road,” will addresses some of these concerns, it is increasingly imperative for China to transform its current economic structure. Innovation is expected to become the core engine for China’s future economic growth, so China’s NIS will have to

132    Xue, Li, and Yu Table 2.1.3. The Targets of 13th Five-​Year Plan for Science and Technology

Innovation Target

2015

2020

Global innovation ranking

18

15

Contribution of science and technological advances to economic growth

55.3%

60%

R&D as share of GDP

2.1%

2.5%

Number of R&D personnel per 10,000 people employed per year

48.5

60

Revenue of high-​technology enterprises

22.2 trillion RMB

34 trillion RMB

Share of value-​added knowledge-​intensive services industries to GDP

15.6

20

R&D intensity*

0.9

1.1

Global ranking for the number of citations in international science and technology papers

4

2

Patents filed under the PCT† per 10,000 patents

3.05

6.1

Patents filed per 10,000 people

6.3

12

National technical contract turnover

983.5 billion RMB

2 trillion RMB

Proportion of the total population possessing scientific degrees

6.2%

10%

Source: Chian’s13th Five-​Year Science and Technology Innovation Plan. * R&D intensity is a firm’s total expenditures on its R&D divided by its net sales. † The Patent Cooperation Treaty (PCT) provides a unified procedure for filing patent applications to protect inventions in each of its contracting states.

shoulder much more responsibility than ever. It is vital for China to improve its NIS performance as soon as possible. Second, it could lead to catastrophic consequences if China builds only an “engine system” for the country’s NIS, without a “steering system” or a “brake system.” This is particularly worrisome with the arrival of the Fourth Industrial Revolution, which, it is widely believed, could cause an unprecedented impact on human society (Schwab 2016). Technology progress in, for example, life sciences and AI has greatly benefited people’s lives but is also accompanied by many social challenges such as job replacement, safety concerns, social inequity, and ethical dilemmas. In the past few decades, S&T innovation has been given a halo by the Chinese society, and many policy efforts focus on promoting S&T innovation development, but very little attention has been paid to their potential social risks. Taking AI as an example, China has secured a leading position in the top echelon in both technology development and industrial development and is in a race with the United States (CISTP 2018). Chinese society generally has a very optimistic attitude toward AI development, with more than 80% of the respondents expressing a supporting attitude (CISTP 2018). While the European Union’s AI strategy has put great emphasis on the possible ethical challenges and social risks with AI in areas such as privacy and human dignity, China’s

National and Regional Innovation Systems    133 AI strategy has emphasized AI technological development and industrial applications and hasn’t given due attention to ethical issues. Unlike in the past industrial revolutions where China was left behind and struggling to catch up, China has a head start in the Fourth Industrial Revolution; hence, the resulting problems facing China would be the frontier problems in the world, and there will be few lessons that China can learn from other countries. China has to cross the river by touching the stones itself in the governance of emerging technologies. Under this landscape, it is singularly urgent for China to embrace the idea of responsible innovation (Stilgoe et  al. 2013) and to develop an NIS that focuses not only on innovations’ technological feasibility (or advancement) but also on its impact on economic development. It should also consider its ethical and social dimensions. China’s NIS should develop mechanisms of public engagement in policymaking so that policies reflect and incorporate inputs from various parts of society. Universities, research institutes, and enterprises should incorporate more ethical norms into their research activities. Finally, China needs to be more engaged with international S&T collaboration and to play a more important role in the global innovation system. International collaboration in S&T innovation has generated tremendous benefits to the global community. In a context where a force of anti-​globalization is rising around the world, it is critically important for big countries, the United States, the European Union, and China in particular, to strengthen S&T cooperation to address some of the major challenges we are facing, such as climate change, environmental degradation, poverty reduction, food safety, infectious disease, and public health. China has greatly benefited from international S&T collaboration in the past four decades. It will need to get actively involved in the global governance of S&T innovation and play a more positive role in technology development, risk prevention, and formulation of ethical norms to advance their development for a better future of human society.

References Binz, Christian, and Bernhard Truffer. 2017. “Global Innovation Systems—​A Conceptual Framework for Innovation Dynamics in Transnational Contexts.” Research Policy 46 (7): 1284–​1298. https://​doi.org/​10.1016/​j.respol.2017.05.012. CISTP. 2018. China AI Development Report 2018. Freeman, Christopher. 1987. Technology Policy and Economic Performance. London, UK: Pinter. Fu, Xiaolan. 2015. China’s Path to Innovation. Cambridge: Cambridge University Press. Fu, Xiaolan, and Rongping Mu. 2014. “Enhancing China’s Innovation Performance:  The Policy Choices.” China & World Economy 22 (2):  42–​60. https://​doi.org/​10.1111/​ j.1749-​124X.2014.12061.x. Geels, Frank W. 2011. “The Multi-​Level Perspective on Sustainability Transitions: Responses to Seven Criticisms.” Environmental Innovation and Societal Transitions 1 (1): 24–​40. https://​ doi.org/​10.1016/​j.eist.2011.02.002. Lundvall, Bengt-​Ake. 1992. National Systems of Innovation. London, UK: Pinter. Malerba, Franco, and Richard Nelson. 2011. “Learning and Catching Up in Different Sectoral Systems: Evidence from Six Industries.” Industrial and Corporate Change 20 (6): 1645–​1675. https://​doi.org/​10.1093/​icc/​dtr062.

134    Xue, Li, and Yu Mueller, Pamela. 2006. “Exploring the Knowledge Filter:  How Entrepreneurship and University–​Industry Relationships Drive Economic Growth.” Research Policy 35 (10): 1499–​ 1508. https://​doi.org/​10.1016/​j.respol.2006.09.023. Nelson, Richard R. 1993. National Innovation Systems:  A Comparative Analysis. Oxford University Press. Niosi, Jorge. 2002. “National Systems of Innovations Are ‘x-​Efficient’ (and x-​Effective) Why Some Are Slow Learners?” Research Policy, 31(2): 291–​302. OECD. 1999. Managing National Innovation Systems. Paris:  OECD. https://​doi.org/​10.1787/​ 9789264189416-​en. Schot, Johan, and W. Edward Steinmueller. 2018. “Three Frames for Innovation Policy: R&D, Systems of Innovation and Transformative Change.” Research Policy 47 (9):  1554–​1567. https://​doi.org/​10.1016/​j.respol.2018.08.011. Schumpeter, Joseph A. 2017. Theory of Economic Development. Routledge. Schwab, Klaus. 2016. The Fourth Industrial Revolution. World Economic Forum. Stilgoe, Jack, R. Owen, and P. Macnaghten. 2013. “Developing a Framework for Responsible Innovation.” Research Policy 42 (9): 1568–​1580. Sun, Yifei. 2002. “China’s National Innovation System in Transition.” Eurasian Geography & Economics 43 (6): 476–​492. WHO. 2016. China Country Assessment Report on Ageing and Health. https://​apps.who.int/​iris/​ handle/​10665/​194271 Xiao, Yangao, Andrew Tylecote, and Jiajia Liu. 2013. “Why Not Greater Catch-​up by Chinese Firms? The Impact of IPR, Corporate Governance and Technology Intensity on Late-​Comer Strategies.” Research Policy 42 (3): 749–​764. https://​doi.org/​10.1016/​j.respol.2012.11.005. Xue, Lan. 1997. “A Historical Perspective of China’s Innovation System Reform: A Case Study.” Journal of Engineering & Technology Management 14 (1): 67–​81. Xue, Lan. 2018. Science and Technology in China:  Development and Policy (1978–​ 2018). Beijing: Social Sciences Academic Press. Yip, George S., and Bruce McKern. 2016. China’s Next Strategic Advantage: From Imitation to Innovation. MIT Press. Zhong, X., & X. Yang. 2007. “Science and Technology Policy Reform and Its Impact on China’s National Innovation System.” Technology in Society 29(3): 317–​325.

Chapter 2.2

T he Great Dia l e c t i c State versus Market in China

Loren Brandt and Eric Thun The great dialectic in our time is not, as anciently and by some still supposed, between capital and labor; it is between economic enterprise and the state. —​John Kenneth Galbraith (1987)

Introduction From the outset of the reform era, the promotion of innovation and technological upgrading has been a foremost objective of Chinese leadership. China’s leaders have consistently believed that the country’s economic and strategic future rests on the ability of Chinese firms to be at the cutting edge of newly emerging technologies. While the objective has been clear, the best means of achieving this objective have been less so. In particular, policymakers have debated the role of the state vis-​à-​vis the market in directing and shaping innovation efforts. The outcome of these debates has shaped regulatory frameworks and institutional structures, defining in the process the opportunities as well as the constraints facing economics actors. The result has been an ever-​vacillating course for policy throughout the reform era—​strong support for state-​and market-​led approaches coexists in China, with each playing the dominant role at different times and in different sectors. In this chapter we examine China’s upgrading and innovation record in the context of this debate. A key finding that emerges is that sectors that have been consistently most open to competition, in which entry and exit of firms have been far less encumbered and, more generally, in which firms have been free from the all too “visible” and often distorting hand of the Chinese state at both the local and central level, are in fact those that have been most dynamic. They are also the sectors in which Chinese firms are successfully competing today in more demanding markets, domestic as well as overseas. By contrast, those sectors that remain the preserve of state-​owned enterprises (SOEs), and/​or that are tightly regulated by state agencies, have usually failed to deliver dynamic indigenous firms.

136   Brandt and Thun We offer an explanation for why sectors that have been less encumbered with regulatory barriers and more open to competition (for both Chinese and foreign firms) have produced more vibrant and innovative Chinese firms. Central to our interpretation is how China’s domestic market offers a competitive advantage for Chinese firms. Arguments in favor of state-​sponsored industrial policy are often predicated on the belief that local firms have both technological and marketing “gaps” when competing in export markets. In this context, state policy is viewed as a means of nurturing and supporting local firms against their more competitive rivals (Schmitz 2007). Within China’s huge domestic market, however, it is often the foreign firms that are at a disadvantage because they are not able to compete effectively in highly cost-​sensitive market segments. The low-​end segments provide “natural” protection for domestic firms from foreign firms while preserving high levels of competition among domestic firms; the high-​end segments provide the incentive for foreign firms to enter the market; and the “fight for the middle” segments of the market provide incentives for local firms to upgrade and foreign firms to localize. The sectors with more barriers and greater levels of state intervention weakened the competitive interactions that have been most conducive to promoting upgrading and innovation in Chinese firms. Much of our analysis is on the period before the global financial crisis in 2008. In the final section of the chapter we focus on the period since 2008, one in which the role of the state has been resurgent (Lardy 2019), and consider the possible implications for newly emerging technologies and sectors.

The (Uneven) Retreat of the State There have been shifts in how the Chinese state has promoted upgrading and innovation, but an enduring theme has been the coexistence of highly dynamic firms and hugely inefficient ones. State policy has played a key role in determining the balance between the two. A legacy of the planned economy at the start of economic reform was an innovation system that was highly centralized and hierarchical. The science and technology (S&T) system was largely “task led”:  the state determined the needs of each industrial sector, often in light of the needs of upstream and downstream sectors; commissioned civilian and defense-​related projects targeting particular goals; and set up research organizations (within ministries and state research institutes, at universities, and, to a lesser extent, within firms) to achieve these objectives (Zhou and Liu 2016). Under this system, state-​owned firms were the production units of the government and had little incentive (or capability) to innovate in response to market demand. Foreign firms were excluded from the market, although sometimes the state negotiated the licensing of foreign technology or import of turnkey equipment. This “techno-​nationalist” approach to S&T development met some of the state’s objectives, particularly in the defense sector, and fostered the development of strong basic capabilities in many industries, but it did not lead to globally competitive enterprises (Suttmeier 1997; Naughton and Segal 2003). During the 1980s and early 1990s, the state pursued a “dual track” strategy that maintained significant control over the state sector but lowered the barriers for nonstate firms in nonstrategic sectors (e.g., labor-​intensive light industry) (Naughton 1995). Foreign direct investment in newly established special economic zones (SEZs) was also encouraged,

State versus Market    137 primarily for the purpose of exporting. Leveraging China’s comparative advantage, growth in exports in the nonstate sector as well was rapid over this period, and between 1978 and 1995 the export share of industrial output grew from 2.5% to 13.2% (Brandt, Ma, and Rawski, 2017). Competition and entry also provided the incentives and avenues for these same firms for upgrading. In sharp contrast, reform of the state sector met with only limited success. Resources continued to pour into the sector in the form of preferential access to bank credit and foreign exchange that were often used for the purposes of technology licensing and imports of capital goods and equipment. Outside the SEZs, foreign firms were often forced to partner with state firms in joint ventures (JVs), as, for example, in the case of the auto sector. According to the policy of “trading markets for technology,” foreign firms were offered access to China’s domestic market, but only if they conformed with a series of complicated regulatory requirements designed to transfer technology to local partners, usually SOEs (Zhou and Liu 2016). Through this mechanism, some upgrading occurred; however, new technologies and resources tended to be bottled up in hugely inefficient firms. Despite the drag of the state sector, performance of China’s manufacturing sector during this period was impressive. Although this growth is often described as “investment led,” improvements in total factor productivity (TFP) were particularly important (measured in terms of output per units of inputs). These gains in productivity were the product of firm-​ level efforts to lower costs, improve product quality, and move up the global value chain. Estimates suggest that in the 10 to 15 years prior to the global financial crisis in 2007–​2008, productivity at the firm level increased 2.8% and 8.0% per annum on a gross output and value-​added basis, respectively, and at an even higher rate at the industry level.1 This growth was the source of more than half of the total increase in Chinese manufacturing output and is on par with rates achieved by the manufacturing sector in other successful Asian economies (e.g., Japan, Korea, and Taiwan) at similar periods in their development (Brandt, Van Biesebroeck, and Zhang 2012; Yu 2015).2 This dynamism is also reflected in the increasing sophistication of China’s exports (Schott 2008) and the success of manufacturing firms in China—​foreign and increasingly domestic—​to capture growing market share in the highly competitive and demanding export markets in advanced countries (Mandel 2013). Critical here was the deepening of capabilities in the Chinese domestic supply chain, which enabled an increase in domestic sourcing and thus a significant increase in the share of domestic value added in China’s export sector (Kee and Tang 2016). By 2010, China had eclipsed the United States as the world’s largest manufacturer.

1  As explained more fully later, the difference between the growth at the firm and industry level reflects the important role of firm entry and exit and the reallocation of resources among firms within a sector. 2  Estimates made by Brandt, Van Biesebroeck, and Zhang (2012) using the annual firm-​level survey data of the National Bureau of Statistics (NBS) between 1998 and 2007 show that 57% of the growth in industrial output is a result of productivity growth.

138   Brandt and Thun

Where Did the Productivity Gains Come From? The productivity gains that powered Chinese growth had the potential to stem from four sources. First, existing firms (or incumbents) might have improved TFP through innovation and improvements that allowed them to lower production costs and/​or improve product quality, thus commanding higher prices. Second, a reallocation of resources toward more productive firms might have had the same effect. An increase in mergers and acquisitions (M&As) would support gains of this sort, while capital market imperfections, barriers to labor mobility between firms, and restrictive market access would impede such gains. Third, entry of new firms at levels of TFP higher than incumbents would lift average industry TFP. In China, incumbents were largely SOEs and collectively owned enterprises, while new entry was by private and foreign firms. Finally, the exit of poorly performing firms with TFP below average would also contribute to these gains. Generally speaking, the contribution of entry and exit would depend on the volume of these flows as well as the size and relative productivity of these firms. Barriers to entry and exit would both be critical. In the Chinese context, soft-​budget constraints would potentially lengthen the lower tail of the productivity distribution by delaying firm exit. A unique feature of China’s productivity growth in industry during this period is the crucial role of new firm entry: overall, up to two-​thirds of the productivity growth within sectors came from new firm entry, a large percentage of which were private (Brandt, Van Biesebroeck, and Zhang 2012). Entry rates for new firms3 can be calculated based on firm-​ level records from the Chinese Industrial Censuses for 1995, 2004, and 2008.4 The 1995 census puts the number of new firms entering industry in that year at slightly more than 40,000, or an entry rate of 8%. By the time of the 2004 census, the number of new entrants more than tripled in absolute terms, and the entry rate rose to 12%. The rate of entry fell off in 2008—​likely reflecting the effect of the global financial crisis—​however, an additional 150,000 firms were still added.5 The contribution of new firms to the productivity growth in the sector was a product of these high rates of entry and their superior productivity relative to the incumbents. Over this period, institutional barriers to entry facing private sector entrepreneurs and discrimination fell significantly, and the higher productivity of the new entrants relative to incumbents lifted overall productivity levels (Brandt, Kambourov, and Storesletten 2020). While high levels of entry were crucial in driving the increase in productivity, the role of both the reallocation of resources to more productive firms and firm exit was negligible. The limited contribution of efficiency-​enhancing input (capital, labor, and intermediate goods) reallocations to productivity growth was potentially a result of capital market restrictions (Hsieh and Klenow 2009), as well as product market barriers and (more generally) the preferential treatment enjoyed by less efficient, politically connected firms. The limited role of firm exit is likely an indication that large, poorly performing state firms were

3  Entry rates are calculated by dividing the number of new firms established in a year by the total number of firms operating that were established earlier. 4  The activity of these firms covers between 75% and 80% of industrial activity. Those excluded are small in terms of size. 5  These estimates are based on data from the 1995, 2004, and 2008 Chinese Industrial Census.

0

.5

Density 1

1.5

2

State versus Market    139

-.5

0

tfp_growth

.5

1

Source: Brandt (2016), p. 157

Figure 2.2.1  TFP Growth by 4-digit Industry (1998-2007). 

not exiting, and in line with reports of the growing number of zombie (僵尸) firms.6 When state firms began to be privatized and restructured at the end of the 1990s under the policy of “seize the large, release the small” (抓大放小), it was primarily smaller SOEs, whose share of manufacturing output was fairly small, that were either privatized or allowed to go bankrupt.

Differences across Sectors The rate of productivity growth as well as the contribution of innovation and upgrading by incumbents, reallocation, entry, and exit varied by sector. Figure 2.2.1 graphs the distribution for TFP growth at the four-​digit level between 1998 and 2007 and reveals wide differences between sectors over this period.7 Sectors experiencing especially high rates of TFP growth include electronics, office machinery and equipment, and furniture; laggards include electrical equipment machinery, ferrous and nonferrous metals, and chemicals. A critical determinant of the differences between sectors is the role of state-​owned firms in the sector (and hence the incentives for innovation and upgrading, and the regulations governing entry, reallocation, and exit). Drawing on the Chinese Industrial Census, the share of the state sector in gross value of industrial output (GVIO) fell from 53% in 1995 to slightly more than 36% in 2008. Over the same period, the percentage of firms classified as

6  The term “zombies” refers to unprofitable and indebted firms that rely on bank loans and government bailouts to operate. 7  These estimates are drawn from Brandt et al. (2012).

140   Brandt and Thun

Figure 2.2.2  SOES, Productivity and Profitability.

state owned fell even more sharply, reflecting the huge selloff (privatization) and bankruptcy of the smaller SOEs in the late 1990s.8 But the retreat of the state was uneven during this period: state firms continued to dominate in capital-​intensive upstream sectors such as power, telecommunications, transportation, and finance, and in “pillar” and “strategic” sectors such as aeronautics, chemicals, iron and steel, and electrical machinery (Pearson 2015). Figure 2.2.2 shows the relationship between the share of state-​owned firms at the twodigit level in 1998 and TFP growth between 1998 and 2007. The relationship is clearly negative, with those sectors in which the state was most prominent in 1998 experiencing the lowest growth in productivity over the same period.9 Breaking the sources of productivity change into its component parts is equally telling. Table 2.2.1 reports results based on a division of the two-​digit sectors for industry into two groups: those in which the state had more or less than 50% of GVIO in 1998.10 Note the huge gap in TFP growth between the two types of sectors—​negative in state-​dominated sectors and positive in those in which the role of the state is less important. Moreover, in the state-​dominated sectors, the contribution of both incumbents and new entrants to productivity growth is negative. The former occurs when productivity growth of established firms is negative; the latter occurs when new firms enter the productivity distribution at a productivity level that is lower than the industry average. Disaggregating even further by ownership reveals that in state-​dominated sectors, non-​state actors—​incumbents as well as entrants—​also perform poorly and contribute to the declining productivity we observe. This behavior suggests that not only is ownership important, but so is the entire regulatory environment that governs and shapes how firms compete and interact in a sector. The negative contribution to TFP of “new” non-​state actors in state-​dominated sectors—​sectors 8 

State ownership (and control) can be identified in a number of alternative ways, none of which are perfect. The estimates reported previously are based on a relatively conservative definition that includes all state-​owned and state-​controlled firms. 9  These same sectors experienced the fastest growth in profitability over the same period, possibly reflecting some combination of rising market power and preferential access to credit and other inputs.  10  A third of all sectors had a state share of 50% or more in 1998. Using a slightly lower cut-​off point for the state share or dividing sectors into two groups after ranking them does not alter the picture.

State versus Market    141 Table 2.2.1 SOE Shares and Sector TFP Growth, 1998-​2007 Sources of Change in TFP Sectors

Total Change in TFP Existing Firms

Reallocation Between Firms

New Firms

Exiting Firms

SOE Share > 0.50 Soe Share < 0.50

–​0.117  0.208

–​0.048  0.050

 0.007 –​0.024

–​0.080  0.175

0.004 0.007

All Sectors

 0.107

 0.019

–​0.014

 0.096

0.006

Note: 1. Changes in TFP are based on estimates for a gross output function. TFP growth on a value added basis can be obtained by multiplying these estimates by 1/​VA, where VA is value-​added as a percentage of gross output. A value added ratio of 0.25 implies TFP growth on a value added basis that is 4 times higher. 2. Sector shares for SOEs are based on data for 1998. 3. "Within" represents the growth in productivity amongst firms operating in both 1998 and 2007; "between" is the growth in TFP coming from the reallocation of resources to more productive firms; "entry" is from new firms not in the sample in 1998 but present in 2007, and "exit" is from firms operating in 1998, but no longer operating by 2007. Source: Brandt (2016), p. 159

in which profitability was actually rising—​suggests an entry process that is highly politicized and distorted, and in which political connections rather than how good a firm is likely matter most. Indeed, recent work (Brandt, Kambourov, and Storesletten 2020)  finds a strong positive correlation between the size of the state sector in an industry in a province and the size of the entry barrier to that sector. Table 2.2.2, which reveals huge differences in outcomes among three (two-​digit) industrial sectors in which state firms have been important, helps make the point further that ownership alone is not the problem. Clearly, there are sectors in which SOEs appear to be doing reasonably well. Indeed, analysis of the impact of the tariff liberalization mandated by China’s entry into the World Trade Organization (WTO) reveals important effects on incumbents as well as entrants, and on state-​owned as well as non-​state firms (Brandt, Wang, Van Biesebroeck, and Zhang 2017). While firm-​ level data from China’s Industrial Census and Annual Survey of Manufacturing are useful for assessing the contribution of incumbents, new firm entry, reallocation, and exit to productivity growth, understanding how Chinese firms upgrade and innovate requires a more detailed examination of firm and industry dynamics.

Leveraging the Domestic Market During the first three decades of the reform era, the primary emphasis of Chinese firms was on catching up to Western firms in relatively mature industrial sectors. As is typical of

142   Brandt and Thun Table 2.2.2 Heterogeneity in the State Sector TFP Decomposition

Sector

Source of Productivity Change Absolute SOE share SOE share Change 1998 2007 in TFP Within Between Entry Exit Net Entry

Special Purpose Machinery

0.580

0.434

0.209

0.069 –​0.012

0.148

0.004

0.152

Transport Equipment

0.518

0.388

0.163

0.068 –​0.021

0.111

0.005

0.116

Ferrous Metals

0.757

0.602

–​0.062

–​0.014

Chemical Products

0.555

0.406

–​0.116

–​0.055 –​0.001

–​0.061

Non-​ferrous Metals

0.534

0.524

–​0.548

–​0.213

0.064

–​0.386 –​0.013 –​0.400

Petroleum

0.871

0.747

–​0.803

–​0.312

0.080

–​0.570 –​0.001 –​0.571

0.004

–​0.045 –​0.008 –​0.053 0.001 –​0.060

Source: Brandt (2016), p. 159

“latecomer” firms in developing economies, Chinese firms suffered from both technology and marketing “gaps” when competing in export markets: they were cut off from leading sources of technology and had a poor understanding of the demanding customers in the world’s most advanced markets (Hobday 1996; Schmitz 2007). The context in which Chinese firms were attempting to catch up was unusual in that the primary focus was their own domestic market. We do not want to ignore the important returns to exporting in China (Harrison and Rodriguez 2010; Du et al. 2012), but more than 85% of the output of Chinese manufacturing firms was directed to the domestic market. Moreover, for a long list of products (e.g., autos, heavy construction equipment, wind turbines, cell phones and network equipment, glass, and iron and steel), the Chinese market was the largest in the world. A focus on the domestic market radically changes the terms of upgrading and innovation for Chinese firms: rather than attempt to overtake incumbent firms in advanced markets, the objective is to adapt well-​established products for the highly cost-​sensitive domestic market using a process of incremental innovation. Firms lower costs through “good enough” or “fit for purpose” innovation (i.e., tailoring functionality to more exactly meet consumers’ demand; see Gadiesh et al. 2007; Yip and McKern 2016) or through “cost innovation” (i.e., achieving the same functionality at a lower cost by exploiting cost advantages in manufacturing, design, and/​or administration; see Zeng and Williamson (2007). The competitive advantages of these firms include firm-​level resources (e.g., assets, capabilities, knowledge, etc.) such as the technical expertise and the industry experience to detect market opportunities (Hang et al. 2015), research and development (R&D) processes that are able to lower the cost of products (e.g., industrialization of R&D activities, parallel processing, and design changes) (Breznitz and Murphree 2011; Yu and Hang 2011; Williamson and Yin 2014; Wan et al. 2015), and a high capacity for learning (Chen 2009).

State versus Market    143 Implicit in the literature on cost innovation is the view that a firm’s capabilities and resources are heavily shaped by the markets within which it competes, with a subtle interplay at work between demand-​side factors as discussed by Zhu and Wang in Chapter 6.3 (e.g., relative incomes, demographics, etc.) and the capabilities that are developed on the supply side (Kline and Rosenberg 1986). Given that there is no shortage of opportunities for cost innovation in China’s domestic market, it is not obvious why the domestic market sometimes provides a foundation for technological upgrading but other times does not, and why innovation of this sort flourishes in some sectors but not others. The “fight for the middle” focuses explicitly on differences in innovation outcomes in China and the unique role of each market segment (low, medium, and high end) within an industrial sector in the development process. Indeed, the absence of any one of these segments may inhibit the upward trajectory of indigenous firms. The highly cost-​sensitive low-​end segment offers new entrants “natural” protection from foreign firms with higher cost structures and allows local firms to cultivate their capabilities, engage in cost innovation, and gain scale in markets in which they have an inherent advantage. The high-​end segment is dominated by foreign firms that have better access to human resources, capital, and technology. The middle segment is a crucial pathway for the development of new capabilities because it forces foreign and local firms to combine and recombine their respective resources (e.g., through M&A activity, sourcing decisions and supply chains) in new ways so as to achieve the exact ratio of price to quality demanded by “value for money” customers (Brandt and Thun 2010, 2016; Thun 2018). Since a range of state policies affecting both the demand and supply side shape the degree of market segmentation, the state may inadvertently limit the growth of segments that contribute crucial ingredients to the process of capability building, and thus adversely affect upgrading outcomes. On the demand side, a wide range of state policies, for example, market restrictions, tax policy, or tariffs and nontariff barriers, may affect prices and limit the size of market segments in which domestic firms have an advantage. On the supply side, the state shapes the resources and opportunities that are available to firms within the domestic economy, as well as the competitive pressures they face. Again, the distinction between state and non-​state firms is crucial. Non-​state firms have been systematically discriminated against in matters relating to finance (Brandt and Li 2003), access to technology (Brandt et al. forthcoming), and M&A activity, and have sometimes simply not been allowed to enter a sector (Huang 2008). State firms, on the other hand, often enjoy the legacy of decades of state investment in the era of the planned economy and continued state support in the reform era. The pace and extent of market liberalization differs widely between sectors (Brandt et al. 2008). State policy also mediates the flow of global resources in the domestic economy, through rules and regulations governing imports, technology transfer, and foreign investment. In this context, the form of foreign entry (i.e., licensing, JVs, wholly foreign owned) will often shape a foreign firm’s willingness to introduce technology and intellectual property (Hymer 1976; Dunning and Rugman 1985; Dunning 1988). Given that different forms of entry bring different levels of foreign control, regulations governing entry affect the inputs on the supply side within the domestic market. The result is that technology, inputs, and/​or skills that are required to meet different dimensions of demand may be unintentionally excluded and the competitive pressure to meet different aspects of demand dampened.

144   Brandt and Thun

Differences across Sectors A comparison of industrial sectors in China illustrates how state policy and regulations can shape the segmentation of markets and hence the opportunities for technological upgrading. Sectors are more dynamic when there are lower barriers (i.e., to entry by private firms, to multiple forms of foreign participation, etc.), increased competition, and strong demand in multiple segments along the upgrading ladder. The low end provides firms with the incubation space to learn and gain scale, while higher-​end segments offer both the incentive to innovate and upgrade and the knowledge and inputs required to do so. China’s heavy construction equipment sector is a good example of where liberalizing forces over an extended period have contributed to robust growth of the sector and the rise of national champions (Brandt and Thun 2010, 2016). Two decades ago the domestic market was highly segmented, with a long list of Chinese firms dominating the “low end” wheel loader market, and imports and local production of multinational corporations (MNCs) in China serving the “high end” excavator market.11 Since the early 1990s, the sector has been relatively open: tariffs on heavy equipment machinery and intermediate goods were low; entry by non-​state actors, domestic as well as foreign, was relatively unencumbered; and there were few restrictions on the form of technology transfer allowed. With one or two prominent exceptions, M&As were also generally permitted. On the demand side, small and medium-​sized enterprises in the construction sector have been a major source of market demand. The size of the low-​end segments in China offered strong incentives for foreign players to localize supply chains (and train domestic suppliers in the process), develop R&D capabilities in China, often focused on localization of technology, and, in several cases, acquire Chinese firms with strong capabilities in producing low-​cost machines. The intense competition of the low end and the higher profit margins in higher-​end segments created incentives for local firms to invest in upgrading. Multinationals such as Caterpillar, Komatsu, and Volvo continue to be important players in a highly competitive domestic market, but Chinese firms have done remarkably well in the sector. In the wheel loader market, the top four firms—​three of which are Chinese—​ now enjoy upwards of 70% of the market, while in the domestic excavator market, Chinese firms currently capture upwards of half. Only five years ago, it was less than half of this. A  recent in-​depth analysis of the sector attributed this success to the ability of Chinese firms, SOEs as well as private, to compete on the basis of both price and quality in medium-​ market segments (CLSA 2013). In a test of 13 leading excavator brands in China in the midsize excavator market (20–​25 tons), performed over 185 working hours during a two-​week period in 2013, CLSA (2013, 23) found that “technology gaps are non-​existent between top-​ tier Chinese and international companies.” The Chinese automotive sector is a contrasting case: the domestic market is the largest in the world, but the domestic firms have had far more difficulty catching up with the foreign-​ invested firms. The root of the difficulties for domestic firms lies in earlier policies—​most

11  These two products differ enormously in terms of their design and manufacturing requirements, much of which is related to the hydraulic system in an excavator and the integration of hydraulics and transmission. In key respects, however, they are substitutes.

State versus Market    145 notably, very high rates of protectionism prior to the WTO, restrictions on forms of entry and technology transfer, and, until only more recently, a marked policy bias in favor of the state-​owned, JV partners of leading international auto MNCs. Licensing of technology, which was common in heavy construction, was limited to a single, locally state-​owned company, Tianjin Xiali. Although policymakers hoped that state intervention would lead to the development of national champions with independent technological capabilities, the result was the opposite (Thun 2018). The combination of tariff protection and restrictions on entry by private sector firms raised prices out of the range of individual consumers. As a result of the reduced size of the low end, firms had less pressure to innovate for the local market. Foreign partners in the JVs transferred the skills necessary to improve capabilities in the supply chain (Thun 2006) and improve the operations of the assembly plants (Nam 2010), but the foreign partners had little incentive to transfer the design skills that were needed to design new models (Holweg et al. 2005; Thun 2006; Nam 2010). Domestic partners were also complacent. Critics of the restrictions on entry in the sector have referred to the “JV mind-​set” (合资主义): the combination of easy access to foreign brands and technology and the high profit margins that came with an oligopoly meant that the Chinese partners in the JVs had little incentive to invest in the development of independent technological capabilities (Liu and Li 2009). Gains in market share by domestic brands in recent years have been led largely by non-​state firms. While autos and construction equipment provide contrasting examples of success and failure, there are other cases with more ambiguous outcomes and policy lessons. The wind turbine sector is often touted as a case in which public policy played a positive role in promoting the upgrading of domestic firms (Lewis 2013). In the early 2000s, a small nascent domestic industry was dominated by multinationals, largely through local JVs.12 Within less than a decade—​and almost exclusively in the context of a rapid, government-​led expansion in the domestic market—​Chinese firms came to dominate, and today they have all but a relatively small portion of the domestic market. JVs have largely disappeared and MNCs supply the local market through a small number of wholly owned subsidiaries. The extent of upgrading in the wind turbine sector may be more limited than is often believed, however. Chinese firms have been able to increase the size of the wind turbines that they manufacture, but they are not able to compete globally, even in wind turbines between 1.5 and 2 megawatts that are the “bread and butter” of the sector. In 2016, the number of units exported was less than 2.5% of total production. Like their domestic counterparts in the auto sector, they remain weak in design capabilities and systems integration; they are also highly dependent on foreign firms for control systems, the “core” of the wind turbine.13

12 There were a relatively small number of domestic firms, of which Goldwind was the largest, that entered the sector through technology licensing agreements with some of the smaller European manufacturers and design firms. 13  The recent collapse of Sinovel, one of China’s largest wind turbine manufacturers, following charges of Intellectual Property (IP) theft from AMSC, a leading US supplier of the software that controls wind turbines, is a case in point. Goldwind is an exception and is investing heavily in design as opposed to manufacturing capabilities. In this regard, the head of R&D said they aspire to be like Apple (interview with Goldwin, October 23, 2012).

146   Brandt and Thun As was the case in autos, state policy heavily influenced the structure of the wind turbine market on both the demand and the supply side. On the demand side, the rapid expansion in wind farms in China—​the local customers for wind turbines—​has been dominated by subsidiaries of the five big state-​owned power-​generating companies, two of whom have their own wind turbine subsidiaries. This has dampened the demand for more efficient wind turbines compared to a sector in which independent power producers facing hard budget constraints were allowed a larger role. Recently, it has been reported that less efficient wind farms with higher costs were receiving higher feed-​in tariffs. On the supply side, procurement rules and localization requirements made it more difficult for foreign firms to compete, while vertical integration and the dominance of state firms throughout the value chain in key components (e.g., generators, gearboxes, and blades) hamper quality upgrading. A  recent comparison between Chinese and US wind turbine manufacturers suggests huge differences in quality (Lu et al. 2016). The Chinese telecom sector is sometimes viewed as an example of foreign domination (e.g., the low value added of Chinese firms for iPhones) (Linden et al. 2007), sometimes viewed as a prime example of private sector innovation (e.g., the “Shanzhai” model), and sometimes seen as an example of beneficial state-​sponsored innovation (e.g., TD-​SCDMA, the rise of Huawei), but the examples of real technological upgrading and innovation in the sector demonstrate “fight for the middle” dynamics. In handsets, the policy approach in the late 1990s essentially mirrored the auto sector in that foreign firms were forced to form JVs with Chinese state-​owned firms. The outcome was also the same: the JVs were largely involved in the labor-​intensive assembly of imported components; however, the high level of profitability in the sector gave Chinese partners little incentive to push aggressively for technology transfer and/​or build their own brands and capabilities (Fan 2010). The rise of local brands came only after entry restrictions were relaxed in the mid-​2000s, and the low-​end segments of the domestic market began to grow rapidly. This was aided by a further reduction in entry barriers tied to the development by Taiwan-​based MediaTek (MTK), a fabless semiconductor firm, of an integrated solution for low-​end handset manufacturers that included both hardware and software (Imai and Shiu 2007). Both developments gave domestic firms an advantage over global firms (Kimura 2009; Brandt and Thun 2011). As the sector grew, an ecosystem of upwards of 30,000 firms developed, largely in and around the southern city of Shenzhen (Tse et al. 2009; Shih et al. 2010), which catered to the high end (i.e., iPhones), the low end (Shanzhai), and everything in between. Foreign, domestic, and “hybrid” (Fuller 2016) firms in this complex mix were continually combining and recombining resources to meet market demand. In telecom equipment, the Chinese state spent over a decade and many billions of renminbi developing an indigenous 3G telecom standard—​a prime example of state-​sponsored innovation. The most successful firm in the sector, Huawei, was not state owned and received little state support during the firm’s early years of development. The firm was locked out of the market for switching equipment in China’s tier one cities in the 1990s and thus was forced to develop highly cost-​effective equipment for markets in the Chinese interior. Excluded from the domestic 2G market, the firm then moved into global markets, concentrating on developing countries that also demand high “value for money.” The primary beneficiary of state support in the telecom sector, Datang, made little progress (Thun and Sturgeon 2019).

State versus Market    147

The (Uneven) Advance of the State The first three decades of economic reform and development were highly successful by many measures—​improvements in TFP (Brandt, Van Biesebroeck, and Zhang 2012; Yu 2015), the increasing sophistication of China’s exports and their increasing market share in demanding export markets (Schott 2008; Mandel 2013), and the movement of domestic firms into more demanding Chinese market segments (Brandt and Thun 2010, 2016; Thun 2018)—​and this impressive economic growth made China the envy of the developing world. Despite this success, there was concern within Chinese policymaking circles that growth was slowing, precipitating an urgent need to further increase productivity. A particularly important concern was that Chinese firms were failing to develop the capacity for indigenous innovation, defined as innovation by Chinese-​owned firms as opposed to firms operating in China. In export-​oriented industries, a common perception was that the value-​added of Chinese firms was relatively low, and core technologies remained controlled by foreign firms. In this regard, the “trading markets for technology” policy was thought to have failed at fostering technology transfer between foreign and domestic firms. The continued absence of Chinese national champions was especially worrying. Within China’s S&T community, there was a widespread belief that foreign firms could not be relied on for technology transfer, particularly given that WTO accession had limited the policy tools that could be used as leverage vis-​à-​vis foreign firms. Moreover, the royalties that Chinese firms were forced to pay were believed to be excessive (Cao et al. 2006; Serger and Breidne 2007).14 Policymakers also perceived an opportunity in nascent industries and new cutting-​ edge technologies. According to China’s Ministry of Science and Technology in 2005, Chinese firms would be able to seize a leadership position by aiming “at the forefront of world technology development, intensify[ing] innovation efforts, and realiz[ing] strategic transitions from pacing front-​runners to focusing on ‘leap-​frog’ development in key high-​tech fields in which China enjoys relative advantages” (cited in Applebaum et al. 2011: 299). While China’s lack of experience was a handicap in mature industries, giving rise to both a technology and a marketing gap, weaknesses can become strengths in nascent industries: the entry barriers associated with production scale are potentially less important (because production volumes are still small); the knowledge required for entry tends to be public (e.g., universities) rather than private (e.g., firms with proprietary knowledge); and firms are not locked into outdated technologies (Perez 1986; Perez and Soete 1988; Freeman 1989; Lee et al. 2005; Robertson et al. 2009; Robertson and von Tunzelmann 2009).

14  There were dissenting voices—​economists argued that technology transfer from foreign firms continued to be the most cost-​effective means of upgrading, while scientists argued that the top-​down approach led to funding decisions that were biased and inefficient (Cao et al. 2006)—​but these were in a minority.

148   Brandt and Thun An increasingly top-​down approach to technology and innovation, reminiscent of that of pre-​reform China, resurfaced in the mid-​2000s. As Heilman and Shih (2013) document, China implemented national industrial policies as early as the 1980s, but these were typically limited in coverage (i.e., usually focused on a single sector) and few in number until 2004. A  more comprehensive top-​down approach was given the imprimatur of China’s top leadership in January 2006, when President Hu Jintao announced a 15-​year “Medium-​to Long-​Term Plan for the Development of Science and Technology” (MLP). The MLP identified both priorities (including 11 key areas relating to national needs, 8 areas relating to frontier technologies, and 13 engineering megaprojects), institutional reforms that were designed to improve the management and implementation of S&T policy, and a policy framework that was designed to reduce China’s dependence on foreign technology (Cao et al. 2006; Serger and Breidne 2007; Gu et al. 2009). These policies were more comprehensive than in the past, the resources committed were greater, and the focus on independent capabilities was more central. The objective of the MLP was to make China an “innovation-​oriented society” by 2020 and a world leader in S&T by 2025. The global financial crisis of 2008 strengthened the new policy direction in two key respects. First, the failure of Western institutions leading up to the crisis, and disarray following the crisis, bolstered the belief of Chinese leaders that a “China model” of development, combining authoritarian rule with state-​led economic development, was preferable to the liberal democratic model (Zhao 2017).15 China’s policy response to the crisis—​which Nicholas Lardy (2012, 5) called “early, large, and well designed”—​was widely credited with playing a critical role in preventing an even more severe global impact. Second, the massive stimulus plan of 4 trillion RMB ($586 billion) was channeled in many cases through the state sector and hence enhanced the role of state firms vis-​à-​ vis private firms.16 A second wave of policies was issued in 2010, when the Five-​Year Plan on Strategic and Emerging Industry (SEI) committed $1.6 trillion to seven emerging technologies: energy saving and environmental protection, next-​generation information technology, biotechnology, advanced equipment manufacturing, new energy, new materials, and new-​energy vehicles. This was followed by “Made in China 2025” in 2015, a comprehensive plan focused on fostering Chinese leadership in key high-​technology sectors. (For further consideration of this policy, see Mayer and Sun, Chapter  7.3.) Through import substitution, massive government spending, and tighter restrictions on foreign firms, the policy seeks to aid Chinese firms in their effort to capture the high value-​added activities in global value chains. A key aspect of the plan is “indigenous innovation” and “self-​sufficiency” for “basic core components and important basic materials.” Semiofficial documents related to the plan outline concrete localization benchmarks that are to be achieved in targeted sectors by 2025 (Wubbeke et al. 2016).

15 

The idea of a “China model” is one that has evolved over time and means different things to different people. Zhao (2017) provides a good overview in the introduction to a special issue on the topic in the Journal of Contemporary China. 16  See Lardy (2012, 11–​13) for an account of these arguments, and (2012, 33–​41) for his rebuttal.

State versus Market    149

Potential Obstacles While it is too early to assess fully Chinese efforts in nascent industries, it is worth considering the new policies in light of China’s earlier success. In particular, the sectors where China has been most successful in the past combined high levels of competition and high levels of diversity (i.e., in firm ownership, form of technology transfer) on the supply side with high levels of demand in multiple market segments. The former increased the extent of combination and recombination as well as spillovers that are the essence of innovation; the latter provided the incentives that firms required to invest in innovation. Failures and weakness were often the result of state policy interfering with the supply side (e.g., restricting foreign investment to JVs in autos and restricting the entry of private firms) and/​ or the demand side (e.g., the dominance of state procurement in wind turbines). First, a focus on self-​sufficiency will have a high cost. While trade tension and geo-​ strategic posturing inevitably reinforce the desire for self-​sufficient national firms, it is important to keep in mind the benefits that come from cross-​fertilization with foreign firms. The mobile telecom industry, for example, has long been a poster child for Chinese dependence on foreign technology, with iPhone teardown analyses consistently showing the value added of Chinese firms at about 6% (Linden et al. 2007; Dedrick et al. 2009). In 2018 and 2019, the dependence of key Chinese firms (e.g., Huawei and ZTE) was starkly highlighted when US export restrictions threatened their very survival. Nevertheless, it is easy to lose sight of the fact that both Chinese and non-​Chinese handset makers use a largely common supply and contract-​manufacturing base, composed of a mix of Chinese and non-​Chinese within the greater Shenzhen ecosystem, and this has offered strong benefits for all. For Chinese firms, the ready availability of highly capable suppliers freed the Chinese brands to exploit their superior understanding of cost-​sensitive market segments (i.e., from both a design and marketing perspective) to rapidly capture global market share and then move into more premium segments (Thun and Sturgeon 2019). Moreover, the sophistication of the telecom sector enabled service companies such as WeChat and Alibaba to capture the core value (even as the handset became increasingly commodified). These highly innovative technology firms would not have grown so rapidly without the global technologies that underpin their services. In adjacent sectors, other firms have pursued similar strategies to become global leaders. DJI is a highly entrepreneurial startup that harnessed a complex mix of foreign and domestic technologies and a local supply chain to become the world leader in commercial drones. Analysis of DJI’s patents and patent citations indicates a reliance on foreign technology (e.g., Boeing in the United States, Parrot in France), domestic technology that was developed within China’s universities and defense industry (e.g., Beijing University of Aeronautics and Astronautics, Zhejiang University), and the manufacturing prowess of the greater Shenzhen ecosystem, which enabled rapid iteration and flexibility in design (Suh 2017). The size of China’s domestic market gives Chinese firms an inherent advantage at home, due to their speed, flexibility, and superior market knowledge, and this lessens the danger of foreign dependence that might sometimes result from integration in global value chains. Foreign firms have to adapt and localize capabilities if they are to succeed within the Chinese domestic market, and this supports the development of Chinese capabilities and

150   Brandt and Thun the process of cross-​fertilization. Success at home provides Chinese firms the scale that is a crucial advantage in global expansion. A second cause for concern is a decline in experimentation. One of the most distinctive characteristics of economic reform in China has been decentralized experimentation, with the central government encouraging local officials to try alternative approaches to problems, and then utilizing the results of these local experiments to inform national policymaking (Heilmann 2008, 2018). According to Heilmann, there were 500 policy-​related pilot projects being carried out at the provincial level in China in 2010. Six years later the number had dropped to 70. While this decrease was likely the result of many factors, including an anti-​ corruption drive and the increase of top-​down political control within China, the result is a decrease in exactly the sort of experimentation that would be most likely to drive an increase in innovation (Economist 2018). Third, a decrease in the level of competition rarely improves outcomes in China. A key lesson from the early decades of reform and development in China is how new firms drove the steady increases in productivity. This momentum stopped after 2008. Estimates using NBS firm-​level data for the period between 2008 and 2013 reveal a sharp decline in productivity growth, which extends to a majority of sectors at the two-​digit level. Some of this decline can be attributed to falling rates of productivity growth among incumbent (existing) firms, but far more important is the almost total disappearance of the contribution of new firms. This appears to be the result of both falling rates of entry of new firms into industry (a decrease of 3% to 4% between 2008 and 2013) and a sharp drop in the productivity advantage enjoyed by new firms relative to incumbents. This is consistent with rising barriers to entry that have favored potential entrants that were politically connected rather than good and with the greatest prospects. Similar dynamics are evident in data capturing the relationship between R&D activity, patenting, and productivity for China’s listed companies. The series of central government industrial policies that began in 2006 led to a rapid increase in China’s R&D expenditures (from 1% of GDP before 2001 to over 2% in 2013)  and a surge in patent applications. Since 2011, China has led the world in patent applications, but the quality of these patent applications, reflected, for example, by the number of “forward” citations in foreign patent applications, remains low (Boeing and Mueller 2018). Government subsidies for patenting activity are likely distorting firm behavior in ways that reward quantity over quality. One immediate consequence is a reduction in the impact of patenting activity on firm productivity growth, especially that of state-​connected firms (Boeing et al. 2016).

Conclusion Underlying China’s current policy direction, most notably the focus on state support for indigenous innovation and a more limited role for multinational firms in key sectors, is a view that earlier policies failed to deliver, especially in terms of producing “national champions.” While we agree that many sectors failed to produce dynamic national champions, our interpretation of this “failure” differs from the narrative that has motivated the resurgence of state-​led innovation in China. More often than not, these failures were the result of excessive

State versus Market    151 regulation and favoritism for state-​connected firms, both of which skewed incentives and dampened the incentive for innovation and upgrading. The reasons for the distortions that underlie these inefficiencies have not been our central focus. Nonetheless, a case can be made that they are deeply embedded in China’s political economy and often serve multiple purposes: they are an important source of patronage and rents, they help align central and local interests, and they enable the party and the state to fulfill strategic objectives tied to domestic and international security considerations. There are also vested interests. The promotion of innovation and technological upgrading has sometimes been a means of furthering the objectives of Chinese leaders, but it has never been the sole objective. There is little reason to believe that the distortions and inefficiencies that have plagued the Chinese economy in the past will be abated in the future. A weakening of competitive pressures will only exacerbate the situation.

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Chapter 2.3

E ntrepreneursh i p a nd Innovation of Sma l l a nd M edium -​S ized E nt e rpri se s in Ch i na Jin Chen and Liying Wang The long-​term gradual recovery of the world economy has provided a good international environment for entrepreneurship and innovation of small and medium-​sized enterprises (SMEs). With the continuous deepening of reforms and policies such as “Mass Entrepreneurship and Innovation” and “Internet Plus,” unprecedented policy dividends have benefited SMEs’ entrepreneurship and innovation. The “Small and Medium-​Sized Enterprises Promotion Law of the People’s Republic of China” was implemented on January 1, 2018. This is of great significance for protecting the legitimate rights, ensuring fair competition, and supporting entrepreneurship and innovation among SMEs. The State Council continues to introduce tax reduction measures to support entrepreneurship, innovation, and development of small and microenterprises. These tax reduction policies are expected to reduce the tax burden of enterprises by more than 60 billion RMB throughout the year. There are many positive factors in China’s economic growth. In particular, the new round of opening up, led by “The Belt and Road” construction, will stimulate more external demand, which will provide good opportunities for the development of SMEs. With the current weak foundation for the recovery of the world economy, there are still many uncertainties. The problem of insufficient and imbalanced domestic economic development is still outstanding, and economic development still faces many difficulties and challenges. Overall, the international and domestic environment faced by China’s SMEs is improving.

The Entrepreneurship and Innovation Development of China’s SMEs Since 2017, the development of China’s SMEs has been generally stable, and market vitality and creativity have remained active. According to information from the State

Small and Medium-Sized Enterprises    157 Administration of Market Supervision of China, in 2017, the country promoted “one enterprise, one license” and “multiple licenses” throughout the country to further optimize the market access environment. It also promoted the “simple administration, combination of devolution and management, [and] optimization service” reform to reduce the time for enterprises to start. The number of newly established market entities was 19.249 million in 2017, a year-​on-​year increase of 16.6%, and the average number of newly registered enterprises reached 52,700. The number of newly established enterprises was 6.074 million, a year-​on-​year increase of 9.9%. The number of newly privately or individually owned business was 12.988 million, an increase of 20.7% over the previous year. Until the end of 2017, the capital registered by private enterprises was 165.38 trillion RMB, and the number of employees was 341 million (Chi, Liu, Lin, and Qin, 2017) (Table 2.3.1). With nearly 40% of resources, SMEs have created more than 60% of Chinese gross domestic product (GDP), paid more than 50% of tax revenue, contributed more than 70% of technological innovation and new product development, and provided more than 80% of jobs. The number of employees in small and microenterprises increased from 6.1 to 7.3 per company, of which recent graduates and unemployed and re-​employed people accounted for 12.5% and 12.4%, respectively. The activity of small and microenterprises has been continuously improving, and the role of expanding employment has become more apparent. According to the calculation of the State Administration of Market Supervision, from 2013 to 2017, the quality of the newly established market entities continued to improve. The contribution rate of new taxpayers to tax revenue increased from 7.8% to 30.2%. By the end of March 2018, the number of enterprises in the country reached 100.2 million. Among them, there are 31.131 million enterprises and 68.869 million privately or individually owned business (Table 2.3.2). The emergence of a large number of new market entities has become an important symbol of the vitality of entrepreneurship and innovation, helping the economy continue to stabilize and improve. The initial startup small and microenterprises accounted for 85.8% in newly established small and microenterprises, the annual opening rate of the newly established small and microenterprises reached 70%, and nearly 80% of them achieved operating income, among which the innovation and network-​related enterprises have higher profits (Chi, Liu, Lin, and Qin, 2018).The transportation and warehousing, farming, and accommodation industries have the highest opening rate of small and microenterprises; the service industries such as makerspaces and incubators grew rapidly, up 47.3% and 40.9%, respectively, providing a good development environment for entrepreneurship and innovation; the water conservancy, financial, power generation, and supply industries are the least distributed industries due to high monopoly factors. The development of China’s industrial SMEs above designated size is stable, the main business income of them are more than 20  million yuan, with the following features (Table 2.3.3): 1. The number of SMEs still has an absolute advantage. In 2016, there were 317,161 industrial SMEs above designated size, accounting for 87.33% of industrial enterprises above designated size. 2. The scale of assets continues to grow. In 2016, the assets of industrial SMEs in China were 584.94 billion RMB, an increase of 6.78% over the previous year.

158   Chen and Wang Table 2.3.1 Development of Private Enterprises from 2004 to 2017 Number of Enterprises

Number of Employees

Registered Capital

Number

Number

Growth Rate

Capital

Growth Rate

Growth Rate

Year

(Thousand) (%)

(Thousand)

(%)

(Trillion RMB)

(%)

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

4,024 4,720 5,441 6,031 6,574 7,432 8,455 9,677 10,857 12,538.6 15,463.7 19,675.7 22,154.7 27,263.0

50,173 57,240 65,864 72,531 79,040 86,070 94,180 103,536 112,961.2 125,215.6 143,904.0 163,948.6 310,000 341,000

16.7 16.1 13.1 10.1 9 8.9 9.4 9.9 8.66 10.85 15.2 13.89 47.11 9.09

4.8 6.1 7.6 9.4 11.7 14.6 19.2 25.8 31.1 39.31 59.21 90.55 -​ 165.38

35.8 28 23.9 23.5 25 24.8 31.2 34.3 20.6 26.4 50.6 52.93 -​ -​

22.4 17.3 15.3 10.8 9 13 13.8 14.5 12.2 15.5 23.33 27.43 27.59 18.74

Source: According to the information compiled by the State Administration of Market Supervision of China.

3. The overall efficiency of SMEs is generally good. In 2016, the total profits of industrial SMEs in China reached 4.459 trillion RMB, an increase of 4.66% over the previous year. 4. The proportion of employees in SMEs is relatively large. In 2016, the number of employees in industrial SMEs above designated size in China was 6,502,700, accounting for 64.7% of the employees in industrial enterprises above designated size. Due to the continuous improvement of the external macroeconomic environment, the development of SMEs has also shown a steady and positive development trend, which is embodied in the following aspects: The main entities of SMEs have steadily increased. By the end of March 2018, the total number of market entities reached an iconic high of 100.2 million for the first time. Among them, there are 31.131 million SMEs, accounting for 31.3%. According to the national population at the end of 2017, on average, there were 72.1 market entities and 22.5 enterprises per thousand people. At present, there are more than 33.04 million small enterprises and 65.79 million privately or individually owned businesses across the country. The capabilities of entrepreneurship and innovation continue to improve. The awareness of innovation and patents of enterprises has continuously increased, and it has become the main force driving patent growth. According to the Ministry of Industry and Information Technology, China’s SMEs have completed 80% of new product development, 75% of technological innovation, and 65% of invention patents. In the first quarter of 2018, the number of invention patent applications in China was 391,000, a year-​on-​year increase

Small and Medium-Sized Enterprises    159 Table 2.3.2 Development of Privately or Individually Owned Businesses

from 2004 to 2017 Number of Enterprises

Number of Employees

Registered Capital

Number

Growth Rate

Number

Growth Rate

Capital

Growth Rate

Year

(Thousand)

(%)

(Thousand)

(%)

(Billion)

(%)

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

23,505 24,639 25,956 27,415 29,173 31,974 34,533 37,565 40,593 44,362.9 49,840.6 59,950.6 59,300 65,794

-​0.1 4.8 5.3 5.6 6.4 9.6 8 8.8 8.1 9.3 12.35 20.28 -​1.10 9.87

45,871 49,005 51,597 54,962 57,764 65,854 70,977 79,453 86,283.1 93,357.4 105,845.6 116,822 128,260.1 -​

6.7 6.8 5.3 6.5 5.1 14 7.8 11.9 8.6 8.2 13.38 10.38 9.79 -​

505.79 580.95 646.88 735.08 900.6 1,190 1,340 1,620 1,780 2,430 2,930 3,699.7 -​ 4,874.439

20.8 14.9 11.4 13.6 22.5 20.6 12.6 20.8 22.2 23.1 20.57 26.27 -​ -​

Source: According to the information compiled by the State Administration of Market Supervision of China.

of 36.4%; the number of utility model patent applications was 534,000, an increase of 48.9%; and the number of design patent applications was 145,000, an increase of 20.9%. In the invention patent applications, there were 356,000 domestic applications, of which domestic enterprises applied for 235,000, a year-​on-​year increase of 46.1%, accounting for 66.2% of the total, and the contribution rate to invention patent growth reached 70.9%. The ability to review patents has been continuously improved, which provides strong support for market entities to obtain patent protection in a timely manner. By the end of March, there were 10.2 invention patents per 10,000 people in China. China has accepted PCT patent applications of 10,500, an increase of 12.5%, of which domestic applicants submitted 0.98 million, an increase of 16.4%. The amount of new patented deposits was 18.2 billion RMB, a year-​on-​year increase of 12.5%; the number of pledge projects involved was 873, a year-​on-​year increase of 28.7%, and this played an active role in solving the financial difficulties of enterprises (Chi, Liu, Lin, and Qin, 2019). Entrepreneurs are getting much younger, with an average age between 26 and 35 years old. Young entrepreneurs have strong entrepreneurial motivation and innovative ability. University students have become the new force of youth entrepreneurship, and they prefer to choose the service industry. These entrepreneurs have a higher academic background, use new and active thinking, and are more accepting of new things, which plays an important role in the transformation and upgrading of SMEs. The government is also gradually guiding universities to establish an entrepreneurial ecosystem. Universities can strengthen

160   Chen and Wang Table 2.3.3 Main Economic Indicators of Industrial SMEs above Designated Size

in China from 2003 to 2016

Year

Number of Enterprises

Industrial Output (Billion)

Number of Total Assets Main Business Total Profit Employees (Billion) Income (Billion) (Billion) (Thousand)

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

194,238 274,340 269,332 299,276 333,858 422,925 431,110 449,130 316,498 334,321 343,000 367,995 319,445 317,161

9,335.7 13,234.85 16,035.51 20,424.96 26,431.91 33,798.11 37,249.89 46,864.33 49,276.15 –​ –​ 67,559.78 69,176.89 72,061.34

10,253.05 13,681.92 14,970.59 17,743.79 21,430.62 26,701.94 30,056.89 35,662.49 33,279.8 38,880.28 44,265.75 50,641.03 54,736.99 58,449.42

9,061.92 12,786.76 15,485.54 19,729.07 25,462.11 32,728.24 36,182.17 45,972.72 48,293.71 54,462.7 61,927.72 67,028.68 68,826.56 72,250.0

450.13 639.2 800.11 1,090.03 1,574.33 2,004.36 2,364.46 3,541.93 3,496.26 3,674.02 3,815.48 4,180.41 4,260.46 4,459.36

44,419 52,446 53,135 56,362 60,521 68,671 67,877 72,369 59,357 61,290 63,763 65,727 64,815 62,503

Source: China Industrial Statistical Yearbook (2017).

entrepreneurship education through entrepreneurial competitions, teaching method reform, curriculum system construction, etc., and effectively enhance the entrepreneurship and innovation abilities of college students.

Interpretation and Review on the Key Policies of China’s SMEs The structural tax reduction policy for SMEs has been strengthened. The State Council adopted the “Decision on Amending the VAT Provisional Regulations of China” (hereinafter referred to as the “regulations”) at the 191st executive meeting of the State Council on October 30, 2017. The regulations announced on November 19, 2017, mainly revised important matters such as value-​added tax (VAT) taxation, the VAT rate, and the VAT deduction method in China. The change from a business tax to a VAT is a major measure to promote structural reform on the supply side. It is the largest reform measure implemented in China in recent years, and it is also the highlight of the current government’s reform of the fiscal and taxation system. It has promoted the establishment of a unified and simple tax system and the elimination of duplicate taxation, effectively reduced the burden on enterprises and the public, lengthened the industrial chain and expanded basic taxes, implemented the innovation-​driven development strategy, promoted new kinetic energy growth and industrial upgrading, and promoted employment. This measure has played an important role in

Small and Medium-Sized Enterprises    161 making multiple contributions, providing strong support for current economic growth, and adding strong impetus to future sustainable development. The innovative model of SMEs’ credit guarantee policy has been strengthened. On October 30, 2017, the National Development and Reform Commission and the People’s Bank of China issued the “Guiding Opinions on Strengthening and Standardizing the Management of Objects List of the Trustworthy Joint Incentives and Untrustworthy Joint Punishment” to establish a list system of trustworthy joint incentive objects and untrustworthy joint punishment objects, to complete the linkage mechanism of awards for keeping credit and punishment for breaking credit. The proposal established a “green channel” for the objects listed in the “red list,” giving priority to providing service facilities, optimizing the administrative supervision arrangements for honest enterprises, reducing market transaction costs, and vigorously promoting the integrity of market entities. On February 2, 2018, the National Development and Reform Commission issued the “Notification on Giving Full Play to the Role of Credit Service Institutions and Accelerating the Construction of Social Credit System” to vigorously develop credit service agencies and the credit service market. Credit service agencies focus on the relevant qualifications of credit reporting and ratings agencies to participate in the construction of the social credit system. Social Credit System needs to be based on actual credit services and to focus on the social requirements and overall construction goal of the credit system, so that credit service organizations can play a positive role in multiple measures, in multiple channels, and in multiple ways (Wang, Li, Bao, and Wang, 2020). SMEs’ entrepreneurship and innovation policies have been deepened. The policies continue to be guided by supply-​side reforms, with the needs of enterprises as the starting point for policy formulation and continue to deepen various initiatives to promote entrepreneurship and innovation. To further strengthen support for innovation, an institutional environment, conducive to mass entrepreneurship and innovation, was created, and a more competitive market environment with better services, through the approval of the State Council in the “Notification on Promoting and Supporting Innovation-​Related Reform Measure” (hereinafter referred to as the “notification”), has been promoted. With the approval of the State Council, the relevant reform measures will be issued in the country. The notification proposes that to further increase support for entrepreneurship and innovation, an institutional and fair environment conducive to mass entrepreneurship and innovation must be created, and that to provide better services, the government will promote 13 innovation-​related reforms in eight reform pilot areas (Beijing-​Tianjin-​Hebei, Shanghai, Guangdong [Pearl River Delta], Anhui, Sichuan, Hubei Wuhan, Xi’an Shanxi, and Shenyang Liaoning).

Development of Intellectual Property Strategy to Promote SMEs’ Entrepreneurship and Innovation To fully implement the “National Medium and Long Term Science and Technology Development Guideline” and “National Intellectual Property Strategy Guideline” and to

162   Chen and Wang propel “Policies on Supporting Technological Innovation in SMEs,” the State Intellectual Property Office and Ministry of Industry and Information Technology jointly issued the “Notification on Implementing the Strategy of Promoting Intellectual Property Rights in SMEs” on December 31 2009, which determines the implementation of the strategy of intellectual property rights for SMEs. All units should comply with the requirements of the “Implementation Plan for Promoting Intellectual Property Strategy in SMEs” (hereinafter referred to as the “implementation plan”) and consider the actual situation of the regions. The project will be an important task for the implementation of the “Opinions of the State Council on Further Promoting the Development of SMEs” to promote the technological progress and structural adjustment of SMEs. The implementation plan clarifies the implementation of the national intellectual property strategy at the enterprise level, comprehensively promotes the improvement of intellectual property rights of SMEs, strengthens and improves the construction of the intellectual property public service system for SMEs, guides and promotes the development and implementation of innovative technologies with independent intellectual property rights, promotes the formation of core competitiveness of SMEs with independent intellectual property rights, and accelerates the transformation of SMEs and their innovation development. The implementation plan takes urban SME agglomeration areas as the main object of implementation. The overall goal is to cultivate and form 100 SME agglomeration areas with the advantages of independent intellectual property rights, establish 100 intellectual property advisory service institutions for SMEs, train 10,000 intellectual property workers and managers in SMEs, and cultivate 10,000 SMEs with independent intellectual property rights advantages in five years. It can provide all kinds of intellectual property rights public services for the vast number of SMEs and form a practical and effective mechanism for comprehensive intellectual property service assistance for SMEs. It can give full play to the radiation and driving role of demonstration projects in SME agglomeration areas; improve the overall awareness of intellectual property rights of SMEs; enhance their ability to create, apply, protect, and manage intellectual property rights; increase the number of SMEs with independent intellectual property rights; and enhance their ability to resist risks and be self-​reliant. The core competitiveness of the main intellectual property rights has been significantly improved. Through the overall implementation of the project, a number of SMEs with independent intellectual property rights can be formed (Wang, Wang, and Bao, 2014). The State Intellectual Property Office carried out performance evaluation of the intellectual property strategy promotion project for SMEs in 2014. The result shows that this project has achieved positive effects. The intellectual property creation ability and innovation ability of SMEs have been significantly enhanced. The patent structure of the first batch of 32 SMEs has been optimized, and the amount of invention patents and the vitality of innovation are increasing (Wang, 2010). Specific performances include the following: (1) SMEs’ innovative capabilities have been enhanced. (2) The awareness of intellectual property rights of SMEs has improved. (3) Several SMEs with intellectual property rights have been developed. The average annual growth rates of software copyrights, national well-​ known trademarks, provincial well-​known trademarks, foreign patent applications, and

Small and Medium-Sized Enterprises    163 authorization of SMEs in the agglomeration area gain a rapid increase and the number of participants in the formulation of industry standards, national standards, and international standards is increasing significantly. (4) The intellectual property professional service system has been initially established. (5) The policy of promoting intellectual property rights has achieved certain results. Some enterprises enjoy the 150% pretax deduction policy for research and development (R&D) expenditure, and some SMEs have been supported by financial funds at all levels, and even social funds. To implement “Opinions of the State Council on Accelerating the Construction of Intellectual Property Rights in the New Situation” and “Opinions of the State Council on Supporting the Healthy Development of SMEs,” the State Intellectual Property Office and the Ministry of Industry and Information Technology jointly formulated the “Guiding Opinions on the Comprehensive Implementation of the SME Intellectual Property Strategy Promotion Project” on December 22, 2016 (CNNIC, 2018).The main objectives of the project are as follows:  foster the national implementation of the innovation-​driven development and intellectual property strategy, accelerate the formation of the intellectual property system and development mode that adapts to the new normal of current economic circumstances, and improve the ability to create, use, protect, and manage intellectual property rights of SMEs.

Achievements of SMEs’ Entrepreneurship and Innovation in the “Digital Economy” In recent years, with the continuous advancement of supply-​side reforms and under the background of mass entrepreneurship and innovation, “Internet+”, and “Made in China 2025,” the role of Chinese SMEs as innovative resources has been further enhanced, entrepreneurial vitality has been continuously stimulated, and the efficiency of entrepreneurship and innovation has been significantly improved. The digital economy has promoted the entrepreneurship and innovation in SMEs. The Ministry of Industry and Information Technology implemented the “Action for SMEs to Integrate Industrialization and Informatization” and the “Action Plan for Internet+ Small and Micro Enterprises” to promote information service providers to use the internet, mobile internet, cloud computing, big data, and other information technologies to build support for SMEs and to build an information service platform for the development of core business such as R&D, operations management, and marketing. At present, more than 5,900 branch service organizations have been established in the country, equipped with nearly 100,000 professional service personnel, and more than 600,000 software developers and professional partners have been gathered through the information service platform. Currently, 65% of domestic invention patents in China are obtained by SMEs, and 80% of new products are created by SMEs. In particular, the rapid growth of technology-​based SMEs, internet companies, and small and medium-​sized e-​commerce companies have prompted China’s SMEs to rapidly advance the role of technology and

164   Chen and Wang information resources (Wang, Wang, Lou, and Jin, 2020). The Ministry of Industry and Information Technology is building a network of high-​quality industrial cloud service platforms by supporting 30 provinces and five planned cities to build a platform network for interconnection and resource sharing and actively promote the integration of cloud computing, big data, internet of things, and modern manufacturing. E-​commerce, cultural creativity, internet finance, and other industries also accelerate the development of intelligent equipment and intelligent products, supporting the “grassroots” innovation and development of small and microenterprises. Intelligent manufacturing promotes cross-​border collaboration between SMEs’ entrepreneurship and innovation. SMEs use “Internet+ traditional manufacturing” to carry out personalized customization and flexible production and achieve good economic benefits. The “smart factory” enables customers to meet their individualized needs while discovering new ways of creating value and business models, bringing development opportunities to startups and small and microenterprises, and promoting the improvement of downstream service revenue. In addition, the intelligent production of emerging industries pays more attention to the design management ability and digital professional skills of workers and enhances the innovation ability of enterprises by adopting measures to optimize organizational processes, extending the professional lives of skilled workers with lifelong learning and best-​practice demonstration projects. According to the survey, 46.8% of SMEs in Zhejiang province added or updated smart machines and equipment in 2014. Among them, 10.9% of enterprises enjoy the government’s smart manufacturing-​related policies, and nearly 80% of enterprises have the willingness to carry out smart manufacturing. From the perspective of the existing implementation effect in Zhejiang, intelligent manufacturing has alleviated the employment situation of some SMEs, optimized the employment structure, significantly improved labor efficiency, expanded the profit-​making ability of enterprises, saved energy and reduced consumption, eliminated backward production capacity, and promoted the transformation, upgrading, and sustainable development of equipment manufacturing enterprises in Zhejiang province. The integration of industrialization and informatization has led to the doubling of entrepreneurship and the acceleration of innovation in SMEs. The business model innovation and organizational innovation of SMEs are accelerating, and the integration of manufacturing and production services promotes the continuous acceleration of entrepreneurship and innovation in SMEs. SMEs have shifted from heavy assets to light assets, gaining higher industry added value at the high end, promoting higher production efficiency, and further deepening “individualization.” In recent years, some processing enterprises have extended to the front ends of the value chain, such as R&D and design, and to the back ends of the value chain, such as channels and services, which are also the main forms of organizational innovation. The internet of things provides new ideas for the upgrading of the industrial capabilities of SMEs in emerging industries. The simplification of data acquisition and the automation of production can make up for the shortcomings of SMEs. When limited by capital and technology, SMEs rely on the development of the internet of things to improve their management and technology level, promote transparency of the management process, and reduce communication transaction costs.

Small and Medium-Sized Enterprises    165

Problems and Challenges in the Development of Entrepreneurship and Innovation in SMEs What impedes the development of entrepreneurship and innovation are financing difficulties and talent shortages. China has been deepening the reform of the financial system in recent years and issuing a series of policies to alleviate the financing difficulties of SMEs, providing more convenient access for SMEs to obtain funds. However, with the restrictions of the capital market structure, the financing difficulties of these enterprises still exist. SMEs are generally small scale and have weak management, which inhibits the attraction and retention of outstanding talents. The talent shortage restricts the sustainable development of SMEs (Jin, Zhang, and Wang, 2019). With the deepening of supply-​side structural reform, the problem of capital and talent shortages of SMEs is more prominent. For the challenges faced by SMEs, the government has issued a series of support policies. SMEs need to take the initiative to adapt to the new economy and use their advantages to seize the opportunity to meet the challenges effectively. The digital innovation ability of SMEs is relatively weak. The most prominent feature of the contemporary market economy is that enterprises must constantly innovate to meet the changes in market demand. Innovation is the only way for enterprises to survive. Large enterprises have abundant capital and talents, and their digital innovation ability is stronger than that of SMEs overall. SMEs are weak in foundation and cooperation, which brings them lower technical level and more limited investment capacity, without technological development institutions in the majority. SMEs often have an unreasonable knowledge structure of human resources and low-​quality personnel to save labor costs; meanwhile, technicians are multitasking, which makes it difficult for them to catch up with the R&D levels and energy input of large enterprises. The management in SMEs has poor innovation consciousness and rely on specific technologies and products, which brings enterprises shortage both in necessary research facilities and scientific and technological personnel. In addition, SMEs still lack a sufficient ability to collect, collate, and analyze information. This restricts the innovation and development of SMEs. Compared with large enterprises, SMEs lack sufficient funds for innovation, which hinders their development of digital innovation capabilities. SMEs’ capabilities in digital innovation and value chain control need to be strengthened. The Chinese new digital economy, including online shopping, mobile payment, and sharing economy, has been developing vigorously, and is also in the forefront of the world. SMEs’ entrepreneurship and innovation need to aim at the world’s scientific and technological frontiers, concentrate on resources to break through the core technology of big data, and accelerate the construction of the independent and controllable big data industry chain, value chain, and ecological system. China should construct a new information infrastructure, make overall plans for government data resources and social data resources. What is important is to give full play to China’s institutional advantages and market advantages. In this way, it should pay attention to the business innovation model, and upgrade productivity. China needs to focus on the deep integration of industry, university, and research,

166   Chen and Wang with data as the link, to form a data-​driven innovation system and development model, and to cultivate and bring up more large data-​leading enterprises. A multilevel and multitype large data talents team is needed. The high-​value chain can be grasped through source-​born core technology and market channel, thus to transform the technological innovation ability and regional market scale into the global value chain control power. The ecological environment of SMEs’ integration into digital innovation is not yet mature. The core reason the digital economy can lead a new round of industrial revolution is that it has profoundly changed the mode of production, organization, circulation, and sales of products and reshaped the ecological chain of the industrial value chain. In the era of the digital economy, manufacturing enterprises should not only innovate their products, production technologies, and business models but also optimize their business operations and production management level to cope with the changing market in production efficiency. Building a healthy and efficient manufacturing eco-​environment is the necessary way to achieve intelligent manufacturing, whether large-​scale, small-​batch, personalized, or customized production needs. With the advent of the digital economy era, new technologies, products, formats, and models are constantly emerging, which has brought great opportunity for the development of innovative SMEs. However, in the digital innovation ecosystem, innovative SMEs must strive to solve the problems of high R&D costs, long innovation cycles, and high market risks so as not to let the leading edge become a trap hindering development. Under the background of “Integration of Industrialization and Informatization,” the deep promotion of the implementation of digital innovation not only is a unilateral matter for enterprises but also needs to include a benign ecosphere with platform support, talent supply, and policy support. It is not only an opportunity but also a challenge for SMEs to construct a digital innovation ecosystem and to integrate into the intelligent manufacturing ecosystem led by large enterprises.

References 1. Chi R Y, Liu D X, Lin H C, Qin Z H (2017) Climate Index Report of Chinese SMEs 2017. China: Beijing, China Social Sciences Press. 2. Chi R Y, Liu D X, Lin H C, Qin Z H (2018) Climate Index Report of Chinese SMEs 2018. China: Beijing, China Social Sciences Press. 3. Chi R Y, Liu D X, Lin H C, Qin Z H (2019) Climate Index Report of Chinese SMEs 2019. China: Beijing, China Social Sciences Press. 4. CNNIC (2018) The 41st China Statistical Report on Internet Development. Retrieved from China Internet Network Information Center Website. 5. Jin J, Zhang Z Y, Wang L Y (2019) “From the Host to the Home Country, the International Upgradation of EMNEs in Sustainability Industries—​The Case of a Chinese PV Company”, Sustainability, Vol. 11, No. 19, pp. 52–​69. 6. Wang L Y (2010) SMEs’ Intellectual Property Strategy and Method. China: Beijing, Intellectual Property Press. 7. Wang L Y, Li P, Bao H B, Wang H W (2020) Research on the Innovation Development Path and the Policy Support Systems of China’s Small and Medium Sized Enterprises. China: Beijing, China Social Sciences Press.

Small and Medium-Sized Enterprises    167 8. Wang L Y, Wang H W, Bao H B (2014) Intellectual Property System and Regional Industry Innovation Driven—​From the Perspective of Promoting the Manufacturing of the Yangtze River Delta. China: Beijing, Economic Science Press. 9. Wang L Y, Wang Y, Lou Y, Jin J (2020) “Impact of Different Patent Cooperation Network Models on Innovation Performance of Technology-​based SMEs”, Technology Analysis & Strategic Management, Vol. 32, No. 6, pp. 724–​738.

Chapter 2.4

F inancing for I nnovat i on in Ch i na Changwen Zhao and Xiheng Jiang Introduction A panoramic view of the evolution of human history in modern times indicates that continuous improvement in productive forces is underpinned by scientific and technological innovation and financial services. Technology and capital are two fundamental and essential factors in economic growth. Since the First Industrial Revolution in the United Kingdom, each and every technological and industrial revolution has gone hand in hand with new financial patterns and models. Meanwhile, since the modern financial system took shape, new financial patterns and models, more often than not, have come into being thanks to the pioneering application of new technologies in the financial sector (Zhao & Zhu, 2017). Chinese leaders have given great importance to science and technology as well as financing. Deng Xiaoping made it clear in 1988 that “Science and Technology are the primary productive forces,”1 and this has been a fundamental guidance for Chinese public policies since then. Xi Jinping stressed that “finance is central to the modern economy,”2 further prioritizing financing in the economy. Although this chapter does not strictly distinguish between scientific invention and technological innovation, it is noted that science and technology have both common and different attributes. Scientific discovery and technological innovation demand different combinations of the roles of government and market, like a spectrum. The general consensus is that as basic research has a prominent public nature and positive externality, governments should play an important role, on top of market forces. Therefore, the financial activities that underpin scientific discovery and technological innovation must be a combination of public and commercial financing tools.

1 

The judgment that “Science and technology are the primary productive forces” was made by Deng Xiaoping during the first National Science Conference in 1988 and became the foundation of China’s policies on science and technology. 2  Xi Jinping made this statement in April 2017.

Financing for Innovation    169 Developed countries, which are more at the forefront of technology, have implemented different schemes for technological innovation and industrial upgrading at different stages. Taking recent practices as an example, some developed countries have introduced the following plans in the past decade after the global financial crisis: “A Strategy for American Innovation: Securing Our Economic Growth and Prosperity” (National Economic Council, Council of Economic Advisers, and Office of Science and Technology Policy, 2011); “Our Plan for Growth:  Science and Innovation” (UK Department for Business, Innovation & Skills, HM Treasury, 2014); “Industry of the Future” (France, 2015); “The High-​tech Strategy 2020 for Germany” (German Federal Ministry of Education and Research, 2010); and “The Comprehensive Strategy on Science, Technology and Innovation for 2017” (Japan, 2017). The main objective of these strategies or plans is to promote scientific and technological progress to enhance the international competitiveness of the industry, and in them we can find multiple arrangements for fiscal, tax, and financial policies. Science and technology (S&T) has been of great significance to China’s economic growth and structural transformation. The government of China is firmly committed to S&T and keeps promoting such innovation through innovation in financial services (including fiscal and taxation policies). Since the reform and opening-​up policy was introduced in 1978, the central government has launched a number of fiscal and taxation-​supporting policies for S&T, such as the 863 Program in 1986 and the Torch Program (establishment of national high-​tech industrial zones) in 1988. The government also introduced a series of corresponding policies in taxation, for example, tax deduction on research and development (R&D) expenditure in 1996 and policies for high-​tech business in 1991 (Guo, Fu, & Zhang, 2013). Based on the trends in S&T at home and abroad, the government has continued with reforms by improving its administrative system and promoting efficiency in implementation. It has set up various plans and consolidated and improved them, leading to a comprehensive, well-​conceived, visionary, and focused regime of fiscal and taxation policies for S&T sectors. Meanwhile, a market-​oriented financial service system for innovation has emerged. In 1986, state-​owned commercial banks began to provide “loans for S&T.” A  lot of such business services continue today, with myriad new business models. State-​owned policy banks have been involved in financial innovation in different ways. The year 1999, “Year One” for entrepreneurship and venture capital in China, witnessed the rapid rise of angel investment, venture investment, and other equity investment institutions. In 2007, the central government launched its first state venture capital fund for small and medium-​ sized enterprises (SMEs). With such governmental guidance, equity investment has become the most important part in the country’s financial innovation system (Zhao, Chen, & Tang, 2009). The SME board and the Growth Enterprise Market (GEM) launched by the Shenzhen Stock Exchange in 2005 and 2009 further developed the multilevel capital market and underpinned S&T in China (Zhang et al., 2012). In 20113 and 2016,4 the Chinese government approved, in two phases, the pilot programs of 25 cities for integrating innovation

3 

On October 20, 2011, the Ministry of Science and Technology enacted the “Notice on Establishing First Phase Pilots for Combining Sci-​Tech and Finance.” 4  On May 30, 2016, the Ministry of Science and Technology enacted the “Notice on Establishing Second Phase Pilots for Combining Sci-​Tech and Finance.”

170   Zhao and Jiang in science, technology, and finance, strongly boosting the local endeavors through new fiscal, taxation, and financial means. In short, the experience in China and other countries indicates that financial innovation is an important driving force behind S&T development. In the following, some of the key aspects will be covered.

Fiscal and Tax Policies Direct financing is the way many countries used to advance S&T, especially in fields such as basic research, forward-​looking research, and research for major public welfare projects. Over the past 40 years, China has launched a number of programs to support S&T development. They have improved the country’s technological strength, comprehensive competitiveness, and socioeconomic development. Today, in the middle of a new technical and industrial revolution, the Chinese government continues to optimize its strategies and policies. Through deepening reforms, it has promoted S&T-​centered comprehensive innovation and gradually built a financial support system that suits China’s national conditions. At present, the government has carried out five major national programs and formulated corresponding tax policies.

National Natural Science Foundation of China The National Natural Science Foundation of China (NSFC) was established to fund basic research and cutting-​edge scientific exploration, support talent fostering and team building, and promote radical innovation. By the end of 2017, the NSFC has approved over 200,000 projects with 3 million scientific solutions.5

National Science and Technology Major Projects Backed by the state, these projects focus on the country’s major strategic products and industrialization goals and are completed through integrated collaboration within a time limit. China has so far set up 13 major projects altogether, namely, on core electronic components, high-​end generic chips, and basic software products; ultra-​large-​scale integrated circuit manufacturing equipment and processes; next-​generation broadband services and wireless mobile networks; advanced computerized numerical control (CNC) machine tools and basic manufacturing equipment; oil and gas exploration and coalbed methane development; advanced pressurized-​water reactor (PWR) and high temperature gas-​cooled reactor (HTGR) nuclear power plant; water pollution control and treatment; genetically modified organism (GMO) breeding; major drug discovery and development; prevention and treatment of AIDS and hepatitis; large aircraft; high-​resolution earth observation; and 5 

Source: National Natural Science Foundation of China, http://​www.nsfc.gov.cn.

Financing for Innovation    171 manned space program and lunar exploration. By the end of the 12th Five-​Year Plan period (2011–​2015), in these major civilian projects, 61,900 patents were applied, 11,200 technical standards were formulated, and an output of 1.7 trillion RMB was obtained.6 All of these have boosted China’s technology, economy, comprehensive competitiveness, and global influence.

National Key Research and Development Program The National Key R&D Program aims at major social welfare research in areas such as agriculture, energy resources, the ecological environment, and public health. Research as such requires long-​term study and is of great importance to the national economy and people’s livelihood. This program also focuses on strategic, basic, forward-​looking scientific issues that are vital to industrial competitiveness, indigenous innovation capacity, and national security. Key technologies and products as well as international S&T cooperation also fall within the realm of the program. By strengthening R&D and coordinating innovation across different departments, sectors, and regions, this program has been continuously underpinning and leading socioeconomic development.

Special Fund for Guiding Technological Innovation The fund provides grants through risk compensation and results-​based subsidies. This market mechanism was introduced to guide innovation and to commercialize, capitalize on, and industrialize S&T achievements in a more efficient way.

Special Project for S&T Hub Building and Talent Fostering This project helps to build and upgrade technological hubs and enables resource sharing. By providing support to the research of innovative talents and their teams, it better prepares the country for technology innovation. Apart from direct financing, the Chinese government has also put in place a series of preferential taxation policies to support innovation. In 2017, a rough estimate suggests that taxations equal to nearly 300 billion RMB were exempted.7 Typical preferential tax policies are discussed in the following sections.

Policy for High-​Tech Companies Firms accredited as high-​tech companies can enjoy a 15% tax break in the first three years following the accreditation. Enterprises eligible for this tax benefit are the ones in fields such as digital information, biomedicine, aeronautics and astronautics, new materials, high-​tech

6 

7 

Source: Xinhua News Agency, http://​www.gov.cn/​xinwen/​2017-​01/​12/​content_​5159219.htm. Source: State Taxation Administration, http://​www.chinatax.gov.cn.

172   Zhao and Jiang service, new energy and energy conservation, resources and environment, and advanced manufacturing and automation.

R&D Expenses Deduction Policy Qualified companies can have their actual R&D expenditure deducted by 75% in taxation. The expenses that are not included as intangibles in the income statement of the current accounting period can be deducted by 75% from the taxable income. For intangibles, 150% of their cost is amortized before taxation.8

Tax Deferral Treatment for Commercializing S&T Findings 1. For unlisted companies, taxation on qualified stock (equity) options, restricted shares, and equity incentives can be deferred to the time when they are transferred, so that insufficient cash flow incurred by taxation will be avoided. 2. For listed firms, the time allowed to pay tax on equity incentives can be extended. 3. For individuals or businesses who contributed their S&T achievements for investment, taxation can also be deferred. On top of these policies, the government has also put forward a series of tax policies that target key sectors such as software and support S&T, for example, with indirect preferential tax measures that encourage startup investment institutions.

Case 1: Policies for High-​Tech Companies China started to accredit high-​tech businesses in the 1990s when national high-​tech industrial development zones were just set up. A large number of professionals flooded into these zones and started up high-​tech companies. In 1991, to support these startups, the State Council issued the “Conditions and Measures for Determination of High-​Tech Enterprises in National High-​Tech Industrial Development Zones” (hereinafter in short “Conditions and Measures”). Corresponding preferential policies in finance, taxation, trade, and funding were put in place as well. In 1996, the scope of this accreditation was extended to companies outside the zones. In 2000, the Conditions and Measures was revised. On April 4, 2008, the Ministry of Science and Technology (MOST), the Ministry of Finance, and the State Administration of Taxation jointly published the “Measures for Determination of High-​Tech Enterprises” as a supplement to the original document. In 2016, to support high-​ tech companies, especially SMEs; encourage entrepreneurship and innovation; and serve new technologies and new business models, the aforementioned authorities made another improvement to the Conditions and Measures. These policies substantially advanced the development of China’s high-​tech industry. They also helped to attract investment from the capital market. According to statistics available, the year 2016 saw 250,000 newly registered tech companies, making the total number of high-​tech firms in China 104,000, with tax exemptions that totaled 115 billion RMB.9

8 

9 

Source: State Taxation Administration, http://​www.chinatax.gov.cn. Source: State Taxation Administration, http://​www.chinatax.gov.cn.

Financing for Innovation    173 To follow are the conditions for high-​tech company accreditation: 1. The company, when applying for accreditation, should be registered for at least one year. 2. The company should own the intellectual property of the technology that underpins its main product (service) by R&D, transfer, bestowal, or acquisition. 3. The technology underpinning the major product (service) should be in the fields specified in the “High-​Tech Fields Supported by the State.” 4. Technicians engaged in R&D and tech innovation should make up at least 10% of the total staff. 5. The R&D expenditure–​to–​sales revenue ratio in the latest three accounting years of the company should satisfy the following requirements: (a) For companies that earned no more than 50 million RMB in the recent one-​year period, the ratio should be at least 5%. (b) For companies that earned 50 million to 200 million RMB in the recent one-​year period, the ratio should be at least 4%. (c) For companies that earned more than 200 million RMB in the recent one-​year period, the ratio should be at least 3%. Spending of R&D activities conducted in China should account for no less than 60% of all R&D expenditures. 6. Revenues reaped from high-​tech product (service) ought to make up at least 60% of the total revenues. 7. The company’s innovating capability meets certain standards. 8. The company is free of any unlawful conduct associated with public safety, product quality, or the environment in the one year before accreditation.

Private Equity Funds Practices both in and outside the country show that angel investment, venture capital investment (VCI), and other equity investment have substantially boosted S&T across the world. In 1985, the China New Technology Venture Capital Company, the first national venture capital institution in China, was established in Beijing. In 1998, the China National Democratic Construction Association (CNDCA) put forward the proposal of “Opinions on Expediting China’s Venture Capital Investment” at the First Session of the Ninth Chinese People’s Political Consultative Conference (CPPCC) National Committee. The proposal marked the beginning of VCI in China. Foreign venture capital and private capital started to enter China’s VCI market. In 1999, the MOST and six other ministries jointly issued the “Opinions on Establishing a Venture Capital Mechanism.” The document specifies the significance of VCI and provides basic principles guiding and regulating its development. Thanks to an increasingly favorable business environment, rapid economic growth, and the founding of the SME Board, GEM, and abundant capital, many sectors have grown from the extensive stage into a new phase where companies are more specialized, sophisticated, and diversified (Fu, 2012). China’s private equity funds, after more than 30 years, have become an integral part of the new finance sector. They facilitated the transformation and commercialization of S&T

174   Zhao and Jiang Table 2.4.1 The Startup Investment Guiding Fund for Sci-​Tech SMEs Risk Subsidy

Investment Guarantee (Before, After)

Year

Number Fund (10,000 RMB) (Number) Fund (10,000 RMB) Number Fund (10,000 RMB)

2007 2008 2009 2010 2011 2012 2013 2014 Total

50 77 55 66 56 87 96 142 629

7,115 6,590 4,670 4,540 4,110 7,033 9,655 13,175 56,888

52 75 131 180 125 199 162 343 1,267

2,885 3,410 10,330 10,460 10,890 12,967 10,345 36,825 98,112

102 152 186 246 181 286 258 485 1,896

10,000 10,000 15,000 15,000 15,000 20,000 20,000 50,000 155,000

Source: Torch High Technology Industry Development Center, MOST.

findings and boosted the development of emerging industries. In this process, the guidance funds established by the government also played an important role. The central government has set up four S&T-​oriented funds:  the Startup Investment Guiding Fund for Sci-​Tech SMEs, established in 2007, has over 100 subfunds; the National Guiding Fund for Sci-​ Tech Achievement Transformation, set up in 2010, has subfunds worth a total of 30 billion RMB; and the State Council in 2015 agreed to establish a 60 billion RMB National SME Development Fund and a 40 billion RMB National Emerging Industry Venture Capital Guiding Fund. By 2016, the number of guidance funds founded by the Chinese government amounted to 1,013, with an actual funding of around 2 trillion RMB (Chinese Academy of Science and Technology for Development [CASTED], 2016). Driven by the government funds, China’s private equity fund industry flourished. By the end of 2017, China became home to 20,000 private equity funds, managing a total of nearly 6 trillion RMB, among which over 3.6 trillion are managed by venture capital funds. Two-​ thirds of the investments went to SMEs and microbusinesses, with the remaining one-​third of them to high-​tech companies.10

Case 2: The Startup Investment Guiding Fund for Sci-​Tech SMEs The Startup Investment Guiding Fund for Sci-​Tech SMEs11 (Table 2.4.1) is the first fund of its kind founded by the central government. As part of the technological innovation fund for S&T SMEs, the guiding fund was launched in 2007. Based on the market-​oriented mechanism, the fund supports institutions investing in S&T startups through the ad interim equity participation, risk subsidy, investment guarantee, etc. The institutions being supported include startup investment companies, startup investment management companies, SME

10 

Source: Asset Management Association of China, http://​www.amac.org.cn/​index. case is modified from the case study of the Torch High Technology Industry Development Center, Ministry of Science and Technology, http://​www.chinatorch.gov.cn. 11  The

Financing for Innovation    175 service agencies capable of investing, S&T startups, etc., which are registered in the People’s Republic of China. The ad interim equity participation refers to the equity investment made by the guiding fund in startup investment companies. The guiding fund’s equity participation rate does not exceed 25% in the total fund raised by the companies, and the guiding fund is not the biggest contributor. Temporary investment is often used by the guiding fund to attract private capital for innovation and entrepreneurship. Risk subsidy refers to the investment incentive and loss compensation offered by the fund to startup investment institutions for financing tech SMEs. Investment guarantee refers to the fund’s subsidies for “aided companies” before or after the investment by startup investment institutions. The aided companies, designated by the investment agencies, are promising startups engaged in high-​tech R&D. By the end of 2014, the Startup Investment Guiding Fund for Sci-​Tech SMEs founded by the Ministry of Finance and the MOST invested 4.993 billion RMB of the fiscal fund through risk subsidy, investment guarantee, and the ad interim equity investment; 3.443 billion RMB was invested in 100 startup investment companies focusing on S&T SMEs through the ad interim equity participation, and the total registered capital reached around 22 billion RMB. Risk subsidy and investment guarantee programs totaled 1,896 and 1.55 billion RMB of the subsidy allocated. In 2015, the central fiscal policy for S&T investment was adjusted. The guiding fund and other programs have been integrated. Since 2010, the central government has founded the National Guiding Fund for Research Industrialization, the Strategic Emerging Industry Investment Plan, and the National SME Development Fund (MOST, 2013).

Loans for S&T Sectors In 1980, loans for S&T innovation were first granted in regions such as Zhejiang, Hunan, and Hubei provinces. In 1984, the Industrial and Commercial Bank of China (ICBC) started to phase in such loans across the nation. Since then, many commercial banks have actively engaged themselves in the business. Since 2006, the China Development Bank, a policy bank, has greatly fueled the development of this business. “Unified borrowing and repaying” and other business models were invented. Moreover, many regions also conducted their own innovations: in 2009, Chengdu created the first “Technology Branch”; in 2010, Jiangsu province initiated the “Technology Microcredit Company” pilot program; and in 2006, “intellectual property-​backed loans” (IP-​backed loans) were granted in Zhongguancun, Beijing (Zhu, Zhao, & Fu, 2012). Currently, the loans for technological innovation are still the most important financing instrument for innovation. Many regions are actively innovative in founding specialized credit institutions for technological innovation, including technology branches, technology microcredit companies, technology bonding companies, and technology financial leasing companies. Instruments such as “IP-​backed financing,” “technology credit,” and “technological innovation coupons” were launched. Furthermore, the combination of fiscal instruments and credit has improved the risk-​return structure of the loans, which greatly

176   Zhao and Jiang Table 2.4.2 Investment and Lending Synergy Model Participants

Lending banks (technology branches), borrowing companies, and equity investment institutions (VCs or PEs)

Company Condition

Nonpublic, fast-​growing, supported by VCs or PEs

Pledge

Equity pledge

Guarantee

VCs or PEs

Pledge Disposal

Share repurchase by VCs or PEs

Source: the authors

promoted the development of technological small and microsized businesses (SMBs) and the industrialization of S&T research. By the end of 2016, the national balance of SMB loans reached 24.30 trillion RMB, accounting for a quarter of the total. SMB borrowers reached 12.4622 million, with 92.47% of SMB loan applications approved. The balance of the loans for strategic emerging industries from the 21 major financial institutions in the banking sector stood at 2.4 trillion RMB (Fu & Liu, 2014).

Case 3.1: Investment and Lending Synergy Loan The investment and lending synergy loan is a lending model based on the interaction between banks and venture capitalists (VCs) or private equity investors (PEs). In this model, the banks lend to the companies, with VCs’ or PEs’ guarantee. This model, to a certain extent, creates a win-​win landscape for all three parties involved: the borrowers are financed without selling their equity or losing corporate control, the banks lower lending risk to include more promising clients, and the VCs and PEs reduce the threat of equity dilution and increase the likelihood of obtaining equity at a lower cost (Table 2.4.2).

Case 3.2: Bank and Guarantee Synergy Loan The bank and guarantee synergy loan is an option lending model based on the interaction between the banks and the guarantee institutions. This model enables the banks to compensate for lending risks with company growth. Specifically, in this model, while the banks lend to the businesses, guarantee companies obtain the corporate stock option. The banks and the guarantee companies agree on the distribution of the option returns. The introduction of professional guarantee institutions improves the risk-​return ratio for the banks (as seen in Figure 2.4.1): the risks are lowered (L1 < L2) and the returns are higher (Y1 > Y2). In the past two years, particularly, the application of internet plus, artificial intelligence, big data, cloud computing, block chain, and other cutting-​edge technologies in finance has greatly improved the model, efficiency, and scope of financial innovations. Some new and more efficient solutions are emerging. Internet financing is a new financial model. Traditional financial institutions and internet companies use information and communications technology to enable fund sharing, payment, investment, and information services. The deep integration between the internet and finance has had a profound impact on traditional financial instruments, services, organizations, and management. The cost of financial services is tremendously reduced, and

Financing for Innovation    177 Returns

Y1 = interests + option returns

Returns Y2 = interests

0

0 45°

Corporate value

Corporate value

L1 45° L2 Bank & Guarantee Synergy Loan

Loans of Traditional Commercial Banks

Figure  2.4.1  Risk-​return ratio:  bank and guarantee synergy loan versus loans of traditional commercial banks. Source: Zhao, Chen, and Tang (2009)

the quality and efficiency are enhanced. Today, this model is used by traditional financial institutions and nonfinancial businesses. The traditional ones are mainly commercial banks or internet-​based financial inventions by nonbanking financial institutions. Nonfinancial institutions mainly include e-​commerce businesses, peer-​to-​peer (P2P) online lending platforms, crowdfunding online investment platforms, third-​party payment platforms, and other institutions that use information technology (IT) for financial operations. By the end of 2017, online borrowers totaled 200  million and the loan balance was 2,207.32 billion RMB. Of the loans, P2P lending accounted for 39.3%; online microcredit, 27.2%; e-​ commerce transaction finance, 17.6%; and Internet banking, 9.1% (iResearch, 2018).

Case 3.3: Ant Financial Zhejiang Ant Small and Micro Financial Services Group (Ant Financial), which belongs to the Alibaba Group, is based on block chain, artificial intelligence, security technology, the internet of things, financial cloud, and other technologies. It provides inclusive financial services for millions of SMBs, tens of millions of entrepreneurs, and hundreds of millions of individual consumers. Ant Financial is derived from Alipay, founded in 2004. In October 2014, the Ant Financial Group was officially founded. Positioned as a technology company, Ant Financial takes “offering more equal opportunities to the world” as its mission. It provides global consumers and SMBs with safe and convenient inclusive financial services by establishing an open and shared credit system and cooperating with financial institutions and partners. Based on Alipay, Mybank, Myloan Tianhong Asset Management, Credit Sesame, Financial Cloud, and other independent subsidiary corporations, Ant Financial offers a range of internet financial products and services including payment, banking, asset management, insurance, and credit rating. With a huge transaction of data, the long-​term credit ratings of online market players can be analyzed. Individualized investment and financing services can, therefore, be provided to different market participants. Myloan’s cost of credit is less than 0.5% that of traditional banking, and the loans are granted much faster. The average loan per account is

178   Zhao and Jiang lower than 30,000 RMB. Moreover, the Non-​performance Loan (NPL) ratio is also much lower. Alipay’s NPL ratio in 2018 was 0.54%, well below the China Banking Regulatory Commission (CBRC) line of 1.74%.12

Insurance for S&T To enable the support of insurance to high-​tech companies, in 2007, the China Insurance Regulatory Commission (CIRC) and the MOST started the technology insurance pilot program. Twelve pilot cities were selected.13 Four companies including People’s Insurance Company of China (PICC) and SINOSURE participated in the program and created six insurances for technological innovation. In the past decade, technology insurances have been increasing. In 2016, with the approval of the CIRC, the Taiping Sci-​tech Insurance Co. Ltd. was founded by nine companies, including Taiping Property Insurance Co. Ltd. and Zhejiang Provincial Financial Holdings Co. Ltd. It is the first Chinese technology insurance company with a legal person license.

Case 4: First Set of Technological Equipment Insurance On March 3, 2015, the Ministry of Industry and Information Technology (MIIT), Ministry of Finance, and CIRC jointly organized a conference on the pilot program of a subsidizing mechanism for the first set of technological equipment insurance. Equipment in 14 sectors, including clean and efficient power generation and rail transit, was included in the program. Major technological equipment urgently needed by the equipment manufacturing industry was basically covered. The conference marked the official launch of the pilot program in China. The insurance adheres to the principle of “government guidance and market-​oriented operation”: the MIIT formulates the Guiding List for Promoting the Application of Major First Set of Technological Equipment, the insurance companies design comprehensive insurances for the listed equipment, the manufacturers of the equipment are insured, and the central government subsidizes the insurance premium. According to the regulations in the “Articles for the Major First Set Technological Equipment Comprehensive Insurance,” the insurance mainly covers the quality and liability risks of major technological equipment. During the policy period or the retroactive period explicitly stated in the policy, if the insured equipment manufactured or sold by the insured, due to defects, leads to an accident in the user’s operation and, subsequently, the damage of said equipment, physical injury, or other forms of financial loss, when the user files a compensation claim to the insured for the first time for the economic liabilities that should be borne by the insured, including repair, replacement, and refund, the insurance company shall compensate in line with the provisions in the insurance contract.

12 

Source: Alipay Announcement, http://​www.mpaypass.com.cn/​news/​201808/​22084933.html. On July 17, 2007, the Ministry of Science and Technology enacted the “Notice on Establishing First Phase Pilots for Sci-​Tech Insurance.” 13 

Financing for Innovation    179 The insurance establishes policy compensation with governmental subsidies and guidance. The leveraged governmental funding can expand the insurance application, while the market-​oriented operation spreads the risks. The user’s confidence in purchasing the first set of equipment is thus boosted. This is a win-​win for both the manufacturing and the insurance sector. Take Jiangsu province as an example. In 2015, Jiangsu became the first province to launch the pilot program. Over the next three years, 1,108 sets of equipment were purchased and used. The confidence of the manufacturers and users increases, and the innovative advantages of the major equipment were better translated into a competitive edge in the market and the industry.

Multilevel Capital Market Since 1978, the development of the market economy and the deepened state-​owned enterprise (SOE) reform have established and improved the corresponding financial system. With this comes the capital market, playing an active role in promoting the ownership reform and optimizing the market allocation of resources. In 1978, the joint-​stock companies in rural areas began to emerge in the market economy. To facilitate the flow of equity, stocks emerged in the Chinese financial market as a new financial instrument. With the increase of joint-​stock companies, many regions founded corresponding stock markets. In 1990, the Shanghai and the Shenzhen Stock Exchanges were founded and opened for business. Since then, the stock market has kept expanding. In 2004, the Shenzhen Stock Exchange founded the SME Board to finance more SMEs. In 2009, the Growth Enterprise Market (GEM) was founded, providing listing opportunities to more fast-​growing high-​tech SMEs. Today, a multilevel stock market consisting of the Main Board, SME Board, GEM, and National Equities Exchange and Quotations (NEEQ) has taken shape in China (Figure 2.4.2). At the same time, debt securities including government bonds, corporate bonds, and financial bonds, along with futures, continued to develop and were increasingly traded in the public market. This has not only increased the financing instruments for businesses but also optimized the fund allocation. Meanwhile, the financial instruments have become better at discovering market prices. Especially since 2014, the capital market has grown substantially. The launch of the Shanghai-​Hong Kong Stock Connect and Shenzhen-​Hong Kong Stock Connect further benefited the domestic market. On March 30, 2018, the China Security Regulatory Commission (CSRC) issued the “Notice of Opinions on the Pilot Program Enabling Innovative Companies to Issue Domestically Stocks or Depository Receipts.” It lowered the requirements for issuance and encouraged the capital market to support businesses that conform to national strategies, command key technologies, and commercially succeed in the high-​tech and strategic emerging industries, such as internet, big data, cloud computing, artificial intelligence, software and integrated circuit, high-​end equipment manufacturing, biomedicine, etc. The goal is to leverage the capital market as a propeller for technological innovation. Furthermore, the capital market has become better at promoting technological innovation. “Innovation and entrepreneurship” (I&E) bonds were issued in the exchanges and the

180   Zhao and Jiang

Main Board SME Board

A blue-chip stock market for big and mature businesses (Shanghai and Shenzhen Stock Exchange A cradle of growth for SMEs in traditional sectors

GEM

National Equities Exchange and Quotation (New Third Board)

Regional Equity Trading Market

A driving force behind entrepreneurship and innovation for fast-growing and high-tech businesses with innovative qualities An OTC market and a listing incubator for startups A regional OTC market for regional non-public companies and medium, small and micro-sized companies

Figure 2.4.2  Structure of China’s multilevel capital market. interbank market. In March 2017, the first Chinese interbank I&E bonds were successfully issued in Chengdu, marking the beginning of specialized services for technological innovation and SMEs by the bond market.

Case 5.1: The GEM Developed countries’ experience shows that SMEs, especially the technological and innovative ones, are a powerful economic growth driver. To better finance the SMEs, countries in America, Europe, and Asia founded their own GEM, such as NASDAQ in the United States, AIM in the United Kingdom, KOSDAQ in South Korea, and TSX-​V in Canada. On August 20, 1999, the CPC Central Committee and the State Council issued the “Decision on Strengthening Technological Innovation and Developing High Technology and Industrialization,” which pointed out that a high-​tech board should be established in the Shanghai and the Shenzhen Stock Exchange when appropriate. In May 2000, the State Council approved in principle the CSRC’s “Opinion on Establishing a Second Board by the Name of GEM.” In October, the Shenzhen Stock Exchange stopped issuing new shares to prepare for the GEM. The following crash of the dot-​com bubble, however, repeatedly delayed the launch. On May 17, 2004, approved by the State Council, the CSRC officially approved the Shenzhen Stock Exchange’s establishment of an SME board, which was a substantial step toward the GEM. On February 7, 2006, the “National Medium-​and Long-​Term Program for Science and Technology Development (2006–​2020)” was published, pointing out that “we will promote the GEM and build a multilevel capital market to accelerate technological industrialization.” On October 30, 2009, the first 28 listed companies officially opened for trading, marking the official inception of the GEM. Data show that, for the 28 companies, the average price earnings ratio was 56.7, with that of Bode Energy Equipment standing at 81.67, much higher than the ratio of the A-​share and the SME market. This shows that the market had high expectations for the GEM.

Financing for Innovation    181 Table 2.4.3 GEM Stocks’ Data by Sectors (by April 2018)

Sector Name

Stocks

Capitalization of Total Shares Total Capitalization Tradable Shares Tradable Shares (100 Million) (100 Million RMB) (100 Million) (100 Million RMB)

Manufacturing IT Scientific Research Services Environmental Protection Culture & Communication Business Services Construction Agriculture, Forestry, Husbandry, and Fishery Wholesale & Retail Mining Public Health Public Utilities Transport & Warehousing Residential Services Total

509 128 16

2,066.36 671.72 56.56

34,037.51 10,346.22 1,397

138.4 46.06 3.54

20,008.09 6,509.37 422.77

13

106.33

15,13.99

7.53

1,021.37

13

129.69

1,598.15

9.81

1,192.28

9 8 7

54.89 46.17 80.88

592.96 612.48 1,395.83

3.67 3.49 6.09

356.95 446.66 988.64

7 4 3 2 2

31.82 18.67 26.4 12.52 6.63

438.35 178.66 1,006.24 107.44 79.52

1.76 1.44 1.88 0.9 0.6

222.94 131.42 715.62 77.55 71.1

1 722

0.54 330,91,881

25.23 53,329.59

0.01 225.18

6.31 32,171.07

Source: Shenzhen Stock Exchange.

The GEM, over the eight years since its launch, has seen the emergence of the Wens Group, Aier Eye Hospital, and other leading companies in different market segments. It has also offered financial support to Iflytek and BGI, pioneers of Chinese cutting-​edge technological applications, for their growth and expansion. At the same time, the GEM has catalyzed the rise of private investment, industrial restructuring, and better employment through entrepreneurship. By April 2018, 722 businesses were listed in the 14 market segments in the GEM. These companies, mainly from advanced manufacturing, IT, and other high-​tech sectors, boast a total capitalization of 5.3 trillion RMB, accounting for 9.7% of the total (Table 2.4.3).

Case 5.2: I&E Bond The availability and affordability of financing is the biggest headache confronting many small and microsized startups. In February 2017, the National Association of Financial Market Institutional Investors (NAFMII) launched the “Innovation & Entrepreneurship Bond” pilot program, a counterpart to the “high-​yield bond” in the offshore market, to make financing easier for innovative businesses. The bond has many advantages. It expands the source of funding, diversifies fund utilization, and upgrades the bond issuers. This

182   Zhao and Jiang three-​to five-​year financial instrument invented by the NAFMII is issued by qualified platform companies for high-​tech parks, incubators, innovation and entrepreneurship demonstration bases, and so on. The bond buyers are the participants in the interbank market, including major banks and trust companies. The raised fund is used for park infrastructure construction or packaged as an entrusted loan or equity investment to provide stable and low-​cost financing for trustworthy and quality innovative businesses or startups. On May 8, 2017, the Chengdu High-​Tech Free Trade Pilot Zone successfully issued the bond for the interbank market for the first time in China, raising 500 million RMB. In July 2017, the CSRC published the “Guiding Opinions on Conducting the Pilot Program of Loans for Innovative and Start-​up Businesses” (hereinafter in short “Guiding Opinions”) to further implement the innovation-​driven development strategy, enable the exchange bond market to foster the growth of high-​tech growing businesses, serve the real economy, and explore the bond market’s new approaches to support business development. The Guiding Opinions aimed at encouraging startups to finance through the bond market, supporting qualified companies in issuing corporate bonds, strengthening innovation, and diversifying bond varieties. This document offers explicit and detailed plans for the exchanges to better leverage the bond market, explore ways to serve the startups and the real economy, and expand the financing channels for those businesses. The Guiding Opinions can also improve the financing mechanism for SMEs and diversify the issuers of corporate bonds.

Financing Service Platforms To promote technological innovation, many intermediary agencies and platforms have emerged to provide financing solutions. They are known as technology-​oriented financial service institutions. Alibaba, Tencent, Baidu, and other internet companies have all established similar platforms to effectively connect technological SMEs with financial resources through information and capital integration. A key role of these institutions is to identify the potential value and risks of technological resources that belong to those SMBs and to bridge the gap between these resources and investment. With an innovative combination of taxation, finance, and credit instruments, these IT-​based institutions provide funding and growth opportunities to small and microsized companies that have little access to traditional financial services. A beneficial supplement to governmental guidance, these platforms prevent market failures and thus foster innovation and entrepreneurship. In practice, these institutions are mainly derived from technological platforms such as local incubators and productivity promotion centers, which act as intermediary public service institutions that couple technology with finance.

Case 6: Winpower Chengdu is one of the first regions for the National Technology Finance Pilot Program, the IP-​Backed Financing Program, and the National Technology Insurance and Patent Insurance Program. Market oriented, Chengdu works to leverage funds and capital for the growth of technological SMEs and to better integrate technology with finance. In 2008,

Financing for Innovation    183

Service demand Technological Companies Service Professional business

Credit Financing Services

Winpower Technology Financial Service Platform

Resource Information Financial Service Institutions Demand Information

Equity Financing Services

Valueadded Services

Figure 2.4.3  Winpower’s service model. Chengdu began to create the Winpower service platform.14 Based on the principles of “resource and information integration, governmental guidance, and professional service,” the platform offers credit financing, equity financing, and value-​added services, to provide a “one stop” investment and financing experience for technological SMEs. By the end of 2017, Winpower provided over 5,000 SMEs with over 41 billion RMB of credit financing and over 7.5 billion RMB of equity financing. Over 16,000 SMEs were offered investment and financing services, and over 80 SMEs were assisted in ownership reform for listing. Currently, Winpower spreads its model to all cities in the province, with its business covering 64 industrial parks and workstations built in eight areas, including Suining, Ya’an, Deyang, and Neijiang. This has promoted the integration between technology and finance and industrial development. Winpower is going all out to innovate its financing instruments. Its technology-​oriented financial service now covers all of Sichuan: its “park-​backed loan,” a credit financing instrument, and its “innovation financing fund,” an equity financing instrument, now cover all of the province. Its value-​added services are also province-​wide. In 2016, Winpower was nominated in the “2016 Top Ten Cases of Reform and Transformation in Sichuan.” In 2017, Winpower’s “one-​stop investment and financing information service for SMEs” was popularized by the State Council across the country (Figure 2.4.3).

Conclusion The intertwined development of innovation and financial capital is a defining feature in the progress of human productivity. Innovation-​enabling financial policies and tools are a good example of combining the roles of government and market. So far, we cannot find a single country that has become an innovation powerhouse only with governmental support. Nor 14 

This case is modified from the case study conducted by the Financial Institute of Sichan University.

184   Zhao and Jiang can we find any country that has become so only by market forces without some kind of industrial policy (Zhao, 2017). Shifting from high-​speed growth to high-​quality growth, China will focus on improving its industrial innovation capacity and competitiveness as well as the quality and returns of its economic growth. Under such circumstances, a review of China’s policies and practices in promoting S&T through financial innovation in the past four decades will not only guide China’s way forward but also serve as a reference for fellow developing countries. First, by combining fiscal and taxation policies with market mechanisms, China has put in place its own investment and financing system for S&T. From financial instruments to a complete set of solutions in an organizational structure and business model, China has effectively improved the risk-​return structure in traditional financial services. As a result, more financial institutions are willing to provide services while striking a balance between risk and returns, and more technological SMEs have access to financial services, leading to more innovation, commercialization, and emerging industries. Second, in an innovation-​enabling financial system, fiscal and taxation policies play a fundamental and guiding role. In China’s practice, a number of ways have been found to effectively use fiscal funds. For example, to attract more private capital, the VC guiding fund is designed to share risks with private capital to mitigate investment risks for hi-​tech SMEs and uncertainties in emerging industries. Local governments also introduce policies to use fiscal funds to share risks with commercial loans to encourage banks to lend more for innovation. As commercial banks still figure prominently in China’s financial system, such adventures will foster more innovation. Third, myriad innovative business models are examples of diverse ways to support S&T through financial innovation. For example, “investment-​ lending-​ guarantee” products, which integrate investment with lending and guarantees and share returns and risks, provide a model that connects venture capital investors, commercial banks, and guarantee companies, providing comprehensive financial services/​equity investment, bank loans, and financing guarantees for SMEs. Fourth, corporate internal finance has become an important player in innovation. While traditional financing for innovation comes mainly from external sources, a growing number of manufacturing businesses, particularly large ones, have been deeply involved in the financing system for innovation in the past decade. With their strong capital, financing capability, and industrial expertise, these companies have established their own internal venture capital departments or standalone firms and funds to make comprehensive and multilayered investment from upstream to midstream to downstream in specific industries, which substantially facilitates innovation and technological progress. Fifth, digital financial platforms are playing an increasingly important role, though also creating some new challenges. The rise of the digital economy will not only transform the traditional manufacturing sector but also bring about new business patterns, models, and industries to financial and other service sectors. Fintech companies provide internet-​based financial services to startup businesses, while internet giants such as Alibaba, Tencent, and Baidu have made forays into this sector as well. These digital financial platforms surely give a helping hand to innovation. However, many fintech companies are undercapitalized and less capable of managing risks, while internet giants run the risk of monopoly due to their

Financing for Innovation    185 huge customer base and financial resources. They have become new challenges as well in the financial and industrial ecosystems. Sixth, much room is left for the capital market to play an even bigger role in innovation. A multilevel capital market undoubtedly contributes to innovation and entrepreneurship in China. Most flagship businesses in major industries are listed companies in the Main Board, SME Board, or GEM of the Shanghai and Shenzhen Stock Exchanges. However, for businesses, direct finance from the capital market is way smaller than indirect finance from banks; different layers (Main Board, SME Board, GEM, NEEQ, and regional stock exchanges) in the capital market are not well connected; and listing, trading, and exit in the capital market should be more market oriented and better regulated. In short, as China keeps improving its market system and its economy is geared toward higher quality, industrial policy, including the financial investment system, should keep the reform momentum to adapt to the changing needs.

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Chapter 2.5

Innovation a nd E ntreprene u rsh i p E du cation a nd I ts Impl ications for Huma n Capital Devel opme nt in Chi na Fang Lee Cooke Introduction Education plays a fundamental role, through human capital development, in building the innovation capability and ultimately sustainable economic performance and competitiveness of a nation (Becker, 1993). In its effort to catch up and increase China’s global competitiveness, the Chinese government has embarked on an ambitious development program in recent decades (e.g., Lewin, Kenney, & Murmann, 2016) and treats the educational transformation as part of China’s broader development strategy underpinned by innovation (e.g., Johnson & Weiss, 2008; Chi, 2018). However, the education system is informed by societal cultural norms and expectations. As Chen and Arunkumar (2018, 1)  argued, educational systems “always derive from cultural anticipations as well as expectations. There are abundant differences between Eastern and Western educational systems for they share a different culture which can reflect the pros and cons of themselves.” Similarly, the meaning of innovation is informed by the societal values and cultural traditions of a nation. For example, how should the costs and fruits of innovation be shared? What is the role of the state in education reform to develop an innovative/​creative workforce? What are the stumbling blocks in promoting creativity and entrepreneurship education in China? To address these questions, this chapter examines education reform policy and initiatives in responding to the need for innovation and entrepreneurship to sustain the country’s development needs. It discusses characteristics and pitfalls of creativity/​innovation education

188   Cooke and entrepreneurship education at the primary, secondary, and tertiary levels with reference to teaching objectives, mechanisms/​techniques, and effectiveness. It also proposes a number of suggestions for key stakeholders including the state, the education sector, the business sector, parents, and society in order to develop an integrated and effective system of innovation and entrepreneurship education to meet various needs of individuals, communities, and society.

The Chinese Education System and Its Reforms Education in China is primarily a public system run by the Ministry of Education. It consists of nine years of compulsory education for all citizens, including six years of primary education and three years of secondary junior education. Those who achieve sufficient marks in their university entrance examinations (gaokao, 高考) will engage in four years of education for their bachelor’s degrees. Culturally, education in China “is strongly influenced by Confucianism that advocates the value of education, textual transmission, academic excellence, meritocracy, and the respect for teachers” (Tan & Hairon, 2016, 315). In the last three decades, the basic education system has undergone several rounds of reform initiated by the state, involving changes to curriculum goals, structure, and content; teaching and learning approaches; and assessment and administrative structures (Fu, 2018). In 2008, the Ministry of Education issued the “National Medium and Long-​Term Education Reform and Development Project Outline (2010–​2020),” “which consolidated the reform implementation in the long term” (Fu, 2018, 2). The Chinese higher education system has undergone a series of radical reforms since the 1980s to develop world-​class disciplines and universities. Landmark initiatives include, for example, Project 985 (launched in May 1998, with heavy investment in 35 universities); Project 211 to build the top 100 universities (see Zhang, Zhao, & Lei, 2012, for discussion); and “Double First-​Class” (双一流), an initiative launched in 2015 to develop world-​class disciplines and universities by 2050 (People’s Daily Online, 2017). In short, to achieve world-​class status in education, China has engaged in a series of reforms and made heavy investments in priority areas. China’s education reform has attracted considerable public debate, as has been the case in other nation-​states that have been through or are going through education reforms. As in many other countries, global economic pressure underpins the push for a student-​centered education approach, which magnifies “the tension between globalisation and a nation’s traditions in school curriculum” (Fu, 2018, 13). In particular, Chinese education reform has been criticized for its reliance on Western theories, heavy focus on academic knowledge and detachment from classroom practice, and elitist orientation (see Woronov, 2008; Liu & Fang, 2009; Fu, 2018, for reviews of primary and secondary education reforms; see also Zhao & Guo, 2002, for reviews of reforms of the high education system). As Liu and Fang (2009, 408) observed, the reform has been influenced by “a movement towards ‘Western progressivism’ in both curriculum and pedagogy” on the one hand, but is accompanied by an increasing level of “educational injustice” on the other, in part as a result of the uneven economic development across the country and the widening income gaps between the rich

Innovation and Entrepreneurship Education    189 and the poor (Tan & Hairon, 2016). More specifically, the interpretation and transmission of the Western notion of “learner autonomy” and creative thinking into the classroom has been problematic, as it requires fundamental changes in the Chinese educational philosophy and culture, which emphasizes obedience and collectivism (e.g., Liu & Fang, 2009). As Halstead and Zhu (2009, 409) found in their study of a well-​known secondary school in Beijing, which explores how “autonomy” is framed and manifested in classroom practice, the “learner autonomy” promoted as part of the educational reform in China is essentially a “regulated individualism” rather than the “personal autonomy” that is emphasized in the Western education ideology. Nonetheless, the educational transformation aspired to by the Chinese government via its various policy initiatives, programs, and projects is an integral “part of China’s broader development strategy” designed to sustain the country’s economic growth and quality upgrading in different aspects (Li, Whalley, Zhang, & Zhao, 2011, 527). We examine some of the reform elements in the following sections, with a focus on innovation and entrepreneurship education.

Innovation and Entrepreneurship Education in China A major criticism of the (traditional) Chinese education system is the lack of attention to creative thinking development; children are forced to memorize texts without independent thinking or critical analysis (Woronov, 2008). Significant resources and energy are also spent on coaching students to pass examinations rather than improving their all-​around qualities and competences. As part of the educational reform, innovation/​creativity education and entrepreneurship education are being promoted in school and university curricula. It should be noted that the phrases “creativity education” and “innovation education” are often used interchangeably in the Chinese literature and policy documents. Similarly, the phrases “innovation education” and “entrepreneurship education” are often mentioned together as “innovation and entrepreneurship education” (“chuangxinchuangye education,” 创新创业教育). It is beyond the scope of this chapter to distinguish between these terms; for the purposes of this chapter, we will follow the practice of the literature but will try to separate the discussion of these forms of education as far as it is possible. For example, we will focus on “creativity education” in primary and secondary schools and on “innovation education” and “entrepreneurship education” in higher education institutions.

State Policy Initiatives The concept of entrepreneurship education originated in the United States in the 1940s and has been actively promoted in the European Union since the 2000s (European Commission, 2009, 2012, 2014). It is recognized that education plays an important role in embedding an entrepreneurship mindset in children and molding their behavior at an early age. Entrepreneurship education was officially adopted in China in the mid-​2000s,

190   Cooke when the Ministry of Education stipulated that every higher education institution “must provide two-​credit basic entrepreneurship courses for all students starting in 2016” (Ni & Ye, 2017, 1). Prior to the promotion of entrepreneurship education was the promotion of innovation/​creativity education.1 Innovation education was officially proposed by the state in 1998 (Wan & Kang, 2016). It is based on the principle of innovation and aims to cultivate students’ innovation orientation, innovative thinking, innovative ability, and innovative personality. However, as noted earlier, creativity education (Pang & Plucker, 2013) and entrepreneurship education (e.g., Zhou & Feng, 2013) have often been promoted together as “innovation and entrepreneurship education” without clear definitions of what they are or specific guidelines as to how they can be effectively achieved. The vigorous promotion of creativity and entrepreneurship education in China is motivated by the desire to sustain its economic development through innovation and technological upgrading on the one hand (Pang & Plucker, 2013), and to reduce the growing pressure for university graduate employment following the major expansion of higher education since the turn of the century on the other (Ma & Bai, 2015; Cooke & Wang, 2019). Indeed, the strong emphasis on innovation has been a key feature in the Chinese government’s economic development policy in the drive to catch up with the world economy. According to the Global Innovation Index 2017, China has become the 22nd most innovative economy in the world (Dutta, Lanvin, & Wunsch-​ Vincent, 2017). Innovation and strong support for new and high-​tech programs are constant themes in the state-​formulated five-​year plans. As Ni and Ye (2017, 1) observed, “In 2015, the State Council issued three consecutive policies that aimed at boosting public innovation and entrepreneurship.” If the emphasis on innovation has been manifested in high-​level state policies with local governments and firms as the main routes for technological upgrading in the past, then the 2015 initiative of mass entrepreneurship and innovation (known as “Mass Entrepreneurship and Innovation,”大众创业, 万众创新), proposed by Premier Li Keqiang in the Summer Davos Forum of 2014, is a mass movement involving individuals directly in the innovation drive (see Chinese Government Website, 2015). This initiative is seen as an important strategy to create employment opportunities and sustain economic growth as China has entered a “new normal” (新常态) phase of slower growth. It is, to some extent, the government’s strategy to redirect employment pressure to individuals and society, particularly new university graduates and their families. Yet only a small proportion of university graduate startup businesses are successful, measured by the length of time they stay in business. University graduates are in fact engaged in self-​employment in the name of “entrepreneurship.” They have little, if any, experience of running a business. Nor do they have the opportunity to acquire business skills and insights first through working for a company before becoming an “entrepreneur” (Cooke & Wang, 2019). In short, entrepreneurship is pushed by the government to reduce unemployment pressure, rather than wished for by students and their parents. Entrepreneurship education is a top-​ down requirement instead of an education institution–​led initiative and has considerable implementational challenges, as exemplified in the “maker education” (创客教育) initiative discussed next.

1  See Pang and Plucker (2013) for a systematic review of policy reform that promotes innovation and creativity education in China.

Innovation and Entrepreneurship Education    191

The Maker Education Initiative Maker education has been promoted by the state since the mid-​2010s as part of creativity/​ entrepreneurship education. It is underpinned by the educational theory of “learning by doing” that was expounded by the American education philosopher John Dewey (Liu, 2018). The “Education Informationalization 13th Five-​Year Plan” (教育信息化“十三五” 规划), as part of the “13th Five-​Year Plan on Education” was issued in 2016 (Ministry of Education, 2016). In this Plan, the Ministry of Education specifies that those regions that have the conditions to do so should actively explore the application of information technology in new educational models such as “makerspace” and engage in interdisciplinary learning (i.e., STEAM education)2 and maker education to enhance students’ information literacy and innovation consciousness and ability, develop students’ digital learning habits, promote students’ all-​around development, and play a leading and supportive role in developing information-​and future-​oriented high-​quality talents (Bo, 2018). In a broad sense, maker education refers to an educational style that aims to foster a public maker spirit; in a narrow sense, it refers to an educational model with the goal of developing the learners’ competences to utilize various techniques, both technical and non-technical, to identify and solve problems and to develop creative products (Wan & Kang, 2016). According to Wan and Kang (2015), maker education incorporates three core elements: creation, makerspace, and maker. Creation refers to a set of learning activities that are orientated toward design and production. Maker education intends to change the traditional educational concepts, organization, models, and methods. Maker education integrates the ideas of innovation education, experience education, and project learning, which is in line with the nature of students’ curiosity and creativity. The essence of maker education is to integrate scientific research, technical production, and artistic creation into the education and teaching process through the development of maker activities. These will foster students’ creative thinking and creative capability by stimulating them to ask questions, analyze and solve problems, and engage in hands-​on learning. Maker education content consists of subject knowledge, innovation and creativity, self-​awareness, cooperation, effective communication, and a sense of responsibility. In terms of learning approach, maker education requires both formal learning in the school and informal learning that accompanies the learners throughout their lives (i.e., lifelong learning). It is a self-​initiated, self-​regulated, and self-​sufficient constant learning process. As such, maker education is not just an “internal business” in the education sector. Rather, it is a systematic project that needs to be coordinated through the maker environment, maker course, maker learning, maker culture, maker teacher team, maker education organization, and maker education program. In other words, the cultivation of innovative talents requires the seamless 2  “STEAM” refers to science, technology, engineering, arts (and humanities), and (applied) mathematics. STEAM education involves not just the integration of knowledge in various disciplines; more importantly, the integration of different practical processes and spiritual connotations of different disciplines is in itself an innovative disciplinary integration. The core characteristics of STEAM are interdisciplinary, open, interesting, experiential, collaborative, and design-​focused education to cultivate students’ innovative thinking and creative ability. In STEAM education, students will experience the real world, engage in practical activities, integrate knowledge from different disciplines into solving practical problems, design the output of knowledge systems, and design innovative products (Bo, 2018).

192   Cooke integration of family education, social education, and school education. It requires the participation of various stakeholders, such as enterprises, associations, nonprofit organizations, and research institutions (Liu, 2018). However, existing research evidence reveals that there are considerable challenges in truly embedding maker education, and innovation and entrepreneurship education more broadly. To follow we discuss some of these challenges faced by primary and secondary schools and tertiary education institutions.

Challenges to Maker Education and Creativity Education in Primary and Secondary Schools Research has identified a number of related problems in school education that are nonconducive to maker education and creativity education (e.g., Bo, 2018; Ji, Zhou, & Zhou, 2016; Jin, 2018; Li, 2015; Lu, Cheng, Peng, & Li, 2018; Wang, 2018). The main barriers are incompatibility of the educational culture and approach, the utilitarian pursuit of performance outcomes, and resource constraints. First, the majority of schools continue to adopt traditional teaching methods, with the main mode of delivery being the teacher doing the lecturing and students listening passively. As class teaching is delivered in a standard manner, there is little attention paid to individual learning needs and interests. This approach is not conducive to attracting students’ attention or accommodating their specific learning styles and speeds. Moreover, the Confucian education culture expects the learner to accept existing norms and wisdoms without challenge. By contrast, maker education and creativity education require independent thinking and active participation from the student, as well as a tailored approach to matching individual learning characteristics and preferences to get the best results (Wang, 2018). In fact, a common observation shared by university lecturers in developed countries is that the Chinese students tend to be rather quiet and passive in the class and group discussions for language and cultural reasons. Second, the content of the education is academic oriented to impart existing knowledge rather than practice based to develop the student’s all-​around ability and independent thinking. By contrast, maker education and creativity education require students to be hands-​on and perform practical tasks through small laboratory experiments and project designs, in order to arouse student curiosity and creative desires. The younger generation of Chinese has been criticized for having poor hands-​on ability, because they have been spoiled as the only child of the family, as a result of the “one child” policy enforced from the 1980s to the mid-​2010s (e.g., Connor, 2013). It is not uncommon that homework that requires designing and hands-​on creative activities (e.g., handicrafts) is completed with substantial parental input or by the parents alone (e.g., People’s Daily Online, 2016). Thus, the competition is between (competitive) parents rather than their schoolchildren. In addition, although textbooks and curricula are being revised and updated, technology and theories at the cutting-​edge technologies and theories that would enhance maker education have rarely been incorporated in the textbooks (Jin, 2018). Third, there is an overemphasis on students’ academic attainments (i.e., assessments and results) rather than their comprehensive skills and abilities, as the former is critical in

Innovation and Entrepreneurship Education    193 performance assessment and parental choice of the school. By contrast, in maker education and creativity education, the process by which the student carries out learning by doing and developing innovation awareness and confidence is important (Bo, 2018). Fourth, students’ psychological well-​being is largely neglected in the learning process. Since schools and parents are chasing high marks as indications of high achievements, failure to obtain high marks is hardly tolerated, and as such, students are under constant pressure to study the same texts and do mock tests repeatedly until they get the answers right. By contrast, maker education and creativity education require a high level of patience and tolerance of uncertainty and failure. The aim is to encourage innovative achievements, nurture students’ psychological state of pursuing innovation, and incentivize/​reward such developments (Wang, 2018). Fifth, driven by performance indicators such as the proportion of students advancing to top schools and universities, schools tend to allocate their resources and activities to those areas that count in a utilitarian manner (Li, 2015). Maker education and creativity education are not part of the formal examination for students’ progression to the higher level of education; these educational activities are seen as distractions that would disadvantage the student and the school. Maker activities are often carried out on students’ own time rather than during class time. The need to develop students’ interdisciplinary knowledge and abilities to solve real-​life problems through codesign, collaborative problem solving, and teamwork is not a priority (Bo, 2018). While the single-​child syndrome may hamper students’ ability to collaborate via teamwork, parents may also oppose activities that distract the students from their study and negatively affect their chance of progressing to a top school/​university. In addition, there is a misperception that maker education is about achieving tangible outcomes such as awards and patents, rather than developing students’ innovative mindset and ability (Li, 2015). Sixth, maker education and creativity education require considerable resource investment in both infrastructure/​hardware and teaching resources/​capacity. Bo (2018) argues that incorporating STEAM education will facilitate schools’ interest in developing maker education. However, the majority of the primary schools are poorly resourced, with the exception of well-​resourced schools in premium cities. For example, Shanghai has built 1,141 innovative laboratories in 656 primary and secondary schools, covering 41% of primary schools, 55% of junior secondary schools, and 83% of upper secondary schools. It aims to achieve full coverage of innovative laboratories in primary and secondary schools by 2020 (cited in Liu, 2018). By contrast, in some poor regions, teachers not only suffer from poor terms and conditions but also are subjected to wage arrears, which have led to teachers’ protests (Elmer & Crothall, 2016). Moreover, teaching resources in the interdisciplinary space are limited due to the underdevelopment of the interdisciplinary training that straddles STEAM fields (Lu et al., 2018). Those schools willing to implement maker education often find themselves stuck without adequate teaching materials and curriculum, as the new education model is yet to be developed systematically (Jin, 2018). Finally, as with the implementation of many state-​driven initiatives, maker education became popular as a movement. As a result, some schools promoted the initiative to demonstrate their technological prowess, such as in 3D printing and robotic learning, instead of helping the students to acquire a deeper understanding of what they are learning (Bo, 2018). Some schools carry out creativity education activities as a formality in response to the state initiative (Li, 2015).

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Innovation and Entrepreneurship Education in Tertiary Education How do the Chinese higher education institutions respond to the need for entrepreneurship and creativity to meet the country’s development needs? The higher education sector is largely publicly funded and state run, and unsurprisingly, innovation and entrepreneurship education in China are also primarily state driven. The state is the policymaker, resource provider, and quality monitor of innovation and entrepreneurship education in universities (Mei & Meng, 2016). According to Mei and Meng (2016), between 1998 and 2016, the central ministries and commissions of China issued at least 169 policies, laws, regulations, or implementation opinions related to innovation and entrepreneurship education. The speed of their introduction has accelerated since 2009, demonstrating the state’s strategic intent and the ascending priority of innovation and entrepreneurship education. However, the effect of these policies has not been systematically evaluated. In principle, innovation and entrepreneurship education help alleviate the unemployment of university graduates, improve the conversion of scientific research findings into practical products, and promote the construction of an innovation-​oriented country (Tang, Chen, Li, & Lu, 2014). As such, innovation and entrepreneurship education in the higher education sector took off rapidly, with a strong push by the state, after a short period of autonomous trial in the early 2000s. In 2002, nine universities were selected as the pilot sites for entrepreneurship education. In 2005, the “Know about Business” (KAB) program of the International Labor Organization was introduced. In 2012, every university was required to introduce at least a compulsory course worth two credits. In 2015, entrepreneurship colleges and makerspace mushroomed following the state’s announcement of the “Mass Entrepreneurship and Innovation” strategy (Mei & Meng, 2016). The role of the state is indispensable in driving these initiatives because of the weak collaborative links between universities and enterprises in the early stage of the development of innovation and entrepreneurship education. State priority and support helped direct the attention of university educators to developments in innovation and entrepreneurship education outside China and develop innovation and entrepreneurship courses and training sites (Mei & Meng, 2016). However, like creativity education in primary and secondary schools, as discussed earlier, innovation and entrepreneurship education in higher education institutions also faces challenges (e.g., Huang, Qu, Shi, & Zeng, 2014). First, entrepreneurship education appears to have benefited only a relatively small proportion of students participating in entrepreneurship practice. Despite the increasing instances and levels of participation in entrepreneurship education by universities, the number of entrepreneurial courses available is very limited and unable to meet the needs of students from diverse regions and disciplinary backgrounds. Second, these entrepreneurship courses, mostly adopted/​adapted from elsewhere instead of home-​grown, have not been mainstreamed into the curriculum and teaching. Nor has their effect been fully assessed. Third, a supporting system for entrepreneurship education has yet to be fully developed (Huang et al., 2014). More broadly, the aforementioned state-​led innovation and entrepreneurship education initiatives are designed to contribute to the state strategy of technology catch-​up through collaborative innovation (协同创新) (c.f. Liu, Ying, & Wu, 2017, for discussion of collaborative

Innovation and Entrepreneurship Education    195 innovation as a catch-​up strategy for latecomer emerging economies). However, collaborative innovation requires coordinated activities from multiple stakeholders. It requires higher education institutions to develop high-​quality and high-​skill training as part of their core activities of education. As developing collaborative relationships with industry partners has been a major challenge for many higher education institutions, this bottleneck constrains their ability to engage in innovation and entrepreneurship education. Zhao’s (2011) study of graduate entrepreneurship identified a number of personal and institutional challenges. At the personal level, challenges include lack of practical experience; social capital, financial capital, and other social resources; managerial experience in running businesses; entrepreneurial skills; and psychological resilience in overcoming difficulties. At the institutional level, cultural and social norms, entrepreneurship education, and government policy are some of the associated barriers. According to Xu, Mei, and Ni (2015), the entrepreneurship success rate for university students is low. A study revealed that only 17% of the 97 student enterprises set up in the early period was profit making, and only 30% of the businesses started up by students survived five years (cited in Xu et al., 2015). Several factors accounted for this poor record. One relates to the broader entrepreneurship environment in China, including poor financing opportunities. Currently, there are four main channels for graduate entrepreneurship financing:  bank favorable policy loans, government entrepreneurial special project foundation funds, venture capital investment funds, and self-​raised funds. As venture capital funds have high requirements of market maturity and self-​raised funds are subject to family backgrounds, bank policy loans and government startup special funds should in principle become the main source of university student entrepreneurship financing. However, in practice, family funds are the main source for financing student entrepreneurship. It was reported that 58% of the graduate business startups launched by students graduating in 2013 came from their family, whereas 22% came from personal savings, and only 2% came from venture capital and government funding, respectively (Xu et al., 2015). Another reason, and the most important one, concerns the lack of entrepreneurial experience and ability of the university graduates. This is largely due to the lack of long-​term collaboration mechanisms between the higher education institutions and entrepreneurs, as noted earlier. As a result, entrepreneurship education in higher education institutions has generally focused on knowledge rather than ability, and classroom teaching instead of practical experience (Xu et al., 2015). A third reason is the lack of family entrepreneurship culture that supports graduate entrepreneurship (Liu, 2014). And a fourth reason, again, is related to the utilitarian approach to entrepreneurship education in the higher education institutions; many carry out the education in order to comply with the state requirement (Liu, 2014).

Changes Required and Roles of Stakeholders The previous discussion of creativity/​innovation education and the entrepreneurship education situation suggests that institutional and cultural changes are necessary to make these activities more effective in producing the right type and level of human resources for an

196   Cooke innovation-​oriented economy. These changes cannot be carried out in isolation but require coordinated efforts from stakeholders at all levels. For the state as the strategy maker and policymaker, and education funder and regulator, there is a need to consider how other stakeholders (e.g., the education sector, industry, and parents) can be mobilized/​incentivized to participate in innovation and entrepreneurship education with more enthusiasm. Otherwise, high-​level top-​down policy may trigger opportunistic compliant activities rather than generating genuine activities and effective outcomes on the ground. In particular, some questions need to be asked: Is it realistic to expect university graduates without any business experience and with little life experience and financial power/​savings to become successful entrepreneurs when the life expectancy of Chinese private businesses is shorter than 10 years? Is it realistic to expect schools in poor regions to be engaged in creative education when they are struggling to provide good-​ quality basic education and teacher salaries? What can be done to eliminate the growing development disparity across regions and between rural and urban regions? For the education sector and education system, continuing reform and improvement are necessary for curriculum design, teaching style/​delivery approach, and the development of trainers and educators with relevant aptitude and attitude to assume creativity/​innovation and entrepreneurship education tasks (e.g., Bian & Miao, 2015; Mei & Meng, 2016). In addition, investment is needed to provide makerspace, entrepreneurship incubators, and other software and hardware to deliver these forms of education. The performance management system should also reflect and incentivize these education activities. In particular, autonomy in learning is critical in innovation education to encourage students to carry out their learning in a more proactive manner so as to develop their creative thinking and innovation ability (Bian & Miao, 2015). This calls for a fundamental cultural and pedagogical change in the Chinese education system (Ming, 2016). Moreover, Li and Huang (2014) pointed out that the current generation of university graduates tends to be highly confident and intelligent but is not sufficiently resilient against defeats. They are eager to establish their social identity but are uncertain what that identity might be, and self-​doubt may creep in readily when encountering setbacks. Therefore, emotional intelligence and resilience training needs to be incorporated in innovation and entrepreneurship education to prepare students for the tough world. As Li and Huang (2014) argued, entrepreneurship education in higher education institutions needs to transcend from a pedagogical perspective of promoting students’ economic integration with society toward a more comprehensive social integration incorporating economic integration, social capital integration, cultural integration, and identity integration. In addition, given the uneven resource distribution across regions and subsectors within the education sector (e.g., schools vs. universities), mechanisms may be created for resource sharing between schools and higher education institutions. For instance, universities can invite schools in by opening up their laboratories, seminars, public lectures, and so forth to school students and teachers; universities can also do outreach by sending university lecturers and students to schools to deliver guest lectures and contribute to school research capacity building by helping them to set up laboratories/​ experiment bases and mentoring school teachers to raise their research capability (Shu & Chen, 2002). For business sectors, there is already a growing collaborative relationship between businesses and universities, albeit this often is confined to a relatively small number of elite academics and institutions that are well resourced for such engagements. One way

Innovation and Entrepreneurship Education    197 of promoting a stronger collaborative education-​business link would be to appeal to businesses’ corporate social responsibility and award public procurement contracts to private businesses, with their citizenship role in supporting education as one of the conditions. As with many initiatives and regulations in China, opportunistic behaviors may still occur without genuine support. For parents and society as a whole, as discussed earlier, a culture to support entrepreneurship education and entrepreneurship is needed. However, this suggestion is not presented as a superficial remedial recipe. Rather, several deeper-​level questions need to be addressed, as they have profound social, economic, and psychological implications. For innovation and entrepreneurship education, we have already discussed why parents are unwilling for their children to engage in extracurricular activities if they do not contribute directly to advancing their children’s prospects of entering a good school or university. Not entering a good university means not being able to get a good job in the current Chinese labor market, which will have a negative impact on the graduates’ career and livelihood. For entrepreneurship, given the high proportion of university student startup failures and that the majority of these ventures are financed by their parents’ savings, what may be the consequences for these families, especially when the savings are likely to be the pension supplements for the parents in their old age, or could be used to subsidize housing for the university graduate (a common practice in China)? What may be the broader cost of these startup failures for the economy, community, and society as a whole? How can the financial risk of entrepreneurial startup failures be spread across institutions through policy interventions? Existing research shows that only a small proportion of the university startups are really innovative entrepreneurial businesses. Since the majority of the startups are essentially self-​employment of university graduates as an alternative to corporate employment (Wang, Cooke, & Lin, 2016), how can these be differentiated to identify and foster genuine innovative entrepreneurship? And how can the commercialization of innovations be more heavily incentivized? In short, as Liu (2014) argued, some cultural building is required involving different stakeholders to support entrepreneurship education. This includes developing a competitive and progress-​oriented national culture, invigorating a family culture that supports entrepreneurship, creating a university culture of experimenting with new things, building a corporate culture that advocates innovation and creativity, and reshaping a culture in society that is tolerant of failures. Underpinning all these areas for cultural change is a more holistic, humanistic, and tolerant approach to education that takes into account individual characteristics and emotional well-​being. This presents a very significant challenge to the Chinese education system and the societal culture that emphasizes collectivism, conformity, efficiency, and self-​sacrifice.

Conclusions This chapter critically discussed China’s education reform initiatives, with a specific focus on innovation and entrepreneurship education, in the context of its national strategy of economic growth that is innovation driven. It identified a number of challenges that need to be addressed if the effectiveness of these reform and educational initiatives is to be

198   Cooke improved. In terms of approach, a top-​down approach and movement-​style promotion and implementation of reform programs carry the pitfalls of superficial compliance for various reasons and resource waste. The current government-​pushed and supply-​side-​ driven entrepreneurship education needs to take into account the needs and preferences of students and parents. In terms of curriculum design, the education focus should be broadened from a relatively narrow focus on human capital and technological competence development to all-​around skills, qualities, and resilience from a STEAM approach. As Shi and Sewell (2011) argued, employability and entrepreneurship education should include four dimensions: technical dimension, skills dimension, motivation dimension, and cultural dimension. Finally, the benefits of innovation education cannot be fully materialized without taking into account the following questions:  Where and how can creativity and entrepreneurship skills be best developed? Should university graduates be channeled to self-​employed businesses as demonstrations of entrepreneurship? Is this the most effective use of resources for the nation? For those who enter employment in corporations, what is the role of corporate human resource management (HRM) in facilitating a smooth transition between education and employment so that graduates’ creative talent can be better harnessed? For example, is innovativeness and creativity of the job candidate part of the recruitment selection assessment criteria? Are Chinese workplaces/​managers sufficiently prepared to help graduates transition from education to the work environment so that their creative passion is not lost? What types of HRM practices are conducive to eliciting employees’ innovativeness and creativity? What data analytic techniques can be used to manage innovation? What may be the demographic differences (e.g., gender, age, and family background) in shaping employees’ expectations and innovative/​creativity behaviors? What may be the dark side of innovation and creativity for individuals, organizations, communities, and society, and how can these be mitigated to minimize the negative impacts?

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Innovation and Entrepreneurship Education    199 Connor, S. (January 10, 2013), One-​ child policy:  China’s army of little emperors. The Independent. https://​www.independent.co.uk/​news/​world/​asia/​one-​child-​policy-​chinas-​ army-​of-​little-​emperors-​8446713.html, accessed on December 15, 2018. Cooke, F. L., & Wang, M. (2019), Macro-​level talent management in China. In Vaiman, V., Schuler, R., Sparrow, P., and Collings, D. (eds.), Macro Talent Management in Emerging and Emergent Markets. London: Routledge, pp. 64–​84. Dutta, S., Lanvin, B., & Wunsch-​Vincent, S. (2017), The Global Innovation Index 2017. Cornell University, INSEAD, and the World Intellectual Property Organization.https://​www. globalinnovationindex.org/​gii-​2017-​report, accessed on November 18, 2017. Elmer, K., & Crothall, G. (2016), Over-​worked and under-​paid: The long-​running battle of China’s teachers for decent work. China Labour Bulletin. https://​clb.org.hk/​sites/​default/​ files/​Teachers%20final.pdf, accessed on December 2, 2018. European Commission. (2009), Best procedure project: Entrepreneurship in vocational education and training. http://​ec.europa.eu/​DocsRoom/​documents/​10446/​attachments/​1/​ translations/​en/​renditions/​native, accessed on March 15, 2019. European Commission. (2012), Effects and impact of entrepreneurship programmes in higher education. https://​ec.europa.eu/​growth/​content/​effects-​and-​impact-​entrepreneurship-​ programmes-​higher-​education-​0_​en, accessed on March 15, 2019. European Commission. (2014), Entrepreneurship education:  A guide for educators. http://​ ec.europa.eu/​DocsRoom/​documents/​7465, accessed on March 15, 2019. Fu, G. P. (2018), The knowledge-​based versus student-​centred debate on quality education: Controversy in China’s curriculum reform. Compare: A Journal of Comparative and International Education, DOI:10.1080/​03057925.2018.1523002. Halstead, J. M., & Zhu, C. Y. (2009), Autonomy as an element in Chinese educational reform: A case study of English lessons in a senior high school in Beijing. Asia Pacific Journal of Education, 29, 4, pp. 443–​456. Huang, Z. X., Qu, X. Y., Shi, Y. C., & Zeng, E. L. (2014). A new model of higher education institutions entrepreneurship education oriented by position entrepreneurship: The case of Wenzhou University. Journal of Higher Education, 35, 8, pp. 87–​91. Ji, X., Zhou, Y., & Zhou, Y. (2016), An analysis of how to strengthen the development of students’ scientific innovation competence. Education Space, 2, pp. 161–​162. Jin, Y. B. (2018), The construction of an ecological system model for primary and secondary school creative education. Journal of Xinyang Normal University (Philosophy and Social Sciences Edition), 38, 1, pp. 84–​89. Johnson, W., & Weiss, J. (2008), A stage model of education and innovation type in China: The paradox of the dragon. Journal of Technology Management in China, 3, 1, pp. 66–​81. Lewin, A., Kenney, M., & Murmann, J. P. (eds.). (2016), Overcoming the Middle-​Income Trap. Cambridge: Cambridge University Press. Li, Y. A., Whalley, J., Zhang, S. M., & Zhao, X. L. (2011), The higher educational transformation of China and its global implications. World Economy, 34, 4, pp. 516–​545. Li, Y. X., & Huang, Z. X. (2014), From “blending” to “integration”: On the social integration mode of entrepreneurship education in higher education institutions. Higher Engineering Education Research, 1, pp. 76–​80. Li, Y. Y. (2015), An analysis of difficulties and solutions of innovation education in secondary schools. Journal of Tangshan Normal University, 37, 2, pp. 154–​156. Liu, H. Y. (2014), Entrepreneurship education should remould university students’ innovation culture. Higher Agricultural Education, 6, pp. 29–​32.

200   Cooke Liu, R. J. (2018), The long road of Maker education, it is the right time for talent. HR, 3, pp.  18–​21. Liu, Y., Ying, Y., & Wu, X. J. (2017), Catch‐up through collaborative innovation: Evidence from China. Thunderbird International Business Review, July/​August, pp. 533–​545. Liu, Y. B., & Fang, Y. P. (2009), Basic education reform in China: Globalization with Chinese characteristics. Asia Pacific Journal of Education, 29, 4, pp. 407–​412. Lu, F., Cheng, Y. S., Peng, X. F., & Li, Z. (2018), An applied analysis of Maker education in primary and secondary education. Journal of Hubei Normal University (Philosophy and Social Science), 38, 2, pp. 122–​125. Ma, Y. B., & Bai, Z. (2015), A study and exploration of the practice model of university innovation and entrepreneurship education. Tsinghua Journal of Education, 36, 6, pp. 99–​103. Mei, W. H., & Meng, Y. (2016), Innovative entrepreneurship education in Chinese universities:  The role positioning of the government, the university and the society and their action strategies. Journal of Higher Education, 37, 8, pp. 9–​15. Ming, Z. (2016), Enlightenment of innovation education to secondary school education in China. Innovation Education, 2, p. 118. Ministry of Education. (2016), The announcement of the “13th Five-​ Year Plan of Education Informationalization” issued by the Ministry of Education (教育部关于印发《教育信息化“十三五” 规划》 的通知 [EB/​OL]. [2016-​06-​24]). http://​www. moe.gov.cn/​srcsite/​A16/​s3342/​201606/​t20160622_​269367.html. Ni, H., & Ye, Y. H. (2018), Entrepreneurship education matters: Exploring secondary vocational school students’ entrepreneurial intention in China. Asia-​Pacific Education Research, 27, 2, pp. 1–​10. Pang, W. G., & Plucker, J. (2013), Recent transformations in China’s economic, social, and education policies for promoting innovation and creativity. Journal of Creative Behavior, 46, 4, pp. 247–​273. People’s Daily Online. (June 29, 2016), Kindergarten homework burdening Chinese parents. http://​en.people.cn/​n3/​2016/​0629/​c90000-​9079255.html, accessed on December 15, 2018. People’s Daily Online. (September 21, 2017). China to develop 42 world-​class universities. http://​en.people.cn/​n3/​2017/​0921/​c90000-​9272101.html, accessed on December 12, 2018. Shi, J. J., & Sewell, P. J. (2011), In search of the entrepreneurial spirit in China. Journal of Chinese Entrepreneurship, 3, 1, pp. 58–​7 1. Shu, Y. M., & Chen, J. L. (2002), A new exploration of developing a new scientific innovation education model through cooperation between universities and primary and secondary schools. Liaoling Education Research, 11, pp. 16–​17. Tan, C., & Hairon, S. (2016), Education reform in China:  Toward classroom communities. Action in Teacher Education, 38, 4, pp. 315–​326. Tang, M. F., Chen, X. G., Li, Q. H., & Lu, Y. (2014), Does Chinese university entrepreneurship education fit students’ needs? Journal of Entrepreneurship in Emerging Economies, 6, 2 pp. 163–​178. Wan, L. Y., & Kang C. P. (2016), Internet plus Maker education:  The construction of the new ecology for innovation and entrepreneurship education in universities. Education Development Research, 7, pp. 59–​65. Wang, C. Y. (2018), A few thoughts on the reform of primary education against the background of new curriculum reform. Science and Technology Industry Park of China, 5, p. 124. Wang, J., Cooke, F. L., & Lin, Z. H. (2016), Informal employment in China: Recent development and human resource implications. Asia Pacific Journal of Human Resources, 54, 3, pp. 292–​311.

Innovation and Entrepreneurship Education    201 Woronov, T. E. (2008), Raising quality, fostering “creativity”: Ideologies and practices of education reform in Beijing. Anthropology & Education Quarterly, 39, 4, pp. 401–​422. Xu, X. Z., Mei, W. H., & Ni, H. (2015), Dilemma of university student entrepreneurship and its institutional innovation. Chinese Higher Education Research, 1, pp. 45–​48&53. Zhang, G. M., Zhao, Y., & Lei, J. (2012), Between a rock and a hard place: Higher education reform and innovation in China. On the Horizon, 20, 4, pp. 263–​273. Zhao, J. S., & Guo, J. Y. (2002), The restructuring of China’s higher education: An experience for market economy and knowledge economy. Educational Philosophy and Theory, 34, 2, pp. 207–​221. Zhao, X. Z. (2011), The causes and countermeasures of Chi ship dilemma. Journal of Chinese Entrepreneurship, 3, 3, pp. 21–​227. Zhou, Y., & Feng, Q. L. (2013), The construction of an ecological system of innovative entrepreneurship education in higher education institutions:  The case of Jiangsu Province. Journal of Higher Education Management, 7, 3, pp. 120–​124.

Pa rt   I I I

NAT IONA L I N C E N T I V E S F OR A N I N N OVAT ION -​ DR I V E N E C ON OM Y

Chapter 3.1

System Re form, C om petition, a nd Innovation i n  C h i na Weiying Zhang Introduction Four decades have passed since China inaugurated its market-​oriented economic reform in 1978. While the Chinese economy is not a true market economy using the Western criteria, China has indeed made huge progress toward a market system. The Chinese economic system now is very different from 40 years ago in almost every aspect. Changes are much beyond expectations of both insiders and outsiders of the early stage of reform. China’s market-​oriented economic reform has been accompanied by unprecedented economic growth. China’s average annual growth rate of the past four decades is about 9%. China became the second-​largest economy in the world in 2010. This is a strong demonstration of the power of the market. The power of the market comes from two main sources: the efficiency of resource allocation and technological innovation. While textbook economics focus on resource allocation efficiency, innovation should be the first-​order force of the market for growth. The worldwide progress of human life in the past 200 years has come mainly from technological innovations. However, China’s high economic growth in the past four decades has mainly been driven by resource allocation efficiency rather than by innovation. Two reasons can be offered to explain why resource allocation efficiency played such a dominant role. The first is that the resource allocation was so inefficient during the pre-​reform period that even without opening the door to the outside, China could have achieved a reasonably good growth by marketization. The second and perhaps more important reason is that China is a latecomer of economic development. When it began economic reform, its economy was so far away from an equivalent open economy. China has had opportunities to exploit all of the technologies developed by the West through the three successive industrial revolutions over 300 years. In fact, China has had a three-​in-​one

206   Zhang industrial revolution without any important self-​original innovation. In Hayek’s words (Hayek, [1960] 2011), China is a parasitic economy so far. Nevertheless, after four decades of high economic growth, the potential latecomer’s advantages are being depleted, and the room for arbitrage is shrinking. Solely relying on resource allocation efficiency will no longer be able to help it sustain high growth. China’s future growth will have to increasingly rely on technological innovations. Even though some progress in innovation has been made in terms of research and development (R&D) intensity and patents in the past decade, China has a long way to go to become an innovation-​driven economy. So far, among all of the technologies that have supported China’s high growth, no single fundamental one has originated from China. China must recognize that it is the entrepreneurs in a competitive market, not the government, that are the major driving force for innovation. Overall, China’s current system favors entrepreneurial arbitrage, but it is severely disadvantageous to entrepreneurial innovation. If private property rights cannot receive effective legal protections and a true rule-​of-​law system cannot be established, China will not be able to become an innovative country. This chapter is organized as follows. In the next section, I will give a brief description of China’s economic reform process. Then I will discuss the definition and measure of competition, how the economic system reform has improved market competition in China, and what kind of progress China has made in innovation in terms of R&D intensity, patents, and sales of new products. After that, I will show that innovation is positively and significantly correlated with marketization and competition by a cross-​regional comparison. I will conclude the chapter by pointing out what kind of reform is urgently needed for China to become a real innovating economy.

A Brief Description of China’s Economic Reform A typical planned economy has two fundamental features. First, it is the government, not price, that directs resource allocation. Prices of both inputs and outputs are fixed by the government, not by the market, which plays little role in decision making of what to produce, how to produce, and for whom to produce. Second, enterprises are solely owned and controlled by the state. There is no entrepreneurship. The managerial goal of enterprises is to execute the production targets set by the state, not to pursue profits. The income and welfare of employees are independent of the firm’s profits. While China’s pre-​reform economic system was not 100% planned, it shared the basic characteristics of the planned economy. Therefore, price liberalization and ownership changes have necessarily been the two most important components in its reform agenda. These two reforms are also related to liberalization of factor markets. In addition, given that China was a closed and self-​sufficient economy, openness (including liberalization of trade and capital flow) has also been an important part of the reform program. In fact, openness has not just introduced external competition but also promoted internal reform. Without openness, China’s reform would have been much slower and even halted.

System Reform, Competition, and Innovation    207

Price Liberalization Roughly speaking, lifting control of product price in China was completed in the first 15 years of its reform, as shown in Figure 3.1.1(a)–​(c). In terms of transaction amounts, 97% of the retail prices, 92.2% of the agricultural product prices, and 100% of the production material prices were set by the government in 1978. By 1993, the shares of these prices set by the government dropped to 6.2%, 12.5%, and 18.9%, respectively. The prices of the remaining products still set by the government are mainly in monopolistic industries and infrastructure, such as oil, natural gas, water, power, telecoms, etc. There have been no significant changes in the price mechanism since 1993, although some microadjustments have been made from time to time. China took the so-​called dual-​track approach to incrementally lift the government control of prices, not the one-​shot (big bang) approach typically adopted by Eastern Europe and the former Soviet Union. The dual track means that the market is introduced first at the margin, and then gradually takes over the remaining planned domain. One reason for China to take this approach is that at the early phase of reform, it did not intend to go to a full-​scale market system, and the market was only half-​mindedly trusted. Another reason is that price reform was related to too many important economic and social issues, and it was too risky for the government to take a once-​for-​all approach. By respecting the status quo of vested interests and stabilizing the major part of the planned economy, the dual-​track approach did not provoke big risk on the one hand, but provided market incentives to resource allocation at the margin. In fact, in many sectors, when the dual-​track approach was first introduced in January 1985, it did not do much except legalize the then-​black and -​gray markets.1 Corresponding to the gradual liberalization of prices, the basic production decisions were also gradually transformed from the government planning agent to management of enterprises, and private enterprises gradually emerged in markets.

Enterprise Reform and Development of Private Firms Before reform, the Chinese industry,2 like in all other socialist economies, was monopolized by the state. For instance, in 1978, the output of state-​owned enterprises (SOEs) accounted for 80.7% of total industrial output. The remaining 19.3% was produced by collective enterprises. There were no private enterprises at all.3 The SOE reform started with zhengqi fengkai (separating firms from government) and fangquan rangli (granting autonomy to and sharing profit with enterprises). This reform policy was based on the doctrine that SOEs could be made efficient through empowering management and motivating employees without changing state ownership. While it had achieved some positive results, the overall performance of the SOE reform was not

1 

For detailed discussion of China’s price reform, see Zhang (2015, Chapter 12). Here “industry” loosely refers to all nonagricultural sectors. 3  The following contents of this subsection are partly drawn from Zhang (2014). Also see Zhang (2015, Chapter 11). 2 

208   Zhang 120

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Figure 3.1.1  Changes in price mechanism in China (1978–​2004). Source: Zhang (2015, Chapter 12)

System Reform, Competition, and Innovation    209 satisfactory.4 By the late 1980s, facing strong competition from nonstate firms such as township and village-​owned enterprises (TVEs) and foreign-​invested enterprises, most SOEs couldn’t even survive without government subsidies and bank loan support. By the early 1990s, many government officials and economists had realized that some fundamental changes in the ownership structure of SOEs were needed. The reform doctrine then changed and ownership reform of SOEs began after Deng Xiaoping’s Southern visit in spring 1992 calling for going back to the reform road, and “Socialist Market Economy” was adopted as the reform goal by the 14th National Conference of the Communist Party of China (CPC). Many local governments initiated privatization campaigns for their controlled SOEs (and TVEs), which was encouraged, or at least tolerated, by the central authority. By 1997, most county-​level SOEs and TVEs were fully or partially privatized. In 1998, partially triggered by the Asian financial crisis, the central government launched the pilot project to corporatize 1,000 large SOEs. By 2003, most large SOEs controlled by municipal, provincial, and even by the central government had been corporatized through ownership diversification and stock listing. SOEs gradually retreated from competitive sectors. In 2003, even state-​owned banks and financial institutions were listed in stock exchanges after introducing international strategic investors. However, starting from 2004, the ownership reform of SOEs lost momentum. This happened mainly because Hu Jingtao’s regime became more conservative when the previous privatization was charged with looting state assets by Lang Xianpingm, a Hong Kong–​ based Taiwanese economist. The goal of the State Assets Supervision and Administration Committee (SASAC), newly established in 2003, was changed to making SOEs bigger and stronger through improving corporate governance and market concentration. As a result, SOEs became more aggressive and more dominant in some key sectors. In November 2013, “mixed ownership” was proposed as a “new idea” for SOE reform by the third plenary session of the 18th Central Committee of the CPC under Xi Jinping’s regime.5 Since then various practices have happened nationwide, but their real results are to be seen. My worry is that, given the overall atmosphere of going back to the old system under Xi Jinping’s regime, the mixed ownership reform is more like a nationalization of the private sectors than a privatization of the state sector. In parallel with the SOE reform, private enterprises gradually emerged and developed. Legalization of private businesses has been a long process of several administrative and legislative steps. Self-​employed businesses were legalized in 1982 after their spontaneous emergence for several years. Privately owned enterprises obtained legal status in 1988 after a long debate. However, following the June 4 event in 1989, the government launched another crackdown on the private sector. As for the SOE reform, the year of 1992 was also a turning point for the development of private enterprises. With Deng Xiaoping’s new reform push, the government reversed its anti-​private policy, and private enterprises became less discriminated against and even

4  For the performance of the early-​ stage enterprise reform, see Chen et  al. (1988), Dollar (1990), Groves et al. (1994), and Zhang (1997), among others. 5 In some sense this “new” idea is not really new, and how it differs from the old concept of “corporatization” is that it can refer either to introducing private owners into the SOEs or to introducing the state owner into privately owned firms, while the corporatization mainly refers to the first.

210   Zhang encouraged. By the turn of the 21st century, private enterprises had emerged as the dominant ownership type of the newly established firms in China.6 The development of private enterprises was further pushed by the hi-​tech industry and internet boom, particularly after China entered the World Trade Organization (WTO) in 2001. However, it should be pointed out that the government has never given up the idea of the dominance of SOEs. Private enterprises are still discriminated against and restricted in market entry, financing, taxation, product licenses, and other aspects.7 In particular, private entrepreneurs are very vulnerable for being charged as criminals even if they do nothing illegal, and when the case happens, their properties are confiscated even before court decisions are made. As a result of four decades of enterprise reform and development of private firms (plus introducing foreign investment, see later), the overall picture of the ownership structure of the Chinese economy has changed dramatically. Figure 3.1.28 shows the changes in ownership structure in the industrial sector from 1998 to 2016 in terms of different measures for enterprises above designated size.9 It shows that regardless of what measures are being used, the share of state-​holding enterprises10 decreased, the share of private enterprises increased, and the share of foreign-​, Hong Kong–​, Macao-​, and Taiwanese-​invested firms first increased up till around 2006 and then decreased afterwards.11 While the state sector still accounted for the largest part of assets in 2016 (38.5%), its share was significantly smaller than in 1998 (68.8%), and also smaller than the total share of the other two categories (41.6%). In the other three measures (number of the enterprises, sales revenues, and employment), the shares of state ownership changed from dominance to that smaller than both the share of private enterprises and the share of foreign-​, Hong Kong–​, Macao-​, and Taiwanese-​invested enterprises. However, it should be pointed out that the aforementioned statistics do not conclude that the state sector has lost its dominant status in the whole Chinese economy. SOEs still hold a monopolistic position in key industries such as energy, raw material, equipment manufacturing, and particularly the financial sector, telecommunication, oil and gas, and major public utilities. In other words, the state still controls the lifeblood of the Chinese economy even after 40 years of reform. Furthermore, there is no level playing field between SOEs and private enterprises. The key industries are still not open to private enterprises.

6  For

example, from 2000 to 2001, the number of private firms increased by 15.1%, while the total number of firms of all ownership types was reduced by 4.1%. 7  See Shen and Zhao (2012) for a detailed description of discrimination between SOEs and private enterprises. 8  Most sources of the following figures come from China Statistical Yearbook (years between 2000 and 2017), which is published by China Statistics Press every year. In the following, sources will not be cited except otherwise from other sources. 9  The industrial enterprises above designated size were all state-​owned industrial enterprises and non-​ state-​owned enterprises with revenue over RMB 5 million from principal business from 1998 to 2006; all industrial enterprises with revenue over RMB 5 million from principal business from 2007 to 2010; and all industrial enterprises with revenue from principal business over RMB 20 million from 2011 on. 10  State-​holding firms cover both original state-​owned firms and the state-​holding firms in which the government holds more than a 50% share or is the largest shareholder. 11  The sum of three shares is smaller than 100% because there are other types of ownership that cannot be ascribed to either one of the previous three categories.

System Reform, Competition, and Innovation    211 (a) Shares in Number of Firms (%) 70.0% 60.0% Private firms

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Figure 3.1.2  Changes in ownership structure in industrial sector (1998–​2016). Source: China Statistical Yearbook 2017 (and other years)

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Figure 3.1.2 Continued

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System Reform, Competition, and Innovation    213

Liberalization of Factor Markets Along with liberalization of product prices, enterprise reform, ownership changes, and openness, factor markets have also gradually developed, although liberalization of factor markets has proceeded much behind product markets. Labor Market. In the planning system of China before reform, there were no factor markets. In the late 1950s, China implemented a household registration system (hukou) under which no one could immigrate to other place without government permit. Rural people had to live in their birth villages, much like serfs of the feudal system in the medieval age. In urban regions, the government was the sole employer that had the authority to assign jobs to people. All college graduates were allotted jobs by the government according to plan. Labor market first emerged in rural regions in the early 1980s. This was the result of rural reform. The household production system made a lot of peasants redundant and gave a great push to development of TVEs. At the beginning, redundant rural people found seasonal or full-​time jobs in their local TVEs. Gradually, more and more rural people began to move cross-​county, cross-​prefecture, and cross-​province. In urban regions, labor mobility emerged in the second half of the 1980s. Initially, the young urban population, who were not offered jobs with the state sector, had to make a living by themselves. They took every opportunity to try to find jobs for themselves wherever they could. The employees of the state sector were also gradually allowed to use no-​ paid leave to move to other jobs. With the abolishment of the rationing system of basic living materials in the late 1980s and early 1990s, urban labor got more freedom to choose their employers. From 1996 on, the uniform allotting system of college graduates was also abolished, and millions of college graduates every year must go to job markets. On the demand side, TVEs and private enterprises had to recruit workers in the labor market from the very beginning. With the introduction of management autonomy, SOEs were allowed to hire contract-​based temporary workers from the middle of the 1980s on, and eventually all their employees, although their firing authority was very limited. From the start, the foreign-​, Hong Kong–​, Macao-​, and Taiwanese-​invested enterprises were all off plan, and they gradually became a large employer in the labor market. Attracted by higher salaries and more pleasant work conditions, more and more high-​skilled laborers (including engineers and managers) moved from the state sector to the nonstate sector. Today, the labor market is very competitive on both the supply side and demand side.12 The most substantial obstacle to the labor market today is still the hukou system. Although towns and many small cities have loosened control of hukou, most large and midsized cities still hold it intact. Those who work and live in locations different from their hukou locations are called the “floating population.” This floating population contains the major suppliers in the labor market. Figures 3.1.3 shows that the total floating population reached 245 million in 2016, which is equivalent to 17.7% of the total population, 31.6% of total rural and urban employment, and 59.1% of urban employment. Capital Market. Under the planning system of China, there were only government investment and government finance. There were neither commercial banks nor capital markets. Along with the enterprise reform in the 1980s, SOEs were allowed to make some 12 

See Knight and Song (2005) for a detailed discussion of China’s labor market.

214   Zhang Floating population: size in 100 million and percentage in urban employment 3.00 63.7% 2.50

52.3%

2.21 51.8%

63.6%

64.0%

2.30

2.36

64.1%

2.45

64.4%

2.53

70.0% 61.1%

2.47

59.1% 60.0%

2.45 50.0%

2.00 1.50

40.0%

1.47 1.21

30.0%

1.00

20.0%

0.50 0.00

10.0%

2000

2005

2010

2011

Floating population

2012

2013

2014

2015

2016

0.0%

% in urban employment

Figure 3.1.3  Floating population in labor market. investment with their retained funds and to borrow from banks. In the late 1980s, some SOEs began to raise funds by issuing internal stocks to their employees. Self-​raised funds gradually became the main source of their investment, although investment decisions and even bank loans had to be approved by the government. Non-​state-​owned enterprises were mainly financed by self-​raised funds. In 1984, the state-​owned Industrial and Commercial Bank of China (ICBC) was established by taking over the commercial banking function of the People’s Bank. Following this, three other state-​owned specialized banks were successively transformed into commercial banks. In 1987, Community Bank was established in Shanghai. Since then, these “big five” have been the dominant players in savings and loan markets, although about 200 city commercial banks have been established by reorganizing old credit unions since the middle of the 1990s.13 The single most important event of capital market development in China was the establishment of the Shanghai Stock Exchange and Shenzhen Stock Exchange in early 1990. Both SOEs and private enterprises could then raise funds by public issuing if approved by the authority. Since the late 1990s, some Chinese companies have also been allowed to raise funds in overseas stock exchanges under the condition that they get government approval.14 At the turn of the century, foreign venture capital (VC) and private equity capital (PE) were introduced into China. They financed the most important hi-​tech and internet companies of China in the first decade of the 21st century. In the past decade, thousands of domestic VC and PE companies have been founded, either privately or by the government. They have considerably eased financial constraints for business startups. 13 

14 

See Wang (2009) for a detailed discussion of commercial banking reform. See Qi (2009) for a detailed discussion of the development of China’s capital markets.

System Reform, Competition, and Innovation    215

Figure 3.1.4  Actual fund structure of fixed investment in China (1981–​2016). While China’s capital market is still underdeveloped and tightly controlled by the government, both demand and supply are very diversified and have become somewhat competitive after four decades of reform. Figure 3.1.4 shows that from 1981 to 2016, the share of the state budget in fixed investment decreased from 28.1% to 5.9%, while the share of self-​ raised funds increased from 55.4% to 82.9%. Figure 3.1.5 shows that from 2002 to 2016, the share of renminbi loans in aggregate financing to the real economy decreased from 91.9% to 69.8%, while the shares of equity financing, corporate bond financing, and entrusted and trust funds increased from 3.1%, 1.8%, and 0.9% to 7%, 16.9%, and 17.1%, respectively.15

Openness and Integration into the World Economy From the very beginning, openness and gradually integrating into the world economy was a very important part of China’s reform agenda. As early as 1979, the central government established four “special economic zones” neighboring Hong Kong and Macao (including Shenzhen, Zhuhai, Shantou, and Xiamen). They were authorized to trade directly and introduce overseas investments under some favorite policies. In 1984, anther 14 coastal cities were announced to open to the outside world. They were also authorized to do trade and use overseas investments. Meanwhile, the central government abolished the monopolistic status of 11 state-​owned specialized export and import companies by authorizing 15  Aggregate financing to the real economy (AFRE) (flow) refers to the total volume of financing provided by a financial system to the real economy during a certain period of time, where real economy means domestic nonfinancial enterprises and households.

216   Zhang Composition of Aggregate Financing to the Real Economy (2002–2016) 100.0% 90.0%

91.9% 81.1%

80.0%

79.2%

70.0%

78.5%

73.8%

60.0%

70.3%

73.1% 69.8%

69.0%

60.9% 56.7%

50.0%

58.2%

61.4% 52.0%

51.3%

40.0% 30.0% 20.0% 10.0% 0.0%

3.1% 1.8%

1.6%

2.4% 1.6%

6.7%

5.4% 1.1% 3.6%

7.3% 3.8%

7.9% 4.8%

8.9% 2.4%

7.9% 4.1%

10.6% 3.4%

14.3% 1.6%

10.5% 1.3%

15.3% 2.7%

19.1% 4.9%

16.9% 7.0%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 RMB Loans Entrusted and Trust loans Corporate Bond loans Equity financin on domestic marekt

Figure 3.1.5  Composition of aggregate financing to the real economy (2002–​2016). some industrial enterprises to export and import directly. During this period, various important policies were made to encourage and promote foreign companies to make direct investments by forming joint ventures with Chinese counterparts. China’s entry into the WTO in 2001 was the further and perhaps most important step for openness and integrating into the world. To meet the WTO’s criteria and to prepare for new challenges, the Chinese government launched a campaign a few years earlier to clear up those regulations that were inconsistent with WTO rules. The government also promised to further liberalize its economy. Although China has not yet honored all its promises, these promises indeed played an important role in driving the domestic reform in first few years after 2001. For example, introducing foreign strategic investors into state-​owned banks in 2003 was partially a response to the WTO rules. Openness for four decades has not only made China become a leading player in the world economy but also made foreign companies become important competitors in China’s domestic market. China became the largest exporter by 2008, the second-​largest importer after the United States by 2009, the second-​largest receiver of foreign direct investment (FDI) inflows by 2010, and the third-​largest investor of FDI outflows by 2013. Figure 3.1.6 shows that from 1978 to 2006, the ratios of export, import, and total trade to gross domestic product (GDP) of China increased from 4.6%, 5.1%, and 9.7% to 35.4%, 28.9%, and 64.2%, respectively. Although the trade-​GDP ratios decreased significantly after the global financial crisis, China is still a very open economy among the top 10 economies in terms of trade-​GDP ratios, as shown by Figure 3.1.7. More interestingly, Figure 3.1.8 shows that from 2001 to 2015, export by foreign-​funded enterprises accounted for 44% to 58% of the total export of China, and export by wholly foreign-​owned enterprises alone accounted for 26% to 39.5%. Although their export shares have steadily decreased since 2009, they still accounted for 44.2% and 31.3%, respectively, in 2015.

System Reform, Competition, and Innovation    217 Ratio of Export, Import and Total Trade to GDP in China (1978–2016) 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0%

1978 1980 1985 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

0.0%

Export/GDP ratio

Import/GDP ratio

Trade/GDP ratio

Figure 3.1.6  Changes in trade/​GDP ratios of China (1978–​2016).

Trade/GDP Ratios of Top 10 Economies in 2016 45.0% 38.6%

40.0% 35.0%

30.4%

30.0% 25.0%

24.3% 21.1% 21.4%

15.0% 10.0%

21.9% 15.9%

15.6%

14.2% 13.1% 12.3%

12.1%

23.2%

20.3%

18.7%

20.0%

27.2% 25.5%

24.9%

11.7%

10.3% 8.0%

7.8%

5.0%

Ratio of Export/GDP

Ratio of Import/GDP

Figure 3.1.7  Trade/​GDP ratios of top 10 economies in 2016.

da Ca na

il az Br

Ita lia

a In

di

ce an Fr

UK

y an Ge

rm

n pa Ja

a in Ch

US A

W

or ld

0.0%

218   Zhang Shares of Export by Froeign-funded enterprises in total export of China (2001–2015) 70.0% 60.0% 50.0%

50.1%

52.2%

54.8%

40.0% 33.3%

30.0%

57.1% 58.3%

58.2% 57.1%

39.5% 36.1% 38.4%

39.3%

55.3%

38.1%

55.9%

39.5%

54.6%

52.4%

38.5% 37.1%

49.9%

35.1%

29.5%

47.3%

45.9% 44.2%

32.9% 32.3% 31.3%

25.9%

20.0% 10.0% 0.0%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 All foreigned funded enterprises

Contractual joint ventures

Equity-joint ventures

Wholly foreigned owner enterprises

Figure  3.1.8  Shares of export by foreign-​funded enterprises in total exports in China (2001–​2016). Source: China Trade and External Economic Statistical Yearbook 2017

Competition and Innovation The power of the market comes from its nature of competition. Innovation is, to a large extent, a result of market competition. As argued by Schumpeter (1934, 1943), it is market competition that drives entrepreneurs to innovate. Nevertheless, economists have no consensus on the effect of competition on innovation. A large number of empirical studies have been done.16 Some find positive17 and others find negative effects.18 More recently, some studies find an inverted-​U relationship between competition and innovation (Aghion et al., 2005; Im et al., 2015). In my view, the inconclusiveness results primarily from our misunderstanding of competition.

Definition and Measures of Competition In mainstream economics, competition is benchmarked on the concept of “perfect competition.” By definition, perfect competition means an infinite number of small firms are using the same technology to produce a homogeneous product at an identical cost. Thus, each firm faces a level demand curve with infinite price elasticity. Any drift from the perfect 16 

For a comprehensive literature survey, see Cohen (2010). E.g., see Nickell (1996), Geroski (1990), and Blundell et al. (1999). 18   E.g., see Jadlow (1981), Lunn (1986), Kraft (1989), and Hashmi (2013). 17 

System Reform, Competition, and Innovation    219 completion implies some degree of monopoly. Concepts of monopolistic competition, oligopolistic competition, and monopoly are accordingly defined. Based on this definition, in both theoretical and empirical studies, competition is measured by market concentration ratios, or market power. The higher the concentration ratio is, the less competitive and the more monopolistic the market is. The textbook definition of competition is totally misleading and is completely different from real competition in the market. As Hayek (1948) argued, perfect competition means no competition at all.19 In a real market, competition always means doing differently from competitors, rather than doing the same as competitors: producing different products, using different technology at lower costs, and serving different customers. However, all these kinds of measurements of real competition are viewed as monopolistic by textbook economics. Many economists attribute to Schumpeter that monopoly favors innovation. This is a total misunderstanding of Schumpeter. The essential element of Schumpeter’s argument is that the mainstream concept of competition mistakes real competition as monopoly. The perfect competition model is wrong not only because it is unrealistic but also because it is undesirable. More importantly, perfect competition is incompatible with innovation. Innovation means differentiation in this or other aspects. It naturally implies that an innovator’s demand curve is always downward sloped, rather than horizontal. The more disruptive the innovation is, the steeper the demand curve faced by the innovator. Only when innovation completely stopped would it be possible to have perfect competition. Thus, it is nonsense to discuss whether competition defined as such has positive or negative effects on innovation. The true causality is that innovation leads to market power, rather than the other way around. When the conventional concepts of competition and monopoly are applied to China, they are more problematic. First, in the pre-​reform planning system, most of China’s manufactories had much lower concentration ratios, with too many and too small producers, compared to the developed economies, and very few enterprises had market power. No one would dare say then that the Chinese economy were more competitive and less monopolistic than the developed economies. It was the case simply because of lack of any innovation at that time, so that the same obsolete technologies were duplicated everywhere. In fact, duplication of production capacity was the lasting headachy problem for the Chinese government. Various administrative measures were taken, but it was never solved. Second, the conventional definitions of competition and monopoly make no distinction between market power as a result of market competition and market power as result of government regulation. By the textbook definition, Baidu, Alibaba, and Tencent are as monopolistic as China Mobile, Petrol China, and ICBC, if not more.20 However, the real situation is that Baidu, Alibaba, and Tencent have huge market power because they are more efficient and innovative, while China Mobile, Petrol China, and ICBC are monopolists because no competitors are allowed to enter their markets. So, while Baidu, Alibaba, and Tencent are 19 

See Kirzner (1973) for an Austrian conception of competition as a process. Alibaba, and Tencent are dominant respectively in search engines, customer-​to-​customer e-​commercial platforms, and internet-​related communication services and entertainment in China. So they are coined “BAT.” They are all privately owned listed companies, established in the late 1990s and early 2000s. China Mobile, Petrol China, and ICBC are dominant respectively in telecommunications, oil production and supply, and commercial banking in China. Although these three companies are also listed in stock exchanges, the government holds the absolute major shares of each and so they belong to “state-​holding enterprises.” 20  Baidu,

220   Zhang always under high pressure of competition, China Mobile, Petrol China, and ICBC can enjoy the easy life. Considering these arguments, conducting empirical tests of how (conventionally defined) competition affects innovation in China would tell us little. Competition has little to do with the number of firms and the so-​called market power. For a market to be competitive, the single most important element is free entrance. If entrepreneurs are equally free to enter the market and free to choose what to produce, how to produce it, whom to sell to, and how much to charge, markets would always be competitive, regardless of how many players are in the market. On the other hand, true monopoly would occur as long as market access is blocked or restricted and discriminations, either legislative or administrative, are made by the government. Put simply, the only relevant measure of competition and monopoly is the degree of freedom of doing business. Competition is negatively and monopoly is positively related to government regulation and intervention.21

Competition in China According to our definitions, all the economic reforms described in the section of “A Brief Description of China’s Economic Reform,” including price liberalization, enterprise reform and ownership changes, factor market liberalization, and openness, have promoted competition of the Chinese economy, because they all freed, more or less, business activities from government control. However, if measured by the conventional market concentration ratios, most manufacturing sectors would be less competitive than before reform, and the oil industry, post and telecommunications, and banking would be the only few sectors more competitive than before reform, since no single player has a 100% share as they did before reform. According to World Bank’s doing business indexes, taking Shanghai as the representative,22 China’s business environment has significantly improved since 2004. Figure 3.1.9 shows that the score of starting a business increased from 46.65 in 2004 to 85.7 in 2018 (2009 was the only worsening year), up by 39.05 points; the overall score of ease of doing business increased from 45 in 2005 to 66 in 2018, up by 21 points. The number of procedures for starting a business decreased from 11 to 7, and time for registration decreased from 46 days to 22 days (Figure 3.1.10). One of the most important single deregulations was that the requirement of minimum capital for starting a business, which was equivalent to 1,236.5% in 2004 and 78.2% of per capita income in 2014, was dropped in 2015. Other subscores (including dealing with construction permits, getting credit, trading across boards, and solving insolvency) have also improved more or less.23 21 

Simpson (2005) argues that monopoly occurs only when it is supported by political forces. As we will see in the next section, economic reform processes and business environments vary from region to region. It should be said that the business environment in Shanghai is better than in most other regions. 23  Score is measured by the distance to frontier (DTF) and helps assess the absolute level of regulatory performance over time. It measures the distance of each economy to the “frontier,” which represents the best performance observed on each of the indicators across all economies in the Doing Business sample since 2005. An economy’s DTF is reflected on a scale from 0 to 100, where 0 represents the lowest performance and 100 represents the frontier. For example, a score of 75 in 2017 means an economy was 25 percentage points away from the frontier constructed from the best performances across all economies and across time. 22 

System Reform, Competition, and Innovation    221 Scores of Doing Business in China (Shanghai) (2004–2018) 90 85 80 75 70 65 60 55 50 45 40 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Ease of Doing Business DTF global (DB17-18 methodology) Ease of Doing Business DTF global (DB16 methodology) Ease of Doing Business DTF global (DB15 methodology) Ease of Doing Business DTF global (DB10-14 methodology) starting business DTF - Starting a business

Figure 3.1.9  Changes in score of Doing Business in China. Source: World Bank Doing Business Data (http://​www.doingbusiness.org/​dataRanking)

Starting buisness: Procedures and Time (2004–2018) 14

50 45

46

46

11

11

46 11

12 11

12

12

12

11

40

11

11 9

39 36

35

12

33

33

30

36

36

7 31

8 7 6

31 28

4

28 26

25 20

10 9

2

22 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Time (days) (Left))

Procedures (number) (right)

Figure 3.1.10  Starting a business in China: procedures and time. Source: World Bank Doing Business Data (http://​www.doingbusiness.org/​dataRanking)

222   Zhang Marketization Score (1997-2014) 9 8.19

8

7

6.92

6

6.1

6.12

7.18

7.47

7.34 6.8

7.69

7

6.37

5.5 5.02

5 4.64 4.23 4

3

4.01

4.12

4.28

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Figure 3.1.11  Marketization Index in China (1997–​2014). Source: National Economic Research Institute (Beijing) Marketization Database

Another indicator we may use to measure change in competition in China is the degree of marketization over time. Beginning in 1997, the National Economic Research Institute (Beijing) compiled the marketization indexes of China and each of its provinces.24 Figure 3.1.11 shows that the overall marketization indexes in China steadily increased from 1997 to 2014, except in 1999 and 2010. It should be pointed out that while the overall competition in China has been greatly improved since reform, the Chinese economy is still heavily regulated. There was strong resistance to liberalization from bureaucrats who introduced or reintroduced regulations from time to time under the name of “normalization,” which has greatly weakened the effects of reform policies on competition.

From Arbitrage to Innovation As I argued in the introduction, China’s high growth of the past four decades has primarily come from improvement in efficiency of resource allocation, not from innovation.25 In the standard framework of the production possibility frontier as shown in Figure 3.1.12, China’s

24 The

overall index was constructed by weighted aggregating of five subindexes (including government-​market relation, development of nonstate sectors, development of product market, development of factor market, and development of intermediary organizations and legal environment). See Wang et al. (2017) for technical definitions and calculation of the marketization score. 25  See Zhang (2017) for a detailed discussion.

System Reform, Competition, and Innovation    223 Y Y2 Y1

B C

E

P’P’

A

PP X1

X2

X

Figure 3.1.12  China’s growth in the production frontier framework. high growth mainly resulted from moving resource allocation points A or B to point C, rather than shifting the production frontier from X1Y1 to X2Y2.26 The basic reasons are as follows. First, given that resources were seriously misallocated and many products were in shortage before reform, reallocation-​based arbitrage was much more profitable and less risky for entrepreneurs than innovation.27 Second, given that China’s technologies were so backward and labor cost was so low, profitability could be maintained by simply copying and applying the Western accumulated technologies to China. As a result, neither Chinese enterprises nor foreign-​invested enterprises in China had strong incentives to innovate. By arbitraging between different markets, they were able to make huge profits. Even obsolete and outdated technologies were “new” and profitable in China. In fact, TVEs were long charged for being technologically backward, but they survived for a long time. Multinational companies simply moved their existing equipment or applied their existing know-​how to China to capture market opportunities. For instance, top multinational car makers made a considerable part of their profits by producing the existing car models in China (mainly through joint ventures). However, as Chinese markets have become more competitive and arbitraging opportunities have gradually shrunk, the need for innovation has been steadily increasing. This has been the case particularly since China jointed the WTO in 2001. The result is that all enterprises in China, both domestic and foreign invested, have increasingly put more and more efforts into innovation.

26  In

Figure  3.1.12, PP and P’P’ are two respective consumption substitution ratios determined by consumer preferences; therefore, points C and E are two respective equilibria. Economists typically attribute the increase in total factor productivity (TFP) to technological progress. This is right only if the economy is always on the production frontier. When the economy is not on the production frontier, as in China, the increase in TFP could be simply a result of improvement of allocative efficiency without true technological progress. 27  Hsieh and Klenow (2009) use microdata on manufacturing establishments to quantify the potential extent of misallocation in China and India compared to the United States. They show that when capital and labor are hypothetically reallocated to equalize marginal products to the extent observed in the United States, China and India can obtain manufacturing TFP gains of 30% to 50% and 40% to 60%, respectively.

224   Zhang National R&D Investment Gross R&D as a percent of GDP

5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5

19

95 19 9 19 6 9 19 7 9 19 8 9 20 9 0 20 0 0 20 1 02 20 0 20 3 0 20 4 0 20 5 0 20 6 0 20 7 08 20 0 20 9 1 20 0 11 20 12 20 1 20 3 14

0.0

S. Korea

Japan

Germany

U.S.

Finland OECD

Taiwan China

EU-28

Source: OECD Main Science and Technology Indicators 2016. ©2016 AAAS

Figure 3.1.13  International comparison of R&D as percentage of GDP. R&D intensity (percentage of R&D expenditure in sales revenue), patents, and percentage of sales of new products of total sales revenue are widely used to measure the innovation of an economy or firm. Although each has its flaws,28 they are the best available data for use and together provide some useful information. Using these three indicators, China has indeed made considerable progresses in innovation in the past decade. The gross R&D expenditure as the percentage of GDP of China increased from 0.6% in 1995 to 2.11% in 2016. Although this percentage is still lower than South Korea, Japan, Finland, Germany, and the United States, China has been growing the fastest and passed the European Union average in 2012 (see Figure 3.1.13). Given China’s GDP size, its total R&D expenditure is already the second largest after the United States. Figure 3.1.14 shows that R&D intensity in the industrial sector increased from 0.60% in 1999 to 1.23% in 2016 for large and middle-​sized enterprises, and from 0.61% in 2008 to 0.94% in 2016 for all above-​designated-​size firms. Although this percentage is much smaller than that of developed economies (roughly 3% to 4%), the increase is significant. Figure 3.1.15

28 

R&D expenditure measures input and may be wastefully used; number of patents does not tell us the quality of patents, and most patents have no commercial value; and new products may be new only for concerned enterprises, not the economy. For the merits and drawbacks of each measure, see Taylor (2016, Appendix 3).

System Reform, Competition, and Innovation    225

Figure 3.1.14  R&D intensity of industrial sector (1998–​2016).

Index of Domestic Patents Granted (1990 = 1) 350.0 329.4

320.8

304.5

300.0

282.5 263.0

259.7

250.0

245.7 229.3

225.8

200.0 166.0

150.0

125.2

100.0 65.5

50.0 6.7 2.1 1.8 1.3

51.6 24.6 18.0 4.9 8.9 5.4 4.7 3.2

21.8 11.6 6.3

86.0 27.8 15.6

97.8

92.6

40.5 18.3

141.6 124.9

56.9 26.0 12.1

69.4 38.4 20.4

45.8 24.2

60.3 33.8

63.6 41.0

62.7 41.8

82.7 51.9

84.4 53.6

8.9 10.5 1.0 0.0 0.0 1985 1990 1995 2000 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Invention

Utility model

Design

Figure 3.1.15  Index of domestic patents granted (1990–​1991).

Total

226   Zhang Percentage of Sales of New Products in Total Sales Revenue In Industry (2008–2016) 22.0% 20.4%

20.0% 18.6%

18.0% 16.0%

17.3%

17.3% 16.6%

16.1%

16.0%

17.5%

16.3% 15.1%

14.0%

13.6%

12.0% 10.0%

11.9%

11.9%

12.5%

12.9%

10.4% 2008

2009

2010

2011

Large and middle-size

2012

2013

2014

2015

2016

Above designated size

Figure 3.1.16  Percentage of sales of new products in total revenue (2008–​2016). indicates that total granted domestic patents increased more than 84-​fold.29 Although it is widely known that Chinese patents are low quality compared to developed countries, the progress is impressive.30 In particular, invention patents increased 263-​fold, much higher than the total patents, and as a result, the share of invention patents in the total patents went up from 6% to 18.5%. Figure 3.1.16 shows that the percentage of sales of new products in total sales revenue increased from 11.9% to 15.1% for all above-​designated-​size and from 16% to 20.4% for the large and middle-​sized enterprises, respectively, between 2011 and 2016.31

The Origin of Innovation: A Cross-​R egional Comparison While economic reform has been a nationwide agenda of China, there have been considerable variations between different regions in terms of marketization and other reform measures over time. Leaders have moved far ahead of laggards in the overall transition to a market system. Factors that have affected the variation include the central government’s regional reform policies, the leadership and ideas of local authorities, geographical locations, 29  Patents granted to foreigners by the Chinese Patent Office are excluded. The share of total invention patents granted to foreign individuals and corporations in total decreased from 42.5% in 1990 to 10% in 2016. 30  Citation-​weighted indexes of patents are better measures of patent quality. Unfortunately, they are not available for Chinese patents. 31  Wei et al. (2017) provide more comprehensive data on China’s progress in innovation.

System Reform, Competition, and Innovation    227 Average Marketization Index (1997–2004) 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0

0.0

Zhejiang Guangdong Jiangsu Shanghai Beijing Tianjin Fujian Shandong Liaoning Chongqing Anhui Henan Sichuan Hubei Hebei Hunan Jiangxi Jilin Hainan Guangxi Heilongjiang Inner Mongolia Shanxi Yunnan Shaanxi Guizhou Ningxia Gansu Xinjiang Qinghai Tibet

1.0

Figure 3.1.17  Marketization indexes of different provinces. Source: National Economic Research Institute (Beijing) Marketization Database

richness of resources, development level, status quo of industrial ownership structures, cultures, and so on. Figure 3.1.17 presents average marketization indexes of 31 provinces between 1997 and 2014, and it shows the variation is indeed big. Given that China is a big country with many different regions,32 this variation of reform progress provides a good opportunity to test the relation between economic reform and innovation by a cross-​regional comparison. In the following, I  use various indicators of provincial-​level data to show how innovation of different provinces is correlated with their economic reform and competition.

Marketization and Innovation Figures 3.1.18 to 3.1.20 show that R&D intensity in industry, patents granted per capita, and percentage of sales of new products in total industrial revenue are all positively correlated with marketization indexes at the provincial level, and coefficients are statistically significant.33 In other words, the more marketized a province is, the more likely it has higher R&D intensity, more per capita granted patents, and higher percentage of sales of new products

32  China has 31 administrative provinces (including 4 municipalities and 5 ethnic autonomous regions), 334 prefectural regions (including 293 prefectural cities), and 2,851 counties. 33  Taking into account that the effect of marketization on innovation is lagged, I use here the marketization index of 2014 and the innovation variables of 2016. I also tested the corrections for other years; the results are very similar.

228   Zhang

Figure 3.1.18  Marketization and R&D intensity in industry across provinces.

Figure 3.1.19  Marketization and per capita patents granted across provinces.

System Reform, Competition, and Innovation    229

Figure 3.1.20  Marketization and new product sales across provinces. in total industrial revenues. This demonstrates that marketization is indeed an important driving force for innovation.34 Both competition and innovation depend upon development of factor markets because enterprises need both human resources and financial capital to compete with rivals through innovation. Figure 3.1.21 shows that R&D intensity is positively correlated to development of factor markets, and Figure 3.1.22 shows that per capita patents granted is positively correlated to the percentage of the nonpermanent household registration population, which reflects labor mobility. The two correlation coefficients are statistically significant.

Government Size and Innovation Figures 3.1.23 and 3.1.24 show that per capita patents granted across provinces is negatively and significantly correlated both to the per capita number of government entities and the percentage of public employment in urban units. In other words, the larger the government size, the less innovative a province is. This is the case because more government entities

34 An

alternative measure of marketization is “business environment indexes.” Using “Business Environment Indexes” compiled by the National Economic Research Institute (Beijing) for each province in 2008 and 2013, it is shown that R&D intensity, per capita patents granted, and percentage of sales of new products in total industrial revenue are significantly positively correlated with business environment indexes at the provincial level. The provinces with better business environments are more statistically innovative in terms of three measures of innovation.

230   Zhang

Figure  3.1.21 Development of factor markets and R&D intensity in industry across provinces.

Figure 3.1.22  Labor mobility and per capita patents granted.

System Reform, Competition, and Innovation    231

Figure 3.1.23  Number of government entity and patents granted per capita.

Figure 3.1.24  Share of public employment and per capita patents granted.

232   Zhang means both that more resources are used nonproductively and that government intervention is more pervasive.

Ownership Structure and Innovation Ownership structure is the most important determinant of competition in any national or regional economy. Generally speaking, the economies with higher shares of private enterprises and foreign-​invested enterprises and lower shares of SOEs are more competitive than the economies with the opposite ownership structure. This is the case for two reasons. First, SOEs have low-​powered incentive and have limited managerial autonomy; second, SOEs are likely to get more favorite support from the government. As a result, SOEs have lower incentive and lower pressure to be efficient and innovative. Naturally, the economies with a higher share of SOEs will be less competitive and less innovative. There are some empirical studies on comparing the SOEs and non-​SOEs of China in efficiency and innovation.35 Empirical findings are mixed.36 One reason is that the existing literature focuses only on the efficiency and innovation of each ownership type at the micro (firm) level and neglects the overall negative spillover effects of SOEs on efficiency and innovation at the macro (regional) level. Figures 3.1.25 to 3.1.27, using the shares of assets in industry as a measure of ownership structure, show that in terms of all three measures of R&D intensity, patents per asset, and percentage of new product sales in total revenue, the provinces with a higher nonstate sector and lower state sector are more innovative than the provinces with a lower nonstate sector and higher state sector. Although some correlation coefficients are not statistically significant, the overall relation between ownership structure and innovation is confirmed. In particular, all the coefficients with the share of foreign-​, Hong Kong–​, Macau-​, and Taiwanese-​invested enterprises are statistically significant.

Openness and Innovation Openness is also important for competition and innovation at the provincial level. Both competitiveness in international markets and survival in home markets of the enterprise at least partially depend on innovation.37 Figures 3.1.28 and 3.1.29 show that per capita

35 

See Jiang et al. (2013), Song et al. (2015), and Berkowitz et al. (2017), among others. Using firm-​level data, Fu et al. (2018) show that a mixed ownership (i.e., increasing state ownership in privately owned firms and reducing it in state-​owned firms) increases innovation in Chinese firms. Hu and Jefferson (2009) and Li et al. (2010) show that foreign investments have positive effects on China’s domestic firms’ innovation. Fu and Gong (2011) find that FDI exerted negative pressure on technical change in domestic firms in China. 37  However, empirical studies of firm-​level data give mixed results. Lim et al. (2018) show that scale effects of trade on innovation are positive in the aggregate, whereas its competition effects are negative. Liu and Qiu (2016) show that input-​tariff reductions in China have had negative effects on firms’ patent applications because high-​quality imports have substituted for internal innovation. Fu et al. (2018) show that the effects of import-​induced competition on innovation vary by a firm’s technology level and ownership type. 36 

System Reform, Competition, and Innovation    233

Figure 3.1.25  Ownership structure and R&D intensity in industry.

234   Zhang

Figure 3.1.26  Ownership structure and patents per asset in industry.

System Reform, Competition, and Innovation    235

Figure 3.1.27  Ownership structure and new products sales in industry.

236   Zhang

Figure 3.1.28  Trade and innovation.

Amount of FDI and Granted Patents Per 10000 Persons across Provinces (2016) 50

40 y = 7.8084ln(x) + 23.238 R² = 0.6118

30

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–10

Figure 3.1.29  FDI and innovation.

1.5

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System Reform, Competition, and Innovation    237 patents (applications or granted) are significantly and positively correlated both to ratio of trade/​GDP and per capita FDI. That is, the more open a province is, the more likely it is to be innovative.38

Concluding Remarks Although China has made great effort and some progress in innovation, it is far from an innovative economy. The high growth of the past four decades is mainly a result of improvement in allocative efficiency driven by entrepreneurial arbitrage. As the potential of pure allocative efficiency is exhausting, future growth will be more and more dependent on entrepreneurial innovation. So far, however, Chinese entrepreneurs are, to a large extent, still incentivized in arbitrage much more than in innovation. The reason is that the current economic, political, and legal systems of China are not innovation friendly. Given that technological innovation is of great uncertainty and much more time-​consuming, innovation is much more sensitive than arbitrage to freedom, property rights, and the rule of law. Entrepreneurs would have incentive to be innovative only if they expect that they can harvest long-​awaited fruits, which can be true only under the rule of law. China is neither yet a true market economy nor a rule-​of-​law country. For Chinese entrepreneurs to be really innovative and for China to be a real innovative country, abolishing the dominance of the state sector and putting the government under law are urgently called for. China must also modify certain specific laws and remove certain policies that create obstacles to innovation. In particular, the following measures should be taken.39 First, most of the industrial sector regulations should be abolished, since they are only good for rent-​seeking, not for value-​creating, let alone for innovation. Second, all ownership-​based discriminations in market access, financing, and subsidies must be removed. Only by so doing could a level playing field be established. Third, anti-​monopoly law should be modified to focus on the government-​imposed monopoly, rather than competitiveness-​based market power. Administratively discretional power of the anti-​monopoly officials must be restricted by judicial procedure. Fourth, industrial policy should be abolished completely. The industrial policy encourages entrepreneurs to do rent-​seeking and misleads them to overinvest in government-​favored industries. Industrial policy also causes seriously unfair competition. So far China’s industrial policy has done nothing good for innovation. It should be recognized that government has neither entrepreneurial competence to make nor the right incentive to implement an innovation-​friendly industrial policy. Last but not least, government should avoid using loose monetary policy to stimulate aggregate demand and rescue ailing firms, since this kind of policy can obstruct entrepreneurial innovation. According to Schumpeter’s theory, innovation is a process of eliminating “old” by “new.” Many innovating activities begin in the trough of recession.40 Utilizing monetary policy to 38 

Using other variables of innovation or separating export from import gives similar results. See Zhang (2017) for more discussion on policies harmful to innovation. 40 See Mensch’s (1978) Stalemate in Technology:  Innovation Overcome the Depression; also see Rosenberg (1994, 80–​83) for comments on Mensch’s arguments. 39 

238   Zhang stimulate aggregate demand will inevitably delay and obstruct this process of elimination, thus harming innovation and long-​term economic growth. What is the real danger is that since the global financial crisis, the Chinese government has become overconfident in its current economic and political system. The high economic growth of the past four decades is mistakenly attributed to the so-​called China Model.41 This overconfidence may delay necessary reform and destroy its possibility of becoming an innovative economy. Acknowledgments. The author is grateful to Xiaolan Fu for her helpful comments and to the Beijing Cairncross Economic Research Foundation for the financial support under the project “China’s Industrial Policy Research.”

References Aghion, P., N. Bloom, R. Blundell, R. Griffith, and P. Howitt, 2005. “Competition and Innovation: An Inverted-​U Relationship,” Quarterly Journal of Economics, Vol. 120, Issue 2, 701–​728. Berkowitz, D., H. Ma, and S. Nishioka, 2017. “Recasting the Iron Rice Bowl: The Reform of China’s State-​Owned Enterprises,” Review of Economics and Statistics, Vol. 99, Issue 4, 735–​747. Blundell, R., R. Griffith, and J. Van Reenen, 1999. “Market Share, Market Value and Innovation in a Panel of British Manufacturing Firms,” Review of Economic Studies, Vol. 66, Issue 3, 529–​554. Chen, K., G. Jefferson, T. Rawski, and H. Wang, 1988. “Productivity Change in Chinese Industry: 1953–​1985,” Journal of Comparative Economics, Vol. 12, 570–​591. Cohen, W., 2010. “Fifty Years of Empirical Studies on Innovative Activity and Performance,” In Handbooks of Economics of Innovation, Vol. 1, 129–​213. Elsevier B.V. Dollar, D., 1990. “Economic Reform and Allocative Efficiency in China’s State-​ Owned Industries,” Economic Development and Cultural Change, Vol. 39, 89–​105. Fu, X., and Y. Gong, 2011. “Indigenous and Foreign Innovation Efforts and Drivers of Technological Upgrading,” World Development, Vol. 39, Issue 7, 1213–​1225. Fu, X., G. Shen, and S. Huang, 2018. “Competition, Openness and Innovation in Emerging Economies: The Roles of Technology and Ownership.” Working Paper. Oxford University. Geroski, P.A., 1990. “Innovation, Technological Opportunity, and Market Structure,” Oxford Economic Papers, Vol. 42, Issue 3, 586–​602. Groves, T., Y. Hong, J. McMillan, and B. Nuaghton, 1994. “Autonomy and Incentives in Chinese State Enterprises,” Quarterly Journal of Economics, Vol. 109, Issue 1, 202–​226. Hashmi, A.R., 2013. “Competition and Innovation: The Inverted-​U Relationship Revisited,” Review of Economics and Statistics, Vol. 95, Issue 5, 1653–​1668. Hayek, F.A., 1948. “The Meaning of Competition.” In Individualism and Economic Order. 1976. London and Henley: Routledge and Kegan Paul. Hayek, F.A., (1960) 2011. The Constitution of Liberty. Chicago: University of Chicago Press. Hsieh, C., and P. Klenow, 2009. “Misallocation and Manufacturing TFP in China and India,” Quarterly Journal of Economics, Vol. 124, Issue 4, 1403–​1448.

41 

See Zhang (2019) for a criticism of the China Model.

System Reform, Competition, and Innovation    239 Hu, A., and G.H. Jefferson, 2009. “A Great Wall of Patents: What Is behind China’s Recent Patent Explosion?,” Journal of Development Economics, Vol. 90, Issue 1, 57–​68. Im, H.J., Y.J. Park, and J. Shon, 2015. “Product Market Competition and the Value of Innovation: Evidence from US Patent Data,” Economics Letters, Vol. 137, 78–​82. Jadlow, J.M., 1981. “New Evidence on Innovation and Market Structure,” Managerial and Decision Economics, Vol. 2, Issue 2, 91–​96. Jiang, L, D.S. Waller, and S. Cai, 2013. “Does Ownership Type Matter for Innovation? Evidence from China,” Journal of Business Research, Vol. 66, Issue 12, 2473–​2478. Kirzner, I., 1973. Competition and Entrepreneurship. Chicago: Chicago University Press. Knight, J., and L. Song, 2005. Toward a Labor Market in China. New York: Oxford University Press. Kraft, K., 1989. “Market Structure, Firm Characteristics and Innovative Activity,” Journal of Industrial Economics, Vol. 37, Issue 3, 329–​336. Li, J., D. Chen, and D.M. Shapiro, 2010. “Product Innovations in Emerging Economies: The Role of Foreign Knowledge Access Channels and Internal Efforts in Chinese Firms,” Management and Organization Review, Vol. 6, Issue 2, 243–​266. Lim, K., D. Trefler, and M. Yu, 2018. “Trade and Innovation: The Role of Scale and Competition Effects.” Working Paper. National School of Development, Peking University. Liu, Q., and L.D. Qiu, 2016. “Intermediate Input Imports and Innovations:  Evidence from Chinese Firms’ Patent Filings,” Journal of International Economics, Vol. 103, 166–​183. Lunn, J., 1986. “R&D, Concentration and Advertising:  A Simultaneous Equation Model,” Managerial and Decision Economics, Vol. 10, Issue 2, 101–​105. Mensch, G., 1978. The Stalemate in Technology: Innovation Overcome the Depression. Ballinger Publishing Co. Nickell, S. J., 1996. “Competition and Corporate Performance”, Journal of Political Economy, Vol.104, Issue 4, 724–​746. Qi, B., 2009. “China’s Capital Markets.” In Z. Min, C. Jinqing, and M. Avery (editors), China’s Emerging Financial Markets. Singapore: John Wiley & Sons (Asia) Pte Ltd. Rosenberg, N., 1994. Exploring the Black Box: Technology, Economics and History. Cambridge University Press. Schumpeter, J.A. 1934. The Theory of Economic Development. 1983 edition. London: Transaction Publishers. Schumpeter, J.A. 1943. Capitalism, Socialism and Democracy. Fifth edition, 1976. London: Routledge. Shen, H., and Z. Nong, 2012. China’s State-​Owned Enterprises:  Nature, Performance and Reform. Singapore: World Scientific Press. Simpson, B.P., 2005. Markets Don’t Fail. Lexington Books. Song, M., H. Ai, and X. Li, 2015. “Political Connections, Financing Constraints, and the Optimization of Innovation Efficiency among China’s Private Enterprises,” Technological Forecasting and Social Change, Vol. 92, Issue 3, 290–​299. Taylor, M.Z., 2016. The Politics of Innovation. New York: Oxford University Press. Wang, J., 2009. “Commercial Banking Reform.” In Z. Min, C. Jinqing, and M. Avery (editors), China’s Emerging Financial Markets. Singapore: John Wiley & Sons (Asia) Pte Ltd. Wang, X., F. Gang, and Y. Jingwen, 2017. Marketization Index of China’s Provinces (Zhongguo fensheng shichanghua zhishu baogao). Beijing: Social Sciences Academic Press. Wei, S.-​J., Z. Xie, and X. Zhang, 2017. “China’s Transition to a More Innovative Economy: Progress and Challenges,” Journal of Economic Perspective, Vol. 31, Issue 1, 49–​90.

240   Zhang Zhang, W., 1997. “Decision Rights, Residual Claim and Performance: A Theory of How China’s State Enterprise Reform Works,” China Economic Review, Vol. 8, Issue 1, 67–​82. Zhang, W., 2014. “The Future of Private and State-​Owned Enterprises in China.” In S. Fan, R. Kanbur, S.-​J. Wei, and X. Zhang (editors), The Oxford Companion to the Economics of China. Oxford University Press. Zhang, W., 2015. The Logic of the Market:  An Insider’s View of Chinese Economic Reform. Washington, DC: Cato Institute Press. Zhang, W., 2017. “China’s Future Growth Depends on Innovation Entrepreneurs,” Journal of Chinese Economic and Business Studies, Vol. 15, Issue 1, 19–​40. Zhang, W., 2019. “The China model view is factually false.” Journal of Chinese Economic and Business Studies, Vol. 17, Issue 3, 287–​311.

Chapter 3.2

Ref orm s of th e S c i e nc e and Technol o g y M anagem en t Syst e m Zhijian Hu, Zhe Li, and Xianlan Lin The ability of science and technology innovation (STI) governance determines the overall efficiency of the allocation of STI resources. China has focused on transforming government functions and eliminating institutional disadvantages that restrict the market from playing a decisive role in the allocation of resources in order to better support the development of a modern economic system and achieve innovative, coordinated, green, open, and shared development. In 2018, a series of institutional reform measures was implemented, including the reorganization of the Ministry of Science and Technology, and this had a profound impact on improving the country’s ability in STI governance. The Ministry of Science and Technology and the State Administration of Foreign Experts Affairs integrated their responsibilities, and the Ministry of Science and Technology now manages the National Natural Science Foundation of China. The newly formed Ministry of Science and Technology is responsible for formulating national innovation-​driven development strategy guidelines, organizing and implementing scientific and technological development, and basic research planning and policies. It will comprehensively promote the development and the reforms of national innovation systems, and will better organize and coordinate national major basic research and applied basic research. It also compiles the national major scientific and technological projects and supervises their implementation. It leads the establishment of a unified national science and technology management platform and scientific research project fund as mechanisms to coordinate, assess, and supervise. It is also responsible for the introduction of foreign intellectual work. All this is conducive to promoting the implementation of national innovation-​driven development strategies as a whole. It will centralize and coordinate resources such as science and technology investment, scientific and technological personnel, and scientific research bases around the innovation chain, and will produce and allocate high-​quality scientific and technological resources to economic activities.

242    Hu, Li, and Lin

Science and Technology Investment With respect to the science and technology investment system, China’s scientific and technological plans are evolving from nothing, to being excellent, to being unified. Since the reform and opening up, China has successively developed the Spark Program, the National Natural Science Foundation, the 863 Program, the Torch Program, the 973 Program, and the special research projects of different industries. The implementation of these plans has brought together the visionary insights of several generations of leaders and the wisdom and efforts of the scientific and technological workers of various periods. Facts have proved that these scientific and technological plans have lived up to their missions and have accomplished a large number of major scientific research achievements that have attracted worldwide attention. They have cultivated and pooled a large number of high-​level innovative talents and teams, and they have solved a large number of technical bottlenecks that have constrained economic and social development. The overall strength of China’s scientific and technological innovation has strongly supported the process of China’s reform and development. Various scientific and technological plans (special projects, funds, etc.) were set up at different times, lacking top-​level design and overall consideration, with numerous management departments, one for each stage. The project arrangement pursued being “big and complete,” which causes a scattering of the allocation of scientific and technological resources, divergence of planned goals, and disconnection of the innovation chain. In 2014, the Ministry of Science and Technology and the Ministry of Finance jointly formulated the Program on Deepening the Management Reform of the Central Government’s Science and Technology Plan (Special Projects, Funds, etc.) (hereinafter referred to as the “Reform Plan”), on the basis of fully soliciting the opinions of relevant departments (units) and experts. The Reform Plan proposes to optimize the layout of the central government’s financial science and technology plans, and integrate existing plans (special projects, funds, etc.) according to the five new categories by means of withdrawal, merger, transfer, etc. The number of plans was reduced significantly. The optimization and integration work is aimed at all scientific and technological plans through open competition and does not include special funds that provide the stable support of central-​level research institutions and universities. The newly formed five categories of science and technology plans (special projects, funds, etc.) have their own supporting priorities and distinctive management methods. They complement each other and form a cross-​plan coordination, assessment, and supervision mechanism through a unified national technology management platform. The mechanism ensures that the five categories of scientific and technological plans perform as an integrated whole, focusing both on priorities and on avoiding duplication. The National Natural Science Foundation mainly supports basic research and scientific frontier exploration; it also supports talents and team building, so as to enhance the source of innovation. The national scientific and technological major projects focus on national major strategic products and major industrialization targets, give full play to the advantages of the nationwide system, and tackle key problems through integrated collaborative research within a set time limit. The national key research and development

Reforms of the S&T Management System    243 (R&D) program is aimed at major social welfare research in the fields of agriculture, energy resources, ecological environment, and health that affect the national economy and people's livelihood, as well as the strategic, fundamental, forward-​looking major scientific issues; major common key technologies and products; and major international scientific and technological cooperation that concern the industry’s core competitiveness, overall indigenous innovation capability, and national security. They are organized and implemented by means of key special projects to strengthen interdepartmental, cross-​ industry, and cross-​regional R&D layout and coordinated innovation, so as to support and lead the growth of major areas in national economic and social development. Technical innovation guidance special funds take full advantage of their leverage role of fiscal capital through the use of risk compensation, postsubsidy, venture capital guidance, etc. Market mechanisms guide and support technological innovation activities and promote the transfer and industrialization of scientific and technological achievements. The special projects on innovation bases and talents focus on optimizing the layout and construction of scientific and technological innovation bases, promoting the opening up and sharing of scientific and technological resources, and supporting scientific talents and excellent teams, so as to improve the conditions and capabilities of China’s scientific and technological innovation.

Research Institutions In China, research institutes and institutions of higher learning are the main force of source innovation, carrying out a large amount of basic research, strategic high-​tech research, and major public-​welfare research according to the needs of national economic and social development and national security. Higher education institutions also shoulder the important mission of training high-​level innovative talent. At the same time, these institutions are also the main suppliers of scientific and technological achievements supported by public finance. These institutions are closely linked to whether the transformation of research results can be effectively realized. Since the founding of New China in 1949, China has established a large number of public scientific research institutions through financial input, laying a foundation for China’s development of science and technology. Since the reform and opening up, the updated classification of these scientific research institutions has become an important part of China’s science and technology system reform, of which the main practice is to continuously adjust the management system to allocate the scientific and technological knowledge to economic activities and social development. Generally speaking, China’s scientific research institutions fall into one of five categories (MOST, 2016, p. 60), namely, those affiliated to the State Council and the central ministries and commissions, to local government, to colleges and universities, to business subordinates, and to other types of scientific research institutions. At the beginning of the reform and opening up, there were more than 5,000 research institutes affiliated with the government at or above the county level in China, including more than 1,000 central-​level research institutes. After several rounds of reforms of the science and technology system, by 2016

244    Hu, Li, and Lin 4,000

45%

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Intramural Expenditure on R&D by Higher Education Establishments (100 million yuan) Intramural Expenditure on R&D by R&D Institutes (100 million yuan) Number of R&D Institutes Number of Higher Education Establishments Ratio of Institutes to National total (%) Ratio of Higher Education Establishments to National total (%)

Figure  3.2.1  Trends of numbers of institutes and higher education establishments with number, intramural expenditure, and ratio to national total. there were a total of 3,611 R&D institutions1 in China, of which 734 were in the central government and 2,877 in the locality; 13,062 research institutions have been established in 2,596 colleges and universities.2 From the perspective of development trends, the number of R&D institutions and universities is relatively stable; the former has increased slightly, and the latter has declined slightly. The internal R&D expenditures of both have increased substantially, but the proportion of domestic R&D expenditures has declined, especially in government R&D institutions. They respectively accounted for 14.4% (about 42% between 1995 and 1998) and 6.8% of the total in 2016 (Figure 3.2.1). From the perspective of the types of R&D activities, China’s R&D institutions and universities have carried out basic research and application development. However, in terms of experimental development, the R&D expenditure of universities is significantly lower than that of R&D institutions, while the latter is far lower in R&D spending than enterprises (Figure 3.2.2). 1 

The description “research and development institution” was adopted in National Bureau of Statistics (NBS) and Ministry of Science and Technology (MOST), yearly published, the China Science and Technology Statistical Yearbook, China Statistics Press. 2  R&D institutions in universities are often not independent legal entities, unlike the central and local R&D institutions.

Reforms of the S&T Management System    245 3,000 2,500 2,000 1,500

1,281

1,000 500

642 369 26

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432

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528 111

0 Enterprises Basic Research

R&D Institutes Applied Research

Higher Education

Experimental Development

Figure 3.2.2  Intramural expenditure on R&D by performer in China (2016) (100 million yuan). One of the representatives of the Central Research Institute is the Chinese Academy of Sciences, founded in 1949. At present, the Chinese Academy of Sciences has more than 100 directly affiliated research institutions and more than 50,000 scientific research personnel, and it is an important part of China’s innovation system. In recent years, the Chinese Academy of Sciences has further deepened the pilot work of knowledge innovation projects and successively launched the “Innovation 2020” plan and the “First Action Plan” to carry out reforms concerning the development of a modern institution system, the promotion of scientific and technological management reform, the improvement of the academician system, and the evaluation system for science and technology (MOST, 2016, p. 54). In recent years, China’s provincial and municipal governments have established a number of industrial technology development institutions, and their institutional mechanisms and management innovations are becoming a force to be reckoned with in China’s scientific research activities. Compared with traditional scientific research institutions, these institutions have the following distinctive features: First is the diversification of investment entities. They have been established by enterprises, universities, and institutions and are jointly funded according to the agreement. The board of directors is responsible for decision making, and the director of the institute is responsible for the daily operations. The second feature is the allocation of production factors of scientific research such as technology, capital, talents, equipment, venues, etc., by means of the market, so as to form a system and model that integrates domestic and foreign innovation resources, as well as industry, university, and research institutions. Third, in terms of employment, project management, financial accounting, evaluation, and transformation of research results, a management mechanism similar to a corporate management system has been adopted. Fourth is the aim to design the organizational structure around the needs of regional economic and social development, to clarify R&D tasks and carry out R&D activities, and to emphasize the participation of users in the R&D process so that R&D always meets the market demands. The fifth is to be open to the world and select talents through an open competition mechanism and openly recruit them from around the world.

246    Hu, Li, and Lin

Research Funds In China, a large number of scientific research institutions are public institutions. Some of their funds come from various projects and others from the finances allocated by the government (Li, 2016, pp. 117–​121). Project funding is very important for stimulating competition and mobilizing the vitality of researchers, while the operating costs are the basis for maintaining the stability of the research team. With regard to the scientific research expenses of various research institutes, they were listed in the Provisional Regulations on the Management of Scientific Expenses published in 1987. According to the principles set by the Decision of the Central Committee of the Communist Party on the Reform of the Science and Technology System and the Provisional Regulations of the State Council on the Management of Scientific and Technological Appropriations, scientific research units are divided into such types as technology development, basic research, social public welfare undertakings, technical foundations, and agricultural scientific research by the characteristics of their main scientific and technological activities. In terms of funding sources, scientific research institutions that mainly engage in technological development and applied research that is expected to acquire practical value in the near future will gradually implement a technology contract system; scientific research units that mainly engage in basic research and applied research that are unlikely to achieve practical value in the near future will gradually implement a fund system. Research institutions that mainly engage in social public welfare undertakings such as medicine and health, labor protection, family planning, disaster prevention, and environmental science, and those that mainly engage in technical basic work such as information, standards, measurement, and observation, or that engage in agricultural scientific research, in principle, will adopt an expense package system. The proportion of research expense depends on the availability of funding from other sources. The scientific research expenses of various types of scientific research units are calculated in a unified manner with other sources of funds, with classified budget management. Scientific research units focusing on technological development implement difference budget management; scientific research units focusing on basic research implement full budget management. As for research institutes focusing on social welfare services and other social services, the scientific research expense is still allocated by the central government, and related to the tasks, under the principle of full budget management and the expense package system. For the scientific research units related to a variety of activities, their scientific research expense is separately managed in accordance with the classification and proportion of scientific and technological activities. The budget funds of various types of scientific research units are managed at different levels.

The Enterprise Transformation The reform of the enterprise transformation system was started with the research institutions affiliated with the ministries. Chinese research institutes experienced substantial

Reforms of the S&T Management System    247 adjustment to restructure the layout and optimize the allocation of scientific and technological resources; 242 scientific research institutes affiliated with 10 national bureaus were transformed into enterprise-​based systems. On April 12, 1999, the General Office of the State Council published the Notice of the Ministry of Science and Technology and Other Departments on the Reform of the Management System of the Scientific Research Institutions of the 10 National Bureaus Administered by the State Economic and Trade Commission; 242 scientific research institutions affiliated with the internal trade bureau managed by the former State Economic and Trade Commission, Coal Bureau, Machinery Bureau, Metallurgical Bureau, Petrochemical Bureau, Light Industry Bureau, Textile Bureau, Building Materials Bureau, Tobacco Bureau, Nonferrous Metals Bureau, and another 10 national bureaus reformed their management system. According to the requirements of the notice, and based on the overall requirements for industrialization and practical conditions, these 242 scientific research institutions independently selected their modes of reforms, including either transformation into technology-​based enterprises, merging into other enterprises, or converting to technical services intermediaries. A few scientific research institutions that have been approved by the central government to continue to retain the nature of public institutions must also introduce the operating mechanism of scientific and technological enterprises. In recent years, some major problems faced by research institutes and institutions of higher learning have affected the efficiency of scientific and technological innovation (Li, 2017, pp. 177–​182). On the one hand, there is no targeted guidance based on the characteristics of different innovation activities, resulting in unclear positioning and insufficient vitality. For example, the reform policy of the institutes is inappropriate. The management of public-​welfare institutions is rigid. The industry positioning is unclear after the transformation of institutions focusing on applied R&D, with their services weakened. The scientific research system of higher education institutions needs to be improved. On the other hand, due to the imperfect mechanism on achievements’ commercialization, it is difficult for scientific and technological achievements to effectively meet market demands. For example, the process of project initiation and research has not been effectively connected with the market, so that the adaptability of the research results is not strong, resulting in difficult transformation in the later stages. Many universities and scientific research institutions simply evaluate the scientific and technical personnel by the number of papers and project funds, and insufficient attention has been paid to the transformation of achievements; the incentive policies for the transformation of science and technology achievements during the work have not been implemented, which has affected the enthusiasm of the scientific and technological personnel. In response to these problems and new demands, China’s science and technology management policy hotspots have three clear features. First, they clarify the positioning of different types of research institutes and improve the governance level of the institutes. As for the public welfare institutions, to improve the mechanisms and stimulate the vitality, it is clearly necessary to formulate the charter, to explore the corporate governance structure with the board system as the core, to abolish the administrative level, to standardize the management of leaders, to implement the internal management autonomy, to increase the number of institute directors through global recruitment, and to establish a performance evaluation and suitable performance system. For

248    Hu, Li, and Lin applied R&D institutes, the policy emphasizes classification reform while insisting on enterprise transformation, with “collectivization” and “marketization” as important directions for reform. Among them, the institutes that undertake ordinary industry business can set up industrial technology groups, carrying out classified management and classified assessment on common technology research and market operation activities of the industry. For institutes based on market operations, reform should be deepened by introducing social capital or overall listing. For new types of R&D institutions, the “Implementation Plan” proposes to encourage its socialization and nonprofit operation and to formulate policies for macroguidance. Second, they improve the scientific research system of higher education institutions and establish a network of R&D and services. This reform requires a broader perspective, from the discipline setting, evaluation, and personnel development to the construction of scientific research bases. For example, to develop the world’s leading universities and first-​class disciplines, Chinese higher education institutions should be in line with the international standards, by designing a professional setting and establishing corresponding dynamic adjustment mechanisms, so that the discipline evaluation is structured in line with international first-​class standards. Reforms on scientific research and organization of institutions of higher learning have started and include carrying out pilot projects for independent R&D and promoting reform in employment systems for researchers. At the same time, it is necessary to optimize the layout of national laboratories, key laboratories, engineering laboratories, and engineering (technical) research centers and to integrate them according to functional positioning, so as to build an open, shared, and interactive innovation network, through which the research base set up by public investment can provide a wider service to the economy and society. Third, they should open up the channels for results’ transformation through which to create wealth. By implementing the “trilogy,” namely, amending the law, introducing the implementation plan (State Council, 2016-​16), and transforming research results (State Council, 2016-​28), the central government will improve the system of utilization, disposal, and income management of scientific and technological achievements from institutions of higher learning, research institutes, the state-​owned enterprises, and public institutions, as well as increase incentives for scientific research personnel to transform scientific research results, so as to build a service support system. For example, on the basis of promoting the revision of the Law on Promoting the Transformation of Scientific and Technological Achievements, it is committed to improving the supportive policy system and service system through the system engineering approach, emphasizing the incentives for people, the operability of the system, and the convenience of transformation. In this way, the reform policy related to promotion, use, disposal, and income management of research results was put forward systematically, and the equity and dividend incentive policies were implemented (MOF and STA, 2016-​101). An incentive payment of on-​duty invention and the payroll management system were improved, and the intangible assets management system of public institutions was explored. Transfer exemption policies of technology-​based state-​owned shares were formulated, and a technology transfer system in universities and research institutes was improved. The implementation

Reforms of the S&T Management System    249 of these specific reform measures will bring the transfer of scientific and technological achievements to a new level.

Scientific Research Talents Talent evaluation and incentives are the core of the talent policy and play a role of “baton” and “wind vane” for scientific and technological personnel and activities. For a long time, the talent evaluation and incentive mechanism have been the subject of the most heated discussion by the Chinese scientific and technological community, especially by the employer institutes. For example, the title evaluation system, originally restored in the early stage of reform and opening up as an important measure of “respecting knowledge and respecting talents,” has gradually evolved into a set of national unified talent evaluation systems led by government personnel departments and business departments (or local government) after more than 30 years of practice. With the rapid development of China’s science and technology cause and the fierce competition in the science and technology field around the world, it has become more and more difficult to adapt to the needs of employers and to the development of scientific and technical personnel. In response to these problems, on the one hand, the classified evaluation of scientific and technical personnel was implemented, so as to establish a capacity-​and contribution-​ oriented evaluation and incentive mechanism, which is typically reflected in the Opinions on Implementing the Policy of Adding Knowledge Value-​Oriented Distribution issued in November 2016. It proposes that the income distribution mechanism should increase the value of knowledge, a stable growth mechanism for performance wages should be established, and contract management for targeted application-​oriented scientific research projects should be gradually implemented. As for social science research institutions and think tanks, a government procurement service system was implemented. At the same time, the autonomy of income distribution for scientific research institutions and colleges was expanded, and for those who engage in basic research, agriculture, and social welfare research, their basic wages were steadily increased. For those who engage in applied research and technology development, their incentives and rewards were mainly realized through the market mechanism and the performance of scientific and technological achievements transformation; for those who engage in philosophy and social science research, the evaluation was based on theoretical innovation, decision-​making consultation, and social influence, so as to develop a reasonable compensation and incentive mechanism for intellectual labor. On the other hand, the reform of the science and technology reward system was deepened, and the rewards encouraged. For example, the recommendation nomination system was gradually improved, highlighting the incentives for outstanding innovation teams and young talents who have made major scientific and technological contributions. The awards set by social forces were guided and standardized, and guidance was formulated on encouraging social forces to establish science and technology awards.

250    Hu, Li, and Lin

Scientific Research Bases At present, Chinese research institutions and universities are experiencing new issues. For example, the Chinese government will take the construction of national laboratories as the starting point to enhance national strategic scientific and technological strength (Xi, 2016, p. 10). The national laboratory will focus on major scientific and technological tasks and large-​scale science and technology infrastructure, as well as integrate national innovation resources relying on the most advantageous innovation fields, to establish a new operational mechanism with goal orientation, performance management, collaborative research, and open sharing. In this way, the national laboratory should be built with features oriented by scientific originality and cooperation (Xi, 2016, p. 10), which reflects the major adjustment to the layout of national scientific research forces in order to realize the long-​term development goals. Another example is the optimization and integration of scientific research bases. In August 2017, the Ministry of Science and Technology, the Ministry of Finance, and the National Development and Reform Commission issued the “Optimization and Integration Plan for National Science and Technology Innovation Bases, which requires optimizing and integrating various national STI bases.3 The National Science and Technology Innovation Base was developed according to the three categories of layout, namely, scientific and engineering research, technological innovation and achievement transformation, and basic support and conditional guarantee. After optimizing and integrating, it will also change the existing operational management mechanism. First, management methods, evaluation standards, and selection mechanisms will be developed, which are compatible with the characteristics of the base, so as to develop a talent evaluation system that focuses on results and contributions. Second, assessment will have a policy-​oriented role, in order to establish an evaluation index system consistent with the development goals of the national STI base. Its dynamic will be adjusted frequently, so as to achieve a virtuous circle of progress in the construction of the base. Third, the classified and stable supporting method and mechanism will be further improved, so as to strengthen the convergence of performance appraisal and financial support. For example, the national STI bases regarding science and engineering research, basic support, and conditional guarantees should highlight stable financial support. The central budget should firmly support the operation and capacity building of national key laboratories. National STI bases regarding technological innovation and achievement transformation should give full play to the decisive role of the market in allocating resources. Government guidance and third-​ party assessment should be strengthened, to support capacity building of the innovation bases by providing subsidies for support after R&D activities.

3  This policy defines the national science and technology innovation base as follows: it is an important component of the national innovation system according to national strategic needs, scientific frontier development, and industrial innovation and development needs. It carries out basic research, R&D of industry-​wide key technology, scientific and technological achievements’ transformation and industrialization, science and technology resource-​sharing services, and other important scientific and technological innovation activities.

Reforms of the S&T Management System    251 At the same time, new explorations are being carried out regarding the autonomy of research institutions and universities. In 2017, seven departments including the Ministry of Science and Technology jointly issued a pilot work plan and conducted pilot projects in 44 central-​level universities and research institutes. By enforcing and expanding the autonomy of the pilot units regarding research project funding, research results transformation, institutional development, cadre personnel, and salary distribution, the enthusiasm of universities, research institutes, and scientific and technological personnel will be stimulated.

Current Achievements and Future Directions Focusing on three tasks, namely, optimizing the allocation of scientific and technological resources, mobilizing the enthusiasm of scientific researchers, and improving the STI governance system, the reforms of the science and technology management system in China have achieved substantial breakthroughs. For instance, the management reform of the central government’s financial science and technology plans has made decisive progress. Nearly 100 science and technology plans scattered throughout more than 40 departments have been integrated into a new five-​category planning system, and an open and unified national science and technology management platform has been established. Strengthening the open sharing of scientific and technological resources, 73,000 large-​scale scientific research instruments and 139 major scientific and technological infrastructures are open to the public, and more than 100,000 national science and technology reports have been put online. A distribution policy that is oriented to increase knowledge value has been implemented, management policies’ scientific research projects and funds have been improved, pilot projects to expand the autonomy of universities and research institutes have been carried out, and evaluation processes on projects, talents, and institutions have been streamlined. To optimize national STI governance, the Chinese government has deepened the reform of the science and technology reward system, improved the academician system and the national technology forecasting and innovation investigation system, and established a national major scientific and technological decision-​making consultation system. In addition, the government has encouraged the maintenance of scientific research integrity and created a sound academic ecology. With the in-​depth implementation of the “Outline of the National Science Quality Action Plan,” the proportion of Chinese citizens with scientific quality4 reached 8.47% in 2018. Regarding future challenges, the process of the reforms of the science and technology management system in China still needs to be accelerated. In particular, for the management

4  Based on the action plan, scientific quality refers to the ability to understand the necessary scientific and technological knowledge, master the basic scientific methods, establish scientific ideas, advocate scientific spirit, and apply them to deal with practical problems and participate in public affairs.

252    Hu, Li, and Lin reform of scientific research institutions, those kinds of applied research institutes should accelerate the legalization. An objective fact is that traditional research institutes have long been attached to a certain enterprise or group of enterprises, engaging in scientific argumentation and technological R&D directly related to enterprises; or they have been affiliated to government departments at all levels, accepting administrative instructions to carry out scientific research activities; or they have been nationally funded, carrying out scientific research activities around the national and government’s ruling and service functions, under national financial support; or they have been related to the characteristics of public goods, manifesting as a public welfare system. These facts have led research institutes to survive by being attached to other institutional forms. The research institute system, as a concept, is a growing form of economic organization, concealed, replaced, or even overwhelmed by other forms of economic organization (Qiao, Wang, and Hao, 2011, p.  2). From this point of view, the development of policies and regulations of scientific research institutions still has a long way to go. It is necessary to rationally define, adjust, and standardize the rights and obligations in the field of scientific and technological innovation through policies and regulations, especially for various types of scientific research institutions funded by the government, such as science and technology institutions, social service agencies, etc. It must be recognized that the science and technology foundation in China is still weak and its capability for scientific and technological innovation is yet to be enhanced. To achieve future tasks, China needs to enhance basic research so as to make breakthroughs in key technologies, in order to strengthen the development of innovation systems by measures such as developing national laboratories and scientific infrastructures. It needs to accelerate the internationalization of its STI to further the supply-​side structural reform; it should also speed up the development of new kinetic energy and foster a culture of innovation as well as cultivate innovative talents. All these tasks cannot be successfully achieved unless the reforms of the science and technology management system in China continue to be developed.

References Li, Zhe. From “Bold Absorption” to “Innovation Drive”:  Evolution of China Science and Technology Policy. Beijing: Science and Technology Literature Press, 2016, pp. 117–​121. Li, Zhe. “Hotspots and Reflections on Science and Technology Innovation Policies.” Studies on Science of Science, 2017, 35(2): 177–​182. Ministry of Finance (MOF) and State Taxation Administration (STA) (2016-​101). Notice on the Improvement of Equity Incentives and Technology-​Related Income Tax Policies. Ministry of Science and Technology (MOST) (2016). Report on the National Innovation System Development 2014, Beijing: Scientific and Technical Literature Press, pp. 54, 60. National Bureau of Statistics (NBS) and Ministry of Science and Technology (MOST). The China Science and Technology Statistical Yearbook. Beijing: China Statistics Press, yearly published. Qiao, Chuanfu, Wang, Laiwu, Hao, Shujun, et al. Research on the System of Modern Scientific Research Institutes in China. Beijing: Economy Science Press, 2011, preface, p. 2.

Reforms of the S&T Management System    253 State Council (2016-​16). Notice of the State Council on Printing and Implementing Certain Provisions of the People’s Republic of China on Promoting the Transformation of Scientific and Technological Achievements. State Council (2016-​28). Notice of the General Office of the State Council on Printing and Distributing Action Plan for Promoting the Transformation of Science and Technology. Xi, Jinping. “Strive for Building a Science and Technology Power,” Speech at the National Science and Technology Innovation Conference, Conference of CAS and CAE, and the Ninth National Congress of China Association for Science and Technology. Beijing: People Publishing House, 2016 edition, p. 10.

Chapter 3.3

M ass Entrepre ne u rsh i p and M ass In novat i on in Ch i na Jian Gao and Rui Mu Introduction The concept of mass entrepreneurship and innovation was first proposed by Chinese premier Li Keqiang in 2014 at Summer Davos, with the intention to create a better environment for enterprises and individuals through delegation of power to lower-​level governments, simplification of administration, improvement of the capital market, and different types of financial support. More specifically, the concept of mass entrepreneurship and innovation aims to stimulate business development and an entrepreneurial spirit among the general public, expand employment opportunities, increase personal income, and facilitate social and economic mobility (Liu et al., 2018). To have a comprehensive understanding of the mass entrepreneurship and innovation initiative in China, this chapter first reviews the literature on entrepreneurship in China as well as the social-​economic background of entrepreneurship and innovation. Subsequently, the chapter elaborates on the policies and measures implemented by the Chinese government to promote the mass entrepreneurship and innovation initiative and analyzes the measures and polices from the perspective of the entrepreneurial ecosystem. Lastly, the chapter concludes that the mass entrepreneurship and innovation initiative is an innovative reform on the institutions and mechanisms of entrepreneurship and innovation in China, as significant improvements have been seen since its implementation. We want our readers to gain a general idea of what the mass entrepreneurship and innovation initiative is and how it was formed. Moreover, we want to depict a picture of what exactly the mass entrepreneurship and innovation initiative does and our understanding of the mass entrepreneurship and innovation initiative.

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The Background of Mass Entrepreneurship and Innovation in China Entrepreneurship in China: The Literature Entrepreneurship research has grown significantly and received greater academic legitimacy in recent decades (Frank and Landstrom, 2016; Bruton et al., 2008). Although different entrepreneurship research has different themes, concepts, and perspectives, the characteristics of entrepreneurs, the influence of institutions and social networks on entrepreneurship, and the comparative studies of entrepreneurship across different regions have drawn the most attention from scholars (Aldrich, 2000; Welter, 2011; Terjesen et al., 2013). As in other research regarding management and strategy, entrepreneurship research is context based (Meyer, 2006); socioeconomic and cultural environments will influence entrepreneurial activities. As Zahra (2007) indicated, context is what gives entrepreneurship research complexity, uniqueness, and richness. In this chapter, we will focus our literature review on the Chinese context. The entrepreneurship research in China started in the late 1990s (Li and Matlay, 2006), because private sectors in China have only been permitted since the 1980s. By reviewing the existing literature in this field, we can see that the characteristics of entrepreneurial activity, the impact of institutional changes, and the unique social context in China are the most debated topics.

Characteristics of Entrepreneurial Activity in China The Global Entrepreneurship Monitor (GEM) is an important data source and analytical framework for research on the characteristics of entrepreneurial activities in China, and many scholars performed this research from different perspectives or in different regions (Ahlstrom and Ding, 2014; Zhang et al., 2016; Au and Kwan, 2009; Tsai et al., 2016; Meyer, 2017). According to GEM research in China, entrepreneurial activities in China have been active in the last 15 years, and the quality of entrepreneurship has been improving gradually. Entrepreneurship can be classified as opportunity motivated or necessity motivated. Those who are pulled to entrepreneurship by opportunity and because they desire independence or to increase their income are opportunity-​motivated entrepreneurs, while those who are pushed to entrepreneurship out of necessity or those who sought only to maintain their income are necessity entrepreneurs (Reynolds et al., 2001). The proportion of opportunity-​ motivated entrepreneurship has increased from 51% in 2009 to 71% in 2016. Meanwhile, the industry sectors that entrepreneurs are participating in are changing in China. There is a clear trend showing that more entrepreneurs have started in the information and communications technology (ICT), finance, and professional service sectors compared to a decade ago, which means the industrial structure is upgrading. With regard to the impact of entrepreneurial activities, job creation, the level of innovation, and the orientation of internationalization have also been enhanced. Entrepreneurship is expected to bring job opportunities (Foelster, 2000). The percentage of entrepreneurs who anticipated

256   Gao and Mu adding 10 or more employees in the next five years was 16% in 2009 and increased to 23% in 2016. Innovation represents newness to a market and within an industry. In 2009, only 20% of entrepreneurs considered their products or services new to at least some customers and offered by few or no competitors. This figure increased to 29% in 2016. Lastly, the proportion of overseas customers of startup companies increased from 1% in 2009 to 8% in 2016. Considering the motivation, industry sector participation, level of innovation, job creation, and international orientation of entrepreneurship, the GEM data shows that the quality of entrepreneurship in China is improving.

The Institutional Context in China The institutional context, including formal institutions such as laws and regulations as well as informal institutions such as social norms and attitudes, has a significant influence on entrepreneurship (North, 1990; Chiles et al., 2007). Good institutions can facilitate entrepreneurial activities by providing supportive policies, complete legal protection, and favorable atmospheres, while weak institutions impede the development of entrepreneurship through factors such as rent-​seeking and political and legal uncertainty. Therefore, institutional context is recognized as an important theoretical foundation for exploring a wide variety of topics in entrepreneurship (De Clercq et al., 2010). The institutional context in China has changed dramatically in the last four decades. Before the 1980s, China was a centrally planned economy and private sectors were restricted during that time. After the opening-​up policy had been released, the economic structure in China transformed into a market-​oriented economy and the private firms gradually acknowledged their legitimacy. Along with the rapid economic development and integration into the world economy in the new century, the government policies toward entrepreneurship began to change from a relaxation of constraints to proactive encouragement (Su et al., 2015). Given the remarkable changes in the institutions and the unique social-​economic system in China, much entrepreneurship research has debated the institutional context of China with regard to government regulations, funding channels, entry barriers, property rights, legal systems, and so on (He et al., 2019; Zhuang, 2005; Elston et al., 2016; Huang et al., 2016; Zhou, 2014; Fuller, 2010). Although the national institutional environment in China was not favorable to the private entrepreneurial sectors before the mass entrepreneurship and innovation initiative, entrepreneurship as well as the economy developed rapidly in China (Zhou, 2011). Several institutional constraints confronted the private sectors. First, many industries in China have entry barriers for the private sectors, such as oil, petrochemicals, aviation, steel, coal, finance, telecommunications, and railway. According to National Development and Reform Commission (Wang, 2010), private firms were still allowed to enter only 41 out of more than 80 total industries in China by 2009. Second, the private entrepreneurial sectors had difficulty accessing many critical resources, such as capital and land. State-​owned enterprises still preferentially obtained bank financing and other resources from both the formal regulations and informal institutions. Furthermore, the government bureaucracy and insecure property and contractual rights were also concerning for the private sector. Although the private entrepreneurial sectors encountered all these disadvantages, as we stated earlier, entrepreneurship in China still developed smoothly and rapidly. The implementation of the mass entrepreneurship and innovation initiative will make the institutional context of entrepreneurship in China even more interesting.

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The Unique Social Network in China Theoretically, the social network is a part of informal institutions. However, it is unique and important for the development of entrepreneurship in China. In Chinese culture, individuals are strongly related to their family members and friends, and interpersonal relationships (guanxi) are extremely important for entrepreneurship. A long and vibrant literature on social capital (guanxi) suggests that social capital not only has a different character in China but also influences resource acquisition, investment decisions, business opportunities, and competitive advantages (He et al., 2017; Park and Luo, 2001; Sorenson, 2017; Wang, 2016; Zhang, 2015). In many circumstances, the social network is essential for obtaining scarce resources as well as for dealing with bureaucratic issues in China (Talavera et al., 2012). Therefore, this unique social network is another important context that should be considered by researchers on entrepreneurship.

The Background of Mass Entrepreneurship and Innovation Policy Along with the economic development in China, entrepreneurship and innovation have been regarded as the twin engines for future development, and the mass entrepreneurship and innovation initiative has been regarded as a national strategy with “innovation-​ driven development.” Why has the mass entrepreneurship and innovation initiative been so emphasized by the government? The following social-​economic background will reveal the answer.

An Irreplaceable Engines for Future Development As Chinese president Xi Jinping noted at the 2016 G20 Hangzhou summit, “The growth drivers from the previous round of technological progress are gradually fading, while a new round of technological and industrial revolution has yet to gain momentum”; China needs entrepreneurship and innovation as new engines for future development. With the rapid development in the last few decades, the economic structure and mode of development have to be changed from excessive reliance on natural resources to reliance on human capital; therefore, an innovation-​driven development strategy must be implemented.

An Effective Way to Increase Employment and Enrich People China has a population of 1.3 billion, putting large pressure on employment opportunities. However, the population also provides an opportunity to transform rich human resources into human capital. According to Premier Li Keqiang’s speech at the Summer Davos opening ceremony in 2016, among the 1.3 billion population, over 900 million are in the labor force and over 170  million have received higher education or acquired specialized skills. Meanwhile, China produces over 7  million college graduates and over 5  million graduates from secondary vocational schools every year. In addition, China also has the largest number of science professionals in the world. All those numbers represent an infinite source of entrepreneurship and innovation. The nature of mass entrepreneurship and

258   Gao and Mu innovation is creating more entrepreneurial opportunities for science and technology–​ based professionals, college graduates, migrant workers, retired veterans, and the unemployed. By starting up their own businesses, not only can their quality of life and overall standard of living be enhanced, but also communities can be uplifted and supported.

An Ideal Method to Reinforce Entrepreneurial Culture Entrepreneurship and innovation need institutional supports. China is an emerging economy, the social perception toward entrepreneurship and innovation is relatively weak. Mass entrepreneurship and innovation initiative provides an ideal opportunity to cultivate an entrepreneurial spirit and culture in China, such as encouragement of innovation and tolerance of failure. Aside from the social perceptions, the entrepreneurs’ self-​ perceptions regarding their capabilities in entrepreneurship and innovation also need to be improved. According to the GEM research in China, entrepreneurial education, especially in primary and secondary schools, as well as research and development transfers are the weakest aspects of the entrepreneurial environment in China. Building a multilevel entrepreneurial education and training system and promoting an entrepreneurial culture will improve entrepreneurs’ competence and enhance the social values of entrepreneurship. Consequently, it will support the development of entrepreneurship and innovation in the long run.

The Policies and Measures of Mass Entrepreneurship and Mass Innovation After elaborating on the background of the mass entrepreneurship and innovation initiative, we will illustrate the policies and measures that have been implemented by the government to answer the question, “What does the mass entrepreneurship and innovation initiative do?” Since the mass entrepreneurship and innovation initiative was first introduced in 2014, hundreds of government policies and initiatives have been issued. Among those government policies, the “Opinion on Significantly Promoting Mass Entrepreneurship and Innovation,” issued in 2015, and the “Guideline to Further Strengthen the Implementation of Innovation-​Driven Development Strategy and Reinforce the Spirit of Mass Innovation and Entrepreneurship,” issued in 2017, are the most significant, comprehensive, and representative.

Opinion by Government The “Opinion on Significantly Promoting Mass Entrepreneurship and Innovation” is the first comprehensive and systematic initiative issued by the State Council to boost mass entrepreneurship and innovation. The specific measures in the opinion were originally classified into nine categories, and we regroup them into four main aspects.

Mass Entrepreneurship and Mass Innovation    259 First, the government is determined to innovate its institutional mechanism to facilitate mass entrepreneurship and innovation. These measures include creating a better environment for fair competition, deepening business system reforms, strengthening intellectual property protection, and establishing a mechanism for the training and hiring of talented professionals. Moreover, the initiative also asks various levels of government bodies to strengthen their leadership and coordinate with each other to ensure the implementation of supportive policies and measures. Second, the government will optimize financial policies and further develop financial markets to support mass entrepreneurship and innovation. To be specific, the fiscal and taxation ministries are asked to strengthen financial support policies, improve inclusive financial measures, and implement more government purchases. Furthermore, the government will expand various forms of financial instruments to help the startup companies access capital, including the bond market, venture capital, and innovative banking services. Third, the government is aiming to develop entrepreneurial services and build an entrepreneurial ecosystem. Business incubators, third-​ party professional organizations, Internet Plus services, and other newly public services should be prioritized. Public platforms for innovative technologies and entrepreneurship are also highly recommended. Lastly, the government wants to stimulate the vitality of entrepreneurship and expand the channels for entrepreneurship to increase employment. The government is encouraging research staff, college graduates, and those who returned from overseas as well as expatriates to start their own businesses in China. Moreover, the government will also support the development of e-​commerce in rural areas and encourage rural residents to open businesses in their hometowns and optimize public services for entrepreneurship in rural areas. In summary, the “Opinion on Significantly Promoting Mass Entrepreneurship and Innovation” is a systematic, synthesized initiative containing various measures to boost entrepreneurship and innovation with regard to the institutions, financing, related services, and vitality of entrepreneurship.

Government Guideline “The Guideline to Further Strengthen the Implementation of Innovation-​ Driven Development Strategy and Reinforce the Spirit of Mass Innovation and Entrepreneurship” was also released by the State Council as the top-​level design for the combination of policies. The guideline underlines the crucial role of pushing forward mass innovation and entrepreneurship in the process of deepening supply-​side reform, fully carrying out the innovation-​driven development strategy, and replacing old growth drivers with new ones. To further promote mass innovation and entrepreneurship, the guideline required related departments to speed up efforts in turning scientific achievements into products, expanding financing channels for enterprises, upgrading and transforming the real economy, enhancing incentive mechanisms for the flow of talent, and increasing administrative reform. First, to speed up the transformation of scientific achievements into products, systemic obstacles should be tackled with enhanced knowledge of intellectual property rights, marketization of intangible assets such as patents, proper guidance for coworking spaces

260   Gao and Mu and makerspaces, and promotion of the sharing of research facilities, equipment, and resources among the different institutions. Moreover, the guideline also indicates to expand the financing channels for startup companies. County-​level branches of large banks will be authorized to offer loans to enterprises with enhanced financing services. The mechanism of financing services such as debt and equity will be improved with the intention of providing more forms of financial services covering the whole life cycle of the technology-​based small and medium-​sized enterprises (SMEs). Standards and regulations will be established concerning the involvement of state assets in venture capital investments, and preferential tax policies will be launched for the venture capital and angel investment sectors to attract more social capital. Lastly, the government will establish and improve a series of venture capital funds funded by the government, including the government-​guided fund on national emerging industries, the national development fund for SMEs, and the government-​guided fund on the national scientific and technological achievement transformation. Furthermore, the government urges the upgrading and transformation of the real economy. The specific measures include strengthening the basic research and improving the original innovation ability; integrating the existing innovative resources to build a number of industrial innovation centers in strategic industries; encouraging the large enterprises to comprehensively promote the mass entrepreneurship and innovation initiative and share best practices to promote cross-​boundary integration and achievement transformation; and promoting the sharing economy, digital economy, and advanced manufacturing industries. Meanwhile, enhancing incentive mechanisms for the flow of talent is also an important part of the guideline. Talent including foreigners, returning overseas students, science and technology experts, and migrants returning to their hometowns should all be entitled to incentive measures, such as easier access to work permits and local residency. Local governments can release flexible talent recruitment policies based on the needs. Lastly, the guideline requires the ministries and different levels of government to continue to deepen the administrative reform and form a better ecosystem for entrepreneurship and innovation. In detail, the business environment will be further improved and fair competition will be enhanced by regulations and institutions. All-​in-​one business registrations will be promoted and tax services provided across provinces. Demonstration zones and cities will be established and “mass entrepreneurship and innovation week” activities will be organized nationwide to build a better atmosphere for entrepreneurship and innovation. To summarize, the “Guideline to Further Strengthen the Implementation of Innovation-​ Driven Development Strategy and Reinforce the Spirit of Mass Innovation and Entrepreneurship” initiative involves the majority of national ministries and governments at all levels to reinforce the implement the mass entrepreneurship and innovation strategy with measures focused on research and development transfer, entrepreneurial finance, industry upgrading, entrepreneurial talents, and administrative reform.

Policies to Boost Entrepreneurship and Innovation Having reviewed the most important opinions and guidelines by the State Council on the mass entrepreneurship and innovation, we will now provide a more thorough review of the

Mass Entrepreneurship and Mass Innovation    261 Chinese literature on what policies and measures have been implemented since the mass entrepreneurship and innovation. Wang et al. (2018) summarized the policies related to entrepreneurship and innovation released by the State Council and 10 national ministries from March 2015, when the “mass entrepreneurship and innovation” initiative was first introduced in the premier’s government work report, to the end of 2017. In their research 53 policies were classified into three dimensions. First, with respect to the objectives, the policies can be categorized as supply policies, environment-​related policies, and demand-​oriented policies. Based on the process of mass entrepreneurship and innovation initiative the policies can be divided into the preparation phase, starting-​up phase, and development phase. Lastly, the targets of the policies are different. Enterprises, universities, research institutions, and intermediary institutions are all the targeted sectors. After analyzing the 53 entrepreneurship and innovation policies and their connections, financial support, public entrepreneurial service, tax burden reduction, and building of an entrepreneurial and innovative environment are the top four areas that policies focused on. More specifically, around 60% of policies are aiming to improve the entrepreneurship and innovation environment, and another 36.5% of policies are supply-​oriented policies, such as financial support, tax reduction, human resource cultivation, building of public platforms/​services, and improvement of institutions and regulations. However, only 3.5% of policies (only two in number) are demand-​oriented policies, which lower the barriers for startups and government purchasing. The demand-​ oriented policies could be reinforced in the future. According to the Report on the Development of Innovation and Entrepreneurship in China (Li and Xu, 2017), 94 policy documents in terms of entrepreneurship and innovation were issued by the State Council from 2012 to 2016. In the same time, 334 policy documents were released by the 18 national ministries and departments, including the State Administration of Taxation, Ministry of Finance, National Development and Reform Commission, State Administration for Industry and Commerce, People’s Bank of China (The Central Bank), Insurance Regulatory Commission, Banking Regulatory Commission, Securities Regulatory Commission, Ministry of Industry and Information Technology, Ministry of Commerce, Ministry of Human Resource and Social Security, Ministry of Education, Ministry of Land and Resources, Ministry of Science and Technology, Ministry of Agriculture and Rural Affairs, Ministry of Civil Affairs, National Audit Office, and Ministry of Culture and Tourism. To better understand the policies and measures of the mass entrepreneurship and innovation initiative, the report regrouped the policies into five categories. The first category is the mechanism of entrepreneurship and employment. It contains the policies focused on the public service, entrepreneurial education and training, flow of talents, and platform building. The second category concerns the financial environment, paying attention to the fiscal support, taxation reduction, and financial support. The third category focuses on the management of SMEs, which includes optimizing the institutional environment, enhancing support to the technology-​based SMEs, strengthening collaborative innovation, and further improving the financial resources for SMEs. The fourth category concentrates on the mechanisms of science, education, and innovation. Accelerating the transformation of scientific achievements and evaluating the degree and contribution of innovation are the main concerns of these policies. Lastly, the fifth category focuses on the coordination of different policies. The purposes of those policies are aiming to setting up a systemic mechanism

262   Gao and Mu that benefits and facilitates all stakeholders, such as the government, universities, research institutions, and corporations.

Policies for People with Different Backgrounds College Student Entrepreneurship The youth are the most active age group for entrepreneurship in China according to the “2015 Chinese Global Entrepreneurship Monitor Report.” Chinese Primer Li Keqiang indicated that “the college students are the main force to implement the innovation-​driven development strategy and promote the mass entrepreneurship and innovation” (Ye, 2015). Since the mass entrepreneurship and innovation initiative was carried out, a series of preferential policies have been released by the government to encourage college students to participate in entrepreneurship and innovation. First, the startup companies established by college graduates enjoy taxation reductions exclusively for college student entrepreneurship. The actual business tax, urban maintenance and construction tax, education surcharge, local education surcharge and individual income tax could be deducted successively according to the limit of 8000 yuan per household per year. Second, the government provides guaranteed loans and subsidies to college student entrepreneurs, and the limit of the loan is 100 thousand yuan. Third, the government exempts administrative fees, such as the business registration fee, for college student entrepreneurs within two years of graduation. Fourth, college student startup companies can apply for one year of social insurance subsidies for their graduate employees. Fifth, college graduate entrepreneurs can enjoy free entrepreneurial services provided by public employment and talent service intuitions, including policy consultation, program development, risk assessment, opening guidance, and financing services. Sixth, colleges and universities are encouraged to set up more entrepreneurship and innovation courses with credits and to be more flexible regarding the management of students. College student entrepreneurs may be allowed to apply for a delay of graduation depending on the circumstances. Lastly, college student entrepreneurs are allowed to apply for a residence registration (hukou) where the business takes place, except in the municipalities directly under the central government. In summary, a series of policies benefit college student/​graduate entrepreneurs, from taxation reduction to guaranteed loans and subsidies, from entrepreneurship courses in universities to professional guidance by public service institutions, and from social insurance to residence registration management.

Migrant Workers Returning Home Start-Up A growing number of China’s migrant workers are returning to their rural homes to start their own businesses, and the government considers this a vital way to boost development in rural areas. Rural migrant workers in cities may face constraints, such as lack of local registration (hukou) and social welfare (Chan and Buckingham, 2008), but their vision has been broadened and their skills and competence have been improved. Therefore, they have advantages to start up businesses at rural homes with their local social networks. Given this

Mass Entrepreneurship and Mass Innovation    263 situation, the government has rolled out a set of policies to encourage migrant workers to return to the countryside and start up their own businesses. Empowered by initiatives of mass entrepreneurship and innovation, the incentive policies include lowering the barriers for returning entrepreneurs, providing targeted tax and tariff reductions, enhancing financial support by the local government, enriching the forms of financial services, and establishing innovation parks for returning entrepreneurs. To be specific, returning migrant workers whose startups have been running for one year or more will be eligible for a lump-​sum subsidy. Where public finances allow, rural business startups will also be entitled to subsidies to relocate or purchase production equipment. Moreover, financing services and land-​use support will also be bolstered for rural entrepreneurship, as will policies to provide guarantees. The financing model covering government, banks, and insurance will be extended to rural startups. Furthermore, returning entrepreneurs will be allowed to launch small processing programs using rural homestead plots to build factories.

The Entrepreneurial Ecosystem Perspective The entrepreneurial ecosystem has attracted a lot of attention in the entrepreneurship research field in a short period of time (Isenberg, 2010, 2011; Stam, 2015; Stangler and Bell-​ Masterson, 2015; Spigel, 2017; Stam and Spigel, 2017). Entrepreneurial ecosystem scholars claim that entrepreneurship needs to be understood in a broader context rather than just at the level of individual or firm characteristics and behaviors (Autio et al., 2014; Zahra et al., 2014). Meanwhile, research has to consider entrepreneurship more holistically, with a focus on the interrelated aspects of entrepreneurship (Acs et al., 2014). Based on these interests, the entrepreneurial ecosystem literature aims to explain entrepreneurship by a set of interdependent actors and factors that coordinate to enable productive entrepreneurship (Stam and Spigel, 2017; Alvedalen and Boschma, 2017). An entrepreneurial ecosystem refers to the social and economic environment affecting regional entrepreneurship. Although different research works consider different components or elements significant for the local entrepreneurial ecosystem, most of them deem the conditions of policy, finance, culture, supports, human capital, and markets to have an influence on entrepreneurial activities. However, in the context of the mass entrepreneurship and innovation in China, most policies are aimed to enhance the institutional mechanisms, finance, intellectual capital, and services and supports for the mass entrepreneurship and innovation, as demonstrated in Figure 3.3.1. The policies focusing on enhancing the institutional mechanism contain the aspects of providing a fair market, fiscal and tax support, and intellectual property rights protection; streamlining administration; and coordinating different policies and government departments. The financial policies aim to provide inclusive financing to the participants of the mass entrepreneurship and innovation through the aspects of the capital market, bank support, venture capital, and new models of financing. Intellectual capital is also an important area receiving government emphasis. Attracting talent, commercialization of science and technology, and entrepreneurial education and innovation capacity promotion have also gained more attention from the government. Lastly, intensive policies have been issued to improve the services and supports for the entrepreneurship and innovation, including incubation, professional services, public platforms, and the

Incubator

Public service supply Anti-monopoly & protectionism Business credit system

Quick approvals Registration reform Qualification cancellation

Increasing financial input Inclusive taxation policy Government purchase

New forms of IPR protection Promotion of IPR transaction IPR protection centers

Organizational leadership Linkage mechanism Supervision of implementation

Fair market

Stream lining administration

Fiscal and tax support

IPR protection

Coordination Stock market

Maker space Collabortation with VC & universities

Incubation

Capital market

Accounting

Inclusive finance Professional service

Legal service

Bank Support Service and support

Information platform Technology platform

Mass Entrepreneurship and Innovation

Entrepreneurship & innovation week Competitions & other activities

Professional services Coordination with other institutions

Finance

Government fund Venture Capital Public platform

Tax pilot on VC

Intellectual Capital

Regional platform Demonstration centers

CDR

Instituinal Mechanism

Management

Bond market

Promoting foreign investment

Entrepreneurial culture

Talents Research professional entrepreneurship College student entrepreneurship Overseas talent entrepreneurship Migrant works entrepreneurship

New models of financing

Commercialization of S&T

innovation capability promotion

Entrepreneurial education

Marketization of intangible assets

Strengthening basic research

Univerrsity curriculums

Intensify incentives for transformation

Innovation centers of strategic industry

Vocational training

Equipment sharing

Collaborative innovation

Education system reform

Online finance Crowd funding platforms Entrepreneurship secured loan

Figure 3.3.1  The measures and policies that have been implemented to promote mass entrepreneurship and innovation.

Mass Entrepreneurship and Mass Innovation    265 entrepreneurial culture in the society. Within the four aspects of the elements of the entrepreneurial ecosystem in China, many specific measures have been implemented, as shown in Figure 3.3.1.

Mass Entrepreneurship and Innovation Initiative as an Institutions and Mechanisms of Entrepreneurship and Innovation Having reviewed and analyzed the background and policies of mass entrepreneurship and innovation initiative, we have found that the essence of the initiative is not just encouraging innovation in China but also promoting the reform on the institutions and mechanisms of entrepreneurship and innovation. Through the mass entrepreneurship and innovation initiative, the economic structure has been changed and the new economic momentum has been fostered. Meanwhile, in the process of promoting the initiative, the government has made great efforts to streamline administration and delegate power to reduce unnecessary interference with enterprises and improve productive relations. Furthermore, the mass entrepreneurship and innovation initiative is also significantly improving the state governance systems and governance capabilities.

Liberates and Develops Productivity Productivity is significantly determined by labor, capital, and technology. The mass entrepreneurship and innovation initiative attaches great importance to human capital and talent, breaking down many obstacles in the flow of talents and promoting entrepreneurial education and training. Meanwhile, through innovative and targeted financial means, the mass entrepreneurship and innovation initiative tries to increase the financial support and enrich the financial channels for the startup companies. Lastly, the mass entrepreneurship and innovation initiative cultivates the entrepreneurial and innovative culture in society and encourages research professionals to commercialize their scientific and technological achievements. By combining all three aspects, the mass entrepreneurship and innovation initiative forms an interaction and mutual promotion system in entrepreneurship and innovation in China.

A Way for the Large Enterprises to Prosper The mass entrepreneurship and innovation initiative urges collaborative innovation of large enterprises and SMEs through building platforms. Large enterprises have advantages

266   Gao and Mu in technology, talent, and capital, while SMEs have new business models and more flexible mechanisms. The integration of the two sectors will promote economic transformation and bring vitality to social-​economic development. Haier Group is a good example of innovation in the organizational structure and mechanism. Haier Group is a world-​leading brand of major household appliances and has transformed from a traditional manufacturer to an open entrepreneurship platform. By the end of 2017, Haier Group’s platform had attracted 4,325 organizations and 2,483 startup projects, of which 256 entered into  the incubation process in 24 innovation and entrepreneurship sites that Haier established in nine different countries and districts. More than 200 customer-​facing microenterprises, 3,800 service and support microenterprises, and 1.22 million microstores have attracted both capital and labor to the Haier platform. Haier uses its abundant resources to cultivate many microenterprises and has improved the efficiency of innovation for small enterprises and itself.

Promotes the Governance System and Capability Streamlining administration, delegating power, strengthening regulation, and providing better services are the combination of policies that the government carried out to improve the governance system and capabilities. In 2015, the State Council canceled 62 administrative approvals originally required by the central government and abolished 453 items of nonadministrative approvals. By the end of September 2017, only 632 administrative approvals were still required, compared to 1,700 at the beginning of 2013. In terms of regulations, the government has strengthened its supervision of the fair competition and credit system of enterprises. With regard to government services, the mass entrepreneurship and innovation initiative urges the government to provide inclusive and sustainable services to the public. According to the World Bank “2017 Doing Business” report, China had improved 18 ranks in ease of doing business compared to 2014.

Accelerates the Transformation of Government Functions The market vitality that has come about as a result of the mass entrepreneurship and innovation initiative is not only an outcome of government reform but also a starting point for the further reform. On the one hand, the workload of the government has been dramatically enlarged due to the increase of market entities, and the government has to innovate the working mechanism to adapt to the new circumstances. On the other hand, the new industries and new markets that have emerged from mass entrepreneurship and innovation are also seriously challenging the original management system of the government. They have also stimulated the government to improve its systems and capabilities. For example, the old enterprise registration system required entrepreneurs to obtain three licenses from three different departments—​the industry and commerce administration department, quality and technology supervision department, and taxation department. Following the implementation of administrations streamlining, only one certificate is required to start a business, which is called the “3 in 1” registration system.

Mass Entrepreneurship and Mass Innovation    267

Changes since the Implementation of Mass Entrepreneurship and Innovation Initiative At the macro level, the mass entrepreneurship and innovation initiative has changed the institution and mechanisms in China. This section will reveal the details on how entrepreneurship and innovation have been changed since the implementation of mass entrepreneurship and innovation. Table 3.3.1 indicates the changes in the number of entrepreneurs, unicorn companies, cutting-​edge research, and venture capital investments from 2014 to 2017. As the mass entrepreneurship and innovation formally started in 2015, the changes from 2014 will demonstrate the possible impacts of the initiative on entrepreneurship and innovation. First, the number of registrations of enterprises has increased rapidly, and a lot of technology-​based and high-​growth enterprises have emerged. The number of market entities in China has increased by more than 19 million, with a daily average of 45,000 in 2017. Among the new registrations, more than 6 million are enterprises, and the average registered capital is more than 400,000 yuan. Moreover, enterprises with the potential for high growth are developing in China. According to the complete list of unicorn companies, which are the private companies with a valuation over $1 billion, approximately a third of companies were born in China globally in 2018. Second, the enthusiasm for entrepreneurship and innovation has increased, and the backgrounds of entrepreneurs are more diversified. The number of entrepreneurs who are returning students from abroad has increased from 50,000 in 2008 to more than 360,000 in 2014; the percentage of entrepreneurs who are returning students from abroad is over 15%. Meanwhile, college students are also more willing to start up businesses. Only 2.8% of college graduates chose entrepreneurship in 2013, and this increased to 6.3% in 2015. In addition, more peasant workers are starting up businesses at home rather than migrating to cities for employment.

Table 3.3.1 Changes in Entrepreneurship and Innovation since the Mass

Entrepreneurship and Innovation Initiative Was Implemented 2014 Number of market entities (millions) Number of enterprises (millions) Number of unicorns Valuation of unicorns (billion dollars) Granted invention patents (thousands)

12.93 3.65

2015 14.8 4.45

19

60

47 229.7

2016 16.51 5.53

2017 19.25 6.07

131

164

238.1

487.6

628.4

359

404

420

PCT patent applications (thousands)

26.17

30.55

45

51

VC investment amount (billion dollars)

15.5

27.4

31

40

Loan balance of small and microenterprises (trillion yuan)

15.46

17.4

20.84

24.3

268   Gao and Mu Third, the investment market is more dynamic. The size of government-​guided funds is expanding. Until the end of 2016, 901 government-​guided funds had been raised with a total target size of 3,200 billion yuan. In the meantime, venture capital and angel investment is being further developed. In 2017, over $40 billion of venture capital investment took place in China. Both the number of cases and investment amounts have increased compared to 2016 and before. In addition, there was more than a 40% increase in the number of mergers and acquisitions in 2016, and 5,034 more enterprises were listed on the National Equities Exchange and Quotations. Lastly, the reform on the institutions and mechanisms of entrepreneurship and innovation has deepened, and the ecosystem for entrepreneurship and innovation has improved. The registration procedures for startup companies have been further optimized and 433 professional qualifications removed to lower the barriers of market entry. Meanwhile, the transformation of scientific and technological achievements also developed rapidly, as the amount of technology-​based contracts broke 1,000 billion yuan for the first time in 2016. In addition, fiscal and taxation support of entrepreneurship and innovation have also increased, with a total tax reduction of over 500 billion yuan on enterprises in 2016. Furthermore, the protection of intellectual property rights continues to improve, and more demonstration bases for mass entrepreneurship and innovation were built in 2016 as well. Many activities to promote the culture of entrepreneurship and innovation were also held in 2016, such as “Mass Entrepreneurship and Innovation Week.”

Conclusion This chapter intends to provide a comprehensive understanding on the mass entrepreneurship and innovation in China. By reviewing the entrepreneurship literature and the social-​ economic background in the Chinese context, the mass entrepreneurship and innovation initiative is recognized as imperative for economic structure transformation and further development. After answering the questions “What is the mass entrepreneurship and innovation?” and “Why mass entrepreneurship and innovation?,” the chapter explains the third question, “How is mass entrepreneurship and innovation implemented?” After elaborating on the important government policies on the mass entrepreneurship and innovation, the chapter identifies that the institutional mechanism, finance, intellectual capital, and services and supports for the mass entrepreneurship and innovation are the most significant elements in the entrepreneurial ecosystem in China. Although the policies on mass entrepreneurship and innovation are comprehensive and effective, the majority of them are supply oriented, which ignores the constraints and difficulties faced by entrepreneurial enterprises. More policies should be considered based on the demand of entrepreneurial enterprises and other participants in the entrepreneurial ecosystem, not only the government. Lastly, the chapter reveals that the mass entrepreneurship and innovation initiative itself is an innovative reform on the institutions and mechanisms of entrepreneurship and innovation in China, with significant improvements on the governance systems and governance capabilities.

Mass Entrepreneurship and Mass Innovation    269

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Pa rt   I V

DE V E L OP I N G I N N OVAT ION -​ FAVOR I N G I N ST I T U T ION S A N D E C O SYST E M

Chapter 4.1

T he Role of C lu st e rs in the Devel op me nt of In novation Ca pa bi l i t i e s in Chi na Tuoyu Li and Jiang Wei Introduction Industrial clusters have long been recognized as an important engine of the Chinese economy. We always look at the industrial cluster through an economic lens. Here we focus on the innovation lens to talk about the roles of industrial clusters. This chapter discusses the industrial clusters’ success and their contributions to the long-​term enhancement of innovation capability. Increasingly, innovation is being regarded as an evolutionary, nonlinear, and interactive process between the firm and its environment (Kline and Rosenberg, 1986; Dosi, 1988). A large amount of literature has tried to explore the innovative processes within the firm and between the firm and its environment by view of the innovation system. Consequently, by view of the innovation system, innovation has become an important topic not only in the context of the market and the firm but also in the context of regional growth and development. As the “reduced-​scale innovation system” (den Hertog, Bergman, and Charles, 2002), the industry cluster is dominating the world map of the economy, fostering world-​class enterprises, and boosting regional development (Markusen, 1996). For example, Silicon Valley has been a prototypical example of successful industrial districts. The recipe for its success has been studied extensively, and several attempts have been made to duplicate the industrial structure of Silicon Valley elsewhere in the world (Saxenian, 1998). Generally speaking, there are two perspectives on the research of innovation systems of the industrial cluster. One perspective of recent research on clusters’ innovative behaviors stresses the importance of network building, whether through economic considerations of the role of suppliers and customers in shaping innovations (Lundvall, 1998) or through social constructivist and actor-​network accounts (Latour, 1996). Empirical observation has

276   Li and Wei shown that such resources related to particular industries have become more concentrated in particular places, with the consequence that firms in those locations have easier access to the tools for innovation. Actually, all the agents and firms form an innovation system in a particular place and in a particular industry. Another perspective stresses the communities of practice within the firms: tightly knit groups of people who constantly work together, exchange knowledge, and develop a shared understanding of the environment in which they work, the knowledge on which their work depends, and the context in which it is used (Brown and Duguid, 2000). Clusters can be seen as “ecologies of knowledge” where there is an agglomeration of firms with parallel communities of practice that are connected through networks that permit knowledge to leak and quickly find complementarities (Charles, 2002). Such an idea is adopted by many literatures to explore the regional competitiveness and to make policies of industrial development via innovation system views. For example, in Cooke’s (2002) abstract structuring, the two key subsystems, the knowledge application and exploitation subsystem and the knowledge generation and diffusion subsystem, are functioning as the core of the regional system of innovation. However, literatures on the cluster innovation system, or that use the concept, are large (Hertog, 2000; Lee, 2003; Miles, 2005; Strambach, 1997), especially in highly developed innovation systems and in metropolitan areas, but neglect their specific role for low-​tech industries and peripheral regions (Thomi et al., 2003). Particularly in the China context, a rapid development of clusters in a relatively low-​technology industry within China’s peripheral eastern coast region has resulted in an increase in collaborations among firms and between the firms and their environments of the same scale. In transitional China, industrial clustering has been blooming in recent years. Especially, in eastern China, the rapid economic development since the early 1990s is obviously achieved to a considerable extent by industrial clustering. Individual regions and industrial cities have been highly specialized in the production of certain goods and have become a world center for this kind of production, for example, Da Tang Socks City, Jia Xing Sweater City, Zhi Li Kid’s Clothing City, Jin Jiang Footwear Capital, and so on. They associate thousands of specialized small and medium-​sized enterprises (SMEs) but also larger players, who cooperate with each other in the same area, which naturally favors the formation of clusters in China. Zhejiang is one of the most developed economic regions in China. Zhejiang’s industry clusters involve most industry sectors, including the machinery manufacturing industry, textile industry, garment industry, pharmaceutical industry, and information technology industry. This chapter will look specifically at the development of clusters in China, the forces facilitating their success, and their contribution to the economy and the long-​term enhancement of innovation capability. In the next section empirical research of the innovation system in the Shaoxing textile cluster is discussed to explore the determinants as well as the elements that interactively constitute the localized innovation networks in this narrow industrial district. Through the network approach, the chapter captures the main features and relationships of a functioning cluster innovation system. The chapter then moves on to focus on the innovation action of the cluster firm itself. Based on the questionnaire data from a software cluster in Hangzhou, China, we notice that a partial technological learning mechanism has been operating efficiently in the current software cluster. We find that technological followers fail to benefit from knowledge diffusion within the industrial cluster,

Clusters and Development of Innovation     277 so a technological innovation system is required to enhance the learning capabilities of clustering enterprises with the support of local universities, research institutes, industrial associations, and governments. The chapter then provides a longitudinal study of the industrial cluster, the Da Tang traditional socks industry in the eastern coast of China’s peripheral regions in Zhejiang province, to show that knowledge-​intensive business services (KIBS) facilitate the flow of knowledge among firms in the cluster network. After that the chapter provides empirical research on a geographic search in two industry clusters of Zhejiang province to explore the role of the local-​nonlocal search balance in product innovation. Finally, a conceptual framework of the cluster innovation system is designed to capture the linkages within industrial clusters.

Innovation System and Industry Cluster Clusters can be characterized as being networks of production of strongly interdependent firms (including specialized suppliers), knowledge-​ producing agents (universities, research institutes, engineering companies), bridging institutions (brokers, consultants), and customers, linked to each other in a value-​adding production chain (OECD, 1999; Charles, 2002). Thus, the cluster approach of innovation systems helps to describe the linkages and interdependence between actors in the network of production when producing products and services and creating innovations. The idea of clusters as innovation systems should perhaps not be surprising given the common identification of competitiveness with innovation. The commonly described advantages of clusters in terms of rapidity of response, learning, and the accumulation of a stock of both tacit and codified knowledge clearly underpin the innovative capacity of firms (Charles, 2002). When we observe the current research on clusters in systems of innovation, we find that there are very few empirical studies on the innovation system of clusters. The term “cluster innovation system” cannot be effectively defined either but tends to refer to a set of elements or factors that interact in ways that influence the development, diffusion, and use of innovations (Edquist, 1997; Charles, 2002). Further, the systematic framework of cluster innovation behavior is less consensus to be regarded, which may include the interconnected model of the firms and agents, the structure of innovation system in clusters, and determinants of components of innovation system. Obviously, all these issues are very important for clusters and policymakers to reinforce such systems by strengthening the knowledge base, facilitating knowledge transfer, and encouraging collaboration. Therefore, we develop a tool to describe the cluster innovation system based on the empirical analysis in the Shaoxing textile industry in China.

Shaoxing Textile Industry Shaoxing is a county (xian) of Zhejiang province, located in eastern China. Since the mid-​ 1990s, Shaoxing County has developed to be one of the most important centers of the textile industry not only in China but also in Asia. In 2005, employees in the textile industry accounted for 67.8% of the total industrial workers in Shaoxing County. Also, the gross

278   Li and Wei production value of the textile industry has reached ¥74.7 billion (approximately US$10.66 billion) in current prices, which covers 66.8% of the total industrial production value of this county. Because most firms and institutions, as well as employees, are specialized in the textile industry, and all of these interconnected companies and institutions are aggregated in a very small geographic space, we call this phenomenon a textile industrial cluster. The textile industrial cluster can be further characterized by: • more than 30 years of development in the textile-​related industry; • 1,600 interconnected firms including chemical fiber, fabric, printing and dyeing, and garment by which the industrial value chain is formed; • hundreds of related firms, institutions, and organizations to provide technology and information services, supplementary material such as dyestuffs and aided reagents, and management support; • the largest market center of textile products in Asia, China Textile City, which is located in this county; and • a significant structural adjustment process since the Asian financial crisis. If we compute the number of related firms, institutions, and organizations, the total number of interconnected firms in this industrial cluster has reached more than 2,000 firms. It is these textile firms, related organizations, and other institutions that build the innovation system of Shaoxing’s textile industrial cluster. More specially, due to the Asian financial crisis, the textile industry cluster has recognized the necessity of improving cluster innovation capacities. In recent years, both the cluster and local government have devoted resources to develop the innovation system.

Determinants of Shaoxing Textile Cluster Generally speaking, the innovation system of the Shaoxing textile cluster is dominated by three categories of determinants:  core-​ level determinants, supplementary-​ level determinants, and periphery-​level determinants, in which the first two categories mainly offer the “collective learning” (Lawson and Lorenz, 1999; Camagni, 1997; Capello, 1999) in this special field, and the third category provides the context of the cluster’s knowledge activities. In the cluster innovation system, each of the core-​and supplementary-​level organizations interacts with the others, with local government as well as its institutions, and with national innovation organizations such as outside universities, public research and development (R&D) institutes, national laboratories, and outside market relationships. In the following sections, we are going to deal with aforementioned three categories of determinants of the textile cluster’s innovation system in detail.

Core-​Level Determinants According to Cooke’s (2002) abstract structuring, the core-​level determinants function as the systems of knowledge application and exploitation in the industrial cluster. It is

Clusters and Development of Innovation     279 constructed by two subsets: one is the core value chain of the textile industry, and the other is the related firms that support the innovation activities of core value chain. These two subsets are located in the industrial cluster that function interactively as the core-​level innovative network. Figure 4.1.1 shows that the core value chain of the textile industrial cluster is linked by four types of firm groups, namely the chemical fiber firm group, fabric firm group, printing and dying firm group, and garment firm group. Our investigation finds that 94% of firms positioned in the core value chain are SMEs with fewer than 100 employees. Among the four types of firm groups in the core value chain, the fabric firm group is the strongest level in the industrial cluster which is indicated by innovative activities in 2005 (Figure 4.1.2) and by the ratio structure of the productivity capabilities of these four groups in 2005 (Figure 4.1.3). Relatively, both the printing and dying firm group and the garment firm group lack innovative capacities. Therefore, it can be inferred that the imbalance of innovative capacities in the different groups has impeded the technological competitiveness of the whole industrial cluster. More specially, the low innovation capabilities of the printing and dying firm group lead the garment firm group to purchase the sophisticated cloth materials from Italy and Korea, which leads to the high production cost of garment firms. On the contrary, the relatively strong innovative capacities of fabric firms have made Chinese Textile City,

Related firms Dyestuff firms group

Textile machinery firm group

Fabric firm group

Chemical fiber firm group

Aided reagent firm group

Printing & dying firm group

Garment firm group

Core value-chain of textile industry

Figure 4.1.1  The key actors of core-​level determinants in the Shaoxing textile industry.

Clothing group Printing & dying group Fabric group Chemical fiber group 0

20

40

60

80

100

Process innovation Product innovation

Figure  4.1.2  Ratio of product and process innovations in different groups (%  of total amount). Source: Data provided by local Department of Science & Technology, Shaoxing County, 2005

280   Li and Wei Clothing group Printing & dying group Fabric group Chemical fiber group 0

20

40

60

80

100

Productivity capabilities

Figure 4.1.3  The ratio structure of the productivity capabilities of these four groups. Source: Data provided by local Department of Science & Technology, Shaoxing County, 2005

Shaoxing, the largest trade center of fabric products in Asia. To improve the cluster innovation capabilities, both the cluster and local government have made a series of policies to build the innovation system by emphasizing the upgrading of innovative capacities of the printing and dying firm group and garment firm group, as well as the interactive innovation between these four firm groups. The related firms in core-​level determinants are those that are located outside the core value chain but also provide raw materials and factors, such as dyestuffs, textile machines, aided reagents, and so on. These related firms interact with those located in the core value chain through supplier-​user relationships. Our investigation finds that the related firms are strongly devoted to the development of technological capabilities of the core value chain firms. For example, in the 1990s, the textile industry purchased a large amount of sophisticated equipment from overseas, which challenged the textile machinery firm group very much. Then the textile machine manufactories cooperated with the textile firms to assimilate the imported technologies, and it helped not only the textile machinery firm group to improve their R&D capabilities but also the textile industry to lower the production cost caused by continuous equipment purchases. The machinery manufactories have gradually cultivated the indigenous innovation capabilities and developed world-​class textile machines, such as SJ758 fabric equipment, HKV141 mounting machines, HKV151 serials of twisting machines, and HKV161 short fiber twisting machines. In short, the cooperative R&D between the core value chain firms and related firms greatly promoted the innovation capabilities of the cluster, and both of them have built the core-​level determinants of the innovation system together.

Supplementary-​Level Determinants We will now look at the supplementary-​level determinants of the innovation system in the Shaoxing textile industry. The supplementary-​level determinants are dominated by (1)  infrastructures, such as physical structures and institutional arrangements (Padmore and Gibson, 1998), which facilitate access to resources and support innovation of core-​ level firms, and (2)  a few knowledge generation and diffusion organizations, which mainly offer direct support like technological knowledge and management information for innovation activities within core-​level determinants. In the Shaoxing textile industrial cluster, the supplementary-​level determinants can be grouped into three subsets, namely infrastructures, collective agents (Bianchi and Bellini, 1991), and public service sectors.

Clusters and Development of Innovation     281 At the level of Shaoxing County, the main focus is the upgrading of infrastructures for technological improvement. Infrastructure consists of physical infrastructures, such as roads, pipelines, water, electronic power, internet, and telecommunications, and institutional infrastructures, such as policies, social elements, and cultural elements. Recently, support of Digital County Engineering (DCE) has become most important. DCE, which is implemented and partially funded by the local government, aims to build the information expressway in local regions and provide the telecommunication infrastructure for the industrial cluster, as well as the whole region. In 2002, DCE will be accomplished as planned. Then, the information platform based on DCE and the market platform based on China Textile City can be integrated to provide the physical infrastructure system for innovation activities of the industrial cluster. China Textile City, established in 1988, mainly acts as an important trade center for textile products. However, to a great extent, it also functions as an infrastructure of information communication in the cluster. As an infrastructure, the roles of China Textile City can be concluded to have three aspects: information platform of marketing, information center of technological development, and steering “institution” of the cluster’s technological innovation. The trade turnovers of China Textile City reach approximately US$2.2 billion per year, and more than 80% of textile products are traded in this market. Naturally, China Textile City has evolved into the technological information platform and the steering institution of cluster innovation activities. Due to geographic accessibility, the cluster firms can gain a large amount of technological knowledge and information at a low cost for information searching and collecting. Formal policies construct an important level of government. Some very local issues, such as municipal zoning rules and incentive policies such as tax policies and loan policies, can be critical for the development of innovation system. Meanwhile, special emphases must be given to informal institutions. Shaoxing has a long history of textile tradition. It is estimated that handcrafts of fabric originated nearly 1,000 years ago. Without question, the textile tradition has become part of the local cultural and social environments, which greatly support creating today’s “economic communities” of the cluster. Due to a lack of technical universities and national laboratories, policymakers in Shaoxing County became very interested in technology policy in recent years. When both the cluster and local government recognized the imbalance of innovative capacities in the core-​level determinants, the importance of cluster technology capability was emphasized and resulted in the establishment of the Textile Science and Technology Center (TSTC) in 1995. It is organized as an independent institution and run as a firm to support public innovation activities in stimulating technological development. The objectives of the TSTC are to strengthen the transfer of technology and knowledge, to support future promising technologies, and to support innovation through cooperation with core-​level firms. In recent years, the TSTC has developed into a provincial high-​tech R&D center and national computer-​aided design (CAD) exemplary firm, and an important contract research organization with more than 10 R&D institutes and universities. So far, it has owned intellectual property rights of world-​ level CAD software, the Jinchang EX6000 CAD color assortment system, which greatly contributes to the improvement of SMEs’ CAD/​computer-​aided manufacturing (CAM) technologies. Concretely, the role of the TSTC in the innovation system can be examined by its contributions in 2001. In 2001, it provided more than 2,300 information requests for local textile firms, developed and diffused 22 generic technologies, organized more than 10 technological exhibitions, and trained over 1,100 managers and technicians for core-​level

282   Li and Wei organizations. As a consequence, we consider the TSTC to be the main base of knowledge generation and diffusion in the textile cluster. Besides the TSTC, the local education and training institutes also act as the public service sector for knowledge generation and diffusion in the Shaoxing textile cluster. The importance of education and training centers is also emphasized by the policy in Shaoxing County. Due to a lack of universities within the cluster, local government allied with Zhejiang University, a key national university located outside the cluster, to establish the Vocational Education School of Zhejiang University, which focuses on training managers and technicians for the cluster. Meanwhile, another vocational education center that targets training of labor/​skilled workers for the cluster was established in the beginning of the 1990s. These two institutes have developed into important components of the knowledge generation and diffusion system by providing the human resources for the cluster innovation system. In a short, both the TSTC and training centers have become key public service sectors supporting knowledge generation and diffusion in the innovation system. The third subset of supplementary-​level determinants of the innovation system of the Shaoxing textile cluster is the collective agents. According to Bianchi and Bellini (1991), collective agents refer to institutions sponsored by the local public authorities and entrepreneurial associations to take over and collectively manage the cost of coordinating and acquiring specific entrepreneurial activities that are necessary for the formation and development of the local network of innovators. In the Shaoxing textile industrial cluster, the Entrepreneurship Association functions as a collective agent. The major fundamental role of the Entrepreneurship Association is to focus on the main problems concerning the internal relations and to channel information to solve these problems. But it has not monitored the existing problems concerning technological innovation and market positioning of the companies and the cluster as well. To build the cluster innovation network, the collective agent should act as an instrument of industrial policy when it proposes to solve a problem through a higher-​level solution (Bianchi and Bellini, 1991). However, in the Shaoxing textile industry, the interventions directed at the relations of firms and the interventions coordinating the market positioning of firms are first made by the local government, and the collective agent acts as the “assistant” of the local government.

Periphery-​Level Determinants In the Shaoxing textile cluster, the outside organizations, such as universities, national labs, and private R&D institutes, play important roles by supporting the innovation activities of core value chain firms. Due to a lack of local education institutes, technical universities, and R&D institutes, up to now, there are more than 450 firms, the vast majority of them are large enterprises, to cooperate with out-​of-​town universities in R&D activities. Meanwhile, a few contract research centers have been set up through the strategy of strategic alliance. These organizations, located outside the cluster, also function as the determinants of knowledge generation and diffusion. The local government, as well as its structural policies, is explicitly oriented to support the cluster’s innovation. It needs to be emphasized that, though the local government is located in the industrial district, we still call it a peripheral element of the innovation system because it does not participate in the knowledge generation and application activities but

Clusters and Development of Innovation     283 mainly acts as a contributor to create the settings and make policies for the cluster’s innovation activities. However, in the Shaoxing textile cluster, the local government has played very important roles in the development of the textile industry. We have already discussed the roles of the local government in building the innovation system. More importantly, the local government has made a series of structural policies to support the local aggregation of new business and to promote the innovation capacities. The Generic Technology Innovation Funds, which are sponsored by Shaoxing County and went into effect in 1999, are regarded as one of the important tools to promote technological innovation. Here, we define all these organizations located outside the cluster and the local government as the periphery-​level determinants of the textile cluster.

Functions of the Determinants Among the three categories of determinants, the core-​level determinants are the key elements of the innovation system. All of the elements of the core-​level determinants function as the knowledge application and exploitation subsystem (Cooke, 2002). Basically, the core-​level determinants consist of two main subsets of actors and the interaction between them (Asheim and Isaksen, 1997): core value chain firms and related firms, in which the related firms support the innovation activities by providing the production factors for the core value chain firms. These two subsets located in the industrial cluster function interactively as the core-​level innovative network. In the innovation system of the industrial cluster, there are several elements that function in the knowledge generation and diffusion subsystem (Cooke, 2002) and support the innovation activities. All these elements are characterized by public, cluster-​oriented, or shared ownership and access (Padmore and Gibson, 1998). Put differently, these elements to some extent depended on the development of the cluster. Here, we call these elements of this subsystem the supplementary-​level determinants. In the Shaoxing textile cluster, the supplementary-​level determinants can be grouped into three subsets:  public service sectors, collective agents, and infrastructures. The first subset, public service sectors, targets helping networks facilitate the exchange of technological knowledge and collective learning (Storper, 1997; Maskell and Malmberg, 1999) and creating the preconditions for innovation such as research and higher education institutes, technology transfer agencies, vocational training organizations, business associations, finance institutions, etc., which are important for supporting regional innovation (Asheim and Isaksen, 2002). The second subset, collective agents, aims at taking over and collectively managing the cost of coordination and acquisition of the specific entrepreneurial activities that are necessary for the formation and development of the innovation system. The third subset, infrastructures, focuses on building the innovation climate within the cluster and providing the preconditions for innovation such as transportation, production power, telecommunication, and so on. The periphery-​level determinants consist of two subsets: local government and outside organizations. In many literatures (e.g., Asheim and Isaksen, 2002; Krugman, 1991, 1995; Padmore and Gibson, 1998), local government is only regarded as a variable element rather than an independent element in the innovation system. However, in transitional China, the local government always plays a potential role in cluster development, which has been mentioned earlier, so here, it is emphasized as a subset of periphery-​level determinants.

284   Li and Wei Another subset, outside organizations, includes outside market relationships that constitute various kinds of networks (e.g., supplier/​client, cooperation, information) together with cluster firms, and external knowledge organizations that provide special knowledge for the cluster’s R&D activities. Both subsets are independent of the cluster. Put differently, without the cluster, these elements still exist externally. Therefore, we call these elements periphery-​ level determinants. Table 4.1.1 shows the three levels of determinants and their elements of the CSP (short for core-​level, supplementary-​level, and periphery-​level determinants) model of the cluster innovation system.

Table 4.1.1 Determinants of CSP Model of Innovation System in Industrial

Cluster Determinants

Elements

Core-​level Determinants

Core value chain firms

Variables of Elements Suppliers

Providers of production factors

Competitors

Competitive firms and supplemental firms

Users

Demanders of intermediate and end products

Related firms Supplementary-​level Determinants

Periphery-​level Determinants

Infrastructures

Firms with relevance to resources and production factors Physical infrastructures

Road, harbor, pipelines, telecommunication, water, electronic power, etc.

Institutional infrastructures

Policies (e.g., tax policy, technology trade policies, financial policy, relative laws, and regulations); social elements (e.g., business and employment settings, quality of life); and cultural elements (e.g., ethics, conventions, values, and relationships)

Collective agents

Entrepreneur association, industrial association, etc.

Public service sectors

R&D institutes, universities, public laboratories, human-​training organizations, financial sectors, etc.

Local government

Local government structures, such as Department of Science and Technology, Department of Economy and Trade, etc.

Outside market relationships and knowledge organizations

Outside providers of resources and production factors, outside demanders, and knowledge organizations like universities, national labs, and R&D institutes

Clusters and Development of Innovation     285 Based on analyses of the determinants of the innovation system, we summarize three determinants covered in the CSP model of the cluster innovation system. They are core-​ level, supplementary-​ level, and periphery-​ level determinants. Basically, the core-​ level determinants consist of two main subsets of actors and the interaction between them (Asheim and Isaksen, 1997): core value chain firms and related firms, in which the related firms support the innovation activities by providing the production factors for the core value chain firms. These two subsets, located in the industrial cluster, function interactively as the core-​level innovative network. However, despite several industrial surveys (e.g., Pavitt et al., 1987; Centre for Business Research, 1996; Thomas and Jones, 1998), there is still little empirical evidence about how core value chain firms have improved their capacity for technological innovation. It is argued that the knowledge spillovers within an industrial cluster would benefit from the development of a network of innovators (Freeman, 1991; Jaffe et al., 1993).

Technological Learning among Core-​L evel Determinants The world map of the economy is dominated by industrial clusters that have fostered world-​class enterprises and boosted regional development (Markusen, 1996). For example, Silicon Valley has been prototypical of successful high-​tech industrial districts. The recipe for its success has been studied extensively, and several attempts have been made to duplicate the industrial structure of Silicon Valley elsewhere in the world (Saxenian, 1998). In China, a large number of high-​tech clusters have played a significant role in regional economic development. However, due to the poor technological infrastructure and imperfect learning network within the narrow district in which the clusters are located, these clusters are confronted with a shortage of technological capability, which hampers the upgrading of industries and sustainable development of regions. One would hope that the policies aiming to nurture the innovative performance of these clustering companies could be informed by solid empirical research. The mechanism of learning within a cluster has been the focus of research (Asheim, 1996; Keeble et al., 1999; Lawson, 1999). It is supposed that gaps of technological capability exist among clustering enterprises. Generally, two types of clustering enterprises could be classified, namely the technological leading enterprises and technological following enterprises. Hereafter, we call the former the high-​level-​capability enterprises and the latter the low-​level-​capability ones. It is argued that these two types of enterprises should play different roles in the technological learning of a cluster. Furthermore, it has been questioned whether the basic technological learning mechanism in traditional clusters (Wei, 2002) still works in high-​tech clusters. To understand if there are different pathways for technological learning in high-​tech clusters, we take the software industry in Hangzhou as an example and try to find a reasonable and effective learning mechanism for these clusters that can integrate clustering members and coordinate technological learning activities so as to accelerate the capability development of their cluster.

286   Li and Wei

Hangzhou Software Industry Cluster In recent years, the software industry has been one of the most vigorous and fastest-​ developing industries of Zhejiang, a prosperous coastal province of China. From a regional viewpoint, the fast emergence of the Hangzhou software industry is noticeable and worth analyzing. It consists of most software enterprises in Zhejiang province. According to the statistics of the Industry and Commerce Bureau, a local governmental organization, there are more than 500 software enterprises in Hangzhou, including those with well-​ known brands in the domestic market, such as Handsome Electronics, Sunyard, IechoSoft, NewGrand, etc. A significant feature of the Hangzhou software industry is its geographic location. Most software enterprises are located in the software district of the Hangzhou High-​Tech Industrial Development Zone and the West Lake Software Zone. This helps in the establishment and development of the software industrial cluster since they are located in proximity and connected geographically (Audretsch, 1998; Porter, 1998). The Hangzhou software cluster focuses on application software products, especially financial security software, accounting management software, healthcare management software, clothing CAD software, etc. These products occupied a very large share in their market niche (Figure 4.1.4). Other software products occupied considerably less market share. Obviously, the products are somewhat similar in the cluster, which could speed up the collective learning of the clustering enterprises (Capello, 1999). On the other hand, the software industry of Hangzhou faces a common problem of domestic software companies—​ that is, the software development processes are not standardized and normalized yet. Hence, the companies have difficulty exporting their products. Moreover, the development of companies in the cluster is not balanced. Whereas there are a number of competitive software companies in Hangzhou, most local software companies encounter difficulties such as failure to achieve economy of scale, capital shortage, and lack of technological competence. The prospects of these small local companies are not promising, and to some extent these companies would have negative effects on the competitiveness of the whole cluster. Data for this research were acquired via a questionnaire survey of 51 local software firms in Hangzhou. Thirty-​nine questionnaires were returned valid. The survey revealed detailed information about the technological activities within the cluster as well as a wide range of internal and external regional actors that might have contributed to the technological competence of the cluster. Interviews were conducted together with the questionnaires to understand the subtle relationship between learning activities within the cluster. We

Platform software 5%

Base software 5%

Embedded software 20%

Application software 70%

Figure 4.1.4  Product classification of software industry cluster in Hangzhou.

Clusters and Development of Innovation     287 classify the 39 surveyed software firms into two categories (high-​level-​capacity and low-​ level-​capacity enterprises) using the cluster analysis tool.

Learning Activities within the Local Network First, the differences of 14 learning activities within the local network between the high-​ level-​capability and low-​level-​capability enterprises were tested. The results are shown in Table 4.1.2 and Table 4.1.3.

Table 4.1.2 Analysis of Learning Activities within the Local Network H-​L-​C/​L-​L-​Ca

N

Mean

SD

Std. Error Mean

A1b=L-​L-​C =H-​L-​C

29 10

2.10 1.90

0.67 0.88

0.13 0.28

A2  =L-​L-​C =H-​L-​C

29 10

2.00 1.90

0.65 0.74

0.12 0.23

A3  =L-​L-​C =H-​L-​C

29 10

1.41 1.40

0.57 0.70

0.11 0.22

A4 = L-​L-​C =H-​L-​C

29 10

2.07 2.10

0.80 0.88

0.15 0.28

A5  =L-​L-​C =H-​L-​C

29 10

1.90 2.50

0.72 0.71

0.13 0.22

A6  =L-​L-​C =H-​L-​C

29 10

1.76 1.80

0.87 0.79

0.16 0.25

A7  =L-​L-​C =H-​L-​C

29 10

2.00 1.60

0.85 0.70

0.16 0.22

A8  =L-​L-​C =H-​L-​C

29 10

1.90 2.40

0.77 0.52

0.14 0.16

A9  =L-​L-​C =H-​L-​C

29 10

2.03 2.50

0.78 0.71

0.14 0.22

A10  =L-​L-​C =H-​L-​C

29 10

1.97 2.20

0.82 0.79

0.15 0.25

A11  =L-​L-​C =H-​L-​C

29 10

1.76 2.20

0.79 0.79

0.15 0.25

A12  =L-​L-​C =H-​L-​C

29 10

2.00 1.80

0.76 0.79

0.14 0.25

A13  =L-​L-​C =H-​L-​C

29 10

2.28 2.10

0.75 0.57

0.14 0.18

A14  =L-​L-​C =H-​L-​C

29 10

2.21 1.30

0.62 0.67

0.12 0.21

a

In the following tables, H-​L-​C stands for high-​level-​capability enterprises, while L-​L-​C stands for low-​level-​capability enterprises. b An is the symbol used in Table 4.1.2 to denote a technological learning activity.

288   Li and Wei Table 4.1.3 Independent-​Samples Test for Learning Activities within the Local

Network Levene’s Test for Equality of Variances

t-​Test

F

Sig.

t

1.911

.175

.762 .670

37 12.871

.451 .515

A2 equal variances assumed equal variances not assumed

.486

.490

.403 .380

37 14.212

.689 .710

A3 equal variances assumed equal variances not assumed

.223

.639

.062 .056

37 13.341

.951 .956

A4 equal variances assumed equal variances not assumed

.219

.642

-​.103 -​.099

37 14.521

.918 .923

A5 equal variances assumed equal variances not assumed

.079

.780

-​2.285 -​2.313

37 16.017

.028 .034

1.164

.288

-​.132 -​.139

37 17.209

.895 .891

A7 equal variances assumed equal variances not assumed

.316

.578

1.343 1.475

37 18.818

.187 .157

A8 equal variances assumed equal variances not assumed

.924

.343

-​1.911 -​2.317

37 23.696

.064 .029

A9 equal variances assumed equal variances not assumed

.000

.997

-​1.667 -​1.748

37 17.132

.104 .098

A10 equal variances assumed equal variances not assumed

.024

.877

-​.785 -​.802

37 16.287

.438 .434

A11 equal variances assumed equal variances not assumed

.082

.776

-​1.530 -​1.527

37 15.634

.135 .147

A12 equal variances assumed equal variances not assumed

.247

.622

.714 .699

37 15.116

.480 .495

A13 equal variances assumed equal variances not assumed

4.448

.042

.675 .774

37 20.718

.504 .448

A14 equal variances assumed equal variances not assumed

.007

.931

3.902 3.740

37 14.600

.000 .002

A1 equal variances assumed equal variances not assumed

A6 equal variances assumed equal variances not assumed

df

Sig. (Two-​Tailed)

It should be noticed that the occurrence of learning activities between clustering enterprises is infrequent and accidental. In Table 4.1.2, no single mean value of any learning activity exceeds 2.50, regardless of whether it is for high-​level-​capability or low-​level-​ capability enterprises. From this angle, the software cluster in Hangzhou does not have the capabilities or practices to utilize the learning effect within a cluster and is still in its initial stage of development. It has a considerable gap from those innovative clusters in European scientific parks. It should also be noticed that low-​level-​capability enterprises

Clusters and Development of Innovation     289 have a significantly higher frequency of localized technological imitations. Yet this is not very meaningful for the low-​level-​capability enterprises, since it can be deduced from Table 4.1.2 that this difference is largely due to high-​level-​capability enterprises’ reluctance to imitate. Moreover, except for localized imitations, low-​level-​capability enterprises are lagging in other aspects, such as communicating with local entrepreneurs, participating in activities of industrial associations, communicating with local colleges or R&D institutes, etc. It should also be noticed that only the difference in participating in local industrial associations is statistically significant, which might indicate that the industrial associations within the cluster were dominated by high-​level-​capability enterprises. Besides, the low-​ level-​capability enterprises do not do well on cooperation with local colleges and research institutes, though these organizations are regarded as important in collective learning (Keeble et al., 1999), partly because they are more likely to be neglected by the local institutes. According to this analysis, the low-​level-​capability enterprises failed to utilize the local network to learn from the knowledge diffusion of their high-​level-​capability neighbors. It also indicates that knowledge diffusion is not very smooth between the high-​level-​capability and low-​level-​capability enterprises. Even if the high-​level-​capability enterprises were able to learn from outside of the cluster, the low-​level-​capability enterprises could not improve their capabilities by benefiting from knowledge spillovers. Hence, the supposed division of technological learning between the two types of enterprises failed to establish a sound mechanism to improve the technological capabilities of the whole cluster.

Learning Activities among Regional Networks This section attempts to investigate whether the high-​level-​capability enterprises have significantly higher values on learning activities among regional networks since such learning activities are important to keep the cluster innovative and competitive (Belussi and Arcangeli, 1998; Macevily and Zaheer, 1999). The independent-​samples t-​test is used to examine if the high-​level-​capability enterprises introduced more knowledge or skills from outside of the cluster. The results are shown in Table 4.1.4 and Table 4.1.5. They support that high-​level-​capability enterprises are better at absorbing external knowledge. The sample of high-​level-​capability enterprises has notably outstanding performances on cooperating on interregional new product development and marketing, communicating with external entrepreneurs, introducing professionals from other clusters, on-​the-​job training in other regions, searching for external information, establishing “window” organizations, and participating in industrial associations in other regions. As for interregional cooperation on R&D or consultation, the high-​level-​capability enterprises performed as poorly as the low-​level-​capability ones. This might be due to the amplitude of outstanding universities and research institutes located in Hangzhou. The high-​level-​capability enterprises do not perform better on utilization of external experiences and technological imitation, partly because the low-​level-​capability enterprises do not have much difficulty in these two learning activities. Besides, high-​level-​capability enterprises showed little willingness in interregional financial cooperation. Generally speaking, it can be concluded that high-​level-​capability enterprises in the Hangzhou software cluster acted as “learning pioneers” and performed much better in absorbing external knowledge than low-​level-​capability local enterprises.

290   Li and Wei Table 4.1.4 Analysis of Learning Activities among Regional Networks H-​L-​C/​L-​L-​C

N

Mean

SD

Std. Error Mean

B1  =L-​L-​C =H-​L-​C

29 10

1.97 2.90

0.82 0.32

0.15 0.10

B2  =L-​L-​C =H-​L-​C

29 10

2.10 2.90

0.86 0.32

0.16 1.00E-​01

B3  =L-​L-​C =H-​L-​C

29 10

1.62 1.70

0.82 0.87

0.15 0.21

B4  =L-​L-​C =H-​L-​C

29 10

2.00 2.80

0.93 0.42

0.17 0.13

B5  =L-​L-​C =H-​L-​C

29 10

1.52 1.60

0.69 0.52

0.13 0.16

B6  =L-​L-​C =H-​L-​C

29 10

1.52 1.70

0.78 0.82

0.15 0.26

B7  =L-​L-​C =H-​L-​C

29 10

1.69 2.60

0.85 0.70

0.13 0.22

B8  =L-​L-​C =H-​L-​C

29 10

1.76 2.50

0.79 0.71

0.15 0.22

B9  =L-​L-​C =H-​L-​C

29 10

2.14 2.30

0.64 0.67

0.12 0.21

B10  =L-​L-​C =H-​L-​C

29 10

2.07 2.00

0.80 0.82

0.15 0.26

B11  =L-​L-​C =H-​L-​C

29 10

0.59 0.90

0.68 0.32

0.13 0.10

B12  =L-​L-​C =H-​L-​C

29 10

0.21 0.60

0.41 0.58

7.66E-​02 0.16

B13  =L-​L-​C =H-​L-​C

29 10

2.28 2.10

0.51 0.32

9.44E-​02 0.10

The Mechanism of Learning in the Hangzhou Software Industry According to the aforementioned cluster analysis and statistical tests, some conclusions can be drawn on the software cluster in Hangzhou. The high-​level-​capability enterprises are the main force to conduct learning activities among the interregional networks so as to absorb external knowledge into the cluster. The high-​level-​capability enterprises performed significantly better on activities such as interregional cooperation on R&D and marketing, participation in industrial associations in other regions, introduction of external professionals, and establishment of window organizations in other knowledge-​intensive regions. Instead of endeavoring to cooperate inter-​regionally on R&D or consultation, the high-​ level-​capability enterprises take advantage to strengthen their relationship with local colleges

Clusters and Development of Innovation     291 Table 4.1.5 Independent-​Samples Test for Learning Activities among Regional

Networks Levene’s Test for Equality of Variances

t-​Test

F

Sig.

t

df

Sig. (Two-​Tailed)

9.718

.004

-​3.478 -​5.117

37 36.368

.001 .000

16.393

.000

-​2.844 -​4.229

37 36.703

.007 .000

B3 equal variances assumed equal variances not assumed

1.745

.195

-​.275 -​.302

37 18.918

.785 .766

B4 equal variances assumed equal variances not assumed

15.037

.000

-​2.623 -​3.677

37 33.786

.013 .001

B5 equal variances assumed equal variances not assumed

1.645

.208

-​.347 -​.399

37 20.865

.730 .694

B6 equal variances assume equal variances not assumed

.027

.871

-​.627 -​.613

37 15.048

.534 .549

B7 equal variances assumed equal variances not assumed

.213

.647

-​3.501 -​3.533

37 15.938

.001 .003

B8 equal variances assumed equal variances not assumed

.369

.548

-​2.633 -​2.776

37 17.300

.012 .013

B9 equal variances assumed equal variances not assumed

.335

.566

-​.682 -​.664

37 14.972

.500 .517

B10 equal variances assumed equal variances not assumed

.059

.810

.234 .234

37 15.381

.816 .820

B11 equal variances assumed equal variances not assumed

9.488

.004

-​1.394 -​1.944

37 33.412

.172 .060

B12 equal variances assumed equal variances not assumed

3.663

.063

-​2.437 -​2.180

37 13.186

.020 .048

B13 equal variances assumed equal variances not assumed

48.012

.000

-​2.426 -​3.034

37 25.652

.020 .005

B1 equal variances assumed equal variances not assumed B2equal variances assumed equal variances not assumed

or research institutes. This might be due to the large amount of outstanding universities and research institutes located in Hangzhou. Hence, the high-​level-​capability enterprises in the software industry are reluctant to seek partners outside Hangzhou, as enterprises in other regions tend to do. The low-​level-​capability enterprises failed to utilize the local network to learn from the knowledge diffusion of their high-​level-​capability neighbors. This may result in a vicious circle in which the high-​level-​capability enterprises grow stronger in technological capabilities while the low-​level-​capability enterprises become weaker. The technological learning mechanism in high-​level-​capability enterprises worked well, but the knowledge

acquired from outside the cluster cannot be diffused to those low-​level-​capability enterprises. It shows that knowledge diffusion is not smooth between high-​level-​capability and low-​ level-​capability enterprises. Since a partial mechanism of technological learning in high-​level-​capability enterprises has been operating efficiently, it is worth mentioning that a reasonable collaboration mechanism between suppliers and supporting firms is necessary to support and motivate the division and cooperation of innovation in an industrial cluster. In the context of collaboration or interaction within clusters, most researchers have observed the interactions between important service actors providing KIBS and manufacturing firms, seldom discussing on a systematic level how these collaborations or KIBS’ embeddedness affect collaborations within the industrial cluster (Muller and Zenker, 2001), especially collaborations between horizontal firms, or how these “bridge roles” affect the whole network structure or the evolution of the whole cluster network structure. Furthermore, research has mainly focused on the role of KIBS in highly developed innovation systems and in metropolitan areas, neglecting their specific role for low-​tech industries and peripheral regions (Thomi and Böhn, 2003). Therefore, it becomes worthy to discuss the flow of knowledge and the impact of KIBS’ embeddedness within the Chinese industry cluster in a much deeper way and to improve horizontal learning between member firms within clusters.

The Flow of Knowledge with Supplementary-​L evel Determinants There are various forms of collaboration between the actors in the cluster (Best, 1990; Harrison, 1994; Liyanage, 1995; Staber, 2001). Collaborations can be between universities and industry (Fontana et al., 2006; Owen-​Smith et al., 2002; Wright et al., 2006); among universities, government, and industrial firms (Inzelt, 2004); and between research & technology organizations and industrial firms (Preissl, 2006). The establishment of these collaborations supports the idea that district firms are not atomistic in an open marketplace. They are indeed embedded in a dense and cohesive web of relationships (see Figure 4.1.5) through which they obtain critical resources (Staber, 2001), disseminate innovation (Davis, 1991), and foster adaptation (Kraatz, 1998). Extant studies examining innovations of clusters mostly focus on the cooperation between major enterprises (e.g., vertical or horizontal relationships between member firms along the value chain) or the roles of public service sectors within clusters. Few studies take a systemic perspective on how the knowledge in clusters is created and transferred. Particularly, KIBS, an important actor, have been overlooked. KIBS refer to providers, users, originators, and intermediary institutions that transfer technological and nontechnological innovations (Miles et al., 1995) to promote innovation capabilities of member firms in the clusters (Muller and Zenker, 2001; Smedlund and Toivonen, 2007). However, the literature on KIBS, or that uses the concept, is large (Hertog, 2000; Lee, 2003; Miles, 2005; Strambach, 1997). Most of the authors do not link KIBS to innovation systems, and only a few studies are about embedding KIBS in a territorial context (Barras, 1990; Bilderbeek et  al., 1997; Hertog, 2000a), especially in the context of the industrial

Clusters and Development of Innovation     293

Knowledge storegy

Knowledge base of innovative organizations

Flow of knowledge

Absorption capacity

KIBS - firms as bridging organisations

Transfer capacity Regional science and policy base

Other service institutions

Firms and networks

Higher education & research institutions

Government and nonprofile organization

Figure  4.1.5  Network of industrial cluster:  factors, interfirm interactions, and knowledge base. Source: Revised from Thomi et al. (2003)

cluster. As for those that embed KIBS in a territorial context, they either focus on the interaction between KIBS and client firms (Bettencourt et al., 2002; Muller and Zenker, 2001), which belong to the firm-​level studies, or point out that KIBS have played a bridge role during the interaction process (Czarnitzki et al., 2003; Thomi and Böhn, 2003). Furthermore, research has mainly focused on the role of KIBS in highly developed innovation systems and in metropolitan areas, neglecting their specific role for low-​tech industries and peripheral regions (Thomi and Böhn, 2003). Particularly in the China context, a rapid development of industrial clusters in China’s Zhejiang province has resulted in an increase in the collaborations between horizontal firms of the same scale. Therefore, this section employs influential Da Tang Socks manufacturers located in this province as the research context to improve the understanding of how these horizontal firms establish collaborations through the embeddedness of KIBS and how such bridging roles affect the entire network structure. By employing this traditional sock manufacturing cluster, this section is able to address the role of KIBS in a relatively low-​technology industry within China’s peripheral eastern coast region. This industrial cluster provides significant evidence of learning strategies within the cluster through the embeddedness of KIBS.

Da Tang Socks Cluster The Da Tang Socks cluster is one of the most representative traditional clusters with the fastest growth rate in Zhejiang province. The cluster has formed a complete industry value

294   Li and Wei chain including knitting, coloring, manufacturing, and service of knitting machines, as well as marketing, logistics, and information technology services. The network relationship data is based on a survey of the Da Tang Socks cluster in Zhejiang province, Southeast China, from 2007 to 2008. The first step in the survey was face-​to-​face interviews with director generals of local governments and trade associations to gather general information of the Da Tang Socks cluster, including the entire development process of the cluster, the embeddedness of KIBS, and information about member enterprises. The next step was to conduct face-​to-​face interviews with 10 typical enterprises (by random selection of 6 leading firms and 4 small-​ and medium-​sized firms) to verify the information gathered from the first step. The third step was to conduct face-​to-​face interviews with the important KIBS (with the degree of embeddedness in the top five) to know more about the reason they embed into the clusters, the distribution and number of their clients, and the services they provide. The questionnaire was then adjusted and distributed to member firms. A pretest questionnaire was also conducted to help refine the final questionnaire. Finally, there were 45 questionnaires distributed to 45 member firms by the local government. There were 38 returned questionnaires, with 37 valid. After that, face-​to-​face interviews were conducted with key member firms and KIBS again to ensure the correctness of the returned questionnaire.

The Evolution of Network Structure in Da Tang Socks Cluster Generally, the Da Tang Socks cluster has undergone three evolution phases as shown in Table 4.1.6.

Phase of Atomic Structure Before 2000, socks knitting machinery successfully transformed from hand-​driven machines to electronic equipment. Many home workshops took this opportunity to update their equipment and developed into preliminary factories in the mid-​1990s. The firms in this phase were mostly knitting firms purely involving in manufacturing. During this phase, there were still no orders for member firms in the cluster. The cluster network was mainly a structure of loosely connected small home workshops with 20 to 80 employees, as shown in Figure 4.1.6.

The Phase of Emerging Satellite Structure From 2000 to 2003, large modern factories emerged and mainly supplied the fast-​ growing export market. Knitting machines began to move from simple mechanic knitting machineries to computer-​ controlled equipment. Da Tang Socks started an extensive manufacturing era receiving orders, fulfilling orders, and delivering orders. The increase of the textile importing quota of Western countries during this period resulted in the demand greatly exceeding the supply in the export market. Some leading enterprises began to seek more professional management expertise by bringing in KIBS. Meanwhile, technical and trade barriers against the socks knitting industry appeared in the European and American markets in 2003. As a result, some foreign certification organizations came to be involved in providing product certification and testing services.

Clusters and Development of Innovation     295 Table 4.1.6 KIBS Emerging in China Socks Cluster Development Phase

Key Issues

Types of KIBS Embedding

Phase 1 (1970s–​2000)

1) Transformation of knitting machinery from hand-​driven to electric equipment 2) Original capital accumulation

Unknown

Phase 2 (2000–​2003)

1) Transformation of knitting machinery from simple mechanic electric machinery to computer-​controlled equipment 2) The emergence of large-​scale modern factories 3) Increase in technology and trade barriers

1) Knitting machine services; format design services 2) Professional consulting; staff training 3) Foreign certification organizations providing standard explanation, product certification, and testing services

Phase 3 (2004–​2008)

1 ) Sales by famous bands 2) R&D and application of new functional cloth or new functional material 3) Formation of regional socks band

1) Professional market consulting; professional advertising companies 2) Public KIBS with technology services 3) Foreign certification organizations providing standard explanation, product certification, and testing services

B33 A21

B12

B32

B

B22 A41

C31

B31

C12

B13

C22

C

B23 B11

C21 C11

A22

A

A11

C13 B21

A12 A13

A23

D14

D21

A32 A14 A33

D

D13

D12

A31 D11

Figure 4.1.6  Network structure of the Da Tang Socks cluster in 2000.

296   Li and Wei A few leading enterprises with greater technology and capital strength became the main economic units to contact the embedded KIBS organizations. These leading enterprises absorbed external knowledge introduced by KIBS through more consolidated connections. Because demand highly exceeded supply, leading enterprises and medium-​scale enterprises were in a better position in price negotiations. Further, the leading enterprises scrambled to ally with the medium-​scale enterprises to extend their manufacturing capacity. Small firms with very limited production capacity preferred to contact only regular large-​scale enterprises. On this basis, firms in the cluster began to split into different levels and formed a satellite structure, as shown in Figure 4.1.7. The lines between nodes represent direct relations between firms. In this stage, the structure of the cluster network became more of a hierarchy. C31 D14 D13

D21

C22

A41 D

A31

D12

B21

C13

A14

C12

A21 B23

A33

C

C21

B32

B11

A13 A22

B12 B B22

A32

B13

B31 D11

C11

B33

A A12

A23 A11

Figure 4.1.7  Network structure of the Da Tang Socks cluster in 2003. (a) without KIBS organizations embedded; (b) with KIBS organizations embedded.

Clusters and Development of Innovation     297 The cluster network structure during the phase of the emerging satellite structure is influenced by KIBS. This influence is exerted first by changing the nature of the client-​ leading enterprises, such as their scale and power expansion, which further changes the structure of the connections among them and their subordinate enterprises. The influence of KIBS is mainly on their bridging effects. With the embeddedness of KIBS as shown in Figure  4.1.7(b), the cluster network becomes more compact and more interconnected than without KIBS as shown in Figure 4.1.7(a). The new pattern is better for knowledge acquisition and diffusion, which in turn improves knowledge production in the cluster. Particularly, the consulting, training, testing, and certification services embedded in the Da Tang Socks cluster bridge the knowledge gap while providing services to the enterprises. KIBS integrate the knowledge acquired from outside the cluster with their own knowledge and pass the combined knowledge to the client firms during the interaction process. Meanwhile, KIBS also transmit the knowledge acquired from certain enterprises to other enterprises within the cluster.

Phase of Formation and Development of Network Structure Since 2003, the foreign trade ministry has raised the trade and technical barrier. Firms are pressed to change their policy from indirect exports to direct exports and from the export market to the domestic market. Most leading enterprises have started to focus on brand strategies aiming to increase the value of their products and have begun to contact professional consulting companies for marketing and brand management.

Impact of KIBS Embeddedness in Da Tang Socks Cluster The evolution of network structure by the change in network density, network betweenness centrality, and network cohesion is depicted in Table 4.1.7 and Figure 4.1.8.

Increase of Network Density In phase 2 (2000–​2003) and phase 3 (2004–​2008), the value of network density substantially rose after the introduction of KIBS (i.e., from 0.0387 to 0.0511 in phase 2 and from

Table 4.1.7 The Embedding of KIBS and Optimization of Cluster Network Network Variables Year

Density

Betweenness Centrality

Cohesion

2000 2003 (without embedding) 2003 (with embedding) 2007 (without embedding) 2007 (with embedding)

0.0336 0.0387 0.0511 0.0657 0.0736

2.54% 4.42% 22.60% 20.52% 18.66%

-​0.900 -​0.913 -​0.061 -​0.051 0.048

298   Li and Wei D12 B22 A23

B12

A32

A33 A11

A12

C13

D21 C21

A22

A31

D

D11

C22

B32 B23

B31

A A14

D14

C31

A21

A13

D13

C12 A41

B

C C11

B13

B33

B11

B21

Figure 4.1.8  Network structure of the Da Tang Socks cluster in 2004: (a) without KIBS organizations embedded; (b) with KIBS organizations embedded. Add the influence of KIBSs embedding of phase 1.

0.0657 to 0.0736 in phase 3). The increase in network density indicates that the actual contacts between nodes are more frequent and without redundancy (Burt, 2009). KIBS facilitates knowledge diffusion among nodes by strengthening the corporations within the entire network. The increase in density in phase 2 is due to the implicit bridges among leading enterprises created by KIBS.

Clusters and Development of Innovation     299

Increase of Network Agglomeration The agglomeration rises after the introduction of KIBS in phases 2 and 3 (i.e., from −0.913 to −0.061 in phase 2 and from −0.051 to 0.048 in phase 3). The increase in network agglomeration indicates that contacts are more frequent and relationships are strengthened among coherent groups within the cluster. Thus, the embeddedness of KIBS facilitates the knowledge transfer among firms by building more channels of communication among them. In phase 2 there are multiple subgroups, dominated by medium and large enterprises. Socks manufacturing is a traditional industry with a low entry barrier, leading firms to often keep a distance from the other leading competition firms to protect their technological secrets. Subordinate factories often lack sales and marketing capabilities and usually rely on serving the leading client firms. After the introduction of KIBS (certification, training, or testing and design) into the cluster, the contacts are established among these groups through the processes of providing various services. Then, in phase 3, a new type of subgroup dominated by leading corporations and surrounded by medium-​and large-​sized enterprises is formed. Through the embeddedness of KIBS that provide R&D and other professional services, leading corporations start to establish contacts that promote network agglomeration.

Decrease of Network betweenness Centrality The network betweenness centrality substantially rises in phase 2, from 4.42% to 22.60%; however, it drops from 20.52% to 18.66% in phase 3.  Network betweenness centrality indicates the extent to which the information is monopolized by a few corporations. A higher betweenness centrality means a higher degree of information monopoly. Betweenness centrality is closely related with the extent to which nodes take the positions of structure holes (Burt, 2009). In phase 2 of cluster evolution, the introduction of KIBS initially increases the betweenness centrality. KIBS promote the contacts between leading corporations as well as large-​and medium-​sized enterprises being the terminal nodes of knowledge diffusion. In this way, these enterprises can leverage the advantage of being in a structural-​hole position while the cluster is evolving on the way to a more stabilized status. When the cluster evolves to reach a stabilized status in phase 3, KIBS lowers the network betweenness centrality. The decrease in network betweenness centrality promotes effective contacts among nodes and knowledge transfer.

Heterogeneous Bridges Built by KIBS Member firms belonging to the same manufacturing sector tend to monopolize important information within the firm to maintain their competitive position. These firms are not willing to enter into a homogeneous bridge that cannot meet their knowledge requirements. To fill this gap, KIBS are the heterogeneous nodes that can intentionally and unintentionally disclose information to member firms to arrive at a win-​win relationship among them. Therefore, as a heterogeneous node, KIBS build the bridges to promote the flow of heterogeneous information within and across clusters that drive the evolution of the cluster network.

300   Li and Wei

Strength of Weak Ties Brought by Invisible Nodes The strength of weak ties is stressed during the information transfer (Granovetter, 1973). Compared with the member firms, KIBS are heterogeneous actors within the cluster acting as an invisible node bringing member firms heterogeneous information. Continuing and increasing cooperation increases the strength and the influence of weak ties built by KIBS, thereby promoting the emergence of new contacts and the flow of information. Member enterprises are not always passive receivers. These firms sometimes seek information from KIBS to obtain the heterogeneous information, further increasing the strength of weak ties. Research on innovation has shifted its focus from the Schumpeterian type of entrepreneurial innovations toward a new understanding of innovation as a result of interactive processes between different actors embedded in a specific social, political, and economic environment. Based on the case study of the China socks cluster, this section explores why and how the embeddedness of KIBS influences network structure. This section finds that the introduction of KIBS into the cluster network has a positive impact on the network structure in terms of facilitating the flow of information among firms. Consequently, innovation has become an important topic not only in the context of the market and the firm but also in the context of regional growth and development. Within an industrial cluster, cluster firms are a geographically proximate group of interconnected companies and associated institutions in a particular industrial field, linked by commonalities and complementarities (Porter, 1998, 2000). Researchers have argued that organizational knowledge search fosters product innovation by augmenting firms’ knowledge base (Grant, 1996; Levinthal and March, 1981). Cluster firms, owing to their geographical proximity and interconnectedness of business fields (Porter, 1990, 1998), are able to augment the knowledge base not only through integrating internal knowledge (Nonaka, Reinmoeller, and Senoo, 1998) but also, and importantly, through accumulating knowledge from beyond firms’ organizational boundaries (Rosenkopf and Nerkar, 2001; Von Hippel, 1994). The issue is therefore how cluster firms might balance their knowledge search for external knowledge (Bathelt et al., 2004). Some scholars consider that furthering this debate of local and nonlocal balance will enrich our understanding of cluster firms’ innovation (Gertler and Levitte, 2005; Oinas and Malecki, 2002; McKelvey et al., 2003).

Geographic Search and Product Innovation External knowledge search has a geographic dimension. Geographic search refers to firms’ knowledge search within and beyond firms’ geographic boundaries, that is, in local and nonlocal spaces (Ahuja and Katila, 2004; Sidhu et al., 2007). Scholars rather early on argued that cluster firms need to balance their local and nonlocal search (Scott, 1998). This argument is backed up by recent empirical studies that report that neither local nor nonlocal search alone could be said to contribute to cluster firms’ innovation in decisive ways. On the one hand, the effect of local search on product innovation is uncertain. While some studies suggest that local search is positively related to cluster firms’ innovation (Baptista

Clusters and Development of Innovation     301 and Swann, 1998; Porter, 1990, 1998; Saxenian, 1994), others report otherwise (Beaudry and Breschi, 2003; Suarez-​Villa and Walrod, 1997). Some scholars further argue that the relevance of spatial proximity for knowledge exchange tends to be exaggerated (Boschma, 2005; Gertler, 2003) because firms’ ability to benefit from neighboring knowledge is largely context-​dependent (Shaver and Flyer, 2000; Beaudry and Breschi, 2003). On the other hand, the effect of nonlocal search on product innovation is also highly complex. While some scholars advise cluster firms to establish systematic linkages with nonlocal knowledge sources (Camagni, 1991; Ratti et al., 1997) to acquire nonlocal knowledge that may facilitate cluster firms’ product innovation (Asheim and Isaksen, 2002; Bathelt et al., 2004), others caution that cluster firms’ ability to access and utilize large amounts of geographically distant knowledge is limited (Phene et al., 2006) because they may find it difficult to incorporate and adapt to nonlocal knowledge (Owen-​Smith and Powell, 2004). Drawing on the complexities of local and nonlocal searches, researchers increasingly recognize the importance for cluster firms to balance both forms of search to foster product innovation (Bathelt et al., 2004). However, so far researchers have not pointed out specifically how such balancing can be achieved, and the question of the relative importance of local versus nonlocal search in innovation remains unsettled (Gertler and Levitte, 2005; Oinas and Malecki, 2002; McKelvey, Alm, and Riccaboni, 2003). One possible reason for this gap in current research is that extant studies predominately assumed that the knowledge from different local and nonlocal sources—​such as customers, suppliers, and universities—​is homogeneous (Camagni, 1991; Ratti et al., 1997). This assumption about the homogeneity of local and nonlocal knowledge has an important, and in our opinion undesirable, implication, for it overlooks the search for heterogeneous knowledge—​or search breadth—​as a distinctive search behavior. Increasing evidence suggests that knowledge from different local and nonlocal sources is often heterogeneous (Audretsch and Feldman, 2004; Gilbert, Dougall, and Audretsch, 2008). Research on innovation search has already found that a firm’s innovation search varies on two distinctive dimensions (breadth and depth), and that these two dimensions of search have different roles in firms’ innovation (Katila and Ahuja, 2002; Laursen and Salter, 2006). However, we are yet unclear of the different roles that breadth and depth play, with regard to both local and nonlocal searches, in cluster firms’ product innovation.

Industry Clusters in Zhejiang Province Based on a questionnaire survey in Zhejiang province, China, we obtained valid data from 229 firms, representing an effective participation rate of 32.7%. Of the responding firms, 53.3% were in the textile industry and 46.7% were in the pharmaceutical industry. To assess the nonresponse bias, we compared early respondents with late respondents and found no significant differences in firm size, age, and sector. We also compared the responding firms with the nonresponding firms and found no significant differences in firm size, age, and sector. We were confident in the quality of data because the respondents were experienced and knowledgeable about the issues under study: 51.5% of firms reported that their top executive had completed the questionnaire, and 48.5% reported that marketing, R&D, and product managers filled out the questionnaire on part 1 and financial officers filled out the questionnaire on part 2.

302   Li and Wei We employed ordinary least squares regressions to analyze the effect of geographic search on the product innovation of cluster firms. Model 1, with only control variables, is a benchmark against which to test the effects of four types of geographic search (local search breadth, local search depth, nonlocal search breadth, and nonlocal search depth), relative local search depth, and relative nonlocal search breadth on the product innovation of cluster firms. In Models 2, 3, 4, and 5, we added local search breadth, local search depth, nonlocal search breadth, and nonlocal search depth, respectively, to Model 1 to examine their individual impacts on the product innovation of cluster firms. In Model 6, we added all four of these geographic search variables to the control variables to further confirm their impacts. In Model 7, we added both relative local search depth and relative nonlocal search breadth to the control variables to examine their impacts on the product innovation of cluster firms. We estimated separate models for the textile and pharmaceutical industries rather than pooling them and using interactions to test cross-​industry differences (Henderson et al., 2006). In Model 10, we tested the effects of relative local search depth and relative nonlocal search breadth with the sample of firms in the textile industry. We tested the effects of relative local search depth and relative nonlocal search breadth with the sample of firms in the pharmaceutical industry in Model 13. We compared the different influences of relative local search depth and relative nonlocal search breadth between textile firms and pharmaceutical firms. Additionally, the value of Variance Inflation Factor (VIF) is below 3, indicating that the multicollinearity is not a serious problem in our study.

Local Search and Nonlocal Search Table 4.1.8 reports the means and standard deviations of the dependent, independent, and control variables and their correlations. Table 4.1.9 reports the results of various regression models explaining the product innovation of cluster firms. In this study, we have found that local search breadth, local search depth, and nonlocal search breadth play a positive role in the product innovation of cluster firms. However, we did not find the positive role of nonlocal search depth in the product innovation of cluster firms. One possible reason for this is that cluster firms have limited capability to access and deeply utilize large amounts of geographically distant knowledge (Phene et al., 2006). Excessive reuse of the same nonlocal knowledge may lead to very limited potential for new recombination innovations (Katila and Ahuja, 2002). Previous studies (e.g., Katila and Ahuja, 2002; Laursen and Salter, 2006) also found the negative role of external search depth in the innovative performance of firms. Thus, deep search for nonlocal knowledge cannot significantly contribute to and may have a negative impact on a cluster firm’s product innovation. It is particularly true that most of China’s cluster firms, which are SMEs with limited resources, may find it difficult to effectively absorb geographically distant knowledge.

Relative Local Search and Nonlocal Search Moreover, and importantly, we found that both relative local search depth and relative nonlocal search breadth play a significant role in the product innovation of cluster firms. Our findings show that cluster firms may balance local and nonlocal search through

Table 4.1.8 Descriptive Statistics and Correlation Matrix Variables

Mean

SD

1

1. Product innovation 2. Firm age 3. Firm size 4. Firm R&D intensity 5. ROA 6. International orientation 7. Sector 8. Local search breadth 9. Local search depth 10. Nonlocal search breadth 11. Nonlocal search depth 12. Relative nonlocal search breadth 13. Relative local search depth

0.34 11.96 5.43 0.06 0.18 3.30 0.53 8.85 2.41 7.27 1.41 -​1.58 1.00

0.21 6.96 1.30 0.07 0.16 1.08 0.50 2.12 2.49 3.47 2.33 2.80 2.05

0.16* 0.10 0.38*** * 0.14 0.03 0.08 0.11 0.24*** 0.12† -​0.01 -​0.27*** 0.38*** 0.06 0.24*** 0.02 0.42*** 0.20** 0.10 -​0.04 0.23*** 0.20** 0.17** 0.06

†

p < 0.10, * p < 0.05, ** p < 0.01, *** p < 0.001 (two-​tailed).

2

3

4

5

6

0.15* 0.15* 0.11† *** 0.32 0.10 0.16* * * -​0.17 -​0.15 -​0.14* -​0.26*** -​0.03 0.08 0.18** 0.30*** 0.17** 0.08 0.11 0.43*** *** 0.26 0.05 0.10 0.59*** * 0.14 -​0.06 0.01 0.39*** *** 0.34 0.01 -​0.01 0.50*** 0.06 0.17** 0.12† 0.08

7

8

9

10

11

12

0.02 -​0.07 -​0.18* -​0.08 -​0.21** 0.01

0.36*** 0.59*** 0.21** 0.03 0.20**

0.36*** 0.64*** 0.40*** 0.17* 0.79*** 0.34*** 0.49*** -​0.02 -​0.36*** -​0.18**

Table 4.1.9 Results of OLS Regression All Firms Variables

Model 1

Model 2

Control variables Firm age Firm size Firm R&D intensity ROA International orientation Sector

0.175* 0.143* -​0.047 0.013 0.127† 0.105† 0.036 -​0.011 0.238** 0.127† 0.122† 0.091 0.326***

Local search breadth Local search depth Nonlocal search breadth Nonlocal search depth

Model 3

Model 4

0.182* -​0.056 0.121† 0.030 0.172* 0.114†

0.125* 0.180* -​0.063 -​0.050 0.133* 0.132* 0.042 0.038 -​0.003 0.221** † 0.125 0.123†

0.160*

Model 5

0.427** 0.045

Firms in Pharmaceutical Industry

Model 8

Model 10

Model 11

0.167† -​0.237* -​0.006 0.009 0.277*

0.163† 0.094 0.145 0.083 0.101 0.062 0.259* 0.216* 0.232* -​0.008 -​0.048 0.009 -​0.003 -​0.111 -​0.032

Model 6

Model 7

0.112† -​0.033 0.102† 0.009 -​0.016 0.101

0.147* 0.174† 0.149 -​0.086 -​0.199† -​0.184† 0.115† -​0.022 -​0.010 0.048 0.040 -​0.032 0.126 0.418*** 0.078 † 0.126

0.133† 0.154† 0.353*** -​0.142†

Model 9

4.071** 0.100 0.075

7.411*** 0.191 0.165

4.295*** 0.120 0.092

8.595*** 3.540** 7.104*** 0.215 0.101 0.247 0.190 0.073 0.212

4.707*** 0.147 0.116

Model 12

0.202* 0.267* 5.402*** 5.848*** 0.190 0.322 0.155 0.267

Standardized coefficients are reported in the table. † p < 0.10; * p < 0.05; ** p < 0.01; *** p < 0.001 (two-​tailed test).

Model 13

0.315* 0.061 0.088 -​0.094

0.064 0.215† 0.437** -​0.146 0.169* 0.228**

Relative local search depth Relative nonlocal search breadth

F value R2 squared Adjusted R2

Firms in Textile Industry

5.270*** 0.246 0.199

0.101 0.073 2.746* 0.120 0.076

3.577** 0.249 0.180

2.132* 0.131 0.070

Clusters and Development of Innovation     305 simultaneously emphasizing relative local search depth and relative nonlocal search breadth. That is, for each individual dimension (depth and breadth) of local and nonlocal search, a cluster firm needs to focus more on local search depth than nonlocal search depth, and more on nonlocal search breadth than local search breadth. However, jointly considering the depth and breadth of geographic search, cluster firms need to balance relative local search depth and relative nonlocal search breadth. Specifically, to improve product innovation, cluster firms, on the one hand, need to search in the local area deeper than in the nonlocal area, and on the other hand, need to search in the nonlocal area wider than in the local area. Interestingly, we further found that relative local search depth and relative nonlocal search breadth only matter in the textile (stable) industry, but not in the pharmaceutical (dynamic) industry. Specifically, on the one hand, we found that the product innovation of textile firms benefits significantly from both local search depth and nonlocal search breadth, but neither from local search breadth nor from nonlocal search depth. Thus, the two dimensions of relative geographic search can facilitate their innovation. However, conducting R&D internally does not significantly improve textile firms’ innovation performance. On the other hand, we found that the product innovation of pharmaceutical firms greatly benefits from their local search breadth, but not from the other three types of geographic search (local search depth, nonlocal search depth, and nonlocal search breadth). We also found that internal R&D effort plays an important role in the product innovation of firms in the pharmaceutical industry. Put together, on the whole, the product innovation of firms in the textile (stable) industry depends on both their local search depth and nonlocal search breadth, while the product innovation of firms in the pharmaceutical (dynamic) industry depends on local search breadth and internal R&D investment. It also should be noted that Chinese clusters may have very different attributes than Western courtiers. For example, clusters in Western countries are formed by a few major companies that come together from a same or close industry, and clusters in China may have thousands of small, medium, or large companies that come from different industries (Jeannet, 2009). Thus, the content and structure of the local knowledge base in China clusters is different to some extent from that of Western countries. For example, local search in the China context may encompass search behaviors for knowledge from firms in other or distant industries, which would be categorized by nonlocal search in the Western countries. It would be helpful to explain why local search can play an important role in the product innovation of both textile firms and pharmaceutical firms. Cluster firms are a geographically proximate group of interconnected companies and associated institutions in a particular industrial field, linked by commonalities and complementarities (Porter, 1998, 2000). Our study helps advance our understanding of the role of geographic search in the product innovation of cluster firms. With regard to local search, extant studies show the inconsistent results on the role of local search in cluster firms’ innovation. Our study finds not only that both local search breadth and local search depth contribute to the product innovation of cluster firms but also that relative local search depth can contribute to cluster firms’ product innovation, which helps advance our understanding of the role of local search in cluster firms’ innovation. Therefore, clusters can be regarded as groups of interacting firms and agencies that collectively enhance innovation performance through acting as a system (Charles, 2002), which has become a selective approach to explore the regional innovation system (Asheim and Isaksen, 2002; Cooke,

306   Li and Wei 2002). Then, the cluster concept has become an almost obligatory element in economic development policies in recent years and it is viewed as primarily innovation-​or knowledge-​ based communities by system perspectives. Now, almost all of the literatures argue that the regional innovation systems (RIS) is partly a new theoretical construct to analyze and grasp important aspects of the working of regional clusters, a reference to some actual development tendencies in the building of networked innovation architectures in some regions, and a tool in policymaking to create systems of innovation in support of business competitiveness on a regional scale, even on a national level (Padmore and Gibson, 1998; Tödtling and Kaufmann, 2002; Asheim and Isaksen, 2002; Cooke, 2002; Rip, 2002).

Summary According to the aforementioned cluster innovation system analysis, we explored the categories of determinants and three special practices at different level determinants, which may lead to the emergence of an innovation system in the industrial cluster. Figure 4.1.9 presents a conceptual framework of the cluster innovation system. It is partly a new theoretical construct to analyze and grasp important aspects of the working of the industrial cluster. The cluster innovation system may be delimited by the characteristic of the industrial cluster: geographically bounded concentrations of interdependent business (Rosenfeld, 1997). Furthermore, the cluster innovation system denotes an industrial cluster surrounded by “supporting” organizations (Cooke, 2002). Then, the cluster innovation system can be defined as economic communities of local networks of innovators located in a narrow industrial district, with the cross-​fertilizing effects of supporting systems, such as internal and external knowledge service organizations, local government, and relative institutions and infrastructures, with the aim of promoting knowledge generation, exploration, diffusion, 0.4 0.3 0.2 0.1 0 –0.1 –0.2 –0.3 –0.4 –0.5 –0.6 –0.7

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03

20

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dd

20

fo be

e mb

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ft 3a

0

20

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dd

e mb

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07

20

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o ef

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f 7a 00

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–0.8 –0.9 Network a agglomerate Network between centrality Network density

Figure 4.1.9  Evolution trend of structure of cluster network.

Clusters and Development of Innovation     307 Periphery-level Determinants

Local government

Supplementary-level Determinants

Competitors

Users

Complementary firms

C ollectiv e a gen ts

Suppliers

S erv i ce & col l ecti v e m anagem ent

Related firms Vertical n etw or k in g

P u b lic ser v ice sector s

K now l edge & i nform ati on support

Horizontal networking

Core-level Determinants

Resources & climate Infrastructures

Outside market relationships & institutions

Figure 4.1.10  Conceptual framework of the cluster innovation system. and application within the industrial cluster through formal or informal interactivities between actors. In this definition, there are some assumptions. First, the research object of the cluster innovation system concentrates on the innovation activities within a narrow industrial district. Second, close interfirm communication, social-​cultural structures, and the institutional environment may stimulate socially and territorially embedded collective learning and continuous innovation (Asheim and Isaksen, 2002). Third, formal and informal interactivities promote the internal collaboration between firms (core value chain firms and related firms), between firms and knowledge service organizations, and to external cooperation with other firms (especially with customers and suppliers), knowledge providers (like universities and technology centers), finance, training, and public administration (Tödtling and Kaufmann, 2002). Fourth, the goal of the cluster innovation system is to facilitate knowledge generation, exploration, diffusion, and application within the cluster. In the conceptual framework of the cluster innovation system (Figure 4.1.10), local networks of innovators are mainly constructed by the core-​level determinants, which are classified into two forms of subnetworking: horizontal networking and vertical networking. Moreover, vertical networking is “woven” by the core value chain firms, and horizontal networking by related firms. Meanwhile, the supporting systems refer to the supplementary-​ level determinants and the periphery-​level determinants.

308   Li and Wei This conceptual framework attempts to capture the main features and relationships of a functioning cluster innovation system. Because it only indicates the linkages in empirical research of the Shaoxing textile cluster, it may be suitable for analyzing the innovation system of the industrial cluster in transitional economies like China. More empirical research is necessary to capture the variety of degrees of influence and decision-​making authority, the presence and absence, or relationships among the diverse possible kinds of all elements of special industrial clusters and their degrees of “systemness” (Cooke, 2002). Taking this view that clusters are primarily innovation-​or knowledge-​based networks, then, this chapter explains the CSP model and conceptual framework of the cluster innovation system by case study. On the basis of the empirical study presented here, it also may be concluded that innovation systems have pronounced regional dimensions and industrial differences. That is, the cluster analysis should not be enough to provide a common framework to integration alongside cluster innovation. Innovation activities as well as industrial policies always show a great deal of variation from cluster to cluster. Even if the clusters locate in a certain region, these clusters, in general, are diversified in their determinants and elements of the innovation system. For instance, the cluster innovation activities in traditional industries and in high-​tech industries are very different. Hence, more empirical research is given so as to explore the cluster innovation system. What we have to emphasize is that the differences in industrial characteristics among the different clusters may lead to the different linkage patterns among the elements of innovation systems in various clusters. For example, the commonest linkages in the core-​level determinants can be either vertical, moving from supplier to client, or horizontal, among related firms or between firms and various forms of economic infrastructures (Hanson, 1994; Padmore and Gibson, 1998), but the interactivities among vertical linkages, or among horizontal linkages, are possibly stronger or weaker. Nevertheless, no matter how the interactivities happen in a different cluster, the conceptual framework, to a certain extent, is designed to be tolerant of different specifications of the cluster in transitional economies. Simply speaking, the significance of exploration of the cluster innovation system may be discussed at a variety of spatial scales: local government, industrial cluster, and microscale. First, local government can use the idea of the cluster innovation system as an excuse for a wide variety of policies, both to strengthen existing clusters (however well developed) and to attempt to create new clusters. In the Shaoxing textile industrial cluster, we view this cluster as an innovation system, and we may make appropriate policies to strengthen the knowledge base, to facilitate knowledge transfer, and to encourage collaboration between the three levels of determinants. Meanwhile, the idea of the cluster innovation system can be used to making clustering policies, which encourage collaboration and networking between firms in the hope that these will then become a cluster (Charles, 2002). Of course, both policies of either strengthening existing clusters or creating new clusters will be tailored to the specific needs of an individual cluster. Second, the idea of a system suggests the industrial cluster itself to develop the infrastructures, collective agents, and public service sectors, through which the system is well developed to support the competitiveness of a particular industrial cluster. For example, knowledge institutes are increasingly being recruited by economic development agencies to develop or enhance clusters, and indeed have been seen as key actors in the formation of some of the paradigmatic cases of clusters used as templates by policymakers. In case clusters, knowledge-​ producing bodies, such as universities and R&D institutes, are still the weak subsystem of

Clusters and Development of Innovation     309 the innovation system, and the cluster should develop its knowledge institutions as a core and strategic task to strengthen the knowledge base. Third, at the microscale, both core value chain firms and related firms should pay attention to developing themselves to local networks of SMEs, with a strong focus on collaboration and the development of shared resources (OECD, 1999; den Hertog et al., 2001), because the firms within the cluster are more innovative, and the innovativeness derives at least in part from the advantages of the cluster. Generally, based on the empirical research of the innovation system in the industrial cluster, this chapter summarizes the CSP model of the cluster innovation system by three categories of determinants:  core-​ level, supplementary-​ level, and periphery-​ level determinants. These determinants provide a complete picture to analyze the elements of the innovation system of a cluster. By combining with empirical research, the CSP model more clearly shows the roles of each category of determinants. Further, the emergent systems of innovation are shaped through the interaction of the three determinants. As a result, this conceptual framework is useful for innovation system building and policymaking for cluster development. Especially, both the CSP model and the conceptual framework of innovation systems of clusters are presented based on one cluster. Actually, a cluster can be much localized, such as the Shaoxing textile industry centered in a town of Shaoxing County, or very dispersed, such as the North American auto industry (Padmore and Gibson, 1998). However, the given conceptual framework of the innovation system of the industrial cluster may also capture the linkages that stick an industrial cluster together and attach it to supporting firms and institutions. In the Shaoxing textile industry, we find that cooperation with external knowledge organizations is very important. A  great number of firms in the clusters develop new technologies as radically new products with the use of formal, scientific knowledge jointly with actors outside of the cluster. To some extent, intentional cooperation with outside organizations in knowledge generation and diffusion may substitute for internal collective learning because of competitive relationships among the firms. The extensive collaboration with external actors reveals the potential importance of the national innovation system, which greatly helps the cluster to gain the competitiveness. As a consequence, developing the innovation system of the cluster should pay more attention to combining with the national innovation system. On this basis, we may find that the policies improve the innovation capabilities of the Shaoxing textile industry. As mentioned earlier, the imbalance of innovation capacities among the different linkage points of the core value chain has impeded the technological competitiveness of the whole industrial cluster; also, there is a lack of internal R&D institutes to develop the “bottleneck” technologies in a short time. Hence, the firms have to cooperate with the best R&D milieus, which they find at the national level.

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Clusters and Development of Innovation     311 Cooke, P. 1998. Introduction:  origins of the concept. In H.-​J. Braczyk, P. Cooke, and M. Heidenreich (Eds), Regional Innovation Systems—​The Role of Governances in a Globalized World. UCL Press, London. Czarnitzki, D., and Spielkamp, A. 2003. Business services in Germany: Bridges for innovation. Service Industrial Journal 23(2): 1–​30. den Hertog, P., Bergman, E., and Charles, D.R. (eds). 2001. Innovative Clusters:  Drivers of National Innovation Policy. OECD, Paris. Dosi, G. 1988. Sources, procedures and microeconomic effects of innovation. Journal of Economic Literature 26: 1120–​1271. Edquist, C. (ed). 1997. Systems of Innovation—Technologies, Institutions and Organizations. London and Washington, DC. Pinter. Fontana, R., Geuna, A., and Matt, M. 2006. Factors affecting university-​industry R&D projects:  The importance of searching, screening and signalling. Research Policy 35(2): 309–​323. Freeman, C. 1991. Networks of innovators:  A synthesis of research issues. Research Policy 20: 499–​514. Gertler, M.S. 2003. Tacit knowledge and the economic geography of context, or the undefinable tacitness of being there. Journal of Economic Geography 3(1): 75–​99. Gertler, M.S., and Levitte, Y.M. 2005. Local nodes in global networks: The geography of knowledge flows in biotechnology innovation. Industry and Innovation 12(4): 487–​507. Gilbert, B.A., McDougall, P.P., and Audretsch, D.B. 2008. Clusters, knowledge spillovers and new venture performance:  An empirical examination. Journal of Business Venturing 23(4): 405–​422. Granovetter, M. 1973. The strength of weak ties. American Journal of Sociology 78: 1360–​1380. Grant, R.M. 1996. Toward a knowledge-​based theory of the firm. Strategic Management Journal 17(S2): 109–​122. Preissl, B. Research and technology organizations in the service economy: Developing analytical tools for changing innovation patterns[J]. Innovation: The European Journal of Social Science Research, 2006, 19(1): 131–146. Harrison, B. 1994. Lean and Mean: The Changing Landscape of Corporate Power in the Age of Flexibility. Basic Books, New York. Henderson, A.D., Miller, D. and Hambrick, D.C. 2006. How quickly do CEOs become obsolete? Industry dynamism, CEO tenure, and company performance. Strategic Management Journal 27(5): 447–​460. Hertog, P.D. 2000. Knowledge-​intensive business services as co-​producers of innovation. International Journal of Innovation Management 4(4): 491–​528. Inzelt, A. 2004. The evolution of university-​industry-​government relationships during transition. Research Policy 33: 975–​995. Jaffe, A.B., Trajtenberg, M., and Henderson, R. 1993. Geographic localization of knowledge spillovers as evidenced by patent citations. The Quarterly Journal of Economics 108: 577–​598. Jeannet, J. 2009. Clusters companies in China’s Zhejiang province:  Will they take on the world? Tomorrow’s challenges, July: 1–​5. Katila, R. and Ahuja, G. 2002. Something old, something new: A longitudinal study of search behavior and new product introduction. Academy of Management Journal 45(6): 1183–​1194. Keeble, D., Lawson, C., Moore, B., and Wilkinson, F. 1999. Collective learning processes, networking and ‘institutional thickness’ in the Cambridge region. Regional Studies 33(4): 319–​332.

312   Li and Wei Kline, S.J., and Rosenberg, N. 1986. An overview of innovation. In R. Landau and N. Rosenberg (Eds), The Positive Sum Strategy:  Harnessing Technology for Economic Growth. National Academy Press, Washington, D. C. Kraatz, M.S. 1998. Learning by association? Interorganizational networks and adaptation to environmental change. Academy of Management Journal 41: 621–​643. Krugman, P. 1991. Increasing returns and economic geography. Journal of Political Economy 99(3): 483–​499. Krugman, P. 1995. Development, Geography, and Economic Theory. MIT Press, Cambridge, MA. Latour, B. 1996. Aramis or the Love of Technology. Harvard University Press, Cambridge, MA. Laursen, K., and Salter, A. 2006. Open for innovation:  The role of openness in explaining innovation performance among UK manufacturing firms. Strategic Management Journal 27(2): 131–​150. Lawson, C. 1999. Towards a competence theory of the region. Cambridge Journal of Economics 23(2): 151–​166. Lawson, C., and Lorentz, E.H. 1999, Collective learning, tacit knowledge and regional innovative capacity. Regional Studies 33: 305–​317. Lee, K.R. 2003. Knowledge intensive service activities (KISA) in Korea’s innovation system, OECD Report. Levinthal, D., and March, J.G. 1981. A model of adaptive organizational search. Journal of Economic Behavior & Organization 2(4): 307–​333. Liyanage, S. 1995. Breeding innovation clusters through collaborative research networks. Technovation 15(9): 553–​567. Lundvall, B.A. 1988, Innovation as an interactive process: From user-​producer interaction to the national system of innovation. In G. Dosi, C. Freeman, R. Nelson, et al. (Eds.), Technical Change and Economic Theory, pp. 349–​369. Pinter, London. Macevily, B., and Zaheer, A. 1999. Bridging ties: A source of firm heterogeneity in competitive capacity. Strategic Management Journal 20: 1133–​1156. Maskell, P. and Malmberg, A. 1999. The competitiveness of firms and regions: Ubification and the importance of localized learning. European Urban and Regional Studies 6(1): 9–​26. Markusen, A. 1996. Sticky places in slippery space: A typology of industrial districts. Economic Geography 72(3): 29–​313. McKelvey, M., Alm, H., and Riccaboni, M. 2003. Does co-​location matter for formal knowledge collaboration in the Swedish biotechnology-​pharmaceutical sector? Research Policy, 32(3): 483–​501. Miles I. 2005. Knowledge intensive business services: prospects and policies. Foresight 7(6): 39–​63. Miles, I., Kastrinos, N., Bilderbeek, R., Hertog, P. D., Flanagan, K., Huntink, W., & Bouman, M. (1995). Knowledge-intensive business services: users, carriers and sources of innovation. (EIMS Reports). European Commission, Brussels. Muller, E., and Zenker, A. 2001. Business services as actors of knowledge transformation: the role of KIBS in regional and national innovation systems. Research Policy 30(9): 1501–​1516. Nonaka, I., Reinmoeller, P., and Senoo, D. 1998. The “art” of knowledge: Systems to capitalize on market knowledge. European Management Journal 16(6): 673–​684. OECD. 1999. The Response of Higher Education Institutions to Regional Needs, OECD. Paris. Oinas, P., and Malecki, E.J. 2002. The evolution of technologies in time and space: From national and regional to spatial innovation systems. International Regional Science Review 25(1): 102–​131.

Clusters and Development of Innovation     313 Owen-​Smith, J., and Powell, W.W. 2004. Knowledge networks as channels and conduits: The effects of spillovers in the Boston biotechnology community. Organization Science 15(1): 5–​21. Owen-​Smith, J., Riccaboni, M., Pammolli, F., and Powell, W.W. 2002. A comparison of US and European university-​ industry relations in the life sciences. Management Science 48(1): 24–​43. Padmore, T., and Gibson, H. 1998. Modelling systems of innovation: II. A framework for industrial cluster analysis in regions. Research Policy 26: 625–​641. Pavitt, K., Robson, M., and Townsend, J. 1987. The size distribution of innovating firms in the UK 1945–​1983. Journal of Industrial Economics 35: 279–​315. Phene, A., Fladmoe-​Lindquist, K., and Marsh, L. 2006. Breakthrough innovations in the US biotechnology industry: The effects of technological space and geographic origin. Strategic Management Journal 27(4): 369–​388. Porter, M.E. 1998. Clusters and the new economics of competition. Harvard Business Review, November–​December,  77–​90. Ratti, R., Bramanti, A., and Gordon, R, eds. 1997. The Dynamics of Innovative Regions. Ashgate, Aldershot. Rip, A. 2002. Regional innovation systems and the advent of strategic science. Journal of Technology Transfer 27: 123–​131. Rosenkopf, L. and Nerkar, A. 2001. Beyond local search:  Boundary-​spanning, exploration, and impact in the optical disk industry. Strategic Management Journal 22(4): 287–​306. Saxenian, A.L. 1994. Regional Advantage: Culture and Competition in Silicon Valley and Route 128. Harvard University Press, Cambridge, MA. Scott, A.J. 1998. Regions and the World Economy:  The Coming Shape of Global Production, Competition, and Political Order. Oxford University Press, Oxford. Shaver, J.M., and Flyer, F. 2000. Agglomeration economies, firm heterogeneity, and foreign direct investment in the United States. Strategic Management Journal 21(12): 1175–​1193. Sidhu, J.S., Commandeur, H.R., and Volberda, H.W. 2007. The multifaceted nature of exploration and exploitation:  Value of supply, demand, and spatial search for innovation. Organization Science 18(1): 20–​38. Smedlund, A., and Toivonen, M. 2007. The role of KIBS in the IC development of regional clusters. Journal of Intellectual Capital 8(1): 159–​170. Staber, U. 2001. The structure of networks in industrial districts. International Journal of Urban and Regional Research 25(3): 3–​18. Storper, M. 1997. The Regional World: Territorial Development in a Global Economy. Guilford, New York. Strambach, S. 1997. Knowledge intensive business services and innovation in Germany, Final Report for the Commission of the EU–​TSER Project. Suarez-​Villa, L., and Walrod, W. 1997. Operational strategy, R&D and intra-​metropolitan clustering in a polycentric structure: The advanced electronics industries of the Los Angeles basin. Urban Studies 34(9): 1343–​1380. Thomas, M., and Jones, P. 1998. UK Results from the 2nd Community Innovation Survey. UK Government, Department of Trade and Industry. Thomi, W., and Böhn, T. 2003. Knowledge Intensive Business Services in Regional Systems of Innovation—​Initial Results from the Case of Southeast-​Finland. 43rd European Congress of the Regional Science Association.

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Chapter 4.2

China’s Scienc e -​Base d Innovation a nd T echnol o gy Tra nsfe r i n the Gl obal C ont e xt Jizhen Li, Ximing Yin, and Subrina Shen Introduction Since the reform and opening up in 1978, China, as a typical example of emerging economies, has made remarkable progress in both economic growth and innovation capability. In the past 40  years, during the transition from a central-​planned economy toward a market-​ oriented economy, China has become known as “the factory of the world” because of its lower-​wage labor-​related advantages and the benefits from the worldwide manufacturing shift (Richard, 2017; Shang-​Jin, Xie, & Zhang, 2017). On the other hand, China is seeking more indigenous innovation (Fu, X., & Gong, 2011), aiming to achieve the second transition from a labor-​intensive industrial country to an innovation-​driven modern country with a global competitive advantage in innovation and entrepreneurship (Fu, Woo, & Hou, 2016; X. Li, 2009; Minister of Science and Technology, 2016; Schmid & Wang, 2017). This leads to a new challenge as well as an opportunity for the global innovation landscape, the so-​called innovation race between West and East (Someren & Someren-​Wang, 2014). The innovation policy implementation and the performance in China is so impressive that some scholars are treating it as “a wake-​up call for America” (Currall, Frauenheim, Perry, & Hunter, 2014; Ernst, 2011; Fu et al., 2016; Knight, 2017; N. Li, Chen, & Kou, 2017). As China’s innovation is changing the global innovation landscape, it has gained worldwide attention (Hu & Mathews, 2005; Lewin, Kenney, & Murmann, 2016; Phan, Zhou, & Abrahamson, 2010). With continuous construction of the national innovation system and technology transfer system, China is becoming an attractive innovation hub for innovators, entrepreneurs, and investors from all over the world (WIPO, Cornell University, & INSEAD, 2018). An overview of science-​based innovation and technology transfer between the university and industry in China, including the most recent developments, its implications,

316    Li, Yin, and Shen and factor analyses, can help people and organizations better understand the relevant experiences, opportunities, and challenges related to China’s innovation from the past toward the future. This chapter provides a critical overview of science-​based innovation and technology transfer in the context of globalization and the new industrial revolution. By doing this, we attempt to provide critical insights for stakeholders—​whether they be researchers, innovators, entrepreneurs, government officials, investors, or international organizations—​ in China’s development, innovation, and technology transfer. We answer three questions related to China’s innovation and technology transfer in comparison with other major players in the field. First, how well do Chinese companies, and China as a whole, innovate? Second, what is the current state of science-​based innovation, especially with regard to China’s university technology transfer (UTT) and innovation commercialization? Third, what factors led to the progress in innovation and technology transfer entering the 21st century, and what challenges and opportunities remain for China to achieve its dream of being a main power of innovation in the world? To answer these questions, we first provide an overview of China’s science-​based innovation capability and ranking in a global context by examining the overall input, output, performance, and global ranking of China. We then give an overview of China’s technology transfer at the national and university levels, with a focus on UTT progress and policy changes, followed by a comparison with similar universities around the world. We then provide a short but comprehensive framework for people who want to know further about China’s path toward innovation and UTT, including national strategy that drives innovation and commercialization, as well as opportunities and challenges in the near future.

China’s Science-​Based Innovation Capability in the Global Context China has continuously invested in science, technology, and innovation (STI), aiming to move up in the global value chain, as well as forge a strong national innovation system to achieve greater economic growth and social transformation. Alongside efforts to take global leadership in economic growth and gross domestic product (GDP), China has been trying to climb the rankings on the global innovation map through continuous STI-​focused policy and effective implementation of the national innovation-​driven strategy (J. Chen et al., 2018; Minister of Science and Technology, 2016). But first of all, it is useful to have a big picture about the overall performance and ranking of China’s innovation capability with respect to the rest of the world.

Overall Performance of China’s Science-​Based Innovation A national action plan was launched in 2017 with a sweeping vision for artificial intelligence (AI) development, aiming to attract talent from around the world to make major

S&T Innovation and Transfer    317 breakthroughs by 2025. As an MIT Technology Review paper argues, “The West shouldn’t fear China’s artificial-​intelligence revolution. It should copy it” (Knight, 2017). This is a recent example of the effects of China’s STI policy and indicative of China’s desire to become a leading innovator for new and disruptive technologies. Since the reform and opening up in 1978, China has put an immense emphasis on STI policy, leading to remarkable economic growth. China has also been working toward a leadership role in global patent applications, academic research publications, research and development (R&D) investment, and high-​ tech industry exports, which has led to impressive progress (X. Li, 2009; Liu & White, 2001; Richard, 2017). As an example, China’s STI policy on building a high-​speed rail network since the early 2000s spurred technological development and improved the country’s transportation system as well as accelerated innovation in the manufacturing industry (J. Chen et al., 2018; Knight, 2017; Sun & Gao, 2017). According to the Bloomberg Innovation Index 2018,1 China ranks 19th in the world for innovation capability, moving up from 21st in 2017. The report notes, “China moved up two spots to 19th, buoyed by its high proportion of new science and engineering graduates in the labor force and increasing number of patents by innovators such as Huawei Technologies Co.” One significant change behind the improvement is that people in China are more tolerant of failure, accepting it as a natural part of the innovation process—​a crucial step toward creating an environment for cultivating talent, creativity, and entrepreneurship in the national innovation ecosystem (J. Chen & Lyu, 2017; Clarke, Chelliah, & Pattinson, 2018). According to the Global Innovation Index 2018 report released jointly by the World Intellectual Property Organization (WIPO) and Cornell University, China ranked 17th in the year 2018, which was 5 up from the year 2017. Most impressive, China became the first-​ ever middle-​income economy in the top 20 innovative countries (WIPO et al., 2018). According to the European Innovation Scoreboard 2018 report by the European Commission, even though the European Union continues to improve its position relative to the United States, Japan, and Canada, “China is catching up at three times the EU’s innovation performance growth rate.”2

Input, Output, and Performance Ernst (2011) examined the impact of China’s innovation policy on the country’s innovative capability and reviewed data on the speed of learning and catching up that is transforming China’s production and innovation system. He found that both input indicators (R&D investments, number of engineers and scientists) and output indicators (science and technology publications, patents) of China’s evolving innovation capabilities show that China has become a serious competitor of the United States, not only on price but also on technology. In the four decades since its opening to the world economy, China’s speed of catching up in innovation has been truly impressive. Research from the National Science Foundation of America also shows similar results (National Science Board, 2018). 1 

https://​w ww.bloomberg.com/​news/​articles/​2018-​01-​22/​s outh-​korea-​tops-​g lobal-​innovation-​ ranking-​again-​as-​u-​s-​falls 2  http://​ec.europa.eu/​growth/​industry/​innovation/​facts-​figures/​scoreboards_​en.

318    Li, Yin, and Shen

R&D Expenditure R&D expenditure in China has continued to increase in the past decades, even during the global financial crisis of 2008, during which most other countries reduced R&D spending (Figure 4.2.1). According to the Ministry of Science and Technology (MOST), China’s spending on R&D reached 1.56 trillion RMB (US$235 billion) in 2016, with over 78% coming from enterprises. Gross domestic expenditure on R&D accounted for 2.1% of GDP in 2016, with a 17-​year continuous growing streak (Figure 4.2.2). According to the MOST in China, the scientific and technological progress contribution increased to 56.2% in China’s economic growth in 2016, which means that China is becoming a research-​intensive and innovation-​driven economy, not a labor-​intensive economy anymore. With continuous increases in R&D expenditure, China’s contribution toward worldwide R&D expenditure growth is rising. According to the US National Science Foundation’s (NSF) 2018 Annual Science & Engineering Indicators, China accounts for 31.4% of worldwide R&D expenditure growth in 2015. In fact, China’s domestic R&D expenditure amounts have grown faster than any other main country or region since 2008 (Figure 4.2.3). China’s R&D expenditure also championed the global innovation map. The study of global R&D data in the Global Innovation Index 2018 report by WIPO indicates that about eight years after the financial crisis in 2008, the worst-​case scenario of permanently reduced R&D growth has to date been avoided, thanks to these anticyclical innovation policies and the role of R&D champions such as China, which have consistently spent large and growing sums on R&D. China’s gross domestic expenditure on R&D (GERD) has increased by 276% compared to that of 2018, ranking first among all nations.3

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Figure  4.2.1 Growth of domestic expenditure on R&D in China (2000–​2016). Unit: RMB mn. Source: OECD

3 

See http://​www.globalinnovationindex.org/​Home.

S&T Innovation and Transfer    319

Percentage

2.5% 2.02% 2.06%2.11% 1.99% 1.91% 2.0% 1.78% 1.71% 1.66% 1.37%1.44% 1.5% 1.31%1.37% 1.21% 1.12% 1.06% 0.94% 1.0% 0.89%

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Figure  4.2.2  Growth of domestic expenditure on R&D in China (2000–​2016, by percentage). Unit: RMB mn. Source: OECD

600

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NOTES: Data are not available for all countries for all years. Dotted line connects across missing values. Indicators 2018: Cross-National Comparisons of R&D Performance, Chapter 4.

Figure 4.2.3  Domestic R&D expenditures by selected country: 2000–​2015.

320    Li, Yin, and Shen 700

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Figure  4.2.4 Science and engineering articles by selected region, country, or economy: 2003–​2016. Data Source: Science & Engineering Indicators 2018 Digest

Science-​Based Innovation Performance: Research and Citation Volume China has gained ground in the ranking of research nations, based on the analysis conducted by Elsevier, and has garnered the second-​most worldwide citations of academic research papers, just behind the United States and ahead of the United Kingdom.4 The number of papers published in most influential international journals in various disciplines written by Chinese scholars has been ranked second in the world for seven consecutive years, which means China has also made a huge improvement in science research and innovation. According to the Science and Engineering Indicators 2018 by the National Science Board of the United States, China’s share of the world’s total science and engineering publications grew from 12.1% in 2006 to 18.6% in 2016, becoming the leading country among the science and engineering publications, while the US share declined from 24.4% to 17.8% (National Science Board, 2018). Even though China ranks fifth in most-​cited publications in 2016, the National Science Board report observes: “The US continues to be the global leader in science and technology, but the world is changing”; “the shifting landscape is already evident in terms of the sheer volume of publications: China published more than 426,000 studies in 2016, or 18.6% of the total documented in Elsevier’s Scopus database. That compares with nearly 409,000 by the United States” (Figure 4.2.4).

Science-​Based Innovation Performance: Patent Applications One useful indicator used to measure the performance of science-​based innovation is patents (Acs & Sanders, 2012; Clarke et al., 2018; X. Li, 2009). Since 2000, China has experienced relatively consistent growth in the number of patent applications, both requested 4 

See the newspaper: http://​www.chinadaily.com.cn/​world/​2017-​10/​17/​content_​33340948.htm.

S&T Innovation and Transfer    321 3,464.82

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Figure 4.2.5  Number of patent applications and patents granted in China (2000–​2016). Unit: thousand. and granted—​ a reasonable result of continuous investment in R&D (Figure 4.2.5). Globally, China ranks first in patent, trademark, and design filings in 2016, followed by the United States, Germany, Japan, Korea, and France. According to World Intellectual Property Indicators 2017, “Worldwide filings for patents, trademarks and industrial designs reached record heights in 2016 amid soaring demand in China, which received more patent applications than the combined total for the United States of America, Japan, the Republic of Korea and the European Patent Office.”5 “China received about 236,600 of the nearly 240,600 additional patent filings, accounting for 98% of total growth. Trademark applications jumped by 16.4% to about 7 million, and worldwide industrial design applications grew by 10.4% to almost 1  million—​both also driven by growth in China” (WIPO, 2017). If we compare China and other top patent offices around the world, the trend in Chinese patent applications becomes more prominent (Figure 4.2.6). There is no doubt that China has built up a strong potential of technological innovation and will take advantage of its intellectual property (IP) in a knowledge-​based competitive world. China released its first patent law in 1985 and received its first patent application on April 1, 1985—​very late compared to other offices. However, the amount of applications received and granted has exploded since the 2000. After the global financial crisis in 2008,

5 

See http://​www.wipo.int/​pressroom/​en/​articles/​2017/​article_​0013.html.

322    Li, Yin, and Shen Trend in patent applications for the top five offices, 1978–2017 1600000

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European Patent Office

Figure 4.2.6  Trend in patent applications for the top five offices, 1978–​2017. Source: WIPO

China put more emphasis on its innovation-​driven development strategy, calling for rapid growth in science-​based innovation and IP creation, such as patents, trademarks, and designs (Dang & Motohashi, 2015). According to WIPO’s annual World Intellectual Property Indicators 2018 (WIPI) report on worldwide filing activities for patent, trademark, and industrial design applications for 2017, worldwide filings for patents, trademarks, and industrial designs reached record heights in 2017 amid soaring demand in China, which received more patent applications than the combined total for the United States, Japan, the Republic of Korea, and the European Patent Office. Innovators around the world filed 3.17 million patent applications in 2016, up 5.8% in an eighth straight yearly increase, which was mainly driven by the increasing of IP filings from China. From already high levels, patent fillings in China grew by 14.2% and trademark fillings by 55.2%. These high growth rates propelled China’s shares of global patent filings and trademarks to reach 43.6% and 46.3%, respectively. China’s office received a record total of 1.38 million patent applications in 2017, more than double the number received by that of the United States (606,956). “In just a few decades, China has constructed an IP system, encouraged homegrown innovation, joined the ranks of the world’s IP leaders—​and is now driving worldwide growth in IP filings,” said WIPO Director General Francis Gurry. “China recorded the highest application volume for each of these IP rights as innovators and creators inside the country, as well as foreign entities, seek to protect and promote their work in one of the world’s fastest-​ growing major economies.”6

6

  See https://​www.wipo.int/​pressroom/​en/​articles/​2018/​article_​0012.html.

S&T Innovation and Transfer    323 Urbanization in China (1978–2016) 56

757,028,650

51 657,028,650 46 41 %

Person

557,028,650

36

457,028,650

31

357,028,650

26 257,028,650

157,028,650

21

1977 1981 1985 1989 1993 1997 2001 2005 2009 2013

CN: Urban Population

16

CN: % of urban population on total population

Figure 4.2.7  Urbanization in China (1978–​2016). Source: World Bank

China’s Technology Transfer: From National Technology Transfer to University Technology Commercialization Overview of China’s Technology Transfer Scientific and technological innovation is not just research in the laboratory, but rather the transformation of technological innovation into a realistic driving force for economic and social development (Fu et al., 2016; Minister of Science and Technology, 2016; Shang-​Jin et al., 2017; Wang, Zhou, & Li-​Ying, 2013). Since innovation and technological development ultimately lead to better capitalization and industrialization, one milestone in China’s technology transfer development is the State Council of China’s plan to build a national technology transfer system. The target is to build a basic national technology transfer system and a market of technologies by 2020, embedded with market-​oriented technological transfer institutions, professionals, and extensive international cooperation under the Belt and Road initiative.7

7  For more information, see also http://​english.gov.cn/​policies/​latest_​releases/​2017/​09/​26/​content_​ 281475886854922.htm.

324    Li, Yin, and Shen Innovation is not done for its own sake but for the momentum it can provide to the continuous industrial upgrading, economic growth, social transition, and, ultimately, improvement in human well-​being (Acs & Sanders, 2012; Bauer & Flagg, 2010; Drivas, Economidou, Karamanis, & Zank, 2016; Jasinski, 2009; Kafouros & Wang, 2015). In the past decades, China has made great improvements in science, engineering, and innovation, as discussed earlier. China started emphasizing and investing in technology transfer even more after entering the 21st century (A. Chen, Patton, & Kenney, 2016). In May 1996, China launched its first Law on Promoting the Transformation of Scientific and Technological Achievements—​ the starting point of the development of technology transfer in China. Following the 1996 law, the Regulations on Universities’ Intellectual Property Protection and Management was released by the State Council in April 1999. However, China’s path to technology transfer and commercialization was hindered by controversial practices and institutional deficiencies. The technology transfer system did not mature as expected because of four reasons:  lack of high-​quality innovations (Dang & Motohashi, 2015), lack of institutional and cognitive legitimacy (Jasinski, 2009), weak IP protection (Fang, Lerner, & Wu, 2017), and weak demand within the labor-​intensive economy (A. Chen et  al., 2016; Jasinski, 2009; Yin, Wang, & Chen, 2017). To encourage healthy technology transfer in China, the National People’s Congress revised the Science and Technology Progress Law, in hopes of enhancing transfer and encouraging local governments to support research cooperation between industries and universities. When market demand shot up in 2008, it became a new driving force for China’s technology transfer. This is supported by statistics collected by China’s State Intellectual Property Office (SIPO): there was almost no patent licensing from universities to firms before 2008, then a sharp increase during 2008 and 2009. Yin, Chen, and Wang (2017) argue that this resulted from the national government push, market demand of external technology for new product development, and the use of patents as a tool for attracting financial capital in the short term. Due to policy changes and increases in firm innovation capability (X. Li, 2009; Li-​Hua, 2014; Ning, Sutherland, & Fu, 2017; Wang, Pan, Ning, Li, & Chen, 2015), both demand and the absorptive capability of firms and local industry increased sharply (Armanios et  al., 2017), and China’s technology transfer has improved quickly over the past few years. In 2016, the total contract revenue of technology transfer reached 1.141 trillion RMB, or US$180.1 billion—​this is the first time total revenue surpassed 1 trillion RMB in Chinese history, an increase of 15.97% compared to that in 2015. The total number of technology transfer contracts in 2016 reached 320,437—​an increase of 11.16% from 2015. As for technology transfer intermediaries, there are more than 1,000 technology transfer local market platforms.8 In 2017, the technology transfer market grew even faster. The total number of technology transfer contracts was 367,586—​an increase of 14.71% from 2016. The total contract revenue of technology exchange was 1.342 trillion RMB, or US$211.80 billion—​an increase of 17.68% from 2016. Firms remained the dominant players in technology exchange, constituting about 88.46% of participants, an increase of over 10% from the percentage in 2016.9

8 

9 

For more information, see also http://​www.xinhuanet.com/​2017-​02/​21/​c_​1120505922.htm. For more information, see also http://​www.sohu.com/​a/​224463423_​99916535.

S&T Innovation and Transfer    325

Overview of China’s UTT Universities are the main players in the national innovation system as well as the national technology transfer system (A. Chen et al., 2016; Miller, McAdam, & McAdam, 2018). In recent years, UTT in China has attracted more attention from the government and the research community (A. Chen et al., 2016). Despite bringing economic and social benefits, university technology licensing remains a highly controversial practice in China due to contested ministerial interests and the ambiguous legal status of the practice. The MOST has a strong interest in promoting technology transfer and academic entrepreneurship from universities to further stimulate economic growth. The mission of promoting innovation from universities and building more university science parks departments was written into the National Medium and Long Term Plan for Development of Science and Technology 2006–​2020. In contrast, the Ministry of Education (MOE)—​t he main regulator of universities—​views commercialization as a diversion of universities’ resources and attention from the goal of cultivating world-​ class research. In our interviews with the MOE, the MOE expressed substantial dissatisfaction with the idea of having university academics working part time or full time in industry before the passing of the amendments to the Law on Promoting the Transformation of Scientific and Technological Achievements. The MOE emphasized that “scholars should stick to their roles as teachers and researchers.” Meanwhile, though the amendments to the Law on Promoting the Transformation of Scientific and Technological Achievements were passed in 2015 to further stimulate technology transfer from universities and research institutes, practitioners still find ambiguous and even contradictory stipulations in other laws concerning the legal status of university IP. Neither the state’s evaluation schemes nor third-​p arty ranking schemes have incorporated universities’ technology licensing performance as a key indicator. To circumvent various regulative and legal barriers, universities have had to create new organizational structures and hire legal professionals, IP managers, and technology agents. Chinese research universities didn’t engage in licensing activities on a large scale until after 2008 (A. Chen et al., 2016; Yin et  al., 2017), partially due to the contested nature and ambiguous legal status of licensing. After 2008, previously labor-​intensive industries realized the need to develop innovation capacities, generating a sharp increase in demand for technologies from universities and public research institutions. The most successful Chinese university10 in terms of commercialization—​Tsinghua University—​received $89.7  million from technology transfer in 2015, comparable to the amount Stanford University received in 2014–​2015 ($95.1 million from royalty and $3.2  million from liquidated equity) and almost double the amount MIT received in 2014–​2015 ($45.8  million in total with $850,000 from liquidated equity). However, among the 100 research universities in our sample, 33 had zero technology licensing in 2015. In 2016, Tsinghua University received $97  million, more than the amount Stanford University received in 2016 ($94.2  million) and almost double the amount

10 

According to disclosure from university technology transfer offices in 2016.

326    Li, Yin, and Shen Table 4.2.1 University Technology Commercialization: An International

Comparison University

Patent Issued

Patent Licensing

Technology Transfer No. Startups Based Revenue (million) on U-​Patent

Stanford (US)1

289 (2016) 298 (2017)

141 (2016) 137 (2017)

95.10 (2015) 94.22 (2016)

26 (2015) 32 (2016)

Tsinghua (China)2

2,086 (2015—​domestic)2.1 530 (2015—​international) 1,890 (2016—​domestic)2.2 360 (2016—​international)

287 (2014) 405 (2017)

89.70 (2014) 93.96 (2015) 97.01 (2016)2.3

18 (2015) 31 (2016)

MIT (US)3

328 (2015) 301 (2016) 296 (2017)

105 (2015) 112 (2016) 122 (2017)

45.8 (2015) 53.6 (2017)

25 (2017)

Cornell4

341 (2017)

  87 (2017)

15.3 (2017)

12 (2017)

Sources: 1 Stanford University OTL Annual Report: http://​otl.stanford.edu/​documents/​otlar16.pdf. 2 TLO office and interview; 2.1 TLO slides; 2.2 Tsinghua University official website, facts; 2.3 http://​www. zuihaodaxue.com/​. Note: According to the annual internal report from the TLO, the total technology commercialization contract revenue in 2016 was 2.00471 billion RMB, equal to US$317.34 million. 3 MIT facts: http://​web.mit.edu/​facts/​industry.html. 4 Cornell University CTL annual report: http://​www.ctl.cornell.edu/​news/​annual-​report/​.

MIT received in 2017 ($53.6 million). This indicates that the best universities in China have been catching up quickly in technology transfer volume, especially after the State Council granted universities more freedom to deal with IP such as patent licensing and patent transferring abilities. Table 4.2.1 shows an international comparison of university technology commercialization among China’s Tsinghua University and other universities, including Stanford University, MIT, and Cornell University. Tsinghua University received more patents than any of the other universities, which provides a relative advantage in technology stock for further commercialization. In fact, Tsinghua University licensed 287 patents in 2014 and 405 patents in 2017, more than the other universities. However, even though China’s government and universities are allocating more resources to UTT, overall technology transfer is still very low, especially from universities to industries. As shown in Table 4.2.2 and Table 4.2.3, according to the China Patent Survey Report by the SIPO, the patent licensing and transfer rate in China is lower than the desired level, with no indicator reaching a rate greater than 10%. Even more alarming, the patent licensing rate of universities has decreased from 2016 (3.3%) to 2017 (2.5%), with the invention licensing rate declining significantly. However, this might be due to a structural change making patent transfer more preferable than licensing for both firms and universities.

S&T Innovation and Transfer    327 Table 4.2.2 Patent Licensing and Transfer Rate in China, 2016 Licensing Rate

Firm

University

Research Institution

Individual

Total

Invention patent Utility models Design patents Total

7 8.3 9.1 8.2

5.8 3 2.1 3.3

5.6 4.6 6.7 5.4

8 6.9 12.9 8.6

6.7 7.9 9.5 8.1

Transfer Rate

Firm

University

Research Institution

Individual

Total

Invention patent Utility models Design patents Total

5.6 5.4 5.7 5.5

3.8 1.6 1.3 1.9

6.6 2.9 6.3 4.4

7.7 3.9 9 5.9

5.4 5.1 6 5.4

Table 4.2.3 Patent Licensing and Transfer Rate in China, 2017 Licensing Rate

Firm

University

Research Institution

Individual

Total

Invention patent Utility models Design patents Total

7.4 7.1 7.2 7.2

3.4 1.6 1.0 2.5

6.6 6.7 19.7 6.8

12 5.3 7.1 6.8

7 6.5 7.1 6.8

Transfer Rate

Firm

University

Research Institution

Individual

Total

Invention patent Utility models Design patents Total

6.1 5.6 5.9 5.7

4.1 1.7 1.3 3.0

7.6 4.3 6.4 5.6

5.7 5.2 6 5.4

3.4 3.4 2.8 3.4

China’s Path to Innovation and UTT: Main Drivers and Challenges Five Main Drivers for China’s Growth in Technological Innovation The international community has for a long time been preoccupied with China’s innovation model (Richard, 2017). Reviewing China’s remarkable achievements in STI, it is important

328    Li, Yin, and Shen Table 4.2.4 Five Main Drivers for China’s Growth

in Technological Innovation 1 2 3 4 5

National STI policy and efficient implementation Initiated by infrastructure and urbanization Led by informationalization Driven by globalization Supported by entrepreneurship

to further ask: How well is China making the transition from a labor-​intensive economy to an innovation-​driven and knowledge-​based economy? What is behind China’s innovation strategy? Richard Li-​Hua proposed a strategic model named “China’s embracing innovation” to refer to the strategy of seeking common development, sharing resources, and achieving win-​win solutions (Li-​Hua, 2014). Embracing innovation is a novel and innovative solution to a complicated social problem, which defines the concept of embracing innovation as a social innovation with Chinese characteristics (Li-​Hua, 2014), rather than a comprehensive perspective to reflect China’s STI performance in the past decades. On the other hand, Huang and Sharif (2016) identify three sources of competitive advantage for China’s ascent in the global technology stakes:  its massive domestic market, its centralized power and willingness to employ state-​sponsored industrial policy and government support, and the process of globalization that continues to transform markets worldwide. However, they did not consider the effects of environmental change, institutional innovation, and entrepreneurship on STI policy. We identify five main drivers for China’s growth in technological innovation: first and foremost, China’s national STI policy and implementation; second, China’s massive infrastructure and recent urbanization; third, informationalization and its effects on industrial upgrading, economic transition, and firm innovation; fourth, globalization, which has driven China into a new era in which both the government and firms can take advantage of global innovation resources to catch up with mature economies; and fifth, China’s recent steps toward fostering greater entrepreneurship (Table 4.2.4).

National STI Policy and Implementation As Martin (2016) points out, before the Great Depression, the government’s role in liberal market economies such as those of the United States and United Kingdom was viewed as largely confined to fixing market failures, such as those in defense, health, education, and research (and more recently banking). If governments do not take risks in their policies, they may not have any spectacular failures, but they will not have any spectacular successes either. Western governments in general believe that markets should drive innovation (Ernst, 2011), and the role of government has been small due to politics and ideology, especially in the United States (Martin, 2016). On the other hand, China’s government emphasizes the critical role of public policy in fostering indigenous innovation,

S&T Innovation and Transfer    329 accelerating innovation, participating in globalization, and competing in the global value chain (Ernst, 2011; Someren & Someren-​Wang, 2014). The most recent milestone in STI policy is a national action plan providing “Three Steps to Global Innovation Leadership”11—​the 2016 Outline of the National Strategy of Innovation-​ Driven Development (hereafter referred to as the “Outline”). In the Outline, the government notes that science and technology is a strategic pillar for boosting social productivity and comprehensive national strength and therefore must be placed at the heart of the country’s development. The Outline identifies three steps for implementing the strategy of innovation-​driven development, which are consistent and mutually reinforcing and possess the strategic goal of achieving China’s modernization: Step 1: China should become an innovative country by 2020 to provide strong support for a moderately prosperous society. Step 2:  China should move to the forefront of innovative countries by 2030 to lay a solid foundation for building China into a major economic power and a society of common prosperity. Step 3: China should become an innovation power by 2050 to support the building of a prosperous, strong, democratic, culturally advanced, harmonious, modern socialist country and the realization of the Chinese dream of national renewal.

Infrastructure and Urbanization Cities and urbanization play an important role in knowledge spillovers that generate economic growth and greater productivity (Andersson, Quigley, & Wilhelmsson, 2009). The characteristics of cities are also propitious to innovation and provide appropriate conditions for innovation diffusion. Sha et al. (2006) observe that during the past two decades, “China has witnessed a rapid rate of urbanization and is faced with unique problems due to the country’s natural resources, history, society, economy, and culture” (p. 573). Decades ago, a portfolio of highly effective policies created rural surplus labor, making China the manufacturing hub of the world, and also organized resources for building infrastructure, new cities, and massive residential housing projects. These policies have run their course, and sustaining the significant economic growth they brought represents a daunting challenge for China. From Figure 4.2.7, we see that the total urban population has seen continuous growth since 1978. Also, the rate of urbanization is accelerating, increasing from 17.9% in 1978 to more than 56.7% by the end of 2016, signaling growth in both talent and market size.

Informationalization Learning and information accumulation has been proven to play a major role in innovation and innovation diffusion (Feder & O’Mara, 1982; S.  Li, Xu, & Zhao, 2015; Rogers & 11  See the original version of the Outline of the 13th Five-​Year Plan for the National Economic and Social Development of the People’s Republic of China: http://​www.xinhuanet.com/​politics/​2016-​05/​19/​c_​ 1118898033.htm.

330    Li, Yin, and Shen Shoemaker, 1971; Swanson, 1994). In an era of revolutionary developments in basic information technology, innovation regarding its use in organizations has become increasingly crucial to competitive survival and success, not only for firms (Swanson, 1994) but also for national competitive advantage (J. Chen, 2017; Leamer & Storper, 2014; J. Lee, Kao, & Yang, 2014). In recent years, the Internet of Things (IoT) has drawn significant research attention and will have a promising impact on the future of the internet, which will empower those connected with new capabilities (S. Li et al., 2015). Because of the great improvement in informationalization, both traditional industries and new industries that are based on the internet have obtained a great advantage in productivity and technological innovation. China has an ambitious high-​tech development strategy, but high-​tech development does not automatically bring about innovation. In recent decades, the Chinese government has launched high-​tech development plans every five years and issued national strategies such as Made in China 2025 to promote the combination of informationalization and industrialization.12

Globalization Foreign direct investment (FDI) can benefit innovation activity in the host country via spillover channels such as reverse engineering, skilled labor turnovers, the demonstration effect, and supplier-​customer relationships (Wu, Ma, & Shi, 2010). Under the “Market for Technology” policy, China has become the largest recipient of FDI among developing countries in the 1990s. Since it gained entry to the World Trade Organization (WTO) in 2001, China has been adapting to become a global center for many different stages of production. Intensified globalization will continue to benefit Chinese companies in the coming decades, providing a third advantage in its goal to become a global force in technology. On one hand, Chinese firms need not develop every advanced technology on their own in a globalized world. Backed by the government’s “go global” strategy, they can acquire such technologies through mergers and acquisitions abroad. On the other hand, as the economy grows and domestic companies move up the technological ladder, foreign multinational corporations will be increasingly tempted, or perhaps feel compelled, to bring their advanced products to the Chinese market, eventually even patenting their cutting-​ edge technologies in China. This will in turn generate the demonstration effect, labor mobility, and competition effects—​or spillovers—​to benefit local firms.

Entrepreneurship Phan, Zhou, and Abrahamson (2010) observe that “entrepreneurship . . . is a multi-​level phenomenon that begins with the combination of human creativity, financial resources, and technological capital; fostering the discovery and establishment of new ways to organize production processes and new institutional forms; and leading to such outcomes as venture growth and new ventures,” (p. 175) further noting that new venture growth is a defining characteristic of developing economies. Within the largest transition economy in the world on the way toward a market-​based economic system, entrepreneurship has been an 12 

See http://​www.gov.cn/​gongbao/​content/​2017/​content_​5241931.htm.

S&T Innovation and Transfer    331 important driver of the Chinese economy. Among all entrepreneurial activities, domestic entrepreneurial organizations, including private startups, townships, collective enterprises, and transformed state-​owned enterprises, have emerged as some of the most important (Yang & Li, 2008). “China’s biggest strength for development lies in its rich human resources,” noted Premier Li Keqiang. “The 1.3 billion Chinese people, of which over 900 million are in the labor force and over 170 million have received higher education or acquired specialized skills, represent an infinite source of entrepreneurship and innovation.”13 To better utilize Chinese human resources as well as the power of entrepreneurship, China launched a mass entrepreneurship and innovation initiative, greatly unleashing social creativity and benefiting market vitality. The number of market entities in China increased by a daily average of 40,000 in the past three years. Fourteen thousand enterprises were registered every day on average, with about 70% of them active in business. The birth rate of new enterprises rose to 8,000 a day in the year 2017, giving a strong boost to job creation and new wealth.14 Mass entrepreneurship and innovation not only allowed new industries to flourish but also helped transform the country’s traditional sectors and accelerate the upgrading of the entire economy. Mass entrepreneurship and innovation has been observed to be an effective instrument of inclusive growth and will continue to be used to develop national innovation capabilities.

Key Challenges of China’s UTT From 2014 to 2016, with the support of the MOE, the Research Center for Technological Innovation in Tsinghua University designed and conducted the first survey focused on Chinese UTT. The purpose of the survey was to investigate the current progress of UTT development and identify key challenges and help prescribe future actions to improve UTT. The research team received 682 valid questionnaires from 682 universities in mainland China. The sample covers most of the research universities that were core players in China’s technological innovation system and now provide social service and knowledge to promote national and regional economic growth (A. Chen et al., 2016; Yin et al., 2017). As discussed previously, the current UTT rate is low. In response to the survey question on why so many patents are left in the desk instead of transferred to industries, the researchers found that although existing scientific and technological achievements in universities may be applied in the market, they first need to be combined with other scientific and technological achievements to better meet the market’s needs. Unfortunately, universities lack a good business model to transform the technology. The other part of the scientific and technological achievements needs to be further exploited and developed before they can license or sell to firms. This indicates that China should improve universities’ capabilities regarding the mining of the combination value of scientific and technological achievements.

13 

See http://​www.xinhuanet.com/​english/​2017-​09/​12/​c_​136603727.htm. According to the speech by Premier Li Keqiang at the opening ceremony of the Annual Meeting of the New Champions 2017, also known as the Summer Davos, held in northeast China’s coastal city of Dalian. 14 

332    Li, Yin, and Shen To do this, the government should promote the exploration of the business model of UTT, build a specialized transformation team, and assist the secondary development of scientific and technological achievements. This will promote the transformation of science and technology into productive forces. The top four problems of UTT in China mentioned in response to the survey and interview include flaws in the incentive mechanism of UTT, flaws in social system construction for technology transfer, university inattention, and ambiguity in the channels for technology transfer. The core problems affecting the motivation for researchers to engage in the UTT process is the incentive mechanism, which includes revenue distribution, the right to deal with the Intellectual Property Rights (IPR), and contribution to tenure. This is consistent with findings in the current literature (De Silva, 2016; Ferretti, Ferri, Fiorentino, Parmentola, & Sapio, 2020; Grimaldi, Kenney, Siegel, & Wright, 2011). Looking into the general factors affecting UTT, the researchers split problems into internal and external challenges. The main internal problems of UTT are the lack of technology transfer specialists and inadequate evaluation and incentive mechanisms for researchers. The former results from the weak organizational capability of university technology transfer offices (TTOs), which used to handle IP protection and have no incentive or experience to handle technology transfer. The latter is related to two mechanisms of UTT—​one is the evaluation and pricing of technology, and the other is income distribution for UTT royalties. Given these two challenges, even though some researchers and inventors expressed eagerness to apply their technologies to new products and change industries (Shane, 2004), they felt disappointed after talking with the TTO transfer team, who were willing but unable to provide professional guidance (Goel & Göktepe-​Hultén, 2018). After the State Council updated the Technology Transfer Law in 2015, the inventor’s share of total royalties increased from 15% to 70%—​two times higher than that found in universities in the United States and European Union. This dramatic change in income distribution policy provided a strong incentive for researchers and inventors to engage in UTT or academic entrepreneurship. However, it remains a challenge for the TTO to evaluate patents properly, especially when state-​owned assets are at risk in China’s context. Thus, the challenge of UTT is not only to increase the inventor’s share of the royalty but also to allow universities more freedom to deal with the UTT and invest more resources in the organizational capability of the TTO. Among the main external problems of UTT, the first is weak support of government policy. This does not mean there is no support from the State Council—​the State Council has released many new policies to encourage academic entrepreneurship and UTT in China, especially since 2015. However, as mentioned earlier, different departments have different goals and expectations for universities. The MOST tends to encourage universities to put more effort and resources into UTT, while the MOE is still struggling to balance the traditional mission of research and education and the emerging mission of serving regional economic growth. The tension between science norms and market norms (De Silva, 2016) and the tension between the functions of research universities and entrepreneurial universities (Brown, 2016; Guerrero & Urbano, 2012) are still challenges in UTT development. The second external problem is that the local technology exchange market is not yet mature, which means information asymmetry and matching still hinder the knowledge flow from universities to industries. The third problem is the lack of supporting institutions and agencies. Bauer and Flagg (2010) find that intermediaries are very important for bridging

S&T Innovation and Transfer    333 technology supply with demand. These institutions and agencies, including the formal local technology transfer market and exchange rules, technology managers, and IP agencies, only emerged a few years ago. Other external challenges include weak IP protection and an imperfect innovation and entrepreneurial environment. While these challenges remain pressing, visible progress has been made. Over 55% of Chinese universities have set up TTOs, and there were 11 IP courts across China and more than 1,000 formal technology exchange markets or platforms by the end of 2017.

Conclusion and Outlook This chapter provides a critical overview of China’s innovation and technology transfer in the context of globalization and new industrial revolution. By doing this, we are trying to provide critical insights for relative stakeholders who are interested in China’s development, innovation, and technology transfer to know more about three aspects related to China’s innovation and technology in comparison with other major plays in the fields. In detail, we first provide an overview of China’s innovation capability and ranking in the global context, including the overall input, output, performance, and ranking, combined with typical firms or industry cases. In the second section, we give an overview of China’s technology transfer, including national and UTT with a focus on UTT progress and dramatic policy changes. Then we provide a short but comprehensive framework for people who want to know further about China’s path toward innovation and UTT, including national strategy that drives innovation and commercialization and opportunities and challenges in the near future. In the future, China needs to continue to invest in R&D, especially disruptive innovation, via basic research under the guidance of the national innovation strategy. Further, innovation includes not only the experiments in laboratories but also diffusion, allowing sustainable new knowledge for socioeconomic development.

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Chapter 4.3

Science Pa rks a nd High-​T ech  Z one s Susan M. Walcott Background and Major Issues in Science Park Development Science parks were envisioned as an economic development institution from their inception, designed to provide employment that is particularly geared toward a highly educated labor force. Funds generally come from government sources at the early stage. The intention of park development is to jump-​start businesses that could benefit from research generated by a nearby university or research institution. The advantages of clustering businesses to encourage sharing information face-​to-​face concerning advances in related areas has been the focus of numerous research projects and is clearly understood—​if unevenly put into practice (Bathelt et al., 2004). The 1951 establishment of Research Triangle Park (RTP) in the Raleigh–​Durham–​Chapel Hill area of North Carolina pioneered the first major science park developed in the world. It remains anchored by the three research universities in the area: Durham’s Duke University, the University of North Carolina in Chapel Hill, and the technology-​oriented North Carolina State University in the state’s capital of Raleigh. An important anchor initially for RTP came from a large federal research laboratory located there, although RTP management is in private hands and received North Carolina state-​ based incentives. China picked up on the success of this regional development policy as enacted in more advanced countries, from Japan to Western Europe, as it began its own launch into modernization following the turmoil of the Cultural Revolution. At this point in time a total of 54 national-​level Science Parks and High-​Tech Zones (SPHZs) have been established around the country. A review of the trajectory of park development and the nationwide establishment of science parks and high-​technology zones (SPHZs) indicates a variety of outcomes. Successes were predictably encountered in the most fertile areas of high-​performing research universities proximate to major urban centers. Many have similar features, such as a high-​tech pioneer center, high-​and new-​tech enterprise incubator, and overseas students’ park (open to students with a minimum of one year in a non-​Chinese university). Key

338   Walcott features of the SPHZ model include convenient proximity to a research university, firms nestled in a high-​amenity landscape, and ease of knowledge transfer to and from anywhere in the world (Lofsten and Lindelof, 2002). It is argued that China’s economy clearly benefits from these well-​nurtured SPHZ cluster developments. Since their inception and to the present they continue to provide jobs for university graduates and synchronize China’s investment in high-​level education by matching students approved to major in particular fields with the need for workers and researchers in such areas. This function was particularly important when suitable jobs were not as available as they are now when the opportunities are much greater, given the successful attraction of foreign companies that could employ these high-​skill, low-​cost talented people; the sending of students for education abroad; and the creation of incentives to encourage their return. Assessing the success of SPHZ policy must be viewed within the framework of a host of policies designed to launch China’s modernization since the late 1970s, covering various steps of this transition. These policies are periodically reassessed at each government level. Detailed descriptions of the many aspects of China’s steps in this transition are provided in other chapters of this Handbook, notably Chapters 1.3, 1.4, 2.1, 4.1, and 4.2 Challenges to quantifying an accurate assessment of SPHZs include well-​ founded skepticism of publicly provided numbers from parks and government sources, such as censuses. Political interest in economic policy outcomes, particularly those requiring large investments and with significant future expected economic impact, are presented as a rosy—​though less than fully accurate—​picture, to justify the wisdom of investments in projects designed to accelerate China’s modernization. Responsibility for formulation and implementation of SPHZ-​related policy falls to designated state bodies. The Ministry of Science and Technology of the People’s Republic of China oversees operations involving SPHZs. The Chinese Academy of Sciences consults closely with this body in terms of intellectual development and allocation of resources. These powerful bodies do not want to see a low return on their substantial investments in entities like SPHZs. Given the tenuous nature of high-​risk entrepreneurial high-​tech ventures, combined with the benefits of increased employment, particularly for the well-​educated, and the accompanying socioeconomic externalities, most science parks are wholly or at least in part funded by the government at a city, provincial, and/​or national level. In China large firms at a more advanced technology level receive greater preferential treatment due to their affiliation with government and the need for greater funding. National incentives to attract top talent to particular SPHZs include preferential housing, obtaining a hukou residency permit for a desirable location, and discounted tax treatment. This does not, however, ensure their success compared to provincial or municipal parks despite the sponsor, location, or industry concentration. One example of the complexities involved in park competition was the challenges faced by the China-​Singapore Suzhou Industrial Park (SIP). As its original name indicates, this park resulted from an agreement in 1994 signed between the two countries, with Singapore controlling a majority share. The relationship stemmed from China’s desire to learn management techniques from the premier (and largely ethnic Chinese) success story of Southeast Asia. Occupants of the park were largely foreign investors attracted by management’s English-​speaking and Western-​savvy connections, such as familiarity with Western culture and business practices. Three years later, a park founded in 1990 by the municipal-​level

Science Parks and High-Tech Zones    339 Suzhou New District and allied with rival Japanese companies threatened SIP’s success, due to preferential treatment by the other levels of government supporting the local development. In 1999 Singapore’s share of SIP control was reduced by mutual agreement. The city of Suzhou, for its part, agreed to prioritize promotion of the renamed Suzhou Industrial Park. By 2011 almost three-​quarters of the SIP were foreign investors, including some high-​tech-​ level producers. The lesson learned: it is best to deal with local political-​economic bodies rather than attempt to go over their heads at the national level only. Linkage to a higher education institution oriented towards technology research confers notable advantages for the survival of related firms (Cheng et  al., 2013). Chinese SPHZs frequently function with strong ties to a local university affiliate, utilized particularly by Chinese firms employing graduates of that university. Foreign firms are relatively more autonomous, utilizing their location in China more for assembly and/​or manufacturing under less costly conditions. (See McKern, Yip, and Jolly in Chapter 5.1 for discussion of location choices by MNCs.) High-​tech-​reliant foreign firms in the vicinity or members of SPHZs do use their location to hire Chinese talent, as local employees can be attracted (or assigned) to their location. Top firms with global standing compete for top talent graduating from Chinese universities. Their pull relative to Chinese firms can be quite strong for a variety of reasons, often including higher pay, better non-​pecuniary advantages, and the prestige of working for a large foreign company (although in recent years many young scientists and engineers prefer to work for a Chinese company rather than a multinational). To promote technology transfer, SPHZ managers consciously place small and medium-​sized Chinese companies in the vicinity of foreign firms as a co-​location strategy that is quite successful in information-​intensive parks such as Beijing’s Zhongguancun (Zhou and Xin, 2003). One statistical study related science parks to the location of high-​tech firms, and the location of a high-​tech firm in a science park to the firm’s success (Zhang and Tetsushi, 2011). This study noted that larger high-​tech firms are somewhat more successful than small and medium high-​tech firms, since the smaller enterprises often need to add manufacturing capacity to sustain their research-​intensive activities. By their nature, the latter take longer to develop than manufacturing or assembly operations and are inherently riskier. Contention among those supporting and opposing SPHZ development arises around several key points concerning the projected and realized economic effects of SPHZs (Cao, 2004). Measurement over time of outcomes for these very expensive projects is of major interest to urban and economic planners, as well as their political sponsors and firms that establish tech ventures with substantial outside funding. A study in 2004 by MacDonald and Deng asserted that SPHZ effects on firms were negligible. This study echoed earlier criticisms of these zones as voiced by British researchers Massy and Wield (1992). However, statistical calculations in a later study (Huang, He, and Zhu, 2017) of the profitability of firms in and outside economic development zones affirmed the economic benefits to firms clustered in these designed agglomerations and consequently to their surrounding regions. A detailed study of Shanghai’s Zhangjiang High-​Tech Park (Gang et  al. 2011)  found nuanced results:  Chinese firms benefited from their intermixture with foreign firms by studying their production processes and labor practices but did not consequently produce competitively cutting-​edge research results or applications. Controversy concerning the benefits of science parks is discussed at greater length in a later section on research positions and controversies. The intervening sections consider in greater detail China’s continuing experience with SPHZs as a development tool.

340   Walcott

Development of SPHZs in China China’s surge to incorporate science and technology–​related applied research as an economic development engine began shortly after the late 1978 launch of the “Reform and Openness” movement by Deng Xiaoping. China’s new leader was returned from his rural banishment and installed in Beijing’s top position with a mandate to modernize the country quickly. The early years of Deng Xiaoping’s accession to power (1978–​1984) saw the beginning of science and technology promotion in government research institutions. The science and technology policy promoted by his successor, Jiang Zemin, also followed a two-​track path of supporting the development of an indigenous innovative engine to accelerate economic development, along with attraction of foreign direct investment (FDI) in sectors that China saw as useful for employment and technology learning purposes. The next period through 1991 linked native firms with matched FDI. Occupants of Chinese SPHZs initially matched foreign firms and their related Chinese assembly and/​or manufacturing operations for convenience and cost reduction (Walcott, 2002b). In 1991 China’s State Council approved the development of its initial group of high-​tech parks, followed by another batch the next year, bringing the total approved in the early 1990s to 51. Several parks actually began in 1988 but were elevated to national-​level SPHZs in recognition of their accomplishments or potential. Declared goals were to serve as an economic engine for China’s modernization by attracting FDI to serve as suppliers of jobs, promote technology transfer, incubate Chinese high-​tech startups, and raise Chinese technology capabilities by following the SPHZ examples in other industrial countries throughout Asia, Europe, and the United States. The primary intention of the latter was to use the concentrated SPHZ facilities to lessen overhead costs for startups by providing physical (electricity, equipment) and intellectual (lectures, instruction, discussion) infrastructure. The rise of Jiang Zemin saw the country’s transition to a socialist market economy “with Chinese characteristics”: centralization promoted research within business enterprises. The period of movement to increased privatization was finalized in 1999–​2004. A turn to newer and greener technology areas since the year 2002 signaled China’s attention to global economic trends and future development planning (Campbell, 2013). The most recent report by the United Nations Educational, Scientific, and Cultural Organization (UNESCO) on “Science Parks in Asia” lists no less than 80 in China. Japan claims 23, Korea has 18, and Taiwan lists 2 in this report (UNESCO, 2017). As in China, these are geographically distributed throughout each country. An earlier study listed a total of 54 Chinese “science and industrial parks” (Campbell, 2013). Names for these classified zones include “high and new technology development zone,” “agri-​tech demonstration zone,” “high-​tech industrial park,” “Torch High-​Tech Industrial Development Zone,” “science and technology industrial park,” “high-​tech industry development zone,” “new and hi-​tech industry development zone,” “new technology industry development zone,” “development zone for high and new technology,” “high-​tech park,” and simply “science park.” A  2013 study cited the Chinese Ministry of Science and Technology as listing 88 national-​level science parks, with double that number of provincial-​and municipal-​level science parks competing for development spillovers. A main target is to support the development of a semimarket economy of small and medium enterprises by transferring university-​level research into nascent companies nurtured in government-​sponsored incubators. Chinese names for these geographic zones include kejiyuan (science park), gaoxinqu (high new area), gaoxin jishu kaifaqu (high new development area), and similar terms, referring

Science Parks and High-Tech Zones    341 to the same type of area set aside for these firms and their related activities. Table 4.3.1 lists all 54 of the national-​level SPHZs along with the date of their establishment and major areas of specialization, as much as can be determined using internet sources (Ministry of Science and Technology, 2011). Reference to this table yields the following observations. Table 4.3.1 China’s Science Parks and High-​Tech Zones by Location Name

Specialties

Date

Anshan Natl HNTIDZ, Liaoning

Steel, environment, materials, electronic info

1993

Baoding HTIZ

Energy, electronics, IT, biopharmaceutical

1992

Baoji HTIDZ

Titanium

1992

Baotou Rare Earth HTIDZ

Rare earth industry (Inner Mongolia)

1992

Changchun National HTIDZ

Tourism, ecology

1995

Changsha HTIDZ

Environment, materials, energy, biomedical, electronics, advanced manufacturing

1988

Changzhou HTD

Eco-​industry, logistics zone, manufacturing, photovoltaic, energy, AI, composites

1992

Chengdu HTIDZ

Microelect tech, biopharmaceutical, TCM, advanced manuf; (“New Tianfu City”)

1988

Chongqing HTIDZ

LCD panel, auto parts, bio industry

1991

Dalian HTIZ

Software, IT, pharm, new material/​energy, tech finance, e-​commerce

1991

Daqinq HTIDZ

Petroleum products

2014

Foshan NHTIDZ

European focus; vehicles, biomedical

1992

Fuzhou HNTIDZ

Cross-​straits; biomed, electric, software, bioengineering, materials, optical

1991

Guangzhou HTDZ

IT, biomed, materials, electric vehicles, environ, AI; (“Science City”)

1991

Guilin HNTIDZ

IT, mechanical electronic, materials, biopharm, environ, industrial chains, logistics

1988

Haikou HTIDZ

Biopharm, low carbon manufacturing; SE Asia area

1991

Hangzhou HTDZ

Communications, software, IC, materials, biomed, electro mechanic

1990

Harbin High New TDZ

Welding, mechanical engineering, electrical instruments, software

1988

Hefei State NHTIDZ

IT, bioengineer/​pharm, materials, advanced machinery, optic-​mechanical-​elec integration

1991

Huizhou Zhongkai NTIDZ

LED, internet, flat panel, energy adv manuf, electronic info

1992

Jilin NHTIDZ

Auto, chemical; (NE corner of China-​Russia-​Korea)

1992

Jinan HTIDZ

Auto, electronics, IT, food, pharmaceutical, machinery

1991

Kunming HTIDZ

Steel, biotech, optoelectronics, IT

1992

Lanzhou HNTIDZ

Materials, biopharm, microelectronics, adv manuf, environ, energy saving

1991

Luoyang NHTIDZ

Optical-​mechanical-​electronic integration, new materials & energy

1992 (continued)

342   Walcott Table 4.3.1 Continued Name

Specialties

Date

Mianyang HNTIDZ

(“Science City”), atomic bomb; electronics, engineering, aerodynamics

2001

Nanchang State HTIDZ

Adv manuf, aviation, biopharm, photoelectric, new energy & materials

1991

Nanjing NHTIDZ

Electronic info, optical-​mechanical-​electronic integration, new chem materials

1988

Nanning Natl NHTIDZ

Biopharm, electric & mechanical equipment manufacture, IT

1988

Qingdao HTIP

IT, biopharm, new material/​energy, advanced equip manuf, marine/​defense tech

1992

Shanghai Zhangjiang HTP

Software, biopharm, integrated circuits, semiconductors

1992

Shanghai Zhongke HTP

Optical communication, new materials, opt-​mech integrated design; (Volkswagen)

Shenyang HTIDZ

Robotics, batteries; 1930s industrial center; aerospace, chem pharm, auto

Shenzhen HTIP

Electronics, IT, biology, opt-​elect-​mech integ, pharm

1996

Shijiazhuang HNTIDZ

Electronic info, biopharm, new materials

1991

Suzhou DZHNT

County level; IT, chemicals, enviro protection new material, precision machinery

1990

Taiyuan HNTDZ

1 of 3

Tianjin S&T IP

1 of 3; software, IP, electron info, green, advanced equip manuf, biotech

1988

Urumqi HNTIDZ

New district; elect machinery, biopharm, new mats/​ energy, petrochem, rare resources

1992

Weifang NHTIDZ

IT, biopharm, machinery

1992

Weihai Torch HTIDZ

Marine aquaculture, fiber opt, medical application

Wuhan E. Lake HTDZ

Optoelectronic, telecomm, equipment manufacture, laser

1988

Wuxi DZ for HNT

Electron, IT, IC, photovoltaic, auto, bioengineering, pharm

1992

Xi’an National HTIDZ

Elect info, adv manuf, biomed, service industry, environment IT, energy material & vehicles

1991

Xiamen Torch HTIDZ

IT, opt-​mech-​electronic integration, biology, medicine

1991

Xiangfan HTIDZ

opt-​mech-​electronic integration, new materials & energy

1992

Yangling Ag-​tech Demo Z

Shaanxi province; agricultural tech

1997

Zhengzhou HNTIDZ

Software, IT, new materials, biopharm, opt-​mech-​elect integ, new energy

1988

Zhongguancun Sci Park

Electronics, IT; (7 parks; 2 universities)

1988

Zhongshan Torch HTIDZ

(Province + city); new energy, electronics, telecomm, biol/​ tech, chemical, autos,

1990

Zhuhai State HTIDZ

IT, machinery, biology, pharm

1992

Zhuzhou State HTIDZ

Opt-​mech-​elect integ, IT, new mat, biomed/​food, aviation, new energy, auto, adv equip

1992

Zibo HNTIDZ

(Tsinghua U; SH Jiaotong U), biomed, chem/​high polymer, inorganic nonmetal elect info

1992

Science Parks and High-Tech Zones    343

Geographic and Scientific Specialization and Major SPHZ Programs Parks are placed in virtually every province for geographic, political, and economic balance, although the concentration is greater in coastal provinces. Specialties reflect local strengths, from a scarce resource such as rare earths to new applications for a traditional manufacturing role such as steel or machinery. Other SPHZs reflect a local decision to develop a hoped-​for theme, from tourism promotion to “science city.” Firms solicited or permitted to locate in an SPHZ often conform to the target model at that time, especially in industries primed to promote high-​technology economic development. In the early 21st century such specific sectors included computers, information technology (IT), pharmaceuticals, and new materials (Walcott, 2002a). Major initiatives funded by the central government include a focus on agriculture, electronics, energy, and new materials. The Key Technologies Research and Development Program, begun in 1982 (the 863 Program, named for the date in which it was announced), supports marketable technology in areas including biotechnology, astro-​ biology, IT, lasers, automation, and energy, similar to those of several US nationally funded research-​oriented departments, including the Department of Defense. The 973 Program (also date-​named, for cutting-​edge multidisciplinary projects), in seven industries, helps local governments with high-​tech zones, personnel training, and FDI-​Chinese cooperation projects. The Torch Program started in 1988 provides funds to entities fostering high-​ tech product commercialization. Named for a famous saying by Mao Zedong that “a little spark can start a forest fire,” the Spark Program supports technology development in rural areas. Though the more than 50 national-​level parks are consciously scattered across almost all provinces, they are economically concentrated in major research-​producing cities with the strongest intellectual and business-​supportive infrastructure:  metropolitan Beijing, Shanghai, and Guangzhou and in lesser numbers in other first-​and second-​tier cities, such as Shenzhen, Qingdao, Hangzhou, Chongqing, etc. Policy requires firms in these SPHZs to apply a minimum of 3% of gross revenues to research and development. Additionally, a minimum of 30% of their labor force must hold a college degree (Brookings, 2015). A special effort to modernize agricultural areas by infusing technology to enhance productivity resulted in a geographically targeted SPHZ program to disperse development to all provinces (Liangyu, 2018). In 2004 China began to promote “eco-​industrial” parks (EIPs). EIPs were concentrated in the most developed eastern half of China, particularly in Shandong, Jiangsu, Guangdong, and Shanghai. A study reviewing the first decade of this refinement to the SPHZ concept declared that for the 17 EIPs examined, industrial value added increased, while chemical oxygen and sulfur dioxide pollutant emissions decreased (Tian et al., 2014). While not strictly part of the SPHZ designated areas, developments in the EIPs test practical applications of scientific methods and may supplement or direct research conducted in SPHZs nearby that declare an environmental or ecological focus. A hallmark of President Xi Jinping’s decadal strategy proclaims 10 sectors for advancement of the Chinese economy, including aerospace and aviation, high-​end machinery and robotics, new energy vehicles, advanced IT, and high-​performance medical devices. Transformation of the existing production capacity relies on raising the domestic content

344   Walcott of export goods in these sectors to 70%, with the longer-​term goal of securing the global market in these strategic sectors for Chinese manufacturers. Overcapacity in steel and coal has been cut in an effort to meet the targets set by the central authorities. For example, Liaoning province shuttered over 40 coal mines and reduced over 13 million tons of steel capacity. Despite funds contributed by the central government to assist the transition of workers from industrial to more modern jobs, subordinate-​level government entities must contribute their plans and funds to complete the upgrading of skills and suitable job provision. Growing awareness of the cost of overpopulation and the advantages of being more ecologically conscious concerning the byproducts of rapid development led to the now-​ popular creation of Chinese EIPs. These grew out of improvements to industrial parks, not science parks themselves. Much science and research has focused on coming up with technological “fixes,” or treatments to production processes that could minimize pollution to air and water.

Park Profiles The Diverse Focus of China’s SPHZs China’s technology policy has shifted over time to a less directed approach, although government still has a strong role in planning the location and focus of new parks and zones. This is in line with “the strong state role in driving investment and rapid growth in innovation-​ intensive activities” outlined in the “Sixty Decisions of the CCP” promulgated by Xi Jinping in 2013 (Rhodium Group, 2021). Costs and the labor market also currently favor dispersion away from congested city centers to outlying areas, including in the case of Shanghai a relocation of parts of all major university campuses to suburban Minhang, linked by subway to the city. This reflects the discovery that universities are economic engines in themselves, spurring construction and maintenance of residential, retail, and service businesses. A comparison of specialties focused on by each park is shown in Table 4.3.2. These categories and their frequency should be considered indicative, not exhaustive or exact, since they are drawn from the website of a particular park or from a reputable secondary source. The variety of terms for high-​tech parks should be noted; throughout the text they are referred to by their specific formal name as well as grouped as applicable under the shared category of “high-​tech parks.” The area of biology and biopharmaceutical products forms the clearly favorite concentration, with almost double the number of parks listing it rather than the next most common specialty—​new materials. Some researchers conclude that traditional Chinese siting practices such as feng shui are factors in the location placement of SPHZs (Fang and Xie, 2008). This combination of old and new serves as a popular bridge, easing transition to new notions. A similar positioning comes into play with the boosting of traditional Chinese medicine (TCM) as an alternative to Western pharmaceuticals. Shanghai’s Zhangjiang Hi-​ Tech Park was founded in 1992 with this specialty as its primary purpose. While profit margins and demand are high, products in this field take a relatively long time to develop given both their complexity and, more importantly, the long time it takes for testing to ensure human safety. Many start but few finish. This realization eventually led Zhangjiang

Science Parks and High-Tech Zones    345 Table 4.3.2 China’s SPHZs by Major Scientific Fields Code

Category

Number

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39

Aeronautics, aviation, aerodynamics Agriculture tech Artificial intelligence Atomic Batteries Biology, biopharmaceutical Chemical Communications (incl. telecommunications) E-​commerce Electronics Energy (savings, new forms) Engineering Environment, ecology Food processing Integrated circuits Industry supply chains Information technology Laser LCD panel Logistics Machinery, incl. precision Manufacturing (advanced) Marine/​defense technology/​aquaculture Medical devices/​appliances New City site New materials, composites Optical (communication, fiber) Optical-​mechanical-​electrical integration Photovoltaic Rare resources Regional focus Robotics Semiconductors Software Steel Tech finance Tourism Traditional Chinese medicine Vehicles (parts, electric)

4 1 2 1 1 39 6 3 1 20 13 3 9 2 3 1 21 2 2 2 7 12 2 2 5 22 4 10 3 5 5 1 1 7 2 1 1 1 11

developers to add a significantly large focus on specialties with high investment cost but much faster payoff: software development and the related areas of semiconductors and integrated circuits. The specialty field of new materials and composites serves China’s infrastructure construction boom across a large country with widely varying climate conditions. Roads,

346   Walcott rail and subways, airports and runways, ships and satellites, and dams and bridges are sprouting up across the country, encountering every climate zone, as in the United States. Construction is famous as a job generator, and a high government priority. As in other popular areas including lasers, advanced materials are an important priority for military-​ industrial technology transfer. Information technology and electronics, the third and fourth most common specialties, are related and relatively less expensive to develop. The strategic push for energy independence drives the fifth most popular specialty, particularly useful as more middle-​class consumers begin to demand labor-​saving devices and affordable electricity to run them. Advanced manufacturing, the next most common specialty, serves China’s need to move from a low-​skill, low-​cost manufacturing focus to a higher value level. The area of vehicle manufacturing features two different regions: the old “Rust Belt” region on the Russia-​Korea border of early industrialization, and the east coast region where FDI in vehicle manufacturing was directed to locate. The area of environmental and ecological focus reflects a new policy push, reacting to citizen demand for ameliorating the pollution accompanying China’s rapid industrialization and in response to the desire to be seen as a developed country in a cutting-​edge field. Solar and wind power equipment flow from this area and may make China a world leader in the market, as detailed by Huang and Lema in Chapter 7.1 of this Handbook.

Evolution of SPHZs Beijing’s Zhongguancun High-​Tech Park arose as a grassroots clustered development of firms retailing high-​tech products, formalized as the first Science and Technology Industrial Park (STIP) in 1988 and tagged as “China’s Silicon Valley” due to its focus on computer ware, as well as biotech. Zhongguancun was established in a northern area of Beijing with easy access to several of the best universities and attracted a number of multinationals to set up R&D centers there. By 1991, 26 parks were established across China, with another 25 approved in 1992. The greatest number of parks are in the four cities of Beijing, Shanghai, Tianjin, and Chongqing, while 23 are located in other provincial capitals, and 27 are sited in rapidly developing cities such as Shenzhen or with specialized local concentrations as in agricultural technology, or positioned to attract overseas Chinese investments such as cross-​strait (Taiwanese) interests. The Pearl River Delta city of Shenzhen, itself a new project developed to showcase China’s modernity close to Hong Kong, served as the first site approved for an SPHZ in 1985 with the launch of the Shenzhen Science and Technology Industrial Park in partnership with the Chinese Academy of Sciences. The Shenzhen Hi-​Tech Industrial Park (SHIP) debuted in 1989 along with 27 other SPHZs. Both domestic research from the Chinese Academy of Science and advances brought in by foreign companies permitted to settle there demonstrated the usefulness to both of this two-​track approach. The municipal government of Guangzhou, the capital of Guangdong province, is drafting a five-​year plan dedicated to IT, artificial intelligence, and biomedicine and plans to set aside 150 million yuan a year to help with the development of these industries. In the Yangtze River Delta to the north, Shanghai’s Zhongke High-​Tech Park joins the other metro Shanghai development districts of Caohejing (1999), Zhangjiang (1992),

Science Parks and High-Tech Zones    347 Shanghai Manufacturing University Science Park (1994), the International Fabric Science and Technology City (1994), Jinqiao Manufacturing and Exporting District (1994), and Jiangding Science and Technology Park (1994) in the “One District, Six Parks” plan set up by the Chinese Academy of Sciences and the State Council. As Shanghai grew rapidly, its earliest SPHZs ran out of space and the city and municipality reshaped population and land use toward its formerly lightly settled, rural reach of Pudong, on the eastern side of the Huangpu River. This large area now hosts a booming business, finance, and technology center. In addition to the earlier established zones, it now includes Lingang New City (commenced in 2003 and renamed Nanhui New City), which is a 315 km2 new high-​tech industrial and residential area under development to the southeast of the region. Several other SPHZs including those in Taiyuan, Tianjin, and Xi’an include a number of separately configured and specialized parks under one management umbrella and on a large plot of land. Features in inner China SPHZs are in several cases particularly designed to retain or attract back able natives or graduates of local universities outside the most prestigious east coast cities. Park grounds can include amenity features such as “villas” (relatively large and well-​equipped residences), golf and country club–​like amenities, pleasant natural settings, and high-​quality schools for children of residents. Convenient banks, restaurants, sports facilities, “pedestrian mall” retail streets, organized cultural activities, and other nontraditional features are not unusual in several parks. Internal design of affiliated office buildings consciously promotes social gathering places to ease exchange of ideas, construction of social networks, and similar possibilities for congenial face-​to-​face encounters. These include the siting of foreign-​brand coffee shops such as Starbucks and food settings (Kentucky Fried Chicken, Popeyes, McDonalds, and domestic Chinese competitors) not otherwise conveniently available. Park designers appear to have done their homework, observing many features of successful settings around the world that serve as virtually independent cities. Several other specialties merit a mention, though they are not as widespread. A focus on “rare resources” is accompanied by a “regional focus” in provinces where high-​value items such as rare earths and petroleum are present. The regional focus also indicates proximity to a market such as Russia in the northeast, Southeast Asia, or the far northwest along the “New Silk Road” development. Roughly half a dozen cities used SPHZ construction to spur development of an entirely new urban extension. The “Science City” in Mianyang reflects the prominence of this city safely deep in an interior location of Sichuan province as the development site for high-​priority military-​related technology, from aerospace to the atom bomb. The rapidly developing interior city of Chongqing leveled a large section of its hilly landscape to create a large suburb for its SPHZ and resettlement for populations moved due to the Three Gorges Dam construction. Cities in China’s lagging interior areas have become a focus for new urban development policies. The central government seeks to close the central provinces’ development gap, particularly in the west-​central region, including Chengdu and Chongqing. Zhengzhou used a foreign-​ invested factory—​ in this case Foxconn’s assembly plant primarily for Apple’s iPhones—​as a stepping stone for an entirely new and giant development complex. Zhengzhou’s “aerotropolis” in Henan province is a city between two cities, constructed as a concept of commercial airport–​centered shipments for global (primarily European) destinations. Zhengzhou’s High and New Technology Industrial Development Zone (HNTIDZ) was established originally as early as 1988. Its designation in 2013 as China’s first

348   Walcott formal aerotropolis (Zhengzhou Airport Economic Zone) accelerated large construction projects and focused local technology research and related businesses on the aero-​related industry. Zhengzhou won this designation after a spirited competition among other cities. Technology-​improved agriculture was added as a focus for an SPHZ in the former northeast manufacturing center of Shenyang as late as 2015, expanding efforts in a zone launched in 1997. The year 2015 also marked the central government’s proclamation of a “Made in China 2025” campaign promoting a vision of moving beyond traditional reliance on coal, steel, food production, and traditional mass manufacturing to “new forms of employment . . . into the next phase of the industrial revolution for the region” (Shenyang, 2016). The “Made in China 2025” campaign sought ways to move the “world’s factory” from low-​skill inexpensive labor to higher-​value-​added, more middle-​class creative work. The intertwined considerations of the market for land, accumulation of educated labor, and the designed development of a specific region are all parts of typical SPHZ considerations (Zhang, 2015). Shenyang HNTIDZ’s list of clustered specialties includes a number of industries focused on the linchpin of automotive production, including robotics, batteries, and aerospace, anchored by a Sino-​German industrial park. Japanese and Korean car manufacturers of leading global brands utilize robotics; batteries can be used in electrical cars; and aerospace includes many transferable advances that can cross into car manufacture. The Sino-​German cluster includes both Germany’s BMW (very popular among those Chinese who can afford it) and France’s Michelin tire factory. In Harbin, a “multinational direct trade channel” enables direct access to Russia. A cooperative relationship has been set up between the Harbin Development Zone in China’s northeast and the Novosibirsk Science Institute Technological Park of Russia to form the Russia-​oriented Scientific and Technological Cooperation Center. In bustling southeastern China, Hong Kong Special Administrative Region’s (HKSAR) role in these developments remains significant. As “a research and biotechnology hub” (Sanders, 2012), Hong Kong continues to link research and related businesses within and outside China. Its previous history as an English-​proficient, open-​trade British colony permitted the growth of global networks that China drew on heavily in its initial development stage and now uses to ascend the ladder of sophistication. Nearby Shenzhen was especially reliant on business know-​how instruction from Hong Kong and representation from northern China’s major universities to furnish personnel for its new academic backbone. Similar to many other provinces, Hong Kong has set up delegation offices in major Chinese provinces. These promote the exchange of personnel, products, and ideas from Hong Kong and the outside world. A separate Hong Kong Science and Technology Parks Corporation (HKSTPC) promotes the relocation of high-​tech firms and research to Hong Kong, placing them under the “One Country, Two Systems” umbrella. A 22-​hectare Hong Kong science park serves around 400 companies in the Special Autonomous Region. Hong Kong’s “six key industries” include innovation and technology, testing, and certification. Specialized “institutes” promote research and development of high tech, including nano and advanced materials. The five major industries include communications, consumer electronics, integrated circuit design, materials and packages, and biomedical electronics. The HKSTPC provides the usual combination in one concentrated geographic area of office spaces, infrastructure, laboratories, and a business incubator. These are complemented by the usual configuration of services for which Hong Kong is renowned: finance, legal,

Science Parks and High-Tech Zones    349 management, marketing, and technical advice. Business attraction focuses on five high-​ tech industries:  electronics, IT and telecomm, engineering, biotechnology, and green tech (Sanders, 2012). Park developers promote the benefits of clustering to provide competitive challenges and creation of new ideas and improvements. Research universities within HKSAR support technology transfer from bench research to business offshoots, whose success returns funding received from HKSAR initially. In addition, Hong Kong is embracing the integration of the key cities in the Pearl River Delta region to form a megalopolis with rapid transport links between 13 major cities. In 2020, Hong Kong and neighboring Shenzhen were jointly planning a new Shenzhen/​Hong Kong Innovation and Technology Co-​operation Zone in the Lok Ma Chau Loop, a riverside location between the two cities.

Research Positions and Controversies Do Chinese SPHZs do what they are designed to do: encourage the development and export of high-​technology goods for sale, preferably as exports? Numerous issues muddying the waters include the effects on accuracy of numbers due to distorting practices in areas such as the awarding and dispensing of funding and promotion. Transparency remains an issue, with data needing to be cross-​checked for accuracy. A strong argument for the economic value of these parks lies in a comparison of the export value of products from high-​tech zones as a percentage of China’s total exports over the decade from 2006 to 2016. The latest statistics available from both the World Bank and the China Statistical Yearbook show the increasing value of HTDZ products. While the total value of China’s exports was increasing over this period, the percent represented by the 54 zones almost doubled from 15% in 2006 (Zeng, 2011) to 28% in 2016 (China Statistical Yearbook, 2017). Expenditures on research and development as a percent of gross domestic product, which the Organisation for Economic Cooperation and Development (OECD) terms “research intensity,” was 2.11% in 2016, compared to 2.7% in the United States and 2.3% in OECD countries on average (OECD, 2018). Some variations appeared in the total value of products among the parks over this decade, with Beijing’s Zhongguancun Science Park and Shanghai’s Zhangjiang Hi-​Tech Park continuing to lead the pack. Wuhan and Xi’an replaced Nanjing, Wuxi, and Shenzhen as top value-​added sites, however (China Statistical Yearbook, 2017; Zeng, 2011). Effects of zone development on urban areas are another major consideration of SPHZs in addition to their economic effects (Fang and Xie, 2008). For Chinese urban planners, prospective benefits included land development yielding higher taxation rates than agriculture or residential uses. SPHZs were also more recently designed to showcase China’s adoption of environmental best practices by including water features and green spaces. Location features include development of rural land in areas outlying densely urban cities. This land was more affordable to acquire, with fewer residents to relocate, and drew on workers from population centers in the nearby city as well as providing land for new residences, from worker-​affordable housing to “villas” for highly paid talent, attracted in some cases from overseas as well as from within China. China’s transition along the continuum from socialist state–​provided goods to buyer-​seller market capitalism shows up in the divergences among the various SPHZs. The opportunity to construct “high-​tech towns” (Miao, 2016) differed by

350   Walcott municipality in terms of land available and the willingness or ability to provide commute-​ convenient, affordable, and enticing housing. More high-​tech firms locate within than outside SPHZs, but one study found that these park companies have less revenue and export earnings or value-​added production than the less tech-​intensive off-​park firms, which profit from a low-​cost labor base rather than skilled employees (Zhang and Sonobe, 2011). The flow of patents granted based on indigenous research in these parks that lead to marketable transfers remains fairly modest. A  National Bureau of Economic Research study (Wei et  al., 2016)  found, however, that Chinese patent applications had picked up markedly, particularly from small firms rather than the much better-​funded but larger state-​owned enterprises (SOEs), as asserted in an earlier study (Huang, Yu, and Seetoo, 2012). Using data publicly available from the standard reference China Statistical Yearbook on Science and Technology, the authors noted perceptible movement over the years 2001–​2014 in the innovation-​sourcing behavior of firms. There was a shift from purchasing foreign technology to funding in-​house research. Since the majority of firms reliant on technology developments for their competitive edge are located in SPHZs, this feature can be said to represent a value-​added contribution of location within an SPHZ to increase innovation through improved competitiveness. This can be seen as an indicator of the maturation of domestic market demand toward higher-​quality domestically produced goods and services, as a result of a shift from low-​income consumers into the middle class, a shift requiring advanced manufacturing. China is considered by many researchers to be more successful in incremental improvements than game-​changing advancements. Government support for infant and mezzanine-​level take-​off stage ventures can smooth the rocky road to economic sustainability. Intellectual property violations are not infrequently alleged, encouraging the shortcut route to marketing modern products, rather than encouraging time-​consuming development of technologies in house. The issue of time needed for adequate and safe testing weighs especially heavily in popular profitable fields such as biotechnology and pharmaceuticals, where numerous hierarchical tests, from animals to carefully selected human clinical trials, need to succeed prior to market debut. Promotion of Chinese traditional medicine (TCM) has been used to fill the time gap, but Western science–​based treatments seem to be preferred by the market that can afford them. Despite the questionable nature of exact figures provided by Chinese sources, the sheer volume of activity apparent around the development of Chinese SPHZs in numerous cities across the country attests to the development boost they provide. The amount of capital necessary to modernize a country in the political and economic transition from a communist state to a market orientation can only come from the central government. In the case of China, this pattern is frequently referred to as a capitalist model “with Chinese characteristics.” The SPHZs profiled vary in their degree of success, as a reflection of the prosperity of their location and the ability of their particular leadership to leverage local and personal assets. The latter includes networks with well-​placed Chinese officials, the ability to speak English with foreign business personnel, and familiarity with the type of research or firm specialty. Overall, it would be very difficult to argue persuasively that these clusters of technology-​infused firms, with incentives to share information, train new business managers, and build new-​tech businesses are less than a successful step in the

Science Parks and High-Tech Zones    351 rapid modernization of this vast country. Nevertheless, significant questions remain and more data needs to be systematically generated to answer them, as detailed in the following section.

Areas for Future Inquiry Measures of success for the SPHZ policy continue to be contested, as does the scanty reliable data to support a well-​substantiated assessment. The heavy importance placed by the Chinese government on scientific innovations fueling economic development acts to distort unbiased evaluation. The State Steering Committee of Science and Technology and Education falls under the State Council to coordinate policy for science, education, and economic development, reflecting the high-​level visibility of these issues. The Ministry of Science and Technology manages science parks and support for businesses nurtured there. As “the factory of the world,” China’s production of low-​skill, assembly-​level goods remains a sticking point, with a greater share of technology-​infused products coming from foreign firms located in that country rather that patent-​owning Chinese businesses. However, the rapid rise of Chinese firms’ ability to generate patents is a strong indicator that the basis for indigenous innovation is changing rapidly (see Chapter 1.4 of this Handbook). The ability of a politically powerful developmental state to create circumstances for a desired outcome, as referenced in the phrase “with Chinese characteristics,” is the subject of numerous studies that look at varied success patterns, primarily in Asian countries. In the case of Chinese SPHZs, one camp argues (Zhang, 2015) that the results reflect a variety of complex factors, particularly land development processes providing infrastructure needed for the specific industries targeted for development. The case of Shanghai’s Zhangjiang High-​Tech Park and its biotech focus is offered as a successful mix of government policies at all levels, with educated skill recruitment from domestic and global sources. Others would argue that the inherent attractiveness and political-​economic power concentrated in cities such as Shanghai and Beijing make them unsuitable for a test of this proposition, rather than less inherently attractive locations in other SPHZ sites, such as inner China. Research trends applicable to emerging business opportunities for high-​tech firms include searching for alternative energy and environmentally friendly mitigation of pollution and fossil fuel depletion. Since the early 1990s, funding for renewable energy technology has soared in China, including wind and solar cell technology. Since the slowdown in funding for this area of research in the United States, a previous source of scientific breakthroughs, it would be interesting to follow China’s development, particularly in eco-​ industrial applications in those SPHZs specializing in alternate energy. And in all cases, there is no substitute for being on the ground to observe and discuss the evolving processes under way. The January 3, 2019, unprecedented landing of a Chinese spacecraft on the darker side of the moon signaled the success of China’s government-​funded promotion of applied science, the hallmark of its SPHZ focus. Perhaps this widely covered breakthrough should spur more interest and support in other advanced countries for examining the Chinese path and progress.

352   Walcott

References Bathelt, Harald, Malmberg, Anders, and Maskell, Peter, (2004) “Clusters and knowledge: local buzz, global pipelines and the process of knowledge creation,” Progress in Human Geography, vol. 28, no. 1: 31–​56. Campbell, Joel, (2013) “Becoming a techno-​industrial power: Chinese science and technology policy,” Brookings Institute Issues in Technology Innovation, no. 23. https://​www.brookings. edu/​wp-​content/​uploads/​2016/​06/​29-​science-​technology-​policy-​china-​campbell.pdf Cao, Cong, (2004) “Zhongguancun and China’s high-​tech parks in transition: ‘Growing pains’ or ‘premature senility’?,” Asian Survey, vol. 44, no. 5: 647–​668. Cheng, Fangfang, van Oort, Frank, and Geertman, Stan, (2013) “Science parks and the co-​ location of high-​tech small-​and medium-​sized firms in China’s Shenzhen,” Urban Studies, vol. 51, no. 5: 1073–​1089. China Statistical Yearbook, (2017), http://​www.stats.gov.cn/​tjsj/​ndsj/​2017/​indexeh.htm Fang, Chuanglin, and Xie, Yichun, (2008) “Site planning and guiding principles of hi-​tech parks in China: Shenzhen as a case study,” Environment & Planning B: Planning & Design, vol. 35, no. 1: 100–​121. Gang, Zeng, Liefner, Ingo, and Si, Yuefang, (2011) “The role of high-​tech parks in China’s regional economy: Empirical evidence from the IC industry in the Zhangjiang high-​tech park, Shanghai,” Erdkunde, vol. 65, no. 1: 43–​53. Huang, Kuo-​Feng, Yu Chwo-​Ming, Joseph, and Seetoo, and Dah-​Hsian, (2012) “Firm innovation in policy-​driven parks and spontaneous clusters: the smaller firm the better?,” Journal of Technology Transfer, vol. 37 no. 5: 715–​731. Huang, Zhiji, He, Canfei, and Zhu, Shengjun, (2017) “Do China’s economic development zones improve land use efficiency? The effects of selection, factor accumulation and agglomeration,” Landscape and Urban Planning, vol. 162: 145–​156. Liangyu, (2018) “China pushes technology development to modernize agriculture,” Xinhua, http://​www.xinhuanet.com/​english/​2018-​01/​29/​c_​136934385.htm Lofsten, Hans, and Lindelof, Peter, (2002) “Science parks and the growth of new technology-​ based firms -​academic–​industry links, innovation and markets,” Research Policy, vol. 31 no. 6: 859–​876. Macdonald, Stuart, and Deng, Yunfeng, (2004) “Science parks in China: a cautionary exploration,” International Journal of Technology Intelligence and Planning, vol. 1, no. 1: 1–​14. Massey, Doreen, and Wield, David, (1992) “Science parks: a concept in science, society and ‘space’ (a realist tale),” Environment and Planning D: Society and Space, vol. 10: 411–​422. Miao, Julie Tian, (2016) “Housing the knowledge economy in China:  an examination of housing provision in support of science parks,” Urban Studies, vol. 54, no. 6: 1426–​1445. Ministry of Science and Technology, (2011) List of national high-​tech development zones, accessed August 7, 2011, http://​www.most.gov.cn/​gxjscykfq/​gxjsgxqml/​. OECD, (July 2018) Main science and technology indicators, accessed January 2019, http://​ www.oecd.org/​sti/​msti.htm. Rhodium Group, (2021) “The China Dashboard—​Winter 2021, https://​rhg.com/​research/​ the-​china-​dashboard-​winter-​2021/​ Sanders, Sean, ed., (2012) “Hong Kong in focus:  Asia’s research hub,” Science, vol. 338 no. 6114: 1657–​1658. Shenyang Municipal Bureau of News, (2016) “Shenyang, a city of successful transition from China’s industrial pioneer to innovative manufacturer,” https://​www.prnewswire.com/​

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Chapter 4.4

Venture Capi ta l , A ng e l C apital, and Ot h e r Finance, I P O s , a nd Ac quisi t i ons Lin Lin Introduction This chapter focuses on the development of nonbank financial institutions, particularly venture capital, and their role in funding entrepreneurial new ventures. It covers the rationale for their development in China and includes angel funds, private equity, and foreign funding sources, as well as the market for liquidation through initial public offerings (IPOs) and acquisitions. It evaluates institutional changes and policy actions for reforming access to funds for small enterprises, including the launch of ChiNext, and other mechanisms for financial support.

Venture Capital The concept of venture capital was first debated in China in 1985, in the central government’s Decision to Reform the Science and Technology System.1 The term “venture capital” was initially translated as “risk capital” (fengxian touzi) in the official documents to reflect the “high risk” nature of this investment method. To encourage entrepreneurship and innovation, several government agencies, including the National Development and Reform Commission (NDRC) and the Ministry of Science and Technology, began to use instead the term “entrepreneurial capital” (chuangye touzi) in the text of their regulations (Li, 2007; Lin, 2021). 1 

CPC Central Committee, The Decision to Reform the Science and Technology System (March 13, 1985).

Venture Capital, Angel Capital, and Other Finance    355 Today, the understanding of “venture capital” among Chinese professionals is consistent with international practice, in the sense that venture capital is a subset of private equity.2 It is an investment in high-​growth, high-​risk, and often high-​technology firms that need capital to finance product development or growth in the form of equity instead of debt. Although venture capital and private equity share similar legal structures, incentive schemes, and investors, venture capital focuses on early-​stage high-​risk and technology companies, whereas private equity invests in virtually every industry and later-​stage companies.3 Nonetheless, due to the short history of the Chinese venture capital market, the understanding of venture capital among ordinary investors is limited and the term “venture capital” is commonly confused with “private equity.”4 According to an interviewed practitioner in the Chinese venture capital market, the number of venture capital firms that strictly invest in the venture capital sector but not the private equity sector is much smaller than reported.5 Many existing Chinese venture capital firms arose with the boom of the capital market and have limited experience in the venture capital industry.6 Many local venture capitalists were investment bankers before entering the venture capital market and hence do not possess sufficient expertise or experience compared to their counterparts in the United States (Lin, 2021, 9). Meanwhile, some local investors (individual investors or state-​owned enterprises) are more active than American investors in making investments and try to participate in the management of the fund through various ways (such as by exercising voting rights in the advisory committee and the investment committee of the fund). (Lin, 2021, 77–​80). Some investors in venture capital funds are even inclined to make short-​term investments in later-​ stage portfolio companies in traditional industries to achieve quicker returns (Lin, 2013, 187, 192). Further, unlike a typical venture capital cycle in the United States, which usually lasts for 7 to 10 years, a 2012 survey shows that the average cycle in China is shorter, indicating that the Chinese market is less patient and mature as compared to the US counterpart.7 The boundary between venture capital and private equity is blurred in China (Lin, 2021, 10). Some venture firms that used to invest in early-​stage startups, having had to cope simultaneously with fundraising difficulties as well as investors’ expectations for higher returns, have become more inclined to invest in later-​stage enterprises, especially pre-​IPO companies, to gain quick returns (Zhou, 2008; Lin, 2021, 10). Meanwhile, recent regulatory efforts in IPO reforms, the launch of the Shanghai Stock Exchange Science and Technology Innovation Board (the STAR market), coupled with the rapid development of the technology and e-​commerce industry, have motivated some traditional private equity funds to invest in early stage companies (Lin, 2021, 10). Compared to the United States, the history of angel investment in China is relatively short, with there being only a few dozen angel investors before 2010 (Dong, 2013).

2 

Lin Lin, Venture Capital Law in China (Cambridge University Press, 2021), at 9. Lin Lin, supra note 2, at 9. 4  Lin Lin, supra note 2, at 9. 5  Lin Lin, supra note 2, at 10. 6  Lin Lin, supra note 2, at 10. 7  Zhong Zhimin, “287 VC/​PE Backed Companies Are Applying for Listing,” China Securities Journal [Zhongguo Zhengquanbao] (June 20, 2012). The survey was conducted using data as of June 14, 2012. Statistics show that the investment cycles of two venture capital firms were less than 20 months, and only five firms had cycles above 40 months. Seventeen firms had investment cycles between 20 and 40 months. 3 

356   Lin Since May 2013, the central government has issued at least 22 documents, including two fundamental opinions issued by the State Council to embark on the “Mass Entrepreneurship and Innovation” reform.8 This was followed by several specific measures that aimed to improve institutional mechanisms to facilitate entrepreneurship and innovation, for instance, by deepening business registration system reforms, strengthening intellectual property protection, and establishing a mechanism for the training and hiring of talented professionals.9 With China’s policies promoting entrepreneurship and innovation, as well as the increase in its number of high-​net-​worth individuals, the market for angel investment in China has reached an unprecedented level of activity since 2013. In 2013 and 2014, many local governments within the country successively established angel investment guidance funds, with the governments taking the lead to encourage angel investment institutions to provide entrepreneurial support to entrepreneurs. Correspondingly, the 31 angel investment funds newly raised by angel investment institutions in 2014 collectively raised US$7.73 billion of funding, with this amount doubling from 2013 and to a record high. In terms of investment, the angel investment market in 2014 was extremely prosperous, and according to 2014 statistics from the Zero2IPO Research Center, China’s angel investment institutions completed 766 investment cases altogether, with the disclosed total amount invested exceeding US$5.26 billion. The number of investment cases has been increasing by 353% year on year, while the total amount involved has too been rising by 161.7% yearly (Cyzone, 2015). From August 2015 to August 2016, there were 2,293 angel investment cases in China, with the total investment amount being US$16.61 billion, and the average single investment being US$4.72 million (China Securities Network, 2016). After 2012, the China Angel Investment Association, China Business Angel Association, Angel Investment Club, and other industry organizations have also been set up, building a platform for investors to interact, pass down their experiences, and share resources. However, since the “capital winter” in 2016, many angel investment institutions have slowed the pace of investment. At present, domestic angel investors generally fall into three main categories, namely, successful entrepreneurs, wealthy individuals or families, and senior executives in high-​tech companies. Nevertheless, due to the short history of Chinese venture capital market, China’s angel investor community is not as experienced as that in the United States. Currently, the active angel investors in China range widely in age and their backgrounds span numerous fields. Further, Cyzone (2015) reports that many public figures, such as entertainment stars, have also joined the community of angel investors. China is currently the second-​largest country in terms of venture capital investment, ranking only behind the United States.10 According to data from the Zero2IPO Research Center (2018), in 2017 alone, 895 new venture capital funds, collectively raising more than US$40 billion worth of fresh capital eligible for investment,11 were set up in China, and

8 

“Views of the State Council on Policy Measures Relating to Mass Entrepreneurship,” Press Release, Guowuyuan [State Council], Guowuyuan Guanyu Dali Tuijin Dazhong Chuangye Wanzhong Chuangxin Ruoga Zhengce Cuoshi de Yijian (国务院关于大力推进大众创业万众创新若干政策措施的意见) (June 16, 2015), See Lin Lin “Engineering a Venture Capital Market: Lessons from China” (2017) 30(1), Columbia Journal of Asian Law, at 170–​171. 9  Lin Lin, supra note 10, at 170-​171. 10  Preqin, “2018 Preqin Global Private Equity & Venture Capital Report” (Preqin Ltd., 2018), at 110. 11  See KPMG Enterprise, “Venture Pulse Q4 2017:  Global Analysis of Venture Funding” (KPMG International Cooperative, 2018), at 98.

Venture Capital, Angel Capital, and Other Finance    357 470 companies which were invested in by venture capitalists (VC-​backed companies) went public in China (as shown in Table 4.4.2 later). Venture capital has had a much shorter history in China than in the United States.12 The Chinese government has sought to replicate America’s success in developing an effective venture capital market since the 1980s, with the concept of venture capital being first officially introduced in China in 1985.13 The industry began to emerge when the first venture capital firm, the China New Technology Venture Capital Company, was set up in the same year as a government initiate (Zhu and Ge, 2004, 4; Lu, Tan, and Chen, 2007). In 1988, the Torch Program was launched by the Ministry of Science and Technology to develop technology and innovation in China.14 Thereafter, a number of government-​backed investment companies were set up to provide financing to high-​tech startups.15 However, due to the lack of a stock market and appropriate business vehicles for venture capital fund raising, the venture capital market developed slowly during this period.16 The year 1998 marked a turning point in China’s venture capital market.17 Mr. Cheng Siwei, the then-​ vice chairman of the National People’s Congress Standing Committee, presented a groundbreaking “No. 1 Proposal” urging the development of a venture capital market in China.18 After that, a series of government policies were issued, including the Strategy of Invigorating China through Science and Education and the Law on Promoting the Transformation of Scientific and Technological Achievements.19 Various government guidance funds were also set up to provide capital to high-​tech startups.20 Foreign venture capital firms like IDG Capital Partners and Walden International also started to enter the Chinese market.21 The establishment of the Shanghai Stock Exchange and the Shenzhen Stock Exchange in 1990 offered a new channel for venture capital investments to exit via IPOs within China.22 However, government-​backed venture capital firms still dominated the industry during this period,23 and the role of private venture capital firms was very limited due to foreign investment control and limited choices of business vehicles for venture fund-​raising.24 After the burst of the “dot-​com bubble” in 2001 and the global economic slowdown in 2002, venture capital investment declined substantially in China.25 To provide a conducive regulatory environment for venture capital investments, clearer rules and regulations were issued on matters pertaining to the establishment, management, supervision, taxation, and foreign investment of venture capital.26 The Shenzhen Stock Exchange Small and

12 

Lin Lin, supra note 2, at 17. Lin Lin, supra note 2, at 17. 14  Lin Lin, supra note 2, at 17. 15  Lin Lin, supra note 2, at 17. 16  Lin Lin, supra note 2, at 17. 17  Lin Lin, supra note 2, at 17. 18  Lin Lin, supra note 2, at 18. 19  Lin Lin, supra note 2, at 18. 20  Lin Lin, supra note 2, at 18. 21  Lin Lin, supra note 2, at 18. 22  Lin Lin, supra note 2, at 18. 23  Lin Lin, supra note 2, at 18. 24  Lin Lin, supra note 2, at 18. 25  Lin Lin, supra note 2, at 19. 26  Lin Lin, supra note 2, at 19. 13 

358   Lin Table 4.4.1 Number and Amount of Foreign and Domestic Funds Raised

(2006–​2017)

Year

Annual Number of Foreign Funds Raised

Annual Amount Raised by Foreign Funds (in RMB million)

Annual Amount Annual Number of Raised by RMB Funds RMB Funds Raised (in RMB million)

2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006

72 99 108 69 37 31 57 23 19 59 80 64

1,145.53 1,836.07 1,498.89 1,414.76 711.51 600.82 1,466.89 1,406.42 445.25 3,059.46 2,641.35 1,284.59

3502 2339 2862 676 511 590 560 217 105 108 42 15

16,743.20 11,875.98 6,350.60 3,703.22 1,802.99 1,577.09 2,764.60 1,161.47 839.73 1,616.61 349.92 134.38

Source: Data from Annual Research Reports on Venture Capital In China, published by Zero2IPO.

Medium-​Sized Enterprise Board (SME Board) was also launched in 2004, providing a new exit channel for venture capital investments.27 The introduction of the limited partnership by the revised Partnership Enterprise Law in 2006 was a milestone in the history of the Chinese venture capital market.28 The limited partnership has become a popular business vehicle for venture fund-​raising.29 Although the number and volume of funds raised dipped in 2009 due to the global financial crisis, both the number of newly established venture funds and the amounts raised doubled in 2011 (Table 4.4.1).30 The launch of a new NASDAQ-​like secondary board, ChiNext, in 2009, new measures allowing insurance funds to make equity investments in 2010, the launch of several regional Qualified Foreign Limited Partner (QFLP) schemes and the substantial increase in investments by the National Social Security Fund (NSSF) in private equity have contributed to the boom (Lin, 2017a, Appendix 2).31 The NSSF, established in August 2000, is a national social security reserve fund composed of funds from the central government’s budget, transfers of state-​owned capital, fund investment proceeds, and other means approved by the State Council. It is to be exclusively used to supplement and adjust social security expenditures such as pension insurance during the peak period

27 

Lin Lin, supra note 2, at 19. Lin Lin, supra note 2, at 19. 29  Lin Lin, supra note 2, at 19. 30  Lin Lin, supra note 2, at 20. 31  Lin Lin, supra note 2, at 20. 28 

Venture Capital, Angel Capital, and Other Finance    359 of population aging, with the National Council for Social Security Fund (NCSSF) being responsible for its management and operation. Although the suspension of the IPO process by the China Securities Regulatory Commission (CSRC) from November 2012 to January 2014 negatively affected fundraising in both 2012 and 2013, the reforms discussed in the previous paragraph accelerated the reboot of the venture capital market in 2014.32 This was further assisted by the 2013 nationwide expansion of the National Equities Exchange and Quotation (NEEQ) system, which is a new exit vehicle for VC-​backed startup firms.33 As reported by the Zero2IPO Research Center (2015a), since 2014, the Chinese central government has seemed to be moving toward a “Government Led + Market Operation” model in providing public funding, instead of directly participating in the allocation of capital. In 2016, the State Emerging Industries Venture Capital Investment Guidance Fund was set up by the State Council to support startups in emerging industries, foster innovation, and upgrade the industry (Lin, 2017b, 192–​203). From 2016 to 2017, local and foreign venture capital supply has grown rapidly in China.34 However, following the promulgation of the “Guidelines on Regulating Financial Institutions’ Asset Management Business” in 2018,35 fundraising sources for investment institutions in China was subject to greater supervision.36

Foreign Funding There is no unique definition of foreign funding in China. “Foreign” private equity or venture capital funds possess certain foreign elements and can be differentiated from local funds according to the source of funding, location, and type of currency. Purely foreign funds generally refer to funds that are set up abroad by foreigners according to foreign laws. The main source of funding of these funds comes from overseas and the fund’s currency is foreign currency. Such funds generally do not establish entities in China, only setting up representative offices and investing in Chinese opportunities (Beijing D&T Law Firm, 2012, 3). The development of foreign funds in China has been closely tied to the evolution of China’s laws and policies. Per Beijing D&T Law Firm (2012), in 1993, IDG and the Shanghai Science and Technology Committee founded the Pacific Technology Venture Capital (China) Fund, with this being the very first foreign venture capital investment firm to enter China. This was followed by a large influx of foreign venture capital into China, which also kicked off the development of China’s venture capital market in the process (p.  4). During the 1990s, when the dot-​com bubble was growing, an immense 32 

Lin Lin, supra note 2, at 21. Lin Lin, supra note 2, at 21. 34  Lin Lin, supra note 2, at 23. 35 “Issuance of the Guidelines on Regulating Financial Institutions’ Asset Management Business [guanyu guifan jingrong jigou zichan guanli yewu de zhidao yijian fabu]” (April 27, 2018), Caixin Global. 36  Lin Lin, supra note 2, at 23. 33 

360   Lin number of foreign venture capital funds began investing in Chinese internet technology companies, with the three major web portals, Sina, Sohu, and NetEase, all bearing traces of foreign venture capital investment.37 After 2000, China’s supervisory controls on foreign funds were relaxed to some extent and the corresponding laws and regulations were promulgated, which enabled greater development of foreign venture capital and private equity in China. In 2004, Newbridge Capital acquired shares of the Shenzhen Development Bank from Shenzhen’s municipal government, with this marking the first case of a successful foreign private equity investment.38 In summary, foreign funds, mainly dominated by US dollar funds, have been consistently leading the development of China’s private equity and venture capital industry before 2009. However, in 2009, the share of renminbi (RMB) funds, that is, the funds raised in RMB currency, exceeded that of foreign currency funds for the first time, both in scale and in quantity (Beijing D&T Law Firm, 2012, 5). In addition to providing capital for small and medium-​sized enterprises (SMEs), foreign funds have helped Chinese enterprises to internationalize. Foreign funds also contribute a wealth of experience in fund management. They have managers who are both talented and experienced, and this is beneficial to their portfolio companies, helping them break into the international market, enhancing company value, and strengthening their brand.

Exit via IPOs As shown in Table 4.4.2 later, IPOs have been the most popular exit method for venture capital in China. Share buybacks, for instance, are usually only opted for either when exits cannot be done via IPO or merger and acquisition (M&A) or when the portfolio company no longer wishes to be controlled by the venture capitalist.39 This is unsurprising given that share transfers and share buybacks usually mean relatively lower rates of return on the investments. Moreover, there are relatively more legal restrictions on share buybacks under Chinese law.40 Further, write-​offs are naturally reserved as a method of last resort for venture capital funds. In particular, IPO exits in China tend to give high returns.41 China’s multi-​layer capital market includes the main board of SSE and the main board of SZSE, the SME Board of the SZSE, the ChiNext Board of the SZSE, the NEEQ,42 the recently 37 

Lin Lin, supra note 2, at 106. “After Three Years Of Wrestling, New Bridge 1.2 Billion Yuan Acquisition of Shenzhen Development Bank Insider” (6 July 2004) Business Sohu, https://​business.sohu.com/​2004/​07/​08/​18/​article220911816. shtml. 39  Telephone interview with Ms. S, Vice President, Gaorong Capital, Beijing (October 29, 2015) and Ms. K, Partner, Global Law Firm, Beijing (October 29, 2015). 40  Article 142 of the Companies Law of the People’s Republic of China provides the situations under which a company can buy back their own shares. Also, in practice, it is difficult for unlisted companies to obtain bank loans for share buybacks. 41  Lin Lin, supra note 2, at 220. 42  The NEEQ is not identical to a normal stock exchange like the SSE and the SZSE. See Lin Lin, “Venture Capital Exits and the Structure of Stock Markets:  Lessons from China” (2017) 12(1), Asian Journal of Comparative Law, 1, at Part VI(A) for detailed discussion. 38 

Venture Capital, Angel Capital, and Other Finance    361 Table 4.4.2 China Venture Capital Exits via IPO and M&A and Amount of New

Capital Committed to VC funds (2006–​2017) Methods of Exit Year

IPO

M&A

Share Transfer1

Total Number of Exits2

2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006

470 277 257 172 33 144 312 331 82 43 100 30

148 155 280 111 76 31 55 24 6 6 13 25

360 223 197 70 58 44 41 20 24 27 -​ 12

1420 2001 1813 444 230 246 456 388 123 135 142 100

Amount of New Capital Committed to VC Funds (in USD million)3 115,362.35 53,795.365 29,982.33 19,021.78 6,919.07 9,311.55 28,201.99 11,169.00 5,855.86 7,310.07 5,484.98 3,973.12

In this table, the IPO figure only refers to exits by VC-​backed companies going public on the Chinese stock market. It does not include IPO exits via overseas markets. 1 This total figure includes management buyouts and share buybacks but excludes the NEEQ listings. 2 Data from Annual Research Reports on Venture Capital In China, published by Zero2IPO. 3 “Share transfer” excludes management buyouts and share buybacks. Source: Zero2IPO (for the data from 2008 to 2017) and ChinaVenture (for the data from 2006 to 2007).

introduced STAR market and other regional equity markets.43 Since 2000, the CSRC has taken substantive steps to improve the regulatory environment of the stock market so as to facilitate the exits of VC-​backed companies via IPO.44

The NEEQ The NEEQ system (the New Third Board), is a national over-​the-​counter (OTC) market.45 The NEEQ is targeted at “innovation-​oriented, entrepreneurial, and growing medium, small and microsized businesses,”46 instead of more mature companies like the main boards' companies (Lin, 2017a, Appendix 1). Further, per Lin (2017a), the NEEQ has a much higher investor

43 

Lin Lin, supra note 2, at 224. Lin Lin, supra note 2, at 224. 45  The NEEQ is administered by a special-​purpose company that was registered in 2012 and has been operating since January 16, 2013. 46  State Council, The Decision of the State Council on Issues Relating to the National Equities Exchange and Quotations [guowuyuan guanyu quanguo zhongxiao qiye gufen zhuanrang xitong youguan wenti de jueding], Guofa (2013) No. 49. 44 

362   Lin requirement: companies quoted on the NEEQ are able to offer securities only to specific qualified investors, not the public.47 The NEEQ’s origins can be traced back to 2001 when the “Proxy Equities Exchange and Quotation” system (PEEQ) (guquan daiban zhuanrang xitong) was set up to provide a platform for companies delisted from the Main Board as well as for companies formerly using the Securities Trading Automated Quotation (STAQ)48 and National Exchange and Trading System (NET)49 to transfer their equities. The PEEQ was called the “Third” Board because it was the third stock exchange when it was developed in 2001, after the Main Boards (the SSE and the SZSE) and the SME Board (NEEQ, 2013). It was named the “New Third Board” in 2006 as part of a trial OTC program involving only a few high-​tech enterprises in Beijing’s Zhongguancun Science Park. In 2012, the pilot program was expanded to include the high-​ tech zones in Zhangjiang in Shanghai, Wuhan’s Donghu, and Tianjin’s Binhai. In 2013, the pilot program was again expanded to cover all qualified companies nationwide and the NEEQ was officially launched.50 A year later, the market maker mechanism was introduced by the Regulations of the National Equities Exchange and Quotations on the Administration of Market Makers’ Market-​Making Business on June 5, 2014 (Lin, 2017a, 24–​25). On June 27, 2016, the NEEQ implemented a stratification reform and divided the NEEQ-​ listed companies into two tiers—​the Base Layer (Jichuceng) and the Innovation Layer (Chuangxinceng). The reform sought to improve the market efficiency and liquidity of the NEEQ. In 2016, a total of 953 companies were selected for the Innovation Layer (Wu, 2018). On December 22, 2017, the NEEQ carried out another round of reforms to the stratification and trading systems. With the number of listed companies rapidly increasing in 2017, the number of companies listed on the Innovation Layer saw a corresponding rise to 1329 (Wu, 2018). The NEEQ revised its stratification system for the third time, such that starting from May 2, 2018, there were modified eligibility requirements for the Base Layer and Innovation Layer. According to the new method of stratification, for companies to qualify for the Innovation Layer, they must have completed a stock offering in the last 12 months, the accumulated amount of financing must not be lower than 10 million yuan (US$1.52), and there must not be fewer than 50 qualified investors, among other requirements (Securities Daily, 2018). In comparison to the previous two reforms, the latest stratification considerably heightened the difficulty for companies in the Base Layer to break into the Innovation Layer, with chances of selection being very low. In light of these new standards, it is predicted that some companies in the Base Layer will put in more effort to attract more qualified investors

47 

Lin Lin, supra note 2, at 224. The Securities Trading Automated Quotations System (STAQ) is a comprehensive over-​the-​counter market for securities trading based on computer networks. It officially began operation on December 5, 1990. On September 9, 1999, this system stopped operating. 49  The National Exchange and Trading System (NET) uses the computer network system to provide centralized trading of securities, quotations, and clearing, delivery, registration, custody, and consulting services for the securities market. This system was commissioned on April 28, 1993. It stopped running on September 9, 1999. 50  State Council, The Decision of the State Council on Issues Relating to the National Equities Exchange and Quotations [guowuyuan guanyu quanguo zhongxiao qiye gufen zhuanrang xitong youguan wenti de jueding], Guofa (2013) No. 49. 48 

Venture Capital, Angel Capital, and Other Finance    363 so as to increase the financing amount. Objectively, this is likely to boost the liquidity and enhance the financing function of the NEEQ market (Securities Daily, 2018). The launch and development of the NEEQ has greatly facilitated financing for VC-​backed companies. With a series of positive laws and policies being promulgated to facilitate the development of the NEEQ, this board has emerged as an attractive and important financing channel for small and medium-​sized companies. As of May 14, 2018, 10,082 companies had listed on the NEEQ Base Layer, with trade volume reaching a new high at 41,451,300 shares; 1,263 companies had listed on the NEEQ Innovation Layer (NEEQ, 2018). There are several distinctive features of the NEEQ. First, the NEEQ uses a filing system, in which board listings are not subject to CSRC approvals. It is for the NEEQ itself to approve the listings based on the application materials prepared and submitted by sponsors of the applicant companies. Second, the relatively low listing requirements and shorter listing time on the NEEQ have greatly expedited financing for small, high-​growth internet enterprises, especially companies that were hitherto unable to meet the listing standards of the Main Boards, the SME Board, or ChiNext. Third, among all the stock markets in China, the NEEQ has the least stringent listing requirements. Listing on the NEEQ requires a company to have a valid existence for only two years, whereas the other three boards (the Main Boards, the SME Board, and ChiNext) require three years (Lin, 2017a, Appendix 1). Meanwhile, unlike the other three boards that have minimum pre-​IPO profit requirements, the NEEQ only requires a company to have “sustainable profitability” and does not prescribe detailed requirements. Further, while the other boards have a minimum requirement of 200 shareholders, companies listed on the NEEQ may have fewer than 200. There is also no listing requirement pertaining to cash flow, net assets, or total share capital.51 Finally, unlike listings on the Main Boards, which usually take one year (SSE, 2012), listings on the NEEQ only require an average of six months (Wang, 2015). Fourth, companies listed on the NEEQ can seek financing through various means, including private placement of ordinary shares, private issuance of preference shares,52 issuance of convertible debt, and privately raised company bonds. These investment tools meet the particular needs of the various high-​growth enterprises that constantly need urgent funding as there is uncertainty as to the legal validity of preference shares under the Company Law of the People’s Republic of China (Lin, 2019). Fifth, the NEEQ runs on a market maker mechanism introduced in 2014. Companies listed on the NEEQ appoint securities firms to act as market makers to “quote” buy or sell share prices,53 and so transactions are not concluded directly between buyers and sellers.54

51  See

CSRC, Interim Measures for the Administration of National Equities Exchange and Quotations Co. Ltd [quanguo zhongxiao qiye gufen zhuanrang xitong youxianzerengongsi guanli zhanxing banfa] (2013). 52  Preference shares are only permitted in a few eligible companies in China. See CSRC, Administrative Measures on the Pilot Scheme for Preference Shares [youxiangu shidian guanli banfa], Zhengjianhuiling (2014) No. 97, which indicated the formal launch of the Chinese preference shares scheme for specific companies. 53  That is why companies listed on the NEEQ are also termed “quoted companies” (guapai gongsi). 54  Market makers are employed by many leading stock markets such as the NASDAQ and the London Stock Exchange.

364   Lin The market maker has to meet certain trading requirements and bear various obligations to “make the market.” These include responding to quote requests within a set time limit and providing continuous stock quotes within certain trading hours. However, due to the NEEQ being depressed with a long-​standing liquidity bottleneck, its ability to function as a market marker mechanism has been severely stifled (Zhou, 2018). Arguably, the high investor threshold of the NEEQ has partially contributed to the low liquidity of the market. According to the past rules, for institutional investors, only legal person-​type investors with at least RMB 5 million in registered capital or partnership-​type investors with at least RMB 5 million in paid-​up capital could trade on the market (Lin, 2017a, 17). As for individual investors, the admission standard required them to have at least RMB 5 million worth of securities in assets. On June 27, 2017, the NEEQ issued the revised Rules on the Suitability Management of Investors on the NEEQ, improving the threshold for investors to open trading accounts. In terms of asset size, the revised rules mainly state that legal person-​type investors are to have paid-​in capital or paid-​up share capital of at least 5 million yuan (US$0.76), while partnership-​type investors must have made a capital contribution of at least 5 million yuan. For individual investors, the daily average of the financial assets under their name over the most recent 10 transfer dates must be at least 5  million yuan. Investors who do not fulfill the threshold requirements for opening an account may indirectly invest in the New Third Board via wealth management products developed by professional institutions such as securities companies, fund management companies, trust companies, private equity investment funds, and venture capital funds. It is hoped that the revised investor threshold will solve the liquidity issue to some extent.

The IPO Reforms China’s IPO regime has long been subject to tight administrative controls, which are commonly blamed for distorting the capital market and encouraging official corruption.55 Under the merits-​based regulatory system, many aspects of securities offerings are heavily regulated, such as the pace of listing, the price of shares, and the permitted industries, thereby significantly hampering the efficiency of the capital market as well as the operation of market forces. As mentioned earlier, due to difficulties with listing on China’s stock market, many Chinese companies, especially high-​growth and internet companies, have chosen to turn to overseas capital markets for listing. China’s IPO system has been undergoing a series of reforms since the 1990s.56 The first system implemented in China was a strictly planned “Quota Management” system,57 under which the issuer had to first obtain share issue quotas from local governments or central 55  Benjamin L. Liebman and Curtis Milhaupt, “Reputational Sanctions in China’s Securities Markets” (2008) 108, Columbia Law Review, 929 at 931 and 939. 56  For more information on the evolution of IPO in China, see Robin Hui Huang, “The Regulation of Securities Offerings in China: Reconsidering the Merit Review Element in Light of the Global Financial Crisis” (2011) 41, Hong Kong Law Journal, 261. 57  On April 25, 1993, the State Council of the People’s Republic of China issued Provisional Regulations on the Administration of Share Issuance and Trading, signaling the official establishment of the administrative approval system.

Venture Capital, Angel Capital, and Other Finance    365 ministries.58 The IPO system was transitioned into the “IPO Number Management” system in 1996, under which the CSRC would set a quota for the number of IPOs for relevant local authorities to adhere to (Lin, 2017a, 30). From 2004 till now, the Sponsorship System has been used,59 under which certified sponsors may recommend companies for stock issuance and listing. In 2015, the Standing Committee of the National People’s Congress approved a proposal to revamp the IPO system (CSRC, 2013),60 under which the financial intermediaries, instead of the CSRC, will be primarily responsible for the substantive verification of such applications (Du, 2015). Since 2018, the pace of domestic IPO approval has continued to slow down. Statistics show that in 2018, the Issuance Appraisal Committee reviewed a total of 172 companies’ initial applications (excluding cancellation reviews), of which 111 companies passed, with the passing rate being 64.53%, a record low in five years (Xu, 2019). The IPO slowdown has affected venture capital/​private equity exits. Exits being hindered will, to some extent, create difficulties in raising new funds, especially for small institutions. To address the exit problem of venture-​backed investments in China and to increase China’s attractiveness to the fast-​growing number of technology startups, the president of the People’s Republic of China, Xi Jinping, announced that the Shanghai Stock Exchange would set up the New Science and Technology Innovation Board (the STAR market) on November 5, 2018 (Liu, 2018). On 13 June 2019, the STAR market was launched and the first batch of companies were listed on 22 July 2020.61 The STAR market allows companies with dual-​class share structure to get listed, which has greatly facilitated VC-​backed exits within China. Significantly, the STAR market introduced the registration-​based public offering system,62 which emphasises information disclosure and market-​based pricing. Thereafter, the CSRC announced in October 2020 that the country will gradually roll out the new IPO system in all parts of its capital market as conditions have gradually matured after a pilot program in the STAR market.63

Exits via M&A An acquisition exit includes a sale of shares, a merger, or a sale of the firm’s assets, in which the entire firm is sold to a third party, and is one of the principal venture capital exit vehicles 58 

People’s governments of the province, autonomous regions, municipality directly under the central government, or municipality listed separately under the state plan (collectively referred to as the “local governments”). 59  Lin Lin, supra note 2, at 232. 60  In the Opinions on Further Promoting the IPO System Reform [zhengjianhui guanyu jinyibu tuijin xingu faxing tizhigaige de yijian], Zhengjianhui gonggai (2013) Order No. 42. The CSRC announced that, under the registration-​based IPO system, it would focus on the compliance review of the new listing candidates without assessing the profitability of the IPO companies. The timing of new share issuances and the question of how to issue shares will be determined by the market, in the hope that the valuations of new share offerings will better reflect market demand and supply. 61  Lin Lin, supra note 2, at 234. 62  Lin Lin, supra note 2, at 234-​258. 63  Xinhua News, Economic Watch:  China Deepens Capital Market Reform with Expansion of Registration-​Based IPO (October 25, 2020).

366   Lin (Cumming and MacIntosh, 2003, 106). In China, exits by private equity and VC-​backed firms in China totaled 7,256 from 2006 to 2017 (inclusive) (as seen in Table 4.4.2). This included 2,121 exits via IPO (29.23%), 892 exits via M&A (12.29%), and 1,064 exits via share transfer (14.66%). The remaining 3,179 exits were executed via other means including share buybacks,64 write-​offs, and other methods.65 From 2006 to 2017, VC-​backed IPO exits totaled 2,251—​almost two and a half times the number of VC-​backed M&A exits in the same period (930). Of the 2,813 M&A exits accomplished in 2017, 1,550 were backed by private equity or venture capital, accounting for 55.10% of the M&A exits that year (Han, 2018). As shown in Table 4.4.2, though being a popular exit channel for VC-​backed firms, M&As are less feasible than IPOs as an alternative exit option in China. First, M&A activities are uncertain as regulatory approval is required for them.66 Listed and non-​listed public companies need to seek approval from relevant regulators when the acquisition and/​or relevant equity changes pertain to issues such as national industrial policies, industry access, transfer of state-​owned shares, and foreign investments.67 Second, some local governments may use their administrative powers to obstruct M&A activities, especially those involving state-​owned enterprises.68 Meanwhile, any M&A activity by foreign-​invested enterprises requires approval from the Ministry of Commerce (MOFCOM) or a provincial department in charge of commerce.69 Further, there is stringent control over debt financing in China.70 Banks in China have very conservative lending practices, making it difficult to conduct Leveraged Buyout (LBO).71 The 2015 Guidelines on the Risk Management for M&A Loans of Commercial Banks72 expanded the potential sources of funding by allowing policy banks and branches of foreign banks to provide acquisition financing.73 However, although the 2015 Guidelines allow People’s Republic of China-​incorporated banks to provide acquisition financing to an onshore enterprise to acquire a target,74 this is subject to various limitations 64  A  share buyback by an entrepreneurial firm is permissible under the Interim Measures for the Administration of Venture Capital Enterprises [Chuangye Touzi Qiye Guanli Zhanxing Banfa], National Development and Reform Commission (2006) Order No. 39, and the Provisions Concerning the Administration of Foreign-​Funded Business-​Starting Investment Enterprises [Waishang Touzi Chuangye Touzi Qiye Guanli Guiding], Ministry of Foreign Trade and Economic Cooperation, the Ministry of Science and Technology, the State Administration for Industry and Commerce, the State Administration of Taxation, and the State Administration of Foreign Exchange (effective March 1, 2003, revised on October 28, 2015). 65  See the respective Zero2IPO Annual Reports for the detailed breakdown for each year. 66  Lin Lin, supra note 2, at 281. 67  Lin Lin, supra note 2, at 281. 68  Lin Lin, supra note 2, at 281. 69  Lin Lin, supra note 2, at 281. 70  Lin Lin, supra note 2, at 282. 71  Lin Lin, supra note 2, at 282. 72  Notice of the China Banking Regulatory Commission on Issuing the Guidelines on the Risk Management for M&A Loans of Commercial Banks [Zhongguo Yinjuanhui Guanyu Yinfa Shangye Yinhang Binggou Daiguan Fengxiangguanli Zhiyin De Tongzhi], China Banking Regulatory Commission (effective February 10, 2015), No. 5. 73  See King & Wood Mallesons, “CBRC Amends Guidelines for Risk Management of M&A Loans Granted by Commercial Banks” (King & Wood Mallesons, March 24, 2015), online: www.kwm.com/​en/​knowledge/​ insights/​cbrc-​amends-​mergers-​and-​acquisitions-​loans-​guidelines-​20150324, accessed July 5,  2016. 74 CBRC, Guidelines on Risk Management of Merger and Acquisition Loans Granted by Commercial Banks (2015), online:  http://​www.cbrc.gov.cn/​chinese/​home/​docDOC_​ReadView/​7DABC8D29C0148B 6B35F0B4A7DA804EC.html.

Venture Capital, Angel Capital, and Other Finance    367 (Ye, 2016, 21).75 In addition, LBOs by foreign funds are also subject to scrutiny by the MOFCOM.76 Despite China’s progress toward cultivating a favorable regulatory environment for VC-​backed exits via IPOs and M&As, there remain various institutional impediments within the stock market that may hinder the development of the venture capital industry. A wide range of complex institutions, including sophisticated financial intermediaries, venture capitalists and investors, strong investor protection, and effective dispute resolution mechanisms, are needed to further develop the venture capital market in China.

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Chapter 4.5

Intellectua l Prope rt y Rights Prot e c t i on Can Huang and Naubahar Sharif Introduction To fully appreciate China’s role in an increasingly knowledge-​based global economy, we must understand its approach to intellectual property (IP). The World Intellectual Property Organization (WIPO) defines IP as “creations of the mind.” Such creative products include inventions, literary and artistic works, and symbols, names, images, and designs used in commerce (WIPO, 2004). Unlike other forms of property that can be assigned, combined, and licensed, a piece of IP is both an abstract entity claimed by its creator(s) and, in a legal sense, a piece of intangible property that can be owned. The WIPO recognizes two broad categories of IP: (1) industrial property (which includes inventions, patents, trademarks, industrial designs, and geographic indications of a source) and (2) copyright (which includes literary, artistic, and musical works). Intellectual property rights (IPR) protect original ideas and inventions against unauthorized use. IPRs play an important role in permitting the transfer of knowledge and technology, such as knowledge transfers from universities and public research organizations to industrial and commercial enterprises. IPR protection helps foster innovation; businesses and individuals would be unable to reap the full benefits of their inventions and would have fewer incentives to promote innovation without such protections, nor would artists be fully compensated for their creations. IPR protection is important because businesses use IP to distinguish themselves from competitors. As such, IP can be sold or licensed, providing an important revenue stream and playing an important role in marketing and branding by offering customers new or improved products or services. Rules and laws protecting IP have evolved over time. Peng et al. (2017), focusing on IPR in the United States, demonstrate that a country’s IPR system as an institution evolves as its economy and society develop. Indeed, IPR protection typically parallels an economy’s development from agriculture to manufacturing to a postindustrial mix built on the generation and utilization (or exploitation) of information and advanced technology. In the

Intellectual Property Rights Protection    371 early stages of economic development, with limited resources and limited capacity for research and development (R&D), there may be few incentives to establish stringent IPR protection. During this stage, the domestic industry typically grows by imitation rather than innovation, and a weak IPR regime may actually support technological diffusion, with broad economic benefits.1 During later stages of development, though, a weak IPR regime discourages domestic innovation. Economies that shift successfully into knowledge-​based production leverage indigenous innovation supported by appropriate and adequately enforced IPR laws.

Background to China’s IPR System In industrialized countries such as the United Kingdom, the United States, and Italy, IPR protection regimes have developed over several centuries. As such, researchers have been studying IPRs since at least the 19th century. China, on the other hand, has a far younger IPR system and only about four decades of experience using and protecting IPR. Prior to enacting modern IPR laws in the 1980s, China contended for 30  years with IP institutions, mostly borrowed from the USSR, with mixed results. The October 1949 founding of the People’s Republic of China (PRC) was followed in August 1950 by the promulgation of the central government’s Provisional Regulations on the Protection of Inventions Rights and Patent Rights. Although few trademarks were registered, the procedures for registering trademarks had been established as far back as 1950. New trademark regulations were issued in 1963 to improve product quality.2 The Cultural Revolution (1965–​1976) then undermined this system as the professional activities of scientists, artists, and writers were curtailed and regulations governing compensation for authors and inventors were either ignored or rescinded. Restoration of an IPR system began in the late 1970s when China began the process of reforming and opening its economy to market mechanisms (La Croix and Konan, 2002). In the 1980s and early 1990s, China enacted and promulgated its Trademark Law, Patent Law, and Copyright Law, laying the foundations for a modern IPR system. With the initiation of economic reforms, it became increasingly necessary to establish an IPR system that more closely reflected contemporary international standards. Such an IPR system also proved vital in helping China achieve two further goals: attracting greater foreign direct investment (FDI) and fulfilling China’s obligations under bilateral agreements on science and technology with foreign governments (Huang, 2017).3 In 1980, China established its own patent office, which eventually became the State Intellectual Property Office (SIPO). China’s Patent Law was enacted by the Standing Committee of the National People’s Congress in 1984 and it governs the protection of 1 Imitation

allows for low-​cost production, lower prices, and stimulation of consumption and employment. 2  Publishing regulations provided authors with rewards based on the nature of the work, quantity and quality of Chinese characters, and number of copies printed. 3  An example of such a bilateral agreement is the China–​US Agreement on Cooperation in Science and Technology, signed in 1979 by then–​Chinese premier Deng Xiaoping and then–​US president Jimmy Carter (SIPO, 2016, 78).

372   Huang and Sharif technological inventions in China. The Patent Law went into effect in 1985 and has been amended four times, in 1993, 2001, 2009, and 2021, to strengthen patent protections and improve patent quality. The Patent Law was first revised in 1993 to keep two promises. The first promise was what China made in the negotiation to enter into the General Agreement on Tariffs and Trade (GATT). The second promise was made by China in the negotiations with the United States that culminated in the signing of the “Memorandum of the Chinese and U.S. Governments on Protecting Intellectual Property” in 1992 (SIPO, 2008a). The second revision of the Patent Law was undertaken to align China’s patent regime with global standards when it was admitted to the World Trade Organization in 2001, which had superseded the GATT in 1995. China signed the Agreement on Trade-​Related Aspects of Intellectual Property Rights that year, fulfilling an obligation that permitted its entry into the WTO. In contrast to the revisions undertaken in 1993 and 2001, the third round of revisions in 2009 was prompted by calls for better patent protection from domestic and foreign companies operating in China as well as Chinese universities and research institutes. Indeed, these calls were so strong that the 2009 revision of the Patent Law was listed as a prioritized action item in the country’s National IP Strategy for promoting indigenous innovation and establishing an innovative economy (SIPO, 2008b). Similarly, the fourth amendment of patent law in 2021 was self-​initiated efforts to further strengthen patent protection in order to incentivize innovation, promote patent licensing and technology transfer, and improve patent application review process and quality of patents (Huang, 2017). In particular, the amendment aimed to solve the problem of “difficulty in collecting infringement evidence, long legal and administrative procedure, low awarded damage, high cost and low effectiveness of enforcement” associated with the then patent law. In addition to revising its Patent Law, China adopted a multitude of other IP-​related regulations in the 1990s to strengthen its IP regime. These included Regulations on the Protection of Computer Software, the Anti-​Unfair Competition Law, Regulations on the Administration of Audio-​Visual Products, Regulations on Customs Protection of Intellectual Property Rights, the Law on Promoting the Transformation of Scientific and Technological Achievements, and Regulations on the Protection of New Varieties of Plants. In the early 2000s, China enacted Regulations on the Protection of Integrated Circuit Layout Design and Measures for the Administrative Protection of Internet Copyright. Establishing laws and regulations represented one important dimension of China’s maturing IP system. Another dimension was captured in China’s efforts to join international treaties regulating IP. In 1980, China joined the WIPO. As Bosworth and Yang (2000) have noted, enlisting in the WIPO helped pave the way for developing an IPR regime that complies with international norms and standards. China then joined the Paris Convention for the Protection of Industrial Property in 1985, the Madrid Agreement Concerning the International Registration of Marks in 1989, the Berne Convention for the Protection of Literary and Artistic Works in 1992, the Convention for the Protection of Procedures and Phonograms against Unauthorized Duplication of Their Phonograms in 1993, the Patent Cooperation Treaty (PCT) in 1994, and the WIPO Copyright Treaty in 2007. By joining these treaties, China signaled its explicit recognition of the principles they established as

Intellectual Property Rights Protection    373 well as its acknowledgment of certain rights and obligations reflecting widely held international standards and frameworks related to IP.

The Explosion of Patenting Activity in China China witnessed a prodigious surge in patenting activity during the first two decades of the 21st century (Huang, 2017). Patent statistics reveal that the number of invention patent applications received by the SIPO increased from 63,000 in 2001 to 1.40 million in 2019. Domestic and foreign applications for invention patents grew at an annual average rate of 17% between 1985 and 2019. In 2011, China surpassed the United States as the country receiving the most invention patent applications in the world. This surge was also mirrored in China’s overseas patent filings—​as facilitated by the PCT, which is administered by the WIPO. PCT filings are one of two options for filing overseas patents (the Paris Convention being the other). Based on patent filings under the PCT, China is moving up in the global rankings: in 2020, it ranked first in PCT patent filings for the first time—​surpassing the United States which topped the PCT ranking since the system took effect in 1978—​reflecting the growth in patent applications filed by Chinese entities abroad. Liang and Xue (2010) have linked the steep increase in patent applications in the first two decades of the 21st century with two particular pro-​patent reforms of China’s patent system. First, patent protection was extended to cover additional years and patent coverage was broadened. In the first revision of the Patent Law in 1993, invention patent protection was extended from 15 years to 20 years. At the same time, food, beverages, flavorings, pharmaceutical products, and substances obtained through chemical processing were also covered by patent protection. Second, the regulation governing the circumstances under which individuals were permitted to apply for patents was relaxed. In the first revision of the Patent Law in 1993, individuals were permitted to own patents for inventions created during work hours provided that there was a formal agreement between the individuals and their employers. After the second revision of the law in 2001, state-​owned and privately owned enterprises were treated equally regarding patent rights. A rise in R&D conducted in China in the late 1990s—​spawning many new patentable technologies—​contributed to the rapid rise in patenting (Hu and Jefferson, 2009; Hu, 2010). Another factor was stronger flows of FDI into China. FDI provided domestic firms with opportunities to imitate the activities of foreign firms and also incentivized domestic firms to apply for patents to compete more successfully with their foreign counterparts. The privatization of state-​owned enterprises was another reason. As economic reforms in China accelerated, some state-​owned enterprises were privatized. These newly privatized firms protected their IPR more ardently than they did when they were state owned. The introduction of a subsidy to finance patent applications also contributed to the increase in patenting in China (Li, 2012). Provincial-​level patent subsidy programs incentivized individuals to join entities more typically associated with patent applications—​firms, universities, and research institutes—​to apply for patents. Provincial-​level patent subsidy programs help filers pay for patent filing and renewal fees, with no reference to the types of technologies patented. The central government also began administering its own patent

374   Huang and Sharif subsidy program in 2009. The Ministry of Finance, on behalf of the central government, established the program to subsidize overseas patent applications.4 Liu et  al. (2016) have argued that the subsidy programs for patent applications have encouraged entities to file for “junk” patents for which it is likely that no one would have applied had the subsidies not existed. Dang and Motohashi (2015) provide empirical evidence indicating that the subsidy programs led to a 30% increase in patent applications, inducing firms to narrow their patent claims to obtain a higher number of patents (while diminishing patent quality). It is noteworthy that the governments’ patent subsidy program became more robust with the announcement of the 12th Five-​Year Plan in 2011. In this iteration of the plan, the government listed “number of invention patents per 10,000 inhabitants” as one of its 24 performance indicators. In response, municipal and provincial governments encouraged patent applications to meet the central government’s quantitative targets. This indicator was also included in the 13th Five-​Year Plan covering 2016–​2020, encouraging municipal and provincial governments to continue subsidizing and rewarding patent applications. However, due to the criticisms leveled against such patent subsidy program, the Chinese government began to curb patent subsidy in 2021 which marks the beginning of the 14th Five-​Year Plan, starting from those directly subsidizing patent applications and vowed to phase out all patent subsidy by the end of the 14th Five-​Year Plan, i.e., 2025 (CNIPA, 2021). Subsidy programs are but one tool employed by the government to promote patent applications. Patent remuneration disbursed directly to inventors for patent application projects is another such tool. Yet another tool is the extension of preferential tax treatment: companies that can be certified as high-​technology operations qualify for a reduction in the tax rate from 25% to 15%. A core criterion of such certification is IP ownership, further incentivizing patent applications. Combined, these incentives have contributed to the emergence of a system that rewards patent quantity over patent quality. As already noted, this system tends to create patent rights that could not have been acquired without the subsidies, and in that way commits public funds to sponsoring the acquisition of private rights of questionable quality. To its credit, the Chinese government acknowledged the problem and devoted efforts to improving the quality of patents (State Council 2015), but it remains a work in progress.

Legislative Progress Regarding IP Management in and Technology Transfer from Chinese Universities and Public Research Organizations Universities and public research organizations are integral to China’s national innovation system and, as such, are important centers of innovation tasked with cultivating human capital and providing fertile ground for the incubation of new technology firms in the emerging knowledge economy (Etzkowitz, 2001; Xue, 2006). In 2016, the total R&D expenditure of

4  Companies, universities, and research institutes interested in applying for this subsidy are required to do so through the provincial IP offices (Ministry of Finance, 2012).

Intellectual Property Rights Protection    375 Chinese universities amounted to RMB 107.2 billion. These universities generated 173,000 invention patents, while public research organizations applied for 55,000 such patents—​but these patents do not necessarily translate into economic growth. If the patenting activities of Chinese universities and research institutes are to fuel economic growth and development, they must produce technologies and inventions that can be commercialized. Those technologies and inventions must also spawn spin-​off companies to optimize the performance of China’s national innovation system. In spite of significant investments in R&D, however, technology transfer rates (i.e., the share of technologies that are commercialized) in Chinese universities remained significantly low, at 5% (Ministry of Education [MOE], 2015). Universities and researchers face strong government pressure to commercialize and transfer technology at a much higher rate of 80% to meet government standards (Zhao, 2015), evidently an unreasonable expectation. To address these challenges, in October 2015 China modified its Law on Promoting the Transformation of Scientific and Technological Achievements, which is considered an important step toward removing certain barriers to technology transfer (Cheng and Huang, 2016). This law originally came into force in 1996. The amendment of the law addressed legal risks associated with the transfer or sale of university-​owned IP, as universities and public research organizations did not possess full authority over technology transfer. The Law on Science and Technology Progress, which was promulgated in 1993 and amended in 2007, stipulates that patents, copyright in software, integrated circuit design proprietary rights, and new plant varieties created in a university or public research organization using government science and technology funds should be held by the institution, except when the IP rights involve national security, the national interest, or other major social and public interests. In other words, the law made universities and public research organizations the sole owners of the IP they create (National People's Congress [NPC], 2007). However, the law now permitted universities and public research organizations to transfer or sell IP (also known as state assets) only after a lengthy and complicated process of approval overseen by the State-​Owned Assets Supervision and Administration Commission (SASAC), a ministry-​level government agency. According to Article 75 of the State Assets Law, the parties responsible “shall be subject to criminal liability if the violation constitutes a crime,” making technology transfer or sale without the approval of the SASAC a potential violation of the law (State Council, 2008). The lengthy and complicated approval process has made the timely pursuit of technology transfer or sale extremely difficult (NBD, 2014). In addition, prior to the 2015 amendment of the Law on Promoting the Transformation of Scientific and Technological Achievements, Chinese universities and public research organizations lacked incentives to engage in technology transfer activities (Cheng and Huang, 2016) insofar as they were not permitted to retain revenues obtained from transferring technology. Such income had to be transferred to government agencies. Technology transfer was not incorporated into the university performance evaluation system, in which the main criteria consisted of publications, patents, science and technology awards, and corporate consulting services (MOE, 2015). Moreover, university researchers often prioritize obtaining patents over seeking the commercialization of the patented technologies because, on the one hand, patents are more directly linked to career development opportunities, access to funding, and awards and recognition while, and on the other hand, researchers are constrained by limited time, resources, and experience. The pressure to patent often leaves university researchers facing

376   Huang and Sharif dilemmas over the best methods to promulgate IP since not all technology can be patented, and other methods may not be unrecognized under the law (Li, 2015). All of the aforementioned factors impeded effective technology transfer and necessitated appropriate changes. On October 1, 2015, an amendment to the Law on Promoting the Transformation of Scientific and Technological Achievements took effect. It instituted four major changes: (1) scientific and technological achievements (including new technologies and patents) were to be disclosed to the public; (2) universities and public research organizations were incentivized to transfer technology, not least by allowing them to retain the revenue from technology transfer without prior government approval (a minimum of 50% of the revenue from technology transfer had to be shared with the inventors of technologies, and the law permitted price negotiations as well as auctioned sales); (3) companies were encouraged to play a more active role in technology transfer; and (4) governmental organizations were required to improve their services that support technology transfer activities. Following this 2015 amendment of the law, almost every provincial government enacted regulations, often called Regulations for Promoting the Transformation of Scientific and Technological Achievements, to implement the provisions of the national law (Chen et al., 2021). For example, several provinces boosted incentives by increasing the proportion of technology transfer revenue that can be used to reward R&D and technology transfer personnel. Other provinces established funds to promote technology transfer activities in their regions.

Challenges Remain Regarding IP Management and Patent Licensing on the Part of Chinese Universities and Public Research Organizations It would be too optimistic to expect the aforementioned amendment to address all of the challenges related to technology transfer in China. For example, the technology transfer offices (TTOs) of universities and public research organizations represent a weak point in the Chinese system. Following the typical pattern in a Western university, a researcher or organization discloses an invention to its institution’s TTO, which then evaluates the invention’s patentability and commercial value and decides whether to file a patent application. If the outcome of the evaluation is favorable, the TTO will also decide where to file an application—​that is, choose between filing domestically or internationally in compliance with the PCT and later prosecute the application. If a patent is granted, the TTO will seek interested parties for commercialization and negotiate a deal, maintaining the patent throughout the process (Rotenberg, 2016). In contrast to this Western model, in many Chinese universities, decisions about whether and where to file patents are left to academics who invent new technologies rather than TTOs. In such cases the TTOs mostly facilitate filings based on researchers’ requests, often connecting the researchers with patent agencies that would do the actual drafting and filing of patents. Therefore, strategic planning on the part of academics or TTOs rarely informs patent applications in China. In addition, the TTOs in Chinese universities seldom actively screen or scout research projects, identify those which may become high-​value IP assets, or carefully design and execute commercialization strategies. Lacking the relevant capabilities

Intellectual Property Rights Protection    377 and professional experience, TTOs in many Chinese universities generally relegate IP strategy and management decisions to researchers. This pattern might also attributed in part to China’s having amended the Law on Promoting the Transformation of Scientific and Technological Achievements only in 2015, thus granting autonomy to universities to manage and profit from technology transfer activities only recently. The new law grants TTOs in Chinese universities added incentives and responsibilities, which should encourage them to develop their capabilities to a higher level. Patent licensing is a key aspect of technology transfer that has the potential to stimulate innovation in indigenous companies. Wang et al. (2015b) find that licensing universities’ technologies can contribute substantially to the innovation performance of licensee firms. Based on a survey of the top 100 university patent applicants, Liu et al. (2007) find that the income generated from such activities in turn becomes an important source of science and technology research funding for these universities. A survey of the literature on patent licensing reveals, however, four main barriers to the licensing of university and public research organization patents in China (Chen et al., 2021). First, there are insufficient licensing opportunities for some advanced technologies; the majority of licensing contracts occur in traditional industries. Fewer licensing contracts involve emerging industry technologies such as new energy sources and biotechnology (Wang et al., 2015a). The second barrier to patent licensing in China is a lack of experienced indigenous licensees. Most state-​ owned enterprises are required to undergo complicated vetting processes before signing licensing agreements. Even after signing such agreements and licensing the associated patents, licensees find it difficult to realize a patent’s market value. Consider, for example, the licensing agreement between Fudan University and Huya Bioscience International for indoleamine 2,3-​dioxygenase (IDO) inhibitors. Domestic drug firms are not incentivized to innovate due to high risk, long development cycles, and the complex approval process associated with many drugs, so Fudan University ultimately decided to license its patent to a US bioscience company and earned at least US$65 million from the agreement (Zhang, 2016). Tan et  al. (2013) analyzed 1,359 licensing contracts involving 1,352 university patents signed by Chinese universities in 2011. They point out that more than half of Chinese university patent licenses are granted to foreign investors. They also report that the majority of licensees are enterprises located in the eastern regions of the country including Shanghai, Jiangsu, and Guangdong provinces. This implies that regional innovation capacities or firm capabilities influence the likelihood that firms seek collaboration with universities or public research organizations. A third barrier to patent licensing in China is weak long-​term financial support. Again, as illustrated by Tan et al. (2013), most government patent subsidy programs provide funding for five years or less, an insufficiently long period in which to develop and commercialize an invention. Most universities therefore lack the requisite financing to maintain patents for longer than five years. As a result, many patents owned by universities, although perhaps valuable, expire within five years of being granted. The final barrier to patent licensing in China is the absence of intermediary agencies, which can facilitate the process and reduce transaction costs. Zhang (2016) found that many university professors choose not to license their technologies because they lack either the time or the experience they would need to conduct the associated business negotiations and marketing activities.

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Emergence of Stronger Intellectual Property Protection Contrary to common media portrayals suggesting that China has a weak patent protection regime, some experts argue that China’s legal system actually favors patent owners in patent litigation (Robinson, 2017). Indeed, patent litigation win rates in China are high, just over 80%. Moreover, the time required to adjudicate patent cases, from filing to judgment and injunction, is shorter in China than in many other countries, ranging from 6 to 14 months. The legal cost is also low, as little as one-​tenth the cost of patent litigation in the United States. Forum shopping is also available because patent litigation cases are allowed anywhere that an accused product is sold. Pretrial freezing is available for bank accounts, inventory, and documents, providing patent owners in infringement cases with a useful negotiating tactic. Finally, China has established an effective system for blocking export goods at customs. Lui and Jin (2018), based on information drawn from the disposition of 2,200 invention patent trial cases across China in 2016, shows that foreign entities suing to enforce their patents did not suffer unfair treatment or bias in the courts. They also found, however, that if a foreign party is not familiar with the specific requirements of the Chinese legal system when initiating a litigation case, the result will be less favorable. For instance, evidence collection becomes a major hurdle facing patentees suing to enforce their patents, a condition that applies to both Chinese and foreign corporations. The Chinese government has acknowledged this as a weakness of the Patent Law. It is worth noting additional steps that have been taken to strengthen the enforcement of IPR protection in China. Most notably, specialized IP courts were established in 2014—​ in the key cities of Beijing, Shanghai, and Guangzhou—​with the objective of improving the effectiveness and efficiency of IPR adjudication. This objective is being achieved along three dimensions: higher decision quality, more timely handing down of judgments, and consistency in judgments. Because IP laws can be technically challenging, assigning experienced judges in specialized courts devoted to processing only IP-​related cases should help China achieve each of these goals. Assigning cases to specialized IP courts has also provided aspiring judges with opportunities to receive higher-​quality and more specialized training, thereby populating the courts with judges who are better trained to rule on IP-​related matters. In evaluating the relative effectiveness of these newly established IPR courts, a 2016 study by IP House found that the average size of damages awarded in cases processed by Beijing’s IP Court in 2015 was RMB 460,000, far higher than the average of RMB 80,000 awarded prior to its establishment, as revealed in a SIPO-​commissioned study published in 2011 (Intellectual Property Research Center, 2012). IP House’s study further found that the 18 judges on the IP court ruled, on average, on 239 cases in 2015. This was three times the number of cases that judges were previously able to adjudicate in the Beijing Intermediate Court in 2014 (Hu 2016). This early evidence indicates that the specialized IP courts have enhanced the efficiency of IP enforcement in China. A statistical summary of the operations of the Beijing IP Court from November 2014 to June 2017 shows that, in the 142 civil litigation cases on which the court handed down verdicts, plaintiffs prevailed in 116 cases, yielding an overall win rate of 82%. Foreign firms won 12 out of the 13 cases in which they were involved. Moreover, the foreign plaintiffs

Intellectual Property Rights Protection    379 who won in these cases were on average awarded higher damages than their Chinese counterparts. The average damage award in patent cases is about RMB 1 million (Schindler, 2018), but the court handed out even larger damage awards by Chinese standards in several high-​profile cases. For example, in December 2016, the Beijing IP Court ordered a defendant, Hengbao Co. Ltd., to pay a total of nearly RMB 50 million ($7.2 million) in damages to the plaintiff, Watchdata Co. Ltd., the highest amount since the court was established in November 2014 (Zhao, 2016). Both the plaintiff and defendant produce USB keys to be used as electronic authentication devices in financial services. Watchdata filed the lawsuit in February 2015, claiming that Hengbao had developed and sold USB key products to several banks in China using Watchdata’s patent for a “physic identification method and electronic device” without its authorization. The court’s investigation enabled it to calculate the sales volume of the infringing products, leading to actual damages of about RMB 48.1 million. On June 1st 2021, the fourth amendment to the Patent Law came into effect. Like the third amendment passed in 2009, the fourth amendment was a self-​initiated legislative effort designed to improve the patent system and further strengthen IPR protection. The amendment contains five major changes: first, it strengthens patent protection; second, it facilitates the use of patenting and technology transfer; third, it clarifies and enhances the role of government in IPR enforcement; fourth, it improves the patent application and review process; and fifth, it improves the services provided by patent intermediary service companies (Huang, 2017). As a measure to strengthen patent protection, the fourth amendment increased both ends of the range of statutory damages, from RMB 5,000 to 1,000,000 in the then patent law to RMB 30,000 to 5,000,000 in the fourth amendment. Additionally, the fourth amendment introduced stiff punitive damages, which could rise to five times the extent of losses incurred by a plaintiff. Furthermore, a mechanism similar to that found in the Trademark Law, “reversing burden of proof,” was now available in patent cases. With this mechanism, following the conclusion of an infringement case, a court can shift the burden of proof to the defendant—​ordering the defendant to provide evidence (such as account books) if the plaintiff has tried his or her best to collect evidence pertaining to damages. This clause was introduced in response to difficulties experienced by plaintiffs seeking infringement evidence. These amendments to China’s Patent Law support the prediction by Peng et al. (2017) that China would voluntarily enhance its IPR protection to support the objective of establishing an innovation-​driven economy (as occurred in the United States). Following the aforementioned progress, which has enhanced a legal system that favors patent holders and strengthened patent protection provided by specialized IP courts, China has become a top forum for patent litigation (Schindler, 2018). Some of the most high-​ profile global patent disputes involve campaigns in China. For example, in January 2017, Apple filed two lawsuits against Qualcomm in the Beijing IP Court. In one case, Apple alleged that Qualcomm failed to license “standard essential patents” properly; in the other, Apple sought RMB 1 billion in damages for Qualcomm’s alleged violations of China’s Anti-​ Monopoly Law. In October 2017, Qualcomm countersued Apple in the same IP court, seeking to ban the sale and manufacture of iPhones in the country. It is surely significant that China was chosen along with the United States and Germany as the locations for adjudicating this global IP battle. A final noteworthy development in China’s IPR regime is the entry of so-​called nonpracticing entities (NPEs), which began operating in China as its patent protection system

380   Huang and Sharif strengthened. WiLAN, a technology development and IP licensing company with headquarters in Ottawa, Canada, filed a patent infringement suit against Sony in Nanjing in November 2016, which is believed to be the first litigation case involving a Western NPE in China. Domestic NPEs have also emerged (Wild et al., 2017). A licensing company called Dunjun was founded in Shenzhen by former employees of Huawei and Foxconn in 2014. It has sued both foreign and local technology companies for patent infringement. Public records show that it has purchased a number of patents from Huawei and subsequently sought to enforce them against such major companies as Microsoft, Samsung, and Tencent (Schindler and Zhao, 2018).

Conclusion In 2012, during the 18th National Congress of the Communist Party of China, the Chinese government unveiled its “innovation driven” development strategy to promote economic and social development. Despite the forceful rhetoric of this pronouncement, China faces a number of serious challenges as it strives to implement this strategy. Among the most vexing of these challenges has been the widespread perception that IPR protection is inadequate and patent infringement rampant. Chinese universities and public research organizations have faced legal barriers to transferring the technologies they generate to industrial and commercial applications. The Chinese government has acknowledged these problems and has pledged to implement stricter IPR protection (State Council, 2015). The establishment of the specialized IP courts and amendments to the Patent Law reflect these efforts to enhance the robustness of IPR protection. As a result, China has emerged as a top forum for patent litigation and attracted NPEs to the country. The amendment of the Law on Promoting the Transformation of Scientific and Technological Achievements removed several obstacles to technology transfer, but continuous reform and improvement of the technology transfer system in Chinese universities and public research organizations remain necessary. Further research is needed to evaluate the effects of such Chinese policies and legislation designed to strengthen IPR protection to assess how these policies and laws influence the behaviors of researchers, firms, universities, and public research organizations. Insights generated from such studies would help policymakers and both firm and university managers improve on existing policies and processes and develop more effective IP management strategies. Acknowledgement. Can Huang acknowledges the financial support provided by the National Office for Philosophy and Social Sciences of China through grant no. 21AZD010, the National Natural Science Foundation of China through grant no. 71874152, 71732008 and 71572187, and by the Fundamental Research Funds for the Central Universities. Naubahar Sharif acknowledges the financial support from two sources: 1. “School-​Based Initiatives” (SBI) at the Hong Kong University of Science and Technology. Project Number: SBI16HS05. Project ID: N1538; 2. The Research Grants Council of the Hong Kong Special Administrative Region, China (Project No. HKU C7011-​16GF).

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Chapter 4.6

Innovation E l e me nts in Traditiona l C h i ne se Cu ltu re Jin Chen and Qingqian Wu Introduction The dispute between traditional Chinese culture and Western cultures has long been one between an archaic, outdated culture and a modern, new culture. Traditional Chinese culture is deemed synonymous with backwardness, decrepitude, and decadence and doomed with the passage of time, particularly since social Darwinism swept across the late Qing Dynasty and captured the spiritual world of Chinese intellectuals. Nevertheless, with the peaceful rise of the Chinese people and progress in culturological research, cultural identity and self-​confidence have been fortified across the nation, leading to the dispute focusing on the culture type (Chen, 2005). Despite differences in culture types, both traditional Chinese and Western culture contribute to the future of creative transition and innovative buildup. In other words, cultural modernization is not restricted to one form, but has diverse forms. As Tu Weiming pointed out, “Modernization in itself is preconfigured in the form of various cultures rooted in various specific traditions.” East Asian Confucianism realized modernization without being Westernized, which illustrates that modernity can take different forms (Tu, 2000). In some sense, the China-​US trade disputes point to the competition, cooperation, and interaction of Eastern civilization and Western civilization, that is, how to harmonize “Make China Rise Again” with “Make America Great Again.” If the dispute or confrontation does not end up with a zero-​sum game or even mutual destruction, their respective innovation elements, which will generate benefits in the future, are bound to complement and interact with each other. Consequentially, what matters a great deal to discovering and analyzing the innovation elements inherent in traditional Chinese culture includes not just a historical context of conflicts and interaction of civilization but also the pursuit of a path of modernization under the banner of the “Four-​Confidence Philosophy,” that is, confidence in path, confidence in institution, confidence in theory, and confidence in culture.

Innovation Elements in Traditional Chinese Culture    385 Is there any innovation endowment in traditional Chinese culture? Chairman Xi Jinping answered the question affirmatively with an insightful saying: “The progress of a nation is built on innovation, which pumps inexhaustible vitality into a country and makes it prosper. Innovation is the deeply-​rooted endowment of the Chinese people as well (Literature Research Office of the CPC Central Committee, 2014).” A basic definition of innovation behavior is any behavior that has the potential to turn existing resources into wealth (Li, 2011). While many inventions, creations, notions, and ideas that constitute traditional Chinese culture wouldn’t be considered innovative, they’re proven to have provided motivation for innovation in the past thousands of years, transforming traditional Chinese wisdom into a current and future asset. This is the very topic we focus on when elaborating on the aforesaid innovation elements.

Innovation Elements in Traditional Chinese Culture By and large, the components of culture include the mode of thinking, ideals and beliefs, organizations and institutions, and implementations and technology, among others. Here, we will approach the innovation elements from these perspectives.

Innovation Elements in the Traditional Mode of Thinking Prominent sinologist Lou Yulie commented: “In Chinese culture, people’s mode of thinking is dynamic, holistic, relevant, random and comprehensive (Lou, 2015).” Contrary to the partial, static, analytical, and reductive mode of thinking that characterizes modern and contemporary Western science, traditional Chinese culture features dynamism, balance, comprehensiveness, and holism. In a word, Chinese culture is based on a holistic, global, and systematic mode of thinking. One example is the biological holographic theory typical of traditional Chinese medicine, according to which headache can be cured by applying medication to the feet. Furthermore, this holistic mode of thinking is a dynamic one, hence a dynamic whole. In Book of Changes, it is believed that qi forms a bond to integrate heaven with earth as a perpetual whole (Zheng & Kong, 1976). In traditional Chinese medicine, meridians (pinyin: jingluo) underlie the perpetual flux of spirit, qi, and vitality in the human body. The holistic mode of thinking is a forward-​looking one, since it includes a traceable sort of dynamism. One case in point is disease prevention (pinyin: zhi wei bing) in traditional Chinese medicine, the illustrious brainchild of a forward-​looking philosophy. The holistic mode of thinking deals with ethics as well, in that the whole is deemed to comprise multiple closely bound inseparable parts. In Zhuangzi: Egalitarianism, Zhuangzi insists he “coexists with heaven, earth and the world (Guo, 2004).” Book of Rites: The Conveyance of Rites proposes that the saints deem the world, including the Chinese people, as one family (Zheng & Kong, 1976); similarly, in Western Inscriptions (pinyin: xi ming), Northern Song Neo-​Confucian Zhang Zai put forward something of an inclusive life philosophy that suggests looking at all people as compatriots and all beings as peers. Cheng Hao, another

386   Chen and Wu Northern Song Neo-​Confucian, held that men of virtue should look at heaven, earth, and the world as an entirety (Zai, 1978). When it comes to modern government and world order, the Chinese concept of the “Community of Common Destiny for Mankind” is, in a measure, in confrontation with the “United States First” proposition. As for the two modes of thinking, President Xi remarked in an important address at the New York United Nations headquarters: “The current world is one featuring interdependence and reciprocity among countries. We should continue to pursue and promote the tenets and principles in the Charter of the United Nations, establish new international relations centering around cooperation and reciprocity and forge a Community of Common Destiny for Mankind (Ministry of Foreign Affairs, 2016).” In a measure, what the Chinese leader proposes, like the Community of Common Destiny, Common Interests, and Common Obligations, originated in large part from the holistic ethical values of traditional Chinese culture, whereas the “United States First” concept originated largely from the Western nonglobal individualistic mode of thinking. The innovation elements brought by the holistic mode of thinking do much more than innovate in the governance of China and lead the country onto a path of “peaceful rise,” rather than colonization and hegemony. They also contribute to blazing a characteristic trail to independent technological innovation. “A distinctive feature of our trail to independent technological innovation is that it has been covered in hierarchical phases. Since the founding of the New China, we have experienced three phases in independent innovation, i.e. secondary innovation, combinatorial innovation and comprehensive innovation. The megatrend now is an open and comprehensive innovation (Chen & Wu, 2018).” In 2002, Professor Xu Qingrui made a breakthrough in the long-​held Western innovation paradigm by putting forth comprehensive innovation management. “Oriented to fostering core advantages and sustainable competitiveness, comprehensive innovation management should aim at creating and adding to values by means of combining various innovation elements (including technology, organization, market, strategy, management, culture, institution, etc.) for synergistic effects. Efficient management institutions, methods and tools combine to enable innovation in elements and personnel whenever and wherever as long as the innovation elements, coordinated, are in place to motivate the personnel (Chen & Wu, 2018).” In some measure, comprehensive innovation management, traceable to traditional holistic thinking, addresses concerns in an era of big science and global interconnection and exerts an increasing influence on China’s independent innovation efforts.

Innovation Elements in Traditional Notions and Beliefs When it comes to the innovation elements in traditional Chinese values, the innovation spirit in Chinese culture is an unavoidable issue. In the address at the 17th Chinese Academy of Sciences (CAS) Academician Convention and the 12th Chinese Academy of Engineering (CAE) Academician Convention, President Xi put a premium on the spirit by citing Book of Rites: Great Learning: “If I reform myself today, I shall persist every day, time and again (People’s Daily, 2015).” The adage, in the context of Da Xue (The Great Learning), originally concerned renewing ethical values on a daily basis, yet it evolved the meaning of perpetual devotion and self-​reform. This spirit of innovation (Chinese:  革新) can be traced as far back as Book of Changes. Ding (Chinese: 鼎), one of the 64 hexagrams, is an unarguable

Innovation Elements in Traditional Chinese Culture    387 denotation of an innovation philosophy and is interpreted in the classic text as propitiousness and prosperity. As noted in Book of Changes: The Interpretation of Miscellaneous Hexagrams, “革” means forsaking what is old and “鼎” means introducing what is new (Zheng & Kong, 1976). As noted in Book of Changes: Xici I, persistence in reform is a great virtue, which is to say, forsaking what is old and introducing what is new brings along propitiousness and prosperity (Zheng & Kong, 1976). The sun hexagram (Chinese: 损) proposes embracing the newest changes with the passage of time. As noted in Book of Changes: Sun, it’s important to change policy as losses, gains, fullness, and voidness occur (Zheng & Kong, 1976). Book of Changes: Xici II makes a pertinent explanation: “Changes ensue from a dead-​ end and lead to a way out and sustainability” (Zheng & Kong, 1976). This notion of strategic flexibility and resilience also constitutes part of a traditional innovation spirit, which embodies a profound concept of tolerance as well. On the one hand, this tolerance means a generosity of mind and a diversity of coexisting ideas. As stated in Book of Rites:  The Golden Mean, all beings nurture rather than harm one another, as the many laws run parallel without causing confrontation(Zheng & Kong, 1976). That explains why Chinese civilization hasn’t so far experienced any large-​scale religious war in history, which is a rarity of religious tolerance in the world’s religious history. Tolerance underlies the open, liberal, and innovative civilization. On the other hand, this tolerance includes tolerance of failures, as evidenced by the extolment of great losers in ancient stories, such as Kua Fu, a fabled sun chaser, and Xing Tian, a fabled deity with a hatchet and a shield. In a manner of speaking, it’s hard to imagine how Joseph Needham, had it not been for a spirit encouraging reforms, changes, and tolerance, could have enlarged on so many scientific innovations in China in his seven volumes of Science and Civilization in China. When comparing traditional Chinese civilization and Western civilization, we find that many ideas and beliefs of the ancient Chinese philosophers deserve to be called innovative if judged by today’s standards. For example, the Chinese perspective on human nature, more diversified and comprehensive than the Western perspective on human nature, serves to provide fundamental insights into governance and management theory and practice. Seeing human nature as an inborn trait, Confucians insist on soft management and a virtuous style of administration. Legalists see men as selfish in nature and promote hard management, which blends law, stratagems, and power. Taoists, who embrace naturalism, which transcends the concept of human nature, propose something of an anarchism or nihilism. In contrast with their Western counterparts believing in the absolute evilness of human nature, the various Chinese schools of thought treat human nature in a more flexible and global way when it comes to civil administration, which makes the Chinese people more flexible and resourceful in conducting themselves and addressing concerns. Furthermore, traditional Chinese personality doctrines can transform into a positive innovation factor, which provides numerous inspirations for the Western leadership theory. Confucians, Buddhists, and Taoists emphasize a good personality. In Book of Rites:  The Golden Mean, Confucians advocate wisdom, benevolence, and courage as three ultimate virtues (Zheng & Kong, 1976), and in Mencius, the “Five Permanent Principles” (i.e., benevolence, justice, rite, wisdom, and trust) are advocated as a personality doctrine (Zhao & Sun, 1976). Taoists hold in Tao Te Ching that the best of men is like water and that the Tao derives from nature. Besides, Taoists are advised to “hold proper offices and be open-​ minded, good to people, trustworthy, capable of responsibilities and civil administration and prompt in action (Chen, 2007).” Buddhists enjoin upon practitioners the guard against

388   Chen and Wu taboos, the consolidation of willpower, the achievement of wisdom, and the elimination of greed, temper, and folly, which reduce to a universal nirvana. Militarists enjoin five virtues:  wisdom, faith, benevolence, courage, and stringency. All of the aforementioned philosophers make very strict demands on a leader’s self-​discipline and competency. In contemporary times, the new trends in China are that theoretically and practically, leaders tend increasingly to be civil servants and visionary and knowledgeable reformers with transcultural perspectives (Chen, 2017). As far as new leadership promotion is concerned, Confucian, Buddhist, and Taoist perspectives on personality have unique advantages, since they emphasize benevolence and philanthropy and agree with the notion of civil service–​ oriented leadership. Confucianism, Buddhism, and Taoism pursue wisdom in a state of flux depending on time, place, and things, as well as knowledge and truths about the cosmos, society, and life, all of which help nurture visionary and reform-​and transculturally inspired leaders. Confucians, Buddhists, and Taoists take leadership ethics seriously as well. As noted in The Analects: Zi Lu, “he who has moral integrity obtains obedience without a command; he who has no moral integrity cannot obtain obedience in spite of a command.” The teachings contribute significantly to company leaders practicing moral self-​discipline and taking up social responsibilities, especially in light of the global financial crisis in 2018, which awakened the world to what terrible consequences could have resulted from undisciplined businesses. There are so many other traditional Chinese values inspiring today’s governance and management innovations. In a speech at the 13th Workshop of Chinese Communist Party (CPC) Politburo on February 24, 2014, President Xi pointed out:  “We are committed to discovering and developing the excellent values of our traditional culture, like humanitarianism, people orientation, honesty and integrity, justice, harmony and cosmopolitanism, which supply essential nourishments to our core socialist values (People’s Daily, 2015).” Harmony, as a critical component of the Chinese people’s life philosophy and an important trend of governance innovation, guides people in forming their own perspectives on ethics, society, cosmopolitanism, and world views. At the International Friendship Convention in May 2014, President Xi said: “We have been a peace-​loving nation throughout history. Chinese culture upholds harmony, which is an age-​old concept embodying many values, including oneness of man and nature (world view), world peace (cosmopolitanism), cultural diversity (social view) and humanitarianism (ethics). The Chinese people have been pursuing and pushing ahead with their solid faith in peace, harmony and harmony for over 5,000 years of civilization (People’s Daily, 2015).”

Innovation Elements in Traditional Organization and Institutions Organizations and institutions are more concrete and operable than manners of thinking, ideas, and beliefs. As a very ancient civilization, China has accumulated plenty of valuable experience in its pursuit of institutional and organizational systems that has impacted significantly on state governance and corporate management. President Xi summarized the systems as “the Four-​Confidence people have in a Socialist China”—​that is, confidence in road, confidence in theory, confidence in institution, and confidence in culture. There’s no

Innovation Elements in Traditional Chinese Culture    389 question about China leaping onto a unique track founded deeply on conventional Chinese institutions but inspired by Western ideology. In politics, ethnic unification, or multiethnicity, as a traditional Chinese institutional philosophy is blazing an innovative trail for the Chinese people in political modernization. Multiethnicity is an important feature of traditional Chinese culture. Whereas in history Western empires disintegrated into separate countries, China alternated between integration and disintegration. However, integration, rather than disintegration, was never the ultimate end. Multiethnicity is not synonymous with certain exclusive interests; on the contrary, internal multiplicity contributes to the sustainability of Chinese culture (Zheng, 2016). Under the influence of multiethnicity, Chinese politics is characterized with a time-​ honored, unified sort of central authority now headed by an open, pluralistic political party system championed by a ruling party (Zheng, 2016). Openness incorporates different interest groups in a society into political processes. In this way, civil administration can represent the fundamental interests of the most people, including motivating a mixed economy to become China’s economic normal. Through elections based on selection, the Chinese government implements checks and balances among the policymaker, the executive and the supervisor in place of the division of the executive power, the judicial power and the legislative power, thereby addressing many problems, for example, political elite selection, succession of government, and policy execution efficiency. The Chinese model of civil administration takes advantage of electoral and consultative democracy to evade the “negation for negation’s sake” problem of the Western multiparty system and the resulting social disparity and confrontation. For a multiethnic entity, pluralism means coexistence and coordination of interests that contribute to an entirety. “The tributary system, vassal system, general commandery system, chieftain bureaucratization system and prefecture/​county system in our history have unimaginable diversity and inclusiveness from the perspective of modern Western ‘nation-​states.’ However, in a civilized country as China, various institutions could coexist so well. One case in point is ‘One County, Two Systems’ and regional autonomy (Zhang, 2011).” In practice, multiethnic unity has generated such great momentum that the Chinese innovation path has developed sustainable competitive advantages. “Our innovation system differs in strategic leadership and institutions from the western system. Ours features CPC leadership, institutions applied nationwide, the involvement of the masses, openness and liberalism (Chen, 2018).” What’s more, multiethnic unity has ideals and visions of its own. “In China, enduring stability and economy prosperity have long been positioned as a prominent responsibility, so it’s hard to imagine the majority of Chinese citizens would accept the so-​called multi-​party democracy sourced from the Western world when the central government has to be reelected every four to five years. All the prosperous dynasties in ancient China were associated with powerful and enlightened central governments (Zhang, 2011).” Besides, Confucianism and Taoism have gradually proven to be of unique and significant value in the innovation of Chinese firms today. Take Confucianism values as an example; Confucians look at all people as countrymen (or one family) and all beings as peers, which is a typical institutional feature standing out as a quasi-​familial organizational form built primarily on rites and secondarily on law. The feature has driven institutional innovations for numerous Confucianism-​inspired firms (including Fotile, a paragon in this field). A quasi-​familial firm aims to transform itself and its business ecosystem into a big family

390   Chen and Wu that instills into its employees, customers, and partners a sense of belonging and achievement, contributes to self-​actualization, and forms a “close-​knit Community of Common Destiny for Mankind which survives life and death, weal and woe (Li, 2017).” Although Chinese quasi-​familial firms were influenced by the Japanese corporate culture at one time (e.g., lifelong employment), they are gradually blazing a trail on their own. Chinese quasi-​ familial firms attach great importance to employees’ interests (e.g., loyalty incentive), welfare, and sense of belonging/​responsibility/​mission/​achievement, and customer well-​being. This is a customer-​and employee-​centric approach. In this family, the indispensability of rites and rule of law is accepted. Rites in a modern Confucianism-​inspired firm include primarily daily etiquette rules designed to nurture employee personality and rules of conduct, ceremonies in celebration of milestone events for the firm or its employees, rites in celebration of important festivals, and rituals designed to honor promotions and stimulate productivity. In The Analects: Civil Administration, Confucius said: “If a ruler confines his subjects with regulations and penalties, they may stoop to any shameless conduct to evade punishment. If a ruler governs his subjects with ethics and rites, they will comply and develop a sense of shame.” What rites bring to employees—​the sense of ritualism, holiness, responsibility, mission, belonging, and satisfaction (with physical and mind development)—​is very appealing. Apart from Confucianism-​and Taoism-​inspired institutions, Legalism (pinyin:  fajia), which proposes rule of law, and Militarism (pinyin:bingjia), which proposes a paramilitary corporate governance structure, have also influenced the innovation attempts of many firms. In fact, different types of institutions are more or less similar, rather than totally discrete. Therefore, it’s safe to say that certain traditional cultural genes make Chinese entrepreneurs a unique group in terms of responsibility and institution establishment. “A typical Chinese boss assumes the above three roles at once. The firm is an army, and the boss is the commander. It’s also a family, and the boss the patriarch. It’s also school and the boss the principal (Li, 2017).” Chinese entrepreneurs are paying growing attention to the employees’ all-​around development and well-​being, or at least physical and mental development and success in career and family happiness. For example, the firm should care about various benefits of both its employees and customers, not limited to products, technology, and specific services. In this sense, it is fair to say that the organizational form of Chinese firms will mature into one built on learning, self-​enhancement, and a community of common interests.

Innovation Elements in Traditional Chinese Implementations and Technology Technology, especially implementations, is the most concrete embodiment of traditional Chinese culture. Innovation elements and innovative values embodied in traditional implementations have been identified and confirmed in many fields of contemporary practice, especially the cultural and creative industry, which has drawn unlimited inspiration from time-​honored traditional cuisine, medicine, fashion, architecture, furniture, utensils and vessels, and painting and calligraphy. The prolific miracles of creative ideas have successfully been commercialized.

Innovation Elements in Traditional Chinese Culture    391 Traditional Chinese technology is generally deemed synonymous with out-​ of-​ date techniques; some people may credit ancient China with technology and engineering, rather than science. Nevertheless, system science and the systematic mode of thinking are flourishing with the rise of new scientific theories such as relativity theory, quantum mechanics, information technology, and ecological civilization. System science has leveraged on the forms of science significantly: “Due to system science, philosophers switched their focus from substantialism centricity to relationship centricity; researchers switched from a perspective of closed system, where things are studied in an isolated manner, to a perspective of open system, where they are studied in an interconnected manner; researchers switched from a static perspective (existentialism) to a dynamic, evolutional perspective (evolutionary science) (Miao, 2007).” The advent of a system science era is expected hopefully to generate numerous opportunities of technological breakthroughs for the Chinese people, who have a prevalent inclination to holistic thinking. The discoverer of dissipative structures theory, Puligotzin, said: “Traditional Chinese academics leant to holism and spontaneity, focusing on coordination and synergy. The newest developments in modern science, including those in physics and mathematics in the last couple of years, fit more into the Chinese mode of scientific thinking. Examples include Thom’s catastrophe theory, renormalization group theory and bifurcation theory (Wang, 2012).” Similarly, Haken, founder of synergetics theory, pointed out: “Holistic understanding of nature is, in fact, a core part of Chinese philosophy. From my point of view, Western culture doesn’t allow adequately for it (Wang, 2012).” It is foreseeable that the Chinese people are very likely to do a lot more in technological innovation in an era of big science, big data, global interconnection, and world order. In the field of science, Western perspectives credit ancient China with technology but not science, thereby fomenting prejudice very likely to lead to us missing what is innovative in traditional Chinese science. The science problem is the same as the dispute over philosophy, religion, etc. If judged within the framework of the Western scientific paradigm, the answer may be negative. If judged within the framework of the Chinese paradigm, ancient China had philosophy, religion, and science of its own. Renowned British science historians John Bernal and Joseph Needham wrote about many of the scientific achievements in ancient China (Bernal, 2015; Needham, 2018). Fundamental theories of traditional Chinese science consist of so many branches of philosophy, like yin and yang, five elements (pinyin:  wu xing), eight diagrams (pinyin: ba gua), stem and branch (pinyin: gan zhi), etc. Agronomy, traditional Chinese medicine, astronomy, and counting rod arithmetic are representative of traditional Chinese science. One case in point is traditional Chinese medicine, which evolved from close-​knit and effective theory system a long time ago. It is an unscientific discipline, but it has undeniably saved countless lives in past millennia. Practice is the sole criterion of truth testing. In this sense, we might as well remain open-​minded to future science developments, because science has many paradigms and it’s possible for traditional Chinese science to contribute new thoughts and paradigms to future science. Therefore, rediscovering the innovation elements and value in traditional Chinese science is a meaningful effort—​especially in view of the countless achievements made later in support of these findings. As Wang (2012) found, after becoming acquainted of the bagua diagram, German philosopher and mathematician Leibnitz found in surprise that it was not dissimilar to the binary system he invented in 1678. Darwin also cited in his On the Origin of Species (1859) that a great deal of literature on genetics and mutation from what he called the

392   Chen and Wu “great encyclopedia of China” were sourced from Qimin Yaoshu (written by Northern Wei agriculturalist Jia Sixie), Compendium of Materia Medica (written by late Ming herbologist Li Shizhen) and Tiangong Kaiwu (written by Ming scientist Song Yingxing). Moreover, contemporary CNC boring program control was inspired by ancient Chinese jacquard weaving. In sum, there are many science and social hotspots today are associated with Chinese philosophy of natural history and historical natural science: cosmology, tectonics, earthquake forecasting, climate change, sea level fluctuations, environmental succession, biological evolution, among others. Wang (2012) argues that the “great encyclopedia of China” is proven to have played a great part in radio astronomy, epicenter distribution maps and seismic intensity zoning, five millennia of climate history reconstruction, five centuries of drought-​ and-​flood history reconstruction and implicit cycle discovery, etc. We believe that millennia of technological developments will provide more innovative inspiration for the arising technologies, such as artificial intelligence and genome editing.

Conclusion The turbulent wave of modernization is carrying mankind continuously forward. However, it’s been proven that the process doesn’t mean severance with tradition, but creative transition and innovative developments of traditional culture. Therefore, the road of modernization is diverse in nature, encompassing traditional “cultural genes” with a far-​reaching impact. As an ancient and diversified culture, traditional Chinese culture embodies inexhaustible, miraculous innovation elements, regarding the mode of thinking, ideals and beliefs, organization and institutions, and tools and technology. No doubt these will inspire China’s pursuit of a modernization road significantly, exerting more positive impact on wealth creation and value generation. We are in an era of the boom of artificial intelligence, genetic engineering, and many more new technologies, as well as in an era of the rise of China and many more emerging economies. The large-​scale and profound research on traditional Chinese culture and innovative resources will no doubt contribute significantly to the assimilation of Eastern wisdom and Chinese cultural elements. By motivating paradigmatic breakthroughs for an innovation-​centric country and a technological power, these innovation elements will help the Chinese people make more and better contributions to world technology.

References Chen Guying. The present translation and of commentary of Laozi. Beijing: The Commercial Press, 2007. Chen Jin. Management science. Beijing: China Renmin University Press. 2017:338–​343. Chen Jin. The best era of China’s innovation school. People’s Daily Online, November 19, 2018. Chen Jin, Wu Guisheng. Chinese school of innovation: 30 years review and future prospect. Beijing: Tsinghua University Press, 2018:98. Chen Yinchi. Type and era: The difference between Chinese and western cultures—​—​A review from the perspective of “pluralistic modernity”. Historical Review, 2005(2):14.

Innovation Elements in Traditional Chinese Culture    393 Commentary Department of People’s Daily, ed. Dictionary of Xi Jinping. Beijing:  People’s Daily Press, 2015:249. Department of Policy Planning, Ministry of Foreign Affairs of the People’s Republic of China. Chinese diplomacy. Beijing: World Affairs Press, 2016:37. Guo Qingfan. Collection of interpretations of Zhuangzi. Beijing: China Bookstore, 2004:79. International Department of People’s Daily. Compilation of international review of People’s Daily. Beijing: People’s Daily Press, 2015:16. John Bernal. Science in history. Beijing: Science Press, 2015. Joseph Needham. Science and civilisation in China. Beijing: Science Press, Shanghai Ancient Books Press, 2018. Li Honglei. Confucian business wisdom. Beijing: People’s Publishing House, 2017:4-​43. Li Jin. Drucker on management. Shenzhen: Haitian Press, 2011:139. Literature Research Office of the CPC Central Committee. Selections of important documents since the 18th CPC national congress (part I). Beijing: Central Literature Publishing House, 2014:279. Lou Yulie. Chinese character. Chengdu: Sichuan People’s Publishing House, 2015:62. Miao Dongsheng. Lecture notes of system science in universities. Beijing: People’s Publishing House of China, 2007:8. Theoretical Department of People’s Daily. Annual compilation of theoretical writings of People’s Daily. Beijing: People’s Daily Press, 2015:456. Tu Weiming. Implications of the rise of “Confucian” East Asia. Daedalus. 2000 (Winter):207. Wang Yusheng. Traditional culture and the development of science and technology in China. Science and Technology Herald, 2012, 30(36):17–​18. Zhang Weiwei. China shock:  The rise of a “civilized country”. Shanghai:  Shanghai People’s Publishing House, 2011:72–​73. Zhang Zai. Collection of essays on enlightenment. Beijing: China Bookstore, 1978:62. Zhao Qi, Sun Shi. Commentary on Mencius. Taipei: Taiwan Arts and Letters Printing House, 1976:195. Zheng Xuan, Kong Yingda. Commentary on the book of changes. Taipei: Taiwan Arts and Letters Printing House, 1976. Zheng Xuan, Kong Yingda. Commentary on the book of rites. Taipei: Taiwan Arts and Letters Printing House, 1976:431. Zheng Yongnian. Institutional arrangement in accordance with Chinese culture. Theoretical Guide, 2016(5):29.

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OP E N N E S S A N D T H E   AC QU I SI T ION OF T E C H N OL O G Y A N D C A PA B I L I T I E S

Chapter 5.1

In novation St rat e g i e s of M u ltinat i ona l C orp oration s i n C h i na and Their C on t ri bu t i on to the Nat i ona l Ec osyst e m Bruce McKern, George S. Yip, and Dominique Jolly Creation of Foreign Intellectual Capital in China For many years, and with great emphasis since 1995, China has followed a technology-​ and education-​led development strategy. As explained in other chapters in this Handbook, China’s focus has been on establishing the resources, structures, environment, and incentives for innovation as a major force in increasing productivity and domestic incomes. Foreign multinational corporations (MNCs) have played an important role in China’s growth, in developing innovations and contributing to the creation of intellectual capital in China. An important question with policy implications is therefore: to what extent has the presence of MNCs contributed to the development of China’s domestic capability for innovation? We address that question in this chapter. We consider the issue from several perspectives. First, we consider the viewpoint of the MNC in establishing research and development (R&D) operations in China, providing quality control for manufacturing operations, innovating products and services for the Chinese market, and developing innovations for both the Chinese market and markets abroad. We will consider the patterns of development of MNCs’ R&D operations in China and their evolution as a function of their China strategy and the extent of their embeddedness in the economy.

398    McKern, Yip, and Jolly Second, we consider MNC activities in China from the Chinese perspective: their impact on the innovative activities of Chinese companies and on Chinese innovative capacity as a whole. Foreign influence on the innovation activities of another country occurs in three main ways. First, importing materials, technologically sophisticated machinery, or finished products from a foreign country has an impact on the host country’s access to those technologies, and may increase the country’s technological sophistication, but does not necessarily enhance the country’s indigenous technological capacity. Second, acquiring foreign technical know-​how to manufacture products, through the acquisition of intellectual property (IP) and licensing agreements, can increase the country’s technological base, subject to the capacity of the country’s local institutions to absorb, apply, and adapt the new technology. Third, inward foreign direct investment (FDI) usually brings with it know-​ how, initially in the form of the foreign corporation’s embedded capabilities of technology, manufacturing, quality control, and management, and subsequently in the form of potential spillovers of capability to domestic companies, again dependent on the extent of leakage and the domestic economy’s absorption ability, as noted earlier. FDI influences economic growth, employment, and income as well as the innovation capacity of a country. In this chapter, our primary interest is with the impact on indigenous innovation capabilities. A fourth means of acquiring foreign technology is through sending local engineers and scientists abroad for education. China has been very active in this effort, not only in sending Chinese citizens abroad for education, but also, in recent years, in establishing policies to attract foreign-​educated Chinese (“returnees”) to return to China. This policy is discussed in Chapter 5.3 of this Handbook and will not be further addressed in this chapter. From the viewpoint of the MNC, the decision as to whether it will import finished and/​ or intermediate goods and products only, license locals to use its technology to manufacture end products, or invest directly in local operations under its control depends on many factors, including the importance of proprietary IP to the local operations and the MNC’s ability to maintain control of that IP. Later in this chapter we discuss the evolution of MNCs’ local R&D activities, from commencing with operational quality control, to testing of software and local clinical trials, to adaptation of foreign-​developed products to local markets, to design and development of products specifically to suit Chinese needs, some of which may suit both local and global markets. IP is a valuable asset for most MNCs and its protection is an important goal for any MNC operating in a foreign environment, particularly in a country where the legal regime and protection of IP are not well developed. Given China’s goal of creating an innovation-​led economy, IP is an important bargaining chip that can be traded in exchange for access to the marketplace or other government goals. So the depth of MNCs’ R&D functions in China is greatly influenced, on the one hand, by opportunities to create competitive innovations for the China market, and on the other by the risk of loss of IP through copying or government regulation. And government intervention to force transfer is influenced by the Chinese government’s perception of the importance of specific technologies to China’s long-​term development. In the early years of China’s acquisition of foreign technologies, access to a large and burgeoning market was attractive to MNCs, which in some cases transferred technologies that, while new to China, were not at the cutting edge of the world standard. So the compromise of technology for markets was acceptable. What perhaps was not anticipated

Innovation Strategies of Multinational Corporations    399 was the speed and efficiency with which Chinese firms were able to absorb the foreign technology, adapt it, and improve it to become world-​class leaders in offering Chinese-​ adapted technologies in their own market and, increasingly, worldwide. At the same time, and particularly under the current administration, stronger demands have been made on MNCs to transfer advanced technologies as a condition of access to the market, and this has engendered some reaction. MNCs today report being uncomfortable with the requirements and are looking for ways to minimize IP loss and even reconsidering the benefits of a presence in the China market.

Evolution of MNCs’ R&D Strategies in China From the perspective of the MNC, China was not even considered as a source of innovation for foreign subsidiaries of MNCs before the 2000s (Hakanson and Nobel, 1993; Gerybadze and Reger, 1999; Frost, 2001). A weak national innovation system (NIS) plus a lack of IP rights protection affected the choices of companies (Hagedoorn et al., 2005; Banri and Wakasugi, 2007). Then, in the 2000s, the rationale for international location decisions began to change, with a growing emphasis on the development of capabilities in China. As the landscape has changed, early studies of foreign R&D efforts showed that foreign R&D centers in China became not only important vehicles for local market development but also, contrary to expectations, increasingly important sources of locally developed technology (von Zedwitz, 2004), especially inside industrial clusters (Bin and Guo, 2011). Technological richness and diversity and the knowledge linkages of the subsidiary with other entities have been shown as drivers for innovation (Almeida and Phene, 2004) and a rationale for entry by MNCs into countries with developing innovation systems. Recent years have seen a new phenomenon, of MNCs conducting R&D activities in emerging markets to innovate for those markets and, sometimes, for advanced markets, or so-​called reverse innovation (Immelt et al., 2009). In particular, China has become host to over 1,500 foreign-​owned R&D centers.1 MNCs initially entered the Chinese market by exporting host country products whose competitive advantage was based on the firms’ proprietary technologies, brands, or superior management skills, fitting the traditional product life cycle (Vernon, 1966). This was followed by local manufacturing or service operations, and R&D centers were set up to support them, mainly for cost or quality control reasons. MNCs then adapted their products or processes to suit the Chinese market, setting up market-​driven R&D centers and introducing new products designed for local requirements. Consistent with the product cycle, local companies became tough competitors, as they copied and mastered technologies that had become standardized and used their low-​cost inputs, understanding of the local environment, and agility to competitive effect. They have been successful as participants in global supply chains, although few have yet become established MNCs with global reach. 1  Yeung et al. (2011) estimated 1,200 centers set up by the end of 2008, and PricewaterhouseCoopers (2012) put the number at over 1,500 by 2012; in 2018, we estimated the number to be over 1,800.

400    McKern, Yip, and Jolly Jolly et al. (2015) conducted in-​depth interview-​based research in the China R&D centers of over 50 MNCs from 12 different countries (including the United States and European and Asian countries). The main conclusion of this study is that there are indeed different motivations for MNCs to invest in R&D in China. But instead of the four dimensions identified by von Zedtwitz and Gassmann (2002), we identified three major strategies and motivations for foreign R&D in China. We described them as cost driven, market driven (plus a government-​driven subset), and knowledge driven. For each of those drivers, this investigation identified the profiles of firm strategy and R&D investment. Furthermore, the study found that for many companies the motivation, and hence the mode of R&D, has evolved over time. We consider each of these strategies in turn.

Cost-​Driven  R&D Cost reduction is the engine that motivated foreign companies historically to conduct R&D in China (Zeng and Williamson, 2007). Jolly et al. (2015) discovered that companies initially targeted repetitive operations—​such as coding and testing a piece of software—​with operations split between China and the home country. Their offshored R&D activities were concentrated in the development phase, and often at the end stage of development, where budget control is most important and tasks are the most repetitive, taking advantage of China’s low-​cost R&D labor. This cost-​driven R&D was chosen by companies from diverse industries selling global products with few (or no) local features, intended for the local market or for export into the parent company’s supply chain (Breznitz and Murphree, 2011). This phase usually requires a large input of human resources and usually represents the largest share of the R&D costs, so taking advantage of the local labor cost advantage is the prime mover. The MNC’s Chinese R&D entity is typically in-​house, rarely a joint venture. As many firms have experience with this model, the corresponding key factors for success in China were well explained by the companies we investigated. R&D and production need to be well connected and therefore co-​located. Recruitment focuses on graduates with local bachelor’s and master’s degrees, rather than doctorates. Limited new knowledge is developed locally. Most of the knowledge comes from headquarters, so there is no need for the operation to be located inside a local system of innovation, such as a technology park. Adaptations to manufacturing processes may be kept secret or regarded as non-​ consequential. But IP protection is usually considered an important factor in local R&D activities, including applying for patents in China for existing technologies developed abroad, as well as for new processes or products. MNCs take advantage of the foreign location’s attributes—​specifically low labor costs in China, including R&D costs. This was necessary to compete with local firms and also valuable for ensuring the quality of exports entering the global supply chain. However, wage increases in China have averaged some 10 percentage points above the rate of inflation over the last 10 years (China Labour Bulletin, 2013), and local governments have been increasing minimum wages by 15% to 20% per year (McKinnon, 2010) in addition to growing demand for social security coverage, which increased cost as well. With China losing its R&D salary gap relative to more developed countries, the cost-​driven R&D model has become less relevant, except where it has remained feasible by a shift in production plants toward lower-​cost

Innovation Strategies of Multinational Corporations    401 inland cities such as Chengdu, Xian, or Chongqing. Furthermore, growing customer sophistication and the rise of local competitors have necessitated localization and market responsiveness through market-​driven R&D, the second category of R&D investment.

Market-​Driven  R&D Jolly et al. (2015) found that a second category, market-​driven R&D, occurred where localization is needed, as for culture-​bound products such as food, flavors and fragrances, or automobiles, or to align the technology with the local norms or regulations. Market-​driven R&D means taking technologies developed outside China, importing them into China, and modifying them locally to be in line with the preferences of Chinese customers or Chinese regulations. China’s many taste differences from the rest of the world and its numerous microsegments spur the need for adaptation. Furthermore, increasing affluence and sophistication mean that Chinese customers are less and less willing to put up with Western “hand-​me-​downs.” They want products made for China, that is, designed in China, for China. Local competitors are superb at identifying and supplying market needs, and MNCs have had to deepen their knowledge of the Chinese market so as to match local demand. Products must be not just “good enough” (Gadiesh et  al., 2007)  but “fit for purpose”—​ meeting customers’ expectations of functionality and price. Automobile manufacturers, for example, have had to make numerous adaptations to their vehicles to satisfy the diverse requirements of their Chinese customers, including common use of chauffeurs and expectations of in-vehicle entertainment facilities. In the case of market-​driven R&D, the scope of activities carried on in China goes beyond the simple end phase of development—​as in the case of cost-​driven R&D—​but covers the entire development phase of the R&D process, that is, primary development as well as end of development. Jolly et al. (2015) observed that to achieve market-​driven R&D, foreign companies need to deepen their knowledge of the Chinese market. Executives expressed the necessity of direct contact with customers and identifying the multiple segments that exist in each market, as well as the conditions of use, which can be very different from those in their home countries. One interviewee mentioned that a North American–​based engineer usually has little idea of the expectations of the Chinese customer and cannot visualize or accept the changes in product specifications needed. Improvement of the company’s capabilities in R&D is therefore closely associated with on-​the-​ground understanding of the local customer needs. This study also observed that sometimes, local adaptation in China is driven not so much by differences in customer needs or tastes but by differences in raw materials. For example, development could be concerned with testing the combination of different raw materials sourced locally to find the right mix that satisfies Chinese customers’ real needs or cost conditions. A  striking example is the recent development by Chinese metals companies of nickel-​iron as a substitute for nickel, due to a quadrupling in the price of pure nickel. The need for local regulatory approval spurs some market-​driven R&D in China. One example from our research is the pharmaceutical industry. Drug efficacy is not country related; drugs are much the same all over the world. Yet, gaining Chinese approval for a drug already tested and approved by other agencies such as the US Food and Drug Administration, Europe’s European Medicines Agency, or Japan’s Pharmaceutical and Medical Devices

402    McKern, Yip, and Jolly Agency requires R&D and clinical trials in China—​a form of market-​driven R&D due to the requirements of the Chinese regulatory process. Most of the major pharmaceutical companies do some so-​called phase 3 development in China to gain approval for sale in China (we observed this activity in the nine companies of our sample operating in the pharmaceutical industry). The China Food and Drug Administration in fact requires that drug tests are conducted on Chinese people, to verify that the drug poses no particular problem for the Chinese physiology. Samples of as many as 5,000 patients may be required. The product is usually not modified (although the dose can be changed). Such testing on local populations has often been the historical start of R&D activities by foreign pharmaceutical companies in China.

Government-​Driven  R&D A special case of market-​ driven R&D is government-​driven R&D (Economist, 1999; Walsh, 2003). This type of R&D is undertaken to gain access to the local market, government contracts, or big projects. It is alternatively labeled “PR&D” to stress the public relations dimension of this strategy. Usually, such R&D starts with political agreements signed at the highest levels, often between countries. Often the impetus may be to satisfy the Chinese government’s demand for more domestic technological innovation. It is common within business-​to-​government activities, in concentrated businesses with very few global competitors. Such agreements are implemented on the Chinese side by state-​ owned enterprises (under government control) and on the foreign side by MNCs that are close to their own governments. An example was Microsoft’s agreement to establish a major software R&D center in Beijing, which was matched by the Chinese government’s agreement to require the use of genuine Microsoft products in government agencies. An important objective for the Chinese entity is joint technology development. High-​ speed rail, aerospace, and avionics are examples. The driving force for the Chinese entity is acquisition of technology, while for the MNC it is market access. Government intervention has compressed the evolution of the product life cycle in China by forcing inward technology transfer as well as accelerating indigenous innovation. The direct intervention of the Chinese government has stimulated the rise of local competitors, equipped with state-​of-​ the-​art technology, much more rapidly than predicted by the traditional formulation of the product cycle. For the MNCs, the price of participation in these big opportunities has been the creation of potential global competitors.

Knowledge-​Driven  R&D Jolly et al. (2015) found a third category, knowledge-​driven R&D, which differs from cost-​driven R&D and market-​driven R&D in terms of the number of steps of the innovation process undertaken in China. While cost-​driven R&D is focused on the end stage of development and market-​driven R&D does not usually go beyond development, the authors discovered that the activities of companies that perform knowledge-​ driven R&D encompass the full spectrum: fundamental research, applied research, and development.

Innovation Strategies of Multinational Corporations    403 There are also important differences between the three types of R&D strategies in terms of knowledge flows. The key issue is whether to rely on imported knowledge or on knowledge created in China. When cost-​driven R&D is the objective, knowledge comes from foreign R&D sources. Limited value is added to this knowledge in China and there is little return flow to the home R&D location. With market-​driven R&D, both the flows of imported knowledge and the value created in China are more significant. Foreign companies may import into China complete technologies that were developed abroad. These technologies are re-​engineered and redeveloped by the MNC’s Chinese R&D center to fit with local requirements, creating more value in China. This new body of knowledge is created specifically for China, so it is not initially exported outside, with the exception of Asian countries with comparable market requirements to China. In contrast to the two previous modes, knowledge-​driven R&D does not rely mainly on technology imports from abroad. Rather, it aims to take advantage of China’s knowledge base. Value creation by the MNC occurs thanks to technologies fully created in China. Ideally, those technologies developed in China will be later transferred globally. This means that one prerequisite is that the MNC should be willing to locate its R&D from a global perspective (and not to centralize knowledge development at home). Connecting with the Chinese NIS is also a key imperative, because more than in many countries, that is where the innovative ideas are being created. Even companies in consumer mass markets, such as Philips and Unilever, have decided to locate in China some R&D labs with global responsibilities. Some companies in business-​to-​business markets, such as the Belgian chemical company Solvay, have adopted the same strategy.

A Dynamic View Jolly et al. (2015) discovered that R&D in China goes through different stages of development, from cost-​driven to market-​driven to knowledge-​driven R&D. Although MNCs’ R&D rationale is shifting as the Chinese market matures, a majority of the study respondents were still focused on the first two stages of innovation activities: those that seek cost savings (18% of the sample) and adaptation of technologies to market (54%). Nevertheless, a growing proportion (28%) were engaged in knowledge-​driven R&D. Interviews confirmed that these companies have recognized an important shift in the global R&D map: China’s arrival on the world stage as an innovative country with all the necessary ingredients—​top universities and research centers, science parks, startups, venture capitalists, and booming patent applications. Interestingly, among the subsample of companies that have made this change in R&D orientation, more than half had already made this move by 2008. In the first phase, cost-​based R&D, the foreign companies do not have any advantage over locals in the cost of labor, but they do have advantages in technology, production systems, and management. Likewise, their brand may not be a big advantage, unless they are in well-​known consumer products. So they focus their R&D efforts on those areas designed to give them a cost and quality advantage over the locals, including using local labor more efficiently. In the second phase, local companies develop the capabilities to enable them to respond more effectively to market needs, including a superior understanding of customers’ changing needs, identification of diverse niches, delivering “fit for purpose” products, and

404    McKern, Yip, and Jolly moving product quality and attributes upward as customers’ tastes change. The initial cost focus of MNCs doesn’t help them to offset their lack of customer understanding, so they have to move to R&D based on a deeper understanding of the local markets. In the third knowledge-​based phase, MNCs traditionally performed the R&D in developed country markets. But the Chinese knowledge base has evolved rapidly, driven by the Chinese government’s efforts to create an NIS, as detailed in this Handbook, and by the great push for local companies to develop innovation-​based competitive advantages. The Chinese market is large enough, diverse enough, and changing so rapidly, particularly toward higher-​quality and more expensive products and services, that local knowledge creation is rewarded. Therefore, MNCs increasingly find that doing research in China is necessary to take advantage of this knowledge.

FDI in China and the Inflow of Intellectual Capital FDI in the Domestic Market and Local Spillovers In the early years of the opening toward foreign capital, when much of the foreign investment was from overseas Chinese sources and directed toward the Chinese domestic market, there was less emphasis on technology and more on satisfying demand for unsophisticated consumer products. But as MNCs invested more strongly in China, the technology base became more significant. MNCs deployed home-​sourced technologies to provide a competitive edge in the Chinese market, and some of this had the effect of stimulating innovative capability in local firms. In this section we summarize the empirical evidence on this phenomenon, before turning to the impact of processing technology. Much of the evidence regarding technology spillovers into indigenous firms in China has been based on descriptive research and case studies. An early study based on a series of surveys by Long Guoqiang, of the Development Research Center of the State Council, found that joint ventures between foreign and local firms increased the pool of available technology and trained personnel and provided upstream business for local suppliers to MNCs (Long, 2005). Further, MNCs created new product markets into which local firms entered, learning from the MNCs and their ex-​employees and expanding the offerings. Long quoted the example of mobile phones, which Chinese firms began producing in 1999. The local firms’ market share grew from 2% in 1999 to 15% in 2001 and 60% in 2003 (Long, 2005, 331). In addition, Long argued that restructuring of state-​owned enterprises created firms with the resources to enter domestic markets, and the private sector attracted personnel not only from MNCs but also the growing pool of returnees. The large and rapidly growing market provided space for new entrants, except in some controlled sectors such as automobiles, where indigenous joint venture partners were “crowded out.” Long argued that compulsory technology transfer was not an effective means of developing indigenous innovative capacity: competition policy and IP protection were equally important. The research of Zeng and Williamson (2007), discussed in Chapter 6.1 of this Handbook, explains how many Chinese companies initially got started by copying MNC products (the

Innovation Strategies of Multinational Corporations    405 so-​called Shanzhai phenomenon), focusing on their competitive advantage in low-​cost labor, but relatively quickly moved toward providing higher-​quality products at a favorable price, out-​flanking MNCs that were slow to react. Their “good enough” products responded to a large and growing market opportunity, which stimulated these firms to improve their innovation capabilities. This phenomenon clearly benefited from copying the technologies brought to China by the MNCs in their midst and these spillovers enabled local firms to get their start. An environment that lacked protection of IP, as China did in the early days, provided opportunities for local firms to leap the technological capability gap, provided there was adequate ability to absorb and use what was gained. More recently, Yip and McKern undertook a comprehensive empirical study of the development of innovation capabilities in Chinese companies (Yip and McKern, 2016). Using detailed interviews, case studies, surveys, corporate data, and statistical sources, the authors provide evidence of the substantial range of innovation capabilities developed by indigenous Chinese firms following the shift to a market-​oriented economy. Greeven and Yip (2021) have further conceptualized that Chinese companies take six distinctive paths to innovation. While the focus of Yip and McKern (2016) was not on the spillover of technology from FDI, the numerous and detailed examples provide indirect evidence of the MNCs’ impact. This resulted from leakage of personnel, the creation of new markets, copying that was facilitated by the presence of exemplars, the demonstration effect of MNC activities, the circulation of personnel from successful MNCs into local firms, and the entrepreneurial skill of returnees. This is not inconsistent with the main findings of their research, which identified two major forces in the development of Chinese indigenous innovation capabilities: large, diverse, and rapidly growing markets, and the consistent policies of the government to support innovation as a key economic growth engine, with funding and incentives to establish an innovation ecosystem, coupled with the innate entrepreneurial drive of the Chinese people. The government policies that assisted entrepreneurial activities through government technological institutions and universities were complemented by a host of related policies, including financial support and protection. These policies, which were an integral part of the creation by China of a modern technologically based economy, are a consistent theme in many of the chapters of this Handbook. The research of Yip and McKern lends support to the argument that the presence of MNCs was an important factor in strengthening the environment in which the local capabilities could be developed. Their research shows no sign of crowding out of locals by foreigners. Rather, there are many examples of cases where foreign companies were defeated in the local market by Chinese companies that, under the stimulus of MNC competition and despite the MNCs’ long-​established strengths, developed innovative capabilities, including superior understanding of local customers. In the last decade, the 2010s, smaller Chinese companies also were becoming significant innovators, joining China’s rapidly developing innovation ecosystem (Greeven et al., 2019a, 2019b). While these empirical studies suggest an important, if not deliberate, spillover effect from FDI into Chinese firms, a thorough and more recent econometric study by Fu (2015) came to more nuanced conclusions. Fu found that foreign investment in China had a significant impact on the growth of regional innovation capacity and output, but the impact varied according to geography. The impact was more significant in the coastal regions of China, where there were pools of educated research staff available in universities and public institutions to support the local R&D activities of MNCs. In the inland provinces, the

406    McKern, Yip, and Jolly impact of FDI on innovation was less significant, partly because of the scarcity of the local R&D support resources and partly because of a focus in the interior on industries taking advantage of low labor costs and other local inputs. While FDI was important in the growth of the more technology-​intensive industries and the innovations stemming from them, according to Fu there was little evidence of a direct impact on domestic innovation capabilities. Foreign multinationals in the early stages of their operations in China tended to operate their R&D centers independently and not apply for local patents, and local absorption was less common. The reasons for this are explained in our analysis earlier of the stages of R&D undertaken by MNCs during their evolution in China.

Processing Technology for Exports and Local Spillovers Other MNCs used China as the base for processing operations, exploiting China’s low-​ cost semi-skilled labor to assemble materials and components from diverse sources into finished products for sale in the developed world. This processing trade (PT) FDI has been a very important development in China’s export performance, particularly in high-​ technology exports, where China has gained a significant share of world trade. We examine the phenomenon next. An early study to provide evidence on PT is the work of Breznitz and Murphree (2011),2 who studied the entry of Chinese suppliers of components and assemblies into international manufacturing PT through participation in global supply chains. PT quickly became the central mechanism for China’s high-​technology export trade, accounting for as much as 85% to 90% of the total high-​technology exports as recently as 2006 (Fu, 2015, Figure 4). According to Breznitz and Murphree, the environment facing Chinese firms in the early stages of development of export-​oriented processing was one of “structured uncertainty,” where the changeability and significance of government policymaking, coupled with the dynamic growth of end markets, forced suppliers to be flexible and discouraged large-​scale investment. At the same time, they had to absorb quickly the state of the art in manufacturing technologies, often provided by corporate customers from advanced economies, and the rapid evolution of technology encouraged them to learn by doing. This environment stimulated the enormous growth in processing operations, but the authors argue that the impact on innovation was both positive and negative. Uncertainty placed a premium on small-​scale and short-​term commitments, and thus favored incremental, rather than radical, innovation. Since the Chinese contractors sold into MNC-​ controlled supply chains rather than end markets, they were not exposed directly to final customers, so their innovations tended to be product or process improvements, not new products. On the other hand, firms also favored innovations that were immediate, practical, and close to the needs of the customer, and this bred agility and resilience. Over time they found new customers for their capabilities (the export market intelligence spillovers noted by Fu), and some branched out into new industry sectors. These characteristics, the authors argue in this Handbook’s Chapter 6.2, have made them “able to survive both domestic and foreign shocks.” 2 

Chapter 6.2 of this Handbook provides a recent overview of these issues by the same authors.

Innovation Strategies of Multinational Corporations    407 Despite the growth of indigenous capabilities outlined earlier, it is clear that the dominant actors in PT remained MNCs, which accounted for some 89% of high-​technology processing exports in 2006. Remembering that PT was around 85% to 90% of total high-​tech exports, MNCs were thus in control of some 75% to 80% of China’s high-​tech export trade. Because processing exports begin with imported components embodying value added in other countries, to which are added limited local materials and local labor that is not highly skilled, the overall value added in China was low from the outset. The value added and retained in China by high-​tech exports is therefore considerably less than their export value, and while it has increased over time, by 2012, according to one estimate, it was no more than 45% of the export value (Yuqin, 2014). China’s ambition to increase the proportion of added value in manufacturing was formulated in 2015 into a series of policies known as the “Made in China 2025” initiative. The analysis of Breznitz and Murphree (2011) sketched earlier showed the importance of PT for China’s international trade development. A more recent and very thorough analysis over the period 2000–​2007 was undertaken by Fu (2015), covering both conventional FDI as well as FDI in PT (PT-​FDI), which had received very little prior academic attention. Fu looked for effects of PT-​FDI and conventional FDI on indigenous companies’ export performance in the high-​technology sector. The effects were of two broad kinds:



1. “Spillover effects” due to (a) labor movement between firms,3 for which local absorptive capacity is important, and (b) diffusion of intelligence about exporting and export opportunities; this reduces the fixed costs for local firms to begin exporting. 2. A  “competition effect,” where foreign firms stimulate, or conversely crowd out, local firms.

The results of Fu’s study showed that among firms engaged in PT, there were positive spillover effects of export intelligence to local firms resulting in enhanced export performance. However, there was a negative effect regarding technology. Whereas exporting indigenous firms were able to learn about export trade, gain foreign market intelligence, and increase their export performance as a result, this was not the case regarding technological capabilities. It seems that diffusion of technology from MNCs to indigenous firms was not enhanced by the MNC presence. Fu speculated that this may have been attributed to the MNCs’ control of technology embedded in imported components or materials and the relatively low-​skilled labor involved in processing. So non-​exporting firms lacking the capabilities to enter processing were inhibited. On the contrary, firms with existing technical capabilities were not inhibited and were able to compete and learn from the MNC presence. In non-​PTFDI (conventional FDI), there were also positive information spillover effects on the export performance of domestic firms, but a marginally significant negative technology spillover effect. Fu concludes that for the export performance of non-​PT domestic

3  Labor spillover results from movement of personnel from foreign-​owned to indigenous-​owned operations, carrying with them knowledge of best practice. Less directly, labor mobility can lead to upgrading of local knowledge more generally. Another mechanism is IP transfer through copying or theft.

408    McKern, Yip, and Jolly firms, the key factors appear to be indigenous innovation, economies of scale, and export information spillovers. In terms of China’s policy of creating an innovation-​led economy, her conclusion is that the opportunities for learning from MNCs through catch-​up are not enough to increase the innovation capabilities of indigenous firms and their international competitiveness. Although PT-​FDI contributes to employment and income growth, its effects are indirect and slow. Other policies focused on capability building (stressed in many chapters of this Handbook) are needed.

China’s Policies for FDI and Intellectual Capital From the perspective of a host economy with an objective to strengthen its indigenous innovative capacity, policies toward the MNC may be designed to provide incentives (or compulsion) for inward transfer of technology. China, for example, has used access to domestic markets as a quid pro quo for transfer of foreign technology into China, with varying degrees of success, and in recent years this policy has become more demanding. For many MNCs, the attraction of the large Chinese market was sufficient for them to accept compromises in the control of their proprietary technology. The development of the high-​speed railway network in China is a prominent example, in which foreign firms’ access to the China market was contingent on the transfer of technology to Chinese firms in the early stages of its development, which allowed China to become not only independent but also, over time, a world leader in this field. Because China was by far the largest market for high-​speed rail technology in recent years, Chinese firms rapidly became leaders in the field through the absorption of foreign technology and the improvements they were able to make to their capabilities. Today they are active competitors in foreign markets for new rail projects. In the early years of China’s opening to the West, there was a cautious and careful acceptance of FDI and in those days there was little concern for technology transfer. Between 1979 and 1985, China passed a series of laws governing various types of foreign-​invested entities, the first of which permitted FDIs in the form of joint ventures. It also established 4 special economic zones (SEZs)—​soon increased to 14—​to experiment with trade liberalization and foreign investment. From 1986 until 1991, FDI was being encouraged and the range of mechanisms was expanded to include equity joint ventures, cooperative joint ventures, and wholly foreign-​ owned subsidiaries. The central government introduced further laws governing the activities of foreign enterprises, including the Law of the People’s Republic of China (PRC) on Wholly Foreign-​Owned Enterprises, the Law of the PRC on Sino-​Foreign Contractual Joint Ventures, income tax regulation of foreign-​invested enterprises, and the Guiding Directory on Industries Open to Foreign Investment. In the SEZs, enterprises received preferential tax rates, access to land, exemption from central planning quotas and labor regulations, and other advantages. Policies toward FDI were in some respects more advantageous to foreign companies than to locals in the early years, through benefits such as tax holidays, provision of land or buildings, etc. Over time the policies toward FDI became less overtly favorable, with removal of tax advantages and other benefits. The Chinese government officially welcomes foreign

Innovation Strategies of Multinational Corporations    409 investment,4 but MNCs report that in practice the approval process is complex and the administration is bureaucratic and opaque.5 Although a number of industries and economic sectors remain restricted or prohibited to foreign investment, there has been a shift in 2016 to a “negative” list in the Foreign Investment Catalogue, where approval is not required for FDI in sectors that are not listed. On January 17, 2017, the State Council issued a “Circular Concerning Measures on Further Opening Up and Actively Utilizing Foreign Investment,” intended to promote and encourage inward FDI. The Circular included 20 specific measures in three areas (Jin, 2017): • China will revise the Catalogue for the Guidance of Industries for Foreign Investment and open up a number of areas for investment, including those concerned with high-​ technology and “green” industries. • It will increase the transparency of its investment environment and protect the intellectual property of foreign enterprises (italics added). • It will allow local governments to offer concessions to foreign firms for projects that facilitate employment, economic development, and technology innovation, especially for the central, western, and northeastern regions. Then, in June 2018, under trade pressure from the Trump administration, China announced a further revised Catalogue for Guidance, reducing the negative list to 48 industries, and eased curbs on FDI in banking, automobiles, and agriculture. Since then, most recently in March 2019, at the annual “Two Sessions” (China’s National People’s Conference and the Chinese People’s Political Consultative Conference) in Beijing, further measures were outlined to make direct investment in China more attractive to foreign investors. These proposals included establishing a “level playing field” for domestic and foreign firm investments alike and eliminating forced technology transfer (FTT) from foreign corporations. It is not clear to what extent these changes and others will be seriously implemented, whether they are a bargaining element in the US-​China trade frictions under negotiation or whether there will be a significant shift in the regulation of FDI. But they are moving in the right direction to reduce uncertainty among foreign investors. If implemented seriously, the short-​term effect may be to reduce foreign technology transfers to local firms, but longer term, they may herald an environment in which foreign firms feel welcome to innovate locally, both independently and in collaboration with local R&D centers and firms, under the assurance of IP protection, with technology flows into the Chinese economy through

4 

See, for example, the MOFCOM “Invest in China” website: http://​www.fdi.gov.cn. Problems cited by foreign companies include broad use of industrial policies to protect and promote state-​owned and other domestic firms through employing subsidies, preferential financing, and selective enforcement of laws and regulations; restrictions on controlling ownership of foreign entities through equity caps, limited voting rights, limits to foreign participation on companies’ board of directors, etc.; weak protection and enforcement of IP rights; corruption; discriminatory and nontransparent anti-​ monopoly enforcement; excessive national or cyber security requirements; and an unreliable legal system lacking transparency and rule of law. Source:  export.gov, Country Commercial Guide, Investment Climate Statement, China:  China -​1-​ Openness to, & Restrictions Upon Foreign Investment, 7/​20/​2017 5 

410    McKern, Yip, and Jolly sale and licensing of new technologies to Chinese entities. Given the spillovers that occur in other jurisdictions where there is considerable IP exchange, this might have a more positive impact on the development of Chinese indigenous IP capabilities than the more restrictive approach of the past.

Role of MNCs in the Transfer of Foreign Technology The presence of foreign MNCs in any country usually creates some opportunity for the transfer of foreign technology. This phenomenon is particularly true for developed market (DM) foreign MNCs operating in emerging markets (EMs). Furthermore, most host country governments, especially those in EMs, have policies to encourage foreign technology transfer to speed up catch-​up. China is exceptional in this last regard in having the strongest policies in the world, and in history, to encourage and even force foreign technology transfer. As our chosen perspective is from the viewpoint of foreign MNCs (as opposed to the viewpoint of governments and economists), we focus here on how China’s policies affect foreign MNCs. A definitive study on FTT policies in China by Prud’homme et al. (2018) provides an excellent report of the situation. This study focuses on transfer of frontier technology in China’s newly designated strategic emerging industries (SEIs).6 Based on a survey of foreign firms, extensive interviews with foreign firms, and case studies of Chinese firms, the authors identify three categories of FTT policies in SEIs: • Lose the market policies: “foreign firms should transfer technology in line with the policy or lose market access.” • No choice policies: “foreign firms do not have a reasonable choice about whether or not to transfer technology,” partly because of unfair court rulings in IP civil litigation. • Violate the law policies: “foreign firms should choose to transfer technology in line with the written policy/​law, which itself may be ambiguous or burdensome but nonetheless can at least generally be planned around”). Prud’homme et al. (2018) find that the design of FTT policies per se helps determine if they force (i.e., exert significant leverage over) frontier technology transfer, but also that the environment in which they are deployed is equally important. FTT policies appear to exert the most leverage over frontier technology transfer when accompanied by seven conditions (p. 155):

6  SEIs are central to the Chinese government’s ongoing indigenous innovation and larger economic catch-​up strategy (State Council, 2010; Prud’homme, 2016a, 2016b). In 2010, China’s central-​level government designated seven SEIs: (1) energy conservation and environmental protection, (2) new generation information technology, (3) biotechnology, (4) high-​end equipment manufacturing, (5) new energy, (6) new materials, and (7) new energy vehicles. In the same year, the target was set for SEIs' added value to account for 8% of China’s gross domestic product by 2015 and 15% by 2020 (State Council, 2010).

Innovation Strategies of Multinational Corporations    411

1. strong state support for industrial growth, 2. oligopolistic competition, 3. other policies closely complementing FTT policies, 4. high technological uncertainty, 5. policy mode of operation offering basic appropriability and tailored to industrial structure, 6. reform avoidance by the state, and 7. stringent policy compliance mechanisms.

Prud’homme et  al. (2018) conclude that in the absence of some of the conditions and strategies, some FTT policies spur only limited amounts of technology transfer, help spur transfer of technology but not frontier technology, and at worst discourage technology transfer. This means that foreign firms do have some choices, even if often invidious ones. The emphasis on the role of the Chinese government (Prud’homme et al., 2018) mirrors the finding in a different study on what is distinctive about Chinese-​ based MNCs (Ramamurti and Hilleman, 2018). That study concludes that one of four factors explaining the distinctiveness and success of the internationalization of Chinese MNCs (or CMNEs in their terminology) was “government-​created advantages, which complemented China’s natural endowments and for the most part improved CMNEs’ international competitiveness” (p.  35). Also, “The strategy of promoting national champions has turned many Chinese firms, state-​owned and privately owned, into global contenders in their respective industries. The government helped these firms to extract technology or other contributions from foreign multinationals, while offering them preferential access to capital and to the Chinese market” (p. 40).

Conclusion The role of FDI has been an important policy issue for China since the founding of the People’s Republic, and the government’s approach has evolved as the economy has matured. Every nation has the right to formulate a policy toward FDI, and in practice policies range from benign neglect to stringent control. As a country initially lacking a technological base, it was sensible for China to look for technology abroad, and after the market opening, FDI was embraced as a key vehicle to attract technology and innovation. In keeping with China’s pragmatic practice of experimenting with different trials, learning from experience, and adapting to results, its policies have evolved to a stronger emphasis on technology transfer. How best to ensure appropriate levels of technology transfer, however, entails viewpoints at opposite ends of a spectrum. That spectrum ranges from mandatory transfer (e.g., to a joint venture partner) in exchange for the foreigner’s access to the market, to contractual agreements for use of foreign IP, with protection of property rights and a range of mechanisms to effect transfer. Opinions on the best policies for effective transfer are influenced by the mixed evidence of spillovers from FDI into domestic capabilities, shown here. In our view, mandatory transfer is not the best way, unless the market prize being offered is extraordinary and there are technologically capable suitors to choose from.

412    McKern, Yip, and Jolly As concluded earlier, building indigenous innovation capabilities involves far more than acquiring IP: it requires a mature ecosystem of related elements that reinforce the absorption capacity. While the environment for IP protection in China has improved and continues to improve, it is not yet as strong as in the European Union or the United States, particularly regarding implementation. However, as Chinese companies have become more entrenched in global operations, they have become more conscious of the importance of IP protection. Chinese applicants for patents using the Patent Cooperation Treaty (PCT) process accounted for 18.5% of global applications in 2016, and two firms, ZTE and Huawei, were No. 1 and No. 2 respectively among the top patent PCT filers. In time this great growth of domestic IP will help strengthen the domestic regime, but there is a need for more to be done if MNCs are to be confident about their legal IP position. It is promising that the most recent announcements suggest a more protective regime for IP and the end of mandatory transfer. This would be a useful opportunity for China to experiment with a market-​oriented regime for technology transfer. It is to be hoped that the environment for MNCs in China will become more welcoming in practice, and one in which they will see benefit in entering into the local innovation ecology.

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Chapter 5.2

F oreign Tec h nol o g y Transfers i n  C h i na Xiaolan Fu and Jun Hou Introduction After experiencing decades of rapid growth, China has begun to transition toward a “new normal” in economic reform. This suggests that the economy has entered into a new phase in which the structure needs to be readjusted to support long-​term sustainable development. The former drivers of the economy (low-​technology manufacturing sectors) will be gradually replaced by the “new normal” drivers—​high technology and the service sector (Zhang et al., 2016). As the main driver of growth, innovation remains crucial to lead China’s transition to an innovation-​driven country. Innovation can be realized via different channels; the chosen sources of innovation and their effectiveness depend largely on the stage of development as well as the local social-​ economic settings. As a low-​income country typically has a population with low levels of education and near-​negligible capability in technological innovation, the foreign acquisition of innovation may be a practical and available route. Innovation is also characterized as a costly, risky, and path-​dependent process. It is therefore rational for technologically latecomer countries simply to acquire advanced know-​how created in technology frontiers (Barro & Sala-​i-​Martin, 1995; Eaton & Kortum, 1995; Grossman & Helpman, 1994; Romer, 1994; Jiang et al., 2020). On the other hand, when a country is fully developed and on the global frontier of technology, the primary source of innovation might then be indigenous innovation because it has the ability to engage in this endeavor (Fu et al., 2017). In recent years the mode of innovation is becoming more and more open and is making good use of external resources. International knowledge diffusion can, therefore, benefit firms’ innovation at every stage of the innovation process (Narula, 2003; Fu et al., 2011). In particular, emerging economies (e.g., China) have benefited tremendously from knowledge diffusions through international channels in regard to building up the initial technological capabilities. Yet, cross-​border technology transfers and diffusion are neither cost free nor unconditional. They rely on well-​directed technological efforts (Lall, 2001, 2005) and on absorptive capacity (Cohen & Levinthal, 1989). Furthermore, foreign technologies developed

416   Fu and Hou in industrialized countries may not be appropriate to the economic and social conditions of developing countries (Acemoglu, 2002; Atkinson & Stiglitz, 1969; Basu & Weil, 1998) due to their path-​dependent characteristics. A large number of literatures have proved that the foreign source of technology and indigenous innovation are coupled together in rather dichotomous terms (Liu & Buck, 2007; Liu & Zou, 2008; Fu et al., 2011; Li, 2011; Li & Wu, 2010; Hou & Mohnen, 2013). The unsolved puzzles here are to identify the optimal investment combination of different innovation sources across different levels of development and whether foreign knowledge is still valuable to a country where indigenous efforts have already become the primary innovation source. China’s rapid economic ascendance and fast catching up with the leading industrial countries have become a remarkable economic force influencing the world economy. During the past decade, China stands out for its unrivaled speed of economic growth against the backdrop of a worldwide recovery. By 2017, China was ranked the second-​ largest economy by nominal gross domestic product (GDP). Its average contribution rate to the global economy from 2013 to 2016 reached 31.6% (IMF). As the largest trading nation in the world, China is also the largest manufacturing economy and exporter of goods. It plays a prominent role in international trade. Through obtaining membership in the World Trade Organization (WTO) in 2001, China’s economy is becoming increasingly opened up to foreign investors and has become a popular investment destination, due to its abundance of low-​cost labor. China’s integration into the global economy opened up new channels for the acquisition of foreign knowledge, for example, outward direct investment, international innovation collaboration, and attraction of highly skilled migrants. Policy orientation also has become more aggressive in incentivizing indigenous companies to acquire advanced external knowledge through the “Going Global” and “Belt and Road” initiatives. At the same time, external sources such as foreign imported technologies and foreign direct investment (FDI) remain as important complementary sources in boosting innovation. The development path of China has important implications for the world not only in terms of its economic impact but also in terms of the experiences in guiding and promoting the growth process for other developing countries. This chapter reviews China’s experience of using different channels through which foreign technology is transferred and discusses the recent unconventional approaches used in acquiring foreign knowledge sources. Such experiences may provide valuable lessons for other lagging-​behind countries with regard to industrial, technology, and trade policies (Freeman, 2005).

International Technology Diffusion in China In developing countries, innovation concerns not only novel innovations but also innovation via diffusion of existing ideas and techniques. Cooper (1989) has pointed out that most firms in developing countries attempt to reach the technological frontier instead of achieving inventions that are new to the market. Domestic innovation activities are severely constrained in the majority of developing countries due to inadequate capital and

Foreign Technology Transfers    417

1.93% 1.68%

1.23%

2004

1.33%

2005

1.38%

1.38%

2006

2007

1.73%

2.03%

2.02%

2.06%

2013

2014

2015

2.11%

1.81%

1.45%

2008

2009

2010

2011

2012

2016

Figure  5.2.1 Total expenditure on R&D (%  of GDP) in China from 2004 to 2016, in percentages. infrastructure. Foreign technology sources have therefore been the primary driver of innovation for them and account for a large part of productivity growth, especially at the beginning of their industrialization. China’s innovation path was no exception. It has gone through a dynamic process in which foreign sources of knowledge have played a crucial role in particular at the initial stage, and in which the channels used for foreign technology transfer also evolved with the rapid development of China’s technological base. To understand the role of foreign knowledge sources in facilitating China’s innovation progress, it is worth looking back to the early years of reform. In the 1950s, the major source of technology for China was the former Soviet Union. After 1962, Western countries and Japan became the main technology suppliers for heavy industry. When the economic open-​ door policy was launched in 1976 to support the Four Modernization campaign, technology transfers were realized through diversified channels, including the purchase of turnkey plants and equipment, and in the form of disembodied technology including licensing, technical consulting, technical service, and coproduction. Adoption of the existing technology and learning by reverse engineering were the main innovation activities. In 1985, acquiring foreign technology was included in the science and technology system reform as one of the main technological sourcing strategies for promoting technology development. Technology transfer through FDI became a new focus and the capabilities of the high-​ technology industries increased considerably. After 1995, policies were designed to speed up the advancement of indigenous science and technology, for example, investing in research and development (R&D) infrastructures. This resulted in a radical increase of R&D units, from 7,000 in 1987 to 24,000 by 1998, and then to 46,000 in 2012 (National Bureau Statistics of China, 1992, 1998, 2013).1 In 2006, China declared indigenous innovation to be a strategic priority and started shifting its innovation focus from external acquisition of knowledge to internal creation of knowledge. This policy shift is reflected by Figure 5.2.1, showing that R&D takes a greater weight year by year. The total expenditure on R&D as a ratio of GDP grew from 1.23% in 2004 to 2.11% in

1  Source: Ministry of Science and Technology of the People’s Republic of China: http://​www.most. gov.cn/​eng/​.

418   Fu and Hou 3000

100 Million USD

2500 2000 1500 1000 500

19 9 19 0 9 19 1 92 19 9 19 3 9 19 4 95 19 9 19 6 9 19 7 9 19 8 99 20 0 20 0 01 20 0 20 2 03 20 0 20 4 0 20 5 06 20 0 20 7 08 20 0 20 9 10 20 11 20 1 20 2 1 20 3 14 20 1 20 5 16

0 Inward FDI

Outwrd FDI

Foreign contracted project

Figure 5.2.2  The inward FDI, outward FDI, and foreign contracted projects from 1990 to 2016, in US$100 million. 2016, surpassing EU282 (1.94% in 2016) and rapidly closing the gap with the Organisation for Economic Cooperation and Development (OECD) average (2.337% in 2016).3 Since the open-​door policy in the late 1970s, FDI into the Chinese mainland increased considerably and China has become one of the largest FDI recipients in the world during the past decades. A major objective of China’s opening up to FDI is to “exchange markets for technology.” Following the science and technology system reform, which began in 1985, the acquisition of foreign technology has been listed as one of the main strategies for technology development. FDI and imports are accordingly employed as major channels for foreign technology transfer. Membership in the WTO further opened China’s door to foreign investors, with inward FDI nearly doubled in the following seven years, from $49.6 billion in 2001 to $95.2 billion in 2008. During the global financial crisis, FDI dropped by over one-​third in 2009 but quickly recovered in 2010. Despite the economic slowdown in recent years, FDI, which excludes investment in the financial sector, maintained steady growth and peaked in 2015, reaching $126.27 billion. Simultaneously, China diversified its networks to obtain foreign technological knowledge. China is funding more Chinese participation in international innovation collaboration (foreign contracted projects) and encouraging Chinese firms to go abroad to invest in and acquire foreign technology companies. Figure 5.2.2 shows that, in 2016, outward FDI (OFDI) and foreign contracted projects reached $196.1 billion and $244 billion, respectively, while inward FDI was $126 billion. By the end of 2010, China had established formal science and technology relations with 152 countries and regions and signed 104 cooperation agreements (National Bureau of

2  The  EU-​ 28  is the abbreviation of European Union (EU) which consists a group of 28 countries (Belgium, Bulgaria, Czech Republic, Denmark, Germany, Estonia, Ireland, Greece, Spain, France, Croatia, Italy, Cyprus, Latvia, Lithuania, Luxembourg, Hungary, Malta, Netherlands, Austria, Poland, Portugal, Romania, Slovenia, Slovakia, Finland, Sweden, United Kingdom) that operates as an economic and political block. 3  Data source: https://​data.oecd.org/​rd/​gross-​domestic-​spending-​on-​r-​d.htm.

Foreign Technology Transfers    419 Statistics of China, 2011). An ever-​intensifying web of international connections has spread across every aspect of China’s innovation system. We think that international innovation collaboration and OFDI have a greater likelihood of creating radical novel innovations in Chinese firms than inward FDI. Fu and Balasubramanyam (2005) have found that the benefits to the technological and innovation capabilities of Chinese firms from inward FDI are limited, despite some learning by the indigenous partner in the joint ventures, and spillovers to local companies in the same and linked industries. Borrowing these historical lenses, the substantial role of the government in supporting the continuity of China’s innovation policy has been uncovered. The shift of innovation focus was intertwined with the country’s characteristics and economic needs across the different development stages. The marketized economy reform and becoming a WTO member in the early 21st century helped China to overcome some of challenges of the early years and further facilitated the design and implementation of innovation policies.

Trade and Technology Transfer Trade flows increase the likelihood of knowledge transfer and growth (Grossman & Helpman, 1991; Dollar, 1992; Fu, 2005; Fu & Ghauri, 2020; Schiff & Wang, 2006). Although the global pandemic in 2020 has increased the instability and risk of global trade environment (Duan et al., 2020), the development of digital tools and infrastructure which could potentially promote international trade has been accelerated at an unprecedented speed. A  high level of openness and integration in the global production chain allows firms in developing and least developed countries to better access the strategic assets (such as technology, skilled personnel and market, etc.) that would eventually lead to industry upgrading and technical change (Grossman & Helpman, 1991). On the one hand, when exporting to the global market, firms are provided with more incentives to upgrade technological capability and improve competitiveness. On the other hand, importing the advanced technology-​ embodied goods is expected to bring knowledge spillovers to the recipient firms. Forging trade relationships diversifies the channels for technology acquisition (Narula & Driffield, 2012). Through forward or backward linkages in the global value chain (GVC), advanced technological or efficient managerial practices are also expected to be diffused to domestic companies (Fu and Yang, 2009; Fu et al., 2012; Fu and Ghauri, 2020; Fu et al., 2021). First, trade openness allows for the inflow of imported products and exposes domestic producers to foreign competition. The imported capital equipment may be directly used for machinery upgrading and eventually contributes to the technological improvement in developing countries (Habiyaremye & Raymond, 2013). Cross-​country studies on bilateral import data suggest imports as an important channel for countries to acquire advanced technology and enhance competitiveness (Coe & Helpman, 1995; Fagerberg, 1994; Freeman & Soete, 1997). Specifically, trade increases the availability of intermediate inputs, which leads to the change in the technological levels of local firms. A greater variety of intermediate inputs allows domestic producers to choose cheaper, production-​compatible, and technologically appropriate inputs, which facilitates the improvement of technological efficiency (Feenstra et  al., 2005; Bernard et  al., 2003; De Hoyos & Iacovone, 2013). Incorporating the technologically advanced tangible intermediate inputs gained from

420   Fu and Hou exposure to exports into local production processes enables firms in developing countries to learn the embodied intangible ideas (Keller, 2004). A group of studies has focused on the rising availability of inputs that may encourage innovation in developing countries, such as in the case of Indian (Goldberg et al., 2010) and Chinese (Feng et al., 2012) firms. These authors argue that expanding the set of available inputs will directly influence the product and process innovation through a quality upgrading effect due to the presence of more diversified imported inputs (Bas & Strauss-​Kahn, 2013). A recent study of firms in Ghana finds that imports are reported to be the most important source of external knowledge for African firms (Fu et al., 2014). Second, “learning by exporting” is another channel to explain firms’ productivity improvement through the engagement of trade (Grossman & Helpman, 1991). Apart from market exploration skills, exporting requires exporters to offer competitive products that meet the quality standards set up by the importing countries. While exporting, firms in developing countries are able to upgrade their technological capability and production efficiencies through acquiring the feedback and technical assistance from importers in advanced economies. Through the expansion to foreign markets, firms may start exploiting economies of scale and increase their productivity (Fu & Balasubramanyam, 2005; Fu, 2005; Amighini & Sanfilippo, 2014; Fu & Ghauri, 2020). Relying on foreign markets can also help firms to better avoid shocks deriving from domestic demands. In addition, the high degree of competition in the global market will increase the firms’ incentive to innovate and become more productive. Although forming trading partnerships provides learning opportunities for developing countries, the extent of knowledge that can be translated into local use would be a function of the levels of technology content a trading partner provides and the technology gap between domestic and frontier firms (Kokko, 1994; Amighini & Sanfilippo, 2014). Technology transferred through imports of machinery and equipment is embodied in this machinery. Products that used these imported machines will probably be of higher quality, but this does not mean that developing countries thus necessarily master the technology of designing and producing those advanced machines. Substantial technological learning and reverse engineering are required to grasp the technologies embodied in the imported machinery (Fu et al., 2011). Li (2011) empirically investigates the effect of three types of investment in acquiring technological knowledge (in-​house R&D, importing foreign technology, and purchasing domestic technology) on the innovation output of Chinese domestic firms in high-​tech industries over the period 1995–​2004. The results show that purchasing foreign technology alone does not improve the technological capability of domestic firms, unless it is coupled with adequate indigenous innovation efforts. On the contrary, domestic technology purchases alone are found to contribute to innovation, suggesting that indigenous technology can be more easily absorbed by domestic firms (Fu & Zhang, 2011). Previous literature also emphasized that industry heterogeneity may shape the probability and intensity of trade-​induced technology transfer (Melitz, 2003; Bernard et  al., 2007). In industries where a country is likely to have comparative advantages, relatively more capital and production resources are allocated. The learning effects from trade therefore are likely to be higher, especially when technological distance with the trading partner is closer. Edwards and Jenkins (2005) found that firms in labor-​intensive industries are more severely affected by the competition effects caused from Chinese imports and may be more responsive to the increased competition through learning that raises productivity.

Foreign Technology Transfers    421 Regarding the exporting firms in these industries, they have built up a certain capability to compete with foreign producers and for better responding to external market shocks. Therefore, the technological impacts will be greater in industries in which the country has a comparative advantage than those farther away from its comparative advantage.

Acquiring International Technology through Licensing The open innovation concept has sketched a new landscape for technology transfer and knowledge diffusion (Chesbrough, 2003, 2011; Van Haverbeke & Cloodt, 2006; Wang et al., 2012). Firms from emerging economies (e.g., China) are taking advantage of the inbound open innovation and increasingly acquiring foreign knowledge from overseas to accumulate and strengthen technological competencies (Wang et al., 2012). One of the key channels China has adopted to tap into foreign sources of knowledge is through direct technology purchasing, including licensing agreements. Accessing foreign knowledge sources has long been recognized as an important facilitator to accelerate China’s technological upgrading. The importance of acquiring technology via embodied products and equipment has been intensively discussed in previous studies (Coe & Helpman, 1995; Grossman & Helpman, 1991; MacGarvie, 2006). By contrast, findings in regard to the role of licensed disembodied intangibles were scarce. The channels through which the trade in intangibles, including a range of intellectual properties such as patents, know-​how, trademarks, copyrights, brands, and trade secrets, are still to be investigated (Fu, 2018; Fu & Ghauri, 2020). Fu (2018) emphasized that globalization is not constrained to increasing interaction and integration of the flow of goods, investments, and services, but also increases the flow of intangibles, which is more complicated to trace and measure. The purchases of intangible assets, including design knowledge, formulae, drawings, processes, patents, and know-​ how, all closely related to new product development, can be obtained via licensing. These assets do not include the technology-​embodied products, machinery, and equipment. Technological licensing is substantially different from the import of foreign machinery and equipment used directly for production, such as production lines, complete knock-​down kits, and turnkey facilities (Liu & White, 1997; Li, 2011). Licensing disembodied technologies can be obtained from both external and local technology providers such as research institutes and universities and high-​tech or R&D firms (Li, 2011). China has actively engaged in cross-​border licensing activities since the early stage of the economic transition and opening up. Chinese industries and sectors started to emerge following a large amount of investment in purchasing foreign technological licenses. Being a licensee allows Chinese innovators to get access to the intellectual property on the basis of agreed-​upon terms and conditions (Grindley & Teece, 1997). Li (2010) suggests that technology imported from foreign countries and domestic technology via technology licensing from universities, research institutes, or other domestic firms have significantly contributed to the technology capability improvement among Chinese firms. Borrowing from this channel, China has effectively strengthened the domestic knowledge

422   Fu and Hou base by integrating the foreign licensor’s advanced know-​how into the country’s own knowledge pool (Lin, 2003). Novel innovations are likely to emerge from such a recombination process, and technology licensing therefore is acknowledged as an effective way to stimulate technological upgrading. In addition, engaging in licensing activities may force the licensee to reinforce R&D efforts to better assimilate and transfer the licensed foreign technology. These efforts, such as setting up R&D labs and increasing the number of R&D scientists and engineers, will consequently contribute to the improvement of the licensee’s technological capabilities (Lee & Lim, 2001; Wang et al., 2012; Fu et al., 2021). As shown in Figure 5.2.3, the expenditure on imported technology was almost halved during the review period, declining from 0.08% of GDP in 2004 to 0.04% of GDP in 2016. The total expenditure on importing foreign technology has two components: (1) expenditure on direct technology purchases, which to some extent reflects the level of licensing, and (2) expenditure on imported equipment. Before 2009, Foreign Technology Imports (FTI) to China included both direct technology licensing and purchasing technology-​embodied machinery and equipment. The expenditure of embodied purchasing then started declining and was less than 0.01% of Chinese GDP in 2016. Figure 5.2.3 also suggests that the country has gradually reduced its dependency on importing equipment since 2006, which is a strong signal of the emergence of domestic technology suppliers and improvements of indigenous technological capability. Several empirical studies have confirmed the contribution of FTI to productivity and growth in China (Liu & White, 1997; Hu et al., 2005; Liu & Buck, 2007; Li & Wu, 2010; Li, 2011). Liu and Buck (2007) found that “learning by FTI” can directly accelerate a Chinese firm’s innovation potential, measured by new product innovation, independent of internal absorptive capacity. By contrast, many studies suggested that the contribution of FTI to the innovation of firms in a developing country is subject to the level of absorptive capacity. Liu and White (1997) found that Chinese firms can benefit from purchasing foreign technology in highly innovative industries. Yet, imported technology alone did not yield positive returns on a firm’s new product sales. Similar results were found by Li and Wu (2010). Adopting region-​industry-​level data, the authors found that the innovation impact of FTI on Chinese firms is strongly dependent on the level of R&D investment. 0.10% 0.09% 0.08% 0.07% 0.06% 0.05% 0.04% 0.03% 0.02% 0.01% 0.00%

0.09%

0.08% 0.08%

0.08%

0.08%

0.08%

0.07% 0.06%

0.05%

0.05%

0.05%

0.03% 0.02%

0.02%

0.08%

0.05%

2005

0.06% 0.07%

0.06% 0.05%

0.05%

0.05%

0.05% 0.04%

0.04%

0.04%

0.04%

0.05%

0.03% 0.02% 0.01%

2004

0.05%

2006

2007

2008

2009

Import technology/GDP

0.01%

2010

0.01%

2011

Tech/GDP

0.01%

2012

0.00%

2013

0.00%

2014

0.00% 0.00%

2015

2016

Equip/GDP

Figure  5.2.3 The expenditure on importing technology to China from 2004 to 2016 (% of GDP).

Foreign Technology Transfers    423

Inward FDI and Technology Transfer Foreign technology can be transferred between firms and across regions and countries through various transmission mechanisms. One of the most commonly acknowledged approaches is to attract technology-​embodied multinationals (Dunning, 1994; Lall, 1992). Multinational enterprises (MNEs) are treated as the major driver of R&D in the world (Fu et al., 2011). Their physical presence influences the host country in various ways and may also reshape the domestic economy and linked industries. One of the most evident impacts is the competition effect (Newman et al., 2015). The arrival of FDI is expected to yield intensive competition and push inefficient firms to exit the market and force the surviving ones to engage in innovation to be competitive. Meanwhile, linkages with domestic companies will take place in both formal and informal forms, and spillovers may also occur. Horizontal technology spillovers may occur from foreign investing firms to other firms in the same industry and/​or the same region via demonstration effects and the movement of trained labor from foreign to local firms (Caves, 1974; Fosfuri et al., 2001; Fu et al., 2011; Eapen, 2012; Fu et al., 2021). There may also be vertical technology spillovers taking place between foreign and local suppliers and customers within the value chain through forward and backward linkages (Javorcik, 2004; Pietrobelli & Rabellotti, 2007; Pietrobelli & Saliola, 2008; Saadi, 2011; Fu et al., 2011). Moreover, FDI is expected to help a host country to strengthen its comparative advantage via asset accumulation and improve indigenous firms’ exporting capability via technological upgrading (Fu, 2011; Newman et al., 2015). In addition, MNEs’ headquarters are also found to have internal incentives to encourage cross-​board knowledge flows and share technology subsidiaries from different locations (Markusen, 2002; Buckley et al., 2006; Harzing & Noorderhaven, 2006; Eapen, 2012; Brandt & Rawski, 2019). Despite the possible benefits of knowledge transfer and spillovers initiated by FDI, a negative impact may also be revealed if the local industry is incapable of competing with MNEs (Aitken & Harrison, 1999; Hu & Jefferson, 2002; Fu et al., 2011; Xia & Liu; 2017; Fu et al., 2020). Such strong competition from foreign subsidiaries may also reduce local firms’ R&D efforts and consequently impede technological upgrading in the domestic firms (OECD, 2002). Using a panel of Chinese high-​tech firms during 2001–​2007, Xia and Liu (2017) uncovered a U-​shaped relationship between foreign competition and private firms’ innovativeness, and their findings suggest that the impact of foreign competition on the innovation performance of domestic firms may vary depending on the characteristics of the firms. With the absence of a domestic supply chain, foreign subsidiaries may need to seek inputs from foreign sources and therefore remain as enclaves in the host country with a lack of effective linkages with the local economy (Fu et al., 2011). Fu (2004) finds that processing trade-​oriented FDI in coastal regions of China generated limited linkages and weak spillovers across the regions, which exacerbated the existing regional inequalities in China. Using a large firm-​level panel dataset from China, Fu and Gong (2011) find depressive effects of foreign R&D labs on local firms in China. This is likely due to the strong competition for talents, resources, and markets between foreign and indigenous firms, and to the limited linkages between foreign and local firms. Most of the foreign R&D labs indicated that they have no intention to collaborate with local firms, universities, or

424   Fu and Hou research institutions due to concerns regarding intellectual property rights (IPR) protection (Zhou, 2006). There are many necessary preconditions to meet for an effective technology transfer process, including trade policy (Balasubramanyam et al., 1996); legal and regulatory policies, especially those related to IPR; and sufficient linkages between foreign and local firms. Aitken and Harrison (1999) suggested that heavy restrictions on foreign investors and import substitution policy provide foreign affiliates with low incentives for technology transfer. Meanwhile, foreign firms are reluctant to directly apply core technology into their subsidiaries if the host economy suffers from weak IPR protection. Equally, they are also skeptical about undertaking innovation activities (e.g., R&D) in an environment with a weak IPR regime. Based on a panel dataset on Chinese manufacturing firms in 1998–​ 2007, Zhang et al. (2014) showed that the presence of MNEs in an industry yields positive spillovers on domestic firms in the same industry and that such spillovers are stronger when the foreign firms have lower export intensity and lower barriers to imitation. FDI with different characteristics also benefits technology transfer to a different extent. For example, we expect that investments made by R&D-​intensive MNEs from R&D active countries will ceteris paribus transfer more technology. Technological gaps between foreign and local firms also matter. The relationship between the strength of spillovers and the technology gap follows an inverted-​U shape. Spillovers are found to be present when the technology gaps are moderate or when they are much larger (Kokko et al., 1996; Meyer, 2004). Finally, the most necessary condition for effective technology transfer is a sufficient level of absorptive capacity, which is defined as the ability of an organization to identify, assimilate, and exploit knowledge from its surrounding environment (Cohen & Levinthal, 1989; Girma, 2005; Fu (2008)). Fu and Gong (2011) used a firm-​level panel for the period 2001–​2005 to investigate the sources/​drivers of technology upgrading in China. Their findings suggested that indigenous innovation is crucial to improve the dynamic technological capabilities of local firms. FDI has served as an additional source to acquire advanced foreign technology via their global linkages (e.g., suppliers of machines and equipment). Nevertheless, R&D activities undertaken by MNEs yield negative impacts, which impede local firms’ technical improvement. The extent of technology spillovers from FDI may also be geographically bounded (Audretsch, 1998; Audretsch & Feldman, 1996; Jaffe et  al., 1993; Fu et  al., 2011; Fu et  al., 2021). The knowledge spillovers created by foreign subsidiaries tend to be circulated among the firms linked to that specific industry (Marshall, 1920; Krugman, 1991). Previous studies (Chen, 2008) revealed that in locations with a strong clustering of innovative foreign firms operating in China, local firms are likely to take advantage of knowledge spillovers and become active in product innovations. However, no general evidence of industry-​level spillovers from FDI in the high-​technology industries emerges from their analysis, after controlling for firm-​and location-​level effects, suggesting that clustering of innovation activities by foreign firms has a knowledge spillover impact on local firms (Sasidharan & Kathuria, 2011). Generally speaking, empirical evidence suggests that FDI and the linkages with MNEs have been beneficial for technology transfer and technological upgrading of domestic Chinese firms. The positive spillovers are subject not only to the characteristics of domestic sectors, such as the technology intensity (Fu & Gong, 2011) and the absorptive capacity (Liu

Foreign Technology Transfers    425 & Buck 2007; Fu (2008)), but also to the characteristics of the linkages, such as clustering (Thompson, 2002), subsidiary capacity, and intent (Wang et al., 2004).

Internationalization of R&D and Technology Transfer Aiming to upgrade technological capability and enlarge the talent pool, many developing and developed countries strive to introduce various selective policies to attract R&D-​ related FDI (Fu et  al., 2011). At the same time, the motives for MNEs investing in R&D overseas have been intensively discussed; they include market-​driven motives (i.e., exploitation of a firm’s technologies abroad by applying those technologies to the local context to expand in the foreign market) (von Zedtwitz & Gassmann, 2002; Di Minin et al., 2012) and technology-​driven motives (i.e., exploration of a firm’s technologies through access to foreign technology) (Belderbos, 2003; Wu & Callahan, 2005; Motohashi, 2006; Castellani et al., 2013). Accompanied by the country’s increasing global influence and the acceleration of OFDI, China has rapidly transformed from a host country of international R&D into a home country to invest in overseas R&D centers (Chen et  al., 2011). Large Chinese MNEs, in particular the leading high-​tech companies, have successfully advanced their technological competitiveness by undertaking overseas R&D investment. One prominent example is the internationalization of Huawei’s R&D, which is indispensable to the company’s success in global expansion. By 2018, Huawei had a total of 36 joint innovation centers and 14 R&D institutes around the world. As the company’s major innovation hub outside of China, Huawei European R&D centers have received over $1 billion in investment over the past two decades, and the company also actively engaged in collaboration with more than 140 European universities and research and consulting institutes. The company has now become one of the world’s largest patent holders, mounting 87,805 by the end of 2018.4 As Chinese MNEs continue to expand their foreign presence, there has been a growing interest in the global technological learning and cross-​border innovation activities of Chinese MNEs (Di Minin et al., 2012). Following the “asset-​seeking” perspective and “latecomer catch-​ up process,” several studies (Child & Rodrigues, 2005; von Zedtwitz, 2006; Deng, 2007; Gao et al., 2007) stressed that cross-​border R&D investment as part of Chinese OFDI serves the aim to cultivate innovation capability and strengthen competitiveness. Meanwhile, the internalization theory and resource-​based view suggest that a firm-​specific advantage can best be exploited internally by multinational subsidiaries (Hennart, 1989; Rugman, 1981; Di Minin et  al., 2012). Thus, overseas R&D centers are required to facilitate Chinese MNEs’ local operations. Even though the core technologies are borrowed from parent companies, studies have shown that product adaptation and satisfying local customers’ demand were the main functions of international R&D centers (Patel & Vega, 1999). Moreover, firms are 4  Data source:  2018 Annual Report published by Huawei Ltd, https://​www.huawei.com/​en/​press-​ events/​news/​2019/​3/​huawei-​2018-​annual-​report.

426   Fu and Hou also expected to tap into foreign advantageous knowledge bases in various locations and enlarge their knowledge pool (Kuemmerle, 1997, 1999; Castellani et al., 2013). Overseas R&D units are therefore expected to help the learners from developing countries (e.g., China) seek technologies that are unavailable in their home countries (Bas & Sierra, 2002). By studying five cases, Di Minin et al. (2012) explained that the motive of Chinese MNEs undertaking R&D activities in developed countries is to catch up in the technological frontier by learning from them. The overseas R&D units serve as a learning hub to upgrade technological competence. The authors also pointed out that these R&D units gradually fit into the innovation system of the host country and act as knowledge contributors. Evidently, the growing trend of R&D internationalization from China is believed to continue. Yet, successful stories like Huawei are scarce. Internationalization of Chinese MNEs’ R&D has its own features, which are different from those of MNEs of developed countries. When undertaking overseas R&D investment, the majority of Chinese MNEs are still facing persistent barriers and challenges such as lack of local business integration, novelties in products, and management expertise (Steinfeld, 2004; Shimizutani & Todo, 2008; Chen et al., 2011). Chen et al. (2011) also pointed out that urgent reforms are needed to improve the system for science and technology policies to support China’s R&D internationalization. Meanwhile, entry barriers imposed by host countries remain persistent given that the potential technology spillovers brought by the foreign R&D are still inconclusive. Evidence (Chang et al., 2006; Zhou, 2006) has shown that foreign R&D centers are reported to have limited interest in sharing knowledge with domestic firms and R&D labs. Fu and Gong (2011) also found that R&D activities of foreign invested firms at the industry level exert a negative spillover effect on the technical change of indigenous firms. Foreign R&D activities may well intensify competition for the limited domestic talent pool (Chang et al., 2006) and crowd out indigenous firms from local labor, resources, and product markets.

Integration into GVC and Technology Transfer International knowledge and innovation exchange and collaboration, through, for example, interfirm and intrafirm networks and GVCs, have a significant impact on the innovation and technology upgrading of those firms that successfully integrate in the GVC. Firms from developing countries that are embedded in the GVCs are forced to upgrade their technology capabilities so that their products and services can meet international standards (Zhuo & Zhang, 2008; Pananond, 2013; Morris & Staritz, 2017). By means of upstream or downstream linkages, foreign partners sometimes provide technical assistance via employee exchange, training, and financial support (Zhuo & Zhang, 2008; Pananond, 2013). Local firms can therefore get access to advanced know-​how and enhanced innovation. Empirical evidence has shown that participation in GVCs has produced significant technology transfer for industrial upgrading to domestic firms (Pietrobelli & Rabellotti, 2007; Wu & Li, 2010; Pananond, 2013; Sass & Szalavetz, 2013; He, Khan, & Shenkar, 2018). Yet, the question of whether participating in GVCs is a feature of technology acquisition or a curse described as “locking in” low-​value-​added functions remains unanswered.

Foreign Technology Transfers    427 Participation in GVCs may exert a detrimental effect that blocks technology transfer to firms in developing countries (Zhuo & Zhang, 2008; Kaplinsky, Terheggen, & Tijaja, 2011). Pietrobelli and Rabellotti (2011) suggested that the different characteristics of the value chains have an impact on the mechanisms of learning prevailing in the chain. The learning mechanisms can be very different in the various forms of governance the chain may have: they can be the result of pressure to accomplish international standards or they can be facilitated by a direct involvement of the chain leaders when the competence of suppliers is low and the risk of unsatisfactory compliance is very high. When the competences among actors in the chain are complementary, the learning mechanism is mutual and based on intense face-​ to-​ face interactions. In more recent studies, evidence also revealed that knowledge flow within GVCs is subject to the types of GVCs, and the extent to which the learning occurs also varies across different types of industries (Palpacuer et al., 2005; Sass & Szalavetz, 2013; Pipkin & Fuentes, 2017; Morris & Staritz, 2017).

Recent Proactive Approaches to Acquire Foreign Technology OFDI OFDI has been acknowledged as an effective way to enhance innovation capability because it not only offers companies the opportunities to get access to foreign codified knowledge, as trade does, but also facilitates the transmission of tacit know-​how by spatial proximity, social embeddedness, and mobility of skilled workers (Polanyi, 1966, 1967; Uzzi, 1997; Dhanaraj et al., 2004; Narula & Santangelo, 2009). OFDI has not only acted in a conventional way to seek new markets but also served as a strategic asset-​seeking channel for exploiting learning opportunities and building innovation capabilities (Child & Rodrigues, 2005; Mathews, 2006; Luo & Tung, 2007). Given these potential advantages, Chinese firms have extensively engaged in strategic asset-​seeking activities in advanced countries to acquire innovation resources through OFDI (Wang, 2002; Deng, 2007; Burghart & Rossi, 2009). OFDI is also regarded as an effective practice to help developing countries to catch up with the technological frontiers and overcome the lack of advanced technology in their home country (Child & Rodriguez, 2005). Following the announcement of a “going out” strategy at the beginning of this century, many Chinese firms have rapidly expanded their overseas investment, penetrating the market previously dominated by established Western MNEs (Zhang et al., 2010; Peng, 2012; Gu & Reed, 2013). The expansion of Chinese OFDI was further enhanced by a series of policies, including the promotion of the internationalization of renminbi as well as the “Belt and the Road” initiated by the central government in 2013. As a consequence, China has now emerged as a primary FDI-​originating country after three decades as a major recipient of FDI. Previous studies have exploited the potential innovation gains of Chinese FDI (Buckley et al., 2007; Wang et al., 2012; Cui et al., 2013; Fu et al., 2018; Brandt & Rawski, 2019). Fu et  al. (2018) adopted panel data from Guangdong to investigate the impact of OFDI on Chinese firms’ innovation performance back home and uncovered that

428   Fu and Hou participating in OFDI enhances their innovativeness, measured by new product sales. Yet, enhanced innovation through OFDI does not accrue automatically and requires Chinese MNEs to exert continuous effort to explore host-​country resources via various channels (Dunning, 1988; Niosi, 1999; Fagerberg, 2005), as well as to build up compatible absorptive capacity to facilitate reverse knowledge flows (Cohen & Levinthal, 1989; Fu et al., 2008). Their empirical findings suggest that innovation gains via undertaking OFDI involve the presence of contextual factors, including the knowledge environment of a host country and industry dynamics, and certain firm characteristics, such as firms’ strategic orientation, absorptive capacity, and past experiences (Levitt & March, 1988; Jerez-​Gomez et al., 2005).

Returnees and Technological Spillovers The mobility of high-​skilled workers is normally accompanied by knowledge flows. As globalization intensifies, transnational skilled workers (i.e., scientists and engineers) become an important carrier to transfer and diffuse knowledge across national borders (Saxenian, 2006; Liu et al., 2010). Returnees represent a key source of knowledge and network-​based resources due to their acquired skills and confidence with world-​class technologies and overseas markets, and their presence contributes to upgrading firms’ competitiveness (Gao et  al., 2013). Given the tacit nature of such knowledge, it is possible to identify different ways through which the returnees can induce technological spillovers. First, high-​skilled returnees may have acquired academic knowledge in the form of general education, scientific and technical training, and practical business skills that relate to innovation and performance, especially among small and medium-​sized enterprises (Westhead et al., 2005 Liu et al., 2010). Second, most of the high-​skilled returnees who are involved in business activities affirm that they have kept a strong overseas network (Cooper & Yin, 2005; Wang et al., 2011). Such a network is valuable in regard to providing innovation information and resources for domestically developed firms (Davidsson & Honig, 2003). Moreover, workers with foreign experiences in high-​technology industries may serve as a new channel for international knowledge spillovers by bridging the gap between domestic players and foreign technological frontiers (Saxenian, 2006; Liu et al., 2010). Since 1978, about half of the 2 million students who went abroad came back to China, a trend that has increased rapidly in the last few years. China has benefited tremendously from the recent phenomenon of “reverse brain drain,” just like the economies of South Korea and Taiwan did in the late 1980s. These returnees have played an important role in the development of some high-​technology industries and the strategic emerging industries such as renewable energy, electric cars, and biotechnology (Wang, 2012). Highly skilled returnees are strongly represented in the top management of some of the most internationalized investors, including Lenovo and the China Investment Corporation (Luo et al., 2013; Wang, 2012). Previous research has demonstrated that the presence of returnee entrepreneurs positively affects innovation of Chinese firms (Wang et al., 2011; Luo et al., 2013). Liu et al. (2010) suggested that the presence of returnees acts as a new channel for international technology transfer that facilitates both direct technology transfer and indirect technology spillovers to other local firms by using a panel from high-​tech firms in Beijing. Wang et al. (2011) also revealed that Chinese students with overseas backgrounds are not only playing a leading role

Foreign Technology Transfers    429 in many aspects of China’s “going out” strategy but also serving as an alternative solution to build technological capacity for Chinese indigenous firms.

Indigenous Innovation Efforts and Appropriate Technology Throughout the last 30 years of high economic growth, China has consciously strived to move from being an imitative latecomer in technology to become a dynamic independent innovator in technology. China’s road to indigenous innovation is characterized by a steady stream of new science and technology programs initiated by the state. The huge increase in technological capability has doubtless played an important part in transforming China from a low-​to a middle-​income country (Zhang et al., 2016). However, unless China keeps moving up growth trajectories that are increasingly skill intensive and technology intensive, it risks being caught in the middle-​income trap, where there would not be a narrowing of the technological gap between China and the most technologically advanced foreign countries (Fu et al., 2016; Jiang et al., 2020). To successfully upgrade technological capability, China has adopted an open innovation approach that includes dual knowledge sources (Figure 5.2.4). Before the reforms in the 1980s, the science and technology system in China was a closed innovation system that was inspired by the example of the Soviet Union (Xue, 1997). Since the start of opening up and reform in the 1980s, China has been implementing an open national innovation approach.

Dual-sourcing strategy for innovation

Foreign technology Acquiring technology from Soviet Union

Before 1980

( Open up diverse external channels )

Identifying foreign technology as one of the main sourcing: expansion of FDI

1980–1990 Key Technologies R&D Program; Spark Program; Torch program

Help absorption of

Indigenous effort foreign technology

Diversifying external sourcing channels: outward FDI, international cooperation etc.

1990–2000

Attracting returnees; Thousand talents programme; Internationalization of Renminbi

2000–2010

Revitalizing the nation through Indigenous science and education; 973 innovation strategy Programme;

Help 1) absorption of foreign technology; 2) establish innovation infrastructure

Break through the bottleneck of foreign technologydependency

Outward FDI; Overseas R&D centre; The Belt and the road; High-tech FDI

2010–2018 Strengthen indigenous technological capability

Indigenous efforts as the main source of innovation and compliments various foreign sources.

Multiple driving force: state, private sector and MNEs; Supportive institutional settings

Figure 5.2.4  Dual-​sourcing strategy for innovation.

430   Fu and Hou There has been investment in indigenous innovation over the years but with varying efforts at different stages of development: a small amount at the start that was mostly spent on absorption of foreign technology and development, followed by an emphasis on indigenous innovation starting in the late 1990s while maintaining a high level of openness to external knowledge. The system has even become more active in knowledge sourcing since 2000 (Figure 5.2.4), using unconventional channels that are not often used in developing countries, for example, outward direct investment, international innovation collaboration, and attraction of highly skilled migrants. With the wider coverage of globalization and the growth in the technological capabilities of Chinese firms, policy orientation has become even more open and aggressive in incentivizing indigenous companies to acquire advanced external knowledge by OFDI, highly skilled returnees, and overseas R&D centers. At the same time, external sources such as foreign imported technologies and inward FDI remain important complementary mechanisms in boosting innovation. Despite the possible benefits from international technology transfer, catch-​up following this trajectory may still fail because (1) there is not enough indigenous capability to absorb and translate the foreign source into local use and (2) foreign technology may not fit the specific socioeconomic and technical context prevailing in the technology recipient. Foreign technology purchasing is one thing, but being able to use it fully is another. Technological adoption is not a straightforward task even when one has prior technical training in the activity into which the new production technology is introduced (Fu et al., 2017). Thus, the extent to which a country can absorb new foreign technology depends positively on its indigenous technological capacity, and there is synergy between foreign sourcing of innovation and indigenous generation of innovation (Fu et al., 2011). Previous literatures have paid great attention to discussing the potential complementary versus substitutive relationships between foreign technology sourcing and indigenous innovation efforts. One view is that internal R&D and external technology are substitutes. If R&D and technology transfer have independent and similar effects on a firm’s innovation performance, we should expect to find the two types of innovative activity relating as substitutes, because an increase in either of the two choices tends to lower the spending incurred on the other one (Hu et al., 2005; Hou & Mohnen, 2013). Several studies on Indian manufacturing firms supported this view and revealed a substitutive relationship between technology imports and R&D efforts (Fikkert, 1993; Basant & Fikkert, 1996; Katrak, 1997). An alternative view is that in-​house R&D and external technology purchasing are complementary strategies. A crucial condition to obtain effective technology transfer into developing countries is their level of absorptive capacity. In this sense, parallel indigenous innovation efforts are complementary with international technology diffusion. Among the empirical studies with Chinese firm-​level data, most findings confirmed the synergies between in-​ house R&D and foreign technology sourcing (Liu & Buck, 2007; Liu & Zou, 2008; Li, 2011; Li & Wu, 2010; Hou & Mohnen, 2013; Fu, 2018). With regard to FDI, only in the presence of local innovation capacity will MNEs adopt a more integrated innovation practice, which has greater linkages with the local economy and thereby enables greater opportunities of knowledge transfer (Franco et al., 2015; Li et al., 2014). Moreover, technical change is often biased in a particular direction and so the foreign technologies developed in industrialized countries may not be appropriate to the economic and social conditions of developing countries (Atkinson & Stiglitz, 1969; Fu & Gong,

Foreign Technology Transfers    431 2011). Many developing countries use technologies developed in the North, but the factor endowments in the South are significantly different from those in the North. Therefore, these advanced technologies, no matter whether imported or transferred through FDI, will be inappropriate to the conditions in the South, and hence less productive (Acemoglu, 2002; Acemoglu & Zilibotti, 2001). The direction of technical change and, therefore, the inappropriateness of the foreign technology used in the South provides a powerful explanation of the increasing income gap across countries. This issue is especially important for the middle-​income countries trying to catch up. Although imported technology may contribute to economic growth, the South, using inappropriate technology, will grow at a slower rate than the North, and the income gap will persist or even rise.

Conclusion This chapter discusses the international technology transfer in China. It tries to explore in depth the role of foreign technology sources in technological upgrading and catching up, and its interactions with indigenous innovation efforts. China’s catching up with the leading industrial countries has been heavily dependent on foreign sources of knowledge at the initial stage, while it has also progressively accumulated technological capability through various indigenous efforts. Exporting to the global market forces the domestic Chinese firms to become innovative and competitive, whereas importing the advanced technology or embodied goods is expected to exert spillovers on new product and process innovation. Meanwhile, through forward or backward linkages in the GVC, advanced technological or efficient managerial practices are also expected to be diffused to domestic companies (Fu, 2012). A high level of openness and integrating in the global economy by engaging in trade allow Chinese firms to better access both tangible and intangible knowledge assets, which will eventually lead to the nation’s industry upgrading and to technological improvement. Another equally important source of foreign knowledge is generated by multinationals while conducting their cross-​border investment activities. As a major recipient of FDI, technology is transferred from MNEs to domestic Chinese firms formally (and informally) via both horizontal and vertical linkages. Despite the trend of shifting from low-​tech labor-​ intensive manufacturing to attracting high-​tech MNEs, FDI is still treated as a major source of foreign technology for the country’s technology capability upgrading. The evidence has also shown that the benefits of international technology diffusion can only be delivered with parallel indigenous innovation efforts (Li, 2011; Fu, 2008; Fu et al., 2011)  and the presence of modern institutional and governance structures and a conducive innovation system (Sasidharan & Kathuria, 2011; Pietrobelli & Rabellotti, 2011). In this sense, indigenous and foreign innovation efforts are complementary. Without proactive indigenous innovation efforts, foreign technology remains only static technology embedded in imported machines, and it will never turn into real indigenous technological capability. Experiences from China suggest that, to maximize the benefits from innovation and accelerate catching up, the explicit and well-​focused encouragement of indigenous innovation and acquisitions of foreign knowledge must work in parallel (Fu & Gong, 2011). Neither autonomous innovations nor FDI-​reliant strategies can be used independently (Lall, 2003; Pietrobelli, 2000). Fu et al. (2011) emphasized that relying solely on one of them would not

432   Fu and Hou be optimal for technological capability development and catching up. The Chinese model of relying on dual sources proposes a strategy to maximize the benefits for the developing country. How to select and shape the best combinations at different stages of development and for different countries and industries is a question of utmost relevance for future research.

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Chapter 5.3

China’s Internat i ona l M igration:  Stat u s a nd C haracteri st i c s Huiyao Wang Introduction This chapter provides an overview of China’s role in global migration flows, as both one of the largest sources of international migrants and an increasingly popular destination for work, travel, or study. The chapter reviews key trends related to China’s outbound and inbound migration, including geographical distribution, citizenship and visa issues, employment, and other forms of migration. It also summarizes relevant policy and institutional developments, including the recent creation of China’s National Immigration Administration. Finally, the chapter outlines a series of measures to improve migration governance, raise global competitiveness for talent, and enhance international cooperation on migration. It is proposed that China play a larger international role in this field and promote a more person-​centered approach to global migration governance.

China as One of the Four Biggest Sources of International Migrants “Belt and Road” Nations Increasingly Important Destinations for Chinese Migrants In 2015, UNESCO statistics on the numbers of international migrants by country showed that the total number of migrants originating from mainland China, excluding those from Hong Kong and other nonmainland territories, numbered 9,546,100 (including the 2,307,800 who

442   Wang 2500

Thousands

2000 1500 1000 500

US Ca A na d Ja a pa Au n str Si alia ng ap or e Ita ly Ba U ng K lad es Sp h ai Fr n an Ge ce rm a Th ny Ne aila w n Ze d ala n Ko d In rea d Ne one th sia er lan Ru ds Ph ssi ili a pp M ines ya nm Sw ar ed en

0

Figure 5.3.1  The top 20 destination countries for mainland Chinese migrants (2015). Data Source: United Nations Department of Economic and Social Affairs

live in Hong Kong and 281,600 who live in Macao),1 next only to India (15,575,700), Mexico (12,339,100), and Russia (10,576,800), which together with China make up the four top origin nations of international migrants (United Nations 2015). Among Chinese migrants, Asia is the top continent destination with 5,441,700 Chinese migrants migrating there in 2015, followed by North America (3,284,100), Europe (1,169,200), Oceania (658,300), South America and the Caribbean (123,400), and Africa (51,000). The distribution of Chinese migrants between developed and developing nations was relatively even, with 5,755,200 migrating to developed nations and 4,972,400 to developing nations. The five major destinations for mainland Chinese migrants in 2015 were the United States (2,103,600), Canada (711,200), Japan (652,400), Australia (451,100), and Singapore (448,600). Furthermore, among the top 20 destinations for Chinese migrants, seven were nations along the “Belt and Road”:  Singapore (448,600), Bangladesh (177,800), Thailand (100,300), Indonesia (70,300), Russia (56,200), the Philippines (36,000), and Myanmar (33,700) (Figure 5.3.1).

Downward Trend in the Number of Chinese Migrants Obtaining Permanent Resident Status and Obtaining EB-​5 Visas in the United States In recent years, the number of Chinese migrants gaining permanent resident status and citizenship in major migration destinations has been continuously decreasing. The proportion of Chinese national applicants to investment migration schemes such as the United States’ EB-​5 investment visa scheme has also begun to decrease to varying degrees. Although the

1  This data is gathered from estimated figures of Chinese and non-​Chinese citizens residing in countries surveyed.

China’s International Migration    443 900

870 818

800 700

817.72 742

746

761

718

Unit: People

600 500 400 300 200 100 0

2011

2012

2013

2014

2015

2016

2017

Figure  5.3.2 Annual number of Chinese nationals who obtained permanent resident status (fiscal years 2011–​2017). Data Source: US Department of Homeland Security, Yearbook of Immigration Statistics 2011–​2017, last published date: November 14, 2017, https://​www.dhs.gov/​immigration-​statistics/​yearbook

number of applications for these specific visas and the application and acquisition of citizenship do not fully reflect the total number of Chinese emigrants, the decreasing figures do reveal a general trend in the shrinking growth rate of Chinese emigrants. In the 2017 financial year, a total of 74,194 Chinese migrants were granted legal permanent residence status in the United States (i.e., green cards), a decrease of 9.26% over the same period in the previous year. Figures spanning the 2011–​2017 fiscal years show the declining pattern in the number of green cards being obtained by Chinese emigrants (Figure 5.3.2). According to the latest data from the US Department of Homeland Security released in July 2017, EB-​5 visas are mainly dependent on Chinese applications, where the proportion of Chinese applications has declined from a peak of 85.37% in 2014 to 75.56% in the 2016 fiscal year (Figure 5.3.3). Chinese applicants form the second-​largest group of applicants for the US H-​1B visa category, where a total of 41,475 applications by Chinese people were made in 2017. Although this is over double the low of 21,119 applications made in 2010, China still falls way behind India, the largest source group of H-​1B applications, which in 2017 totaled 302,293, 7.3 times as many as the number of Chinese applications (Figure 5.3.4).

Chinese Applications for Citizenship and Permanent Resident Status for the United Kingdom, Canada, and Germany Have Experienced Lasting Decreases In 2017, the number of Chinese applications for British citizenship reached its lowest level since 2007, with only 2,271 applicants. This is the fourth consecutive year the number of Chinese applications for British citizenship has decreased (Figure 5.3.5).

444   Wang 80.16

83.53

90.00 75.56 80.00

9,128 8,156

8,000 (Number)

85.37

69.54

10,000

45.92

6,124

40.95

6,000

6,895

70.00 7,516 60.00 50.00 40.00

24.95

4,000 13.87 110 2007

30.00 2,408

1,979

2,000 0

80.51

20.00

772

360 2008

(%)

12,000

2009

2010

10.00 2011

2012

2013

2014

2015

2016

0.00

(Year) Total

China

Percentage

Figure  5.3.3  Annual number of EB-​5 visas issued to Chinese nationals (fiscal years 2011–​2017). Data Source: US Department of State, “Report of the Visa Office 2007/​2008/​2009/​2010/​2011/​2012/​2013/​2014/​2015/​2016,” https://​travel.state.gov/​content/​visas/​en/​law-​and-​policy/​statistics/​annual-​reports.html

India 302,293

Number of H-1B Applications

350,000 300,000 250,000 200,000 150,000 100,000

China 41,475

50,000 0

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Figure  5.3.4  Annual number of Chinese and Indian nationals applying for H-​1B visa (fiscal years 2007–​2017). Data Source: USCIS, “Trend of H-​1B Petitions FY 2007 through 2017: Receipt Volume Overview,” https://​www.uscis.gov/​sites/​default/​files/​USCIS/​ReData Sources/​Reports%20and%20Studies/ ​Immigration%20Forms%20Data/​BAHA/​h-​1b-​2007-​2017-​trend-​tables-​12.19.17.pdf

Even as one of the main source countries of migrants gaining Canadian citizenship, the number of Chinese applicants granted Canadian citizenship in 2016, 10,797, remained less than half of the number of successful Filipino applications. The number of successful Indian applicants is 1.54 times higher than that of China. This is indicative of data that shows that

China’s International Migration    445 9,000 8,000

7,731

8,302

7,000 6,000

7,863 6,521

5,956

5,000 4,000 3,333

3,000

3,174

3,304

2,662

2,000

2,271

2,419

1,000 0

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Figure  5.3.5 Annual number of Chinese nationals applying for British citizenship (2007–​2017). Data Source: Home Office, “Immigration Statistics-​October to December,” February 22, 2018, https://​www.gov.uk/​ government/​statistics/​immigration-​statistics-​october-​to-​december-​2017-​data-​tables

35,000 30,000 Philippines, 23,890 25,000 20,000

India, 16,615

15,000

China, 10,797

10,000 Pakistan, 5,777 5,000 0

2012

2013

2014

2015

Common wealth of Nations, 4,169 2016

Figure  5.3.6 Top 5 source countries of Canada’s immigrant population (fiscal years 2012–​2016). Data Source: Government of Canada Website, http://​open.canada.ca/​data/​en/​dataset?_​organization_​ limit=0&organization=cic&_​ga=2.81901718.1651973916.1513914143-​220372437.1513914143

since 2014, the number of Chinese emigrants who have gained Canadian citizenship has been declining steadily, and by a large margin (Figure 5.3.6). In the case of Germany, although the total number of Chinese migrants to Germany increased slowly between 2009 and 2016, the proportion of Chinese-​origin expatriates among expatriates in Germany declined from a peak of 1.35% in 2014 to 1.29% in 2016 (Figure 5.3.7).

446   Wang 140,000

1.40%

120,000

1.35%

100,000

1.30%

80,000

1.25%

60,000 1.20%

40,000

1.15%

20,000 0

2009

2010

2011

2012

2013

2014

2015

2016

1.10%

Number of Chinese Nationals in Germany Proportion of Chinese Nationals in Germany’s Foreign Population

Figure 5.3.7  The proportion of Chinese nationals in Germany’s foreign population (%). Data Source: Federal Statistical Office of Germany, “Foreign Population by Selected Citizenships (2008 to 2016),” https://​www.destatis.de/​EN/​FactsFigures/​SocietyState/​Population/​MigrationIntegration/​Tables_​ForeignPopulation/​ CitizenshipTimeSerie.html%EF%BC%8C2017-​11-​30

China Receives the World’s Second-​Largest Amount of Overseas Remittance, Balancing the Impact of China’s Overseas Labor Migration The overseas Chinese population has contributed considerably to China’s domestic economic development. According to World Bank estimates from November 2017, overseas Chinese returned a total of US$62.85 billion to China, making it the second-​largest remittance country in the world after India (with a remittance total of US$68.91 billion) (Figure 5.3.8). World Bank data on global remittance payments reflects to some extent the contribution of the overseas Chinese population to China’s domestic development, especially in the context of overseas Chinese who work in standardized areas of employment. Chinese president Xi Jinping has sought to progress diplomatic relations relating to Chinese migration patterns and, as such, the number of government agencies and personnel working on these issues has increased. At the same time, as China plays an increasingly important role in the processes of globalization, the number of Chinese enterprises and institutions active at the international level has also seen rapid increases. According to data from the China International Contractors Association, in 2016 there were around 9  million Chinese migrant workers working overseas, where 90% were concentrated in Asian and African countries, most of which were nations along the “Belt and Road” initiative (Table 5.3.1). By the end of 2015, China had 260,000 people working in 28 European Union countries, 70% of them in Italy, and 23% in France, Germany, the Netherlands, Spain, and the United Kingdom, with the remainder spread across other European Union nations.2 2  Piotr

Plewa and Marko Stermšek, Labour Migration from China to Europe:  Scope and Potential, International Labour Organization and International Organization for Migration, 2017.

China’s International Migration    447 70.00

65.38

62.85

60.00 50.00 40.00

32.80

30.53

30.00

24.52

22.34

20.00

19.80

18.20

16.28

13.78

10.00

na m

rm Ge

Vi et

an y

t yp Eg

n ist a Pa k

ria Ni ge

an ce Fr

M

ex

ico

in e Ph ili pp

Ch in a

In di a

0.00

Figure 5.3.8  Top 10 remittance-​receiving countries, 2017 (billion USD). Data Source: World Bank, “Migration Remittances Data,” November 16, 2017, http://​www.worldbank.org/​en/​topic/​migrationremittancesdiasporaissues/​brief/​migration-​remittances-​data

Table 5.3.1 Number of Chinese Overseas Workers, 2016 Chinese Workers Sent Overseas in 2016

Number of Chinese Overseas Workers till the End of December 2016

Country/​Region

People

Proportion (%)

Country/​Region

People

Proportion (%)

Macau (China) Hong Kong (China) Singapore Japan Algeria Saudi Arabia Panama Malaysia Iraq Pakistan

69,717 40,028 37,724 36,577 29,931 29,423 18,824 12,883 12,541 11,863

14.1 8.1 7.6 7.4 6.1 6 3.8 2.6 2.5 2.4

Japan Macau (China) Singapore Algeria Hong Kong (China) Saudi Arabia Angola Panama Malaysia Indonesia

146,007 122,636 100,612 91,596 47,825 42,069 29,428 19,662 19,197 16,435

15.1 12.7 10.4 9.5 4.9 4.3 3 2 2 1.7

Data Source: China International Contractors Association; and Wen (2017)

In the first half of 2017, 33 overseas projects with an investment of more than 1 billion RMB were initiated, of which 85% were concentrated in the aforementioned countries and regions.3 Since 2013, Dewey, a Chinese security services company that services clients internationally, has trained a total of 90,000 Chinese individuals before their departure to work 3  Yue

Wen, “2016 Comments on the Development of Cooperation between China’s Foreign Labor Service and Its Partners,” International Journal of Engineering and Labor, 3 (2017).

448   Wang overseas. The vast majority of customers come from state-​owned enterprises, as well as expatriate teachers and overseas students.

China as Destination for Global Migration China Has the Lowest Proportion of International Migrants to Total Population in the World According to United Nations estimates released in July 2017, there are an estimated 1 million expatriates living in mainland China (including those born in Hong Kong or Macau but residing in mainland China), which accounts for only 0.07% of the total population of China (including Hong Kong and Macao residents) (Figure 5.3.9). Excluding the proportion of migrants born in Hong Kong and Macau, the total number of overseas migrants in mainland China only makes up around 0.05% of the total population. Although this data does not include short-​term African migrants concentrated in Guangdong province, estimated to be relatively sizeable, China still has the lowest ratio of immigrants to national population in the world, proportionally lower than that of Vietnam, Cuba, Madagascar, Indonesia Myanmar, and North Korea. On the other end of the spectrum is Saudi Arabia, with the world’s highest proportion of foreign-​born population, at 37% of its total population, and the United States, where 15.5% of the population are migrants. Of China’s foreign-​born population, 60% hail from one of the following four places: Hong Kong, South Korea, Brazil,

0.07%

China Vietnam Cuba Madagascar Indonesia Myanmar North Korea Sri Lanka Philippines Morocco 0

0.05

0.1 0.15 0.2 Proportion of foreign-born residents (%)

0.25

0.3

Figure 5.3.9  Top 10 countries with the lowest foreign-​born population, 2017. Data Source: Dan Kopf, “In One Metric of Diversity, China Comes in Dead Last,” Quartz, December 27, 2017, https://​qz.com/​1163632/​china-​still-​has-​the-​smallest-​share-​of-​incoming-​migrants-​in-​the-​world/​

China’s International Migration    449 South Korea Brazil Philippine Indonesia Vietnam US Thailand Peru UK India Canada Japan Malaysia Sri Lanka Australia Pakistan Bangladesh Russian Federation

186 786 74 289 73 070 39 736 28 095 26 777 15 192 13 483 9 108 8 968 8 629 6 836 6 130 5 435 5 227 4 404 4 018 2 963

Figure 5.3.10  Top 10 source countries of China’s foreign population, 2015 (people). Data Source: Own elaboration based on UNDESA, “Datasets for the 2015 Revision,” http://​www.un.org/​en/​development/​desa/​population/​migration/​data/​estimates2/​estimates15.shtml

and the Philippines.4 The Chinese government has consistently encouraged and promoted the return of overseas Chinese, and in the aforementioned four countries there are large populations of well-​educated overseas Chinese willing to return to China. According to the United Nations Department of Economic and Social Affairs, in 2015 South Korea was the largest source of international migration to mainland China, with 168,800 South Koreans living in mainland China. The second-​largest source nation was Brazil (74,300), followed by the Philippines (73,000), Indonesia (40,000), and Vietnam (28,000). The United States was the sixth-​largest source of international migration, with 26,800 US citizens living in mainland China in 2015. (For statistics on other migration source countries, see Figure 5.3.10).

International Migrants Pursuing Their Futures in China According to the “Expat Explorer:  Broadening Perspectives Global Report,” published by HSBC Bank in October 2017, China ranks second globally for career progression, as well as scoring well for economic and career opportunity advantages. From the perspective of employment prospects for foreign nationals in mainland China, China ranks highly globally and higher than all other East Asian nations. Among 27,500 respondents, 70% thought that mainland China provided strong employment prospects, an increase of 16% compared to the previous year, whereas only 48% of those surveyed thought there were 4  Dan Kopf, “In One Metric of Diversity, China Comes in Dead Last,” Quartz, December 27, 2017, https://​qz.com/​1163632/​china-​still-​has-​the-​smallest-​share-​of-​incoming-​migrants-​in-​the-​world/​

450   Wang 70.00

66.65

60.00 50.00 38.88

40.00 30.00

24.96

20.68

20.29

20.00

16.59

15.29

12.53

11.98

11.61

10.00

Lu xe

m

bo

ur g

ta r Qa

nc e Fr a

it Ku wa

ia Ru ss

Ch in a

an y m Ge r

itz er Sw

Sa

ud i

Ar

ab

lan d

ia

US A

-

Figure 5.3.11  Top 10 remittance-​sending countries, 2017 (billion dollars). Data Source: World Bank, “Migration and Remittances Data,” November 16, 2017, http://​www.worldbank.org/​en/​topic/​migrationremittancesdiasporaissues/​brief/​migration-​remittances-​data

strong job opportunities in East Asia.5 The top three employment sectors are education, hospitality services, and financial services, accounting for 31%, 17%, and 9% of the employment market, respectively. High salaries rank highly among reasons for attracting overseas talent. According to the report, Asia is the most popular region for foreign workers, where the proportion of foreigners living in the region earning more than US$250,000 a year is almost three times more than the number of those earning this level of income in Europe. The probability of earning US$250,000 in China is four times more likely than the global average.6 According to the latest data from the World Bank published in 2017 (as of yet incomplete), China was the fifth-​largest country receiving remittances from abroad in the world in 2016 (Figure 5.3.11). As China has ranked in the top five nations in terms of global remittance, this has confirmed that China not only is a source of international migrants but also has consolidated its position as a leading recipient of global remittances and a rising destination for international migrants.

Outflows and Inflows of Chinese Students Going Abroad in the Past 40 Years Since the reform and opening up, the situation regarding Chinese students going abroad to study has seen rapid development, which in turn gave rise to the phenomenon of Chinese 5 

HSBC, “Expat Explorer: Broadening Perspectives Global Report,” 2017, p. 52, https://​expatexplorer. hsbc.com/​survey/​files/​pdfs/​overall-​reports/​2017/​YouGov_​HSBC_​Report_​Final.pdf 6  HSBC, “Expat Explorer: Broadening Perspectives Global Report,”2017, p. 52, https://​expatexplorer. hsbc.com/​survey/​files/​pdfs/​overall-​reports/​2017/​YouGov_​HSBC_​Report_​Final.pdf

China’s International Migration    451 students who have completed their studies and returned to China (“returnees”). The ever-​ growing community of returnees has made significant contributions to China’s development over the years, where they have garnered significant attention from the state and business and academic circles. The Center for China and Globalization (CCG) has continuously researched and tracked the development of China’s returnees, organizing conferences and seminars as well as publishing reports and providing policy advice on this subject to the relevant government departments. Following the reform and opening up, Chinese policy on returnees can be split into the following three stages:

1978–​1991, Initial Groups of Overseas Students, Many Choosing to Remain Abroad During this first stage, a large number of overseas students went abroad, but returnees were few and far between. In January 1981, the State Council approved the “Notice on Requests for Self-​Funded Overseas Study” and the “Provisional Regulations on Self-​Funded Overseas Study” jointly submitted by the Ministry of Education (MOE) and seven other departments. This marked the official opening of the opportunity for Chinese students to study abroad freely. According to MOE statistics, there were 10,356 government-​sponsored students studying abroad from 1978 to 1981. Yet, by the end of 1981, there were more than 6,000 self-​funded students studying abroad. In the second half of 1986, the State Council approved additional regulations that set out comprehensive guidance and regulations for Chinese students studying overseas, namely the “State Education Commission’s Notice on Provisional Regulations on Overseas Study.” This is the first policy document published on overseas study and marks the initial formation of the Chinese policy system for overseas study. While these policies promoted the development of Chinese students studying overseas, there were stark differences between China’s general conditions, scientific research environment, academic atmosphere, and other areas compared with those that students experienced abroad. At the same time, some students who had studied overseas held differing political standpoints from the authorities. Therefore, it is for these reasons that a large number of overseas students chose to remain abroad, which, for a period, saw China suffer the largest brain drain in the world.

1992–​2006, Transformation in Overseas Study Policy and Increasing Returnees In 1992, the central government issued the “Outline of China’s Educational Reform and Development.” In Shanghai, Shenzhen, and other cities, policies to provide incentives for returnees were launched, such as preferential housing offers, senior titles, and research funding. In 1996, a comprehensive reform was carried out regarding the assignment of government-​sponsored students. The China Scholarship Council was set up to implement a new mechanism to encourage the development of government-​sponsored overseas study based on “individual application, expert evaluation, fair competition, preferential admission, contracts and compensation.” Since then, the return rate of government-​sponsored overseas students has gradually increased. According to 2017 statistics, about 98% of government-​ sponsored overseas students choose to return to China to work after completing their studies.

452   Wang In 2000, the number of returnees was less than 10,000, and the proportion of returnees accounted for less than 25% of the total number of overseas students. Over the following years, although the number of returnees increased with increasing numbers of overseas students, there was no significant change in the proportion of returnees.

2007–​Present, Growth of Overseas Students and an Upsurge in Returnee Entrepreneurship However, this all changed with the outbreak of the 2008 global financial crisis. In 2007 and 2008, the number of returnees grew at an annual rate of nearly 60%, and in the following four years it maintained an average annual growth rate of 36%. This surge slowed in 2014, falling back to less than 10%, but the rapid growth in returnees had flipped the ratio. By 2017, returnees accounted for almost 80% of those studying abroad. In recent years, the government has paid concerted attention to the issue of returnees, implementing additional preferential policies to encourage the return of students after the completion of their overseas studies. These have included initiatives such as offers of tax-​ free car purchases, preferential household registration, government employment and entrepreneurship bonus subsidies, research institute subsidies, and preferential policies for entrepreneurship and children’s schooling. According to the CCG’s Report on Employment & Entrepreneurship of Chinese Returnees 2018, returnee employment broken down by sector is as follows: finance, 14%; information technology (IT), 13%; manufacturing, 12%; education, 11%; wholesale and retail, 8%; and culture, sports, and entertainment, 7%. This research also showed that in the top-​ranking industries, gender differences had an impact on which sector returnees chose to enter. For female returnees, the proportion who entered education (15%) and culture, sports, and entertainment (10%) is significantly higher than that of their male counterparts; for male returnees, the proportion who entered finance (17%) and manufacturing (15%) was higher than that of female returnees. The report also revealed that compared with 2017, finance replaced the IT sector as the top employer of returnees and the manufacturing industry returnee employment proportion rose from fifth to third place.

Diverse International Professionals Can Fill Gaps in Domestic Talent and Skilled Worker Supply From 2008 to 2017, China’s “Thousand Talents Program” has successfully welcomed 13 rounds of the program, at present having attracted over 7,000 global candidates. Through the Thousand Talents Program, areas all over China have attracted top-​class global talent, with more than 50,000 study exchanges.7 Especially in China’s first-​tier cities, large numbers of high-​level professionals across various fields can be found working and studying. For example, in 2013 in Beijing, 22,604 foreign experts were contracted and work visas in excess of 20,000 were issued by the authorities, with even more in Shanghai, where over 7  Xiangguang

Li, “Open the Window, and into the River—​The Achievements of China ‘Thousand Talents Program,'” China Talents, December 2017, http://​www.1000plan.org/​qrjh/​article/​73649

China’s International Migration    453 50,000 foreign experts held working visas and employment in the Eastern city. The Chinese government’s outlook, represented by the Thousand Talents Program and the number of foreign experts working across the country, shows its willingness to encourage overseas experts and talent to contribute to the its development. Besides the Thousand Talents Program, different departments of central and local governments have introduced some policies such as the Changjiang (Yangtze River) Award launched by the MOE that encourages inflows of overseas talent. Apart from the honorary title, the Beijing government provides 100,000 yuan for returnees to start up their business as well as short-​term housing and a duty-​free car. Shanghai also has released policies to provide overseas talent with more subsidies. These programs have played a significant part in attracting returnees and solving problems in the application of policies, settlement and education, account opening and financing, the application of intellectual property rights, and opening up of policy restrictions. According to the figures of the MOE, the number of overseas returnees has been increasing. In 2017, the number of overseas returnees in China reached 480,900, among which there were 227,400 returnees who obtained master’s degrees and doctoral degrees and finished their postdoctoral studies. From 1978 to the end of 2017, there was a total of 3,132,000 students who went back to China to work after they finished their studies abroad, making up a proportion of 83.73% of students who accomplished their studies abroad. As an important component of the international talents in China, many of the overseas returnees have made outstanding contributions in various fields, such as education, science and technology, culture, and health care in the new era. Overseas returnees are active in all areas and have made great contributions to China’s rapid economic growth. In addition to serving as executives of multinational corporations in China, they also play a part in local, state-​owned, and private enterprises, helping Chinese firms to better communicate with the outside world. High-​value service industries such as lawyers, accountants, and consultants have also attracted a lot of returnees, playing a significant role in the process of globalization of Chinese companies. Moreover, there are a number of returnees possessing professional background and international communication skills who have entered international organizations and promoted China’s participation in global governance. At the same time, overseas returnees who start their own business have brought considerable high-​tech and modern enterprise management concepts, introducing risk investment, international capital, and new financing methods. They also bring diversified industrial choices and promote development in various domestic industries and new technologies, including the internet, IT, communication, biological health care, media, and culture and education, helping to achieve more accomplishments in international cooperation. Making an influence in China’s globalized economic development has become an important feature of overseas returnees in the new era. In addition to top-​class overseas experts, the range of skilled workers engaged in China has also seen gradual diversification. Apart from industries that exist along China’s border regions such as traditional sugar, jade, and wood processing, largely conducted by Vietnamese or Burmese handicraftsmen, there are also a rising number of overseas personnel entering and targeting China’s labor-​deficient housekeeping services industry. The issue of China’s employment in service industry has long been highlighted. Hao Fuqing, deputy director of the Department of Social Affairs of the National Development and Reform Commission

454   Wang (NDRC), once described the domestic service industry in China as “demand sprints ahead and supply lags behind.” According to data published by the Beijing Homemaking Service Association, 2 million households out of the 6 million surveyed require housekeeping services, which, due to low levels of supply, leaves over 1 million households without the housekeeping services they desire.8 Statistics show that in Shenzhen there too exists a deficit in the supply of housekeeping service providers of over 200,000.9 In recent years, according to unofficial data, nearly 100,000 Filipino housekeepers (commonly known as “Filipino maids”) have already entered China to work.10 By September 2016 this number had grown to nearly 200,000, meaning that in 2016 there were over 200,000 foreign nationals engaged in the housekeeping industry in China.11 Despite these numbers, the deficit in foreign workers is far from meeting China’s actual demand for professional housekeeping service personnel. Foreign skilled workers have the potential to satisfy this demand while also improving the overall quality and standard of professional skills, industry norms, and level of service of the housekeeping industry within China.

Other Forms of Cross-​Border Mobility in China: International Tourism, Chinese Students Studying Abroad, and Foreign Students in China Increasing household income and the gradual expansion of the middle class that come with the continuing development of China’s economy, coupled with China’s deeper international cooperation, have led to a rapid increase in China’s international tourism. While the rates for Chinese outbound tourism have skyrocketed, the number of inbound tourists to China pales in comparison. The CCG 2017 report on tourism showed that the number of inbound tourists to China increased from 120 million in 2005 to 134 million in 2015, an increase of only 11.2% in 11 years, compared with an increase of 312.9% in the number of Chinese tourists traveling internationally from 2005 (31  million) to 2015 (128  million), a considerable difference. Statistics from 2017 show that, excluding the number of mainland Chinese visitors to Hong Kong, Macao, and Taiwan, China’s international tourist deficit was 316.352 million.12 In spite of the international tourist deficit, the number of inbound tourists to China has increased, but the growth rate has remained very low. The growth

8  China National Radio, “Housekeeping Services Out of Balance: Where Does the Looming Gap in Supply and Demand Stem From?,” September 26, 2017, http://​finance.cnr.cn/​txcj/​20170926/​t20170926_​ 523964843.shtml 9  Shiling Zhou and Xiaoling Zhang, “Housekeeping Industry in Embarrassment: Deficit of 200,000 Workers Causes Losses for Vendors,” Nanfang Metropolis Daily, December 6, 2016. 10  “China Should Legalize Filipino Domestic Helpers,” Global Times, http://​www.globaltimes.cn/​content/​1012500.shtml, October 19, 2016. 11  Duan Jingjing, Ying YuanLiang, and Pu Guofu, “Invisible Foreigners:  Yiwu Employs Foreigners to Mediate in Foreign-​Related Disputes,” Xinhua Net, February 7, 2015, http://​www.cwzg.cn/​politics/​ 201708/​37567.html 12  Center for China and Globalization, “China ought to boost its inbound tourism vigorously as it sees a booming outbound tourism wave,” China’s Globalization Development: Entry-​Exit Tourism, 2017, http://​ www.ccg.org.cn/​archives/​57472.

China’s International Migration    455 rate of inbound tourists to China has been lower than that of developed economies (38.9% increase in 2005–​2015) and emerging economies (57.2% increase in 2005–​2015) and is lower than the overall level in the Asia-​Pacific region, which saw an increase of 81.3% over the same period.13 At the MOE’s 2018 National Conference on Education, it was pointed out that China has educational exchanges with 188 countries and regions, having signed agreements on mutual recognition of academic degrees with 47 of these, and has also collaborated with 46 international educational organizations. China’s role in regional and international educational cooperation is shown by President Xi Jinping’s historic visit to UNESCO’s Asia-​ Pacific Regional Convention on the Recognition of Qualifications in Higher Education.14 As the influence of education deepens and the development of education policy continues, the scale and diversity of foreign students in China have seen gradual expansion in recent years. Although the growth rate of overseas students in China in 2016 was slower than that in 2015, down 8.17%, there were still a total of 544,500 foreign students, a majority from the United States, Canada, Australia, Japan, South Korea, and the United Kingdom.15 The level of education in China has also seen increases; programs such as the MOE’s “Study in China” program and the plan to make China the top destination for studying in Asia by 2020 have pushed up the number of international students in China.

China’s Migration Policy and Governance Official Establishment of the New State Immigration Administration During the first session of the 13th National People’s Congress in 2018, the State Council’s Institutional Reform Program was considered and adopted, including the establishment of the State Immigration Administration (SIA), an initiative that has long been advocated and promoted by the CCG. The establishment of the SIA marks a step to modernize China’s approach to immigration and its management of population migration. This new department seeks to integrate the cross-​border, entry and exit and border control work traditionally performed by the Ministry of Public Security (MPS), dedicated to creating a more focused approach on these areas. The establishment of the SIA is the result of the joint efforts of government departments, research institutions, and scholars, under the leadership, attention, and support of party and state leaders, to tackle the problem of population mobility. In 2010, the CCG published

13 

Center for China and Globalization, “China ought to boost its inbound tourism vigorously as it sees a booming outbound tourism wave,” China’s Globalization Development: Entry-​Exit Tourism, 2017, http://​ www.ccg.org.cn/​archives/​57472. 14  Ministry of Education, “Speech at the National Conference on Education,” February 6, 2018, http://​ www.moe.gov.cn/​jyb_​xwfb/​moe_​176/​201802/​t20180206_​326931.html 15  Center for China and Globalization, Annual Report on the Development of Chinese Studying Abroad 2017, Social Sciences Academic Press, 2017, 21.

456   Wang its report “National Strategy,” which analyzed the importance of attracting international talent to aid in China’s development, and therefore put forward the notion of setting up a specialized department for immigration or international migration. Since 2012, the series of China’s International Migration reports issued by the CCG has emphasized that the migration tide is not a zero-​sum game between China and other countries. Rather, they note that for China to further attract international talent to its shores, it should establish a dedicated immigration bureau to serve this purpose. In 2016, the CCG’s Proposal for the Establishment of a State Immigration Administration was approved by General Secretary Xi Jinping, Premier Li Keqiang, Zhang Gaoli, Wang Huning, and Li Zhanshu. In June 2016, the central government adopted the CCG’s Proposal on China Joining the International Organization for Migration (IOM), shortly after the IOM approved China’s application. In September of the same year, the head of the NDRC’s Social Department made a visit to the CCG to promote further research on the trend of international talent flow for the establishment of the SIA. The SIA, as a new government agency that is part of a wider governance modernization drive, will be responsible for a range of areas. These include routine areas such as entry/​ exit, port inspection, and physical border crossing management, as well as monitoring of non-​Chinese nationals’ stays and permanent residency in China, and wider administration of refugees and foreign nationals. The SIA will function under the guidance of the MPS, working in coordination and cooperation with other departments, especially as the management of illegal entry, illegal residence, illegal employment, and other issues such as the repatriation of illegal immigrants will be under its umbrella. In addition to foreign immigrants and residents, governance of Chinese citizens traveling out of the country and their return also falls within the remit of the SIA. The setting up of this new government body indicates that China aims to approach the complex issue of international migration in a systematic fashion to tackle potential problems head on and gain insights into the trends and patterns of international migration to the Chinese mainland. The topic of Chinese migration not only refers to the status of Chinese citizens abroad but also impacts Chinese and foreign citizens crossing China’s borders, those entering and exiting China, residential and social integration of foreign nationals, and all aspects related to migration itself, such as the actions and behaviors of foreign nationals in China, patterns of migration, and relevant governance mechanisms.

Results of China’s Migration Policy Evolution in the Context of International Talent Strategy Since the reform and opening up, China’s socioeconomic environment has seen continuous improvement, especially the strengthening of the country’s international talent circumstances through various strategies focused on attracting top-​class global talent. The success found in this area can in large part be attributed to the innovative policies and approaches to China’s immigration management in support of global talent programs. First, there has been a determined effort to constantly develop the permanent resident system for foreign nationals in mainland China. In August 2004, China implemented Regulations on the Examination and Approval of Foreigners’ Permanent Residence in China,

China’s International Migration    457 Table 5.3.2 Number of Permanent Resident

ID Cards (Chinese Green Cards) Issued (2010–​2016) Year

Permanent Resident ID Cards

2010 2011 2012 2013 2014 2015 2016

564 656 1,203 1,402 —​ 600 1,576

Data Source: The Ministry of Public Security, “ ‘Two Years of Public Security Reform’: The New Policy of Entry and Exit Has Effectively Served the Overall Situation of National Development,” February 5, 2017, http://​www.mps.gov.cn/​n2254098/​n4904352/​ c5626163/​content.html.

a system to manage foreign nationals permanently residing in China. Preceding this from 1985 to 2004, China maintained stringent conditions and high requirements for foreign citizens to reside in China and only granted just over 3,000 foreign citizens the right to settle in China, with only 90 individuals granted indefinite leave to remain in China. Beginning in 2012, the central government jointly issued documents in conjunction with 25 ministries and commissions to improve the administration of permanent residence permits for foreign nationals. In 2013, the MPS granted 1,402 foreign individuals with “green cards,” an increase of 16.6% compared with 2012 (Table 5.3.2).16 In 2015, the visa process for foreigners in Shanghai was shortened, and in 2016, Beijing upgraded evaluation standards, simplified application processes for foreign talent, and set up a visa processing fast lane. “Through top-​down reforms consisting of simplifying mechanisms, policies, regulations, and application processes,”17 the management of permanent residence of foreign nationals in China has become more rational, pragmatic, and open. According to 2016 statistics, the MPS granted 1,576 foreigners indefinite leave to remain in China, an increase of 163% in comparison with the previous year, and a total of more than 10,000 foreigners were granted permanent residence permits. More than 300 people collected their permanent residence permit from a new service window opened by the MPS in the high-​tech area of Zhongguancun in Beijing’s

16 

According to 2016 Ministry of Public Security statistics (2014 data missing): “Two Years of Public Security Reform: Reformed Migration Policy Aids National Development,” February 5, 2017, http://​www. mps.gov.cn/​n2254098/​n4904352/​c5626163/​content.html 17 Changchun Cai, “1,576 Foreigners were Granted Permanent Residence in China Last Year”, reproduced in Legal Daily, February 5, 2017, http://​www.legaldaily.com.cn/​index_​article/​content/​2017-​ 02/​05/​content_​7000878.htm

458   Wang Haidian district in March 2016, the equivalent to the total amount of “green cards” issued in China the year before reforms were implemented. Second, there has been a series of improvements made to China’s entry and transit systems. In the first half of 2016, the MPS produced a round of policies and measures to facilitate entry and exit visas and residence permits of personnel involved in the construction of the Fujian and Guangdong free trade zones. In 2017, the proven effective entry-​ exit policy measures were extended to the Guangdong Pearl River Delta, South Jiangsu, Hangzhou National Independent Innovation Demonstration Zone, in Zhejiang Province and Changchun New Area, in Jilin. According to the 2013 Measures of the People’s Republic of China on Entry and Exit Administration and Regulations of the People’s Republic of China on Border Inspection for Exit and Entry, a foreign national who transits to China by aircraft, ship, or train on an international journey bound for a third country with tickets for their onward travel can stay in China for less than 24 hours and are visa exempt and can apply for temporary entry permits at their port of entry.18 The following areas have implemented a 72-​hour visa-​ free period for foreign nationals from 53 countries,19 with the date of implementation in parentheses: Guangzhou (August 2013), Guilin (July 2014), Chongqing (December 2013), Chengdu (September 2013), Kunming (October 2014), Xi’an (October 2014), Xiamen (April 2015), Wuhan (May 2015), Harbin (August 2015), Qingdao (November 2015), and Changsha (January 2016). Beijing, Shanghai, Tianjin, Jiangsu, Zhejiang, Hebei, and Liaoning provinces all passed regulations allowing foreign nationals from 53 countries to transit visa-​free in China for up to 144 hours, or six days.20 The creation and implementation of extended visa-​free transits and coverage can help to stimulate international tourists to enter the region, facilitate educational and cultural exchanges, and play a positive role in business and trade exchanges. According to data from the Entry-​Exit Administration of the MPS, 598 million people entered and left the country in 2017, an increase of 4.76% compared to 2016.21 Third, data shows an increasing diversity in the types of visitors to China. In recent years, MPS Entry and Exit Bureau data has revealed an intriguing change. Data shows that in the final quarter of 2016, in addition to the usual domestic and overseas travelers, a new category emerged entering Chinese territory—​border region foreign nationals. Moreover, the data shows that the increase in those visiting mainland China are 18  Ministry of Public Security, “Understanding Regulations on 24 Hour Visa-​Free Transit for Foreign Nationals,” January 18, 2018, http://​www.mps.gov.cn/​n2254996/​n2254999/​c5977576/​content.html 19 The 53 countries with 72-​and 144-​ hour visa-​free transit in China are Austria, Belgium, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, Switzerland, Russia, the United Kingdom, Republic of Ireland, Cyprus, Bulgaria, Romania, Ukraine, Serbia, Croatia, Bosnia and Herzegovina, Montenegro, Macedonia, Albania, Monaco, Belarus, the United States, Canada, Brazil, Mexico, Argentina, Chile, Australia, New Zealand, South Korea, Japan, Singapore, Brunei, the United Arab Emirates, and Qatar. 20  Ministry of Public Security, “Understanding Regulations on 144 Hour Visa-​Free Transit for Foreign Nationals,” January 18, 2018, http://​www.mps.gov.cn/​n2254996/​n2254999/​c5977739/​content.html 21  Ministry of Public Security, “Number of Entry and Exit Personnel and Transport Continue to Grow in 2017,” January 18, 2018, http://​www.mps.gov.cn/​n2254996/​n2254999/​c5977788/​content.html

China’s International Migration    459 140 120

(Millions)

100 80 60 40 20 0

2016 Q4

Chinese Citizens

2017 Q1 Foreign Citizens

2017 Q2

2017 Q3

Foreign Border Residents

Figure  5.3.12 Exit and entry of Chinese citizens, foreign citizens, and foreign border residents (2016 Q4–​2017 Q3). Data Source: Data released by the Ministry of Public Security (China)

not from Hong Kong, Macau, or Taiwan but from China’s other neighbors. In addition to this, the data also shows that since the first quarter of 2017, there has been an increase in a previously limited category of China visitors—​overseas Chinese (Figure 5.3.12). Following increasing numbers of Chinese international travel, China’s entry and exit border inspection classification of Chinese citizens has also changed. Whereas previously Chinese citizens would be separated into “mainland residents” or “Hong Kong, Macau, and Taiwan residents,” starting in the first quarter of 2017, the categorization of “Taiwan resident” has now been changed to “Taiwanese compatriot.” These changes and increases in the various categories of travelers between China and foreign countries highlight the specialization of China’s entry and exit management, as well as improvement in the understanding and management of cross-​border movement of people in border areas.

Management of Foreign Nationals and Innovating International Community Governance Guangzhou is one of China’s first-​tier cities; it is an open city and functions as a window for international trade, and benefits from being located adjacent to Hong Kong and Macau. Therefore, Guangzhou has always had a strong attraction to foreigners, yet at the same time, from a government and governance point of view, certain problems have arisen regarding foreign populations in China, referred to as “three illegal” foreign nationals, which include those who have illegal entry, illegal employment, or illegal residency. By the end of September 2017, the total number of foreigners legally residing in Guangzhou was just

460   Wang above 75,000, of which 13,100 came from African countries, accounting for 17% of the total number of foreigners in Guangzhou. Although the number of “three illegal” foreign nationals cannot be accurately counted, according to results from the research team of the International Migration Research Center of Guangdong University of Foreign Studies and Foreign Trade, from January 2015 to September 2017, there were about 20,000 African foreigners residing in Guangzhou, of which 13,100 had legal residence, and about 6,900 were “three illegal” foreign citizens of African origin.22 Among these 6,900 people, a large part of “three illegal” Africans live in Foshan, Qingyuan, and other places where the cost of living is relatively cheap. Yet the number of “three illegal” foreign residents in Guangzhou is decreasing, in large part due to the continuous improvement of Guangzhou’s governance capacity and improving international economic situation. In 2014, to better serve the floating population in Guangzhou, the Guangzhou municipal government set up the Guangzhou Laizhou Personnel Service Authority, which has the crucial responsibility of governing foreign nationals in Guangzhou. Another development in the governance of foreign nationals can be seen in the establishment of the Dengfeng Street Foreigners Comprehensive Service Center in Yuexiu District in 2015, which marked a grassroots-​level approach to this issue, starting with the social integration of foreigners and effective local governance. In 2016, the Guangzhou Yuexiu District Laizhou Personnel Service Administration began to test the “Guangzhou Yuexiu District Foreigners Social Work Special Service Procurement Project,” recruiting social work institutions to provide services for foreign nationals in the region. Social workers can help to guide foreign residents to public security organizations for registration of residence information, for example, and provide free Chinese-​language teaching services, as well as consultation services in English, French, and Hausa languages.23 Social workers also provide public services for foreign residents on policies and regulations that concern them, build social platforms, and set up volunteer teams to promote foreigners' better integration into Chinese communities.24 Yiwu, in Zhejiang province, is the world capital of small commodities and goods manufacturing, as well as a main area for the flow of foreign nationals in China. There are nearly 500,000 foreign businesspeople entering and leaving Yiwu city every year, and more than 13,000 resident foreign businesspeople from over 100 countries. In 2012, Yiwu set up the International Trade Service Center to provide “one-​stop” services for foreigners, including services related to political and business circumstances as well as general life and well-​being consultation.25 With the increasing volume of international trade, disputes 22  Detailed data can be found in the Chinese section of this report, “The Predicament of African-​ Origin Foreign Migrants’ Governance in Guangzhou.” 23 Taotao Liang, “Testing the Comprehensive Service Center for Foreigners,” Yangcheng Evening News, July 4, 2016, A14G, http://​www.gzmz.gov.cn/​gzsmzj/​mtgz/​201607/​f9aba47e2a8840c886b9ebae57 d44c56.shtml 24 Jin Yangwang, “Yuexiu District Intends to Provide Specialized Social Services for Foreign Residents -​Select Communities Test the Water,” July 1, 2016, http://​news.ycwb.com/​2016-​07/​01/​content_​22404158.htm 25  Xi Jinyan and Chen Jie, “Yiwu Experience of Foreign National Management: Inclusive Achievement of ‘Small United Nations,” China News Network, June 19, 2017, http://​finance.chinanews.com/​sh/​2017/​06-​ 19/​8255098.shtml

China’s International Migration    461 regarding language communication, contract formation, and product quality, common when engaging in international trade, also arise. In 2013, Yiwu pioneered the People’s Mediation Commission for Foreign-​Related Disputes, which employed foreign mediators from 12 countries and regions around the world. With participation of foreign mediators in the mediation process, they are not only able to break the language barrier but also present more effective communication to the foreign national involved. By 2015, the dispute mediation team had successfully settled more than 90 disputes.

Migration Issues at the International Level In September 2016, the United Nations convened the 71st United Nations General Assembly on the theme of “Sustainable Development Goals:  Working Together to Transform Our World,” with high-​level conferences held to address the large-​scale flows of refugees and migrants across the globe, a leading issue throughout the sessions. To push the international community to intensify its efforts to deal with the problem of refugee migration and to establish a global and comprehensive response program, the New York Declaration on Refugees and Migrants was adopted. At the summit Chinese premier Li Keqiang also noted that China would do the following three things in response to the issue of refugees: provide an additional US$100 million in humanitarian assistance to relevant countries and international organizations, work to effectively put to use funds from the China-​United Nations Peace and Development Fund to support refugee migration in developing countries, and explore and build three-​way cooperation with relevant international institutions and developing countries.26 This speech represented China’s future contributions, through innovative diplomatic solutions from the building of a community with a shared future for mankind to world peace and development, in addition to showing that the Chinese government has begun to pay more attention to the governance of immigration and refugee issues.

Summary and Recommendations Deepen International Migration and Talent Awareness in the Public and Policymaking Arenas, and Seek to Enhance China’s Global Talent Competitiveness In comparison with other countries in the Asia-​Pacific region, China has the lowest foreign-​born population, and in the Global Talent Competitiveness Index from 2015 to 2016,

26  Official Website of the Chinese Government, “Li Keqiang’s Speech at the 71st UN General Assembly High-​Level Meeting on the Solution of Large-​Scale Flows of Refugees and Migrants,” September 20, 2016, http://​www.gov.cn/​premier/​2016-​09/​20/​content_​5109857.htm

462   Wang China ranks only 48th, completely out of sync with China’s position as the world’s second-​ largest economy.27 Compared with the developed countries in Europe and the United States, which have attached great importance to international talent for a long period, the competitiveness of China international talent lags significantly behind, with China facing two major challenges. The challenge is that China has the lowest level of global talent attraction globally, and the second is that China is facing a severe brain drain of domestic talent. At the international level, China falls far behind developed nations in attracting global talent, as well as losing China-​born individuals abroad. In terms of international knowledge and skills and international talent development, China again comes in below average compared with other middle-​income countries. China’s global talent development strategy should seek to target top-​class global talent across diverse fields. Technical research and development scientists and those engaged in the wider sciences, business executives, experts in urban planning and management, artists, and professional and technical practitioners in specific areas in the natural and social sciences from all around the world should be looked at as potential future China residents. Professionals from all walks of life who can contribute to China’s development should be the focus of China’s international talent attraction policy. China’s understanding of circumstances and factors driving international talent flows is relatively narrow. This includes the understanding and representation of international talent and immigrants in the public domain, especially in online communities, where public opinion is easily influenced by narrow nationalism, which misunderstands and discounts China’s huge demand for international talent. Therefore, there is a need for an objective and honest perspective to be taken in regard to international migrants in China, whereby the mainstream media should guide domestic public opinion to view this issue objectively, not subjectively. There is a need also to avoid highlighting only the difficulties in managing international migration, but also to highlight China’s diplomatic philosophy and international responsibility as a world power, and increasing awareness of China’s need to attract global talent to drive and push forward sustainable socioeconomic development.

Improve Data Systems on International Migration and the Integration of Migrant Services Reliable and accurate data and information are the foundation of international migration governance. The scientific collection and management of international migration data determine the means and effectiveness of the Chinese government’s governance policies. The gradual and timely implementation of data transparency and cross-​departmental data sharing can help to improve the efficiency of China’s international migration governance. Starting with data from the Ministry of Foreign Affairs all the way to the MPS Entry and Exit Bureau’s records, expert certificates and work permits issued by State Administration of Foreign Experts Affairs, as well as social security and security information held by the

27 

INSEAD (2015): The Global Talent Competitiveness Index 2015–​2016, Fontainebleau, France.

China’s International Migration    463 Ministry of Civil Affairs—​all of this data and information, if shared among departments, can help develop more effective and efficient management of international migration. In addition, it will contribute significantly to researching the gap between the demand for international talent posts and the labor market, so as to better introduce, channel, and govern domestic employment levels and management. There is potential for international migrants to enjoy improved levels of social integration in China. It is far from enough to rely solely on talent introduction plans led by the central government to trickle down through government at all levels; efforts from local and grassroots community groups and Chinese citizens alike are required. Whether regarding top-​class global talent or international students, in addition to establishing the bare minimum of life and work in China, there is also a need to create an inclusive and diverse social atmosphere to encourage social integration. Only by forming effective interpersonal relationships, between individuals or organizations of foreign nationals and the wider Chinese society, can social integration be truly realized. For new arrivals to China, establishing a solid foundation with the local community should be based on effective language-​based communication, as well as the guarantee and provision of information on legal norms and ways and means of obtaining social welfare and services. Through the joint efforts of the Chinese government and Chinese society, China can establish an improved and more effective international migration system.

Strengthen China’s Governance Capacity Regarding Unconventional Migration and Seek to Raise the Profile of China’s Work in this Area In addition to conventional international migration, China should also seek to be engaged in and strengthen its governance of unconventional international migration patterns and crises. China should make efforts to understand the management systems needed and establish governance mechanisms in response to combating human trafficking, protecting women and unaccompanied children in migration crises, and reinforcing humanitarian emergency plans for large-​ scale immigration crises, in addition to strengthening its ability to deal with overstaying visitors and those who enter and cross the border unconventionally or illegally. In cases such as the “three illegal” immigrant situation in Guangdong, the valuable experience gained through the joint efforts of governmental and societal groups has yet to be exploited and put into practice in other areas with corresponding needs. As early as 1982, China became a signee of the 1956 Convention Relating to the Status of Refugees and the 1967 Protocol Relating to the Status of Refugees, detailing the responsibility of nations in providing assistance and aiding resettlement for refugees, and has gained rich experience in the governance of Indo-​Chinese refugees. However, for a long time, under the framework of the domestic legal system, operational rules and guidance in this area are lacking, resulting in China having to adopt international humanitarian relief measures, such as rescuing foreign border nationals who have entered the country in an emergency, which has been misunderstood by the international media and met with undue criticism. Therefore, China should pay increasing attention and play a greater role in international migration and refugee governance. China should incorporate modern governance

464   Wang models in its administration of conventional and unconventional immigrants. Basing its approach on the rule of law, it should make use of scientific and technological means (such as fingerprints, iris identification, and biological sample collections), emphasize the importance of social integration, and embody the humanitarian spirit in the construction of its new immigration system.

Focus on and Play a Greater Role in the Governance of Global Migration and Refugee Issues Over the past five years, multiple large-​scale cross-​border population migration crises have emerged due to various conflicts, natural disasters, and other crises, triggering political, security, and social conflicts in different regions and countries. While individuals caught in these crises can be seen as benefitting from policies and global governance approaches relating to refugee and migrant populations, they have also suffered significant losses at the hands of the international system and been a witness to its failures. China and other players in the global governance of migration and refugees can learn crucial lessons from those involved in migration crises. There is also much to learn from individuals who plan and undertake migration as a life choice. The transnational, cross-​social, and cross-​cultural networks formed by individual migration truly embody the essence of globalization. These networks and actors also offer opportunities for China to improve its approach to global migration governance. The report of the 19th National Congress of the Communist Party of China points out that China should persist in promoting the construction of a community of a shared future for humankind and that the dreams of the Chinese people are closely linked with the dreams of the people of all countries. The realization of the Chinese dream cannot be separated from a peaceful international environment and a stable international order.28 China not only is one of the largest source countries of international migration but also has gradually become a leading destination for international travel and migration. Therefore, the governing of global migration issues offers a good opportunity for China to further enhance its international influence and make new and significant contributions to world peace and development. In addition to working with the international community to improve and create a more people-​oriented global governance system, it will allow China to pursue and achieve its domestic goals of “promoting peaceful development and the win-​win strategy of opening up[;]‌ . . . [t]o seek the prospects of opening-​up, innovation, inclusiveness and reciprocity, promoting and integrating civilized exchanges, and building an ecological system that respects nature and pushes forward green development[;] . . . [t] o always be a builder of world peace, a contributor to global development and a defender of international order.”29

28  Xi Jinping, “Secure a Decisive Victory in Building a Moderately Prosperous Society in All Respects and Strive for the Great Success of Socialism with Chinese Characteristics for a New Era” (delivered at the 19th National Congress of the Communist Party of China), China Daily, November 11, 2017, http://​ language.chinadaily.com.cn/​19thcpcnationalcongress/​2017-​11/​06/​content_​34188086_​2.htm 29 Ibid.

China’s International Migration    465

Actively Participate in the Formation of International Migration Norms and Governance, Promoting the Key Concepts of Openness and Inclusiveness As a world power, China should participate more actively in the negotiation process of the global migration policy and aid in the construction of an improved international migration governance mechanism based on the principle of the sustainable development of China and the world. In comparison with global climate and economic governance, international migration governance offers a solid opportunity for China to present and promote itself as a good player in this field. It will also be an opportunity for China to further understand cross-​border population migration, promote internationalization and standardization of China’s domestic migration system, and enhance the risk prevention and response capabilities brought about by population migration. To promote these goals, China should actively participate in the construction of global migration norms so as to promote the orderly, safe, and free flow of international migrants and talent. At the same time, China should also seek to draw on advanced governance concepts and methods of the international community to further promote the construction and innovation of its domestic migration mechanisms.

Deepen Cooperation with International Organizations Engaged in International Migration United Nations organizations related to migration and development such as the United Nations High Commissioner for Refugees, the International Organization for Migration, the United Nations Development Program, the United Nations Office for Women, and the United Nations Children’s Fund have rich intellectual experience and expertise in their respective fields. China is in the early stage of its involvement in the field of global migration and refugee governance and still requires assistance and professional guidance from more experienced international organizations. Especially in this area, where international migration and refugee issues involve more non-​traditional security issues, no single organization or entity can be effective, and cooperation across organizations is required. China should seek to integrate its previous cooperation experience with other relevant international organizations, continue to expand and explore new areas of cooperation, and adjust its differing modes of cooperation to suit the relevant circumstances.

Use the “Belt and Road” Platform to Establish a Cooperative Regional Migration Governance Mechanism Certain areas in the “Belt and Road” initiative are experiencing challenges such as a large number of cross-​border irregular migration, human trafficking, illegal maritime migration, illegal foreign workers, border migration crises, and groups of stateless people. The very nature of these problems means that no one country can cope with these issues on its own.

466   Wang Confronting such challenges requires the joint efforts and cooperation of countries in the region. In terms of the “Belt and Road” initiative’s programs to attract top-​class international students for the development of the region, China should pursue setting up funds and action plans in cooperation with countries in the region to deal with the aforementioned immigration issues experienced in the region.

Reference Wen Yue, “A Review of the Development of China’s Foreign Labor Cooperation in 2016.” Journal of International Engineering and Labor, 3 (2017): 39–​44.

Chapter 5.4

Chinese Ou t wa rd Fore i g n Direct Investme nts a nd Innovat i on Vito Amendolagine, Xiaolan Fu, and Roberta Rabellotti Introduction After being the largest recipient of foreign direct investments (FDIs) among developing countries for more than two decades and the second-​largest worldwide after the United States since 2008, China has become an important outbound investor. This was especially since the so-​called Go Global strategy was launched in 1999, as an effort by the Chinese government to assist domestic companies in developing a global strategy for expanding in international markets. Afterwards, Chinese companies, initially state-​owned ones and mostly large enterprises and then also medium-​sized ones, invested overseas to diversify their assets and location portfolios, acquire natural resources, and increasingly access knowledge, technologies, skills, brands, and markets. Since 2005, Chinese outward foreign direct investments (OFDIs) have increased by 10 times, and in 2016 China became the second-​largest investing country in the world after the United States.1 In 2017 China’s outstanding investment stock amounted to around US$1,482 billion, which is about 5% of all OFDIs in the world (UNCTAD, 2018). Most of China’s direct investments went to the developing world. By the end of 2016, the total OFDI stock in the developing countries was US$1,142.6 billion, accounting for 84.2% of China’s total OFDI stock. The share to the developed countries was 14.1% and to the transition economies was 1.7%. In terms of OFDI flow, China’s investment into the developed countries has risen rapidly in recent years, with the United States, Europe, and Australia being the top destinations in 2016, with an increase

1 

In 2017 Chinese OFDIs declined by 36% due to the introduction of new capital controls in reaction to significant capital outflows during 2015–​2016 mainly in industries such as real estate, hotels, and sport clubs. As a consequence, China has gone back to the third position in the ranking of the largest investing countries, after the United States and Japan (UNCTAD, 2018).

468    AMENDOLAGINE, FU, AND RABELLOTTI by 94% over 2015. While lease and commercial services and financial services had been the traditional top two industries of Chinese OFDIs, in 2016 manufacturing rose to be the second-​largest industry of Chinese OFDIs, after lease and commercial services (Ministry of Commerce, State Statistics Bureau, & State Foreign Exchange Administration [MOC, NSB, & SFEA], 2016). OFDIs are considered as a key mechanism through which technologically lagging countries, and China is still one of them, seek to learn and improve their innovation capabilities (Cantwell, 1989). In particular, a large part of the investments by multinational enterprises from emerging countries (EMNEs) going toward developed countries can be considered as strategic asset seeking, aimed at attaining key technological assets, advanced markets, and management skills, as well as design and marketing knowledge (Cuervo-​Cazurra, 2012; Cui, Meyer, & Hu, 2014; Meyer, 2015). Due to their weaknesses in leading-​edge technologies, marketing and management techniques, and established brands, Chinese multinational enterprises (MNEs), as well as EMNEs in general, largely utilize their internationalization strategy as a means of rapidly moving toward the technological frontier by directly acquiring capabilities from their competitors in the incumbents’ markets (Luo & Tung, 2007). Nevertheless, although OFDIs are considered as a key mechanism through which Chinese multinationals seek to learn and develop technologies and innovation capabilities, the outcome of the process of accessing local information and pools of knowledge is far from straightforward (Cantwell & Mudambi, 2011). In this chapter, we present a map of the OFDIs undertaken by Chinese MNEs in activities to research and development (R&D) and therefore likely contributing to the country’s innovation capacity. Then we provide an overview of the existing literature that tries to measure the impact of OFDIs on the innovation performance of the investors, disentangling the conditions making these investments more or less effective channels for enhancing the innovation capacity. Furthermore, the mechanisms of learning, knowledge acquisition, and capability upgrading set in motion by the internationalization of Chinese enterprises are also explored. The chapter concludes by offering some issues for further research.

Chinese OFDIs in R&D In this section we rely on firm-​level data on investment deals by Chinese firms in activities related with R&D to provide a general, albeit partial, quantitative assessment of the outward activities that can more directly impact Chinese innovation capacity. We offer an overall view of greenfield investments and acquisitions, based on two different data sources. Information about greenfield investments is provided by fDi Markets (Financial Times Group), which is a deal-​based database reporting all cross-​border investments resulting in a wholly owned subsidiary, covering all sectors and countries worldwide since 2003. fDi Markets collects data through media sources and companies’ websites, and for each investment it provides details about the name and the location of the investor, the year of the deal, the sector and the destination where the investment takes place (in terms of country, region, and city), and the main business activity.

Outward Foreign Direct Investments and Innovation    469 Acquisitions are cross-​border acquisitions of a minimum 10% share of the target2 reported by Zephyr, a Bureau van Dijk database providing information such as the name, the sector of specialization and the location of the acquirer and the target company, the status of the deal (“completed,” “rumor,” “pending”), the percentage of ownership transferred from the target to the investor, and the date of the project. For both greenfield investments and acquisitions we consider the time span between 2003 and 2017.

Greenfield Investments Taking advantage of the available information about the main business activity undertaken with each investment project, we concentrate the analysis on greenfield investments in innovative activities as defined in Crescenzi, Pietrobelli, and Rabellotti (2013), including R&D and design, and development and testing, named in the rest of the chapter as R&D greenfield OFDIs. In the database, there is a total stock of 4,573 greenfield investments undertaken by Chinese MNEs worldwide between 2003 and 2017 (corresponding to a value equal to US$577 billion3), and those in R&D activities correspond to 9.4% of the total (2.2% in value terms).4 Considering their dynamic flows presented in Figure 5.4.1, we can observe an increasing trend from 2003, when R&D greenfield OFDIs represented 6% of total investments, to 2017, when they reached almost 18% of the total, confirming the increasing importance of OFDIs as a means to acquire knowledge and technological assets needed for innovation. As expected, Europe (41% of total R&D greenfield OFDIs), the rest of Asia (28%), and North America (25%) are the main destinations of Chinese innovative greenfield investments (Figure 5.4.2). Table 5.4.1 presents a disaggregation by country of destination and sector of specialization. The United States attracts a large amount of R&D investments from China in industries such as software and IT services (27% of R&D greenfield investments in the country), chemicals (14%), electronics (12%), and automotive (13%). It is also worth noting that in the United States, Chinese investments are clustered in three major hubs: investments in software and information technology (IT) services and electronics go to Silicon Valley in California (35% of its R&D OFDI in the United States); Detroit, in Michigan, attracts investments in the automotive industry (11%), and Seattle, Washington, attracts investments in software and IT services (7%). In Asia, the countries catalyzing Chinese R&D greenfield OFDIs are India, which is a main destination for investments in communications; Japan; and Singapore. In Europe, Germany is the main destination with Dusseldorf (31% of R&D OFDIs in Germany) and Munich (21%) as key hubs for investments in machinery and

2  This

corresponds to the definition of FDI by UNCTAD, available at http://​unctad.org/​en/​Pages/​ DIAE/​Foreign-​Direct-​Investment-​(FDI).aspx. 3  The database also provides information about the value of the investment, but in many cases, this is an estimate rather than the actual value. Given the problem of reliability and availability of the information about values, researchers using this database have mostly utilized the number of the investments instead of the value (Amighini, Cozza, Rabellotti, & Sanfilippo, 2014). 4  The two most common activities undertaken by Chinese multinationals are sales and marketing (30% of the total investments but only 2% of the value) and manufacturing (28% of the investments and 42% in value).

470    AMENDOLAGINE, FU, AND RABELLOTTI 600

20

500 15 400

300

10

200

5

100 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Year % R&d

# greenfield OFDI

Figure 5.4.1  Chinese greenfield OFDIs and R&D share of OFDIs: 2003–​2007. Source: fDi Markets

1.6% 2.1% 24.6% 40.7% 3.3%

27.7%

Africa South America Europe

North America Asia Oceania

Figure 5.4.2  Geographical distribution of Chinese R&D greenfield OFDIs: 2003–​2017. Source: fDi Markets

Table 5.4.1 Spatial and Industry Distribution of Chinese Greenfield OFDIs: 2003–​2017 (# and % of Total R&D OFDIs)

United States Germany India United Kingdom France Japan Singapore Italy Sweden Other countries Total Source: fDi Markets.

Communications

Software & IT Services

Automotive

Electronics

Chemicals

Machinery

Other Sectors

Total

10 (10.1) 6 (15.4) 18 (58.1) 8 (32.0) 9 (45.0) 4 (21.0) 4 (26.7) 7 (50.0) 4 (33.4) 69 (44.2) 139 (32.3)

27 (27.3) 3 (7.7) 7 (22.6) 1 (4.0) 2 (10.0) 3 (15.8) 5 (33.3) 1 (7.1) 2 (16.6) 18 (11.5) 69 (16.0)

13(13.1) 6 (15.4) 1 (3.2) 6 (24.0) 0 (0.0) 4 (21.0) 0 (0.0) 6 (42.9) 4 (33.4) 11 (7.1) 51 (11.9)

12 (12.1) 6 (15.4) 2 (6.4) 0 (0.0) 1 (5.0) 5 (26.4) 2 (13.3) 0 (0.0) 0 (0.0) 19 (12.2) 47 (10.9)

14 (14.1) 1 (2.6) 3 (9.7) 4 (16.0) 2 (10.0) 0 (0.0) 1 (6.7) 0 (0.0) 1 (8.3) 9 (5.8) 35 (8.1)

6 (6.0) 8 (20.5) 0 (0.0) 2 (8.0) 0 (0.0) 0 (0.0) 0 (0.0) 0 (0.0) 0 (0.0) 5 (3.2) 21 (4.9)

17 (17.3) 9 (23.0) 0 (0.0) 4 (16.0) 6 (30.0) 3 (15.8) 3 (20) 0 (0.0) 1 (8.3) 25 (16.0) 68 (15.9)

99 (100.0) 39 (100.0) 31 (100.0) 25 (100.0) 20 (100.0) 19 (100.0) 15 (100.0) 14 (100.0) 12 (100.0) 156 (100.0) 430 (100.0)

472    AMENDOLAGINE, FU, AND RABELLOTTI automotive industries. In this last industry, Chinese investments also concentrate in other European countries such as the United Kingdom, Sweden, and Italy, where in the Turin auto cluster there are 50% of all R&D greenfield investments directed to that country.

Acquisitions Following previous works on the relationship between acquisitions and innovation (Ahuja & Katila, 2001; Valentini & Di Guardo, 2012)  and on Chinese acquisitions (Piscitello, Rabellotti, & Scalera, 2015), we focus on acquisitions in the medium-​and high-​tech manufacturing and service industries5 in Europe (EU-​28), Japan, and the United States. This is to identify deals most likely to be motivated by the acquisition of knowledge and technological assets. In the period between 2003 and 2017, the total number of Chinese acquisitions in these industries was 261, most of them undertaken since 2011, with a peak of more than 60 deals in 2016 (Figure 5.4.3). The highest concentration of acquisitions is in the United States (82 deals) and, more specifically, in California (18 deals) and Michigan (6)  in industries such as electronics (22), communications (12), and automotive (6). In Europe, Chinese MNEs have mainly undertaken acquisitions in Germany (55 deals) in the machinery, electronics, and automotive industries. Other European countries where acquisitions took place are the United Kingdom (32 deals), the Netherlands (14), France (13), and Italy (12) (Table 5.4.2).

60

# Deals

40

20

0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Year

Figure 5.4.3  Chinese acquisitions in medium-​and high-​tech manufacturing and service industries: 2003–​2007. Source: Zephyr

5 

We consider the following two-​digit NACE codes: 20, 21, 26, 27, 28, 29, and 30 (for manufacturing), and 59, 60, 61, 62, 63, 64, 65, 66, 69, 70, 71, 72, 73, 74, 78, and 80 (for services).

Table 5.4.2 Spatial and Industry Distribution of Chinese Acquisitions in the United States, Europe, and Japan: 2003–​2007

(# and % of Total Acquisitions in Medium-​and High-​Tech Manufacturing and Service Industries)

United States Germany United Kingdom Netherlands France Italy Spain Japan Other countries Total Source: BvD Zephyr.

Machinery

Electronics

Automotive

Software & IT Services

Chemicals

Communications

Other Sectors

Total

6 (7.3) 22 (40.0) 5 (15.6) 2 (14.3) 3 (23.0) 8 (66.8) 1 (12.5) 1 (14.3) 5 (13.2) 53 (20.3)

22 (26.8) 10 (18.2) 3 (9.4) 4 (28.6) 2 (15.4) 1 (8.3) 0 (0.0) 1 (14.3) 8 (21.0) 51 (19.5)

8 (9.8) 12 (21.8) 2 (6.2) 4 (28.6) 0 (0.0) 0 (0.0) 1 (12.5) 0 (0.0) 5 (13.2) 32 (12.3)

7 (8.5) 0 (0.0) 3 (9.4) 1 (7.1) 2 (15.4) 0 (0.0) 1 (12.5) 3 (42.8) 3 (7.9) 20 (7.7)

8 (9.8) 3 (5.4) 3 (9.4) 0 (0.0) 2 (15.4) 1 (8.3) 1 (12.5) 0 (0.0) 2 (5.3) 20 (7.7)

12 (14.6) 1 (1.8) 2 (6.2) 0 (0.0) 0 (0.0) 1 (8.3) 1 (12.5) 0 (0.0) 1 (2.6) 18 (6.9)

19 (23.2) 7 (12.8) 14 (43.8) 3 (21.4) 4 (30.8) 1 (8.3) 3 (37.5) 2 (28.6) 14 (36.8) 67 (25.6)

82 (100) 55 (100) 32 (100) 14 (100) 13 (100) 12 (100) 8 (100) 7 (100) 38 (100) 261 (100)

474    AMENDOLAGINE, FU, AND RABELLOTTI Among landmark cross-​border acquisitions that can be considered as good examples of asset-​seeking deals, there are the takeovers of the Italian tire producer Pirelli in 2015 and of the Swiss pesticide and seed producer Syngenta in 2016 for US$43 billion, undertaken by ChemChina, a state-​owned Chinese chemical company, and Volvo’s acquisition by Geely in Sweden. In Europe, Tencent, a video game company, bought Supercell, a Finnish firm known for being the developer of a very popular mobile game, “Clash of Clans.” In the United States, Haier, a multinational in consumer electronics and home appliances, bought GE Appliances for US$5.7 billion, with the aim of leveraging the target’s knowledge base to advance in the field of the Internet of Things and expand its position in the US market (Yu, 2017). Another well-​known acquisition in the United States is the takeover of IBM’s PC division undertaken in 2005 by Lenovo, which became a symbolic beachhead for other Chinese companies eager to build their global presence through acquisitions. Then, in 2014 Lenovo also acquired Motorola Mobility from Google to strengthen its position in the smartphone market and grow its presence in the United States. This kind of acquisition is expected to boost the innovative capabilities of the acquiring companies and promote processes of reverse knowledge transfer to China. However, as we will see in the following review of the existing literature, not all expectations are fulfilled and many frictions and impediments could be involved in these processes.

Strategic Asset-​Seeking OFDIs China has been very successful in attracting inward FDIs from many advanced economies; these investments are supporting the building up of domestic production capabilities, primarily in the manufacturing industry, and progressively contributing to the establishment of an independent innovation capacity (Fu, 2008). The role played by inward FDIs in improving the Chinese technological and innovation capacity is discussed in Chapter 5.1 of this Handbook and well documented in the literature (Fu, 2004), confirming the mainstream theories of FDIs as a recipe for economic growth and development (Blomstrom & Kokko, 1998; Gorg & Greenway, 2004). In addition to inward FDIs, due to the increasing emphasis on the need to build strong independent domestic innovation capabilities for improving competitiveness and appropriating higher value-​added shares in the global market, outward FDIs by Chinese MNEs have also rapidly expanded. As documented in the literature, in addition to resource-​and market-​seeking motives, the strategic asset-​seeking motivation does increasingly play an important role to explain the recent rise of Chinese investments (Cui, Meyer, & Hu, 2014; Deng, 2009). In particular, OFDIs to developed countries are considered as an effective practice to technologically catch up in order to close the gap in advanced technology, knowledge, and skills in the home country (Child & Rodrigues, 2005; Liu & Buck, 2007). Fu, Hou, and Liu (2018) define Chinese OFDIs in advanced countries as an “innovation springboard” for latecomer firms to overcome internal constraints and leapfrog to the technological frontier. Through strategic asset-​seeking OFDIs, Chinese companies seek to augment areas of perceived competitive disadvantages by acquiring a variety of intangible assets such as technologies, managerial skills, innovation capabilities, human capital, market knowledge,

Outward Foreign Direct Investments and Innovation    475 and brand names (Yakob, Nakamura, & Ström, 2018). Asset augmentation is obtained by acquiring foreign codified knowledge as well as tacit know-​how thanks to spatial proximity, social embeddedness, and mobility of skilled workers. According to the economic geography literature, firms can derive several benefits from investing in advanced clusters or regions: the possibility to exploit external economies and trade interdependencies, and access to “localized capabilities” and untraded independencies, which have been stressed as crucial for the processes of learning and innovation (Bathelt, Malmberg, & Maskell, 2004). Therefore, OFDIs allow multinationals that locate in innovative regions and clusters to exploit the local availability of agglomerated resources not available to firms situated elsewhere (Beugelsdijk & Mudambi, 2013). Entry to innovative regional or local ecosystems provides opportunities for tapping into knowledge that is embedded in firms, people, and institutions (thanks to face-​to-​face contacts) and by developing formal and informal networks with local suppliers and customers, universities, and other organizations (Cantwell & Piscitello, 1999; Li, Li, & Shapiro, 2012). As we have seen in the previous section, Chinese MNEs frequently locate their subsidiaries and make acquisitions in clusters with strong technological bases and extensive knowledge assets, such as Silicon Valley or the automotive clusters in Detroit, Dusseldorf, and Turin (Pietrobelli, Rabellotti, & Sanfilippo, 2011). Through their internationalization strategies, they try to establish themselves as insiders in key innovative and technological hubs, benefiting from knowledge spillovers, although, as we will discuss later, the process of accessing local information and pools of knowledge is far from straightforward (Bathelt & Cohendet, 2014).

OFDIs and Innovation Performance The literature about the impact of OFDIs on the innovative performance of Chinese MNEs conveys an inconclusive message. According to Anderson, Sutherland, and Severe (2015), with a focus on acquisitions, there are three different views. The first one is very skeptical about the capacity of Chinese MNEs to integrate and productively utilize the externally acquired knowledge assets, given that they often lack the absorptive capacity needed for effectively exploiting them (Rugman & Li, 2007). While acknowledging the lack of absorptive capacity, a second, more positive position argues that Chinese MNEs are well aware of their limitations and therefore they generally adopt a “light touch” approach in the post-​ acquisition phase, granting quite a lot of autonomy to their subsidiaries (Liu & Woywode, 2013). This light approach is also common in the case of greenfield investments as confirmed, for instance, by the strategy of hiring host-​country managers to run foreign operations adopted by multinationals such as Haier and Lenovo, which have both selected a local CEO for their US headquarters (Luo & Tung, 2007). A third, rather optimistic view underlines the capacity of Chinese multinationals to exploit certain firm-​specific advantages developed in the home market, such as the capability to undertake incremental innovation in the manufacturing process and the ability to produce low-​cost, high-​quality products, which can be complementary with the externally acquired knowledge assets (Tan & Mathews, 2015). Additionally, it has been stressed that in some cases Chinese multinationals have a large amount of financial resources available and this may lead to increased R&D investments in their subsidiaries (Buckley, Elia, & Kafouros, 2014).

476    AMENDOLAGINE, FU, AND RABELLOTTI These somehow conflicting predictions have inspired a few recent works aimed at empirically assessing whether OFDIs contribute to the innovation performance of the Chinese MNEs undertaking the investments and investigating under what conditions OFDIs act as an effective channel to enhance their innovation capabilities. There is a small bunch of studies about the outcome of OFDI activities, which do not directly focus on the innovation output but more generally on the nexus between OFDIs and the investor’s performance. Chen and Tang (2014) investigate the effect of OFDIs on different dimensions of Chinese MNEs’ performance, finding a positive effect on productivity, employment, and several dimensions of export performance. Focusing on acquisitions, Edamura, Haneda, Inui, Tan, and Todo (2014) show the existence of a positive effect for Chinese investors on sales, productivity, and tangible and intangible assets, despite finding no significant change in R&D intensity. Including in the analysis also greenfield investments, Cozza, Rabellotti, and Sanfilippo (2015) confirm that OFDIs have an impact on Chinese investors, finding a positive effect on efficiency and productivity in the long term and a more immediate impact on employment and sales. Some interesting specifications occur when the entry mode is considered because acquisitions favor early access to intangible assets but result in negative financial performance, while greenfield investments have an obvious positive impact on firms’ size and sales. The link between OFDIs and innovation performance is investigated in two recent studies by Fu, Hou, and Liu (2018) and Piperopoulos, Wu, and Wang (2018). Fu, Hou, and Liu (2018) undertake a survey of 189 firms in Guangdong and investigate, based on a panel data analysis for the period 2007–​2009, whether and under what conditions OFDIs yield a positive impact on innovation performance of the Chinese investors, measured as the proportion of new product sales in total sales. They find a positive effect of investments going toward developed countries, enhanced by a number of characteristics of the investing firms, which we will discuss in more details later. Piperopoulos , Wu, and Wang (2018) focus on the innovation performance of the subsidiaries, measured by the number of forward citations received in patents registered at the Chinese State Intellectual Patent Office (SIPO), and base their empirical analysis on a panel dataset for the period 2001–​2012 of a sample of high-​tech publicly listed Chinese enterprises. Their analysis confirms the presence of an innovation-​ enhancing effect of OFDIs, particularly when they are directed toward developed countries. With a focus on Chinese (and Indian) acquisitions, Amendolagine, Giuliani, Martinelli, and Rabellotti (2018) investigate whether these investments have led to higher levels of innovation in the acquiring firms, measured as the number of patent applications filed by the acquirers at any patent office in the three years after the deal. The empirical analysis investigates acquisitions undertaken in Europe and the United States during 2003–​2011 in the medium-​high-​and high-​tech industries and shows that the higher the innovative capacity of the region where the target is located (measured by the wealth of technological knowledge available in the regional ecosystem), the more the acquiring firm will innovate after the deal. Moreover, the authors find that the positive impact of the innovative capacity of the target firm (measured by the size of its innovative output) does depend on the absorptive capacity of the acquiring company and on the reputation of the acquiring firm, which help to overcome possible resistance to knowledge transfer and barriers to the absorption and appropriation of relevant knowledge, common among target firms (Hansen, Fold, & Hansen, 2016).

Outward Foreign Direct Investments and Innovation    477 Anderson, Sutherland, and Severe (2015) similarly focus on acquisitions made in the United States, Europe, and Japan of targets with at least one patent granted either before or after being acquired by a Chinese firm. They find support for the “light touch” hypothesis given that the patent activity of the acquired targets does not change significantly after the takeover. Moreover, they observe a significant increase in patenting activity at the SIPO after the acquisition, therefore supporting the idea that Chinese multinationals internationalize with the aim of accessing advanced technologies for using them in their domestic market. Their confirmation of the reverse-​knowledge hypothesis empirically supports Hennart’s (2012) theoretical bundling model, which introduces the idea that EMNEs undertake strategic asset-​seeking investments for acquiring knowledge resources to exploit them in their own domestic markets, where they maintain location advantages. To illustrate the reverse-​knowledge transfer mechanism, Anderson, Sutherland, and Severe (2015) provide an interesting example of the acquisition of Firecomms, an Irish firm, by ZJF Group, a Chinese manufacturer of optical fibers. With the takeover, ZJF acquired advanced technological capabilities exploited in the growing Chinese market, dominated by public infrastructural projects and of difficult access to foreign firms. A confirmation of the reverse-​knowledge mechanism is also offered by Li, Strange, Ning, and Sutherland (2016), who investigate the effect of OFDIs on the innovation performance, measured by the patents granted per 10,000 inhabitants, of the Chinese provinces from where the investments originate, finding a positive and statistically significant effect. The authors also find a complementary relationship between inward and outward FDIs on regional innovation, which implies that inward foreign investments have contributed to increase local absorptive capacity, which enhances the positive impact of outward investment on local innovation capacity. The existence of positive technological spillovers in the home provinces of investors is also verified by Amendolagine, Giuliani, Martinelli, and Rabellotti (2020), who investigate the different technological specializations of the home and host regions of Chinese MNEs making acquisitions in the United States, European Union, and Japan. They find that investors with stronger knowledge bases, measured as more diversified and larger patent portfolios, invest more intensively in technologically distant regions, that is, regions applying for patents in very different technological classes from the home regions. Therefore, these investors are able to exploit cross-​border acquisitions to extend their knowledge and capabilities to new sectors, expanding their technological horizons.

Factors Moderating the Innovation Impact of OFDIs The empirical studies investigating the contribution of Chinese OFDIs to the innovation performance of the investors and of their home regions identify a number of moderating factors, at the level both of the host countries and regions and of the investing firm, which can influence how investments can be effective in enhancing innovation capacity. Considering possible heterogeneity among host countries, Piperopoulos, Wu, and Wang (2018) find that the geographic location choice of knowledge-​seeking investments can influence the innovation-​enhancing impact. When Chinese MNEs invest in developed countries, endowed with better innovation systems, more demanding customers, and highly

478    AMENDOLAGINE, FU, AND RABELLOTTI competitive markets, the positive effect on their innovation performance is stronger. The latter result is also confirmed by Fu, Hou, and Liu (2018). Although heterogeneity at the country level makes a significant difference in terms of impact on the innovation output of the investors, as shown by Crescenzi, Pietrobelli, and Rabellotti (2016), who considered investments going toward the European Union, when EMNEs undertake investments in activities related with R&D, their location choice is more driven by subregional rather than national characteristics. In fact, Amendolagine, Giuliani, Martinelli, and Rabellotti (2018) find that the stronger the innovation ecosystem of the region where their target company is located, the higher the innovation output of the acquiring Chinese companies. This result is particularly evident when the innovative strength of target regions is measured by the social filter, a composite indicator that considers a set of structural conditions—​region’s education achievement, productive employment of human resources, and demographic structure—​that may make some regions more or less prone to innovate as a consequence of a more or less favorable environment for innovation and knowledge circulation (Rodriguez-​Pose & Crescenzi, 2008). The finding is consistent with the idea that regions with strong human capital endowments (proxied by share of population with tertiary education) and productive use of resources (proxied by the percentages of the labor force employed in agriculture, and long-​term unemployment) offer more learning opportunities to new Chinese investor entries into the local ecosystem. Taking into consideration investors’ characteristics, there is a large agreement in the literature about the key role of absorptive capacity. The technological capabilities of the MNEs from emerging countries such as China may be weak due to the home country’s technological gap (Luo & Tung, 2007), and this implies that investors may not have the absorptive capacity required (Bell, 1984; Cohen & Levinthal, 1990) to recognize the value of the information, to assimilate and combine newly acquired assets with their existing resources, and to transform and apply the knowledge externally acquired (Deng, 2010). Nevertheless, although EMNEs may generally be considered constrained by weaker technological capabilities, many Chinese MNEs have managed to accumulate a sufficient absorptive capacity to be better able to benefit from their OFDIs (Fu, Hou, & Liu, 2018; He, Khan, Lew, & Fallon, 2018). A strong previous international experience is considered by Fu, Hou, and Liu (2018) as a factor helping Chinese multinationals to enhance their learning capability to understand the tacit components of foreign technology. The authors find that learning by exporting allows firms to accumulate technological capabilities and improve absorptive capacity; therefore, the more export experience the investor has, the better it will be able to identify, assimilate, and integrate the knowledge acquired via OFDIs. Moreover, they also find that the complementarity effect between OFDIs and export intensity is stronger for companies in the high-​tech industry in which the tacitness of knowledge may be a dominant characteristic. This is confirmed by Piperopoulos, Wu, and Wang (2018) in their empirical analysis on high-​tech Chinese manufacturing enterprises, who measure international experience in terms of overall number of foreign investments, stressing that the more internationalized firms are better able to accumulate knowledge and, furthermore, are able to increase their absorptive capacity by hiring foreign managers (Luo & Tung, 2007). Absorptive capacity could also be enhanced by internal investments in R&D; however, Fu, Hou, and Liu (2018) find that there is a trade-​off between in-​house R&D expenditures and OFDIs. The substitution effect is explained by the limited resources available for innovation

Outward Foreign Direct Investments and Innovation    479 and by the fact that in developing countries such as China, education and training play a more important role in the development of absorptive capacity than does R&D. Therefore, the authors conclude that in the context of China, OFDIs do represent a more effective channel for building up domestic innovation capability, and even more so in the high-​tech industry, in which the high risks and large investments needed to access and transfer knowledge into local use increase the internal resource constraints. Among Chinese MNEs, state-​owned enterprises (SOEs) are considered to have considerably higher levels of absorptive capacity than private companies because they have been strongly encouraged to invest in R&D (Guest & Sutherland, 2009). However, Anderson, Sutherland, and Severe (2015) empirically test whether SOEs’ postacquisition innovation performance is superior to that of the private sector Chinese MNEs and find that SOEs are not more capable of absorbing knowledge assets because of their possible inefficient use of R&D resources. A confirmation of this finding is also presented in Wu, Chen, and Liu (2017) on the basis of an empirical test undertaken on a sample survey of manufacturing multinationals from Zhejiang province. Besides absolute absorptive capacity, the concept of relative absorptive capacity introduced by Lane and Lubatkin (1998) can also be relevant to investigate the effectiveness of the acquiring firm in learning from the acquired company, as stressed by Yakob, Nakamura, and Ström (2018) in a case study investigating the successful case of the Volvo acquisition by Geely. The authors describe China-​Euro Vehicle Technology (CEVT), the R&D center created by Geely in Goteborg to jointly serve Geely and Volvo as a bridge between the two companies, which is characterized by organizational routines and processes that are aligned with the strategic intent of the acquiring and acquired firms and thus allowing exploitation of existing competences to produce new knowledge. Amendolagine, Giuliani, Martinelli, and Rabellotti (2018) introduce another dimension that may influence the capacity of Chinese MNEs to take advantage of their investments in innovative target firms and regions: the status or reputation of the investor. A perception of poor credibility can hamper the successful integration of operations in both the target and acquiring firms and can undermine the formation of trustful relationships between these firms’ respective managers, which will impede knowledge transfer (Shen, Tang, & Chen, 2014; Hansen, Fold, & Hansen, 2014). Levels of skepticism regarding Chinese firms are various: some are considered by international host country audiences to be more credible or reliable based on positive information on their operations in the international press and other channels, while other firms may be relatively unknown or associated with negative news. For instance, scandals over contaminated pet food ingredients, poisonous toys, defective tires, and tainted toothpaste have worsened perceptions of the credibility of Chinese enterprises and threatened their quest for legitimacy (Fiaschi, Giuliani, & Nieri, 2017). The authors find that status influences the extent to which Chinese MNEs are able to gain from acquisitions, and investors with a good reputation send out positive signals, which are reassuring to target firms’ managers and may contribute positively to the acquisition of knowledge. Moreover, they find that Chinese MNEs perceived to be low status by local audiences may experience more difficulties in accessing high-​quality knowledge from the innovative regional or local ecosystems in which they try to embed, and this could limit their innovation output. Complementing their econometric findings with some interviews undertaken with managers of enterprises acquired by Chinese MNEs, Amendolagine, Giuliani, Martinelli, and Rabellotti (2018) find that when a company is acquired by a

480    AMENDOLAGINE, FU, AND RABELLOTTI low-​status investor, the subsidiary may experience disruption to its innovative routines at the regional level. For instance, some collaborative projects may be discontinued, and talented human resources may be discouraged from applying for jobs following an acquisition if the information on the acquiring company signals poor status.

How Knowledge Is Transferred via OFDIs So far, we have seen how the literature has analyzed whether and under what conditions the internationalization of Chinese MNEs contributes to improve their knowledge and innovative capabilities. Yet, little research has attempted to investigate the mechanisms of learning, sharing, and integration, which will be the focus of this section. In a recent study based on in-​depth case studies of two well-​known Chinese multinationals operating in the telecommunications industry, Huawei and ZTE, Fu, Sun, and Ghauri (2018) unpack MNEs’ external learning process, distinguishing among knowledge-​acquiring, -​ sharing, and integration mechanisms. Considering knowledge acquisition, a subsidiary located in a developed country can be a source of external knowledge for the headquarters first because it undertakes independent R&D activity, which can contribute to the development of new products and processes for the corporation, and second because it is embedded in the host local ecosystem, where it gets involved in backward and forward linkages with suppliers, customers, and networks involving other actors such as universities, research labs, and business organizations, and where it can benefit from access to the local specialized labor pool. Therefore, “the subsidiaries serve as the spokes absorbing and feeding knowledge to the hub” (Fu, Sun, & Ghauri, 2018, 3). The three main learning mechanisms identified by the authors are learning from customers, host context, and cooperation. The importance of being close to the more demanding markets in developed countries was also identified as a key driver of Haier’s investments in Italy by Pietrobelli, Rabellotti, and Sanfilippo (2011). In the host country environments, Chinese MNEs can learn new operating strategies such as increasing attention to corporate social and environmental responsibility. Fu, Sun, and Ghauri (2018) observe a positive impact on MNEs’ reputation and more availability to cooperate with local partners, confirming the role of trust stressed by Amendolagine, Giuliani, Martinelli, and Rabellotti (2018) as a key facilitating factor in knowledge access. Finally, learning from cooperation is a strategy adopted by Chinese MNEs as a shortcut to upgrade their reputation, for instance, building a global brand via collaboration with established enterprises. As an example, Huawei has set up many joint R&D labs with well-​known firms such as Texas Instruments and IBM and built strategic alliances with multinationals like Siemens. Another learning mechanism strongly emphasized by Yakob, Nakamura, and Ström (2018) in the Geely-​Volvo case is the intensive staff mobility between China and Sweden. In this case, not only are Chinese engineers regularly sent to Göteborg for periods of three months to two years to learn from their peers, but also Swedish managers are evaluated for the effectiveness of their training capacity. Besides, learning is not considered a one-​way process because Chinese counterparts also contribute, sharing their knowledge and experience about the Chinese automotive market with their Swedish partners. By establishing in a highly specialized ecosystem, like Göteborg in the case of the automotive industry,

Outward Foreign Direct Investments and Innovation    481 Chinese MNEs also learn from recruiting skilled personal who can help to assimilate advanced knowledge (Piperopoulos, Wu, & Wang, 2018). In the previous section we highlighted the importance of the reverse-​knowledge transfer process from the subsidiaries to the headquarters in the case of Chinese MNEs (Anderson, Sutherland, & Severe, 2015), Fu, Sun, and Ghauri (2018) disentangle this process as a multilevel hub-​spoke knowledge-​sharing mechanism involving a vertical two-​way sharing perspective between the subsidiaries and the headquarters and a horizontal sharing perspective among subsidiaries. Besides, the authors stress the importance of a third mechanism of knowledge integration as a necessary step in which the different knowledge inputs are brought together, assimilated, and transformed to produce competitive advantages and upgrade the MNEs’ innovation capability.

Conclusions and Implications for Further Research As a channel of strategic asset seeking for MNEs and an important method for international knowledge acquisition (though new in the developing countries), outward direct investment has been used increasingly as a path in Chinese companies’ pursuit for innovation technology upgrading. This is reflected in China’s increasing OFDIs into developed countries and the increasing number of acquisitions of technology companies undertaken by Chinese MNEs in Europe and the United States, as well as in the findings from firm-​level surveys regarding the objectives of OFDIs in the developed countries. Findings from the literature on China’s OFDIs and innovation can be grouped into three areas: the impact of OFDIs on innovation, the factors moderating the innovation impact of OFDIs, and the mechanisms of the knowledge transfer process. Overall, despite the wide recognition of the weaknesses of Chinese MNEs in integrating and productively utilizing the externally acquired knowledge assets and the lack of the absorptive capacity needed for effectively exploiting them, statistical analysis of panel data of listed firms and firm-​level survey data find a significant positive impact of OFDIs on innovation and other aspects of performance of the investing firm. It is found that many Chinese firms managed to develop some absorptive capacities that are needed for effectively integrating and exploiting acquired external knowledge. Research also suggests that some Chinese MNEs realize their limitations in international management and absorptive capacity and hence adopt a “light touch” approach postacquisition, granting quite a lot of autonomy to their subsidiaries. It is also found that there is a list of factors that influence whether the innovation capability–​enhancing expectation of the OFDI will succeed. First, the choice of the destination of OFDIs is found to be an important factor determining the innovation outcome of the investing MNEs. When Chinese MNEs invest in a developed country, the positive effect on their innovation performance is stronger. The innovation ecosystem of the region where the OFDI firm is located also plays an important role, implying that regions with strong local ecosystems and large endowments of human resources offer more learning opportunities to Chinese investors.

482    AMENDOLAGINE, FU, AND RABELLOTTI Second, absorptive capacity plays an important role in whether the investing firm can successfully integrate the acquired external technology into the innovation capacity of the firm. Absorptive capacity comes from two sources: in-​house R&D and education and skills of the employees in Chinese MNEs. Although some research argues for the complementarity between in-​house R&D and the innovation outcome of OFDI, other studies find a substitution effect between them. This implies that many Chinese MNEs use OFDIs as a means to overcome their weakness in innovation and technological capabilities. Third, prior international experience is also found to be a factor helping Chinese MNEs to enhance their learning capacity. Finally, the form of ownership does not appear so far to have a significant effect on the strength of the innovation effect of OFDI: state-​owned firms are not more capable of absorbing knowledge assets, and this may be due to their inefficient use of R&D resources. In addition to these factors, the learning mechanisms within the Chinese MNEs are also of crucial importance. The benefits of OFDI to innovation capacity do not come automatically even if MNEs invest in a developed country. A subsidiary-​driven hub-​and-​spoke type of reverse-​knowledge transfer model is beneficial, based on case studies of the success and failure of several selected Chinese MNEs. Learning from customers, the host context, and local cooperation are found to be three important sources of learning. The importance of being close to the more demanding markets in developed countries is also identified as a key driver of success. Trust is another key facilitating factor in knowledge access. Finally, cooperation in the local ecosystem also played an important role in upgrade reputation and enabling the Chinese MNEs to access basic scientific research in host countries and co-​ produce both frontier technology and solutions for local market adaptation. Admittedly, the existing research also has some limitations, and there are considerable areas for future research. First, it is still too early to make a conclusive assessment about the innovation impact of Chinese OFDIs, considering that this a very recent phenomenon, it. Second, more empirical research on the causality between OFDIs and innovation capabilities of the investing firms is needed, in view of the two-​way relationship between OFDIs and innovation capabilities (and controlling for the identification problem with panel data and instrument variables). Third, our understanding of the process of OFDIs from developing countries and how to ensure a positive outcome on innovation and capability building is still limited. More in-​depth case studies of the processes, conditions, and dynamic interactions between the host environment and the MNE subsidiaries and their headquarters, as well as the home country, should be carried out. Finally, the impact of Chinese OFDIs on innovation systems in the host countries is an important, under-​ researched area. Future research should explore this, as well as its further impact on inclusive and sustainable development in the host economies.

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Chapter 5.5

International i z at i on of Chinese Re se a rc h and Devel opme nt Max von Zedtwitz and Xiaohong Iris Quan Introduction: The Rise of the Chinese Multinational Company Within a decade, Chinese outbound research and development (R&D) internationalization has grown from a marginal to a mainstream phenomenon; yet—​given the recency of this development and the inaccessibility of reliable data—​this rise is still enigmatic to many and mostly unexplained by a still quite limited scholarly literature. Some of the earliest records in this literature are case studies (e.g., Liu & Li, 2002; von Zedtwitz, 2008; Duysters et  al., 2009; Ester et  al., 2010)  or capture Chinese R&D as part of a general review of R&D internationalization from emerging countries (e.g., von Zedtwitz, 2006; Li & Kozhikode, 2009). Up until the early 2010s, the scholarly focus was on inbound internationalization of foreign (non-​Chinese) R&D into China, which was far more significant in scale and scope than the few R&D centers that Chinese multinational corporations (MNCs) such as Huawei, ZTE, or Lenovo had set up or acquired overseas by then. The financial crisis of 2008–​2009 and an emergent literature around bottom of the pyramid (Prahalad, 2004)  and reverse innovation (Immelt et  al., 2009; Govindarajan & Ramamurti, 2011)  coincided with a rising interest in the innovation capabilities of emerging market firms, of which Chinese outbound R&D is a subdomain. The Chinese government had explicitly supported internationalization of Chinese R&D, starting with the 2002 “going out” policy and followed up in 2005 with the “indigenous innovation” policy. Together, these two policies called for a reinforcement of Chinese R&D capabilities though investments in domestic technologies and—​ in a gradual replacement of well-​established licensing practices—​the appropriation of foreign technologies and resources overseas. Many Chinese MNCs were encouraged to seek technologies outside China, as long as it strengthened their home base and the Chinese home market. Foreign Chinese R&D in the 1990s and early 2000s was mostly

Internationalization of Chinese Research and Development    487 oriented toward supporting foreign market development and, therefore, was often located in other developing countries such as Russia or India. Similar motives can be found in Chinese outward R&D, such as the case of Huawei discussed in the next paragraph. There is also an important technology orientation, which leads to a focus of international Chinese R&D toward the more difficult but technologically more lucrative markets in the United States, Canada, Europe, and Japan (see, e.g., von Zedtwitz, 2008; Di Minin et al., 2017). Huawei serves as a well-​researched illustration of Chinese R&D internationalization. As Huawei internationalized first into Russia, Latin America, and Africa before progressing into the more advanced markets in Europe and North America, it also set up R&D centers there first. By 2000 (i.e., when the telecom industry was rattled by the new economy crisis), Huawei already had global R&D centers in Moscow (opened in 1997) and Bangalore (1999). Capitalizing on the difficulties of Ericsson and other Western telecom leaders in the early 2000s, Huawei either acquired entire R&D teams or set up new R&D centers close to its Western competitors in, for example, San Diego (2000), Stockholm (2001), Plano/​Dallas (2001), and Basingstoke (2003), but also continued to build a stronger R&D presence in other developing markets such as Bangkok (2001) and Pakistan (2004). The case analysis by Chen et al. (2011) of 16 R&D centers shows that Huawei’s desire to build technology competence, hire talents, and understand local customers was its main motivation to set up these R&D branches abroad. By 2018, our records list more than 50 international R&D centers, development units, and R&D joint ventures for Huawei, with multiple centers in particularly attractive countries. Hisense established R&D centers in both the United States and Europe to serve what are viewed as the biggest LCD TV markets. Since the European and American markets have different television standards from those in China, their local R&D units mostly engage in support for local product adaptation. Hisense has also recognized its technological deficiencies in long-​term global competition, and thus the Hisense US R&D subsidiary is also responsible for monitoring the latest industrial technologies, understanding technical standards and specifications, and conducting proactive product research in the North American market (Di Minin et  al., 2017). Besides its R&D centers in the United States (mainly in Silicon Valley, Los Angeles, San Diego, Chicago, Gwinnett, Maryland, and New Jersey) and Europe (Düsseldorf and Eindhoven), Hisense also has R&D centers in Australia, South Africa, Japan, Canada, and Israel. In the meantime, Chinese R&D internationalization is no longer pioneered by its largest high-​tech firms but has become a much more widespread effort across multiple industries. While some Chinese MNCs only set up one foreign R&D site (e.g., China Mobile in Silicon Valley), others, such as CRRC, have established multiple research centers around the world. Our own data covers 209 Chinese MNCs and 1,390 of their R&D centers; 458 of them are outside China (Figure 5.5.1). In comparison with other countries, China is the seventh-​ largest source of global R&D, at least as measured by the number of international R&D centers, just behind the Netherlands and ahead of Finland. This is an impressive ascendancy for any country, but especially one that had almost no international R&D presence just over a decade ago and still battles the perception of being at best a regional leader in innovation, with few modern breakthrough technologies to its claim. The rest of this chapter examines the (scant) literature on the subject and compares Chinese with Western motivations to globalize R&D, as well as specific challenges

488    von Zedtwitz and Quan

Figure 5.5.1  Global footprint of Chinese R&D centers, with 458 known foreign and 933 domestic locations. Source: GLORAD Database, 2018

that Chinese firms encounter in the process of doing so. We also discuss the results and formulate some insights and takeaways given the still-​limited data and scholarly coverage.

Notes on Methodology The literature on Chinese R&D internationalization is sparse: first, scholarship on this topic has not yet caught up with the phenomenon and little is available beyond descriptive case studies; second, access to reliable and meaningful empirical data from within Chinese MNCs is difficult and limits subsequent academic analysis; and third, research on Chinese firms is often subsumed under research more generally on emerging market MNCs (EMNCs), in part compensating for the lack of in-​depth research possible within any particular emerging market country. All in all, we found nine papers that specifically addressed the internationalization of Chinese R&D. Our own review of the discipline therefore also included literature related to international innovation more broadly, not just from China but also from other developing countries. Other papers have addressed innovation by Chinese firms, sometimes as a means to compete internationally; those papers are often less clear-​cut as to what is done at home or abroad, or what exactly is meant by “innovation,” and we did not consider them in our more narrow focus of “R&D” internationalization. Similarly, some papers look at EMNC R&D in various emerging economies (e.g., China and India), but since their findings are not China specific, we chose only contributions that were especially prominent or insightful with respect to the Chinese angle within R&D internationalization.

Internationalization of Chinese Research and Development    489 Table 5.5.1 An Overview of the Literature Relevant to Chinese R&D

Internationalization Innovation Related

General

Chinese MNC Chen et al. (2011), Di Minin internationalization et al. (2012), Di Minin et al. (2017), Liu & Li (2002), Liu et al. (2010), Wang et al. (2017), Zedtwitz (2005), Zedtwitz (2008), Zhang (2010)

Fan (2011), Prange & Bruyaka (2016), Ren et al. (2015), Wu et al. (2016)

Li et al. (2018), Liu & Buck (2009), Peng et al. (2017), Yuan et al. (2016)

Emerging MNC Awate et al. (2012), Awate internationalization et al. (2015), Ervits (2018), Li & Kozhikode (2009)

Duysters et al. (2009), Ernst (2009), Zedtwitz et al. (2015)

Athreye & Kapur (2009), Dunning et al. (2008), Kotabe & Kothari (2016), Luo & Tung (2007), Mathews (2006), Yamakawa et al. (2008)

General MNC Dachs (2017), Gassmann & internationalization Zedtwitz (1999), Kuemmerle (1999), Pearce (1989), Rubenstein (1989)

Cantwell & Janne (1999), Ghoshal & Bartlett (1988), Rodriguez (2011)

Johanson & Vahlne (1977), Dunning (1981)

Literature Overview

R&D Related

We ignored the more dominant literature on inbound internationalization of R&D into China, except where it was necessary to draw comparisons at the global level. Table 5.5.1 presents an overview of the literature, with our claim to having been as systematic and complete in our compilation as possible only applying to our chosen focus theme; we limited ourselves to list only especially noteworthy and relevant publications in the other eight literature categories. We complemented this analysis with some of our own data collected on Chinese R&D internationalization but did not conduct or explicitly include any qualitative interview-​based research of our own.

Motivations The motivations of MNCs locating in other countries can be explained by Dunning’s (1981) ownership, location, and internalization (OLI) theory, which posits that MNCs leverage ownership advantages such as superior technologies or brands in foreign markets by accessing low-​cost inputs, by being able to serve local markets better, and by lowering transaction costs through internalizing the efficiency gains from economies of scale and scope. Prior to the 1990s, MNC investments were predominately from advanced countries to other advanced countries or developing countries (Child & Rodrigues, 2005). To explain the rise of post-​1990 investment coming from MNCs based in developing countries,

490    von Zedtwitz and Quan Mathews (2006) proposed a linkage, leverage, and learning (LLL) theory. According to this theory, “latecomer firms” from developing countries use their overseas investments and global linkages to leverage existing cost advantages and to learn about new sources of competitive advantage. The drivers and motivations to globalize R&D were a matter of investigation in the 1990s during the early heyday of R&D globalization of US, European, and Japanese R&D internationalization. Gassmann and von Zedtwitz (1998) grouped them into five major categories: input-​oriented drivers that include access to local talent and technology; output-​ oriented drivers such as market and customer proximity, as well as leveraging local cost advantages and efficiency-​oriented drivers (e.g., critical mass of local R&D teams and exploitation of multiple time zones); political and sociocultural drivers such as subsidies, overcoming protectionism, and local content regulations; and R&D external factors that include, for example, merger and acquisition (M&A), peer pressure, and tax optimization. R&D internationalization drivers differ somewhat industry by industry (von Zedtwitz et al., 2004) and they differ between research as opposed to development (von Zedtwitz & Gassmann, 2002). Gammeltoft (2006) proposed a slightly different categorization of these drivers, emphasizing the role of costs and cost reduction in global R&D and differentiating between technology-​driven pull and innovation-​driven push factors in international R&D. R&D globalization drivers were well understood by the time MNCs from China and India started to establish or acquire R&D centers outside their home countries in larger numbers in the mid-​2000s. Of course, EMNCs had set up foreign R&D centers already in the 1990s, such as Huawei in Russia and India, and Samsung and LG in the United States and Europe, but compared to the West-​East R&D internationalization that was just about to shift into high gear, EMNC-​led R&D internationalization seemed to be an exotic outlier at best. Research on R&D and innovation coming from developing countries before the mid-​2000s almost entirely focused on knowledge flows internal to Western MNCs with emerging market subsidiaries (e.g., subsidiary-​to-​headquarter flows) (Birkinshaw & Hood, 1998; Frost & Zhou, 2005; Hakanson & Nobel, 2001). Although as recently as 2015 Awate et  al. found that there was no explicit comparison of R&D internationalization between MNCs from advanced and emerging markets, the first, albeit mostly descriptive, publications on EMNC R&D internationalization appeared in the mid-​2000s (von Zedtwitz, 2006; Athreye & Kapur, 2009). Von Zedtwitz (2006) classified R&D internationalization coming from developing countries as either “catch-​up” (if going into more advanced countries) or “expansionary” (if going into other developing countries with emerging markets of their own). About half of the observed developing country–​originated R&D internationalization was coming from China, with India, Taiwan, South Korea, and Brazil being other significant sources. In a review of Chinese drivers and motivations, von Zedtwitz (2006) found that seeking cost advantages played a negligible role for Chinese MNC R&D outside China. Other differences to MNCs from advanced countries included the presence of a fast-​developing domestic market, which tends to keep market-​oriented R&D at home; relative shortage of homegrown technologies and the need to acquire those abroad; and the opportunity to easily expand domestic products into similarly fast-​paced emerging markets. Since China had been the center for manufacturing for Chinese firms as well as foreign MNCs, few Chinese MNCs saw a need or even an opportunity for process-​ related R&D and innovation in foreign markets.

Internationalization of Chinese Research and Development    491 Table 5.5.2 Selected Motivations for Chinese MNCs to Internationalize R&D Motivation

Early Days (before 2008)

Nowadays (2018)

Access to foreign technology

Strong

Even stronger

Access to foreign talent and creativity

Not unimportant, but not central

Growing in importance

Lower costs

Not important

Growing in importance

Market proximity

Focus was on domestic market

With China’s growing production capability and domestic economy slowing down to a certain degree, foreign markets become more important

Customer proximity

During catch-​up phase, global customer input unimportant

Working with global customers becomes important in designing global products

Overcoming protectionism

Not unimportant, but not central

Becoming a “good local citizen” is growing in importance to more effectively integrate local talent and skills

Setting global technology standards

Not central

Establishment of global technology platforms key in industries such as telecommunications, computing

The temporary weakness of many advanced economies and retrenchment of Western R&D foreign direct investment (FDI) to China during the global economic crisis of 2008–​2009 opened a window of opportunity for Chinese outbound R&D FDI. This window coincided with the growing realization by many Chinese firms that domestic markets had matured enough to absorb (and afford) global technology. Chinese overseas R&D motivations followed suit (see Table 5.5.2). Chinese MNCs started to acquire Western firms increasingly for technology and intellectual property (IP) (e.g., WuXi PharmaTec’s 2008 acquisition of AppTec Laboratories, Shougang’s 2009 acquisition of Delphi’s brake unit; more recent examples include the acquisition of the German robotics firm Kuka by Midea and CNCC’s takeover of Swiss pesticide and seed giant Syngenta) or established R&D centers with the intent to source talent and technology locally, specifically with the ambition to integrate locally embedded creativity and entrepreneurship (e.g., Haier in Silicon Valley). While access to foreign technology is important for any MNC with global R&D, it was always a stated ambition of Chinese MNCs during their main catch-​up period in the 1990s and 2000s; after 2008 the focus also turned to sourcing intangibles and know-​how such as management schemes, new types of organizing for innovation, and out-​of-​the-​box thinking. Chinese MNCs started to run their own corporate venture capital arms that invested in US startups, thereby becoming co-​owners of technologies with breakthrough potential. While US regulators were wary to approve acquisitions of US companies with established technology, the acquisitions of these startups were usually so small that they did not show up on anybody’s radar screen,

492    von Zedtwitz and Quan while of course the economic success of many of these technologies remained uncertain for years to come.

Challenges The difficulties and obstacles to R&D internationalization have been covered at length in the literature (Gammeltoft, 2006). Suffice to say that some of the earlier challenges are no longer as stifling as they used to be.: For instance, limitations in the ability of information and communication technology to guarantee data-​rich and delay-​free representations of products and technologies simultaneously under work in different locations have been overcome due to the progress in telecommunications technologies and a more intuitive familiarity of engineers with such technologies (Howells, 1995; Boutellier et al., 2008). However, challenges such as protection of IP rights remain (Quan & Chesbrough, 2010). Overall, the internationalization of R&D appears to have become easier, given also the growing experience of firms and individuals usually involved in leading these initiatives. There are a few aspects in the ascent of Chinese R&D internationalization that are new or more pronounced than in the conventional R&D internationalization of the 1980s and 1990s. The most obvious one is related to China’s attempt to acquire foreign technologies and leverage them domestically. Of course, US and European MNCs also pursue technology abroad, but from the beginning of their internationalization they operated from a basis of technological strength both domestically and abroad. Even Japanese MNCs had already acquired technology leadership positions by the time they started to internationalize in the late 1980s and early 1990s. Chinese MNCs, at least until recently, did not have this advantage, and their investments in R&D abroad—​whether greenfield R&D centers, technology acquisitions of other firms, participation in technology startups, or university research collaborations—​are viewed with the suspicion that the knowledge flow is primarily one way, toward China, in exchange for capital investment. Poor brand recognition or—​ worse!—​a reputation of poor product or technology quality also does not help in attracting top talent in engineering and management. The success of some Chinese MNCs (such as Tencent and Alibaba, which ranked fifth and ninth respectively as most valuable global brands according to CNN Money in 2018) will likely change these perceptions. Still, many Chinese R&D centers in the United States are more attractive to overseas-​trained Chinese engineering graduates than they are to American graduates. Initially, China had been attractive for foreign R&D because of its low labor costs. Although the labor cost advantage has narrowed, most countries that Chinese MNCs consider as foreign R&D hosts have a higher cost base than China. Low cost is therefore not a typical advantage Chinese MNCs could harness. As long as the Chinese domestic market is growing more strongly than the US or European markets, there is also less of an incentive to support product localization in the West with local R&D centers. Given that Chinese MNCs are still quite young organizations, compared with their Western counterparts, and with more or less explicit involvement by the Chinese government, they also tend to be more centralized, with most technology decision making and R&D in China. An overview of changing challenges for Chinese overseas R&D is presented in Table 5.5.3.

Internationalization of Chinese Research and Development    493 Table 5.5.3 Challenges for Chinese R&D to Internationalize Challenge

Early Days (before 2008)

Nowadays (2018)

Higher R&D costs abroad

High cost differential, especially toward high-​technology Western countries

Declining cost differential

No own technology

Often prohibitive as undermining status as R&D partner

Declining as China owns more and more cutting-​edge IP

Reputation and recognition

Poor product quality and poor career perspectives led to poor brand value

Some Chinese MNCs are now brand leaders, but foreign R&D centers still struggle to recruit top-​caliber local talent

Foreign market support

China is the main market, little need for far-​away product localization; central decision making is strong

Some easement on this situation, but still R&D is very China centric and China oriented

Reception of Chinese inbound FDI

Small and somewhat exotic, nonthreatening

Growing resentment toward Chinese inbound FDI, especially in the United States and Europe

In sum, the internationalization of Chinese R&D and product development has therefore not followed Vernon’s (1979) product life cycle hypothesis in the sense that R&D would eventually follow product management into less developed countries, but given China’s rapid development and emerging global economic presence, this may very well happen over the next two decades. Also, with the growing awareness of strategic overseas investments and acquisitions by Chinese MNCs that seem to be coordinated and guided by a central, Beijing-​led plan, many countries—​mostly the already technologically advanced countries—​have become apprehensive about Chinese R&D in their home countries and carefully scrutinize the plans and investments of Chinese MNCs.

Comparison to the R&D Internationalization of the BRIC Countries and Japan The rise of Chinese R&D internationalization is noteworthy in part due to the expected scale of China’s outward FDI and in part due to the fact that China is rapidly catching up in terms of technology. Within a short timeframe, Chinese MNCs have established a significant foreign R&D presence. Due to its association with the BRIC countries, China is often compared to Brazil, Russia, and India. In this context, China leads R&D internationalization in absolute terms among all four countries, especially Brazil and Russia, which have only little international R&D presence at all. Indian MNCs have achieved significant R&D globalization on their own, led primarily by India’s strong software industry. Despite similar size in population, the Indian economy is still about five times smaller than China’s, yet

494    von Zedtwitz and Quan China has only three times as many foreign-​based R&D centers than India (based on the GLORAD database). Possible explanations are the relative ease of R&D internationalization in software and internet-​based firms, and the smaller cultural and language differences compared with the mostly English-​speaking host countries for R&D centers in the West. Some three decades ago, another country from East Asia—​Japan—​expanded its own R&D globally. Japanese R&D internationalization has been thoroughly researched (Westney & Sakakibara, 1985; Asakawa, 2001; Cantwell & Zhang, 2006). Just like China now, Japan faced great cultural and language barriers establishing R&D abroad. Japanese global R&D presence today is two and a half times that of China and ranks third internationally behind the United States and Germany. But when it went global in the 1980s, Japanese R&D was more advanced and mature than China’s today, and its internationalization was driven by a combined search for markets and technology early on. Furthermore, the Japanese industry suffered a heavy blow in the 1990 crisis that drastically lowered Japan’s gross domestic product (GDP) growth for decades. China, on the other hand, seems to have benefited initially from the 2008 global financial crisis, and although its GDP growth has slowed down after 2013, it has been spared the economic shock Japan went through in the 1990s. Japan’s R&D internationalization is therefore only partially comparable to China’s, and China seems to constitute the first-​ever case of an emerging economy developing a global R&D and technology presence.

How Is China Different? While every country is special or different in some ways, there are several factors that seem to be particular about China’s R&D internationalization. Perhaps first of all, China provides its industry with strong policy support favoring domestic market development and incentivizing the internationalization of Chinese MNCs as well as investment in R&D. The reasoning behind its support for internationalization is that only global Chinese players will be able to hold their own against foreign MNCs in China, and China—​just like any other country—​does not want to see strategic industries being taken over by foreign companies. Second, China already has a very well-​developed domestic market, in terms of not only demand but also, and perhaps more importantly, of supply: local firms build, manufacture, and assemble not just for foreign MNCs but also for other Chinese companies. Although Chinese firms are relatively new to technological specialization, they increasingly rely on a maturing supply pyramid that becomes deeper, more competitive, and more reliable. This frees up resources and attention to seek and develop specialized technology centers abroad. Third, Chinese MNCs also benefit from the presence of foreign R&D centers in China itself. Most of the R&D employees, including its management, are local Chinese trained by Western firms in Western management and engineering practices. Many so-​called “overseas returnees” (Chinese who were educated abroad, perhaps also worked abroad, and later returned to China) bring back firsthand experience in how to manage global organizations and global teams. How much China’s domestic industry benefits from foreign R&D spillover is debated (Agrawal & Cockburn, 2003; Cheung & Lin, 2004), but current and emerging China policy practice operates under the assumption that foreign R&D presence should transfer technology to local Chinese companies (Prud’homme et al., 2018).

Internationalization of Chinese Research and Development    495

How Are Chinese MNCs Different? Research on the structure and design of Chinese organizations is too plentiful to summarize here (Duysters et al., 2009; Luo & Zhang, 2016), but little has been done as of yet with regard to the structure of Chinese R&D organization except for a few. Research by Di Minin, Quan, and Zhang (2017) identified a participative-​centralized R&D structure between R&D units and headquarters for Chinese MNCs in Europe and in the USA, and that R&D structure mainly facilitates learning by Chinese MNCs from host countries. In some cases—​such as ZTE—​they also found hierarchical division of R&D labor in Chinese MNCs in both Europe and the USA, with Chinese overseas R&D units undertaking high-​value-​ added R&D activities while domestic R&D activities in China low-​value added, which reflects a clear technological leadership in developed countries. Relevant for Chinese R&D seems to be the relative lack of international experience of much of the upper management, both for state-​owned and for private firms. This is less the case for young technology startups, but they are hardly represented in China’s foreign R&D. This lack of international exposure also showed itself in initially limited English-​language capabilities. As was the case for many MNCs in the West, the first steps into internationalization are controlled by a strong headquarter, but centralization of decision making and information sharing may be even stronger in Chinese organizations than it was for Western firms at their own respective stages of development. Thus, foreign R&D subsidiaries may have less freedom to act and less freedom to innovate than their Western counterparts; they are often characterized by a hub-​and-​spoke model (Gassmann & von Zedtwitz, 1999). Early internationalization was driven by market access, technology, and distribution network investments in small local firms that had come under economic duress (i.e., acquisitions of firms that were difficult to manage already). A trusted confidante from within the inner circle (often, a Chinese individual with little local experience) was dispatched to turn the acquired company around. Not surprisingly, many of those acquisitions failed. Learning from these experiences, Chinese MNCs later invested in healthy yet pricier firms, and often retained local management and gave them greater operative freedom. In fact, in some cases Chinese firms even leveraged these acquisitions as pivots in their own organizational evolution, such as Lenovo, which set up an international headquarters and R&D organization around its IBM acquisition, and TCL, which used its acquired former Alcatel R&D center in Paris to learn how to run global R&D. Nowadays, Chinese MNCs run global corporate venture capital funds (CVCs) to invest strategically in technology startups worldwide, for example, Xiaomi, Tencent, and Alibaba in Silicon Valley (Weinland, 2018). These investments are comparatively small and often unnoticed by increasingly protectionist governments in the United States, Canada, and Europe.

Summary Despite the first Chinese MNCs setting up R&D centers outside China more than 20 years ago, surprisingly little research has focused on this phenomenon. There are two possible explanations: (1) This area of research is still emerging at a low attention level. Research on Chinese firms is notoriously difficult, and R&D information is especially secretive. As

496    von Zedtwitz and Quan a result, research tends to be qualitative and driven by the opportunistic access to certain firms, and thus more difficult to publish in respected journals. (2) This particular focus of research has passed the main peak of attention of the late 2000s, and scholars have come to the conclusion that there is not much new theory to develop or find in the context of Chinese R&D internationalization; that is, it can all be explained as part of existing theory or the wider field of EMNCs’ internationalization (see, e.g., Dunning et  al., 2008)  that encompasses also research on firms from, for example, India and Korea, where data access is easier, the analysis more profound, and subsequent publications therefore more acceptable in leading journals. In our view, it is too early to tell which of the two explanations prevails for Chinese R&D internationalization, but we expect that China R&D–​specific theoretical insights will be uncovered in due course (Kostova et al., 2016; Di Minin, et al., 2017).

Implications As the Chinese economy continues to expand and Chinese MNCs continue to internationalize into an evolving global economy, a number of research directions open up within ongoing research streams in the international business and innovation literatures. For instance, one aspect often overlooked in international R&D research is the extent to which MNCs engage in sponsored research at local universities and in subcontracted R&D to local supplier firms. These fall technically outside the boundary of the firm, but they are no longer disconnected from the strategic decision making of top management considering technology and innovation options of the overall firm (see, e.g., Chesbrough, 2003, on the impact of open innovation on strategic management). Chinese MNCs may choose to sponsor academic research at universities around the world, securing access to important IP without formally exposing themselves—​and drawing possibly unwanted attention—​through overseas corporate R&D facilities. Related to this trend are investments in and, to a lesser degree, outright acquisitions of technology startups. Research in CVC and its significance for corporate innovation and entrepreneurship is emerging and should extend to Chinese CVC in the United States and Europe (especially by the big three: Baidu, Alibaba, and Tencent). But research will also need to consider alliances between Chinese and non-​Chinese MNCs in the future. R&D done in such international collaborations will also benefit the Chinese partner, either following the example of West-​West collaborations (Narula & Duysters, 2004)  or exporting the Sino-​foreign joint venture arrangements that were relatively successful in importing technology to China for decades (Jolly, 2004). Even if no foreign partners are involved directly, questions will arise with respect to the future development of Chinese MNCs. Will they, as their foreign counterparts did at some point in their evolution, decentralize in terms of decision making and control, or will the influence of government control (which appears to be stronger in the case of China than in most Western countries) and cultural preference for centralized leadership (Boisot & Child, 1996) win over the need to access and leverage dispersed know-​how and talent? Will Chinese MNCs settle in the somewhat suboptimal hub model of R&D globalization (Gassmann & von Zedtwitz, 1999), or will they develop some new form of hybrid decentralized-​centralized organization structures (Di Minin et al., 2017)?

Internationalization of Chinese Research and Development    497 Policymakers have addressed global technology collaborations and acquisitions for decades and formed reference treaties such as the World Trade Organization (WTO) and Agreement on Trade-​Related Aspects of Intellectual Property Rights (TRIPS). MNCs from member states (and China has been a member since 2001) are expected to abide by these rules, and in most cases, they do—​if not, there are instruments to reign them in. But there are two concerns with respect to Chinese MNCs: one is the alleged practice of copying foreign technology and insufficient policing and enforcement of IP (including global IP) in China itself, and the other is the suspicion that the Chinese government itself either explicitly coordinates or implicitly permits “unfair” policy practices that favor Chinese MNCs at the expense of foreign MNCs both within China (e.g., through preferential tax subsidies) and abroad (e.g., by extending state-​protected credit lines for foreign acquisitions) (see, e.g., Prud’homme et  al., 2018). Policing these practices is difficult as China increasingly uses its global economic influence in the form of soft power (Mastro, 2019) or trade wars (note, e.g., the 2018 escalation of tariff impositions between the United States and China). Collateral damage extends to many local firms, consumers, entrepreneurs, and R&D and innovation initiatives that would otherwise have benefited from more global accord and stability. Chinese R&D abroad is affected by these policies and its consequences (and, as a result, local technology spillover to domestic industry), as is the export of Chinese-​invented technology to markets and competitors abroad.

Conclusions Although the internationalization of Chinese R&D is rising in scale and scope, so far the literature on this phenomenon is limited and little theoretical insight has been gained. As the Chinese economy continues to expand, so will China’s global R&D footprint, despite growing apprehension of local governments in some of the new host countries. But most policy, research, and managerial consequences are likely to be driven by the scale rather than the quality, nature, or scope of Chinese R&D abroad.

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Internationalization of Chinese Research and Development    501 von Zedtwitz, M., Gassmann, O., & Boutellier, R. (2004). Organizing global R&D: Challenges and dilemmas. Journal of International Management, 10, 1, 21–​49. Wang, Y., Xie, W., Li, J., & Liu, C. (2017). What factors determine the subsidiary mode of overseas R&D by developing country MNEs? Empirical evidence from Chinese subsidiaries abroad. R&D Management, 48, 2, 253–​265. Weinland, D. (2018). Chinese VC funds pour $2.4bn into Silicon Valley startups. Financial Times, July 17. Westney, D., & Sakakibara, K. (1985). The role of Japan-​based R&D in global technology strategy. Technology in Society, 7, 2/​3, 315–​330. Wu, J., Wang, C., Hong, J., Piperopoulos, P., & Zhuo, S. (2016). Internationalization and innovation performance of emerging market enterprises: The role of host-​country institutional development. Journal of World Business, 51, 251–​263. Yamakawa, Y., Peng, M.W., & Deeds, D.L. (2008). What drives new ventures to internationalize from emerging to developed economies? Entrepreneurship: Theory and Practice, 32, 59–​82. Yuan, L., Pangarkar, N., & Wu, J. (2016). The interactive effect of time and host country location on Chinese MNC’s performance: An empirical investigation. Journal of World Business, 51, 331–​342. Zhang, J. (2010). International R&D Strategies of Chinese Companies in Developed Countries: Evidence from Europe and the U.S. Pisa: Scuola Superoire Sant’Anna. Ph.D. Thesis.

Chapter 5.6

Internat i ona l Innovat i on C oll ab orati on i n C h i na Kaihua Chen, Ze Feng, and Xiaolan Fu At present, with the acceleration of economic globalization and the progress of science and technology (S&T), the flow of innovation elements is unprecedentedly active on the global scale. To carry out sustained, extensive, and in-​depth international innovation collaboration (IIC) has become a necessary way to actively respond to global challenges, to improve the competitiveness of science, technology, and innovation, and to achieve economic growth and sustainable development. At this stage, the international innovation collaboration of major developed countries is deepening. To further develop international innovation collaboration, lots of countries have formulated various incentive policies and measures to improve their scientific and technological innovation and economic development. For example, in 2017, the Research, Innovation, and Science Policy Experts Group (RISE)1 of the European Union published the report “The Future of Europe:  Open Innovation, Open Science and Open to the World (3Os),” which stated that it was necessary to strengthen scientific diplomacy. In the same year, the Academy of Finland (2017) also formulated the international collaboration strategy for 2017–​2021. The strategy drew attention to the quality, impact, and renewal of science and research, and also emphasizes the importance of international engagement for high-​quality science and research. On April 21, 2017, the Cabinet of Japan released the “Comprehensive Strategy on Science, Technology and Innovation (STI) for 2017,” pointing out that they should actively participate in international collaboration and continue to carry out scientific and technological collaboration with America and developed countries in Europe, as well as strengthen collaboration with developing countries. Tracking and judging the research and development (R&D) tendencies and business opportunities of the international community to find out new innovative growth points 1 

The Research, Innovation and Science Expert Group (RISE) was a high-​level group of policy experts who advised the former Commissioner for Research, Science and Innovation of EU, Carlos Moedas. The group was set up in 2014 and concluded its mandate in 2019.

International Innovation Collaboration    503 is also necessary. On September 20, 2017, the United States and the United Kingdom signed a landmark international S&T collaboration framework agreement (Office of Science and Technology Policy, 2017), which creates a pathway for the two nations to collaborate on scientific initiatives that potentially benefit them and the entire world. Not only in the advanced economies but also in emerging countries, like China, international innovation collaboration has become an important means to take advantage of R&D investments abroad and leverage domestic research capabilities (European Commission, 2003; Wagner, 2008; Basu and Aggarwal, 2001). At present, China is in the critical period of economic growth and structural adjustment. Facing the arduous task of promoting economic transformation and development in the new period and new stage, national innovation and development need to transform to a pattern with high quality and high efficiency, for which strengthening international innovation collaboration is particularly important. International innovation collaboration is an important path to promote the establishment of a new type of international relations with win-​win collaboration as its core. It is also an effective way for China to actively participate in global governance, integrate into the global innovation network, and ensure the implementation of the national diplomatic strategy. In recent decades, China has established S&T collaboration with more than 150 countries and signed collaboration agreements with nearly 90 countries. This shows that the development of international innovation collaboration in China is in a very important strategic position at this stage. The “Special Plan of 13th Five-​Year Plan on the International Science and Technology collaboration” also emphasizes that under the dual needs of short-​term steady economic growth and long-​term structural adjustment, international innovation collaboration is an effective means to implement innovation-​driven development strategies, gather global resources, and improve China’s position in the global chain of value. In academia, discussions on international innovation collaboration are also emerging. More and more countries believe that S&T innovation collaboration is the key way to promote and maintain their global innovation competitiveness (Glänzel, 2001; Hwang, 2007). The principle that science has no borders between nations, while technology has borders, makes international collaboration in basic scientific research become more frequent. Therefore, research on international research collaboration (IRC) has received more attention from academia and has developed into an emerging field of innovative research (Chen et al., 2019). Existing research suggests that IRC is the main driver of technological advancement (Wang et al., 2014), industrial innovation, and economic growth (Sharma and Thomas, 2008). Through statistical analysis of the literature in the field of IRC, the research of Xiaolan Fu and Kaihua Chen (2019) drew the Figure 5.6.1, which demonstrated that the IRC studies exhibited an “exponential growth” model and experienced three stages of development: the emergence phase (1957–​1991), the fermentation phase (1992–​2005), and the take-​off phase (2006–​2015). Although research on international innovation collaboration has experienced dramatic growth, there is still a lack of the systematic review that is conducive to a comprehensive understanding of the particular research domain (Martin, 2012). There are distinctive characteristics of international innovation collaboration that differ from domestic research collaboration. International innovation collaboration meets more challenges

504    Chen, Feng, and Fu 180 160

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0

Figure 5.6.1  Trends in the number of international research collaboration papers per year included in SSCI. Source: Chen et al. (2019)

compared with other kinds of research collaboration. As a result, a full understanding of international innovation collaboration as a field is required. This chapter attempts to analyze China’s international innovation collaboration from a more macro level. Combining theory with practice, we analyze the necessity of international innovation collaboration, China’s practice and experience, and the status quo of China’s international collaboration. The chapter provides suggestions for solving the problems existing in the present stage. It also collates and forecasts the future research areas of international innovation collaboration.

Necessity of International Innovation Collaboration in China The Need for High-​Quality Development of S&T The transformation of China’s S&T into high-​quality development and the emergence of technological breakthroughs require international collaboration. In the era of “big science”, China urgently needs to transform to high-​quality development. Improving the level of S&T is especially important for China to achieve high-​quality development. Deep international innovation collaboration can improve the use and allocation of innovative resources and help to achieve major technological breakthroughs and produce high-​level research achievements. In the past 10  years, with the rapid development of China’s S&T innovation, the process of S&T globalization has been greatly accelerated. International collaboration has become an important part of scientific research

International Innovation Collaboration    505 activities and an important way for scientific researchers to create significant original achievements.

The Need for Construction of an Innovative Country with Strong Technological Power The increasing mobility of global innovation resources such as knowledge, talent, information, and technology will accelerate the coming together of countries with stronger innovation capabilities. International innovation collaboration can promote the improvement of innovation capability, and that can further attract global innovation resources, which can further promote a country’s innovation capability and influence, constituting a virtuous circle. China is promoting the construction of a strong country in S&T, with stronger power and more urgent needs to carry out international innovation collaboration to promote the transformation of S&T activities from quantity to quality. Entering a new era, China plans to promote the development of basic research with a global vision, actively integrating and deploying global innovation networks, strengthening international innovation collaboration, and effectively utilizing global innovation resources. It is the only way for China to construct an innovative country with strong technological power.

The Need for Scientific and Technological Diplomacy S&T diplomacy is the use of scientific interaction between nations to highlight common problems of humanity and to build constructive, knowledge-​ based international partnerships. S&T diplomacy came into being under the circumstances in which S&T competition among countries was becoming increasingly fierce and important for enhancing comprehensive national power. S&T diplomacy is an integral part of economic diplomacy. Economic collaboration involves S&T communications. The so-​called sanctions or blockades promoted by some superpowers also contain technological blockades. Although such blockades aimed more at exports and collaboration on specific technologies considered to have military applications, under circumstances in which the US-​led technology powers block the technology, S&T diplomacy will become increasingly important. International innovation collaboration is an effective tool for S&T diplomacy and an important means of building positive international relations.

The Need to Integrate into the Global Innovation Network The global innovation pattern is open, cooperative, and networked. Actively integrating into the global innovation network is an important prerequisite for further enhancing China’s innovation capability and international collaboration status. Through collaboration and communications with other countries in S&T activities, S&T talents, and technology

506    Chen, Feng, and Fu platforms, nations can better understand different culture, enhance trust, and increase talent exchange, thus making it easier for China to integrate into the global innovation network. Actively carrying out international innovation collaboration can effectively promote the absorption of international S&T resources and help to enhance China’s influence in the global innovation network. The “National Key R&D Programs of Intergovernmental International Science and Technology Innovation Collaboration/​Hong Kong, Macao, and Taiwan Science and Technology Innovation Collaboration Key Project” proposed by the Ministry of Science and Technology (MOST) of the People’s Republic of China also promotes the construction of a global innovation collaboration network through international innovation collaboration to serve the specific requirements of the country’s economic and social development.

Some Policy Practices and Experiences of International Innovation Collaboration in China Since the beginning of this century, the Chinese government has attached great importance to international innovation collaboration. During the 11th, 12th, and 13th Five-​Year periods, the government has implemented special plans for international S&T collaboration. At the same time, it has also introduced a series of policies to increase investment in innovation and improve its innovation environment to support and stimulate international innovation collaboration. The 18th National Congress of the Communist Party of China proposed to plan and promote innovation with a global perspective. As a typical technologically catching-​up country, through active promotion by the government, China has entered a new stage of innovation and development, and the direction of innovation elements is no longer “inward”; instead, “inward” and “outward” flow coexist. China’s technological innovation capabilities are effectively enhanced through international innovation collaboration. As early as the end of 2006, the “11th Five-​Year Plan for the Implementation of Interna­ tional Science and Technology Collaboration” proposed that technological innovation should further deepen international collaboration and make full use of international resources to enhance independent innovation capabilities. In July 2011, the “National 12th Five-​Year Plan for Science and Technology Development” further emphasized the importance of international collaboration and proposed to strengthen collaboration with Hong Kong, Macao, and Taiwan. In August of the same year, the “Special Plan of 12th Five-​Year Plan on the International Science and Technology Collaboration” emphasizes the need to improve the overall coordination mechanism for international S&T collaboration. In addition, “Several Opinions on Deepening the Reform of Institutional Mechanisms and Accelerating the Implementation of Innovation-​Driven Development Strategy” (in 2015), the “National Innovation-​Driven Development Strategy Outline” (2016), the “Special Plan of 13th Five-​Year Plan on the International Science and Technology Collaboration” (May 2017), and the “Interim Measures for the Administration of National Key Research and Development Programs” (June 2017) and other documents raised the requirements for the development of international collaboration from different perspectives. Specific measures are shown in Table 5.6.1.

International Innovation Collaboration    507 Table 5.6.1 China’s Tracking of the Opening Requirements of S&T Programs Time

Policy Documents

Points

12/​3/​2006

The “11th Five-​Year Plan for the Implementation of International Science and Technology Collaboration”

Whether it is original innovation, integrated innovation, or import, digestion, absorption, and re-​innovation, it is required to further expand opening up and international collaboration, to broaden the horizons, actively learn from the world’s advanced experience, and enhance the ability of independent innovation on the basis of making full use of global innovation resources.

07/​4/​2011

The “National 12th Five-​ Year Plan for Science and Technology Development”

Gradually increase the opening up of national science and technology plans. Support scientific and technological personnel and institutions in Hong Kong and Macao to participate in and undertake national science and technology plan projects.

8/​19/​2011

The “Special Plan of 12th Five-​Year Plan on the International Science and Technology Collaboration”

Expand the opening up of the national S&T plan and improve the special management mode of international S&T collaboration. As an important part of the national S&T plan system, the national international S&T collaboration project should further improve the overall coordination mechanism with the national S&T major projects and other national S&T plans.

1/​9/​2014

The speech of Wan Gang, minister of China’s Ministry of Science and Technology, at the National Science and Technology Work Conference

Implement the joint scientific innovation fund between China and the United Kingdom, effectively promote the opening of China’s national S&T plan, and attract overseas high-​level experts and teams to jointly undertake or participate in the implementation.

3/​13/​2015

The “Several Opinions on Deepening the Reform of Institutional Mechanisms and Accelerating the Implementation of Innovation-​Driven Development Strategy”

The national S&T plan should be formulated to open up to the outside, and actively encourage and guide foreign R&D institutions to participate in national S&T plan projects in accordance with the principle of reciprocity, openness, and security.

5/​2016

The “National Innovation-​ Driven Development Strategy Outline”

Actively participate in and lead the international science programs and projects, and raise the level of opening up of the national S&T plan.

5/​4/​2017

The “Special Plan of 13th Five-​Year Plan on the International Science and Technology Collaboration”

Increase the opening of national S&T plans (special projects, funds, etc.). Support foreign experts to take the lead or participate in strategic research, guideline preparation, project implementation, project review, and acceptance. Encourage foreign-​invested R&D centers in China to participate in national S&T plan projects.

(continued)

508    Chen, Feng, and Fu Table 5.6.1 Continued Time

Policy Documents

Points

6/​22/​2017

The “Interim Measures for the Administration of National Key Research and Development Programs”

The national key R&D program is opening up. Independent legal entities registered in mainland China, such as overseas scientific research institutions, higher education institutions, and enterprises, may take the lead or participate in project declarations according to the guidelines. Foreign scientists employed by independent legal entities registered in mainland China and scientific research personnel from Hong Kong, Macao, and Taiwan regions may apply for the project following the requirements of the guidelines.

At this stage, to seize the development opportunities brought about by the globalization of S&T, China is comprehensively advancing the international S&T collaboration strategy. During the 12th Five-​Year Plan period, to better implement the “Outline of National Medium-​and Long-​Term Science and Technology Development Plan (2006–​2020)” and to promote the construction of an innovative country, the MOST has issued the “Special Plan of 12th Five-​Year Plan on the International Science and Technology Collaboration” and actively deployed international S&T collaboration and communication in the new era. The various S&T programs (hereinafter referred to as the national S&T plan) implemented and managed by the MOST and the National Natural Science Foundation of China (NSFC) are important ways for China to stably support S&T innovation activities. To implement the country’s international S&T collaboration strategy, the national S&T plan has actively adjusted the specific funding content and targets, for example, setting up a special international S&T collaboration plan, investing in special funds for international S&T collaboration, appropriately opening up national S&T plans and allowing foreign countries or non-​Chinese mainland researchers to participate in the application of China’s S&T plan, establishing an international S&T collaboration base, and so on. In May 2017, the “Special Plan for the National Basic Research of the 13th Five-​Year Plan,” jointly issued by the MOST, the Ministry of Education, the Chinese Academy of Sciences, and the NSFC, made enhancing China’s basic scientific research capabilities the important task of the 13th Five-​Year Plan. It has been highlighted that this plan would be devoted to the formation of a comprehensive and balanced disciplinary system, greatly improving the level of scientific output, quality, and international influence, so that China can be top three among the world in the overall level of the discipline and the number of international scientific papers cited. This shows that China attaches more importance to participating in international S&T collaboration. The “National Key R&D Programs of Intergovernmental International Science and Technology Innovation Collaboration/​ Hong Kong, Macao, and Taiwan Science and Technology Innovation Collaboration Key Project,” published by the MOST, supported China carrying out intergovernmental S&T innovation collaboration projects with the United States, Canada, New Zealand, Mexico, Serbia, the European Union, Germany,

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2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Funding of the International collaboration and Communication Project of the National Natural Science Foundation of China ( Ten thousand yuan)

Figure 5.6.2  Funding of the International Collaboration and Communication Project of the National Natural Science Foundation of China, 2003–​2016. Greece, Israel, Mongolia, Indonesia, South Africa, Egypt, BRICS countries, Finland, France, Belgium, Britain, Hungary, Poland, Australia, Japan, South Korea, Thailand, Vietnam, and other countries and international organizations. The project involves scientific, technical, and engineering issues and issues related to addressing major global challenges through technological innovation collaboration. Only for the year 2018, the first batch of projects is planned to support China’s intergovernmental S&T collaboration with 12 countries, regions, international organizations, and multilateral mechanisms. The number of project tasks is about 121 to 128. Among them, the plan supports the collaboration with Germany for about 60 million yuan and collaboration with the United Kingdom for about 60 million yuan. At the same time, collaboration with Canada, Japan, New Zealand, and other countries and regions is in the detailed project planning stage. Figure 5.6.2 shows the funding of the NSFC for international collaboration and communication projects. It can be seen that from 2003 to 2016, the funding of the NSFC has shown a significant upward trend. First, in 2009 and before, it was a “stable period,” the number of funds increased steadily, and the growth rate was small. Second, during the period of 2010–​2015, there was a “growth period” at the stage of the 12th Five- Year Plan—​except for a small fluctuation in 2014, the amount of funding rose rapidly. From 2015 to the present, since the beginning of the 13th Five-​Year Plan, there was a “flying period,” which reflects China’s increasing emphasis on international collaboration and communication projects. In 2017, the NSFC further expanded its collaboration network with the “One Belt, One Road” countries and regions, and the number of collaboration agreements signed with countries along the “One Belt, One Road” reached 21, accounting for 23.1% of the total number of collaboration agreements. In 2017, a total of 68 substantive collaboration research projects with countries along the “One Belt, One Road” were funded, with funding of 134.01 million yuan, as well as 42 collaboration and communication projects, with funding

510    Chen, Feng, and Fu of 1,108,200 yuan. At the same time, the Bureau of International Cooperation of the NSFC also actively promoted collaboration and communication with counterpart institutions and strengthened collaboration with developed countries, international organizations, and neighboring countries such as the United States, Canada, Britain, Germany, France, Japan, South Korea, Israel, and New Zealand, which included 1,175 projects with funding of 1.07 billion yuan. The total funding for the Science Fund International Collaboration and Communication Project increased from 144 million yuan in 2008 to 1.25 billion yuan in 2017, and the proportion of total funds funded by the NSFC increased from 2.28% in 2008 to 4.19% in 2017. The number of projects increased from 1,008 in 2008 to 1,175 in 2017. In 2017, the International (Regional) Collaborative Research Project funded 477 projects with funding of 1.125 billion yuan, accounting for 90.0% of the total funding for international collaboration and communication projects. It can be seen that supporting substantive international collaboration research has become the strategic focus of the science international collaboration funds.

State of International Innovation Collaboration in China Since basic science research is the main way that international innovation collaboration can be carried out, this section analyzes the state of China’s international innovation collaboration by analyzing the literature records of S&T activities. According to the research on international innovation collaboration by many domestic and foreign scholars such as B. M. Gupta and S. M. Dhawan (Gupta and Dhawan, 2003), it is generally believed that the co-authored paper is an important indicator for measuring international innovation collaboration. When the authors of a paper are from two or more countries, international innovation collaboration can be considered.

Scale of Collaboration In the Core Collection database in Web of Science (WOS), we used the search term “CU=(CHINA OR PEOPLES R CHINA)”2, and the literature type was restricted to “Article” for retrieval. We determined the number of papers that Chinese scholars participated in, and then used the “analyze search results” and “refined search results” functions in the WOS database to obtain the collaboration between China and other countries. Until December 2017, China published a total of 2,718,011 papers. Among them, China co-operated with 246 countries and co-published 664,822 papers, which is less than 25% of the total published volume, indicating that China’s international innovation collaboration is not sufficient.

2  This

chapter attempts a specific search. The search terms include Hong Kong and Macao, and Taiwan is excluded. The results obtained are not much different from the results of direct search.

International Innovation Collaboration    511

Figure 5.6.3  China’s international innovation collaboration in the past 40 years. Through the time chart (Figure 5.6.3), it can be found that China and other countries have gradually increased in the number of collaboration papers published, especially in the past 10  years, which has shown very rapid growth. This is also highly consistent with China’s strategic approach of accelerating opening up and strengthening regional collaboration. Figure 5.6.4 provides an overview of China’s international innovation collaboration partnership, and Figure 5.6.5 shows the evolution trends of its innovation collaboration with the United States, Japan, the United Kingdom, France, and Germany from the time dimension. It can be clearly seen from Figure 5.6.5 that the innovation collaboration trends are basically the same, showing steady growth. The collaboration with the United States has experienced explosive growth in the past two decades. It can be seen that since China started vigorously promoting international innovation collaboration (IIC), it has had the closest collaboration with the United States, with remarkable results. In addition, through the collaboration between China and foreign scientific research institutions in the decade of 2006–​2015, we see that the collaboration between the scientific research institutions in China and the USA is the closest, and the collaboration between China and neighboring countries is relatively close; the main areas of collaboration are mainly concentrated in physics, chemistry, engineering, materials science, and clinical medicine. Figure 5.6.6 shows the trends in the number of international collaboration papers published in major countries in 2006–​2015. It can be seen that in the past decade, China has had the second-​fastest growth rate in the number of published international collaboration papers, after the United States. China, initially one of the countries with the smallest

512    Chen, Feng, and Fu USA

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Figure 5.6.4  Overview of China’s international innovation collaboration partnership (top 15 countries).

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35000 30000 25000 20000 15000 10000 5000 0

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

YEAR USA

JAPAN

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Figure 5.6.5  Innovation collaboration between China and major countries in the past 40 years.

International Innovation Collaboration    513 180000 160000

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140000 120000 100000 80000 60000 40000 20000 0

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Figure 5.6.6  Trends in the number of papers published in the international collaboration papers of major countries. number of international collaboration papers, developed to become the second-​largest country of international collaboration papers after the United States. These data show that China’s international innovation collaboration has increased substantially, and China’s position in the international innovation network is also increasingly important.

Collaborative Strength Figure 5.6.7 shows the volume of China’s overall papers and the number of international collaboration papers in the WOS database. It can be clearly seen from the figure that in the past 20 years, both the overall publication number and the number of international collaboration papers have grown steadily, which increased from 19,384 and 5,195 in 1998 to 337,795 and 90,047 in 2017, respectively. However, the proportion of international collaboration papers fluctuates, first declining and then rising. Nevertheless, in terms of the global share of international collaboration papers, China’s international scientific research collaboration is increasingly active, and China has become a world leader in scientific publications (Aksnes et al., 2014). Figure 5.6.8 shows the proportion of international collaboration papers in major countries. From 2006 to 2015, the proportion of international collaboration papers in major countries has shown an upward trend, and the growth rate is relatively close. However, the proportion of international collaboration papers in China is at a low level among major countries, only slightly higher than in India. This shows that China’s current international innovation collaboration is still less active than the major technology powers such as England, France, Germany, and Canada.

514    Chen, Feng, and Fu 400000 350000

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Figure 5.6.7  China’s overall papers and international collaboration papers, 1998–​2017.

Proportion of International Collaboration Papers(%)

80 70 60 50 40 30 20 10 0

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Figure 5.6.8  Proportion of international collaboration papers in major countries.

Problems Although the international innovation collaboration of China is very active, the intensity is still at a low level. There is a definite gap between China and the world’s leading developed countries. China has the ability to plan and allocate resources from a global

International Innovation Collaboration    515 perspective, but there are still some deep-​seated problems that need to be addressed to effectively promote international collaboration in S&T research. First of all, China has invested less in basic research in the past, restricting international innovation collaboration. More importantly, the imperfection of China’s existing intellectual property protection system is not conducive to the construction of a good collaborative environment, and it is the main factor hindering the flow of global innovation resources into China. At the same time, China’s research atmosphere and research integrity environment are still significantly below many developed countries. Inadequate integrity of the environment restricts international collaboration, and the current international S&T plan has achieved no substantial breakthroughs in external collaboration. For example, although the NSFC seeks international collaboration, there is a problem that funds cannot be fully discharged. Foreign partners are often just named but cannot participate in the project substantively.

Suggestions for Improving International Innovation Collaboration in China Strengthening International Collaboration in Source Innovation Strong basic scientific research is the basis of building a country with globally strong S&T capacity, as noted in a set of opinions published in a 2018 document of the State Council (State Council 2018). At present, compared with developed countries, China’s basic innovation is significantly insufficient, and there is a big gap in the proportion of basic research investment. In 2011, basic research investment in France accounted for 25.3% of total R&D investment; South Korea, 18.1%; the United States, 17.3%; Japan, 12.3%; the United Kingdom, 10.8%; and China, only 4.7%, which is far below the world average level. Strengthening international collaboration can promote the intersection, integration, and mutual penetration of basic research in disciplines and fields, allowing research on scientific issues to be conducted across regions and globally. Through international basic research collaboration, China can not only make full use of foreign advanced technology, information, and equipment and share the research experience and achievements of the international scientific community but also promote more areas of basic research in China to reach the international frontier and achieve development beyond the current stage.

Improving the Environment for Intellectual Property Rights Protection To carry out international innovation collaboration, we must make full use of external innovation resources to promote innovation. However, the imperfect intellectual property

516    Chen, Feng, and Fu protection environment makes it difficult to attract the inflow of international innovation resources. Due to the high risk and high cost in innovation, a sound intellectual property protection system can effectively ensure the inherent interests of advanced technology holders, so that it can encourage investors and innovators to enter innovation activities. Compared with developed countries, China is lacking knowledge accumulation and R&D capabilities and adopting a more relaxed protection policy of intellectual property rights, which is not conducive to helping enterprises get through the “death valley” of the innovation process or transforming from technological advantages to economic advantages. This innovation environment has seriously hindered the entry of advanced technology into China. Therefore, it is necessary to establish a targeted approach of intellectual property management for international innovation collaboration to increase the cost of infringement in collaborative innovation, reduce the cost of safeguarding rights, and effectively protect the enthusiasm of innovators. It is worth noting that the best intellectual property protections applied in countries with different levels of development are different. Therefore, how to construct an optimal intellectual property protection system framework while being in line with international rules is an issue that must be considered in the process of promoting international innovation collaboration.

Sound Integrity Environment of Scientific Research Scientific research integrity is the cornerstone of S&T innovation, as noted by the State Council (Xinhua News Agency, 2018). However, China’s overall scientific research atmosphere and scientific research integrity environment still have problems, such as academic fraud, publishing low-​level papers by using interpersonal relationships, and publishing papers with authors who do not contribute to the paper. It is necessary to strengthen the integrity management of scientific research activities, establish a sound review and management system for scientific research achievements, and strive to deepen the reform of the scientific research evaluation system. The construction of scientific research credibility requires not only the efforts of scientific research institutions and scientific research personnel but also the active promotion at the national level. Starting from the relevant management departments, the establishment of a sound evaluation system for scientific research could make the innovation actors zero tolerance for serious violations of scientific research integrity.

Promoting the Opening Up of the National S&T Plan As an important international innovation collaboration strategy, the opening up of the national S&T plan is increasingly necessary in the process of China’s transition to an innovative and modern country. In the process of China’s innovation and development transformation, the national S&T plan can effectively use funds, equipment, and human

International Innovation Collaboration    517 resources to promote the research level and gain advanced S&T management experience. At present, the acquisition of research funding in China often requires complex application and approval procedures, which makes it difficult for research funding to flow to other countries. In addition, some countries and economies, including China, often impose administrative controls on exchange rates and foreign exchange, which makes the flow of funds between the two nations not smooth enough, limiting China’s international innovation collaboration. Therefore, it is particularly important to increase the international plan to open up to the outside and increase the utilization rate of scientific research funds. At the same time, the opening up of the national S&T plan can also promote the China’s scientific research system. By learning from the experience of developed countries, China can optimize the allocation of S&T resources and the human incentive mechanism to attract more international S&T resources into China.

Strengthening the Layout of the International Innovation Collaboration Network Compared with developed countries such as the United States, developing countries can gain more from IIC (Bote et al., 2013). This indicates that policymakers of developing countries should launch relevant policies and strategies to strengthen multinational collaborations with these developed countries in the S&T field to take advantage of their R&D resources. The top-​level design and strategic layout of the international innovation collaboration network can be strengthened by establishing overseas contacts with a number of countries. The establishment of contacts at overseas institutions can help researchers carry out mutual visits and communications to fully understand the research system, model, project management system, and innovation of the other countries.

Promoting National Innovation Collaboration along the “One Belt, One Road” To further deepen the IIC between governments, China should speed up the construction of the “One Belt, One Road” collaborative innovation community and implement the “One Belt, One Road” S&T innovation collaboration plan. Specifically, China should strengthen communication with countries along the Belt and Road; promote the construction of S&T innovation bases, technical collaboration platforms, and joint research centers (labs); and expand the training of mature and applicable technologies and the transformation of results. Moreover, China should initiate the “One Belt, One Road” technology park collaboration, technology transfer collaboration, joint laboratories, and other action plans in a timely manner and promote international capacity collaboration with technological innovation.

518    Chen, Feng, and Fu

Direction of Future Research In addition to the need to accelerate the promotion of China’s international innovation collaboration at the government level, the academic community should also strengthen research and create conditions for bottom-​up international collaboration. The spontaneous collaboration between scientists and researchers through R&D activities should become a new force for innovation activities. It should be the most dynamic source of innovation beyond the collaboration activities at the government-​led level.

Research in the Field of International Innovation Collaboration At present, the research on China’s international innovation collaboration is too general, and most of it analyzes the current status of China’s international innovation collaboration from the perspective of bibliometrics and observes its distribution to summarize the corresponding conclusions (Niu and Qiu, 2014). Most of the research found that international innovation collaboration in the fields of physics, chemistry, and materials science is more intensive. However, international innovation collaboration needs to be considered within local conditions. Under the background of high-​quality and high-​efficiency development, it is necessary to carry out international innovation collaboration in a targeted manner. For example, the “National Key R&D Programs of Intergovernmental International Science and Technology Innovation Collaboration/​Hong Kong, Macao, and Taiwan Science and Technology Innovation Collaboration Key Project 2018” has more collaboration between China and Germany in the automotive and energy industries, while collaboration with the United Kingdom is more about antibiotic resistance. At the moment when efficiency is emphasized, future research should pay more attention to the effective allocation of innovative resources and strengthen international collaboration in more needed areas. Therefore, we should continue to promote research on the field of international innovation collaboration, analyze the similarities and differences of collaboration in different areas, and determine which areas of collaboration need to be strengthened.

Exploring the Reasons for the Differences in the Benefits of IIC in Different Countries There has been extensive research on the benefits of IIC, which has demonstrated that countries normally gain benefits from multinational S&T collaboration, including (1) access to available ideas, knowledge, technologies, and other resources (Hayati and Didegah, 2010; Kim, 2006); (2) time savings resulting from expediting the research process (Hayati and Didegah, 2010); (3) sharing of the research cost of large-​scale research projects (Hayati and Didegah, 2010); and (4) increase in the visibility (citation rates) of research outputs (Gazni et al., 2012). But do all countries derive these benefits in equal manner? What are the potential factors influencing these benefits that countries receive from IIC?

International Innovation Collaboration    519 Recent studies in one cluster that focused on this topic showed that IIC was not always a “good thing” for some countries. For instance, Zhou et al. (2013) showed that China did not receive any benefits from collaboration with Japan. Tang (2013) found that the research quality of China is not affected by its collaboration with the United States (Tang, 2013). Bote et al. (2013) confirmed the benefit that the countries received from IIC was not uniform. Why? It is necessary to investigate the reasons for this differentiation by country. However, there have been few attempts to investigate this topic.

Analysis of Various Factors and Mechanisms Affecting the Output of IIC Based on bibliographic coupling analysis and main path analysis, we find that the impact of IIC on research performance has been generally investigated by prior research (e.g., Hayati and Didegah, 2010; Tang, 2013; Zhou and Tian, 2014). However, there is still controversy on this topic despite a large amount of research findings. On the one hand, many studies have presented evidence that IIC leads to high research performance. For example, Chinchilla-​Rodríguez et al. (2012) showed that IIC exerted a positive effect on both research outputs and citations in the biomedical science domain. Sin (2011) confirmed that IIC could significantly enhance the citation counts received by publications in the research domain of library and information. Abramo et al. (2011) demonstrated that Italian university researchers received benefits from IIC. Persson (2010) found that IIC publications have a higher impact compared with non-collaboration ones. Similar findings were also found in notable studies by Abbasi et al. (2011) and He et al. (2009). On the other hand, conflicting evidence has been reported too, indicating that the debate on whether IIC activities raise research performance still exists (Zhou and Tian, 2014). For instance, Leimu and Koricheva (2009) showed that IIC had no effect on the visibility of research outputs. Duque et al. (2005) made a comparative study and found that IIC was not associated with the improvement of research productivity in the context of developing countries. Using panel publication data from more than 100 important US universities, Adams et al. (2004) confirmed the existence of a trade-​off impact that IIC exerted on research quantity and quality. Specifically, IIC had a positive relation to research visibility but a negative relation to research productivity. Overall, an expanding body of studies has explored the effects that IIC has on research performance, but the research results are still inconclusive. Why? In our opinion, the factors and mechanisms that may affect the impact IIC on innovation performance need to be investigated. However, to our knowledge, few studies have devoted attention to this topic so far.

Revealing the Causal Relationship between IIC and High-​Quality Output Prior research paid considerable attention to the relationship between IIC and research quality (e.g., Abbasi et al., 2011; Abramo et al., 2011; He et al., 2009). Most previous studies

520    Chen, Feng, and Fu argued that IIC can improve the quality of research findings, rather than the reverse. However, a study by Tang (2013) pointed out that most previous studies neglected the possibility that the countries that had a chance to jump into IIC probably represented an elite group with a high level of research capabilities. Even without IIC, those elite countries likewise would have had higher research performance than others. So, the positive relationship between IIC and research performance, as Fleming and Chen (2007) noted, is likely subject to reverse causality and survivor bias. The assumed logic adopted by most studies is as follows: IIC is conducive to idea fertilization, which is a basic prerequisite for producing a “good paper” that attracts more scholars’ attention and thus is more frequently cited by subsequent literature compared with other papers. Of course, this is beneficial to promoting the country’s S&T reputation. However, some studies argued that reverse causality might exist. That is, since a country with a high S&T reputation is likely to attract other countries to form an IIC relationship with it (Gazni et al., 2012), it is reasonable to deduce that the countries that have a chance to participate in IIC are generally those high-​performing ones, suggesting that IIC is just the feedback from the elite countries with a high level of S&T capacities. Based on this view, it is not surprising to find that the quantity and quality of publications that result from IIC are higher than those that do not have IIC. Therefore, higher research performance should not be solely attributed to a positive effect resulting from IIC. To avoid research bias, the effect of elite countries should be controlled for in the testing of the full dataset. In this manner, we can avoid the possibility of bias. However, with the exception of Tang (2013), similar studies remain scarce. Moreover, by combining the two inverse logics discussed earlier, we deduced that there may be an underlying bidirectional relationship between IIC and high research quality. In other words, IIC leads to high research quality, and in turn, countries with high research quality tend to jump into IIC. However, existing literature ignores the possibility that IIC and high research quality may mutually influence each other; this has not been examined so far. This research gap indicates a direction for future research.

Comparing the Differences between International Scientific Collaboration and International Technical Collaboration Our review suggests that most studies focused on international scientific collaboration rather than international technological collaboration, and this trend will continue, as evidenced by a large amount of works (e.g., Vakilian et al., 2015; Niu and Qiu, 2014; Tan et al., 2015). Why? In our opinion, apart from the fact that the large bibliographic data of international scientific collaboration are more available from big databases such as Scopus and the WOB publication database, the other important reason is that international scientific collaboration is more prone to occur across national borders, compared with international technological collaboration (Ponds, 2009). This is due to the difference between science and technology in underlying applications, directions, norms, and values. More specifically, the goal of scientific collaboration is to produce new scientific knowledge and to enhance the scientific discourse, while the goal of technological collaboration is to exploit scientific

International Innovation Collaboration    521 knowledge for the development of new products and goods and to minimize knowledge diffusion (Ponds, 2009). The increasingly important role that intellectual property rights play in benefiting the countries in the process of international trade may result in their conflicts of interest in the S&T field (Mowery, 1998). For example, developing or emerging countries involved in international S&T collaboration could appropriate knowledge or technology that originated from the research projects funded by developed countries. This can lead to asymmetrical benefits in IIC by privileging developing countries over developed countries. So, some elite countries are likely to take action to minimize knowledge or technology diffusion through the channel of international S&T collaboration. For example, US and EU policymakers restrict China in their military R&D programs. However, compared with international technological collaboration, international scientific collaboration may be less constrained by national boundaries. This is due to the common incentive structure and the “universal” norms of science (Ponds, 2009). Given the potential conflicts between national policies of protecting intellectual property rights and increasing IIC, it seems there is some difference between international scientific collaboration and international technological collaboration under the influence of this potential conflict. However, little attention is devoted to this interesting topic in the existing literature.

Research on the “One Belt, One Road” International Innovation Collaboration Model “One Belt, One Road” is essentially a new model of international development collaboration, which aims at promoting the common development of all countries along the road by strengthening the collaboration among the countries. The “One Belt, One Road” international collaboration is positioned as an open and inclusive international regional collaboration platform. Over the years, China’s international S&T collaboration and communication have adhered to the principle of “bringing in” and “going out.” The opening and collaboration embodied in the “One Belt, One Road” will provide a very strong new impetus and new energy for world peace and economic growth. Under the background of vigorously promoting the “One Belt, One Road,” it is worth further exploring what opportunities and challenges are faced by international innovation collaboration. At present, most of the research on the “One Belt, One Road” international collaboration focuses on the impact and significance of global and regional innovation. From the perspective of domestic research, in many aspects of the global international collaboration for China’s “One Belt, One Road” international collaboration initiative, no consensus has been reached. The geopolitical landscape, trade disputes, and economic development involved in the “One Belt, One Road” are still in discussion. In addition, scholars also pointed out that the implementation of the “One Belt, One Road” international innovation collaboration faces the challenges of sustainable development and funding gaps in developing countries along the line. Therefore, future research on the “One Belt, One Road” international innovation collaboration model needs to further consider the political, geographical, ecological, and financing environment and other aspects to build a more comprehensive collaboration model.

522    Chen, Feng, and Fu

Research on the Risk Mechanism of International Innovation Collaboration Regarding the issue of international innovation collaboration risks, most of the existing research is focused on the enterprise level. For various reasons such as information asymmetry, inconsistency in strategic direction, stage of technology level, and differences between cultures, certain risks may be brought to the collaboration between the two sides. It is generally believed that international collaboration between enterprises faces more serious problems of autonomy and conflicts of interest, which brings greater risks to corporate international collaboration than general collaboration. As it rises to the national level, the classified issues of international innovation collaboration projects are more prominent. For example, in many countries, most industries involved in core competitiveness, nuclear, and military are not engaged in international collaboration. Therefore, in future research, in-​ depth exploration of the causes of risks, the impact path and impact of different risks on international innovation collaboration, and how to deal with the classified issues in international innovation collaboration projects can help the two sides of collaboration to better understand collaboration and conduct collaboration to a certain extent.

Research on Deepening Opening Up the National S&T Plan At present, the practices in the process of opening up S&T programs of countries and regions in the world have their characteristics. From a global perspective, countries, especially developed countries, attach great importance to the opening up of S&T. On the one hand, leading countries in S&T open to each other to form strong alliances, and further develop high-​level R&D collaboration in the high-​tech fields; on the other hand, developed countries open to developing countries, for which they can complement each other and carry out technology transfer and technological assistance. Because developed countries have leading advantages and rich experience, their technology is not meant to be open to the outside world. They are usually open only to serve their strategy and technology security with specific goals. This “open-​up” mode of developed countries has certain guiding significance for developing countries to implement national S&T plans open to the outside world. Accelerating the opening up of S&T programs and optimizing the use of international S&T resources will help promote China’s innovation and development. In the next step, the general idea of China’s international S&T collaboration is to advance “self-​centered, forward-​looking, scientific, and orderly.” However, what is currently lacking in China is the rationalization of the top-​level planning, the overall layout of the S&T plan, and the corresponding policy and legal environment. The central government has not yet made clear provisions on the opening up of the national S&T plan. Therefore, we should have a deep understanding of the opening up of national S&T plans, strengthen research on the opening up of S&T programs, improve the theoretical framework of international S&T collaboration in China, and lay a solid foundation for the transformation of national innovation and development to high quality and high efficiency.

International Innovation Collaboration    523

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Chapter 5.7

Open Innovat i on for Devel opment i n  C h i na Jin Chen and Yufen Chen Against the backdrop and conditions of globalization, innovation has been promoted through the integration of global resources and global markets with an open vision. As a catch-​up economy, China has achieved sustainable and rapid growth by introducing advanced technologies, digesting and absorbing these elements, and promoting innovation to accelerate its technological progress and industrial upgrading. Along with the increasing pace and complexity of technology, the importance of external knowledge exploitation has been acknowledged by many researchers and practitioners. How to manage the innovation efficiently is an important issue for firms to enhance their competitiveness. The concept of open innovation shows a new direction for Chinese enterprises to innovate indigenously. In this paradigm, Chinese enterprises should actively adopt an open innovation model, making full use of external innovation resources, and integrate internal and external resources to promote innovation and enhance competitiveness. The open innovation paradigm campaigned by Henry Chesbrough offers a new way of thinking about and managing innovation (Chesbrough, 2003). Open innovation means that firms can and should use external ideas as well as internal ideas and take internal as well as external paths to market. Open innovation advocates research and development (R&D) collaboration with outside organizations and the integration of internal and external knowledge, and emphasizes outside distribution to market. Open innovation may show the advantage of free flow of new ideas. Through opening the internal R&D process to external market actors such as users, suppliers, and even competitors systematically, innovation provides access to more ideas than could be developed in-​house. By leveraging the discoveries of others, firms can produce spectacular results (Silverthorne, 2003). Open innovation can thus speed innovation and reduce the uncertainty of technology and the market (Fu et al., 2014). Successful open innovation can thus bring many benefits to enhance a firm’s innovation capability and economic competitiveness. For Chinese enterprises, adopting an open innovation mode may be especially important. In many cases, internal innovation resources are clearly inferior and insufficient within Chinese enterprises. The scale and intensity of R&D investments of domestic Chinese enterprises pale in comparison to their multinational counterparts. Therefore, it is more

526   Chen and Chen difficult to carry out indigenous innovation processes by simply relying on internal resources. It can be expected that the open innovation paradigm will not only be confined to firms in developed market economies but also gradually spread among Chinese enterprises.

The Conditions of Openness in the Process of Innovation in Chinese Enterprises Open innovation emphasizes the importance of external creative ideas, external channels of commercialization, and technological collaboration with other firms. Firms in the open innovation mode will open their R&D projects to outside agencies including leading users, suppliers, other firms, and even competitors. The openness promotes the flow of new ideas and innovation resources. In the open innovation paradigm, the boundary of the firm is vague. Innovative ideas may originate internally, from the R&D department or other departments. However, they can also come from outside sources. On the base of intensive internal R&D activities, firms should monitor external technology closely and acquire and exploit external knowledge adequately to close the gap. The capability of using and integrating external knowledge is a kickstart for firms to acquire competitive advantage. Firms can acquire technology through R&D collaboration, technology licensing, and technology acquisition so as to reduce the cost and risk of innovation. Leading users and suppliers full of the enthusiasm for innovation will be important sources and participants. Internal innovative ideas may seep out of firms either in the research stage or later in the development stage through the diffusion of knowledge and mobility of personnel (Chesbrough, 2003). Moreover, new ideas and new products can be taken to the market through external channels, outside the current business of the firm, to generate additional value and reduce the uncertainty of the market (see Figure 5.7.1).

Research Solutions

Employees outside R&D depart.

Internal research projects

Lead users suppliers External research Cooperative Venture investing R&D projects

Development

Boundary of the firm Innovation projects

Technology acquisition Technology in-licensing

Figure 5.7.1  The open innovation model in Chinese enterprises.

New Market and Business Model Current Market and Business Model

Open Innovation for Development    527 Chinese enterprises are becoming more open in the process of innovation, using external resources to gradually improve the efficiency of innovation (Fu and Xiong, 2012). An investigation into the innovative activities in industrial enterprises all over the country was carried out by the National Bureau of Statistics in 2016 to reflect indigenous innovation capabilities and the conditions of innovation practices. This investigation included all state-​ owned enterprises (SOEs) and the non-​SOEs with yearly sales larger than 20 million yuan. More than 726,000 enterprises were included in this investigation. The study covered many industries including mining, food and clothing processing, machinery and transport vehicle manufacturing, electronic products manufacturing, electric, fuel/​gas, and water production and supply. The survey covered activities of the whole innovation process including new ideas, new product design, R&D, technology acquiring, production, and commercialization. The contents of the survey covered innovative expenses, the modes of innovation collaboration, and the sources of innovation. The data indicated that internal R&D expense accounted for 62.6% of the total innovative expense in the enterprises’ innovation practice. This means that about 40% of the funds were used to contract R&D to outside organizations, usually institutions of learning, and to acquire machinery, equipment, and related technologies (see Table 5.7.1). It is very important for enterprises to obtain technology-​ related and market-​related information from users, suppliers, firms in the same industry, universities, research institutions, consultant firms, and governments in the process of innovation (see Table 5.7.2).

Table 5.7.1 The Expenses for Innovation in Chinese Industrial Enterprises (2016) Ratio to the Total Innovation Expense (%)

Total expense in industrial enterprises Grouped by size Large Medium Small Micro Grouped by industry Mining industry Manufacturing industry Electric, fuel gas, water production, and supply industry

Total Innovation Expense (Billion Internal Yuan) R&D

Acquiring the Machine, Equipment, Acquiring External and Software from Technology R&D Outside from Outside

1,747.92

62.6

3.5

30.0

3.9

999.26 373.73 366.50 8.43

57.2 68.8 71.4 47.0

4.3 2.7 1.9 3.3

32.6 26.9 25.8 45.8

5.8 1.6 1.0 3.9

47.68 1,660.29

56.2 63.7

3.7 3.4

37.8 28.8

2.4 4.0

39.95

24.2

3.9

69.6

2.4

Source: National Enterprise Innovation Survey Yearbook, 2017. China Statistics Press.

Table 5.7.2 Distribution of important Sources of Information for Innovation (2016) Proportion of Enterprises Having Innovative Activities (%)

Internal

Users

Suppliers

Other Firms in the Same Industries

All industrial enterprises

26.0

42.2

36.2

14.1

10.1

18.2

34.0

20.7

9.1

Grouped by size Large Medium Small Micro

54.8 34.9 20.7 21.4

32.7 38.9 44.2 42.5

35.9 35.5 36.3 40.7

11.9 12.8 14.7 15.4

11.4 10.2 9.9 8.5

18.1 17.4 18.4 18.1

52.4 37.7 31.4 21.6

37.4 23.5 18.4 16.6

10.4 8.2 9.2 10.8

18.9 43.0  7.7

35.7 36.0 47.6

11.3 14.2  9.9

9.0 10.1 8.9

14.9 18.2 14.5

40.7 34.0 28.4

32.0 20.5 28.1

10.7 9.0 14.2

Grouped by industry Mining industry 33.8 Manufacturing industry 25.6 Electric, fuel gas, water 46.1 production, and supply industry

Consultant Firms

Professional Associations

Universities

Research Institutes

Governments

Source: National Enterprise Innovation Survey Yearbook, 2017. China Statistics Press.

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Some Modes for the Organization of Open Innovation in Chinese Enterprises Users Involved in Innovation Good ideas in innovation derive from observations made from experience and from listening to users. In a study of 252 new products in 123 enterprises, Tucker (2002) found that most new products originated from users’ ideas rather than from elaborate R&D activities or internal brainstorming meetings within the companies. Chinese enterprises also utilize feedback on user needs to iteratively develop successful products. von Hippel (1994, 17) defines “sticky information” as “the information that is costly to acquire, transfer, and use in a new location.” The degree of stickiness is best conceptualized as the incremental expenditure for transferring a certain unit of information to a specified locus in a form that is useable to the information seeker. When cost is low, information stickiness is low; similarly, when cost is high, stickiness is high (von Hippel, 1994, 1998). New products and services must be accurately responsive to user needs if they are to succeed. Because of the stickiness of users’ need-​related information, it is often a very costly and difficult matter for firms to understand deeply and make use of users’ needs well (von Hippel, 2001). Therefore, enterprises usually invite and incentivize users to directly participate in the process of new product development. This will reduce the cost of access to sticky innovation–​related information. Firms can combine users’ need-​related information with their own technology to provide technological solutions. Firms can also let users be designers of new products and “do it themselves,” thus giving users good opportunities to innovate and allowing them to develop their customized products via iterative trial and error. In this practice, users can create a preliminary design, simulate or prototype it, evaluate its function in their own use environment, and then iteratively improve it until satisfied. In this way, the need to shift problem-​solving back and forth between users and manufacturers is eliminated during the trial-​and-​error cycles involved in learning by doing (Von Hippel, 2001). With users’ direct participation in the new product development process, the interface between suppliers and users is streamlined and benefits from the increased diffusion of important need-​related information so as to speed up innovation and reduce the market uncertainty of new products. This section will move on to scrutinize the case of Xiaomi in its application of open innovation processes. Xiaomi Company (Beijing Xiaomi Technology Co. Ltd.) is a Chinese mobile communication terminal equipment development and software development enterprise, established in April 2010. Xiaomi mobile phone, MIUI, and MiTalk are the three core businesses of Xiaomi. Since its inception, Xiaomi has maintained an impressive growth rate. In 2015, 2016, and 2017, Xiaomi reaped 6.1%, 13.4%, and 28.0% of its revenue from other parts of the world. Moreover, Xiaomi’s overseas income doubled every year. In 2017, Xiaomi Group’s revenue was 114.6 billion yuan, a year-​on-​year increase of 67.5%. Compared with listed companies with global incomes exceeding 100 billion yuan and that were profitable, Xiaomi ranked first among internet companies in terms of revenue growth rate. Efficient product supply chain management, high-​cost performance, and advanced marketing strategies are the keys to Xiaomi’s success. Within these factors, the most crucial is

530   Chen and Chen its ability to capture user participation. Xiaomi Company has pioneered the use of the internet model to develop mobile operating systems and to involve their product enthusiasts in development and improvement. Users are thus product managers of Xiaomi products. Through the Xiaomi product user development platform, the firm can listen to users’ views, quickly go through trial and error, and conduct rapid iterative updates, allowing users to participate in the development process of Xiaomi products. Moreover, Xiaomi collects users’ requirements and opinions through open discussions with users as friends on social media and online platforms. They established multiple communication channels including Xiaomi Community, MIUI Forum, QQ Space, Mi Chat, WeChat, Weibo, Xiaomi Home, and Maker Meeting. Users can indicate the problems in product use through these channels and provide personal information, needs, and opinions, as well as contribute ideas, designs, or prototypes and participate in product development, testing, and innovation. In the process of new product development, Xiaomi notably invites users with professional skills to become product developers. The MIUI team will accept users’ comments and feedback, make initial judgments on each submitted improvement point, and finally include effective feedback and suggestions in the system’s improved permutation table. Xiaomi has also outsourced some noncore functions to fans for development and encouraged fans to develop value-​added software in the MIUI system as well. Dedicated enthusiasts for Xiaomi systems thus conducted sizable R&D work for Xiaomi. For instance, fans translated versions of software into 25 languages and adapted them to 143 models for Xiaomi.

Suppliers Participating in Innovation Establishing iterative and long-​term contact with suppliers may help firms make full use of external resources and establish more flexible new product development processes. Firms can shorten the period of innovation through suppliers’ participation in the early design and development process. By discussing and communicating with suppliers constantly, firms can speed up the process of innovation. The earlier a supplier obtains information about a new product, the earlier a firm can attain feedback of the new product prototype from the supplier and thus shorten the innovation process. It is an important headspring for firms to gain a competitive advantage through establishing trusting and long-​term collaborations with innovative suppliers. Moreover, this kind of competitive advantage is difficult for competitors to imitate off-​hand. One example is Baosteel Group Corporation, a leading iron and steel conglomerate, which has set up active and close collaborations with its global leading suppliers to make up for its technical gaps and to guarantee the quality of its products. In June 2018, Baosteel Resources (International) and South32 Corporation signed a cooperation agreement on a coking coal project in Bowing Basin, Queensland, Australia, in which South32 officially replaced Vale as a cooperative developer in this partnership. South32 is a diversified, multinational mining company with an experienced coal management and technical team. This strategic supplier cooperation will undoubtedly help to improve the quality and efficiency of Baosteel’s raw material supply and provide technical support for future product innovation.

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Collaboration with Firms in Other Industries and Competitors In the open innovation paradigm, the resources needed for technological innovation needs are diversified and not easily quantifiable. There is no one firm that possesses all resources internally. Even the best firms with extensive internal capabilities are unable to undertake technological innovation activity unilaterally (Chesbrough, 2003). Potential innovative technologies and ideas can be found in companies of all sizes. Therefore, it is important for enterprises to systematically develop avenues of technology cooperation to make up for the deficiency of innovation resources. Firms complement each other through such technology collaborations. Collaboration improves innovation capacities in two ways. First, it can accelerate the communication of information, and second, it can speed up the rate of diffusion of knowledge whereby firms can enhance their capability to cope with complex circumstances and thereby increase the overall rate of successful innovation. Many Chinese firms have learned to draw on advanced technologies from a strategic network of startups, firms in other industries, and even competitors. They also make full use of global resources for innovation through integrating international and domestic resources. An example of this interindustry collaboration is the strategic cooperation agreement made in May 2017 between Zhejiang Hisun Pharmaceutical Co., Ltd, a leader in China’s pharmaceutical industry, and Agilent Technologies. The two corporations affirmed a commitment to carry out extensive cooperation in leading-​edge instrumentation, maintenance, and quality compliance to promote the renewal and scientific management of the Chinese pharmaceutical industry. In addition, the two corporations will jointly build laboratories for drug R&D. Agilent Technologies not only provides users with comprehensive analytical instrumentation and application support but also helps users develop leading methods through a powerful international technology platform to contribute to the development of the pharmaceutical industry and human health. The strong alliances between the two corporations can better leverage their respective advantages and make important contributions to China’s biopharmaceutical research. Neusoft Company, China’s leading information technology (IT) solutions and product engineering services provider, also constantly participates in global strategic alliances. In some cases, it has even turned potential competitors into complementary partners. These coalitions based on complementary linkages have helped Neusoft gain access to global resources easily. During its period of stable development, Neusoft established strategic partnerships with Harman Industrial Group, Nippon Electric Co. Ltd., Toshiba Solutions Co. Ltd., Alps Electric Co. Ltd., and Alibaba Cloud Computing Co. Ltd. In June 2018, Neusoft and Nokia Bell signed a strategic cooperation agreement, combining Nokia’s world-​leading 5G end-​to-​end commercial products and solutions, its technological advantages and experience on healthcare cloud, smart car interconnection, smart city, etc. and Neusoft’s expertise in the fields of mobile internet, internet of things, cloud computing, big data, etc. The collaboration will promote Neusoft’s development in medical care, smart car interconnection, smart city, and other business areas, and contribute to expanding its market share and competitiveness.

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Cooperation with Universities and Research Institutions Universities and public research institutions are important sources of new scientific and technological knowledge for firms pursuing radical innovations (Belderbos et  al., 2004). Cooperation with universities and research institutions is an efficient way for firms to acquire advanced technologies. Basic scientific knowledge is especially important for innovation in science-​based technology fields such as IT, biotechnology, and nanotechnology, where new breakthroughs can be transferred to applied research and transformed into new products and processes. Universities and research institutions also can provide cutting-​ edge technology to firms. Furthermore, universities do not compete with firms. The more generic nature of a joint research project with universities and research institutions involves fewer appropriation issues as compared to the more commercially sensitive content when cooperating with other businesses. Therefore, industry-​science cooperation is a main mode for innovative firms to acquire external sources of knowledge. Hisun has established long-​term relationships with more than 30 Chinese research institutions to develop new technology and new medicines. Huawei can also make full use of global resources for innovation through multichannel and multilevel cooperation based on the business field and technological development needs. As of 2016, Huawei has established cooperative relationships with more than 40 universities including Beijing University, Peking University, Tsinghua University, and Beijing University of Technology.

Intellectual Property Licensing Monitoring the dynamic development of external technology closely and independently purchasing advanced technology to make up for technology deficiencies are valid ways to increase the rate of successful technological innovation. Firms can create value by combining their own ideas with external technology and also make profits from others’ use of their licensed technology. Chinese firms are increasingly attaching great importance to intellectual property rights and acquiring external technology through licensing or cross-​ licensing. In the initial period of development, many firms use the advanced technologies derived from multinational corporations through licensing and gradually accumulate their own technological capabilities. From 2015 to 2016, Huawei successively transferred 145 patents to SnapTrack, a subsidiary of Qualcomm. This is also a form of strategic cooperation. Selling patents to Qualcomm can both add value for the original patent technology and minimize the license fees Huawei has to pay.

Mergers and Acquisitions Chinese firms have become more and more capable of integrating global innovation resources and global markets and have begun to “go out” to integrate with resources in the global innovation ecosystem on a large scale (Fu et al., 2021). In 2017, China’s foreign direct investments reached US$158.29 billion, ranking third in the world, exceeding the level

Open Innovation for Development    533 of foreign investments absorbed in the same period. These foreign investment activities are diversified. They include purchasing resources, technologies, and developing markets. Among them, the most significant is to merge and acquire technologically innovative enterprises with strong R&D capabilities. A prominent example of this is Geely Group, which has rapidly developed from a small and unknown firm into a multinational group that has been among the world’s top 500 for five consecutive years. Its overseas M&A strategy has contributed to this growth. In 2006, Geely acquired a 100-​year-​old car company, the London Taxi Company, through its 19.77% stake. This helped Geely enter the taxi industry and realize the international production and sales model of production in China and sales in the United Kingdom. Subsequently, in 2009, Geely acquired the world’s second-​largest transmission manufacturer, DSI Automatic Transmission Company of Australia, which enabled Geely to take a big step forward in manufacturing automatic transmission systems and lead this industry. In 2010, Geely also acquired 100% equity and related assets of the world’s high-​end car brand Volvo Car for US$1.8 billion, further enhancing its technological level and brand status. In 2017, Geely once again acquired a 49.9% stake in Malaysia Proton and a 51% stake in UK Lotus, accelerating the internationalization process. In 2018, Geely Group invested heavily in the acquisition of a 9.69% stake in German Daimler and became the largest shareholder to effectively cooperate in developing new-​energy automobiles. Through these mergers and acquisitions, various technologies, products, and marketing strategies of foreign enterprises and Chinese markets were integrated. These acquisitions have helped to greatly enhance Geely’s R&D capability and brand competitiveness.

Setup Overseas R&D Branches At present, most firms in China are in the catch-​up stage. Rapid technology changes have provided an unprecedented opportunity for enterprises to overtake. Some innovative firms set up overseas R&D centers, which are conducive for imitating and learning from competitors, understanding the trends of the world’s most advanced technology, and grasping cutting-​ edge technologies, and attracting local top talents. By the end of 2017, enterprises in state high-​tech zones had set up 994 overseas R&D institutions. Zhongguancun, for instance, set up innovation centers in Silicon Valley and Israel, while Shanghai Zhangjiang set up innovation centers in Boston and other locations. In addition, the Shenzhen High-​Tech Zone plans to build 10 overseas R&D centers, of which 4 have been listed for operation. At present, Huawei has established overseas R&D centers in 17 countries. In October 2006, Huawei launched its first mobile innovation center (MIC) with Vodafone (Spain), and more than a dozen leading operators followed. By the end of 2011, joint innovation centers (JICs) have spanned Europe, North America, Latin America, Southeast Asia, and the Middle East. With more than 100 innovation topics, Huawei’s JIC network has emerged as a key platform for enhancing both sides of any strategic partnership. The Huawei US R&D center is oriented toward the development of emerging technology and positioned at the forefront of technology prediction and exploration. The center focuses on training thinkers. In addition, the R&D center in Silicon Valley can also aid in the understanding of the latest R&D trends and research directions of its peers.

534   Chen and Chen Geely Group established a European R&D center in Gothenburg, Sweden, in 2013, integrating the advantages of Volvo Cars and Geely Automobile to build a new generation of car modular structures and related components to meet the future market demand of Volvo Cars and Geely Automobile. The European R&D center will give full play to Volvo Car’s technical advantages. In March 2015, Geely invested £250 million in Coventry, England, to build a new factory to produce a new generation of London taxis and sell them to markets around the world. Furthermore, in October 2015, Geely invested another £50  million in the United Kingdom to build a cutting-​edge technology R&D center and a new factory to develop and produce nine different models, including Geely’s new lightweight energy commercial vehicles. Establishing overseas research centers helps Geely attract foreign advanced talents and enhance its R&D capabilities and market competitiveness.

Conclusion Open innovation undoubtedly brings many benefits to the advancement of innovation capability and economic growth. It provides smoother access to more ideas than could be conceivably developed in-​house. Chinese firms have become increasingly capable of integrating global innovation resources from foreign markets and have begun to “go out” to actively integrate global resources on a large scale. Through opening up, firms introduce not only new technologies but also, more importantly, powerful demonstration and competition effects. This has broader benefits as more firms feel the pressure of competition in developing advanced technology and products, incentivizing firms to catch up through learning and innovation. Open innovation is an inevitable choice for firms to adapt to the situation of globalization and seize opportunities to carry out innovation. With an open vision to integrate global R&D resources and market resources, Chinese firms’ innovation capabilities have been greatly enhanced. Moreover, with the support of China’s own national innovation system and through the accumulation of technological capabilities, many Chinese firms are realizing indigenous innovation under open conditions and rapidly growing into multinational corporations.

References Belderbos, R., Carree, M., Diederen, B., et  al. (2004). Heterogeneity in R&D cooperation strategies. International Journal of Industrial Organization, 22(8): 1237–​1263. Chesbrough, H. (2003). Open innovation: the new imperative for creating and profiting from technology. Harvard Business School Press. Chesbrough, H. (2003). Reinventing R&D through open innovation. Available at http://​www. utdallas.edu. Fu, X., Li, Y., Li, J., and Chesbrough, H. (2021). When do latecomer firms undertake international open innovation: Evidence from China. Global Strategy Journal. https://​doi.org/​ 10.1002/​gsj.1401

Open Innovation for Development    535 Fu, X. and Xiong, H. (2011). Open innovation in China:  policies and practices. Journal of Science & Technology Policy in China, 2(3): 196–​218. Fu, X., Li, J., Xiong, H., & Chesbrough, H. (2014). Open Innovation as a Response to Constraints and Risks: Evidence from China. Asian Economic Papers, 13(3), 30–58. https:// doi.org/10.1162/ASEP_a_00289 Silverthorne, S. (2003). The benefits of “not invented here”:  aQ&A with professor Henry Chesbrough on his new book. June 9. Available at http://​hbswk.hbs.edu/​item/​3506.html Tucker, R.B. (2002). Driving growth through innovation. Berrett-​Koehler Publishing. von Hippel, E. (1988). The source of innovation. Oxford University Press. Von Hippel, E. (1994). “Sticky information” and the locus of problem solving: implications for innovation. Management Science, 40(4): 429–​439. Von Hippel, E. (1998). Economics of product development by users: the impact of sticky “local information.” Management Science, 44(5): 629–​644. von Hippel, E. (2001). PERSPECTIVE:  user toolkits for innovation. Journal of Product Innovation Management, 18: 247–​257.

Pa rt   V I

I N N OVAT ION W I T H C H I N E SE C HA R AC T E R I ST IC S

Chapter 6.1

Chinese C ost I nnovat i on, the Shan z ha i Phenom enon, a nd Ac celerated I nnovat i on Peter J. Williamson Introduction In the early days of China’s economic reforms back in the late 1970s and the 1980s, Chinese firms earned rents simply through low-​cost labor in assembly and mainly low-​value industries as their labor cost relative to productivity was much lower than that of most other countries. In 1978, for example, China’s wage was only 3% of the average US wage at that time, and it was also significantly lower than the wages in neighboring Asian countries such as the Philippines and Thailand (Li, Li, Wu, & Xiong, 2012). Two developments, however, forced Chinese firms to look for new sources of competitive advantage. First, China’s wage growth started to pick up steam in the 1990s. While China retained a significant cost advantage versus developed countries, this rendered it less competitive relative to other developing economies that had the labor and capabilities to enter simple, low-​value activities. Second, the private sector in China began to expand rapidly, leading to a situation where many Chinese markets became intensely competitive. Low costs alone could not provide a source of sustainable competitive advantage in this environment for the simple reason that all of the growing number of Chinese rivals also had access to similarly low costs. As a result of these developments, forward-​looking Chinese companies realized that they needed to find a way to differentiate themselves if they were to be successful in the future. The strategy they came up with was what Zeng and Williamson (2007, 1)  dubbed “cost innovation”: “the strategy of using Chinese cost advantage in radically new ways to offer customers around the world dramatically more for less.” Over time, the cost innovation strategy itself was imitated by more and more Chinese competitors, as well as some abroad. So, leading companies had to find another new way

540   Williamson to innovate to restore their differentiation and competitiveness. The place they looked to for inspiration was unorthodox; it was the so-​called Shanzhai manufacturers. Shanzhai is a term for the mountain fortress where outlaws hide, hinting at the legally dubious nature of their practices. Shanzhai competitors offered me-​too alternatives to existing products by copying others’ designs, buying components, and assembling them into a final product. They varied the look and feel of the products continuously, sometimes on a weekly basis. What mainstream Chinese companies learned from the Shanzhai was speed. This led to a new competitive strategy: accelerated innovation. Accelerated innovation itself has become a widespread capability of Chinese companies, and their focus has more recently turned to digital innovation. This includes innovations in everything from e-​commerce and mobile payments to bicycle hire, bio-​analytics, and advanced manufacturing processes supported by artificial intelligence (AI) and robotics. In this chapter we will discuss this evolution of Chinese innovation strategies starting with cost innovation, accelerated innovation, and its roots in Shanzhai and ending with digital innovation—​which is the leading edge of Chinese innovation today.

Cost Innovation As noted earlier, Chinese cost innovation strategies have centered on finding ways to use China’s cost advantages to offer customers dramatically better value for the money. This involved three vectors of cost innovation: (1) offering customers high technology at low cost; (2) presenting customers with an unmatched choice of products in what used be considered standardized, mass-​market segments; and (3) offering specialty, niche products at dramatically lower prices, turning them into volume businesses.

High Technology at Low Cost The first of these cost innovation strategies adopted by Chinese firms was to offer customers high technology at low cost. Innovation is traditionally associated with developing new products and services or with adding more functionality and features to existing ones. In both cases, companies expect customers to pay a premium. Innovative companies in most markets around the world usually apply the latest technology only to the most complex applications or sell them to early adopters. By restricting a state-​of-​the-​art technology to a few segments initially and transferring it to mainstream markets over time, they capture the maximum value throughout the technology’s life and enhance the returns on their investments in research and development (R&D). Chinese computer maker Dawning, for example, put supercomputer technology into the low-​cost servers that are everyday workhorses of the world’s information technology (IT) networks. This novel strategy overturned the conventional wisdom that high technology should be restricted to high-​end products and segments, and interrupted the conventional game in which established global competitors maximize their profits along the product life cycle by only slowly migrating new technology from high-​priced segments toward the mass market (Zeng & Williamson, 2007).

Cost Innovation, Shanzhai Phenomenon, and Innovation    541 Similarly, China’s BYD became a global market leader by rewriting the value-​for-​money equation in the lithium-​ ion battery market. Lithium-​ ion cells allow battery-​ powered devices—​be they cell phones or electric cars—​to work longer. When BYD entered the industry in 1995, four Japanese companies controlled the market, and they sold lithium-​ ion batteries, which were expensive, to power only high-​end products. Instead of trying to improve the batteries’ performance, BYD focused on replacing the most expensive raw materials used to make lithium-​ion cells with cheaper substitutes. It also learned to produce them at ambient temperature and humidity, which made it unnecessary to construct expensive “dry rooms” in plants. The company was able to reduce the manufacturing costs of lithium-​ion batteries from $40 apiece to just $12, making them competitive with lower-​ performance nickel cadmium batteries. As BYD developed lithium-​ion batteries for more segments, its costs continued to fall, enabling its lithium-​ion products to capture a 75% share of the batteries used in cordless phones, 38% of those used in toys, 30% of those in power tools, and 28% of those in mobile phones. Its cost innovation strategy enabled it to maintain quality at the same time. Despite its low costs, BYD has never recalled products, whereas lithium-​ion batteries made by Sanyo and Sony have exploded in laptops (Williamson & Zeng, 2009). Other Chinese companies used cost innovation to disrupt high-​tech markets by taking a second look at less sophisticated technologies. Zhongxing Medical transformed the medical equipment business by focusing on direct digital radiography (DDR) in a novel way. DDR transforms an X-​ray scan into a digital signal that a computer can analyze, bypassing the traditional chemical process. There are two types of DDR systems: line-​scan machines, which work best for standard procedures such as chest scans, and flat-​panel imaging systems, which are ideal for sophisticated applications like heart scans. General Electric and Philips focused on developing flat-​panel machines, which each carried a price tag of between $300,000 and $400,000 and offered the largest profit potential. Meanwhile, Beijing Aerospace, which bought line-​scanning technology from the Russian Academy of Sciences in 1998, developed a DDR machine that was adequate for most hospitals’ routine, high-​volume radiography needs. It costs only around $20,000 to build, as compared with between $150,000 and $200,000 for a flat-​panel system. When Zhongxing Medical launched its DDR machine in 1999, it sold well because a large number of second-​and third-​tier Chinese hospitals could afford it on their limited budgets. Facing loss of market share, GE and Philips cut prices on their flat-​panel machines by between $100,000 and $150,000. Even so, Zhongxing Medical won a 50% share of the entire DDR Chinese market. GE had to reduce its prices by 50% compared to what it previously charged. By reinvesting its profits, Zhongxing Medical was able to improve the performance of line-​ scanning devices, reducing scanning time from 10 seconds to 2 seconds, making the process more comfortable for patients, and putting the high-​end profit pool of its multinational rivals under threat.

Variety and Customization at Low Cost A second type of cost innovation used by Chinese companies was to offer customers variety and customization at low cost, proffering an unmatched choice of products into what used to be considered standardized, mass-​market segments. Customers usually have to pay

542   Williamson hefty premiums if they want a large selection of products or desire customized offerings. That is because most companies in developed countries, which focus on gaining economies of scale, fear that if they offer choices, their operations will spiral out of control. They will spend additional time making changeovers on manufacturing lines and lose money from write-​offs on obsolete inventory. Chinese companies have been able to transform the rules of variety and customization by learning to gain economies of scope. They were helped by particular characteristics of the Chinese market environment. Relatively low human resource costs allowed them to hire large numbers of staff to develop customized designs and handle changeovers. Rapid growth in the Chinese market allowed them to justify heavy investment in new capacities. They took advantage of this to invest in automated processes to deliver quality combined with human intervention to gain flexibility. Also, the fact that each market segment in the huge Chinese market is far larger than in most other countries guaranteed enough buyers for Chinese companies to economically support a wide variety of offerings. The harbor machinery maker Shanghai Zhenhua Port Machinery Company (ZPMC) is a good example. It hired 800 design engineers—​between 20 and 40 times the number of design staff employed by their German and Italian competitors. This massive engineering resource allowed ZPMC to offer a far wider product range than its European rivals and the capacity to customize its equipment to the particular requirements of any port operator’s site and cargo mix—​all at a similar price to standardized machinery. This challenged the accepted wisdom that customers who want variety and customization have to pay a hefty price premium. Today ZPMC has over 52% of the world market in harbor cranes and employs 35,000 staff including 2,400 designers. Another example is Goodbaby International Ltd., which used the strategy of variety at low cost to create a line of over 1,600 kinds of strollers, children’s car seats, bassinets, baby walkers, playpens, highchairs, tricycles, and children’s bicycles—​four times more than its rivals offer, but at comparable prices. The Shanghai-​based company created a product to meet every possible need, from strollers that can handle uneven surfaces to those that fold away with two simple movements. Over time it expanded to cover the entire price spectrum, selling the Rolls Royce of strollers for $600 each, as well as inexpensive ones that retail for $30. One of its first products was a stroller that could be converted to a child’s car seat, enabling cash-​strapped parents to do two jobs for the price of one. It was able to do this, in part, because it has invested 4% of its annual revenues into research—​twice the average for the toy industry worldwide. Today, Goodbaby is a world-​leading “parenting products” company with over 15,000 employees and sales offices in 46 countries for its eight brands. It employs over 500 design staff at seven R&D centers in China, Germany, France, the United Kingdom, the United States, and Japan, and has been granted over 9,200 patents.1

Turning Specialty Niches into Volume Businesses Most companies define a niche market as one that consists of relatively few customers, willing to pay premium prices for meeting their specialized requirements. They don’t check 1 

http://​www.gbinternational.com.hk/​company/​overview/​ (accessed July 29, 2018)

Cost Innovation, Shanzhai Phenomenon, and Innovation    543 to see if there may be a wellspring of latent demand choked off by high prices and poor value-​for-​money offerings. But some innovative Chinese companies began to reposition niche products into the mass market, challenging the conventional wisdom of niche-​ focused strategies. Using their low costs to reduce the breakeven point for setting up and launching a new product, they offered specialty products at dramatically lower prices, attempting to unlock latent demand and turn former niche markets into volume businesses. Where they succeeded, the bases of competition shifted toward volume and cost—​a game their competitors were often ill-​equipped to play. Haier, now the world’s largest consumer appliance maker, for example, transformed the market for wine-​storage refrigerators from the preserve of a few wine connoisseurs into a mainstream category sold through America’s Sam’s Club (a subsidiary of Wal-​Mart) at less than half the previously prevailing price. As a result, the size of this former niche market expanded over 10,000% as the latent demand among consumers who wanted to store wine reliably but were unwilling to pay a premium price was unlocked (Williamson, 2010). As the market expanded, Haier was able to capture a 60% market share by value, leaving incumbent niche players floundering. These are just a few examples of the Chinese companies across a wide spectrum of industries and heritages that deployed cost innovation to push into the global market. There are dozens of others, including Galanz, which now supplies more than one in two microwave ovens sold in the global market; China International Marine Containers (CIMC), which now sells over half of the shipping containers used in world trade (from the most basic to the highest-​technology temperature-​controlled and foldable containers); and Pearl River Piano, which is now the global volume leader, producing more than 100,000 pianos every year. Cost innovation often successfully challenged two of the classic generic strategies—​ differentiation and focus (Porter, 1980)—​ by offering high technology, variety, and customization of products to customers at dramatically lower prices. But it did rely on Chinese costs remaining far below the prevailing salaries in developed countries. This enabled large numbers of employees, especially engineers and designers, to be deployed to work on adapting new technology, designing wide product ranges, customizing offerings, and reverse-​engineering niche products, while still keeping overall costs and prices low. Over time, however, rising wage rates and the imitation of cost innovation strategies by competitors meant the innovators had to begin looking for new sources of value to maintain the profitability and continue to grow.

Learning from the Shanzhai Phenomenon Inspiration for the next phase of innovation by Chinese companies came from an unlikely quarter: the shady Shanzhai competitors that offered me-​too alternatives to existing products by copying others’ designs, buying components, and assembling them into a final product (Han, 2017). As unacceptable as this practice may be, over successive cycles it allowed some of the Shanzhai companies involved to develop a formidable set of capabilities. They improved their technological skills, enabling them to focus more on high-​tech or technology-​based products such as consumer electronics, telecom products, and even cars

544   Williamson (at one time copies of top brands such as Mercedes-​Benz and BMW were being produced by Shanzhai companies in northern China). They graduated from making inferior versions of the original products to developing counterfeit models that actually offered additional features or benefits. Being secret operations, these companies are naturally difficult to research. But one such company that came to light was SciPhone, which specialized in producing counterfeited iPhones, branded as “Dream G2.” Their products looked very similar to the iPhone and their basic functionality was sufficient to satisfy the needs of the lower-​end segment of Chinese customers. Although their products were technologically inferior to the original in many respects, they were able to offer unique features that even the original iPhones do not provide, such as the facility to use multiple SIM cards, extra-​loud speakers for use in noisy environments, and rugged metal casing. These Shanzhai smartphones became extremely popular among mid-​and lower-​tier customers due to their versatility, resilience, and lower price points (Wan et al., 2015). Finally, they learned to bring the counterfeited products to the market extremely quickly, sometimes even overtaking the roll-​out schedule of the original manufacturers. In the mobile phone business, for example, the Shanzhai firms were often established by experienced engineers and executives who have worked for mainstream mobile phone producers, such as Nokia, Motorola, Samsung, and so on, for years. They had a deep understanding of the technological and manufacturing processes required to produce mobile phones. By simply purchasing the relevant modules from established suppliers to the major brands, commissioning design and software companies to come up with added features and an exterior case design, and then undertaking the final assembly of the handset, they could almost exclusively manage the supply chain to maximize the speed with which they could launch and test new models in the market. This enabled them to develop a series of process and supply chain innovations that greatly sped up their ability to deliver new models. By re-​ engineering the design and manufacturing processes, they achieved exceptional reductions in the “time to market” from concept to delivery (Williamson & Yin, 2013). Given the obvious limitations of Shanzhai innovation as a strategy for sustainable business even in China and certainly for expansion into international markets, where they were certain to be hit with lawsuits from brand owners (Llewelyn, 2011), a number of the Shanzhai companies used the experience they had gained to leave counterfeiting behind and become future players in the mainstream market. An even greater impact on Chinese innovation, however, came when mainstream companies started to adopt some of the processes Shanzhai companies had pioneered for speeding up the rate at which new products could be designed, launched into the market, and then refined and improved. These techniques seeded what was to become an approach to innovation that placed the capability to rapidly move though “launch-​test-​improve” cycles at its core. Combined with other advances, this ushered in a new phase of “accelerated innovation” (Williamson & Yin, 2014) among Chinese companies.

Accelerated Innovation Building on the lessons from their Shanzhai competitors, Chinese companies began to develop ways of improving the pace of innovation while reducing costs. These approaches

Cost Innovation, Shanzhai Phenomenon, and Innovation    545 included industrializing innovation by applying lessons from production lines, pushing the boundaries of simultaneous engineering to cut the lead times for new product development, rapidly incorporating user feedback into new designs to drive down the learning curve faster, and restructuring their organizations to speed up problem solving.

Industrializing the Innovation Process The classic image of innovation, especially early-​stage R&D, is of an inventor or a small team brainstorming and experimenting with new ideas. Large-​scale and tightly defined processes are generally seen as inhospitable to creativity and innovation. Although innovation may be systematized and scaled up to involve thousands of scientists and engineers in some industries, such as pharmaceuticals and IT, the core R&D activities nonetheless revolve around a set (perhaps a large set) of relatively small teams. A number of Chinese companies began challenging this conventional view by pushing the boundaries of systemization and scale to a whole new level in their efforts to accelerate innovation, leverage the potential of a large pool of competent but mostly unexceptional technicians and engineers, and reduce costs. Their approach was to divide the innovation process into a large number of small steps, and then assign teams to work on each stage. The goal was for this “assembly line” to accelerate the process and deliver results quickly. Huawei, now the world’s largest supplier of telecommunications equipment, has developed the capability to utilize the large number of engineers with basic qualifications available in China to develop products that can respond to the changing needs of new entrants and emerging markets by finely dividing the process into a multitude of specific activities. It then assigns an engineer, or even a group of engineers, solely to that specific, mini task. While a company like Apple might dedicate a total of 10 engineers to a particular product development project, Huawei would assign a 100-​person team to the same opportunity. By increasing the total number of engineers and assigning each individual or small team to work on a narrowly defined task within its “product development assembly line,” Huawei can increase flexibility and reduce the total time necessary to complete a project by making multiple changes to the design concurrently. This enables Huawei to deliver innovations that respond to changes in the market much faster than competitors who deploy only a small team of researchers on each project, where each individual must tackle a broader set of more complex, multifaceted tasks to design a complete, new-​generation product (Zhang, 2011). This flexible assembly line R&D process is generally poorly suited to “traditional innovation” that typically focuses on developing completely new technologies or substantially pushing forward the boundaries of functionality. But it does appear to work well when the aim is to disrupt incumbents who rely on launching new-​generation products that often suffer from performance overshoot, longer lead times, reduced value for money, and less flexibility to adjust to changing market preferences. WuXi AppTec, a pharmaceutical, biopharmaceutical, and medical device outsourcing company with operations in both China and the United States, embraced this industrialized approach. Its work on a new drug for the treatment of chronic hepatitis C provides a good example. As with most drugs, the development cycle involves discovery, preclinical and clinical trials, regulatory approval, and marketing. Rather than relying on a small team working in the laboratory with a few machines, however, WuXi AppTec began by dividing

546   Williamson the R&D process into a series of eight steps, with dozens of people assigned to each step. The initial creation of the reactive intermediates required specialized staff, with at least master’s degrees and considerable research training. The other steps required “R&D workers” (graduates of trade colleges), of which WuXi AppTec hires thousands each year. Rather than relying on automation (with the associated high capital costs and risk of bottlenecks), WuXi AppTec uses manual techniques that can be quickly scaled up or down as required to keep the project moving rapidly. Efficiency is increased by using SAP’s enterprise resource planning software adapted from a manufacturing assembly line to manage the innovation process. This highly industrialized approach has enabled WuXi AppTec to complete projects between two and five times faster than comparable projects using conventional approaches the company benchmarked in the United States.

Pushing the Boundaries of Simultaneous Engineering Traditionally, new product and service development has been organized as a sequential “waterfall” process, where certain steps need to be completed before subsequent stages can begin. More recently, companies have tried to speed things up by tackling certain steps in parallel, an approach pioneered by NASA and now commonly referred to as “simultaneous” or “concurrent” engineering. Although the concept is simple, many companies have found it hard to implement in practice because of barriers such as unwillingness by engineers to release information early, limitations in existing software systems, and difficulties in coordinating multidisciplinary teams (Ribbens, 2000). Chinese companies, however, have not only embraced simultaneous engineering but also pushed it to new levels. A good example is Lenovo Group Ltd., which acquired IBM’s personal computer business in 2005. At the time, its new product development cycle was 12 to 18 months. Since then, Lenovo managed to reduce the cycle in half by applying simultaneous engineering across the entire innovation process, beginning in R&D through design, manufacturing engineering, quality control, procurement, marketing, and service. For every project, team members work on different elements in parallel, under the supervision of one leader. Lenovo overcame the usual problems of implementation by breaking down its product designs into separable modules linked by standardized interfaces, redesigning its software to be compatible across all activities associated with the new product, establishing short lines of communication where each team member can represent their respective functional department, and introducing open design processes where information is shared with the entire team as early as possible. China’s Pearl River Piano Group, the world’s largest piano maker, applied a similar approach to its manufacture of musical instruments. Pianos are made up of four main components: the resonance system, the keyboard, the pedal system, and the case. Western piano manufacturers have traditionally worked sequentially, with teams of two or three professionals spending up to two years going through all of the steps to completion. Pearl River, by contrast, uses a more industrial process. Recently, for example, for its high-​ end Kayserburg pianos, the company used a team of 23 workers (including 6 designers; 10 individuals with expertise in areas such as procurement, manufacturing, and sales; 3 computer engineers; and 2 product testers). This team was supported by an additional 40 craftspeople to enable rapid prototyping of possible new designs. Using this approach, Pearl

Cost Innovation, Shanzhai Phenomenon, and Innovation    547 River was able to launch a range of 10 new Kayserburg pianos in less than five months, at a total cost of just $1 million. Pearl River executives estimate that Western competitors using traditional design processes and small teams would have to invest around $10 million over several years to complete a similar set of new designs. Innovation processes based on industrialization and simultaneous engineering have also been used in China to develop new internet services. Tencent, a leading Chinese internet service portal whose QQ instant messaging service has more than 800 million active user accounts, developed a new integrated calendar and reminder service by assembling a team that included individuals from every function and specialty required to host, launch, and service the new product. This allowed Tencent to coordinate all of the critical elements: the user interface, the programming, the enhancement of the IT infrastructure, and the development of maintenance and customer service protocols. The project was completed in two and a half months, compared with a global norm of six months or more. Tencent’s goal was to be first to market, but it also wanted to develop a process for launching regular upgrades of the calendar and reminder application based on what it learned from market feedback.

Cycling Rapidly through Launch-​Test-​Improve When Tencent launched the first version of QQ reminder application, it was geared toward appointments, birthdays, and anniversaries. Users quickly pointed out a missing feature: reminders for when their favorite sporting events were about to begin. More surprising to Tencent’s developers, however, was the flood of input they got from gaming enthusiasts who wanted reminders about the schedules for computer game tournaments. Within weeks the Tencent team released a new version that incorporated both functions. This rapid cycle of “launch-​test-​improve” has now become core to Tencent’s innovation process. Rather than nailing down a full-​fledged product before launch, the Tencent development team routinely launches ready-​to-​use new platforms with limited functionality and harnesses user feedback to improve the final product. To achieve this, the company has created channels to encourage user feedback, rapidly communicate this to the R&D team, and ensure that the product architecture and design process is sufficiently flexible to incorporate new functionality quickly. Many other companies have adopted similar, rapid “launch-​test-​improve” cycles to innovation. Mindray Medical International Ltd., China’s largest maker of medical equipment, for example, released the initial version of its Beneheart R3 electrocardiograph machine into the market following 18 months of product development. Soon thereafter, doctors asked for some additional functions, such as the capability to monitor oxygen levels in a patient’s hemoglobin and log electrical activity in the brain. Hospitals, for their part, wanted to use the machine for constant monitoring of intensive care wards rather than just for ad hoc testing. Working with their marketing and sales colleagues, Mindray’s R&D team started to design new models that incorporated these functions almost immediately. Using this kind of rapid market feedback, Mindray routinely launches new products every six months, in stark contrast to the typical two-​year launch cycle of competitors. Each product improvement may be relatively simple, but in combination the changes can transform the customer experience. Wide Industrial Corporation, which manufactures energy-​saving evaporative air conditioners, for example, found that units that expelled

548   Williamson exhaust air from the side had a tendency to overheat when customers installed several of them side by side. In addition, customers complained that the fans were irritatingly noisy at night. Within six months, the company’s engineers redesigned the machines to expel exhaust air from the top and introduced an automatic control system that reduced fan speeds at night when ambient temperatures were lower and less airflow was required. SIM Technology Ltd., a designer and manufacturer of cell phones based in Shanghai, practices an even more active form of launch-​test-​improve. It launches new products based on market feedback every month compared to between three and nine months for foreign competitors. Sometimes the improvements are relatively minor (such as giving users the ability to turn up the sound volume higher than competing products in noisy urban environments); others are more significant (such as doubling or tripling battery life). In most cases, rapid response to market feedback drives the innovation process. After SIM Technology launched a handset with large font size and keypad buttons designed for senior citizens, for example, it received requests to add an alarm function in case the user falls or becomes ill, and satellite tracking capability so relatives can locate elderly parents when they are away from home. A number of aspects of the current Chinese market environment have encouraged companies to embrace rapid iteration cycles in the development of new products. The Chinese market is particularly fluid and fast moving, with many first-​time buyers and open-​ minded consumers and generally fewer regulatory hurdles to clear before new products can be launched. Moreover, most Chinese companies historically had relatively little brand equity and thus faced limited risk if a new product failed.

Combining Vertical Hierarchy with Horizontal Flexibility The final piece in the accelerated innovation jigsaw is the way the organization makes decisions and solves problems as they arise. In most of the Chinese companies we studied, project goals, budgets, and timelines were set by top management and cascaded down through a strong vertical hierarchy; for many employees, even senior scientists and engineers, the boss’s word was law. To foreign observers, such structure might appear to be a classic bureaucracy, with all the attendant problems of inflexibility and sloth. But while the vertical hierarchy is often rigid in these organizations, there is also a high degree of horizontal flexibility, allowing for smooth and rapid flows of resources and knowledge between peers in different departments and functions. When an innovation initiative encounters a problem, the project team (often under intense pressure from above) gathers together everyone from within the company that can help them in the mode of “huddle and act,” until a solution can be found. Huddle-​and-​act problem solving is heavily based on personal relationships (consistent with the Chinese concept of guanxi) rather than formal processes. This social dimension has the added benefit that once the outline of a solution is agreed upon, the individuals from the departments involved feel a strong duty to implement their part of the answer quickly so as not to let the team down. This type of decision making has a potential downside:  heavy dependence on a small number of senior executives who set rigid goals can result in misguided innovation efforts. If the judgment of leaders turns out to be flawed, there is little in the system to correct the mistake. At the same time, it offers important advantages: innovation targets and projects

Cost Innovation, Shanzhai Phenomenon, and Innovation    549 can be initiated quickly, resources from across businesses and functions can be marshaled without delay, joint problem solving can be focused and rapid, and execution can be immediate. SIM Technology, the designer and manufacturer of cell phones noted earlier, offers a good example. Whenever it hits a roadblock in the course of creating a new product, it brings together experts across all the disciplines (hardware, software, industrial design, user interface and aesthetics, testing, procurement, and production). When representatives were asked about the incentives people had to work across departmental boundaries, they looked incredulous. Their response was: “Why would we not? The boss only cares about successful completion of the project on time” (Williamson & Yin, 2014, 5). Williamson and Yin (2014) also noted that when Chinese interviewees were asked to compare the huddle-​ and-​ act approach to innovation they practiced within Chinese companies with what they had experienced working in more traditional foreign multinational companies, they pointed out a surprising paradox: multinationals usually had flatter hierarchies than their Chinese counterparts, but because that meant reaching consensus between a larger group of peers across rigid departmental boundaries, the decision-​making process was often slower. Decision making inside multinationals also tended to be more structured, with systematic processes for diagnosis and resolution that often involved writing a report and then circulating it for comment to areas of the businesses that might be impacted. Although this approach might help mitigate risk, it often reduces innovation to a snail’s pace. By contrast, top-​down goal setting combined with horizontal flexibility could accelerate the innovation process dramatically by enabling the organization to reconfigure itself continually to serve customer demand, back new initiatives, solve problems as they arise, and speed up joint learning. Accelerated innovation and many of the processes and techniques it uses are not unique to China. Startups around the world and companies in fast-​moving environments such as Silicon Valley are speeding up the pace of new product development and relying on “beta testing” to achieve some of the effects of launch-​test-​improve cycles we have discussed. What’s noteworthy about China is its ability to combine accelerated innovation, cost innovation, and rapid scale-​up to deliver “good enough” quality at low cost across a wide range of industries. This may not lead to fundamental breakthroughs, but that doesn’t mean that the innovations cannot powerfully disrupt incumbents’ profit models. In fact, the accelerated innovation capabilities developed by Chinese companies are becoming increasingly critical for global competition in light of changes in the overall business environment. First, today’s consumers are better informed than ever. As information moves around the world at lightning speed, customers know immediately whether or not an offering is up-​to-​date. Yet recent research shows that breakthrough innovators often have a harder time capturing market share and cumulative profits than “fast followers” (Golder & Tellis, 1993; Markides & Geroski, 2004; Shenkar, 2010). Some have argued that even Apple has built its success “not as a pioneer, but as a user-​centric fast follower.” (Barwise & Meehan, 2012)2 The Chinese approach to accelerated innovation is about bringing affordable new product designs to market in record time. This capability is based on the idea that more and more markets reflect what Yun Jong Yong, former CEO of Samsung Electronics,

2 

Barwise, P., & Meehan, S., 2012 (May 20) “Innovating Beyond the Familiar,” European Business Review, http://​www.europeanbusinessreview.com/​?p=6409 (accessed February 19, 2021).

550   Williamson called the “sashimi theory,” which he described as follows: fresh raw fish can be sold at a premium in an expensive restaurant; the next day, the fish can be sold for half the price at a second-​tier restaurant; on the third day, the fish sells for one-​quarter of the original price; after that, it is sold as dried fish.3 In practice, companies can earn a premium by staying abreast of the competitors’ pace of innovation and by having up-​to-​date products available in volume at an affordable price—​something Chinese accelerated innovation is well placed to deliver. A second, related advantage is that many of the approaches to accelerating innovation we have described can also reduce costs. Industrializing the innovation process, for example, requires more people, but by using less trained technicians than traditional R&D staff (and paying them less over a shorter development cycle), total outlays for a given project can be reduced. Likewise, companies can rely directly on customer feedback, thus eliminating the need for expensive market research and fancy prototypes. Third, accelerating innovation may be one of the most effective responses to faster and more aggressive imitation by fast-​following competitors. Even where patent protection is available, trade secrets and associated know-​how are notoriously difficult to protect when employees change jobs. Imitation is a natural result of the free flow of knowledge moving around the world through new technologies, widespread use of outsourcing and offshoring, and new competitors emerging from countries, including China, where intellectual property (IP) protection is relatively weak. These forces place a premium on an organization’s capacity to innovate rapidly and stay one jump ahead. Taken together, accelerated innovation amounts to a set of dynamic capabilities (Teece et al., 1997, 509) underpinned by a set of processes that are themselves dynamic and flexible, rather than being fixed, repeatable routines. This allows Chinese companies with these capabilities to quickly respond to, and shape, changes in their environment by learning, innovating, and orchestrating resources in novel configurations (Williamson, 2016). The ability to do so, however, also depends on the perceptions and behavior of the firm’s leadership, operational management, and frontline staff.

Competing in Digital Innovation The accelerated innovation approaches amassed by Chinese companies have widely applied to digital innovation. In many sectors China has become a world leader in digital innovation. Its volume of mobile payments was 11 times the size of that in the United States in 2017. Companies such as Alibaba and Tencent, for example, offer payment portals using super-​ apps that have 90 and 40 functions, respectively, far in advance of anything in the rest of the world. Customers can do almost everything through these portals, from booking every mode of travel and paying utility bills to donating to charity, sharing a restaurant bill with friends, and even buying hot noodles from a street vendor. This has been made possible by the development of technology that uses QR codes so that sellers (even beggars) don’t need any special hardware infrastructure to accept payments. 3 

http://​www.businessweek.com/​stories/​2003-​06-​10/​samsungs-​sashimi-​theory-​of-​success

Cost Innovation, Shanzhai Phenomenon, and Innovation    551 Chinese companies have also become pioneers in the use of so-​called big data. Alibaba’s credit scoring system for businesses and consumers, Sesame Credit, for example, updates the score continuously in real time using data not only on financial measures but also on customer returns, customer satisfaction, stock turns, and discounting to increase accuracy. Chinese companies have also used big data analysis for bioinformatics to support, for example, Car-​T (chimeric antigen receptor therapy), which extracts patients’ white blood cells, genetically re-​engineers them, and then reinjects them to fight cancers and other diseases. Chinese companies have also become leaders in the use of facial recognition to provide everything from payment authorization to personalized cosmetics and individualized, online media offerings. The widely popular Jinri Toutiao—​“Today’s headlines”—​uses sophisticated machine learning to create a virtual newspaper personalized to each of its individual subscribers. The Musical.ly lip syncing app has achieved a quantum leap in karaoke, while Meitec offers sophisticated, easy-​to-​use selfie editing. Ofo and Mobike, among others, have used digital tracking and hiring via a phone app to revolutionize bicycle services. They allow customers to search for the closest bicycle wherever it has been dropped, hire it, and then return it anywhere they please, releasing users from the inconvenience of fixed docking stations. Chinese competitors are now in the process of rolling out this service worldwide. Chinese companies are also placing huge emphasis on innovation in AI technologies. At the 2017 Association for the Advancement of AI Conference in California, for example, China submitted 23% of all papers:  more than the United States. It also had the same number of submissions accepted as the United States. In a recent survey, 58% of Chinese businesses said they had plans to introduce AI into their operations over the next few years. The implementation of robotics is also growing rapidly. According to the International Federation of Robotics, China’s development of robot density (the number of robot units per 10,000 workers) “was the most dynamic in the world” during 2016. Due to the significant growth of robot installations, the density rate rose from 25 units in 2013 to 68 units in 2016 (International Federation of Robotics, 2018). These kinds of digital innovations are being supported by several characteristics of the Chinese market that facilitate digital innovation more strongly than in most other parts of the world. First, China’s huge market enables companies to access even bigger “big data” than is available in other countries. More than 700 million smartphone users (three times the number in the United States), for example, generate data from the phones every minute. And these Chinese consumers seem happier to create content and share data than elsewhere. While concerns about privacy in China are growing, most people still seem happy to allow companies to access their data in exchange for services either free or at low prices. Second, China has a huge number of “digital natives”: 300 million people under the age of 25 years old, compared with 75 million in the United States. They have proven particularly willing to embrace new technologies and accept the launch-​test-​improve cycle that lies at the heart of accelerated innovation. Third, the Chinese government has provided space and support for digital innovators to experiment. Regulations are only added later when the market becomes large and starts to mature. For example, Alibaba launched ESCROW in 2009 (retaining money paid by customers in a trust and only paying its sellers when customers indicate they are satisfied with the product they received, bypassing the problem of low trust). The government did not introduce regulations for consumer goods claims on e-​commence until 2014. Likewise,

552   Williamson Alibaba introduced QR code payments in 2011, and the government only passed regulations, based on Alibaba protocols, in 2016. Fourth, there is now abundant venture capital. By February 2018, China accounted for 33% of the “unicorns” (US$1 billion startups) in the world (compared with 47% for the United States), mostly using digital business models. In 2017 Chinese startups raised $50 billion, with 90 deals over $100 million (the United States raised $60 billion with 97 deals above $100 million). Exits are also relatively easy in China via initial public offerings (IPOs) or trade sales, which are strongly supported by the leading Chinese digital giants, Baidu, Alibaba, and Tencent, which alone provided 40% of trade exits in 2017. Finally, there is an abundant supply of human capital to fuel digital innovation in China, with 4.7 million graduates in technology and science in 2017.

Conclusion China initially focused on leveraging its comparative advantage in low-​cost labor to satisfy growing consumer demand at home and win share in export markets. But as the wages in China began to rise and competition between Chinese companies, all of which had the advantages of low costs, intensified, forward-​looking Chinese companies had to look to develop new sources of advantage. They began by finding new ways to leverage their cost advantages (not only in assembly workers but also in designers and engineers) through cost innovation. They developed innovative strategies that enabled them to bring high technology to mass markets at affordable prices, offer customers a wide variety of choices and models at mass-​market prices, and transform niche segments into volume businesses. Eventually, however, cost innovation strategies were imitated. Leading Chinese companies therefore turned their attention to speeding up innovation while keeping investments and costs low. They drew inspiration, in part, from Shanzhai competitors that offered me-​too alternatives to existing products by copying others’ designs, buying components, and assembling them into final products that they launched into the market at “rapid fire” speed. Over time they were able to build dynamic capabilities in accelerated innovation by industrializing innovation by applying lessons from production lines, pushing the boundaries of simultaneous engineering to cut the lead times for new product development, rapidly incorporating user feedback into new designs to drive down the learning curve faster, and restructuring their organizations to speed up problem solving. Today, these accelerated innovation techniques are being applied to digital innovation, an area where China has already made impressive strides by taking advantage of a conducive environment with the prospect of becoming a world leader in innovation in a number of these new technologies.

References Golder, P.N., & Tellis, G.J. (1993). “Pioneer Advantage: Marketing Logic or Marketing Logic.” Journal of Marketing Research, vol. 30, no. 2: 158–​170. Han, B-​C. (2017). Shanzhai: Deconstruction in Chinese. Cambridge, MA: MIT Press.

Cost Innovation, Shanzhai Phenomenon, and Innovation    553 International Federation of Robotics (2018). “The Automation of Production is Accelerating around the World.” https://​ifr.org/​ifr-​press-​releases/​news/​robot-​density-​rises-​globally (accessed July 29, 2018). Li, H., Li, L., Wu, B., & Xiong, Y. (2012). “The End of Cheap Chinese Labor.” Journal of Economic Perspectives, vol. 26, no.4: 57–​74. Llewelyn, D. (2011). Invisible Gold in Asia:  Creating Wealth through Intellectual Property. Singapore: Marshall Cavendish. Markides, C.C., & Geroski, P.J. (2004). Fast Second:  How Smart Companies Bypass Radical Innovation to Enter and Dominate New Markets. London: John Wiley. Porter, M.E. (1980). Competitive Strategy. New York: Free Press. Ribbens, J. (2000). Simultaneous Engineering for New Product Development: Manufacturing Applications. New York, Wiley. Shenkar, O. (2010). Copycats: How Smart Companies Use Imitation to Gain a Strategic Edge. Boston: Harvard Business Press. Teece, D.J., Pisano, G., & Shuen, A. (1997). “Dynamic Capabilities and Strategic Management.” Strategic Management Journal, vol. 18, no. 7: 509–​533. Wan, F., Williamson, P.J., & Yin, E. (2015). “Antecedents and Implications of Disruptive Innovation: Evidence from China.” Technovation, vol. 39–​40: 94–​104. Williamson, P.J. (2010). “Cost Innovation:  Preparing for the Value-​for-​Money Revolution.” Long Range Planning, vol. 43: 343–​353. Williamson, P.J. (2016). “Building and Leveraging Dynamic Capabilities:  Insights from Accelerated Innovation in China.” Global Strategy Journal, vol. 6, no. 3: 197–​210. Williamson, P.J., & Yin, E. (2013). “Innovation by Chinese EMNEs.” Ch. 4 in Williamson, P.J., Ramamurti, R., Fleury, A., & Fleury, M.T. (eds.), The Competitive Advantage of Emerging Country Multinationals. Cambridge: Cambridge University Press. Williamson, P.J., & Yin, E. (2014). “Accelerated Innovation: The New Challenge from China.” MIT-​Sloan Management Review, vol. 55, no. 4: 27–​34. Williamson, P.J., & Zeng, M. (2009). “Value-​for-​Money Strategies for Recessionary Times.” Harvard Business Review, vol. 83, no. 3 (March): 66–​74. Zhang, L. (2011). Research and Development of Huawei. Beijing: China Machine Press. Zeng, M., & Williamson, P.J. (2007). Dragons at Your Door: How Chinese Cost Innovation is Disrupting Global Competition. Boston, MA: Harvard Business School Press.

Chapter 6.2

Gl obal Su pply C ha i ns as Drivers of I nnovat i on in Ch i na Michael Murphree and Dan Breznitz Introduction “A traffic jam in Dongguan stops the world computer industry.” So went the common saying among Taiwanese computer component and accessory manufacturers in the mid-​2000s. While perhaps somewhat hyperbolic, the expression reflected China’s rise to its title of “Factory of the World.” Taking the national perspective, and perhaps reflecting its early discovery of Japan as an emergent economic giant, The Economist in particular has followed the rise and resilience of China as the world’s workshop. While other outlets emphasized the headwinds buffeting China’s manufacturing sector, The Economist noted that even as land, labor, energy, and input costs rose, China’s position in global value chains (GVCs) remained central; it is increasingly taking on a role as a coordinating node for manufacturing across Asia—​cementing its importance as a manufacturing power even as low value-​added stages of production relocate offshore (Economist, 2015a, 2015b, 2015c, 2015d). China’s contribution to global manufacturing output rose from less than 3% in 1990 to more than 25% by 2015. That year China produced 80% of the world’s air conditioners, 70% of its mobile phones, 60% of its shoes, and 40% of its clothing. As a production node and coordinator of supply chains connecting East and Southeast Asia, China is at the center of “Factory Asia” through which 46.5% of all world manufacturing output is created. China alone accounts for nearly 10% of intermediate goods world imports and 8% of intermediate goods exports, evidence of the migration of value chains to Asia and China in particular (World Bank, 2018). The rise of China as the center of global manufacturing is not the only story. While there remain perceptions of China as merely a low value-​added manufacturer and imitator, its manufacturing dominance has coincided with its rise as a leader in technological innovation. Since 2011, China has been the second-​largest recipient of Patent Cooperation Treaty (PCT) patents and the second-​largest originator of peer-​reviewed science and engineering

Global Supply Chains as Drivers of Innovation    555 journal articles (Royal Society, 2011; WIPO, 2012). Since 2012, Chinese telecommunications hardware giants Huawei and ZTE have been among the top three filers of PCT patents worldwide. China’s rise as a manufacturing center and its increasing importance and capabilities for innovation are directly related. As Denning (2011) and Fuchs (2014) argue, production and the creation of new innovations are related concepts at both the process and product levels:  making things, it turns out, has a bearing on the ability to create them. Where manufacturing is located does, with a time lag, dictate the locus of significant innovation, as understanding of underlying technologies, including their relative strengths and weaknesses, accompanies the act of production. For new product creation, for instance, the availability of complementary resources, most notably rapid prototyping, test production, and component availability, has increasingly led new high-​tech startups to consider China, especially Shenzhen, as a location for initial development. Further, as Steinfeld (2010) notes, China’s ability to deploy new innovations at scale has led to engineering and development capabilities unmatched in the world, giving China significant advantages in developing big data, cloud computing, smart grid, renewable energy, and alternative energy vehicles. The centrality of China to global manufacturing and its increasing dominance as an innovative science and technology power are both cause and result of GVCs. The entry of China into GVCs has led to vast transfers of knowledge that have raised the capabilities of Chinese firms, both as pure contract manufacturers and as technology and product firms with independent brands. Knowledge and technology transfer from buyer-​driven and, later, producer-​driven value chains created human resource capabilities leading to the development of innovation capacity in China. This chapter shows how participation in GVCs, initially driven by foreign investment but increasingly indigenized in the 2000s, drove a process of knowledge transfer and capabilities upgrading that has made China into a leading innovation power. Industries in which China is now world-​leading—​electronics, telecommunications, and autos—​were all those in which China actively participated in GVCs. Critically, this chapter shows how the institutional environment of “structured uncertainty” in China shaped the pattern and impact of entry into GVCs. Structured uncertainty helped dictate which regions were first inserted into GVCs and shaped the types of chains (initially buyer driven) into which China would become predominant. Specifically with regard to which capabilities developed over time in the context of structured uncertainty, China’s entry into GVCs differed significantly from the experiences of other emerging economies, arguably giving it a greater innovation benefit.

Literature Background GVCs have been used as an explanation for the changes in patterns of global trade and development since the mid-​1990s. GVCs are networks of supply-​and-​demand nodes in the global economy that serve as conduits for goods and services across national boundaries (Gereffi, 1996, 1999; Gereffi et al., 2005). GVCs can be sorted into buyer-​driven and producer-​driven chains. Buyer-​driven chains are led by global brands or retailers that lack their own production capabilities and source products through intermediaries and global suppliers. This is most common in labor-​intensive and light industries. Producer-​driven chains are those

556   Murphree and Breznitz led by more vertically integrated global firms, typically in capital-​and knowledge-​intensive industries. Here, the value chains are formed by direct investment in other countries to set up assembly or component production facilities that feed into the internalized production chain of the firm. More recent studies have also emphasized the role GVCs play in the transfer and dissemination of knowledge and technology (Chen and Kamal, 2016; Contractor et al., 2010; Kumaraswamy et al., 2012; Mudambi, 2008; Neilson et al., 2014; van Assche, 2008; Yeung, 2016). The study of GVCs began with examinations of the patterns of production in labor-​ intensive industries such as garments, finding evidence that earlier conceptions such as the Vernon model for international production (Vernon, 1966, 1979) no longer explained how production, distribution, and sale of goods took place. Studies have since shown that networks of independent firms—​both buyers and suppliers—​as well as integrated global firms command the movement of goods and services in both labor-​intensive and capital-​and knowledge-​intensive industries (Gereffi, 1996, 1999; Gereffi and Lee, 2012; Gereffi and Luo, 2015; Gibbon, Bair, and Ponte, 2008; Neilson, Pritchard, and Yeung, 2014; Sturgeon, 2002). Research has also shown that in addition to being an explanation for patterns of global sourcing and trade, GVCs are themselves mechanisms by which countries, subnational regions, and firms may upgrade the quality of their goods or services, as well as innovation capabilities (Corredoira and McDermott, 2014; Kumaraswamy et al., 2012; Luo and Tung, 2007). Participating in a GVC is often the first step toward upgrading local capabilities, followed by joint ventures and licensing (Kumaraswamy et  al., 2012). Foreign investors bring more advanced production technologies, upgrading local capabilities through provision of new capital equipment used in production of export goods (Leung, 1996). Beyond equipment provision, foreign investments spur technology and capability spillovers through labor turnover, competitive pressure, and local sourcing (Blomström and Kokko, 1998; Chowdhury and Islam, 1993; Hitt et al., 2000; Hitt, Li, and Worthington, 2005; Li, Chen, and Shapiro, 2010; Lim and Fong, 1991; Schive, 1990; Soon and Huat, 1990). These spillovers enrich and strengthen local innovation ecosystems. While much of the research on the upgrading and economic impacts of GVCs has considered the impact in East and Southeast Asia, recent research in Latin America has found similar significant benefits for local firms in connecting to GVCs, even in traditional industries such as agriculture (Corredoira and McDermott, 2014; McDermott, 2007). GVCs may also help emerging economy firms upgrade by facilitating their access to potential acquisition targets in developed countries (Luo and Tung, 2007). Studies of the knowledge transfer mechanism specifically note the importance of “strategic coupling” between global forces and local capabilities; where achieved, strategic coupling facilitates significant local competitive advantage (Yeung, 2016). In addition to knowledge transfer benefits through participation in GVCs, GVCs themselves have changed patterns of global production in ways that facilitate greater levels of entrepreneurship and innovation. When production can be conducted anywhere in the world with low transportation costs, it is no longer as necessary for firms to internalize all stages of production within the boundaries of a firm or region. The standardization of components, products, and production processes facilitates the use of offshore outsourcing through GVCs. Strengthening protection of intellectual property rights in many emerging economies has also increased the willingness of foreign buyers to provide detailed orders and contracts with suppliers, further encouraging the development of fragmented and specialized value chain niches and locations. As a result, GVCs have created increasingly thinly

Global Supply Chains as Drivers of Innovation    557 sliced value chains where firms in different regions are able to produce narrow ranges of goods, components, or services that are part of the GVC in a given industry. This thin slicing can serve as a mechanism for protection of proprietary technology as well, since the specialized providers do not have control over the entire technology or product. At the same time, the narrow specialization facilitates suppliers’ learning within the narrow scope of their production niches. As a value chain is cut into thinner or more specialized activities performed by separate firms, regions themselves can begin to specialize in these narrow ranges of activities (Berger and Lester, 2005; Breznitz, 2007). In Taiwan, for instance, firms came to specialize not in “computers” but rather in production of specific subsystems (power supplies, motherboards, etc.) or peripherals (keyboards, mice, printers, etc.). Specializing in production of such goods, often using designs provided by overseas buyers, allowed firms to specialize in the volume production of these items, concentrating resources on engineering and designing for production rather than on new product capabilities. Writ large, these narrow specialists such as TSMC (semiconductor fabrication) and Chicony (computer peripherals) became world leaders in their respective areas. This same logic can lead to disruptive innovations. When a GVC allows for thin slicing, firms can come to completely dominate a given stage of production, allowing startups in other stages of production to emerge without having to internalize the entire production process. The rise of TSMC and UMC as “pure play” foundries in Taiwan, for instance, revolutionized the global integrated circuit industry—​making it possible for firms to specialize only in the design or marketing of chips (Breznitz, 2007; Fuller et al., 2003). Relatedly, global supply chain participation in the context of thinly sliced production lowers barriers to entry for emerging economy firms (Murphree et al., 2016; Tang et al., 2016). Emerging economy firms with limited resources may select and produce for a specific niche in the global production chain. This reduces the initial capital requirements of creating vertically integrated enterprises and has fundamentally changed the pathway by which economic growth and industrial upgrading occur. In addition, new firms may not need to create the technology initially: it is often provided by the customer. Countries and firms are thus no longer reliant on the strong “big push” approaches advocated by both late development scholars (Gerschenkron, 1968) and proponents of developmental state models (Johnson, 1982; Amsden, 1989)—​both of which assume strong financial, strategic, and even direct ownership roles for the state. With this background understanding, we now look to the role that GVC entry and participation has played in the development of innovation capabilities in China.

China’s Experience with GVCs under Structured Uncertainty As discussed in Breznitz and Murphree (2011), Tang et al. (2016), and Murphree et al. (2016), “structured uncertainty” is the primary driver of the types of innovation capabilities developed in China. One of the most serious obstacles to innovation is “uncertainty” (Knight, 1921). Unlike risk, which is probabilistically knowable and offers a predictable set of possible

558   Murphree and Breznitz outcomes or influences that can be mitigated through measures such as insurance or hedging, uncertainty is unknowable ex ante and cannot be hedged against. Uncertainty is not negative, however; Knight claimed that abnormal profits are not possible without uncertainty. Competition under uncertainty does not eliminate the possibility of abnormal profit. Institutional arrangements such as the rule (and application) of law and property rights can help to lower uncertainty. Other institutions aim to reduce risks associated with highly uncertain activities such as research and development (R&D). These include giving R&D grants (limiting the risk of financial loss from R&D failure) and granting monopoly status (with the abnormal profits associated with it) to innovators in the forms of patents. Even with uncertainty-​ mitigating institutions, innovation is, by definition, taking on Knightian uncertainty as attested to by the numbers of failed products and businesses: 56% of all businesses fail within four years, and up to 95% of all new products are unsuccessful (Campbell, 2005; Burkitt and Bruno, 2010). Nonetheless, whenever institutions decrease uncertainty, the output of innovations increases (Bloom, 2007; Bloom, Bond, and Van Reenen, 2007; Dixit and Pindyck, 1994). However, in the case of China, we find that the institutions prescribed to mitigate uncertainty such as rule of law, property rights, and patent rights do not function as they do in the West. Government R&D funding and financial subsidies have, however, mitigated some Knightian uncertainty—​even as other mechanisms have yielded unexpected outcomes. Institutions for mitigating uncertainty fail to do so in China as a result of China’s political economy as it has evolved since the launching of reforms in 1978. Rather than producing a system of rule of law, where rules and regulations are uniform and enforced in the same way for all actors at all times, China has developed a system of rule by law, where formal regulations exist but their implementation is uneven and, at times, seemingly arbitrary. China’s system of uncertain institutions evolved from a combination of factors. First, the personalized nature of power in China means authority is vested in an individual more than in a specific office. As a result, powerful individuals are able to effect change, even where formal procedures or regulations do not allow for it. Further, in China’s political system, chains of authority can be opaque. It is often difficult to know whether the state or Communist Party apparatus is responsible or has decision-​making capabilities in a given situation. There is also often unclear jurisdiction in different functional areas: multiple agencies—​at multiple levels—​may choose, or not, to enforce laws or regulations in any given situation. Taken together, these systemic conditions produce an institutional condition we call “structured uncertainty.” Unlike Knightian uncertainty, the formal institutions normally mandated for mitigating uncertainty are present but their operation and effectiveness is uncertain. Structured uncertainty results in specific patterns of behavior, including a preference for proven business models, risk aversion, and preference for short-​term profit maximization. Structured uncertainty thus makes it very difficult for firms to engage in radical innovation. For radical innovation—​an inherently uncertain and risky process—​ structured uncertainty must be reduced. The result of this system is a business culture that emphasizes speed, rapid returns, and political connections to afford protection. Earning profits or foreign exchange has historically been well received, both for enterprises and for governing bodies overseeing them. Firms thus often seek exports early and often. Knowing that policies can change with little recourse, firms often seek political connections. However, these too can become sources of uncertainty should political patrons fall. The following section explores China’s entry into

Global Supply Chains as Drivers of Innovation    559 GVCs, highlighting the driving role of structured uncertainty and the impact it has had in shaping the impact from GVC participation.

The Root and Beginning of GVCs in China Expansion by European, North American, and Japanese firms in search of lower labor costs and offshore outsourcing to dedicated component producers or contract manufacturers began in the 1960s and 1970s. As later occurred in China, early expansion of production chains outside enterprises’ home countries primarily took place in labor-​intensive light industries, such as textiles, garments, footwear, and toys. As early as the 1960s, US-​based retailers and apparel brands were importing significant and growing portions of their garments from low-​cost manufacturing locations, especially in Asia. Domestic garment producers were beginning to offshore production to remain competitive (Bonacich et al., 1994). Hong Kong, Taiwan, and Singapore emerged as centers for offshore production. High-​technology and capital-​intensive industries also began expanding their global footprint in the 1960s and 1970s, establishing producer-​ driven chains. Fairchild Semiconductor arguably initiated offshore electronics production when it invested in a discrete transistor assembly factory in Hong Kong in 1961 (Brown, Linden, and Macher, 2005). By the 1970s, leading semiconductor firms had dozens of assembly plants in Asia. During these decades, offshoring or outsourcing in consumer electronics became a common cost-​cutting practice (Kotabe, Mol, and Ketkar, 2008). Japanese auto firms similarly expanded their supply chains into Taiwan and Southeast Asia. Offshoring in East Asia concentrated in the tiger economies of South Korea, Taiwan, Hong Kong, and Singapore, as well as in Malaysia, Thailand, and Indonesia, especially in electronics and auto parts (World Bank, 1993). Despite the savings and efficiencies of developing value chains across the Pacific littoral, the relatively small populations, limited land, and rising prosperity in the tiger economies meant labor costs began rising by the late 1970s. With the beginning of reform and opening up in 1978, China offered everything the tiger economies could offer, but on a much larger scale. China’s initial reforms were experimental, beginning with export processing, but foreign firms quickly saw great opportunity in China, thus beginning China’s entry into GVCs. The first foreign-​invested factory tying China into global production networks, the Taiping Handbag Factory, was established with investment from Hong Kong in the summer of 1978. Assembling imported leather, cloth, and fasteners into handbags, it earned over 1 million Hong Kong dollars its first year (Chang, 2008). This factory was the first of tens of thousands of such export-​processing investments that would dominate the economy of Guangdong for the next two decades (Vogel, 1989). These early export processing firms and investments operated under the logic of structured uncertainty. China had no clear long-​term commitment to economic reform in the 1980s. Indeed, the “fang and shou cycle” of reform and retrenchment meant that new opportunities made possible by reform initiatives could be, and sometimes were, rescinded before investors could recover their initial capital (Baum, 1994; Vogel, 1989). Further, even as some localities permitted construction of export processing factories, restrictions on movement of labor—​China’s hukou system—​made worker availability uncertain.

560   Murphree and Breznitz To cope with these uncertainties, local governments innovated. They created novel categories of enterprises specifically designed to target overseas markets and entry into buyer-​driven value chains—​Sanlai Yibu. This policy innovation allowed for rapid investment and commencement of operations, earning foreign exchange, providing employment, and avoiding the potential challenges of formally registered foreign investment. As an adaptation to structured uncertainty—​investment was permitted but the terms were left ambiguous and different levels of the bureaucracy had different degrees of commitment to openness—​ Sanlai Yibu helped shape China’s initial participation in, and learning from, GVCs. In contrast to the large-​scale domestic market–​oriented approach of the producer-​driven value chains of multinational corporations’ (MNC) large equity joint ventures in leading cities like Beijing and Shanghai, investments in coastal Guangdong province were primarily through buyer-​driven chains. Foreign investors on the coast only sought access to the large low-​cost labor force. Foreign investment permits legally barred these firms from selling any of their output on the domestic market (Hsu, 2005; Smart and Smart, 1991; Yeung, 2001a, 2001b). Further, early investments often produced only fragments of finished goods—​ whether zippers or fabric pieces for garments (to ensure they could still be considered “Made in Hong Kong”) or coils for hair dryers (Caryl, 2012; Leung, 1996). Labor-​intensive component production and assembly was well suited to Sanlai Yibu. These business arrangements took four forms (Smart and Smart, 1991; Yeung, 2001a). In all instances, the products were destined for overseas markets: 1. Laijian Zhuangpei:  a Chinese firm would receive a processing fee to assemble components provided by the foreign contractor according to plans or samples provided by the foreign buyer. 2. Lailiao Jiagong:  a Chinese firm would receive a processing fee to assemble raw materials (not components) into finished products, which the foreign partner would then export. This is also a general Chinese term for export processing, whether or not the performing firm was registered as Sanlai Yibu (see later). The activity of contract manufacturing is usually called daigong to clearly differentiate it from these categories of firms. 3. Laiyang Jiagong: a Chinese firm would receive a sample or plans from the foreign buyer and fill the order using independently sourced components or materials. This is most similar to the standard business conception of contract manufacturing for foreign buyers. 4. Yibu: a Chinese firm receives production equipment from a foreign partner and pays for it by providing an agreed amount of processed goods. Necessary production capital equipment, as well as processing fees, came from the foreign partner in a Sanlai Yibu arrangement. Although the firms were domestic, the fees and capital provided counted as foreign investment in Chinese statistics in the 1980s and 1990s. Property rights were thus somewhat ambiguous, unlike sanzi qiye (equity joint ventures, contractual joint ventures, or wholly owned foreign subsidiaries), where ownership and responsibility were explicitly defined. Were Sanlai Yibu firms subsidiaries of the foreign contractor—​the firm placing the orders and providing materials—​joint ventures, or domestic Chinese firms performing daigong? Capital, inputs, and management came from

Global Supply Chains as Drivers of Innovation    561 abroad, but the paperwork would still be signed and stamped by the official local firm. Using this form of investment avoided establishing formal status for the foreign enterprise, allowing eager but time-​sensitive and capital-​poor firms to make products for export (Yeung, 2001b). Sanlai Yibu investment costs were low. Early Hong Kong Lailiao Jiagong investments averaged US$11,538 in 1980 and US$25,641 in 1981 (Smart and Smart, 1991). Through 1987, the average size of a Hong Kong investment was less than US$40,000 (Yeung, 2001a). By requiring minimal foreign investment to commence operations, Sanlai Yibu could be approved locally, thus avoiding the uncertainty of involving higher-​level authorities who may or may not have shared the commitment to GVC participation. Like other adaptations to structured uncertainty, Sanlai Yibu agreements had enabling and constraining impacts on firm and regional capabilities. They were a pragmatic response to uncertainty over approval processes for foreign investments and a means of rapidly jump-​starting local economies. They also facilitated varying degrees of learning for the Chinese contractors as they entered into GVCs. Chinese participants in the system ranged from having near full control—​and hence the greatest learning potential—​to being largely passive assemblers. In Laijian Zhuangpei, the Chinese firm had the least potential for learning as it needed only to supply labor without learning the necessary skills for material procurement, quality control, and component production. In contrast, Laiyang Jiagong contract manufacturing meant the Chinese partner would have to procure its own inputs—​developing early supply chain skills—​and address how to ensure quality and timeliness. The firm would be free to use its own equipment or purchase equipment necessary to meet the demands and expectations of the foreign buyer. In extremis, the Yibu arrangement provided the greatest possible space for upgrading. The foreign buyer would provide more modern production equipment in exchange for receiving a set amount of processed goods. The Chinese firm’s capabilities and technological intensity would be upgraded beyond those of its domestic peers through access to this more advanced production capital. In addition to a one-​off upgrading through the equipment acquisition, the firm was also free to develop its own products and seek overseas orders to increase utilization of the capital goods. To earn more revenue, firms would be forced to continuously seek new uses for their capital goods, finding new and diverse avenues for application. Sanlai Yibu enterprises typically made labor-​intensive products such as garments, textiles, shoes, toys, basic metal housewares, and simple consumer electronics. Early investments from Hong Kong–​based firms were particularly widespread in electronics (Leung, 1996). In all cases, the final source of demand lay outside Asia—​usually in the United States or Europe. For China’s development, however, this connection to the GVCs proved critical. Although these factories’ operations were simple—​even factory buildings were often rudimentary corrugated metal structures or rooms in apartment blocks—​the technology brought in for production was of a higher level and quality than that used domestically. Hong Kong–​based firms tended to bring their most advanced production capital into the mainland, meaning their export processing factories in Guangdong were not inferior to operations in Hong Kong (Leung, 1996). Despite these advantages, Sanlai Yibu was constraining for enterprises in the long term. As discussed later, the terms of investment—​importing 100% of components and exporting 100% of output—​were ill-​suited to formation of locally based industrial districts. It also

562   Murphree and Breznitz hampered the development of indigenous supply chains. Further innovation was necessary for China to broadly benefit from its entry into GVCs.

Broadening GVC Participation: Special Economic Zones and Promotional Policies Given the challenge of reforming a centrally planned economy without changing the political system, China’s central government launched most reforms far from the leading areas of the centrally planned economy, in coastal special economic zones (SEZs) (Shirk, 1993; Naughton, 1995). Each was explicitly intended to attract foreign direct investment, and each was planned to tap into a specific segment of the Chinese diaspora—​Hong Kong, Macau, Southeast Asia, and Taiwan. Central authorities were uncertain about the viability, or even desirability, of the experiment, so SEZs were isolated from China’s economic and industrial heartland. Shenzhen proved rapidly successful in attracting foreign investment and earning foreign exchange. Geographically attached to Hong Kong, Shenzhen was by far the most attractive region with short direct transportation links, making low value-​added export processing profitable and convenient. It thus began attracting investments in the labor-​ intensive export industry from Hong Kong–​and Taiwan-​based enterprises. The process of integration with GVCs accelerated with Deng Xiaoping’s 1992 Southern Tour. Visiting Shenzhen, Zhuhai, and Shanghai, Deng argued for strengthening, deepening, and broadening economic reform in general, and for the opening of Shanghai as an SEZ in particular. The following year, in 1993, China’s new president, Jiang Zemin, officially declared the objective of creating a “socialist market economy,” effectively ending the debates over whether to insert China into the global economy and to continue economic reform. With the future of market-​oriented economics ensured, China’s doors opened wide to foreign direct investment. Export processing earned significant foreign exchange for local governments, whether in SEZs or not. Local governments were often willing to offer significant incentives to increase exports. Regions posting strong economic growth and earning foreign exchange were often lauded by leaders such as Deng Xiaoping, thus encouraging them to accelerate reform. The central government developed policies to encourage movement of parts of the GVC into China. These included initial income tax holidays for foreign-​invested firms, a 15% corporate tax rate, utilities subsidies, and free or guaranteed provisions of land and critical infrastructure. Even though local governments are technically not permitted to make policy, local authorities, especially in the coastal regions opening to buyer-​driven value chains, initiated a number of highly important unofficial policies. One such policy was the “head tax” system. Through 1994, China maintained tight central government control over foreign exchange. This resulted in a dual exchange rate system—​an official rate that did not reflect market conditions and a second unofficial market rate. Local governments could profit from this system by partnering with foreign-​invested enterprises (Wu, 1997). The foreign firm would be granted a privileged connection to local officials and protection from predatory government departments and regulators in exchange for a regular payment of the “head tax.” Whenever the foreign-​invested enterprise would receive

Global Supply Chains as Drivers of Innovation    563 hard currency payments for its exports, it would convert these at the unofficial rate but keep only the official amount. The difference would be paid out to the local government partner. Similar arrangements occurred in Jiangsu and Henan provinces, where foreign enterprises were welcomed with special tax and policy incentives and the local government received financial benefits.

Shifting Investment and GVC Participation In the 1990s, patterns of both buyer-​driven and producer-​driven value chain investment began to shift. Despite the changes in investment patterns, the institutional condition of structured uncertainty remained, although its effects were felt in different areas. Foreign direct investment increasingly took the form of wholly owned foreign investments as opposed to Sanlai Yibu and equity joint ventures. Whereas commitment to economic reform and market economics had been uneven and uncertain in the 1980s, as China’s commitment to the (socialist) market economy became clearer, foreign investors became more willing to make long-​term and larger-​value investments. By 1993, the average size of Hong Kong investments had increased to US$300,000. Rather than contracting with local factories and supplying components or machinery, foreign investors increasingly built their own factories equipped with imported production machinery (Yeung, 2001a). While early export-​oriented factories usually used rented facilities, foreign investors, especially Taiwanese, began negotiating for decades-​long use rights to plots of former farmland. They built their own factories, creating a permanent presence. Long-​term commitments brought new challenges under China’s institutional environment. Taiwanese firms had first begun investment in the late 1980s, in contravention of both Taiwanese and mainland Chinese law. Just as Hong Kong firms used Sanlai Yibu arrangements to facilitate investment, Taiwanese firms routed their funds through Hong Kong to avoid investment restrictions. In the 1990s, however, both governments legalized the operations of Taiwanese enterprises in the mainland. The business model of these enterprises, however, contradicted the legal system in which they found themselves. Taiwanese firms frequently invested as export processors to receive the preferential taxation and investment policies offered to these firms. Export processing meant rapid increases in revenue, employment, and foreign exchange, as well as increased export statistics to which local officials could point when evaluating their performance. Hence, it made sense for Taiwanese firms to invest as export processors, the most preferred form of foreign investment. As export processors, Taiwanese firms were legally obligated to import 100% of their components and export 100% of output. Their preferred business model, however, did not operate in this way. In the 1990s, leading Taiwanese electronics firms such as Primax and Delta began large-​ scale investment, producing computer subsystems for export to computer assembly plants outside China. However, it was inefficient to continue importing all of their components and materials from their supplier networks in Taiwan. They mandated that their supplier factories invest in China as well. Delta alone brought 300 supplier firms to southern China.

564   Murphree and Breznitz By the mid-​2000s, China was producing 90% of the necessary components for most information technology hardware and electronics goods. For most products, only central processing units and sophisticated integrated circuits continued to be imported. The supply chain, however, consisted almost entirely of foreign, especially Taiwanese, MNCs (Hsu, 2005; Liao, 2009; Yang, 2006, 2007). The presence of such large numbers of suppliers supported further foreign investments, including those by leading MNCs such as Nokia, HP, and Philips. The laws governing export processing firms were clear, but it was possible to use special considerations to authorize these locally based agglomerations of foreign-​invested producers. Firms had to receive special permission from customs, tax, and transportation authorities in their cities. So long as the ultimate source of inputs and final destination of output were outside China, permission could be granted. However, it was not easy to receive such certification. Taiwanese firms relied on intervention by and negotiation through the Taiwanese-​Invested Business Association (TBA) to facilitate approval of this business model (Murphree and Breznitz, 2020). Only if all of the relevant government agencies agreed to permit these exceptions would the business model be able to operate legally. The TBA was able to act on behalf of many Taiwanese firms, seeking government support just as individual firms had once done. Political connections and support remained critical to ensuring smooth operations. So long as local authorities remained committed to the success of these businesses, the system could continue. However, it remained vulnerable to policy shifts. These have occurred regularly over the last two decades. The rise of Jiang Zemin and Zhu Rongji shifted the developmental emphasis from rural reform and coastal openness to major cities, especially Shanghai. This moved the locus of policy support from coastal regions connected to buyer-​driven value chains to existing urban centers emphasizing planned development of high-​tech and capital-​intensive industries. Coastal regions were forced to depend more on their own revenues and internal investments to continue developing. In the late 2000s, the central government similarly changed its benefit and incentive policies for certified high-​technology enterprises. While the official requirements for incentive policies did not substantively change—​these have remained largely unchanged since the 1980s—​implementation shifted from emphasizing whether a firm’s industry sector was considered “high tech” to the actual human resource, investment, and intellectual property practices of the firms. Overnight, hitherto “high technology” firms—​including giants such as Foxconn—​were no longer legal beneficiaries of the policies to which they were long accustomed. This was not a change in institutions—​the legal definitions and organizations covering high-​technology subsidies remained the same—​but a change in practice, a common occurrence under structured uncertainty. The business model of many firms in buyer-​driven value chains, as well as some of the leading manufacturers of electronics, came under intense pressure following the 2008 enacting of China’s revised Labor Law. China has long had laws governing the treatment of labor. However, the post-​1978 boom and entry into GVCs took place in an environment in which temporary work contracts—​or employment without any contract—​was commonplace. Much of China’s export economy, especially in coastal cities, was built around an assumption of quiescent local labor officials and ability to squeeze workers when sales slowed or cash flow problems emerged. The 2008 Labor Law and its subsequent enforcement led to rapid increases in wages, formalization of many labor contracts, and the failure

Global Supply Chains as Drivers of Innovation    565 or exit of many noncompliant firms. Taiwanese firms in particular complain that it is impossible to compete while remaining compliant with the Labor Law. Local governments—​once quietly tolerant of violations—​have also begun refusing to renew permits for polluting enterprises. Dirty, undesired, or unsightly industries are increasingly pressured to move away from city centers, showcase towns, and industrial parks, breaking up locally based supply chains or forcing firms out of business. Battery manufacturers can no longer colocate with electronics assemblers. Garment factories cannot operate their own dyeing and drying facilities. The switch in enforcement of existing laws increases the costs to business and has forced them to adapt. Thus, structured uncertainty, while encouraging short-​term profitability and quick adaptations, has also created conditions necessitating significant business and technology innovation in order for firms to remain competitive. For instance, in the case of dyeing facilities, local governments in some townships now provide central facilities that all garment factories can use in a public-​ private partnership. This policy innovation arose to meet the challenge from sudden, and unanticipated, enforcement of rules.

Innovations by Chinese Firms in GVCs Chinese firms have begun to take over key niches from foreign-​invested firms in buyer-​ driven value chains. Chinese startups began entering into subcontracting relationships with foreign-​invested exporters in the 2000s. Often founded by former workers who had learned the business of shoe, garment, plastic, or other production on foreign firms’ assembly lines, these companies initially acted as sources of surge capacity, allowing foreign-​ invested enterprises to meet production deadlines when their own capacity was exhausted. Gradually through advertising their capabilities online or through trade fairs, these firms became independent competitors of their erstwhile foreign partners. Continually drawing upon foreign demand—​whether through producer-​driven chains like those under brands such as Philips or through buyer-​driven chains such as those of Walmart or Target—​China’s export-​oriented firms achieved critical mass. This began to have significant impacts on innovation and upgrading. Firms such as Lee and Fung of Hong Kong, which formerly had produced clothing in their own networks of factories in China, became dedicated sourcing coordinators. With so many potential supplier factories, it was no longer necessary to produce independently. Firms could now specialize in helping branded and retail clothing providers perfect their sourcing in Asia. The supply chain, order management, and production organization capabilities developed in these firms would enrich the Hong Kong and broader Chinese economy. With orders readily available through dedicated sourcing firms like Lee and Fung, Chinese manufacturers developed the ability to produce smaller orders on shorter time schedules. The influence of structured uncertainty in favoring short-​term payoffs facilitated this trend, as shorter schedules also imply more rapid payment. This managerial innovation has facilitated the ongoing strength of Chinese manufacturers in traditional and light industries. In buyer-​driven chains, particularly in shoes and garments, the traditional lead time is a minimum of three months. In China’s factories, however, the demands of global

566   Murphree and Breznitz buyers led factories to organize their production so that smaller and more varied orders could be produced on less than one month’s advance notice. To meet such production demands, China’s firms drew upon the local agglomerations of materials and component suppliers that had originally developed to major foreign MNC exporters. The depth of the supplier network and ability to locally procure a wide variety of necessary inputs with little advance notice made it possible for Chinese firms to meet the demands of flexible, small-​ order, short-​term buyers. According to manufacturers in the Pearl River Delta and the Wenzhou region, this agglomeration of materials and components suppliers, as well as the local availability of subcontractors when orders exceed capacity, enhances China’s competitiveness in these types of value chains. Despite labor costs that have been rising at 12% per year since 2000, these types of production innovations made possible due to participation in GVCs under structured uncertainty have buoyed China’s competitiveness. The demands of buyer-​driven chains have led to increased innovation in capital goods used for production. In shoes and garments, production has traditionally been highly labor intensive and reliant on imported equipment such as supplied to early Yibu enterprises or brought in with foreign investment. Today, through reverse engineering of foreign equipment first acquired in the 1980s and 1990s, the general-​use production equipment is primarily Chinese. Reducing reliance on foreign sources of technology is a potential means of adapting to structured uncertainty by ensuring access to necessary production equipment, regardless of future political shifts. As increasing indigenization of production is seen as valuable by local officials, this approach has the added benefit of improving firms’ relations with local government. Innovation and automation have now moved beyond reverse engineering. Chinese exporters face the dual challenge of existing foreign-​invested large-​scale competitors and an operating environment of rapidly rising wages and falling worker availability. Their need to meet GVC output and quality demands has driven investment in automation, spurring rapid innovation. In the city of Dongguan, Emma CNC, a former contract shoe manufacturer, has moved into development and manufacturing of automated shoe and leather goods production equipment. Shenzhen-​based plastics manufacturers have begun production of industrial molds and injection molding machinery. Former toy manufacturers such as Lungcheong International now make robotic arms. Electronics factories have reduced production workers by as much as 90% as they adopt self-​developed or domestically produced automation technologies. Such innovations are protected by patents. The firms also sell and export their production systems to other regions producing for buyer-​driven chains. The sustained intensity of overseas demand through GVCs has created the impetus for these innovations. Amalgamating the demand of multiple prospective buyers helps reduce the risks when firms develop these new technologies. Firms are confident that development or adoption of these technologies is justified since foreign demand remains strong and expectations of high quality with low cost remain robust. Today, China is beginning to challenge established production equipment manufacturers in Germany and Japan. The marketing and distribution of goods for buyer-​and supplier-​driven chains also gave rise to China’s largest and most valuable internet company—​Alibaba. Alibaba began as a platform enabling sourcing within China. Chinese or foreign firms seeking specific components or final products could source them using the Alibaba platform. The scale of demand meant Alibaba was able to, and indeed had to, expand rapidly. Today, it is the platform of choice for firms seeking production capabilities or generic goods in China. When an American restaurant needs 10,000 take-​out containers, these can be purchased

Global Supply Chains as Drivers of Innovation    567 inexpensively and custom-​designed through producers advertising on Alibaba. Using the revenues from the original platform, Alibaba has since expanded into direct branded goods and consumer sales as well as a variety of high-​value-​added internet services.

Conclusions Throughout the history of China’s involvement in GVCs through economic opening up and reform, firms have contended with internal and external shocks and surprises. Opening to the global economy subjects firms to external risks such as the 2000 dot-​com bubble collapse or the 2008 financial crisis. Domestically, structured uncertainty means firms have to adopt strategies and develop capabilities to prepare for shocks. The nature of China’s system, with a central government able to rapidly enact, enforce, or rescind policies, makes such shocks likely. The shifts brought about under structured uncertainty have created very special moderating and intervening solutions for Chinese firms in GVCs. There remains a focus on short-​and medium-​term returns and practices. However, as noted earlier, short-​term focus has facilitated globally competitive capabilities in flexible small-​order contracting. Chinese firms frequently invest at small scale, often asset-​light, to begin production rapidly. In the early days, this took the form of Sanlai Yibu enterprises. Today, indigenous firms use organizational innovations such as “scalable clustering” to enable large-​scale on-​demand production for overseas or domestic buyers without having to internalize high overheads or excess surge capacity. The emphasis for firms is to earn returns as rapidly as possible so these may be shown to government officials as proof that the current policy environment, whether fully legal or not, is beneficial and should be maintained. This means firms have strong incentives to plug into GVCs, as the conjunction of inputs, knowledge, and market demand facilitates short-​term returns. Chinese firms have become adept at sensing market changes. Under structured uncertainty, they must remain ahead of policy shifts, indicating firms must be highly flexible to survive. They seek to develop or produce new products and search for new markets. With the variety of inputs and sources of demand on which firms can draw, their possibilities for product and market innovation are vast. For example, from 2008 to 2012, Chinese firms began producing hundreds of incrementally differentiated mobile phone models. Based on imported platform technologies accessed through GVCs, these phones could be sold domestically or in price-​sensitive but quality-​seeking markets abroad, such as Africa and Latin America or elsewhere in Asia (Tang et al., 2016; Murphree et al., 2016). These firms were frequently not licensed to produce mobile phones, but local governments supported their activities, as they yielded employment and tax revenue. As the domestic market became saturated, firms aggressively sought new markets abroad. As technologies became outdated—​and smartphones killed this industry niche—​firms shifted to other product lines. Although operating outside officially legal channels, these firms were able to operate because local governments facilitated their business activities, at least in the short term. Finally, innovation is both enabled and constrained by this system. The lack of clarity on long-​term policy direction, institutions, and resources is constraining. Firms will be far less likely to invest in long-​term blue-​sky uncertain research (Breznitz and Murphree, 2011). Hence, models of innovation that assume firms must structure their R&D investment

568   Murphree and Breznitz like firms in Europe or the United States fail to capture the capabilities available to firms in China. Western-​style approaches are inhibited by structured uncertainty. This does not preclude broad, novel innovation, however, as noted earlier. Firms seeking short-​term returns and political support will and do invest in small-​scale, incremental, and rapidly commercializable innovations, especially those arising from the shop floor. Participation in GVCs means such firms are attuned to foreign demand and standards, strengthening their ability to exploit innovations developed elsewhere. Strategic coupling ensures the local capabilities are paired with globally sourced knowledge through GVCs, facilitating ongoing innovations (Yeung, 2016). Proven incremental success can help firms secure access to financial resources necessary to commit to longer-​term research. Mobile phone firms such as Oppo and Vivo relied on sustained demand for their lower-​end models as sources of revenue to secure them as they invested in longer-​term and more complex innovations. In the buyer-​driven GVCs, the mechanisms of producing for overseas consumers drove different upgrading impacts. The contract manufacturer must independently develop production and design capabilities to consistently secure orders from foreign buyers. Their production prowess must be established and advertised on the open market—​as seen in booths such as those at the famous Canton Trade Fair in Guangdong, and similar fairs in Chengdu and Shanghai, or permanent exhibitions such as those at the Yiwu International Trade Center in Zhejiang. Prospective buyers can browse sample products through these exhibitions, meet with potential contract manufacturers, and weigh their capabilities (Bathelt and Zeng, 2014; Bathelt and Zhu, 2017). Forced into competition, manufacturers have to offer better prices, quality control, or independent design as methods for winning business. The interactions within these buyer-​seller relations also transfer significant knowledge, which upgrades the capabilities of the manufacturer, allowing them to become more competitive in seeking future business with the same or other buyers. The same capabilities improve firms’ abilities to build their own brands and eventually market their own branded products. China’s current status as a world-​leading innovator thus owes much to its development experience with GVCs. However, the environment of structured uncertainty shaped the impact GVCs had on the performance of Chinese enterprises. Many firms are and will remain small to preserve the flexibility necessary to address structured uncertainty, thus constraining their ability to marshal resources for breakthrough innovation. The constant challenge of addressing uncertainty, however, also builds resiliency and competitiveness. Firms able to compete under structured uncertainty develop capabilities highly valued in GVCs, enabling sources of revenue that can, and do, facilitate longer-​term investment. Breakthrough innovations are thus possible and increasingly expected. The capabilities enabled within the network of GVCs make Chinese enterprise more competitive and better able to survive both domestic and foreign shocks.

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Chapter 6.3

Market De ma nd, C onsum e r C haracteri st i c s , and Innovat i on i n Chinese Fi rms Hengyuan Zhu and Qing Wang Introduction Market demand is an important source of innovation. Drawing on the demand-​ side approach to innovation (Priem et  al., 2012), this chapter investigates the strategic implications of market demand and consumer characteristics for Chinese firms’ innovation activities. The aim is to examine consumer heterogeneity and market dynamics as a source of value creation and its impact on firms’ innovation decisions and capabilities in the Chinese context. In spite of the crucial role of domestic market demand for China’s economic growth, there is an absence of a consistent and well-​developed demand-​side approach to studying innovation in China. This is a significant research gap for innovation and management scholars. This chapter stresses the importance of a demand-​side approach for studying innovation in China and explores the characteristics of market demand and the interaction with innovation in the context of the past 40 years of rapid economic growth and technological advancements. The second section begins with an analysis of the classic debate on whether market and demand–​pull factors or science and technology–​push factors influence the rate and direction of technological innovation. It is proposed that these two types of factors interact to influence innovation success, but the nature of the interaction and their relative importance vary depending on the sector, stage of product life cycle, and market dynamics. More specifically, the question of how the size, diversity, and growth rate of the domestic market influence innovation capabilities and performance in Chinese firms is explored.

574   Zhu and Wang The third section uses the lens of the diffusion of innovation theory (Rogers, 2003) to examine the characteristics of Chinese consumers and their changing demands over time. A case study of China Mobile is provided where new products and services were developed to target customers with different lifestyles. The aim is to shed some light on how different consumption motives (i.e., functional, symbolic, and hedonic) of Chinese consumers steer Chinese firms to improve product quality and create novel product attributes. The fourth section reviews extant research in international business and strategic management theory on the relationship between firm-​specific advantages (FSAs) and context-​ specific advantages (CSAs) and discusses the limitations of the traditional notion of FSAs in explaining emerging market multinational enterprises (EMNEs). According to Cuervo-​ Cazzura and Genc (2008) and Dunning and Lundan (2008), the rise of EMNEs is attributed to the superior ability of EMNEs to operate in harsh institutional environments in other developing countries and their greater capability to adapt products to the specific demands of import-​protected developing markets (Lall, 1983; Wells, 1983). These are context-​specific advantages that enable EMNEs not only to adapt to the different contexts but also to turn contextual factors into opportunities in competing with multinational enterprises (MNEs). The fifth section summarizes the main points put forward in this chapter and offers a number of insights into the key issues and future research directions for studying the relationship between demand and innovation in China.

Innovation from a Demand-​Side Perspective and the Market Characteristics in China Demand-​Pull, Technology-​Push, and the New Enthusiasm for the Demand-​Side Approach to Innovation Research Following the widespread recognition of the role that technology plays in economic growth (Solow, 1956) and early work characterizing the process of innovation (Schumpeter, 1947; Usher, 1954), a debate emerged in the 1960s and 1970s about whether the rate and direction of innovation have been more heavily influenced by changes in market demand or by advances in science and technology. The core of the science and technology–​push argument is that advances in scientific understanding determine the rate and direction of innovation, which was later termed the “linear model.” This argument envisioned a progression of knowledge from basic science to applied research to product development to commercial products. Dosi (1982) later attributed the prominence of this supply-​side perspective to several aspects of the innovation process: the increasing importance of science in the innovation process, increasing complexity that necessitated a long-​term view, strong correlations between research and development (R&D) and innovative output, and the inherent uncertainty of the innovation process. However, a central critique of the supply-​side perspective of the science and technology push is that it ignores prices and other changes in economic conditions that affect the profitability of innovations, hence the incentives and viability of converting scientific advances to innovative output. Another critique is that the emphasis on a unidirectional progression within the stages of the innovation process was

Market Demand, Consumer Characteristics, and Innovation    575 incompatible with subsequent work that emphasized feedback, interactions, and networks (Kline and Rosenberg, 1986; Freeman and Louça, 2001). The demand-​side perspective, on the other hand, proposes that demand drives the rate and direction of innovation. Changes in market conditions create opportunities for firms to invest in innovation to satisfy un-met needs. Demand steers firms to work on certain problems (Rosenberg, 1969). Demand-​side factors such as shifts in relative factor prices (Hicks, 1932), geographic variation in demand (Griliches, 1957), and the identification of latent demand and potential new markets (Schmookler, 1962, 1966; Vernon, 1966) all affect the size of the payoff to successful investments in innovation. The debate peaks in the 1970s with growing skepticism toward a pure demand-​pull argument (Di Stefano et  al., 2012). Critics of the demand-​pull argument posit that demand-​pull explains incremental technological change far better than it does discontinuous change, so it fails to account for the most important innovations (Mowery and Rosenberg, 1979; Walsh, 1984). It is therefore proposed that both supply-​and demand-​side factors are necessary to explain innovation. But it is not simply that both factors contribute; they also interact (Arthur, 2007). In a survey of 40 innovations, Freeman (1974) found that successful innovations showed the ability to connect, or “couple,” a technical opportunity with a market opportunity. Furthermore, previous research revealed that the nature of the interaction between the two sets of factors and their relative importance vary across sectors. In other words, industry-​specific attributes such as the degree of technological discontinuity and the size and growth rate of market demand affect the degree of influence and the nature of interaction of demand pull versus technology push (Pavitt, 1984). A related stream of research put forward by Christensen (1997) on the notion of disruptive innovation further explores the link between technological innovation and demand-​ side dynamics. According to Christensen (1997), disruptive entrants successfully challenge the dominance of incumbents by initially targeting the somewhat neglected low-​end market with inferior technologies and then tapping into the more profitable mainstream market with improved product performance, while incumbents are usually focusing on the high-​ end market and overlooking the needs of the mainstream and the low-​end markets. Despite the criticisms of disruptive innovation research being ex post and having poor predictive power (Danneels, 2006; Lepore, 2014; King and Baatartogtokh, 2015; Weeks, 2015), the notion of disruptive innovation highlights the importance of understanding the heterogeneity of consumer demand and the possibility of firms with inferior technologies displacing established incumbents. It has had a profound effect on the way in which scholars and managers approach technology competition. However, while the phenomenon of disruptive innovation has been well documented, the underlying theoretical drivers are less understood. Adner (2002, 2004) further identifies the demand conditions that enable disruptive technologies to compete successfully in the marketplace. By examining how consumers evaluate technologies and how this evaluation changes as performance improves, he offers new insights into the impact of the structure of market demand on competitive dynamics. Specifically, he introduces a formal model to analyze how the relationships among the market segment preferences affect technology competition, as well as a demand “S” curve examining consumers’ valuation of technology improvements. Similarly, Priem et  al. (2012) and Levitas (2015) stress the importance of the demand-​ side approach to innovation and other macromanagement research. Specifically, Priem et al. (2012) review the progress of three rapidly growing macromanagement literatures in

576   Zhu and Wang technology innovation, entrepreneurship, and strategic management that have in common the use of a “demand-​side” research perspective. Demand-​side research looks downstream from the focal firm, toward product markets and consumers, to explain and predict those managerial decisions that increase value creation within a value system. Typical characteristics of demand-​side, macro-​level management research include (1) clearly distinguishing value creation from value capture, (2) emphasizing product markets as key sources of value creation strategies for firms, (3) viewing consumer preferences as dynamic and sometimes latent, and (4) recognizing that managers’ differing decisions in response to consumer heterogeneity contribute to firm heterogeneity and, ultimately, value creation.

Market Demand in China: A Large, Diversified, and Dynamic Domestic Market and Its Interaction with Innovation Studies on innovation in China usually fall into several areas, which are (1) the improvement of innovation and technological capability in comparison to other countries; (2) the interactions among actors such as universities, government policies, and enterprises in the national innovation system; and (3) case studies on focal industries such as information and communications technology and green technology (Fu, 2015). While the former two perspectives primarily focus on the supply side of innovation and discuss topics such as knowledge spillover and industry-​research-​government cooperation, the case studies approach usually has more diverse focuses, including both the supply-​and demand-​ side dynamics. Priem et al. (2012) observe that it is only recently that some management scholars have taken the demand-​side perspective instead of the dominant resource-​based view in studying innovation, entrepreneurship, and strategy. Meanwhile, it is commonly recognized that domestic demand has played a crucial role in the significant growth and transformation of the Chinese economy. Domestic demand growth, including consumption and fixed-​asset investment, accounted for 105.7% of gross domestic product (GDP) growth on average from 2008 to 2017. The huge domestic market, rising consumption, diversified demand, and its dynamic changes allow companies to exploit the size and rich contexts of different market segments and thrive in their innovation activities. First, innovators can leverage China’s huge domestic market and rising consumption. As shown in Figures 6.3.1 and 6.3.2, China’s GDP and GDP per capita grew by 9.5% on average over the past four decades, and more than 700 million Chinese people have been lifted out of poverty by current United Nations standards. The economic growth and increase in disposable income provide the basis for an ever-​growing, rapidly upgrading, and increasingly diversified domestic demand. A number of empirical studies have addressed the interactions between market size and innovation activities in China. Lin (1992) tests the validity of the Griliches-​Schmookler demand-​induced model by studying the innovation of hybrid rice in China. He finds that the rate of innovation in hybrid rice crop is responsive to the rice acreages in a province. In addition, some scholars introduce the role of competition into the study. Xu et al. (2008) use data from 37 industries in China and test the relationships between innovation, competition, and market size in a simultaneous equations model. They find mutually enhanced

Market Demand, Consumer Characteristics, and Innovation    577 Gross Domestic Product 16

800000 743585.5

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Gross Domestic Product (100 million yuan) Gross Domestic Product, Growth Rate (%)

Figure 6.3.1  China’s GDP and GDP growth rate. Source: National Bureau of Statistics

GDP per capita 60000

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GDP per capita (yuan)

GDP per capita, Growth Rate (%)

Figure 6.3.2  China’s GDP per capita and GDP per capita growth rate. Source: National Bureau of Statistics

578   Zhu and Wang Contribution Share of the Three Components of GDP to the Growth of GDP (%) 150.0% 100.0% 50.0%

19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 20 10 20 12 20 14 20 16

0.0% –50.0%

–100.0% Final Consumption Expenditure Contribution Share to the Growth of GDP(%) Gross Capital Formation Contribution Share to the Growth of GDP(%) Net Exports of Goods and Services Contribution Share to the Growth of GDP(%)

Figure 6.3.3  Contribution share of the three components of GDP to the growth of GDP. Source: National Bureau of Statistics

Total Retail Sales of Consumer Goods(100 million yuan) 35.0%

3,50,000

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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

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Total Retail Sales of Consumer Goods(100 million yuan)

Annual growth rate

Figure 6.3.4  Total retail sales of consumer goods (100 million yuan). Source: National Bureau of Statistics

effects between market size and innovation and between innovation and competition, as well as a positive impact of market size on competition. Consumption plays an important role in China’s economic development (see Figure 6.3.3). As the economy is transitioning to the “new normal,” growing at a lower but more sustainable rate and shifting toward an innovative, service-​oriented, and consumption-​driven economy, domestic consumption becomes even more important. According to the National Bureau of Statistics (see Figure 6.3.4), retail sales of consumer goods, a key indicator of consumption, grew at more than 10% annually for the past 10  years, reaching 36.63 trillion yuan in 2017. That is to

Market Demand, Consumer Characteristics, and Innovation    579 2016 Per Capita Gross Regional Product (yuan) 1,40,000 1,18,198

1,20,000 1,00,000 80,000 53,935

60,000 40,000 27,643

0

Gansu Yunnan Guizhou Tibet Shanxi Guangxi Anhui Sichuan Jiangxi Heilongjiang Xinjiang Henan Hebei Qinghai Hainan Hunan Ningxia Liaoning Shaanxi Jilin Hubei Chongqing Shandong Inner Mongolia Guangdong Fujian Zhejiang Jiangsu Tianjin Shanghai Beijing

20,000

Per Capita Gross Regional Product

Per Capita GDP (nationwide)

Figure 6.3.5  Per capita gross regional product, 2016. Source: National Bureau of Statistics

say, China’s huge domestic market and rising consumption present huge opportunities for firms to innovate. Second, the diversity of the Chinese market, including regional differences and the urban-​rural divide (see Figure 6.3.5), will allow a gradual and sustained release of multilayered demand and provide a test field for the global market. As shown in Figure 6.3.6, the GDP per capita of the least developed region such as Gansu was less than 28,000 yuan in 2016, while Beijing had four times as much. In addition, more consumption potential will be gradually released as China’s urbanization process continues. China’s urbanization rate was at 56.8% in 2016, while the developed Organisation for Economic Cooperation and Development (OECD) members were at 80.5%. Therefore, the demand for high-​end sophisticated goods and for value-​for-​money products will coexist for a long time. Each market segment is large enough to allow companies to thrive. Most importantly, these different market segments can be seen as test fields for innovations that can be rolled out globally as companies can adjust the products and strategies for other markets based on their experience in China. For example, mobile phones (including Tecno, Itel, and Infinix), produced by Transsion Holdings from Shenzhen, are leading the African smartphone market with over 30% share (International Data Corporation, 2017). This brand is known as designed to suit the local needs in Africa with a high performance/​price ratio. These capabilities are partly indebted to its founder’s work experience in Bird, a company used to supply mobile phones to China’s rural market. An empirical study by Xie and Li (2015) provides some evidence of the positive influence of market variety on innovation performance. Analyzing data from 8,529 Chinese automobile and component manufacturers during the period 2005–​2007, they find that market variety, that is, the composition of qualitatively different geographical and national markets, is conductive to innovation performance.

580   Zhu and Wang 2016 Per Capita Disposable Income (yuan) 60,000.00 54,305.35 50,000.00

40,000.00

30,000.00 23,820.98 20,000.00 13,639.24

0.00

Tibet Gansu Guizhou Yunnan Qinghai Guangxi Xinjiang Henan Sichuan Ningxia Shaanxi Shanxi Hebei Heilongjiang Jilin Anhui Jiangxi Hainan Hunan Hubei Chongqing Inner Mongolia Shandong Liaoning Fujian Guangdong Jiangsu Tianjin Zhejiang Beijing Shanghai

10,000.00

Per Capita Disposable Income (by region)

Nationwide Per Capita Disposable Income

Figure 6.3.6  Per capita disposable income (by region), 2016. Source: National Bureau of Statistics

Third, the dynamic nature of the Chinese market, including an evolving domestic demand, provides rich contexts for companies to innovate. Zhu et al. (2017) observe at least three waves of market leadership change in China’s mobile handsets manufacturing industry between 1998 and 2008, a period with a relatively stable technological trajectory. They find that latecomer firms with limited technological innovation capability could take market share from incumbents through effectiveness-​centered business model innovation. They maintain that government intervention and technological capability building cannot explain these shifts; instead, it is the fit between business model innovation and demand-​ side dynamics that enables the latecomer companies to catch up in market share. The so-​called shanzhai companies flourished in China's domestic markets, despite meagre resources, and grew rapidly by satisfying rapidly rising demand with “good enough” products, as described by Yip and McKern (2016). Furthermore, there are many cases of product innovation that achieve commercial success by satisfying the growing sophistication in consumers’ preferences and lifestyles. For example, Galanz started to provide small, energy-​ efficient, and cheap microwave ovens to meet the domestic demand of the newly emerging

Market Demand, Consumer Characteristics, and Innovation    581 middle class in 1992; it later dominated the market with a 70% share in 2000 (Hang et al., 2010). Another study of five Chinese telecom equipment firms (including ZTE and Huawei) demonstrates that innovation-​based product differentiation, low cost, and outstanding service allow these Chinese firms to catch up with MNEs (Gao, 2011). To sum up, domestic demand has played an important role in China’s economic development, and it can be characterized as large, diversified, and dynamic. These characteristics, we argue, provide companies with rich sources of innovation as well as sufficient economies of scale for commercial success.

Characteristics of the Chinese Consumer and Diffusion of Innovations Consumer Innovativeness and the Diffusion of Innovation A number of consumer-​related characteristics are found to be critical for new product adoption, such as consumer innovativeness and lifestyle preferences. In this section, we look into the characteristics of Chinese consumers and the influence on Chinese firms’ innovation capabilities through the lens of the diffusion of innovations theory. Diffusion of innovations, a theory first developed by Everett Rogers in 1962, attempts to explain how innovations are taken up in a specific population. Rogers (2003) defines consumer innovativeness as the degree to which an individual is relatively early in adopting new ideas compared with other members of a social system. He measures consumer innovativeness by the behavioral profiles of different adopters. These include socioeconomic status, personality variables, and communication behavior. For example, innovators are defined as venturesome; they are resourceful, knowledgeable, and risk seeking. Early adopters are defined as respectable; they are opinion leaders with sound judgment and a responsible attitude. Next, the early majorities are defined as deliberate; they are cautious but positive. The late majorities are defined as skeptical; they have limited resources and avoid uncertainty. Finally, laggards are defined as traditional; they are local and isolated, and the past is their main reference point (see Figure 6.3.7).

Early adopters Innovators 2.5%

13.5% x-2sd

Early majority 34% x-sd

Late majority 34% x

Laggards 16% x+sd

Figure 6.3.7  Adopter categorization on the basis of innovativeness. Source: Rogers (2003)

582   Zhu and Wang China model

Market size

US model Western Europe model Northern Europe model

Time

Figure 6.3.8  Growth model of different markets. Source: Zhu et al. (2007)

Following Rogers’s framework, some scholars have conducted studies on product innovation in China. Zhu et al. (2007) apply the Bass model, a mathematical model of the diffusion of innovation, to the development of the mobile handset market across countries. As shown in Figure 6.3.8, they find that due to the high imitation coefficient among consumers and the large potential market size, the Chinese market grows relatively slowly at the early stage of innovation diffusion but grows exponentially once the early adopters have entered the market. The takeoff curve is much sharper than that of Western markets. In addition, with an emphasis on the dual urban-​rural economic and social structure in China, Yang et al. (2012) apply the Bass model to the color TV market and find that it is better to view the urban and rural markets as separate markets instead of a single, homogeneous Chinese market for new product diffusion. These studies provide strong evidence of the heterogeneity of Chinese consumers. Next, based on the business practices of Chinese firms and Rogers’s theory, Zhu and Yang (2018) put forward the PRE-​M model, a dynamic framework incorporating corporate strategy formulation with market developments. This model closely tracks the change of demand and the characteristics of mainstream customers in the product market. Product market development is analyzed from four dimensions, namely the characteristics of mainstream customers, market size, market growth rate, and demand diversity. As shown in Figure 6.3.9, product market development is divided into four stages, which are incubation, expansion, diversification, and hybrid market. It is argued that in each of the product market stages, companies are faced with different demand structures and competitive situations. Accordingly, the resources required and the capabilities needed in the relevant industry along the supply chain vary over time in the resource market, and so do their valuations in the equity market. This line of research examines the match between market development stage and innovation strategy. Some researchers argue that consumers in emerging markets might accept innovations from Western markets more easily and more quickly than Western consumers when the same innovations were first launched into Western markets. Therefore, imitation could be a feasible strategy at least in the early years of development in the emerging markets. Using a large-​scale, nationwide product innovation survey with more than 400 usable

Market Demand, Consumer Characteristics, and Innovation    583

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Figure 6.3.9  Diffusion of innovations and product market characteristics. Source: Zhu and Yang (2018)

responses from 15 industries in China, Chen et al. (2012) find that at an early stage of market development, companies that seek innovation ideas from leading firms in Western countries achieve superior performance in terms of customer, financial, and technical measures. In addition, using the same set of data, Chen et al. (2011) find that, as the market environment evolves over time with different combinations of low/​high levels of competition intensity and low/​high demand growth rates, firms tend to choose different sources of product innovation. Though they find no significant relationship between customer orientation in the innovation process and the intensity of competition or the growth rate of market demand, further empirical studies into this understudied area would be useful to deepen our understanding of the interactions between firms’ innovation strategy and market environment.

Characteristics of the Chinese Consumer: The Case of China Mobile Customers To understand the demand-​pull influence on innovation, one has to understand why consumers in different segments respond to new technologies or products differently and what stages consumers go through to adopt an innovation. In other words, both consumer-​ related characteristics, such as demographics, lifestyle, personality traits, knowledge, and expertise, and innovation-​related characteristics, including new benefits and costs, usefulness, and ease of use, should be taken into consideration. The former helps explain why different consumers may respond to the same innovation differently, while the latter helps explain why a consumer prefers one innovation to another. Western companies have adopted lifestyle as a criterion to segment their markets and position their products. For example, in 2006, Standard Chartered launched a new

584   Zhu and Wang lifestyle credit card specially tailored to young professionals with adventurous and outgoing lifestyles. Companies in the emerging markets have also applied lifestyle segmentation in their marketing and branding strategy. For instance, in 2002, China Mobile, a leading telecommunications company in China, developed its first customer brand, “M-​zone,” which targeted the fun-​loving youth market. Consumer lifestyle is found to significantly influence consumer response to innovations (Zhu et al., 2009). Product attributes are critical factors for understanding the preferences of consumers with different lifestyles. As people’s disposable income increases with the economic growth of a country, their needs and lifestyle will be upgraded from focusing on functional product attributes (i.e., those concerning the functional qualities of the product) to hedonic and symbolic attributes (i.e., those delivering hedonic benefits) (Snelders and Schoormans, 2001). According to Kivetz and Simonson (2002), functional attributes are conceptually related to necessities and hedonic attributes to luxuries. Similarly, Berry (1994) proposes a “principle of precedence” to argue that there is a moral obligation to fulfill needs first, before looking to fulfill luxuries. Thus, the relative importance of functional versus hedonic product attributes changes as one “moves up” economically and socially. In other words, for some consumers, having additional features enables them to extract greater utility from the product and hence greater satisfaction; for some others, additional features may be undesirable, unusable, and, hence, a waste of time and money (Thompson et al., 2005). The case of China Mobile sheds some light on unique characteristics of the Chinese consumer and society with regard to innovation adoption and diffusion. Using data from a large-​scale survey of China Mobile customers, Zhu et al. (2009) reveal the following four lifestyle clusters: Cluster 1: The conservative powerful consumer (i.e., Conservative Consumer). This type of consumer has the lowest price consciousness score but the highest advice-​seeking consciousness score and confusion from overchoice consciousness score. They do not pay attention to the price but may stick to their habit and seek advice from their friends when they go shopping. Cluster 2: The cautious simple consumer (i.e., Cautious Consumer). This type of consumer has the lowest novelty-​fashion consciousness score, hedonistic shopping consciousness score, and impulsiveness consciousness score. Moreover, this type of consumer is the only one who has a negative advice-​seeking consciousness score and confusion from overchoice consciousness score. They are not interested in fashion and hedonistic shopping and do not ask advice from friends or show any impulsiveness when they go shopping. Cluster 3: The economical impulsive consumer (i.e., Economical Consumer). This type of consumer has the highest price consciousness score and the lowest quality consciousness score. In addition, this is the only type of consumer who has a negative habitual consumption consciousness score and impulsiveness consciousness score. They pay more attention to the price than other types of consumer do and will not show impulsive or habitual behaviors when they buy. Cluster 4: The fashionable quality awareness consumer (i.e., Fashionable Consumer). This type of consumer has the highest novelty-​fashion consciousness score, hedonistic shopping consciousness score, and confusion from overchoice consciousness score. This type of consumer is the only group that has a positive score for high-​quality consciousness.

Market Demand, Consumer Characteristics, and Innovation    585 Therefore, the trend in upgrading from functional consumption to hedonic and symbolic consumption, in turn, creates opportunities for firms to develop new products to satisfy the preferences of customers with different lifestyles. It is therefore likely that people with certain lifestyles will be drawn particularly to a set of product attributes because of the perceived functional, emotional, or symbolic relevance of these attributes to their needs.

Firm-​Specific Advantages and Context-​Specific Advantages for Emerging Market Multinationals Limitation of Traditional Notion of FSAs in Explaining EMNEs The literature on EMNEs emphasizes country-​specific advantages such as access to natural resources as an alternative to traditional firm-​specific “ownership” advantages. In the context of large emerging market economies, the literature highlights the importance of home market size and therefore resulting economies of scale as key country-​specific advantages explaining outward investment by EMNEs. Buckley et al. (2012), analyzing the competitiveness of EMNEs, show that with rapid technological progress or possession of a large and growing domestic market, they can become strong competitors for Western multinationals. A  key insight from their study is that even without possessing FSAs in technology and brand, EMNEs from countries with large and rapidly growing domestic markets and with opportunities for technological learning may become dominant players in the global system. In other words, once EMNEs catch up on technology (while not achieving a competitive advantage) and once their domestic market size increases sufficiently (making the interaction with consumers less costly), they become able to successfully compete with MNEs. These studies highlight the importance of country-​specific advantages that EMNEs have, which can compensate for the lack of FSAs in technology and brand during the stage of technological catch-​up. However, existing research on country-​specific advantages offers little insights into how the relative importance of country-​specific versus FSAs may change as EMNEs strive for superior innovation performance through technological leadership, and whether the nature of FSAs for EMNEs will be different from that for MNEs. In international business theory, FSAs refer to firm-​level assets that can be tangible or intangible (Dunning, 1977) and can take different forms such as technological advantages, brand differentiation, control of distribution channels, and scale economies (Hymer, 1976). The Western management theory asserts that the possession of FSAs, mainly in technological advances and brands, is a necessary condition for the emergence of the MNE (Dunning, 1977, 1988). This is because such advantages are needed to compensate for the liabilities of foreignness (Hymer, 1976), which implies a higher cost of doing business abroad for foreign firms. However, EMNEs present a challenge for international business theory, as their FSAs do not conform to the standard analysis of ownership advantages that is applied to Western firms. Hence, in the absence of such advantages, the rise of EMNEs on the global

586   Zhu and Wang stage such as Huawei, Haier, and Tencent seems to contradict extant explanations for the existence of MNEs. A number of recent studies have identified reasons for the rise of EMNEs including the superior ability of EMNEs to operate in harsh institutional environments in other developing countries (Cuervo-​Cazzura and Genc, 2008; Dunning and Lundan, 2008) and greater capability to adapt products to the specific demands of import-​protected developing markets (Lall, 1983; Wells, 1983). Bhaumik et  al. (2010), for example, highlight the importance of EMNEs’ ability to manage assets across subsidiaries, access to finance, and ability to coordinate resources in the context of varying institutional quality in explaining foreign direct investment by EMNEs. They argue that these FSAs of EMNEs are concerned with CSAs. They are as important as the more traditional notion of FSAs that is built around ownership advantages of MNEs. These CSAs are concerned with the ability of EMNEs not only in adapting to the different contexts but also in turning contextual factors into opportunities for developing unique advantages against MNEs. Next, the authors further discuss the role of CSAs for EMNEs in China based on empirical evidence and illustrate how aligning firms’ strategic orientations to their business environment would influence innovation performance. (An extended version of this view is proposed by Li, Zhou and Yang in Chapter 6.6 of this Handbook).

CSAs for EMNEs: A Case of Adjusting the Firm’s Strategic Orientation to Its Environment The importance of a strong strategic orientation such as FSAs for MNEs to achieve superior innovation performance has been extensively studied (Baker and Sinkkula, 2005; Slater and Narver, 1994). According to Kohli and Jaworski (1990), the degree of competition in an industry has a straightforward bearing on customer orientation as an FSA. Strong competition leads to multiple choices for customers. Consequently, an organization must monitor and respond to customers’ changing needs and preferences to ensure that customers select its offerings over competing alternatives. Innovation performance can be evaluated in terms of product quality, technical superiority, and the speed of market acceptance, all of which are related to superior customer value. Firms with a strong customer orientation have the ability and the will to identify, analyze, understand, and answer current and future customers’ needs. The firm can enjoy an advantage for its new product vis-​à-​vis that of its competitors by focusing its efforts on customer needs and satisfaction (Gatignon and Xuereb, 1997; Han et al., 1998). To understand the effect of a firm’s strategic orientation on EMNEs’ innovation performance in the Chinese context, Yang et al. (2012) examine the relative importance of various strategic orientations including customer orientation, technological orientation, competitor orientation, and interfunctional orientation in different market and technological environments and emphasize the importance of context. Based on data from a large-​scale survey of Chinese firms, they find that there exist various strategic orientations in Chinese enterprises due to their different historical backgrounds, resource bases, and market characteristics. For instance, high-​tech spin-​off companies such as Tsinghua Purple Light and Founder Group tend to inherit a strong technology orientation, whereas new private

Market Demand, Consumer Characteristics, and Innovation    587 enterprises or joint ventures such as Haier (formerly Qingdao-​Liebherr) tend to develop a strong customer orientation. It is found that the effectiveness of a firm’s strategic orientation is conditioned by the nature of the market and technological environment. In other words, to achieve superior innovation performance, Chinese enterprises need to adjust their strategic orientations to the market and competitive environment. Their results are consistent with the research in the marketing strategy literature (Kohli and Jaworski, 1990), where it is found that in a market characterized by strong and fast-​growing demand, an organization with a minimal amount of customer orientation may still perform well. In contrast, in a market characterized by weak demand and slow growth, customers are likely to be highly value conscious, and organizations must be more in tune with, and responsive to, customer needs to offer good value for the money. Therefore, CSA refers to the ability of EMNEs not only in adapting to the different contexts but also in turning contextual factors into opportunities for developing unique FSAs against MNEs. Clearly, it is a different concept from country-​specific advantages. Such a CSA is concerned with the responsiveness to contexts that are transferrable across country borders, whereas traditional country-​specific advantages are localized capabilities that, by definition, are non-​transferable across borders. This notion of CSA is important for understanding the development path of EMNEs in China. The Chinese economy has grown rapidly over the past several decades, and firms have operated under a diverse environment ranging from highly regulated and monopolized (e.g., the telecom industry) to intensely competitive (e.g., the automobile and computer industry). The results suggest that to achieve new product success, firms should be responsive to the environmental contexts and allocate resources accordingly, designing a strategic orientation that fits into the specific context.

Conclusion, Limitations, and Future Research Direction Summary and Conclusion Drawing on the demand-​side approach to innovation (Priem et  al., 2012), this chapter investigates the strategic implications of market demand and consumer characteristics for Chinese firms’ innovation activities. We point out that there is a lack of a consistent and well-​developed demand-​side approach to studying innovation in China, which is a significant research gap for innovation and management scholars. Based on an extensive literature review, conceptual analysis, and empirical evidence, we posit that successful innovations require the ability of the firm to connect a technical opportunity with a market opportunity and to be responsive to factors such as the degree of technological discontinuity, the rate of market growth, and the nature of demand change. Specifically, we identify three unique characteristics of consumer demand in China as size, heterogeneity, and dynamics. We then provide a detailed analysis of the influence of the three main characteristics of the domestic market on the innovation capabilities of the Chinese firms.

588   Zhu and Wang On the basis of recent demand-​side research, we propose that strategies based on consumer heterogeneity in a large and dynamic market like China can result in competitive advantage even if the firm holds only obsolete or mundane resources. These advantages can be sustainable without resource-​or ability-​based barriers to imitation; successful innovations can be consumer driven rather than resource or technology driven. In the past 40 years of rapid economic growth and technological advancements, domestic demand has played a crucial role in the significant growth and transformation of the Chinese economy. The huge domestic market, rising consumption, diversified demand, and its dynamic changes allow companies to exploit the size and rich contexts of different market segments and thrive in their innovation activities. Most importantly, these very different market segments can be seen as test fields for global innovation, and companies can adjust the products and strategies for other markets based on their experience in China. In addition, this chapter contributes to a more granular understanding of the notion of FSAs in the emerging markets context. The traditional notion of FSAs mainly refers to technological advances and brands. However, EMNEs present a challenge for international business theory, as their FSAs do not conform to the standard analysis of ownership advantages that is applied to Western firms. Hence, in the absence of such advantages, the rise of Chinese enterprises on the global stage such as Huawei, Haier, and Tencent seems to contradict extant explanations for the existence of MNEs. Based on an extensive review of recent literature, we conclude that the FSAs of EMNEs have been identified as (1) the superior ability of EMNEs to operate in harsh institutional environments in other developing countries and (2) the greater capability to adapt products to the specific demands of import-​protected developing markets. We argue that these FSAs of EMNEs are more concerned with CSAs than ownership advantages. Unlike the FSAs of MNEs that are built around ownership advantages, FSAs of EMNEs are concerned with the ability of EMNEs not only in adapting to the different contexts but also in turning contextual factors into opportunities for developing unique advantages against MNEs. In summary, the nature of the Chinese market provides rich contexts for companies to innovate. Government intervention and technological capability building alone cannot explain the rise of the innovation capabilities of Chinese enterprises. These findings represent an important departure from a linear model toward integrated theories that could attend to both the demand and the producer side of the value creation equation. They indicate the promise of future demand-​side work for generating new knowledge useful to scholars and managers and, hence, are expected to have broader theoretical implications for demand-​ side research in innovation and international business theory.

Limitations of Existing Research and Future Research Directions With China’s rapid economic growth over 40 years, the market and demand characteristics have undergone radical changes. However, most previous studies have examined the effect of market demand on innovation from a policy angle; fewer studies have examined the dynamics of demand change from the consumer’s perspective and the new challenges to Chinese enterprises and policymakers. In addition, although technological learning has

Market Demand, Consumer Characteristics, and Innovation    589 been critical for the catch-​up of EMNEs, “learning from behind” is fundamentally different from “leading from the front.” The latter requires the pursuit of global dominance in the scientific and technological race. Moreover, most previous studies concerning EMNEs have grouped enterprises from emerging economies such as China, Brazil, and India into one homogeneous entity, neglecting their contextual differences, whereas existing research focusing specifically on Chinese enterprises tends to exaggerate or presume the uniqueness of the Chinese business environment and culture, lacking conceptual and theoretical depth and generalizability of the findings. This chapter represents a departure from such an approach and, thus, has implications for companies and policymakers not only in China, but also globally. For future research, more empirical studies in the Chinese context are required to understand (1) the effect of demand-​pull versus supply-​push strategies at the firm level and at the policy level and (2) the interaction between the firm level and policy level and its effect on innovation capability and performance of Chinese enterprises.

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Chapter 6.4

Chinese Firm s ’ Mov e to the Forefront i n Di g i ta l Technol o g i e s Jiang Yu and Yue Zhang Digital innovation can be defined as a product, process, or business model that is new, requires some significant changes on the part of adopters, and is embodied in or enabled by information technology (IT) (Fichman et al., 2014, 330). Product, process, and business model innovation are becoming intertwined. Some digitalized products can simultaneously function as core platforms, which further facilitate complementary/​peripheral component innovations on them (Yoo et al., 2010) and may give rise to new business models or a highly generative digital ecosystem. The digital innovation and the embeddedness of digital technologies in service innovation benefit from the huge demands of domestic internet users, the fast catching up of information technologies, and the wide-​range construction of information infrastructure both in the developed and developing worlds (Barrett et al., 2015; Spohrer and Maglio, 2010). Since joining the World Trade Organization (WTO) in 2001, China has grown into one of the world’s largest producers and consumers of IT and electronic equipment, including mobile phones, computers, and most consumer electronics. As a large, emerging market, China’s internet penetration and economy digitalization have also deeply impressed the world; moreover, China had the world’s largest population of internet users by 2009. During this period, China achieved the rapid growth of a hyperscale e-​infrastructure. In the past two decades, emerging digital technologies have brought many new products, processes, and business models, and some of them have experienced a particular boom in China, which has important implications for the rest of the world (Liebenau et al., 2019). The digital transformation enabled the diversified service innovation in China. The country has also established its super e-​commerce and mobile payment systems home and abroad, with hundreds of millions of people benefiting from these achievements in Chinese digital technology. As the globalization of production has changed the international division of labor in the form of technological developments and labor markets, China’s leading corporate strategists are thus seeking ways to move beyond the “global factory” model. Essentially,

594   Yu and Zhang China wants to minimize its dependence on foreign technologies and royalties and cultivate its own technology-​intensive industries and indigenous innovation capabilities. Most remarkably, as expressed in studies by, for example, Fu (2015) and Yip and McKern (2016), some leading Chinese companies are transiting from a state of primarily imitation to the pursuit of innovation. In the recent stage of their development, some Chinese companies have met global standards and, in several sectors, are at the forefront of their technological sphere. Now China has built its competences not only in telecommunication, consumer electronics, and PCs but also in some complex technology products like supercomputer systems. However, to encapsulate the present and future landscapes of digital innovation in China, we should acknowledge and clearly understand that some great challenges still need to be overcome in some “bottleneck” technologies for China to become a real digital powerhouse, for example, in the semiconductor and software sectors; only limited progress has been made. The information and communications technology (ICT) industry is a prominent example in which some leading Chinese firms have built their market competences both at home and abroad. To some extent, the rise of Chinese ICT firms is refreshing the landscape of the global ICT sector and changing China’s own position in the global production network. Therefore, we think that academia should embrace new analytical perspectives and research directions that adapt to the uniqueness of large emerging contexts like China, rather than just adapting the context to the perspectives already established in those mature and developed economies with which we are familiar. This chapter seeks to provide an overview of the past, present, and future of digital innovation in China and explore the dynamics of this impressive progress. The mechanism facilitating China’s strategic transition from survival and growth to innovation and market leadership will also be discussed and analyzed. Here we will explore the macroenvironmental factors like institutional and policy support, dynamic technological fields, and related industries and competition. The innovation strategies of China’s firms will also be investigated, such as technological capabilities, cooperation and alliance, dynamic competition, entry or exit strategy, and ecosystem building and governance. Figure 6.4.1 depicts our analytical framework. The rest of the chapter will be divided into four parts. First, several key sectoral developments will be discussed, and then the institution and policy systems will be explored, paying particular attention to the role of government. The innovation and development strategy at the firm level will be depicted here in detail. Finally, some potential

Technological and industrial changes

Innovation strategies of China’s firms Dynamics of China’s position in the global digital competition Institutional support and policy system

Figure 6.4.1  Analytical framework.

Chinese Firms’ Move to the Forefront in Digital Technologies    595 challenges and advice will be presented regarding future digital innovations, with potential future studies.

Development of Key Sectors Building Competence in the Telecommunications Sector: Mobile Miracle The telecommunications sector has become China’s flagship industry for its ability to catch up or leapfrog its way to success. Indeed, China’s mobile communication system earned worldwide attention as a result. China operated its first-​generation (1G) mobile service in 1987 based on the British-​ dominated standard Total Access Communications System (TACS). In 1993, the second-​ generation (2G) digital service, the global system for mobile communication (GSM, a Europe-​dominated standard), was first provided in the Zhejiang province, and was rolled out nationwide in the following years. Since July 2001, China has had the largest number of mobile subscribers in the world, reaching 206.6 million by 2002 (MIIT, 2003). During the period, the equipment market was still dominated by major foreign vendors—​Motorola, Ericsson, Nokia, and Siemens—​which controlled more than 90% of the GSM market (Zhu, 2000). At the beginning of the 2000s, after having followed the technological trajectory and standards of global technology giants from Europe and the United States, China faced the potential danger of settling for low-​level imitations of foreign technologies (Yu, 2007). Along with the development of their own wireless standards, many important institutional initiatives were taken and these strategies were rapidly implemented after China’s accession to the WTO in December 2001. As the latecomer to the mobile communication industry, China is determined to learn and to catch up, quickly, in the following generations of standards. With close collaboration between domestic vendors, institutions, and other stakeholders, China introduced its home-​grown standard, TD-​SCDMA (approved by the International Telecommunication Union [ITU] as one of the three 3G standards), to the ITU to fight for a say in the 3G network system. Meanwhile, the telecommunication and IT industry markets became more dynamic and competitive around the world. As a latecomer, the home-​grown TD-​SCDMA was lagging behind the other two international standards (WCDMA and CDMA2000) in terms of technological maturity and risked dropping further behind in an accelerated global competition. In 2002, with the support of the National Development and Reform Commission (NDRC), Ministry of Information and Industry Technology (MIIT), and Ministry of Science and Technology (MOST), the TD-​SCDMA Industry Alliance (TDIA) was formed to build competence and construct a relatively complete industrial chain for the TD-​SCDMA standard (Chen et al., 2014). In January 2006, the Chinese government approved TD-​SCDMA as the first national 3G technology standard for wireless communication in China. China pursued both path creation and path dependency strategies in

596   Yu and Zhang wireless standardization. In January 2009, China Mobile received a TD-​SCDMA license, China Unicom a WCDMA one, and China Telecom a CDMA2000 one. Thus, China finally entered the 3G era, joining the rest of the world. Some leading equipment vendors like Huawei, ZTE, and Datang Mobile have become the main beneficiaries of this multiple-​ path strategy. They have gradually built up their product development capabilities and are thus able to offer low-​cost turnkey solutions to quickly growing operators and to respond to the dynamic needs of the Chinese market. As we head into the 5G era, we can see an end-​to-​end ecosystem and an entirely mobile and fully interconnected world on the horizon. The evolution of 5G in China seems to be more open and internationalized. We can observe the policy shift toward “going-​out” strategy to reposition its role in the global industrial system. China continues to pursue its ambition to become a leader in the telecommunication sector and emerges as an important player in the international arena of digital standardization. Huawei, for example, as a technology follower, has now caught up and become one of the important 5G technology players in the global market. It established research and development (R&D) offices in the leading centers for telecommunication technologies in the United States (i.e., Dallas, Silicon Valley), Sweden, India, Russia, and so forth.

Significant Rise of China’s Smartphone Industry Mobile phones (mostly smartphones) have a greater reach than any other technology. More than half the world’s mobile subscribers live in Asia-​Pacific—​mostly in China and India—​and more than half of the global population are now mobile subscribers. In China, since 2013, Huawei, Xiaomi, Vivo, and Oppo have become the dominant firms in China’s smartphone market, and they are also aggressively expanding into foreign markets. In the past two years, three of China’s smartphone manufacturers—​Huawei, Xiaomi, and Oppo—​ were in the top five of the worldwide smartphone shipment market, along with Samsung and Apple (IDC, 2020). Huawei acquired 10% of the global smartphone shipment in 2017, approaching the position of Samsung and Apple (Emil, 2018). By heavily investing in R&D and building up a recognized brand, Huawei has evolved from a traditional supplier of telecommunications equipment to a leading supplier of middle-​and high-​end smartphones. With competencies in the network system market, Huawei has rapidly upgraded its technological capabilities. The successful launch of the Mate7 in 2014 was a great milestone. Huawei is using those handsets to pursue relatively young smartphone consumers at home and abroad. According to the IDC Worldwide Quarterly Mobile Phone Tracker (IDC, 2019), other Chinese smartphone suppliers, such as Xiaomi, Oppo, and Vivo, have also entered the global top 10 in terms of sales volume. Xiaomi released its first smartphone in August 2011 and expanded into developing a wider range of consumer electronics, including a growing smart home (Internet of Things [IoT]) device ecosystem. Founded in 2009, Vivo is becoming a design innovator, with such creations as the very first smartphone with a dedicated Hi-​Fi chip and a professional-​grade photography solution. Vivo has quickly expanded into markets in India and Southeast Asia. As of January 2016, the company employed 1,600 R&D personnel in its R&D centers.

Chinese Firms’ Move to the Forefront in Digital Technologies    597 Besides the innovation ecosystem of smartphone hardware, the application ecosystem based on the extension of smartphone application scenarios is being built by top Chinese companies (not only by smartphone producers but also by internet giants). The smartphone has become one of the most important IT devices and drivers to trigger the expansion and upgrading of information consumption (State Council, 2018). For example, Xiaomi has launched product lines in smartwatches, internet TVs, smart voice boxes, and other wearable devices. Therefore, the “ecological chain strategy” is exploring more new fields of the digital economy in China, such as mobile pay (mobile economy) and sharing bikes (sharing economy).

Knowledge-​Based Service Sectors: Software Advancement China’s software industry has experienced uneven development since the early 1990s. As one of the knowledge-​intensive sectors, the software industry in China undergone both the technology learning phase and the product upgrading phase during the past two decades, which, to a large extent, made full use of the advantage of backwardness (Lin, 2011). Driven by the government’s policies (e.g., “Scientific and Technology Innovation 2030” and related action plans about “Information Consumption”) as well as huge domestic demand, China’s software industry developed rapidly in recent years. The gap between Chinese companies and global leading firms in the industry has narrowed. However, there is still a long way to go for home-​ grown software firms to become leaders in global software markets. During the past decade, outsourcing became the main driving force for China’s software development, and cross-​border software development businesses expanded by a large proportion. Chinese companies quickly got involved in the IT outsourcing market due to its cost advantages. To a certain extent, such outsourcing helps Chinese software enterprises to comprehend the business experience within the Western value chain. Under such circumstances, the talent and investment of this industry are highly concentrated in the big cities of East China, which led to a high-​density cluster of the software industry as in Beijing, Shenzhen, and Shanghai.

Cutting-​Edge Innovation Efforts: Chip Value Chain The development of the integrated circuit (IC) has become the top strategic priority in China’s technology planning since the 1990s. China’s semiconductor industry has been committed to diminishing the gap with the international technological frontiers for the past 30 years. Initially, the basic IC manufacturing capacities were built from a diffusion of external technological knowledge derived from close partnerships with multinational corporations (MNCs), and they became gradually embedded within the local innovation system. In 1995, China launched “Project 909” in Shanghai, which was the milestone project for IC industrial development. In July 1997, HuaHong NEC Electronics, the state-​controlled joint venture with NEC (Japan), was established with a total investment of 10 billion RMB —​the largest government investment project in China’s electronics industry—​and it owned, until 2006, the first semiconductor fabrication plant (fab) capable of 0.35-​to 0.18-​micron chip manufacture (Hu, 2006).

598   Yu and Zhang In June 2000, the State Council promulgated Document 18, “Policies of Encouraging the Development of Software and Integrated Circuit Industries.”1 It was the first time that China had developed a national comprehensive strategy for its semiconductor industry. The young chip makers and design houses that had struggled to survive could then have access to more public support, including an additional tax exemption period, enterprise income tax rate reductions, and location subsidies from the areas in which they sited operations. All these measures then triggered the explosive growth of industrial volume (Wu and Loy, 2002). In April 2000, the Semiconductor Manufacturing International Corporation (SMIC), as the first modern pure foundry, was launched in Shanghai with a nearly $3 billion investment from the Shanghai government and several global firms, and China started to approach the mainstream of global chip competition. At the turn of the second millennium, domestic semiconductor design and packaging quickly prospered while more foreign upstream equipment and material firms were expanding China’s market to develop an increasingly globalized supply chain. At that point, the Chinese government underwent a big shift in semiconductor strategy (Zhou and Li, 2007). In 2008, the Mega National Key Programs, focused on catching up and development toward 2020, were announced and formally kicked off in March 2008, one of the critical part of the program was targeting high-​end generic chips and basic software, and the cutting-​edge processes and equipment for advanced processing (MOST, 2008). During the same period, the development of the domestic IC design industry mainly benefited from the return of Chinese talents from overseas with considerable expertise in their field. The number of China’s IC design firms approached 1,700 in 2018 (China Semiconductor Industry Association, 2018). For example, Spreadtrum Communications, founded by overseas returnees in April 2001, became a leading fabless semiconductor company that develops chipset platforms for smartphones and consumer electronics. Spreadtrum’s solutions combine its highly integrated, power-​ efficient chipsets with customizable software and reference designs in a complete turnkey platform. As the world’s third-​largest baseband chip vendor, Spreadtrum has built a globalized customer portfolio including Samsung, Lenovo, and Huawei, and has been one of the Samsung’s largest chip suppliers since 2015. Besides the independent IC design houses, some leading IT and electronics system firms in China, such as Huawei and Haier, have also established their own chipset design branches. These internal-​oriented design houses are good at creating the product designs for mobile communications and consumer appliances. HiSilicon, an IC design company established by Huawei in 2004, has conducted innovation in the global networking and ultra-​HD video technologies. Huawei’s new-​generation processor, the Kirin 970, powers successful handsets like the P20 and P20-​Pro, which were launched in March 2018. In addition to the significant performance enhancement, the Kirin brand aims to offer enhanced artificial intelligence (AI) features.

1 

For a more than 8 billion RMB capital investment in 0.25-​micron technology, the investor can enjoy the policy of lower value-​added tax—​from 17% down to 3%—​plus free income tax for the first two years and a 50% cut for the subsequent three years, as well as free customer tax for the import of raw material and equipment for the IC industry.

Chinese Firms’ Move to the Forefront in Digital Technologies    599 The implementation of the National Science and Technology Major Project increases the innovative strength of domestic equipment sectors and stimulates sustained future development for the chip sector. However, some technological bottlenecks continue to loom; for example, it is still difficult to make major breakthroughs in key equipment and materials production. To address this situation, the Chinese government published its National Guidelines for Development and Promotion of the IC Industry in 2014. The government also launched a special national IC investment fund of more than $20 billion in 2014. Meanwhile, according to “13th Five-​Year Plan on Scientific and Technological Innovation,” China promises to support the new National Mega Project on semiconductor toward 2030.

Cloud Computing and Internet Infrastructure Since Google put forward the concept “cloud computing” in 2006, it has grown into a giant and promising industry and shows a fast growth trend. Global public cloud service market has reached US$233 billion and the grow by 26% compare with 2018 (IDC, 2020b). Globally, 3A (short for AWS, Azure, and Alibaba Cloud) ranks as the top three cloud service providers (Garter, 2018), and in China, Alibaba Cloud leads the domestic cloud services, followed by China Telecom and Tencent Cloud. The cloud computing business in China is still in its primary phase but has maintained rapid growth compared with the global market. Early in 2009, Alibaba established the first electronic business cloud computing center. In October 2010, MIIT and NDRC released their “Nationwide Pilot Demonstration Program for Cloud Computing” to conduct trial cloud computing service in five cities: Beijing, Shanghai, Shenzhen, Hangzhou, and Wuxi (Yu et al., 2016). The cloud service pilot triggered a sizeable expansion of the internet infrastructure and internet data centers (IDCs). Meanwhile, local governments have increased the investment in cloud data centers, which may play a key role in future economic upgrading and industrial transformation. The State Council published three policy documents in 2015, which were closely related to cloud computing. Two years later, MIIT released the “Three-​Year Plan for Cloud Computing Development (2017–​2019),” which proposed the specific aim of developing the cloud computing industry in China. With strong support of the national policy, a large amount of investment contributed to China’s cloud computing market. In 2017 alone, the total amount of financing of the 20 cloud service providers in China was about 9.37 billion RMB. Meanwhile, emerging local IT equipment companies, such as Inspur and Lenovo, are continuously winning contracts on the server, storage, and networking systems operating in China’s infrastructure market as they offer technologically advanced products and have the flexibility to meet the demands of these internet giants and the fast-​growing cloud service providers.

A Promising AI Landscape Since 2014, Chinese high-​tech companies have had insight into the bright prospects in emerging AI. From facial recognition to autonomous cars, China has quickly become one

600   Yu and Zhang of the global hubs of AI development since its vast population and diverse industry foundation generate huge volumes of data with enormous applicational potential. China’s government has attached great importance to AI development. In 2015, the “ ‘Internet Plus’ AI Three-​year (2015–​2018) Action Plan” for 11 key AI-​related industries was announced. In 2017, the major program of “Scientific and Technological Innovation 2030” launched the project “AI 2.0.”(MOST, 2017) In July 2017, the State Council issued “The Next Generation Artificial Intelligence Development Plan,” which set forth initiatives and goals for R&D, industrialization, talent development, education and skills acquisition, standard setting and regulations, ethical norms, and security for the entire AI industry (State Council, 2017). To date, this is the most comprehensive of all of China’s AI plans, which clearly manifests China’s ambitions of becoming a world AI leader by 2030. It is best understood as a three-​step plan, where the first step is to make China’s AI industry “in line” with competitors by 2020, the second step is to reach “world leading” capabilities in some fields by 2025, and the third step is to become the “primary” AI innovation center by 2030. According to the AI plans mentioned earlier, by 2030, China is aiming to cultivate an AI industry worth 1 trillion RMB, with related industries worth 10 trillion RMB. The plan also lays out the government’s decision to attract the world’s best AI talents, strengthen the AI labor force training, and lead the world in laws, regulations, and ethical norms that promote the development of AI. The latter includes the intent to actively participate in and lead the global governance of AI. At the application level, China is approaching other Western countries in terms of algorithm development, especially in voice recognition and targeted advertising. Aided by huge volumes of user data and newly designed product lines, some of China’s internet giants (Baidu, Alibaba, and Tencent) are aggressively exploring the cutting-​edge technologies, such as image and voice recognition. For example, Baidu Brain is developing a platform for third-​party AI applications. Baidu also has heavily invested in the development of autonomous vehicles. In addition, with many experts in scientific research and the industry publishing academic papers and submitting patent applications at the forefront of the technology, China’s AI development is well placed in the catch-​up race. Among the innovative achievements of science and technology projects in the field of AI in China, the main high and new technologies involved are opto-​mechatronics, electronic information, and software. Related technologies are mostly applied in manufacturing, wholesale and retail, scientific research, technology services, information transmission, computer services, and software industries. Initiatives to promote the transition from R&D achievements to industrial applications have been made in terms of technical services, cooperative R&D, transfer of property rights, and capital investment. Large amounts of promising vertical application contexts also create incentives for the local prosperity of technology entrepreneurship, which is strongly encouraged by the government. Thanks to global open-​source platforms, most Chinese companies are able to quickly adopt the most advanced algorithms in the world. More AI startups are focusing on developing machine learning applications and associated business models. Some Chinese startups are even winning prestigious global competitions in AI technology, such as HIK Vision at ImageNet. However, China’s quick push into AI still faces a huge gap between its vast and increasing data pool and its capacity for data analysis and effective data governance. As a result, the main Chinese AI companies still need to be powered by foreign algorithms and basic chips, which are mostly designed by US firms.

Chinese Firms’ Move to the Forefront in Digital Technologies    601

Firm-​L evel Players and Strategies Emerging Giants in China’s Digital Economy Benefiting from the large population size, China is now home to the world’s largest volume of internet users and has rapidly become one of the most significant markets of the digital economy. China already owns several world-​scale telecommunication operators including China Telecom, Chine Unicom, and China Mobile. Take China Mobile as an example: in 2006, China Mobile became the world’s largest mobile operator with the largest mobile subscriber base. The Financial Times ranked it fifth in a list of the world’s most valuable brands in 2007. In the 4G era and beyond, China Mobile continues to be one of the largest telecom operators by market capitalization and had a total subscriber base of over 925 million as of 2018 (Statista, 2020). In addition to having three giant network operators, China has also witnessed the rise of hyperscale internet giants in the past decade. Among the top 10 internet companies worldwide in 2017, four emerged from China, namely Alibaba, Tencent, Baidu, and JD.com. These Chinese internet giants follow unique paths and business models that cater to growing consumer needs, the cultural tradition of China, and the demands of national development, while triggering the great wealth of the digital market in China. Large numbers of users from these leading companies generate massive data which could support the further development of digital economy by adopting the technologies like AI, big data, and cloud computing. The core businesses of BAT are distinct: Baidu is for searching, Tencent is for video games and Instant Messaging, and Alibaba is for e-​commerce. Alibaba was first developed from business-​to-​business (B2B) services of small and medium-​sized enterprises (SMEs), and then extended to business-​to-​consumer (B2C) by Taobao and Alipay. Nowadays, Alibaba, as a big e-​commerce company in China, owns the most valuable business data. As a search engine provider, Baidu presents a new picture of the emerging technologies. The deep learning algorithms, data models, and massive graphics processing unit–​parallel computing techniques are integrated through Baidu Brain. In 2017, Baidu revealed its “Apollo Project” to provide an open, reliable, and complete software platform for partners in the automotive and autonomous driving industry to develop their own autonomous driving systems. Tencent has a vast social media data pool and is good at launching products. Currently, Tencent is trying to integrate the backend data from WeChat, Qzone, and games products and establish a stable ecosystem serving 1 billion online users. Competent ecosystem building and effective governance may be the key dynamics for these Chinese internet giants to achieve sustainable development in the future. China’s mobile payment system has experienced exponential growth since 2012, which is considered as another miracle (Fan et al., 2018) because it is rare for a mobile payment platform to greatly change an existing financial and payment system that covers almost half the population and even change the social lifestyle of this largest emerging country. In the network hardware market, Huawei is a typical company that has built technological competence in the face of fierce global competition. It became the world’s most prolific applicant for international patents in 2017, with 4,024 patents (WIPO, 2018). The explosion

602   Yu and Zhang in the number of patented assets Huawei owns stands as an indicator of the competitiveness of high-​technology firms in international trade and of competition strategies to target particular markets both at home and abroad. During the last decade, it has adopted a preemptive approach to participate in the global intellectual property rights regime by owning more positions in global standardization organizations. Huawei also launched Global Services, which provides many global telecom operators with strong consulting and engineering services to improve operational efficiencies. Even though the globalization process of Chinese technology giants is facing great challenges against the backdrop of an ongoing trade dispute between two economic powers, China and the United States, Chinese corporations continue to focus on the well-​grounded accumulation of their capacities and cost competences for the global markets.

IT MNEs and the Embedding Process in China In spite of China’s fast-​growing role as the world’s electronics manufacturing and export powerhouse, the country is mainly positioned as a final assembly platform for foreign transnational corporations. Most IT MNCs have invested heavily in their Chinese operations over the years, but many are still operating below their potential, especially in functions beyond sales and marketing. Research on the MNCs’ embeddedness in emerging countries largely examines the relationship between MNCs and the host country. Some scholars have tried to explore the drivers for MNCs’ embeddedness in the large emerging countries (Corredoira and McDermott, 2014; Yaprak and Karademir, 2011). Luiz and Stephan (2012) find that the main reasons for MNCs to undertake foreign direct investment (FDI) in emerging countries are to pursue market and profit growth due to saturation in their existing markets and for risk diversification. By the 1990s, most of the leading global telecommunication equipment vendors had established joint ventures in China (Tan, 2002). To retain a competitive advantage in the world’s largest potential market, the MNCs may choose a proactive or reactive strategy to establish themselves in local businesses systems. The proactive strategies are related to strong initial commitments. Firms may become inflexible and forgo the possibility of being able to adjust decisions in response to new information in the future, and may suffer significant losses if the environment becomes hostile (Li and Li, 2010). On the other hand, reactive strategies provide the parties involved with the flexibility to increase commitments or to control losses according to the volatility and uncertainty in the business environment (Dixit and Pindyck, 1994; Trigeorgis, 1996). More MNCs hope to leverage the Chinese manufacturing capacities and design/​development talent to gain advantages both in China and globally. Here we draw on Sako and Zylberberg’s (2017) theoretical framework of firm-​ specific upgrading in value chains. The domestic suppliers entering global value chains (GVCs) can reshape governance mechanisms over time, shift the distribution of power in the value chain, and directly appropriate the gains from the upgrading. In this respect, vertical integration into GVCs has been associated with capacity building of local suppliers in the emerging countries through knowledge transfer from more experienced MNCs. As illustrated by China’s mobile telecommunication sector, the MNCs need to devise dynamic, multiperiod network strategies to coevolve with the local market by embedding themselves in the business and system of standardization and industrial development.

Chinese Firms’ Move to the Forefront in Digital Technologies    603 Specifically, MNCs can embed themselves in business systems through the formation of joint ventures and strategic alliances with local players to build close connections. On the other hand, relationships between foreign and domestic firms are a two-​way process, meaning that Chinese firms cooperate with MNCs to develop the core software and chipset products, while the MNCs work with local partners to leverage preferential policies and local knowledge and to gain more legitimacy in China’s market (Yu et al., 2014).

Institution and Policy Systems Institutional Support to Link Technology with Market Development Many researchers have recognized the impact of institutional forces on large emerging economies, and the role of institutions in these economies is to reduce environmental uncertainty by facilitating the interactions among exchange partners (Hoskisson et al., 2000). Institutional changes provide the incentives for adaptive learning and intellectual property development, encourage more innovative activities, and stimulate improvements in enterprises (Jefferson et al., 1994; Vargo et al., 2015). In the high-​tech sectors like emerging IT, China still adopts a predominantly top-​down approach to the governance paradigm, including conducting national strategies, development plans, R&D programs, and major industrial projects. All these policies and incentives can bring the related firms, research institutes, and universities together to work on key technologies and industrial development. The institution-​based view of competitive strategy can also explain the choice of strategic partnerships between domestic firms and foreign MNCs arising from the intertwined institutional and market considerations. China’s government has for a long time considered the high level of dependence on Western countries for core technologies and software as a potential security concern, and a more localized and independent supply chain may be encouraged. To promote the application of digital technology and gain better economic and social benefits, the central government is working on a draft of a digital economic strategy, while at least 10 city and provincial governments have published theirs. In May 2016, the Chinese central government released the “Outline of the National Strategy of Innovation-​Driven Development,” creating a roadmap for the new technological innovation regime that aims to turn China into a technological powerhouse in the future (State Council, 2016). In the past decade, cloud computing, e-​government, smart healthcare, and intelligent manufacturing have been taken into top-​down economic and innovation policy systems. To accelerate the indigenous innovation of core IT technologies, China’s strategy calls for the development of capabilities and governance capacity, along with the development of a domestic technological base for key hardware and software products, which is considered a cornerstone for the progression to a sustainable industry. For example, the development of the supercomputer system follows a typical mission-​oriented path. The Chinese government, at the national and local levels, realizes the value of high-​performance computers and

604   Yu and Zhang supercomputers in increasing innovation and advancing science and economic growth. The government therefore continues to invest heavily in the research of systems with higher speed and the further cultivation of application ecosystems. For years, China has claimed the top spot in a list of the world’s 500 fastest supercomputers, and it dominated the list in 2017 by holding 202 of the 500 places, pushing the United States into second place (Top 500, 2017). As there has been such a rapid expansion in China’s supercomputers, in terms of both quality and quantity, the scope of computing applications has moved far beyond the macro projects in the domains of energy, climate, or scientific research.

Improving Talent and Education System To facilitate the development of a knowledge-​based economy and society, an innovative talent pool is the key strategic asset to reap the long-​term benefits. However, China’s demographic dividend is decreasing and the development of digital technologies is being confronted with a structural discrepancy between the urgent demand for skilled, innovative talent and the potential for AI as a workforce substitute. The supply of technical, experienced, and innovative labor is far from adequate in meeting the demand in the existing human resource market. To address China’s talent gap in the IT and digital innovation fields, the government actively invests in IT-​related education and research programs, reorients the traditional education system with greater focus on innovation and digital skills, and devises an immigration policy to promote talent mobility and international cooperation, with the aim of attracting the best talents from around the world. The industry also has significant incentives to accelerate the creation of an IT workforce and carry out the plans for selection and cultivation of digitally leading, new-​generation, and specialized talents. Meanwhile, China is also trying to reform its education system by integrating joint efforts of many parties, especially from academia and industry circles. In February 2018, Westlake University opened its doors with the aim of providing top-​level talent for China by cultivating a better academic environment and attracting professors’ contributions from both home and abroad, and it functions as the convergence center of resources from the government, industries, and the wider society.

“Internet Plus”: An Efficient Engine That Boosts New Economy? In 2015, China decided to promote the “Internet Plus” action plan to integrate ICT (such as 5G, cloud computing, big data, and the IoT) and internet platforms with traditional industries and real economies (State Council, 2015). By applying the achievements of internet innovation to the broader economy and social fields, China can further enhance creativity and productivity and facilitate a broader form of economic development based on the internet infrastructure. At the government level, either central or local governments, related action plans have been launched to promote the embeddedness of digital technology and the internet into more social activities, such as public governance, social interaction,

Chinese Firms’ Move to the Forefront in Digital Technologies    605 poverty relief, and classroom education. From the government to the individual level, from education to social discourse, and from scientific and technological research to entrepreneurship, “Internet Plus” became one of the most important guiding principles for governing the business and society development of China. However, it is noteworthy that the “Internet Plus” era is also faced with challenges. One of the most salient challenges lies in the way in which the internet and traditional industries should be effectively integrated. A  simple combination of internet technologies and traditional industries can’t yield the desired outcomes. It may require a change in ways of thinking and, most importantly, drivers to facilitate cross-​sector innovation and entrepreneurship to make joint contributions. “Internet Plus” could act as an efficient engine to facilitate the upgrading and development as long as it is being operated in the right place and in the right way.

Future Trajectory towards Global Competition With the new global waves of mobile internet, especially in the booming Chinese market, both global and domestic brands are actively seeking collaboration with new competent suppliers. The embeddedness and integration of digital technologies in companies’ operations enables the SMEs, local giants, and MNCs to exchange resources in a more efficient way, such as an open innovation platform or crowdsource innovation platform (Majchrzak and Malhotra, 2013). To face global competition and cultivate competitive advantages, local SMEs aim at high-​value-​added and niche fields in the global market, especially for technology-​intensive and high-​tech SMEs. Apparently, open innovation and value chain integration are more important for success on a global scale. Recently, more telecommunication technology alliances have been established including the network operators, service providers, content providers, and other players from the global ecosystem. Mergers and acquisitions become an important vehicle for leading home-​grown brands to break through their strategic limits. Chinese firms have been buying more high-​tech companies, and Lenovo is a typical case. Lenovo attracted international attention through the purchase of IBM’s PC division and the ThinkPad brand in 2005. Lenovo benefited in three ways from the IBM acquisitions, with the ThinkPad brand, advanced PC manufacturing technology, and IBM’s global resources, such as its global sales channels and operations teams. In 2014, Lenovo also acquired Motorola Mobility from Google to enhance its competencies in the global smartphone market. With the deepening of economic globalization, local brands are facing fiercer market competition home and abroad. Being the main source of or channel for international trade, FDI, and technology transformation, MNCs are more likely to build a worldwide innovation ecosystem (Malecki, 2011). To cope with global competition and challenges in the era of the digital economy, some of China’s companies are accumulating technological advantages through increasing R&D investment (Huawei invests more than 10% of sales revenue in R&D each year) and joining or building global innovation ecosystems. To maintain the competitive edge, many companies—​such as Lenovo—​acquire part or all of other foreign companies to expand overseas markets and also acquire related patent portfolios.

606   Yu and Zhang China’s leading companies are paying more attention to overseas intellectual property strategy, which will be one of the most important competitive strategies in the future. Overseas departments of intellectual property and R&D based on digital governance platforms provide institutional guarantees to gain access to the international technological market, bring value chain players together, and integrate innovative resources (Orsi and Coriat, 2006). Besides technological capabilities, service-​dominant logic (Lusch and Vargo, 2006) and customer demand orientation are of equal importance to adapt to global competition, which prompts cooperative innovation with customers and renders the value chain more dynamic, and the business and innovation ecosystem more diversified. At the government level, some policies have already issued incentives and protection policies to support the internationalization of China’s companies. The degree of the marketization of companies is growing while innovation systems for global competition at the industrial and national levels are still at an early stage, which may require governments’ top-​down support and companies’ bottom-​up efforts.

Conclusion: Potential Challenges and Possible Actions in the Future With steadfast ambition to seize high-​end IT development, China is continuously increasing investment in the related fields to show its growth mindset in pushing forward the global technology frontier. After decades of investment, China has achieved breakthroughs and unceasingly narrowed the gap with developed countries especially in the fields of high-​ performance computers, quantum communications, and 5G mobile. Some Chinese companies have attained global standards and are even at the leading edge of technology development in several sectors. Undoubtedly, there are still more potential digital technology and emerging industry fields for China to explore. China needs to make more of an effort to attain a notable shift in the landscape of the global information industry and other high-​tech sectors as well. During this process, some key challenges remain to be solved as the digital industry in China is developed. The first challenge is to overcome the bottleneck of some core technologies. How to accelerate the breakthrough of key technologies remains a tough and inevitable task in China’s digital innovation. Exploring the core technology layout will be one of the most important ways to drive sustainable development of digital innovation in the largest market. The second challenge is to achieve the synergy of technology, market, and institution in digital innovation. Domestic IT core technology development is encouraged through industry consortia as a substitute for global knowledge sourcing. However, effective interaction between leading IT firms and the domestic technology market is still very weak, in spite of the government’s efforts to facilitate integration and cooperation among the leading universities, research institutes, and domestic industries. The fundamental way to achieve this synergy is to build an open and dynamic national innovation system, driven by bilateral endeavors from top-​down and bottom-​up interactions between governments and companies.

Chinese Firms’ Move to the Forefront in Digital Technologies    607 The third challenge is to keep open amid fierce global competition. China’s indigenous innovation is facing new challenges, and its relations with foreign IT firms may become more volatile. Being more familiar with foreign business rules, navigating within the context of global competition, and trying to dominate some strategic industries by developing worldwide technology standards will be necessary for China’s emerging MNCs’ success. The fourth challenge is to upgrade public policy systems. The government needs to reposition its role in providing a more effective and supportive platform for leading research and the industrialization of emerging scientific and technological achievements, to increase its supply of R&D resources, and to stimulate the demand for cutting-​edge science and technology. High-​end think tanks and consultants to promote digitalization are also needed. Besides effective intellectual property protection policies, strategies to promote regional industry clusters and the commercialization of technological achievements in emerging digital fields will be equally important. Last but not least, apart from the economic problems, some deeper social concerns and challenges including protection of privacy and information security, related regulation, and ethical issues may also rise, which warrant further attention alongside the dynamic IT technological trends in the coming digital era.

Acknowledgment This work was supported by the National Natural Science Foundation of China (No. 71834006); Ministry of Education Key Projects of Philosophy and Social Sciences Research (Grant numbers: 20JZD022).

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Chapter 6.5

China’s Fi na nc ia l Innovat i on Process, Drive, and Impacts Liqing Zhang Financial innovation is part of the story of the build-​up of China’s modern financial sector over the past 40 years. Since 1978, the most important driving force of this build-​up has been the strong demand for modern financial services by governments, corporations, and individuals, and this demand has been growing due to China’s rapid economic growth and transition from a planned economy to a market-​oriented economy. Meanwhile, the delay in liberalization of the interest rate and removal of de facto control on credit allocation, as well as the extensive application of internet and other advanced information technology, have played important roles in triggering various financial innovation activities. It is important to note that China’s financial innovation has exerted a profound impact on economic development and social progress.

The Process of China’s Financial Innovation China’s financial innovation over the past 40  years has involved the establishment and transformation of various financial institutions, the deepening and expanding of financial markets, the development and exploitation of financial products, and modernization of financial regulatory regimes. In the early 1980s, as one of the most important institutional innovations after the economic reform and opening up, the People’s Bank of China was transformed into a modern central bank from an institution mainly engaged in corporate loans to Chinese state-​owned enterprises. Meanwhile, China Industrial and Commercial Bank was established to handle all of the business originally provided by the People’s Bank of China, which now has become the largest commercial bank in the world. After decades of evolution, a financial institutional system consisting of the People’s Bank of China as the central bank, state-​owned

China's Financial Innovation    611 commercial banks as the main body, and national joint-​stock commercial banks, policy banks, urban and rural commercial banks, and nonbank financial institutions as important parts has been formed. In the early 1990s, with the establishment of the stock exchanges in Shanghai and Shenzhen, China’s financial market started to develop. After nearly three decades, a modern financial market system, including a money market, bond market, stock market, foreign exchange market, and insurance market, was gradually formed. Almost in the same period, the establishment of the China Banking Regulatory Commission (CBRC), the China Securities Regulatory Commission (CSRC), and the China Insurance Regulatory Commission (CIRC) marked the formation of a modern financial supervision system. There is no doubt that the establishment of institutions, markets, and regulatory bodies has provided important conditions for the development and innovation of various financial products. As the emerging market economy transformed from a planned economy, China’s financial innovation is not a fully new process. It includes many conventional practices that developed countries have accumulated for decades or even centuries. However, China certainly has developed many of its own practices. The following will introduce these financial innovation activities based on China’s own characteristics.

The Reform of State-​Owned Commercial Banks The innovative practice of reforming state-​owned commercial banks started at the beginning of this century, and it played a significant role in the process of China’s financial reform. After the Asian financial crisis in 1998, the nonperforming loan ratio of China’s state-​owned commercial banks rose rapidly, and it is widely seen as technically bankrupt. In December 2003, using part of the official foreign exchange reserves, the State Council set up Central Huijin Investment Ltd., a national holding company, for injecting capital into key state-​owned financial institutions and authorized it to act as the representative of national investment. Through financial restructuring, shareholding reform, introduction of strategic investors, and overall listing at home and abroad, five state-​owned commercial banks, including the Industrial and Commercial Bank of China (ICBC), Agricultural Bank of China (ABC), Bank of China (BOC), China Construction Bank (CCB), and Bank of Communications (BCM), have successfully completed the transformation. Financial restructuring involves stripping away nonperforming assets and injecting new capital. To divest nonperforming assets, the Chinese government set up four state-​owned asset management companies to undertake and dispose of them. In terms of new capital injection, Central Huijin used foreign exchange reserves and set up a joint management account, from which the Ministry of Finance uses the taxes and dividends from the restructuring banks as capital input. In the shareholding system reform, Central Huijin selects directors through market-​oriented ways and then sends them to the state-​owned banks to do their jobs as representatives of state-​owned investors. In addition, regulators require the banks to bring in foreign strategic investors to prepare for overseas listings while maintaining the state’s absolute holdings. After completion of the shareholding system reform, all state-​owned commercial banks had achieved the overall listing at home and abroad, and this not only introduced the incentive and restraint mechanism of the capital market but also led to new equity financing channels being acquired.

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Development Financing Development financing refers to the medium and long-​term financing provided by a country or country consortium for specific demanders through the establishment of financial institutions with national credit. As the main development financing institutions, China Development Bank (CDB) and the Export-​Import Bank of China have tried a lot of innovative practices in operation. For example, CDB has formed the mechanism of “initiated by government –​incubated by development finance –​ended by market operation.” This mechanism is widely used to finance urban construction projects. According to Chen (2010), by establishing a unified financing platform for local governments, CDB has played an active role in improving the management level of government loans, preventing urban construction loan risks, and controlling financial risks. However, due to the rapid development and some institutional problems, the local government financing system still faces huge repayment risks.

Green Finance China’s innovation in green finance is also outstanding. In recent years, China has been leading the world in product innovation in green credit, green securities, and green insurance. Based on the data released by China Banking and Insurance Regulatory Commission, at the end of June 2017, China’s green credit balance accounted for 8.82% of the total credit balance. In 2017, China successfully ranked among the top three green bond issuers in the world, issuing over 250 billion RMB of green bonds in China and abroad. By the end of 2017, there were 19 green environmental protection indexes compiled by China Securities Index Company, accounting for 2% of the total number of A-​share market indexes. In terms of green insurance, nearly 30 provinces (regions and cities) had launched trials of environmental pollution liability insurance by 2016. Over 45,000 enterprises have been insured for environmental pollution liability insurance, and over 100 billion RMB of risk margin has been provided by insurance companies.

Rural Finance Since the reform and opening up, in order to achieve industrialization and urbanization as quickly as possible, China has concentrated limited resources in cities, which to some extent has caused a shortage of rural public financial resources. On the other hand, due to strict regulation of loan interest rates in rural areas for decades, high credit risks and operating costs cannot be reasonably compensated. Thus, the operating losses and nonperforming loans of rural financial institutions are serious, and the ability to serve the rural market is seriously inadequate (Xu and Cheng, 2004). To ease the lack of rural financial services, China has set up new types of rural financial institutions, such as microcredit companies and rural banks. Microcredit companies do not accept deposits from the public; are funded by capital base, by donations, or by no more than two banking financial institutions; and are subject to strict regulations on

China's Financial Innovation    613 leverage ratios. Based on a report released by People’s Bank of China, by the end of June 2018, there were 8,394 microcredit companies nationwide with a loan balance of 976.3 billion RMB. After the rise of internet finance, some microcredit companies made loans on the internet and transferred the loan assets out of the balance sheet through Asset-​ Backed Securities (ABS), bypassing the restriction of operating areas and leverage ratios in a disguised way. The rural bank is a financial institution established in rural areas to provide financial services for local farmers, in order to promote agriculture and rural economic development. Rural banks can accept deposits from the public, but they can’t run business (including accepting deposits and providing loans) across counties. By the end of 2017, there were 1,601 rural banks in China, according to the China Banking and Insurance Regulatory Commission.

Internet Finance Internet finance refers to financial services delivered via the internet. Compared with other fields, China’s innovative development in internet finance is the most remarkable in the world. Mobile payments across the country may be one of the most successful innovations. A research report shows that domestic commercial banks handled over 37.5 billion mobile payment transactions worth over 202 trillion RMB in 2017, up 46.06% and 28.80% year on year, respectively. Over the same period, third-​party payment institutions (i.e., nonbank payment institutions) handled over 239 billion mobile payment transactions worth over 105 trillion RMB, an increase of 146.53% and 106.06%, respectively, from the previous year (China Payment Industry Association, 2018). It is worth noting the rapid rise of third-​party payment institutions in online payment. In 2017, the amount of internet payments and mobile payments of third-​party payment institutions represented by Alipay and Tenpay accounted for 26.9% and 73.1% of the total online payment business, respectively. The emergence of third-​party payment institutions offered many advantages, including its guarantee role in e-​commerce, integration effect on various bank payments, low transaction cost, and wide applications. The combination of mobile payments and money market funds is also a major innovation in the field of internet finance. In 2013, Alipay, China’s largest third-​party payment company, launched Yu Ebao in cooperation with Tianhong Money Market Fund. Users’ idle funds in Alipay can be invested in money market funds, which can earn more than the current deposit rate, and can be easily redeemed when there is demand for shopping. As soon as the Yu Ebao model emerged, it was widely followed. According to Rong 360 Big Data, as of July 2017, there were 70 similar products, linking 97 money market funds, with a total scale of 2.17 trillion RMB, accounting for 42.3% of the total amount of money market funds. There are also many innovative developments in other areas of internet finance. According to a report by China Internet Finance Association, the cumulative amount of peer-​to-​peer (P2P) loans in 2016 reached 1,997.5 billion RMB, an increase of 103.3% year on year. During the same period, internet insurance revenue totaled 234.8 billion RMB, up 5.2% from a year earlier (China Internet Finance Association, 2017).

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Shadow Banking After 2010, due to the changes in the macroeconomic environment and increasingly stringent financial regulations, the investment demand of local governments, real estate companies, other enterprises, and residents was increasingly difficult to meet from the traditional banking channels. As a result, the shadow banking system, whose main motivation is to avoid regulation, has developed. According to the research of Sun and Jia (2015), China’s shadow banking system can be divided into two categories. First, to avoid supervision, banks use nonstandard accounting to keep accounts and provide credit for enterprises in the form of investment assets or off-​balance-​sheet business. In particular, banks use their own funds, wealth management funds, or interbank funds through trust companies, bridge enterprises and banks, securities companies, fund subsidiaries, insurance asset management companies, financial leasing companies, third-​party trading platforms, local financial asset exchanges, and internet financial asset trading platforms, supplemented by commitment letters, guarantee letters, repurchase agreements, drawer agreements, and other explicit or implicit contracts. Financial instruments such as credit, bills, trust loans, private placement bonds, letters of credit, accounts receivable, various beneficial rights, private fundraising debt, and equity financing with repurchase terms are used to invest funds in industries or enterprises whose normal financing is restricted. Second, nonbank financial institutions transfer idle funds and provide credit for enterprises through trust companies, securities companies, fund companies, bonding companies, microcredit companies, and P2P online loan platforms. In short, China’s shadow banking system is actually a nonstandard fixed income securities market or quasi-​bond market, which is quite different from the shadow banking system of the United States, which is highly securitized and derivative. The role of wealth management products in the shadow banking system deserves special attention. While enjoying the guarantee of financial institutions, wealth management products are invested in nonstandard debt assets in large proportions. As the capital source of financial products usually has short-​term characteristics while their capital utilization has long-​term characteristics, the maturity mismatch is relatively serious. This makes a lot of wealth management products have a huge maturity payment risk. There are different estimates of the size of the shadow banking system in China. It is generally believed that in the total scale of social financing, entrusted loans, trust loans, and undiscounted bank acceptance bills roughly reflect the scale of China’s shadow banking system. Based on the data released by People’s Bank of China, as of June 2018, the total amount of social financing was 183 trillion RMB, and entrusted loans, trust loans, and undiscounted bank acceptance bills totaled 25.7 trillion RMB, accounting for about 14% of the total amount of social financing.

Financial Openness and RMB Internationalization Since the beginning of this century, China has gradually promoted financial opening and RMB internationalization. Around 2003, the qualified foreign institutional investor (QFII) and qualified domestic institutional investor (QDII) systems were established to

China's Financial Innovation    615 implement limited financial opening to the outside world. After 2010, the RMB Qualified Foreign Institutional Investors (RQFII) system, which applies to foreign holders of RMB, was introduced, allowing them to invest their RMB holdings in China’s domestic securities market within an approved quota. In addition, in 2014 and 2016, Shanghai-​Hong Kong Stock Connect and Shenzhen-​Hong Kong Stock Connect were launched successively to achieve connectivity in the stock markets of Shanghai, Shenzhen, and Hong Kong, allowing mainland residents to buy shares of Hong Kong–​listed companies within a certain limit and scope. In August 2015, to adapt to financial opening, the People’s Bank of China carried out market-​oriented reform on the formation mechanism of the central parity of the RMB exchange rate. The sharp fluctuations in the RMB exchange rate over the next year or so led authorities to introduce the “countercyclical factor” aimed at eliminating excessive volatility caused by irrational shocks. As an important part of the RMB internationalization, China introduced the “panda bond” issuance in 2005, which allows international multilateral financial institutions to issue RMB bonds in China. In addition, in March 2015, the RMB Cross-​Border Interbank Payment System (CIPS) was established to provide clearing and settlement services for participants in cross-​border RMB payments and trade. In October 2016, with the direct promotion of the Chinese government, the RMB was successfully included in the International Monetary Fund’s (IMF) special drawing rights (SDR) currency basket, thus enhancing the international status of RMB. As the capital account has not been fully opened, the internationalization of RMB first achieved rapid development through the offshore market to some extent. The data released by Hong Kong Monetary Authority show that, by the end of 2014, RMB deposits in the Hong Kong banking sector had reached more than 1 trillion RMB, which later fell sharply due to the devaluation of RMB and strengthening of capital control. Over the same period, the offshore RMB market in Singapore, London, and Taipei has experienced similar fluctuations.

Utilization of Foreign Exchange Reserves After joining the World Trade Organization, China’s foreign exchange reserves grew rapidly as the “twin surplus” of current account and financial account continued to expand. In September 2007, the government decided to set up the China Investment Corporation (CIC), a sovereign wealth fund, to improve the efficiency of foreign exchange reserve investment. The Ministry of Finance issued 1.55 trillion RMB of special Treasury bonds to buy about US$200 billion foreign exchange assets from the People’s Bank of China, including nearly US$90 billion for the People’s Bank of China’s stake in Central Huijin, as a capital base for the CIC. Since its establishment, the CIC has diversified its investments in equities, bonds, hedge funds, private equities, real estate, and direct investment projects around the world. At the end of 2017, its total assets exceeded US$941.4 billion, and its annual return on overseas investment was 5.94% (China Investment Corporation, 2017). To expand the application scope of foreign exchange reserves, the State Administration of Foreign Exchange (SAFE) has established SAFE Co-​Financing, which provides foreign

616   Zhang exchange funds to enterprises through CDB and other development financial institutions in the form of entrusted loans. In addition, new international financial institutions such as the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB) have been set up to participate in infrastructure and energy development projects in Asia and other countries along the “Belt and Road” initiative route.

Monetary Policy Instrument The central bank bill is one of the sterilization monetary policy instruments issued by the People’s Bank of China to the members of the interbank bond market to regulate the base money. Its emergence is related to the continuous expansion of the “twin surplus” of current accounts and financial accounts after 2002. Faced with the pressure of RMB appreciation brought about by the twin surplus, the monetary authorities conducted a large-​scale market intervention, which resulted in a massive flood of base money. To offset the impact of foreign exchange intervention on currency stability, the monetary authorities decided to carry out sterilization operations. The government debt market cannot meet the needs of open market operations due to its small size and unreasonable maturity structure. Therefore, the People’s Bank of China created the sterilization tool of the central bank bill to timely withdraw a large amount of passively released base money. Data show that between 2002 and 2008, central bank bills have basically sterilized the increase in the base currency due to the surge of foreign exchange reserves. In 2012, the People’s Bank of China decided to stop issuing central bank bills and restart reverse repurchase operations, as the twin surplus did not continue to grow significantly and the authorities took a more tolerant attitude toward RMB appreciation. In addition, since 2013, China has made use of standing lending facility (SLF), medium-​term lending facility (MLF), short-​term liquidity operations (SLOs), pledged supplementary lending (PSL), and other liquidity management tools that have innovated the medium-​and long-​ term base money supply mechanism. The dynamic adjustment of the deposit reserve ratio is one of the core tools of the People’s Bank of China in constructing a macro-​prudential financial management framework, for the purpose of exerting countercyclical influences. Its key characteristic is that when credit is released fast, it rises, and vice versa. Since the central bank decided to implement the dynamic adjustment of the deposit reserve ratio in 2011, the growth rate of new RMB deposits and money supply (M2) has slowed significantly. Commercial banks with capital adequacy ratios less than 8% have to scale back the total amount of loans due to the need to turn over more deposit reserves (Wang, 2011). Starting in 2016, the People’s Bank of China upgraded the dynamic adjustment of the deposit reserve ratio and the management mechanism of consensus loans into the Macro-​ Prudential Assessment (MPA). Besides focusing on capital adequacy and narrow credit, the MPA system comprehensively considers seven other aspects: capital and leverage, assets and liabilities, liquidity, pricing behavior, asset quality, cross-​border financing risk, and credit policy implementation; it also makes countercyclical adjustments to the broad credit scale. Therefore, the People’s Bank of China has formed a “monetary policy + macro-​prudential supervision” dual-​pillar monetary and financial regulatory framework.

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Financial Regulation Since the reform and opening up, China’s financial supervision system has gone through a process from unification to separation to coordination. Before 1992, the People’s Bank of China was the only regulator responsible for unified supervision over all financial institutions. In 1993, with the establishment of the CSRC, China began to separate the supervision of the securities industry, insurance industry, and banking industry. In 2003, with the establishment of the CBRC, the “One Central Bank and Three Regulatory Commissions” model of the separated financial supervision framework was fully formed. In recent years, with the financial liberalization and wide application of modern science and technology, innovations of various financial institutions, financial products, and businesses are emerging in an endless stream, and the disadvantages of the separated supervision are gradually emerging. In response to the increasingly serious financial risks, the Financial Development and Stability Commission of the State Council was formally established in July 2017, marking the advent of the era of coordinated supervision. The commission is based at the People’s Bank of China to strengthen its macro-​prudential supervision and systemic risk prevention responsibilities. In March 2018, the first session of the 13th National People’s Congress passed a bill to set up the Banking and Insurance Regulatory Commission and no longer retain the CBRC and the CIRC alone in order to solve problems such as unclear regulatory responsibilities, cross-​regulation, and gaps in supervision.

Driving Factors of China’s Financial Innovation The extensive practice of financial innovation in China in the past 40 years is the result of a series of driving factors. First, the transformation of economic structure and growth model. In 1978, the Communist Party of China decided to carry out economic reform and opening up to achieve the transformation from a planned economy to a market economy. By opening up to the outside world, the Chinese economy was integrated into the global economic system. It is under the impetus of this transformation that the shareholding reform and overseas listing of state-​owned commercial banks, the establishment of the capital market, the opening up of financial sectors, the innovation and development of rural finance, and other financial innovation activities closely related to the operation of market economy have emerged and been strengthened. At the same time, with the continuous development of a modern market economy, the innovation of monetary policy instruments and the establishment and improvement of a financial regulatory framework have become an indispensable and important part of macro-​control. In addition, in the process of economic transformation, as the export-​oriented economy has brought about a large number of trade surpluses, and as a result of the growing need to participate in global financial governance, improving the efficiency of the use of foreign exchange reserves and appropriately promoting RMB internationalization have become reasonable choices for policymakers.

618   Zhang Second, the increasing financing and investment needs of various economic entities. Investment has long been the most important driver of the Chinese economy. To achieve large-​scale investment, both governments and enterprises must rely on various financing channels, including bank loans and capital markets, as well as continuous financial innovation in products and tools. Governments at all levels and state-​owned enterprises have always been the main force for large-​scale infrastructure investment, and their huge financing needs have always been an important driving force for China’s financial innovation. For example, they have been the main beneficiaries of various types of development financing. In the first few years after the global financial crisis in 2008, local governments and large state-​owned enterprises relied heavily on local government financing vehicles (LGFVs) for bank loans to avoid a deep economic contraction, supported by a 4 trillion RMB stimulus package. After 2013, with the maturity of existing bank loans and the return of previous normal bank loans, local governments had to make extensive use of other nonbank financing channels (such as trust loans, entrusted loans, urban investment bonds, etc.) to roll over debts or support medium-​ and long-​term investment projects already started. In fact, most of these channels belong to shadow banking, so it can be said that the financing needs of local governments have largely promoted the development of shadow banking in China. Despite their strong financing needs, most of the small and medium-​size enterprises often have limited access to mobilization of capital from formal banking systems or stock markets. Statistics show that China’s small and medium-​sized enterprises account for 90% of the total number of enterprises, but their loans from banks account for only 30.4% of all bank loans to enterprises. As a result, these companies can only access the necessary financing through private lending, P2P, crowdfunding, and other shadow banking systems. These unfulfilled demands for finance are another main driver of financial innovations in China. In addition to large-​scale financing needs, the rapid development of financial innovation in China also partly reflects ordinary people’s pursuit of higher investment returns and diversification of their financial risks. After 40 years of development, China has stepped into the group of middle-​income countries. Individuals’ and households’ income and wealth are growing steadily, and there is an increasing demand for different types of investment and hedging products. Thus, innovation in areas such as internet finance, shadow banking, and financial openness is clearly related to this kind of drive. Third, avoiding financial regulation. Regulatory evasion is one of the most important drivers of financial innovation in any country. China is no exception. Despite more than 30 years of reform, China’s interest rate control still to some extent exists and has become one of the main driving forces for financial innovations, especially in the areas of internet finance and wealth management products. As some economists have pointed out, the control of the deposit interest rate is the fundamental reason for the development of internet finance, in that people can easily earn a higher interest rate by holding internet financial products, such as Yu Ebao, a money market fund supported by the largest e-​commerce provider in China (Dai and Fang, 2014). At the same time, with the help of window guidance, the local government has always had an important influence on the banks’ credit decision making. In fact, credit rationing became more prominent after 2010. In response to the significant increase in bank lending in 2009, the People’s Bank of China began to strengthen macro-​prudential

China's Financial Innovation    619 supervision in the following year, strictly restricting the loan-​to-​deposit ratio and capital adequacy ratio of commercial banks, thus reducing the lending capacity of banks through formal channels. To maintain profit growth and avoid difficulties in rollover or repayment of loans issued due to the contraction of money supply, many commercial banks have turned to issuing wealth management products, interbank business or entrusted loans, and other off-​balance-​sheet businesses to bypass supervision and continue to provide loans to enterprises in a disguised way. By shifting these loans off balance sheets, banks have succeeded in reducing the proportion of risky assets and raising capital adequacy ratios, thereby effectively meeting regulatory requirements while continuing to earn profits. Fourth, dealing with increasingly fierce competition. In the 1980s, China’s financial services were monopolized by the four major state-​owned banks (i.e., BOC, ABC, ICBC, and CCB), among which there was very limited competition. In the 1990s, with the development of securities, trust, leasing, futures, and other new business forms, China’s financial industry began to enter the era of competition. Though the “Law of the People’s Republic of China on Commercial Banks” passed in 1995 as well as the “Securities Acts” implemented in 1997 provided the legal basis for the separated financial operational and regulatory framework, the overall competition structure started to change after entering the new century. Although the legal framework of separated business operations remains unchanged, various calls for mixed business operations kept emerging, and there were many exploratory attempts at the operational level. The penetration between different types of financial institutions has increased significantly. As of 2016, the five major state-​ owned commercial banks have completed their layout in insurance business, by setting up subsidiary bodies, such as ICBC-​AXA Life, ABC Life, BoComm Life, CCB Life, CCB Property and Casualty Insurance Co. Ltd., BOC-​SAMSUNG Life, and BOC Insurance. Banks are also increasingly competing for licenses of securities brokerage, funds, financial leasing, and consumer finance. Competition in the financial sector comes not only from the intrasector but also from outside, most notably the internet service companies. In July 2015, the People’s Bank of China and other ministries and commissions jointly issued the “Guidelines on Promoting the Healthy Development of Internet Finance,” which put forward a series of policies to encourage and support the steady development of internet finance. With the encouragement of the government, a number of internet companies, including Alibaba and Tencent, have successively entered the field of financial services. They have launched strong competition against traditional financial institutions in the fields of online payment, product marketing, and loans for small and microbusiness units, which to some extent has squeezed the latter’s profit margins. Increased competition has forced all financial institutions, including traditional banks, to accelerate innovation in development strategies, trading methods, and product design. For example, in the face of competition among traditional financial institutions, almost all large state-​owned commercial banks and nonbank financial institutions have accelerated the pace of establishment of financial holding companies. In the face of competition from internet companies such as Alipay and Yu Ebao, traditional commercial banks have significantly strengthened their cooperation with e-​commerce platforms, striving to provide customers with high-​quality and convenient innovative services through the use of online banking and mobile banking platforms.

620   Zhang Fifth, the promotion of scientific and technological progress (STP). Technological progress, represented by internet technology, big data, and cloud computing, has played a very important role in China’s financial innovation. On the one hand, STP has reduced the cost of financial transactions, thus intensifying the competition among financial institutions for the market. On the other hand, STP also makes various financial innovations possible. For example, it is because of the existence of internet platforms that banks, securities, and funds have been able to break through the traditional financial transaction mode and sell their developed financial products online, so as to shorten the transaction time and reduce the transaction cost. Also, it is because of the wide application of internet technology that the third-​party payment platform represented by Alipay has successfully realized cashless transactions and on this basis derived loans, financial management, insurance, funds, and other businesses through the internet, so as to better achieve all-​around business expansion.

The Impact of China’s Financial Innovation China’s various financial innovations over the past 40 years have had a broad impact on financial efficiency, financial stability, and social equity. Generally speaking, these influences are positive, but there are also some negative impacts that cannot be ignored.

Impact on the Efficiency of Financial Resource Allocation Although there are still many market imperfections and residual direct and indirect controls, the modern financial system formed after decades of effort has changed the way financial resources are allocated under the planned economy model, thus having an important and positive impact on the financial efficiency from both the microeconomic and macroeconomic perspectives. Meanwhile, the effective monetary policy and financial supervision have also contributed to better utilization of financial resources through countercyclical adjustment and systematic financial risk control. In recent years, with the technological supports from the internet, cloud computing, and big data, many financial innovations, including mobile payments, electronic banking, P2P, and crowdfunding, have provided great convenience for various consumers of financial services, reduced the financial transaction costs and risks, and enlarged the small and medium-​sized enterprises’ financing channels, thereby improving the efficiency of financial resource allocation (Wang, 2015). Shadow banking and other informal financial sectors are indispensable financing channels for those small and medium-​sized enterprises that cannot obtain loans directly from state-​owned commercial banks or get access to stock markets, which may be very crucial to the maintenance and development of their operations. However, in some cases, the complex design of internet finance and shadow banking products can also lead to inefficiency. In the shadow banking sector, loans are often not directly provided to the final borrowers. Instead, they flow between different financial institutions, often for a few changes of hand, before reaching the final borrowers. Additional financing costs occur in each change of hand. Therefore, when the capital flows to the final borrower, the costs have usually become significantly higher than they should be. According

China's Financial Innovation    621 to Goldman Sachs and other investment banks’ estimates, from 2012 to 2016, the financing cost for companies with shadow banking in China was more than 10% and rising, significantly higher than the average cost for Chinese companies, which is 7%. In addition, some studies have shown that most of the funds coming from shadow banking eventually went to the real estate industry and local government financing platforms, which may increase rather than reduce the financial availability for small and medium-​sized enterprises, thus making the efficiency in allocation of financial resources worse in China (Lu, 2014).

Impact on Economic Growth and Financial Stability There is no academic consensus about the relationship between financial innovation and economic growth. Many scholars believe that financial innovation can effectively mobilize savings, achieve risk diversification, eliminate income distribution inequality, and reduce financing costs, so as to promote economic growth (Wu, 2006; Houston et al., 2010; Pagano, 1993). Some scholars believe that financial innovation promotes economic growth through its coupling with technological innovation. For example, Jiang and Zheng (2012) found that the more financial support enterprises can get for their research and development (R&D) departments, the higher the innovation growth rate and the higher the output growth rate. However, some scholars believe that the role of financial innovation in promoting economic growth cannot be verified. This is simply because financial innovation may bring about or amplify financial risks and even cause financial instability, thereby having a negative impact on economic growth. One of the main reasons behind the American subprime crisis in 2008 is the rapid development of financial innovation. Due to the lack of regulation, the surge of mortgage-​backed securities (MBSs), collateralized debt obligations (CDOs), credit default swaps (CDSs), and other financial derivatives significantly increased the systemic financial risks, which eventually led to the collapse of the entire financial system. In China, due to the low threshold of market entrance and the lack of self-​discipline and necessary supervision, problems in the internet finance business have occurred frequently in recent years. About 80% of P2P platforms have payment difficulties, and the “runaway” phenomenon keeps emerging. In the area of wealth management products, the risks hidden by the multilayer nesting in product design, the widespread maturity mismatch of assets and liabilities, the implicit rigid payment, and even real fraud situations in some cases have significantly increased financial fragility and systemic financial risks. Financial innovation may also affect the operation and effect of monetary policy, thus making it more difficult to adjust the macro-​economy and maintain financial stability. Sun and Jia (2015) argued that the nonstandard investment objects, too many chains between the financing and investment, and the lack of transparency of the shadow banking system will not only increase the operational risks of banks but also cause systemic risks and weaken the effectiveness of monetary policy. Xie and Yin (2001) also argued that currency digitization causes problems in the division and measurement of money levels, as well as traditional money demand functions. Both online banking and electronic currency may have important impacts on monetary policy regarding its intermediary goals, policy tools, policy transmission mechanisms, and independence. Besides, Li and Wu (2011) showed that China’s shadow banking and other financial

622   Zhang innovation activities may weaken the effectiveness of monetary policy by influencing credit creation, intermediate targets, money circulation velocity, and asset pricing.

Impact on Social Equality The impacts of China’s financial innovation on social equality are also twofold. On the one hand, internet finance, microcredit, and rural banks are intrinsically coupled with inclusive finance, because low qualification requirements, simple procedures, and flexible conditions enable low-​income people to access cheap financial services, thus promoting social equity. Due to the concerns of high operational costs and limited financial returns, however, large banks and other financial institutions are often reluctant to set up new branches in rural areas and undeveloped regions. However, the internet-​driven financial innovation has brought about significant changes. People living in rural or undeveloped regions can easily obtain basic financial resources through computers, mobile phones, and other terminal devices even if there are no bank outlets, ATMs, or other hardware facilities. Yu Ebao, online loans, and crowdfunding provide low-​income people with cheap and fragmented financial services. As part of the overall financial innovation, rural banks and microcredit companies provide preferential credit services to small and medium-​sized firms in villages and small townships, which will certainly improve the supply of financial services and eventually benefit economic development and social equality. On the other hand, however, shadow banking and internet finance also go against the characteristics of inclusive finance to some extent. The rapid development of shadow banking and internet financial products can easily bring about significant financial risks due to the imperfect regulatory system. In many cases, the shadow banking business has in fact become a tool for financial institutions and enterprises to evade supervision and engage in arbitrage, which has led to a large amount of money leaving the productive enterprises and self-​circulating within the financial system. This situation has greatly increased the financing costs of enterprises and aggravated the financing difficulties of small and medium-​sized enterprises. Notably, as Ding (2015) argued, internet finance and other related financial innovations are still characterized by investment discrimination, high financing costs, and profitability orientation, which obviously deviates from the nature of inclusive finance and is not conducive to narrowing the income gap and promoting social equality.

Conclusions and Issues for Further Research In conclusion, first, substantial innovations have happened in China’s financial sector over the past four decades. These innovations range from the significant increase of institutions, changes of market structure, and development of products to the improvement of regulatory frameworks. Second, these changes and innovations are a reflection of China’s transition from a central planned economy to a modern market economy; persistent demand

China's Financial Innovation    623 of various financial services derived from the government, corporations, and individuals in a period of rapid economic growth; and alternatively occurring regulation and deregulation by the authorities. Certainly, the unprecedented advanced progress of technology, especially the emergence of modern information revolutions, makes all these changes and innovations possible. Third, financial innovation has made profound impacts on China’s economic efficiency, financial stability, and social equality, among them some quite positive and some relatively negative. As clues for future research, among others, the following issues could be interesting. First, in terms of the speed, scale, driving forces, and impacts of financial innovation, how much difference between China and other countries (especially developed countries) can we see? Particularly, using various pilot schemes, the Chinese government (including the top economic authority and financial regulatory bodies) often plays a key role in pushing forward innovation or experimental practices. In some cases, these kinds of push come with positive results, but in some cases they do not. How should we evaluate the role of the Chinese government in this regard? Second, after four decades of innovation and development, China’s financial sector has emerged as one of the largest in the world, in terms of the scale of financial assets. However, to some extent, it is still distorted in market structure mainly due to the unnecessary intervention from the government in the way of frequent window guidance and even direct control in some circumstances. Though these interventions may continue to be a driving force for financial innovation, should they also be the objective of market-​oriented reform and institutional innovations? And how? Third, the rapid development of shadow banking and internet finance since 2013 has shown that while financial innovation may promote financial development and financial deepening, it may also lead to financial instability and even serious chaos. How should China continue to strengthen and improve its financial regulation and supervision to adapt to the rapid development of financial innovation? Fourth, while China’s banking sector has experienced a remarkably fast expansion over the past decades, development of the capital market has been relatively slack and slower than it should be. To make its financial sector more balanced and largely reduce enterprises’ overreliance on bank loans, it is believed that China needs to accelerate its development of the capital market. In doing so, how to induce more financial innovations into the reform of the capital market should be a very important policy issue. Fifth, after the global financial crisis in 2008, many economists started to rethink the role of finance in economic development and social progress, asking whether it has been exaggerated. Luigi Zingales (2015), chairman of the American Finance Society, argued that there is no theoretical and empirical evidence showing that finance has been significantly beneficial to society. In China, the rapid development of financial innovation over the past decade has raised a similar concern regarding whether finance has well served the real economy or just played for their own. It would be interesting and valuable to conduct deep research, both theoretically and empirically, on the economic consequences of the financial innovation in China and to explore whether, like some developed countries, China is to a certain degree facing excessive financialization of the economy. Acknowledgments:  The author is grateful to Dr.  Chuanwei Zou, a visiting scholar at Harvard University and deputy dean of the Nanhu School of Internet Finance, for his valuable contribution in the first draft of the chapter.

624   Zhang

References Chen, Yuan. 2010. Development Finance and Urbanization Development in China. Economic Research Journal. 45(7):4–​14. China Internet Finance Association. 2017. Annual Report of Internet Finance (2017). China Investment Corporation. 2017. Annual Report (2017). China Payment Industry Association. 2018. China Payment Industry Operation Report (2018). Dai, Guoqiang, & Fang, Pengfei. 2014. Regulatory Innovation, Interest Rate Liberalization and Internet Finance. Modern Economic Research. 2014(7):64–​67. Ding, Jie. 2015. Paradox of Theory and Practice of Internet Finance and Inclusive Finance. Finance & Economics. 2015(6):1–​10. Houston, Joel F., Lin, Chen, Lin, Ping, & Ma, Yue. 2010. Creditor Rights, Information Sharing, and Bank Risk Taking. Journal of Financial Economics. 96(3):485–​512. Jiang, Shuxia, & Zheng, Yawu. 2012. Financial Innovation, R&D and Economic Growth. Financial Theory & Practice. 2012(7):6–​12. Li, Bo, & Wu, Ge. 2011. The Credit Creation Function of Shadow Banking and Its Challenge to Monetary Policy. Journal of Financial Research. 2011(12):77–​84. Lu, Xiaoming. 2014. Comparative Analysis of Shadow Banking System between China and America. Studies of International Finance. 2014(1):55–​63. Pagano, Marco. 1993. Financial Markets and Growth:  An Overview. European Economic Review. 37(2–​3):613–​622. People’s Bank of China. 2018. Micro-​Credit Companies Report (2018). Sun, Guofeng, & Jia, Junyi. 2015. Defining China’s Shadow Banking and Assessing Its Scale—​ Seen in Terms of the Creation of Credit Money. Social Sciences in China. 2015(11):92–​11. Wang, Kaiguang. 2011. A Research of the Policy Effect of Dynamic Adjustment of Deposit Reserve Ratio. Journal of Jilin Financial Research. 2011(5):42–​46. Wang, Xin. 2015. A Study on Internet Finance Helping Relieve SMEs Financing Constraints. Journal of Financial Research. 2015(9):128–​139. Wu, Jinglian. 2006. Achieve Economic Growth through Financial Innovation. Rural Finance Research. 2006(12):6–​7. Xie, Ping, & Yin, Long. 2001. The Financial Theory and the Financial Governance under Internet Economy. Economic Research Journal. 2001(4):24–​31 Xu, Zhong, & Cheng, Enjiang. 2004. Interest Rate Policy, Rural Financial Institution Behavior and Rural Credit Shortage. Journal of Financial Research. 2004(12):34–​44. Zingales, Luigi. 2015. Does Finance Benefit Society? Presidential Address. American Finance Society, August.

Chapter 6.6

T he Puzzle of t h e Underd o g’s V i c tory How Chinese Firms Achieve Stretch Goals through Exploratory Bricolage Peter PIng Li, Shihao Zhou, and Monsol Zhengyin Yang The Concept of Bricolage Traditionally, Chinese companies have been viewed as underdogs in global competition—​ latecomers who have lagged in the global technological races and also lacked the necessary resources and capabilities1 for competitive advantages (Tan & Tan, 2005). However, in the past decade, we have seen that many Chinese latecomers have actually caught up and become major players in the global market. Nowadays, Chinese companies such as Alibaba, Huawei, Tencent, and Haier have been recognized as among the most highly competitive companies in the world. Many top business schools in the West are using these companies for case teaching (Ofek et al., 2018; Wells & Ellsworth, 2017; Wulf, 2010). Scholars have also attempted to explain why such latecomers could overcome their basic disadvantages and launch their unexpected counterattacks against global incumbents (Li, 2013; Li, et al., 2021; Luo & Child, 2015). However, the underlying rationale for these companies’ success is still an understudied puzzle. Further, the rise of innovation capabilities in Chinese firms raises the question of whether these firms have developed a novel system of organizing and managing the innovation process. There is evidence that several firms have adopted Western practices (e.g., Huawei), but it is also known that some firms have introduced innovative organizational structures (e.g., Haier) as well as applying certain practices and processes

Acknowledgement: We acknowledge the financial support from NSFC 71732007 1 

We use the terms “resources” and “capabilities” interchangeably throughout this chapter.

626    Li, Zhou, and Yang differently from other companies. It is also common that leaders of Chinese enterprises often manage in a more authoritarian manner than in non-​Chinese firms, which has both positive and negative influences on innovation and creativity. This begs the question, to what extent do Chinese firms’ practices for managing research and development (R&D) and innovation represent a systemically different and novel approach? This chapter seeks to address this question. The central theme of this chapter that emerges from our case evidence is that many successful corporate underdogs share a pattern with two salient features. First, these firms tend to have stretch goals, that is, seemingly impossible goals given their available capabilities (Sitkin, Miller, Lawless, & Carton, 2011). A  fundamental paradox of entrepreneurship is the tension between a passionate entrepreneur’s stretch goal and the serious lack of resources and capabilities available to a startup. On one hand, a firm’s performance is argued to be largely shaped by the valuable, rare, inimitable, and non-substitutable (VRIN) resources it holds (Barney, 1991), and some organizational learning scholars posit that conducting explorative learning for a stretch goal is likely to be harmful for firms facing severe resource constraints (Sitkin et  al., 2011). On the other hand, almost all these successful firms in China, at both the initial stages and even the later stages of firm growth, emerged under the shared conditions of serious competitive disadvantages due to the severe lack of VRIN resources. Many of those firms started from nearly nothing, with no original technology and technical accumulation, no venture capital, and no political connections. The founders or managers of these companies often made some goals that were in stark contrast to the absence of VRIN resources. These goals were viewed as stretch goals at the time when they were made. For instance, at an early stage, Zhengfei Ren, the CEO and founder of Huawei, once advocated that Huawei would ultimately be one of the top three companies in the information and communication industry all over the world. In 1999, Jack Ma, the founder of Alibaba, claimed that the goal of the company was to radically change the way people do business. However, at that time, Jack failed to raise money from domestic venture capital for the development of Alibaba. He had to resort to Wall Street and gave up most of the shares of the company. These examples illustrate a fundamental paradox of stretch goals: the tension between a passionate entrepreneur’s stretch goal and his or her impossibly resolvable lack of required resources. Second, we have also noticed that many corporate underdogs tend to behave in a way resembling what is being described in the notion of bricolage in terms of “making do by applying combinations of the resources at hand to new problems and opportunities” (Baker & Nelson, 2005, 333). With the potential to address the tension between having a stretch goal and lacking required capabilities, bricolage seems the most relevant notion to explain the special entrepreneurial behaviors in resource-​scarce contexts (Garud & Karnøe, 2003; Guo, Su, & Ahlstrom, 2016; Senyard, Baker, Steffens, & Davidsson, 2014; Welter, Mauer, & Wuebker, 2016). This perspective posits that, to resolve the problem of resource or capability constraints, a firm must engage in bricolage by challenging the extant institutional assumptions as well as applying existing resources to new uses (Baker & Nelson, 2005). In particular, bricolage can provide a viable means for firms in emerging markets such as China to grow under resource constraints (Gurca & Ravishankar, 2016; Wu, Liu, & Zhang, 2017). From the perspective of bricolage, innovation is explicitly and directly viewed as a solution to the problem of resource or capability constraints.

Puzzle of the Underdog’s Victory    627 To fill the aforementioned gaps in the literature, we seek to effectively explain the specific paradox about stretch goals and resource constraints. Specifically, we argue that the extant research on bricolage focuses too narrowly on making do with whatever resources are at hand, similar to the approach of effectuation in terms of pursuing only goals achievable with available resources (Sarasvathy, 2001, 2008). However, cases of Chinese latecomers indicate that firms can also create radical innovations or other extraordinary outcomes out of ordinary resources, or even seemingly valueless “non-resources.” Scholars claim that the traditional bricolage is essentially incremental innovations and can only resolve problems in the short run (Baker & Nelson, 2005; Senyard et al., 2014). Using the typology of March (1991), we call traditional bricolage exploitative bricolage. We, on the other hand, emphasize that the bricolage approach may break fundamental institutional assumptions and impose a long-​term influence on the firm and the industry. We name such an approach exploratory bricolage. In particular, we posit that the key antecedent to exploratory bricolage is a stretch goal with its unique role in driving entrepreneurs to engage in exploratory bricolage (cf. Sitkin et al., 2011). By focusing on the question of how stretch goals and exploratory bricolage work together to enable the success of corporate underdogs in the context of China, we identify the bricolage pattern with both theoretical and practical implications for both scholars and practitioners. Our case studies contribute to the literature about organization (Terjesen & Patel, 2017) and entrepreneurship (Fisher, 2012; Welter et al., 2016) by explaining how those resource-​poor entrepreneurs can achieve seemingly impossible successes via rather radical innovations.

Theoretical Background Innovation of Chinese Firms Academic attention has been drawn to the research on the emerging phenomena of Chinese innovation, though at its incipient stage. The inchoate innovation by Chinese firms is characterized by several points from the perspective of practice:  (1) The main path of innovation for Chinese firms remains introducing, digesting, absorbing, and innovating, which is also a learning process that seems inevitable for later-​coming economies. (2) For most Chinese firms, low cost is still the major competitive advantage of their products. (3) Demand orientation is a key element of “Chinese innovation.” (4) Chinese innovation still lacks originality in “innovation” since China remains a developing country as a whole and its science and technology are still backward overall. It is quite difficult for Chinese firms to contribute original innovation to the world at this stage of their development. However, there are at least two aspects that are worthy of notice concerning Chinese innovation. First, the innovative dynamics or business model is demonstrated by Chinese firms in the process of imitating or catching up with their Western counterparts. Second, leading innovation is done by very few Chinese giants, such as innovations conducted by Chinese information technology (IT) giants Alibaba and Tencent, and innovative technology and management from Huawei. The former pattern is a common phenomenon that many Chinese firms, no matter small or large, all exhibit. Thus, this chapter will focus on

628    Li, Zhou, and Yang this type of innovation by Chinese firms; the later pattern could be the subject of future directions of research. There are mainly two research streams in the extant literature that could be related to the general pattern of Chinese innovation in the process of imitation and catch-​up: disruptive innovation and the composition-​based view. The original concept of disruptive innovation indicates inferior quality and lower price (Christensen, 1997; Christensen & Raynor, 2003; Christensen, Anthony, & Roth, 2004). This implication associates it with the notion of the “bottom of the pyramid,” as the majority of the market populations are at the bottom of the pyramid, as the lowest-​end segment of the global market (Prahalad, 2009). This resembles the scenario in China since its reform and opening up in 1978. The majority of Chinese people cannot afford the products and/​or services designed for the developed markets, which makes the Chinese market fertile ground for disruptive low-​ cost innovation (Govindarajan & Ramamurti, 2011; Ricart et al., 2004; Yu & Hang, 2010), especially business model innovation (Eyring, Johnson, & Nair, 2011; The Economist, 2010). However, while the disruptive innovation studies shed important light on why latecomers can catch up with the first movers, it is still unclear how firms can make disruptive innovation. Luo and Child (2015) present the composition-​based view as a unique way in which enterprises can grow even when they are handicapped by a “lack of core competencies” and “without the benefit of resource advantages, core technology, or market power.” The composition-​based view explicates the growth of enterprises that compete and develop without the benefit of resource advantages, core technology, or market power, which emphasizes how ordinary firms with ordinary resources may generate extraordinary results through their creative use of open resources and unique integrating capabilities, resulting in an enhanced speed and a price-​value ratio well suited to large numbers of mass-​market consumers. According to Luo and Child (2015), Chinese firms could prefer the deployment of compositional capabilities to combine ordinary resources over the pursuit of VRIN resources, as advocated by the resource-​based view (e.g., Barney, 1991). Compositional capability refers to firms’ special capabilities in identifying, obtaining, and integrating ordinary resources available in the market and then combining them in a special way to creatively and speedily adapt to market demands (Luo & Child, 2015). Luo and Child (2015) also claim that the advantages of adopting a composition-​based strategy are temporary in nature and will decline over time, especially after the firm passes the imitative or catch-​up stage. The current criticism of the composition-​based view in general and compositional capability in particular (Volberda & Karali, 2015) is based on the attempt to reframe compositional capability as consistent with the resource-​based view and as a special type of dynamic capability. Thus, it is argued that there is no need for a composition-​based view. Further, this line of criticism implicitly assumes the similarity between the notion of compositional capability and the existing constructs of combinative capability (Kogut & Zander, 1992; Van den Bosch, Volberda, & De Boer, 1999) and recombinant capability (Carnabuci & Operti, 2013; Helfat & Peteraf, 2003; Galunic & Rodan, 1998). In our view, the composition-​based view indeed sheds some light on the innovation pattern of Chinese firms when conducting the imitative or catch-​up strategy, but it lacks a procedural and mechanical explanation. More importantly, we argue that the composition-​based view could be used for situations

Puzzle of the Underdog’s Victory    629 where managers skillfully leverage ordinary resources with compositional capability to realize stretch goals, like many startups, rather than be bounded by situational contexts where an imitative or catch-​up strategy is implemented. Our exploratory bricolage concept could compensate for this shortage.

Stretch Goal We argue that, to better understand the unique pattern of innovation by late-​coming firms in China, it is important to study the role or effect of a firm-​specific stretch goal. A stretch goal is defined as a goal that is extremely difficult and seemingly impossible to achieve given the available resources and capabilities (Gary, Yang, Yetton, & Sterman, 2017; Locke & Latham, 2013; Sitkin et al., 2011). Having a stretch goal is critical because it encourages organizations to push the envelope of available resources so as to stimulate innovations within the firm. However, Sitkin and colleagues (2011) argued that a stretch goal can be achieved only by firms with sufficient resources, so pursuing stretch goals under the condition of resource constraints may impede the satisfactory performance of most, if not all, firms, and accordingly create discomfort, stress, and rigidity at both individual and collective levels. Similarly, Gary and colleagues (2017) found that having a stretch goal does not help most individuals or organizations achieve better performance. Achieving competitive advantages in terms of innovativeness for late-​coming firms in emerging economies can be regarded as a typical stretch goal (Lee & Lim, 2001; Miao, Song, Lee, & Jin, 2018). For example, for a Chinese late-​coming software company, it will be extremely difficult for the company to challenge the dominant position of Microsoft in operating systems. According to Sitkin and colleagues (2011), pursuing a stretch goal under resource constraints will impede the typical growth of late-​coming firms. However, as known to many, Jack Ma set the ideal goal for Alibaba to be the greatest IT company on earth from its early days, although this was seemingly impossible for a new firm given its desperate need for resources. Yet Alibaba became a business leader in the world, which forces us to reconsider the hidden links between available resources, stretch goal, and innovative outcome. Hence, we need to think more deeply about the unique role or effect of bricolage, especially its more creative version for exploration, in contrast to its less creative version for exploitation, as the most relevant means or mechanism to convert or transform available resources into innovative outcomes via the facilitating effect of a stretch goal. Prior literature also indicates that although having a stretch goal may not improve performance generally, the stretch goal can potentially stimulate creativity and innovation (Katila & Shane, 2005; Miron-​Spektor & Beenen, 2015). In an individual-​level study, Miron-​ Spektor and Beenen (2015) found that when people have a specific goal in learning, they are more likely to explore new knowledge domains, making these people come up with novel ideas. Katila and Shane (2005) examine the relationship between lack of resources and firm innovation. They found that lack of resources may encourage the firm to innovate. These studies imply that exploration and innovation could be an effective way of achieving a stretch goal.

630    Li, Zhou, and Yang

Explorative Bricolage Bricolage has been brought into entrepreneurship and innovation research since the early 2000s (Baker, Miner, & Eesley, 2003; Baker & Nelson, 2005). Based on this concept, when entrepreneurs are facing resource constraints, they can “make do by applying combinations of the resources at hand to new problems and opportunities” (Baker & Nelson, 2005, 333). The insight provided by the notion of bricolage is that entrepreneurs may successfully achieve goals under the condition of resources constraints, and the way to achieve that is to test and challenge the existing institutional assumptions (e.g., institutional logic, formal rules, informal norms, dominant logic, prevailing business models, etc.) so as to use ordinary or even seemingly valueless non-resources in novel ways (cf. Baker & Nelson, 2005; Garud & Karnøe, 2003). The concept of bricolage provides many useful pieces of advice for entrepreneurs to survive under resource constraints, while the problem of resource constraints is one of the impeding factors for late-​coming start-​ups, especially in the emerging economies (Miao et al., 2018). This idea has shaken the position of two theories that hold the view that early-​ moving firms have better or more advanced capabilities for innovation. First, bricolage challenges the research-​based view that firm-​specific competitive advantages are rooted in the ownership of VRIN resources (Barney, 1991, 2001). In terms of innovation, the resource-​ based view argues that innovation must be based on the possession of resources such as advanced technologies, R&D stock, and R&D experience (Terziovski, 2010). However, the concept of bricolage indicates that organizations can turn subnormal resources, or even seemingly valueless non-resources, into VRIN resources for competitive advantages so that there is no required precondition for the prior possession of abnormal or extraordinary resources. Second, the concept of bricolage also challenges the view of organizational search for innovation and entrepreneurship. According to the view of organizational search, innovation and entrepreneurial opportunities can be detected through knowledge search (Kaish & Gilad, 1991; Levinthal & March, 1993). Scholars of organizational search differentiate local search from nonlocal search, with the former involving the search for knowledge near the firm’s current knowledge domains, and the latter involving the search for knowledge in distant domains (Rosenkopf & Almeida, 2003; Rosenkopf & Nerkar, 2001). In the traditional view of organizational search, organizations focus on familiar and easily accessible opportunities in local search, which often generate incremental and exploitative innovations; in contrast, organizations that focus on explorative long-​term variables and venture into new fields may discover novel solutions in nonlocal search, which often generate radical innovations (Rosenkopf & Nerkar, 2001). However, the concept of bricolage indicates that some radical innovations can derive from local, yet explorative, search. In fact, recent innovation studies show that, because local search brings a deep understanding of the relevant institutions and customer needs, innovators are more likely to modify the underlying institutional logic via engaging in local, rather than nonlocal, search, and thus can achieve truly radical innovations (Jung & Lee, 2016; Kaplan & Vakili, 2015; Mastrogiorgio & Gilsing, 2016). However, the extant research on bricolage is limited in framing it as leading to frugal innovations on the basis that, with substandard resources at hand, some entrepreneurs can

Puzzle of the Underdog’s Victory    631 only create substandard products that serve customers who cannot afford standard prices (Senyard et al., 2014). Also, bricolage is commonly identified as a more exploitative search with an emphasis on short-​term or near-​term and often path-​dependent goals due to its focus on “make do”—​using whatever resources are available for urgent tasks at hand (Baker & Nelson, 2005). Hence, bricolage has rarely been connected with stretch goals. Further, there is almost a complete blank in terms of literature on the process of bricolage by firms in the emerging economies (Senyard, Baker, & Davidsson, 2009; Salunke, Weerawardena, & McColl-​Kennedy, 2013). Hence, the extant perspective of bricolage seems to imply that bricoleurs can only gain a competitive parity or develop temporary advantages (Baker & Nelson, 2005; Fisher, 2012; Senyard et al., 2014), so it fails to explain why and how some bricoleurs could deliver an abnormal or extraordinary performance under resource or capability constraints. Finally, we know particularly little about the possible link between stretch goals and bricolage because there is little research in the literature. The case of Chinese underdogs’ success may shed light on the surprising gaps in the literature. It is interesting to note that the notion of bricolage is closely related to the recently proposed idea of resource-​ based stretch as “resourcefulness” (Sonenshein, 2017), which is distinct from the notion of stretch goal. In sum, the purpose of this study is to enrich the literature on stretch goals and bricolage by highlighting their deep-​level link.

Research Methodology We adopted a case study approach to investigate how companies with a severe resource constraint achieve a stretch goal with unprivileged resources via ingenious methods. The case study approach is a useful method for theory building (Eisenhardt & Graebner, 2007). Adopting the case study approach is appropriate for us, because the aim of this study is to develop the new concept of explorative bricolage. We chose four cases for our data analysis. The multiple-​case comparative approach provides a stronger base for theory building than the single-​case one (Eisenhardt, 1989; Yin, 1994), since it enables us to verify our findings in diverse contexts so as to enhance their credibility. Specifically, following the general suggestion of Eisenhardt and Graebner (2007), we selected four cases in different industries to strengthen the robustness of our research design. We analyzed four cases to explore the specific mechanisms at different stages of entrepreneurial bricolage, especially the creative type of entrepreneurial bricolage. The four cases are Taiping Life Insurance, Yuanjia Village, ZBOM, and Huawei. The first two cases are in the service sector, while the last two cases are in the manufacturing sector. For all case studies, we collected both primary and secondary data. All the data were collected from Chinese sources, but we were able to analyze the data because our research team members were all Chinese native speakers.

Case Study 1: Taiping Life Insurance Our first case of explorative bricolage is Taiping Life Insurance company, a state-​owned life insurance company located in Shanghai. It offers life, accident, health, and other insurance

632    Li, Zhou, and Yang services to customers throughout China. The company started its business in 2001 in the face of fierce competition from many larger and more established state-​owned insurance companies, such as China Life and Pingan Life. At the end of 2011, Taiping ranked number seven in the list of major insurance firms, with new business sales in the individual agency channel of 3.6 billion RMB, which was the core business of the life insurance market; a net profit of 677 million RMB; and total assets of 132.6 billion RMB. At the start of 2012, Wang Bin, the new chairman of the company, issued a stretch goal. He wanted to turn the company from a smaller-​but-​better firm to a bigger-​and-​best one by doubling all major financial indicators in terms of total assets, gross premium, and net profit in three years from 2012 to 2014. In 2012, the individual agent team experienced great tension between the stretch goal and lack of capabilities and they failed to make substantial progress in terms of a fast growth in sales and profit. Everyone believed that the management team would lower the initial goal. Surprisingly, the chairman proposed a new goal for 2014 with new business sales revenue up to 9.5 billion RMB. During the growth drive, the chairman even demanded a specific objective of having sales of 4 billion RMB in just one particular month. Since the top management team insisted on the seemingly impossible goals, the employees had to explore innovative strategies to achieve them. In July 2013, the company came up with several innovative ideas. First, although price penetration was widely used in many markets, Taiping Life creatively introduced a special pricing strategy into the life insurance industry by launching a new insurance product at an extremely low price (but with a reasonably high commission for sales agents) compared to that of 10 years ago. By doing so, the company gave more benefits to customers under the customer-​oriented business philosophy. Meanwhile, its sales force was rapidly expanded with the needed momentum for rapid growth. Second, life insurance companies traditionally tend to assign the more experienced sales agents to sell high-​margin products because conventional wisdom suggests one should assign more challenging tasks to people with more experience. However, recognizing that life insurance sales agents often start their careers by targeting their close relatives and friends with high trust, Taiping Life attempted to leverage the trusted relationship between the sales agents and their initial customers by asking the new staff to sell high-​margin products. This approach greatly increased both the sales and profit of the company. To strongly support this novel approach, Taiping Life invested needed resources in coaching and training the sales force so as to improve sales agents’ skills and capabilities. It is clear that sales agents with rich experience can help sell more complex and higher-​valued products for the insurance company, which in turn can attract more capable persons to join the company. Finally, the inherent conflict between the initial-​sale unit and renewal-​sale unit is normally a persisting challenge to all insurance companies. Taiping Life resolved this conflict by granting the renewal-​sale unit veto power to ensure the quality of insurance policies sold by the initial-​sale unit, so the initial-​sale unit was forced to work closely with the renewal-​ sale unit. After being forced to work together, surprisingly the two previously conflicting units found and achieved their potential interunit synergy in terms of having higher-​quality insurance sales and long-​term profits for both units. By engaging in these innovative activities, Taiping Life exceeded the goal proposed by the chairman. Its new business sales in the agency channel reached 4 billion RMB within the month of September 2013, 8.8 billion RMB at the end of 2013, and 11.6 billion RMB by the

Puzzle of the Underdog’s Victory    633 end of 2014, with a net profit of 2.7 billion RMB. Now Taiping Life has become the fourth-​ largest company in the agency channel, and the top one in the growth of new business value among insurance companies in China over the past several years.

Case Study 2: Yuanjia Village Yuanjia Village, a tourist attraction literally without any tourism resources, is an ordinary village in Shaanxi province. Before launching the tourism business, Yuanjia Village had only 62 households and 286 villagers. It is a very small village that is poorly endowed with natural resources, including natural tourism resources. Like most villages in the inland region of China, most young villagers of Yuanjia Village went out of the village to make a living in the late 1990s. To revive the countryside, Guo Zhanwu, the village chief, made a stretch goal of helping the villagers get rich through tourism. This idea seemed insipid and challenging, since Yuanjia Village possessed no natural tourism resources on its own. Therefore, despite such a vision, the villagers, including the village leaders, did not know how to achieve it. Even more than 20 outside planning experts also concluded that Yuanjia Village could not get rich through tourism. In the face of a conflict between a sharp ambitious vision and the lack of resources, Guo Zhanwu led Yuanjia Village in a surprising counterattack. After 2007, Yuanjia Village chose to develop folklore tourism as a starting point, breaking through the paradox of grand vision and the scarcity of resources. To achieve the goal, the managers of Yuanjia Village faced two seeming contradictions: fully tapping the local conditions and boldly innovating. In terms of utilizing local conditions, Yuanjia Village focused on the old and rustic aspects—​the original ecology. The village did not recklessly overpursue the integration of new resources to set up new scenic spots. Instead, it showed the most primitive life of peasants in the Guanzhong Plain and opened up a unique tourism model of ancient town plus food. To use this so-​called old-​fashioned advantage, Yuanjia Village took the villagers as the main body and mobilized them in an all-​round way. All the villagers’ clothing, language, and housing were integrated into the scenic spots so as to make tourism more accessible. The concept of “folk-​custom tourism” developed by the village management team is fundamentally different from the traditional tourism industry based on scenic spots. It can be said that they created and seized a “blue ocean” market for experiencing the traditional rural life. From 2007 to 2017, Yuanjia Village successfully made the first step in becoming one of the leaders in the tourist industry. Today, Yuanjia Village has become a well-​known tourist brand in Shaanxi province and even the whole country. Observing the success of Yuanjia Village, many other Chinese villages started to imitate. However, most of them failed. In fact, Yuanjia Village achieved success because it creatively leveraged its local resources. Thus, its business model cannot be copied by other villages with different local resources.

Case Study 3: ZBOM ZBOM is a kitchen supplies manufacturer. Before 2008, ZBOM looked like a small and affluent local company specializing in kitchen cabinet business. From its founding in 1998 until 2008, ZBOM dwelled in its headquarters in Anhui province without any ambition of

634    Li, Zhou, and Yang expanding to other places. The company was a second-​tier company in its field in China. Its annual sales were around 100 million RMB. In 2009, the top management of the company sensed an opportunity in the industry and they believed that to capture the opportunity, the company needed to grow. They therefore set a stretch goal of making the company’s sales reach 1 billion RMB in three years. This goal was bold because at that time, OPPEIN, the biggest player in the market, only had sales of around 300 million RMB. Because of their choice of a stretch goal and in the absence of ample resources, their basic strategic path also had to go beyond the conventional, to find a unique strategic path. This is also the basis for bricolage, that is, giving full play to the undiscovered potential of existing resources. This is exactly what ZBOM chose to do. A  normal practice in the kitchen supply industry is that firms sell products on their own. ZBOM broke this norm by spinning off the sales department. By doing so, ZBOM completely released the potential that they had not previously achieved and made the spin-​off the vanguard of the massive expansion of ZBOM. In addition, ZBOM was almost desperate to recruit dealers across the country to make use of other resources to fulfill rapid expansion. For example, 1 billion RMB in three years meant that ZBOM would have to build 1,000 dealership stores from 2010 to 2012. The goal was successfully completed in the first two years. In 2011, ZBOM recruited 210 dealerships. In 2012, according to the strategic goal, they had to complete the task of recruiting 400 companies. However, at that time, the industry’s highest record of recruitment was just about 200! Driven into a corner, the person in charge of recruitment was inadvertently inspired by his colleagues and proposed a radical strategy by holding 25 major investment conferences, breaking down the target of attracting 400 dealership stores into two steps. This involved (1) 5 large investment conferences that planned to draw 40 investment stores for each, thus a total of 200, and (2) 20 small investment conferences, with each signing up 10 stores, thus a total of another 200. Hence, the stretch goal of 400 stores was achieved. ZBOM is praised as a black horse in the industry thanks to its outstanding performance during the past few years. Inside ZBOM, they have their own self-​deprecating explanation for “black horse”: a horse that is running during both the night and the day. But no one was compelled to behave like this; they did so simply because they had a stretch goal. Since they agreed with this goal, they achieved it: “you are a hero if you realize it; otherwise you will lose.” In fact, it is inexact to say “realize it,” because according to staff from ZBOM, “the goal is not to be accomplished, but to be surpassed.” In other words, the “wolf spirit” of a company is driven by the stretch goal, as is the company’s bricolage approach.

Case Study 4: Huawei The success of Huawei in the international market was triggered by a stretch goal, and Huawei’s bricolage approach is in turn driven by that stretch goal (Tian & Wu, 2015). This is particularly evident in the early and midterm development history of Huawei. Huawei would occupy one-​third of the market share in the global telecommunications industry—​ this is the dream goal that Zhengfei Ren, the founder of Huawei, has pursued in his lifetime. This is also a dream that was so far-​reaching in the early days of Huawei that he was called a crazy man. The stretch goal of Huawei is derived from, on the one hand, the real pursuit of the long-​term survival of the company, which is more obvious in the early and midterm

Puzzle of the Underdog’s Victory    635 development of Huawei, and on the other hand, from Zhengfei Ren’s grand dream, which has been realized numerous times throughout the process of Huawei’s growth (Tian & Wu, 2015). Under the guidance of this grand dream, Huawei successfully adopted ingenious strategies of market competition, many of which have obvious features that break the common competition paradigm. There are two specific examples that illustrate how Huawei adopted explorative bricolage in pursuing the stretch goal. First, normally a new telecommunications company would need to focus on the urban markets where there is a large demand for telecommunications services. Such markets in China were dominated by big companies that have good relationships with the municipal telecommunications bureaus. Hence, the entry barrier into the telecommunications industry is very high, making survival itself a stretch goal for many small companies, as Huawei was in the early 1990s. To overcome this challenge, Huawei developed user exchanges that had little to do with the telecommunications bureaus and conducted a marketing strategy focusing on rural areas encircling cities. A second case of explorative bricolage is the product of Single-​RAN, which is a radio access network (RAN) technology that allows mobile telecommunications operators to support multiple mobile communications standards and wireless telephone services on a single unit. Traditionally, telecommunications companies only provided the network technologies to support a single mobile communication standard. However, in 2008, Huawei observed that many customers, especially customers who come from developing countries with constrained financial resources, often operated in multiple mobile communications standards but could not afford multiple networks. The market leaders at that time, such as Cisco, ignored this market opportunity because their innovation departments were not close enough to the customers, especially these customers in developing countries. Huawei realized this opportunity and launched its Single-​RAN technology. The product helped the company to create a competitive advantage in these markets quickly, playing a very important role in Huawei’s catch-​up to the leading Western companies. In fact, Single-​RAN did not employ very advanced technology. Huawei’s success can be largely explained by its bricolage mindset, which enabled the company to challenge institutional assumptions. These ingenious methods of competition helped Huawei stand out in the competitive Chinese market landscape initially dominated by foreign giants. Obviously, the ingenious mechanisms of Huawei are specific strategic actions for its central dream of occupying one-​ third of the world market share.

Case Study Summary The four cases we discussed illustrate how firms facing resource constraints can achieve abnormal or extraordinary performance by setting and chasing a stretch goal. To achieve their stretch goals, all four firms not only worked very hard but also adopted a local exploratory approach: they all stayed in their existing business domains rather than rushing into new domains, and at the same time, they explored and figured out radically novel approaches to use their limited resources at hand. As a result, their successes were often unexpected. Our theory of exploratory bricolage provides a good explanation of such success stories concerning unexpected entrepreneurship against the odds in the context of emerging economies. We summarize the four cases in Table 6.6.1.

Table 6.6.1 Summary of Four Cases Time Period for Bricolage

Resource Status before Bricolage

Case 1 Taiping Life Insurance (a large state-​owned insurance enterprise)

1/​2013–​1/​2016

Case 2 The company of Yuanjia Village (a small collective tourism enterprise)

Transition starting from 2007

Case Study

Stretch Goal

Explorative Bricolage

Results of Bricolage

Lack of needed capabilities Ranked No. 7 on the list of insurance companies Sales revenue of 3.7 billion RMB and profit of 677 million RMB, with total assets of 132.6 billion RMB

The goal of shifting from small but good to big and best: Business doubled in three years (total sales, total asset, gross premium, net profit) Another goal of increasing sales to 4 billion RMB within a single month Another goal of sales in 2014 of 9.5 billion RMB.

Using price penetration Using new staff to sell high-​ profit products Resolving the conflict between initial sale of insurance and renewal of insurance

Sales reached 4 billion RMB in September and 5.6 billion RMB at the end of 2013, 9.5 billion RMB of 2014 and the profit is 2.7 billion RMB. And at the end of 2013, there are 113,000 employees. Milestone: Become the third largest company and No. 1 of profit in the insurance field.

Lack of natural tourism resources Lack of financial resources

Develop tourism with no tourism resources Labeled as “fraud” of national subsidy by tourism experts

Developing “peasant household tourism” and creating a new tourism mode of “folklore tourism” (challenging the assumption that natural tourism resources are necessary for developing tourism industry; use peasant household as a resource for tourism)

Became the most popular destination for tourists Became the most attractive tourist attraction in Shanxi province during the national holiday

Case 3 ZBOM (a small private kitchen-​supply manufacturer)

12/​2009–​12/​ 2012

Sales exceed 100 million RMB

Reach 1 billion RMB in sales in 3 years Ranked No. 3 in the field (No. 1 had sales of up to 300 million in 2008)

Case 4 Huawei (a small to medium-​sized telecommunications company that does not have a competitive advantage in the international market)

1990s to mid-​2000s

Latecomer in the technological race with international competitors such as Cisco

Top three in the world

A radical strategy to attract new dealers: opening 25 attracting investment conferences, breaking down the target of attracting 400 dealership stores (challenging the institutional assumption that the kitchen-​ supply business is operated in a self-​operated business model) Marketing strategy of rural areas encircling cities (challenging the assumption that major customer of the industry is in the city) Single-​RAN (challenging the assumption that a single network can only use a single mobile communication standard)

Became top three domestic company in the industry Achieved goal of 1 billion RMB in sales that increased by 10 times in 3 years

Caught up with the leading Western companies

638    Li, Zhou, and Yang

Discussion Interplay between Stretch Goal and Exploratory Bricolage Combining the interplay between exploratory bricolage and stretch goal for innovation, we argue that firms can achieve a stretch goal by engaging in creative bricolage. This type of bricolage is the key to radical innovation for late-​coming firms in such emerging economies as China. However, while the extant research on bricolage regards stretch goals for late-​ coming firms as seemingly impossible (cf. Baker & Nelson, 2005; Senyard et al., 2014), the extant research fails to pay attention to the potential effect stretch goals can have on bricolage (cf. Sitkin et al., 2011). In this sense, integrating the two ideas provides us with more valuable insights, especially concerning the interplay between the two factors. The impossibility of stretch goals derives from the old norms within mature firms, which assume existing endowments of resources that can be applied to innovation. By challenging the domain technologies, business models, and operating processes, large firms can achieve stretch goals through radical or disruptive innovations (Wu et al., 2010). In contrast, given the resource constraints of late-​coming firms, they must focus on improving the effectiveness of applying currently available or easily accessible resources, which renders stretch goals primarily distractive and harmful. Finally, the traditional theories imply that radical or disruptive innovations cannot be achieved via local research and local resources (Laursen & Salter, 2006; Laursen, 2012; Rosenkopf & Nerkar, 2001). However, bricolage-​ related activities, such as challenging the current institutional assumptions, can facilitate the creation of radical or disruptive innovations if the current resources are applied in some novel patterns (Baker & Nelson, 2005). In addition, the notion of exploratory bricolage suggests using local resources in novel ways. This is based on the fact that radical or disruptive innovations can be achieved only by breaking and transforming the formal rules and informal norms that are built upon the previous institutional assumptions. The insight of exploratory bricolage is that innovators can conduct radical or disruptive innovations by re-​examining the taken-​for-​granted assumptions (Kaplan & Vakili, 2015). In particular, stretch goals can serve as the salient enabler for bricolage. Even though exploratory bricolage and radical innovation are always hard to achieve, and even harder for late-​coming firms from the emerging economies, unexpected outcomes can be achieved in the light of a stretch goal, which may guide such firms to the final realization of bricolage. Due to the path-​dependent nature of a technological trajectory, economists find that it is difficult for late-​coming firms to challenge the early-​moving firms in terms of technological innovations (Mueller, 1997; Nelson, 1990). Because technology development is restrained by path dependence (Mahoney, 2000), the late-​coming firms could be locked for a long time in a lower and less competitive position. Advancement in IT also makes it harder to achieve radical innovations by following the same path of the first-​movers. Given this situation, radical innovation is the only way for the latecomers to surpass the first-​movers. Due to the difficulties involved in the innovation process, perhaps only those latecomers with strong stretch goals can push themselves hard enough to adopt radically different patterns for their disruptive innovations.

Puzzle of the Underdog’s Victory    639 Stretch Goal

Unprivileged Resources

Ingenious Methods

Figure 6.6.1  Interplay between stretch goal and exploratory bricolage. Radical or disruptive innovation tends to be highly difficult to achieve, especially for the latecomers, even though some latecomers may have potential competitive advantages, so it would be misguided if the latecomers adopt the well-​known paths of successful first-​movers. In this sense, we argue that a stretch goal may function as a driving force for radical innovation. From the perspective of the behavioral theory of the firm (Cyert & March, 1963), organizational search is always triggered by existing problems. When the traditional solutions to such problems fail, managers can be forced to engage in some innovative activities so as to achieve radical or disruptive innovations as novel solutions to such problems. Hence, pursuing a stretch goal can serve as a salient trigger for exploratory bricolage. Figure 6.6.1 demonstrates the interplay between stretch goal and exploratory bricolage. In essence, contrary to the traditional view that firms cannot achieve stretch goals with local search or resources, we posit that bricolage, at least exploratory bricolage, can help achieve stretch goals with local search or resources. This raises an interesting and challenging question: Can large firms use bricolage with local search or resources to achieve stretch goals as often as small firms? In other words, does the bricolage process require an organizational culture and/​or leadership not common in large firms? We do not have any definitive answer to this question. Our hunch is that large firms do not feel the pressure of limited resources or stretch goals as strongly as small firms, so they are not pushed hard enough toward exploratory bricolage. In this sense, we can even rephrase “exploratory bricolage” as “stretch bricolage.” In sum, we believe that the concept of exploratory bricolage provides important insights into the process where resource-​constrained latecomers from China can convert or transform stretch goals into radical innovations so as to catch up with and even surpass the first-​movers from the advanced economies. We also note that implementing exploratory bricolage must be supported by a variety of managerial measures. Exploratory bricolage is essentially about using local resources to explore radically novel (thus nonlocal) solutions in the focal organization’s current business domain. Given the fact that the strategies of exploration and exploitation constitute one of the most salient organizational paradoxes (Smith & Lewis, 2011), balancing explorative search for non-local solutions versus exploitative search for local resources is highly challenging, because these two search behaviors require incompatible routines, organizational processes, and cognitive frames (Andriopoulos & Lewis, 2009; Smith & Lewis, 2011). Hence, one of the most important antecedents to exploratory bricolage is the managers’ paradoxical mindset, which enables them to embrace

640    Li, Zhou, and Yang the opposite elements as a holistic and dynamic balancing so as to engage in explorative and exploitative actions simultaneously (Li, 2012a, 2016).

Conclusion By enriching the literature on stretch goal and bricolage (Baker & Nelson, 2005; Sitkin et al., 2011), including the idea of resource-​based stretch as resourcefulness (Sonenshein, 2017), our study makes several critical contributions to the organizational learning and search literature (March, 1991; Laursen, 2012; Terjesen & Patel, 2017). Different from the traditional view of innovation, which emphasizes the importance of being creative by non-local search (Ahuja & Lampert, 2001; Rosenkopf & Nerkar, 2001), but in line with the recent findings of Kaplan and Vakili (2015) and Mastrogiorgio and Gilsing (2016), our theory highlights the importance of local search for somewhat radical innovations. Obviously, conducting innovation through non-local search is more difficult than conducting innovation via local search, because local search often relies more on redundant knowledge elements, but nonlocal search introduces new knowledge elements to the focal organization. However, non-local search has two important limitations. First, in non-local search, because the focal organization must enter into an unfamiliar domain, it is difficult to develop in-​depth domain-​specific knowledge. Second, search into distant knowledge domains tends to be costly (Ahuja & Lampert, 2001), and small and young organizations with constrained resources may not be able to afford such cost. Local search, on the other hand, requires fewer supporting resources but deeper domain-​specific understanding, so it requires the focal organization to come up with more creative or novel approaches to recombining redundant and familiar resources. Hence, the balance between local search and non-local search is an important puzzle in the innovation and organizational learning literature (Gupta, Smith, & Shalley, 2006; Lavie, Stettner, & Tushman, 2010). We propose a new way of balancing these two search strategies and argue that firms can use local resources to explore non-local solutions. By analyzing four cases, we illustrate the usefulness of our approach, especially for latecomers with a stretch goal and severe resource constraints. The core component of exploratory bricolage is creativity. We believe that exploratory bricolage, which is based on local search for non-local innovation, requires a higher level of creativity than traditional breakthrough innovation based on non-local search. Future studies may make a connection between explorative bricolage and the creativity literature (Anderson, Potočnik, & Zhou, 2014). Specifically, in the Chinese context, radical creativity is closely related to the concept of “Wu”—​intuitive imagination for insight via metaphor (Li, 2012b, 2014). The research on Wu and our concept of exploratory bricolage can be integrated in the future. Future research can also investigate the organizational enablers of exploratory bricolage. Conducting exploratory bricolage needs to be supported by organizational flexibility and agility. To break its path dependence, the focal organization needs to be agile so as to respond to the changing environment by updating assumptions, routines, and organizational processes (Sambamurthy, Bharadwaj, & Grover, 2003). Consequently, organizations must have strong dynamic capabilities (Teece, 2007; Teece, Pisano, & Shuen, 1997) to effectively engage in exploratory bricolage. Accordingly, organizational structure, governance

Puzzle of the Underdog’s Victory    641 structure, the reward system, and employee training programs need to be carefully designed to facilitate the development of dynamic capabilities and organizational learning. In addition, exploratory bricolage requires strong leadership. How to motivate human talents and coordinate their activities is one of the most critical issues of implementing exploratory bricolage. Leaders play a central role in motivating and guiding employees of the whole organization for the pursuit of a stretch goal and exploratory bricolage. As we can see in the four cases discussed, all of them faced frustrations when proposed plans failed to deliver expected performance. If such stress and frustrations cannot be managed well, such organizations will fall into a vicious spiral, and the negative effects of having a stretch goal will occur (Sitkin et al., 2011). A strong leader can serve as a motivator, a role model, and a coordinator and inspire an organization to commit itself to a stretch goal and maintain strong motivation during challenging times. In this sense, only a strong leader, often featured as transformational and anti-​fragility, can manage exploratory bricolage in an effective pattern. Last but not least, our study provides important practical implications to the entrepreneurs and managers of late-​coming companies. Although more and more recent studies attempt to understand how these firms can catch up in the technological race and compete with first-​movers and incumbents (Luo & Child, 2015; Miao et  al., 2018), we still need more theories to explain this important puzzle. By incorporating the literature of stretch goal, bricolage, and organizational search, our study offers a unique explanation of this puzzle and a useful guideline for practitioners. Our study also has several implications for future studies. First, while our case studies primarily focus on Chinese latecomers, we believe that resource-​constrained firms in other countries can also use the explorative bricolage approach to achieve stretch goals. In global competition, incumbents are often from developed countries. Thus, while a latecomer from a developing country may have a window of opportunity to implement a catch-​up strategy before incumbents’ market entries, a latecomer from a developed country may meet direct competition from incumbents at the very early stage. Thus, future studies may explore how latecomers from developed countries conduct explorative bricolage. Second, in this chapter, we analyzed small firms’ and new ventures’ explorative bricolage strategies. It is important to note that explorative bricolage also can be meaningful to large firms and incumbents. Although an incumbent is more likely to have slack resources at the firm level, some of its product teams can still face severe resource constraints. Specifically, large firms also need to conduct entrepreneurial actions, especially in the presence of environmental changes. A  large firm can face severe resource constraints when taking multiple entrepreneurial actions simultaneously. Future studies can examine how large firms adopt the explorative bricolage approach and conduct radical innovations.

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Pa rt V I I

I N N OVAT ION C A PA B I L I T Y T R A N SI T ION A N D U P G R A DI N G F OR A N I N C LU SI V E A N D SU STA I NA B L E I N N OVAT ION SYST E M

Chapter 7.1

Green Innovat i on in Chi na Ping Huang and Rasmus Lema Introduction With rapid industrialization and urbanization in the past decades, there has emerged an increasing concern about the mounting pressures related to energy security, resource scarcity, and environmental degradation in contemporary China. As a response, the Chinese government has made substantial investments in the greening of economic development. This green turn is increasingly visible in both political discourse and practice in China. The concept of ‘ecological civilization’ is now engrained as a key part of the national agenda of socialist modernization. Written into the constitution in 2018, the ‘ecological civilization’ strategy entails a series of sectoral and technological guidelines for transition and upgrading toward a green and low-​carbon economy. With respect to sustainable energy, a key set of changes were already put in motion with the Renewable Energy Law from 2005. These new policy priorities were essentially rooted in environmental imperatives. Yet, they induced technological changes and modified market conditions. Hence, these changes created ‘green windows of opportunity’ for economic structural change and new sectoral pathways (Lema, Fu, and Rabellotti 2020). As a result, in several new and renewable energy sectors (e.g., wind power, solar energy, and several emerging energy sources), China is aiming—​and in some cases beginning—​ to take the lead in terms of not only manufacturing capacity but also, more importantly, innovation capability. This chapter explores the genesis and nature of these windows of opportunity for sectoral development in renewable energy. Furthermore, it examines sectoral trajectories, including how these sectors acquired innovation capabilities and what learning mechanisms were utilized. Based on a review of these experiences in green innovation in China, we provide both broader insights into the future directions of the greening of China’s innovation system as well as a discussion of global implications.1 1  A comprehensive discussion of green transformations needs to keep a wide view to the planetary boundaries that defines the key dimensions of environmental sustainability (Rockström et al. 2009). In this chapter we focus mainly on one such planetary boundary (climate change) and its underlying techno-​economic determinants, particularly those related to sustainable energy sources. We deal only with other boundaries such as those related to air quality, freshwater supply, land use, and biodiversity where these interrelate with climate change and green energy policy and technology.

650   Huang and Lema

Green Transformation in China It is widely agreed that China is making substantial inroads in sustainable energy production and consumption. As a matter of fact, the consumption of renewable energy is growing faster than energy from fossil fuels (Wu, Zhu, and Zhu 2018), and ambitious policies have been put in place to facilitate green transformations (Tyfield, Ely, and Geall 2015). The share of fossil fuels in the Chinese energy system decreased from 77% to 64% in the 10 years between 2007 and 2016, and projections based on this trend show that it will be below 50% in another 10 years (Mathews and Tan 2017). According to the National Energy Administration (NEA), electricity generation based on fossil fuels fell from 82% to 72% in the last 10 years with significant increases in solar photovoltaic (PV), wind, and hydro energy (CEP 2018; NEA 2017a). In terms of industry capacity, China has become the world’s largest producer of wind turbines, photovoltaic panels, and, since 2015, electric cars and buses (Binz and Diaz Anadon 2016; CWEA 2016; Organisation for Economic Cooperation and Development/​International Energy Agency [OECD/​IEA] 2016). Moreover, in the last several years, China has been the largest investor in research and development (R&D) in green technologies (Frankfurt School-​UNEP Centre/​BNEF 2017). It is hence plausible to assume that China will be a frontrunner in green technologies. As one of the largest countries in the world in terms of population and geographic size, but also increasingly gross domestic product (GDP), China provides a large experimental field allowing for different green sectors to be developed. In green sectors, the levels of public policy interventions, regulations, and financing have far exceeded those that are typical of other industries, even in China. Green technology innovation paths have been characterized by government creation of demand (e.g., subsidies in the form of feed-​in tariffs [FITs]), creation of legitimacy for novel technological pathways, and supply-​side support (Binz et al. 2017; Chen and Lees 2016; Liu and Liang 2013). These go beyond typical catch-​up policies such as technical regulation and market entry barriers to foreign incumbents (Altenburg and Rodrik 2017; Zhang et al. 2017). Internationally, China is moving to the forefront of the green transformation. In 2016, China ranked first in annual investment in renewable power and fuels, followed by the United States, the United Kingdom, Japan, and Germany (Appavou et al. 2017). Seen from technologies, investments concentrate on solar and wind energy but also include a range of less mature renewable energy sources.2

Renewable Energy and Sustainable Development There is worldwide attention on environmental innovation, with concepts and political agendas centered on green growth, low carbon development, and transition to sustainability. Central to these concepts is addressing the tensions between the environment and the incumbent (unsustainable) economic regime. Achieving a green economy, therefore, requires the coupling of economic growth with controlled carbon emissions and enhanced 2  The

focus on wind and solar PV is not specific to China. According to recent statistics by the International Renewable Energy Agency (IRENA), between 2013 and 2016, investment in solar and wind energy accounted for an average of 90% of total private investment (IRENA and Climate Policy Initiative 2018), indicating greater market maturity of solar and wind energy than other renewable technologies.

Green Innovation   651 energy and resource efficiency. This means the reorientation of investments to greener industries and businesses, which relies largely on green technological innovation and the creation of new sectors (Borel‐Saladin and Turok 2013). The transition to sustainability consists of “long-​term, multi-​dimensional, and fundamental transformation processes through which established socio-​technical systems shift to more sustainable modes of production and consumption” (Markard et al. 2012, 956). Given the relative immaturity, such transition typically relies on the scaling up of innovative “niches” in green technologies (Geels 2007). Hence, the rolling out of green technologies typically involves protected experimental and learning spaces for the nurturing and empowering of innovations. Renewable energy technologies have followed such paths in many countries, promoted as sustainable solutions for the incumbent fossil fuel–​based energy system. This chapter addresses the problem of transition to sustainable energy sources and innovative solutions in China. It shows how the Chinese response to the sustainable challenge has depended on both “hard” (technological) and “soft” (institutional) innovations. The cornerstone in the transition of the Chinese energy system from black to green energy sources is diffusion of renewable energy technology. Whereas neo-​classical economics typically adopt a clear separation between “innovation” and “diffusion” and treat the two as distinct processes, this chapter is rooted in the tradition of innovation studies and does not adopt such a distinction. Diffusion is treated as an innovative process in its own right. This is not to say that problems and solutions in (1) development and manufacturing of green energy technology and (2) deployment of green technology are the same.3 However, both are innovative processes, and both depend on hard and soft innovations. As this chapter shows, the combination of hard and soft innovations was key to the inroads made in sustainable energy production and consumption in China. The chapter is organized as follows. The next part of the chapter seeks to draw the bigger picture emphasizing both the environmental challenges and the policy responses initiated by the central, provincial, and urban governments. After that the chapter focuses on renewable energy and, after providing an overview, provides insights from the trajectories of key renewable energy technologies. The final section discusses the wider global implication of China’s mounting innovation capacities in green technologies, in terms of both global competition and collaboration in renewables.

China and the Green Economy This section provides context and background on the buildup of China’s green economy. Today, China produces and consumes more renewable energy than any other country in the world. Together, hydro, wind, and solar power now feed 1.618 trillion kWh into the electricity system (CEC 2017) and accounted for 11.7% of the total energy supply in 2017. It should be noted, however, that 70% of renewable power at present is supplied by hydroelectricity, which accounts for 8.3% of China’s total power supply, while renewables (solar, wind, biofuel) provide 3.4%. Nuclear power provides an additional 1.8% of total energy—​almost as much as renewables (excluding hydro). The share of carbon-​based energy has been dropping but in 2017 still accounted 3 

On the contrary, Lema (2016) showed that distinct value chains and institutional frameworks exist for manufacturing deployment of renewable energy.

652   Huang and Lema for over 86.4% of the country’s total energy output (with coal the major source). Projections by BP to 2040 expect carbon-​based sources to drop to 66% of the total, as renewables grow to 18% of total output, nuclear grows to 8%, and hydro drops to 8%. After an initial period of rapid growth based on consumption of fossil fuels, China has now started to set targets and invest substantially in low-​carbon development. These form part of the sustainability-​oriented innovation systems (Altenburg and Pegels 2012; Lema, Iizuka, and Walz 2015), both at the central government level and at the decentralized provincial government level.

Drivers and Pressures for Green Innovation In the past decade, China has made remarkable achievements in the development of renewable energies. China’s “green” turn is a response to a number of challenges that have become increasingly evident and acute after three decades of rapid economic growth and urbanization. Since the economic reform in the late 1970s, China’s top national priority has been economic development and poverty alleviation, while environment issues were considered less important. Due to long-​term and large-​scale application of less environmentally friendly technologies in industries, environmental issues are getting so severe that they can no longer be ignored by both politicians and the Chinese people. For instance, the well-​known heavy smog in Beijing and many other mega cities represents serious air pollution, which nowadays manifests most frequently as regional atmospheric environment problems from inhalable particulate matter (PM10) and fine particles (PM2.5) (State Council [SC] 2013). In 2016, the air quality of 78.4% cities in China was not up to standard (SC 2016). The situation is similar for other natural resources such as soil and water. Energy security is another issue. Rapid and large-​scale urbanization and industrialization have posed significant pressure on domestic energy supply. In particular, the resource-​intensive growth path China has followed for years is very inefficient in terms of energy use (Xu et al. 2018). In 2010, China surpassed the United States and became the world’s largest energy consumer and polluter. However, domestic energy resources are far from sufficient to meet the country’s huge energy demand. As a result, its energy supply is highly dependent on foreign imports. In 2017, China’s dependence on foreign oil and natural gas reached 67.4% and 39%, respectively (CNPC Economics & Technology Research Institute 2017). In combination with changing global geopolitics, the fact that China’s strategic energy resources are highly dependent on foreign imports poses serious questions on the stability of the energy supply and the country’s energy security. Furthermore, together with its increasing economic scale and importance, China is also taking greater political responsibilities on the global stage and is playing a more active role in multiple international affairs (Climate-​Group 2014). This has partly explained China’s active engagement in the global climate change discourses, especially after the United States’ withdrawal from the Paris Agreement. China has made strong commitments in tackling climate change and reducing greenhouse gas emissions, which are aligned to current priorities of the development of a green economy and fundamental transformations of the energy structure. Overall, a combination of these factors has enabled China’s “green” turn. To facilitate this process, policy initiatives at several levels of government have been put forward, supporting both technological innovation and institutional innovation.

Green Innovation   653

Central Policy Initiatives From the viewpoint of central policy strategies, starting from the 12th Five-​Year Plan period (2011–​2015), a special focus has been placed on the building of national innovation capacities. Chapters 1.1, 2.1, and 2.2 of this Handbook describe these initiatives in some detail. In 2013, the 12th Five-​Year National Independent Innovation Capacity Building Plan was published, which is China’s first national plan and guiding document for the systematic enhancement of independent innovation capacity. The main objectives were to construct innovation infrastructures, build innovation partnerships, cultivate innovation talent, and improve the innovation environment. This strategic policy emphasis on innovation capacity building is further strengthened in the 13th Five-​Year Plan for National Scientific and Technological Innovation. Specifically, for green innovation in the energy sector, two important documents were promulgated: the Energy Technology Revolution Innovation Action Plan (2016–​2030), released in March 2016, and the 13th Five-​Year Plan for Energy Technology Innovation, released later in December 2016. These two documents have put forward specific aims, measures, and initiatives for advancing technological innovation in the energy sector. Table 7.1.1 shows the 15 areas for technological innovation highlighted in the action plan. Clear roadmaps for innovation in each area are also provided, which generally consist of three stages, namely research on tackling key problems, experimentation and demonstration, and diffusion and application. Along with all this clear and strong guidance on clean energy technologies, a large amount of public R&D investments is flowing into these fields. For example, the National Key R&D Program of China—​the newly integrated national R&D program (reintegration of the 863 and 973 Programs)—​has been focusing on clean coal, new energy vehicles (NEVs), green building, and the smart grid (see Table 7.1.2 for the latest investment expenditures).

Table 7.1.1 Fifteen Key Areas for Energy Technology Innovation 1. Coal mining risk reduction 2. Unconventional, deep, and deep-​sea oil and gas extraction 3. Clean and efficient coal technologies 4. Carbon capture and storage 5. Advanced nuclear power 6. Spent fuel reprocessing and radioactive waste disposal 7. High-​efficiency solar power technologies 8. Large-​scale wind power 9. Hydrogen and fuel cell technologies 10. Biomass, ocean, and geothermal power 11. High-​efficiency gas turbine technology 12. Advanced energy storage 13. Key grid modernization technologies 14. “Energy internet” technologies 15. Energy-​saving and energy-​efficient technologies Source: Energy Technology Revolution Innovation Action Plan (2016–​2030).

654   Huang and Lema Table 7.1.2 R&D Investments in Clean Energy

Technologies from the National Key R&D Program of China R&D Investment (Million CNY) Technology

2017

2018

Clean coal New energy vehicle Green building Smart grid

575 1120 430 486

423 900 320 463

Table 7.1.3 Renewable Energy Targets in the 13th Five-​Year Development Plan

for Renewable Energy (2016–​2020)

Renewable Energy

2020 Target

2015 Level

Annual consumption of renewable energy (million tce) Percentage of non–​fossil fuel in primary energy consumption (%) Installed capacity of hydropower (GW) Installed capacity of grid-​connected wind power (GW) Installed capacity of solar PV power (GW) Annual consumption of solar water heaters (million m2)

730  15 340 210 105 800

512.48 12 319.54 129 43.18 440

In addition to the building of innovation capacity, China has also made long-​term efforts to boost the deployment of renewable energies. A landmark in the course of China’s renewable energy development is the Renewable Energy Law (REL) passed in 2005, which has established four key mechanisms to promote the growth of renewable energy in China, including a national renewable energy target and central and local renewable energy development and utilization planning, a mandatory connection and purchase policy, a national FIT system, and a cost-​sharing mechanism and a special fund for renewable energy development (Schuman and Lin 2012). Under the institutional system established by the REL, mid-​and long-​term targets for renewables are provided in development plans. For instance, in 2007 the State Council released the Mid-​and Long-​Term Development Plan for Renewable Energy, with targets of increasing the share of renewable energy in primary energy consumption to 10% by 2010 and 15% by 2020. The most recent targets were provided in the 13th Five-​Year Development Plan for Renewable Energy (2016–​2020), which was released in January 2017. Table 7.1.3 provides an overview of the targets set in the newly released development plan. Besides the overall renewable energy plan, development plans for specific energies are also promulgated for the period of the 13th Five-​Year Plan, as shown in Figure 7.1.1.

Green Innovation   655 The 13th Five-Year Development Plan for Renewable Energy (2016–2020) 13th FYP for Hydro Power Development

13th FYP for Wind Power Development

13th FYP for Solar Power Development

13th FYP for Bioenergy Development

13th FYP for Geothermal Energy Development

Figure 7.1.1  China’s renewable energy planning system during the 13th Five-​Year Period. To achieve the intended targets by 2020, multilevel governments have enacted a series of regulatory policies and financial incentives to advance the application of renewable energies. FIT is one of the most commonly used regulatory policies to stimulate investment in renewable energies. FIT requires grid companies to buy electricity from renewable generators at certain government-​specified prices (Intelligent Energy Europe 2011). This scheme ensures that more expensive renewable generation sources are profitable to investors. China has adopted a FIT scheme for different types of renewable energies, including wind, solar PV, and biomass (Schuman and Lin 2012). The FIT scheme has provided substantial incentives for investors and promoted the development of renewable energies at early stages (Tang et al. 2018). However, with rapid growth of the installed capacity of renewables (particularly wind and solar PV), the policy failed to effectively channel the consumption of renewable power, and serious problems of wind and solar energy curtailment emerged (He et al. 2015). Against this background, the government has started to consider other complementary policies, such as the renewable power quota system (also called the renewable portfolio standard, RPS). The renewable power quota system requires generators, grid companies, and multilevel municipalities to meet certain targets in the use of renewable power sources. China first introduced the system in 2007 in the aforementioned Mid-​and Long-​Term Development Plan for Renewable Energy, and the measure was further specified in the Regulations for Management of Renewable Power Quotas (Opinion-​Soliciting Draft) in 2012 (Lo 2014). The later document provided renewable power targets for 2015 for the 14 largest generators in China, four grid companies (State Grid, Southern Grid, Inner Mongolia Power Grid, and Shaanxi Provincial Power Grid), and provinces (including four provincial-​ level municipalities) (Schuman and Lin 2012). Unfortunately, this opinion-​ soliciting draft encountered strong opposition from many provincial governments. After a long process of negotiation between different stakeholders, a new draft of renewable energy quota regulation was released by the government in March 2018, the Renewable Power Quota and Assessment Method (Opinion-​Soliciting Draft). In this document, mandatory provincial-​ level quotas of renewable electricity for 2018 and 2020 were assigned to electricity users such as grid companies and electricity retail companies (Chinadialogue 2018). The renewable power quota system officially came into force in 2019. Besides regulatory policies, multiple financial incentives have also been provided, including grants, subsidies, public investment, and tax credits. In REL, a Renewable Energy Development Special Fund was established to support the development of renewable energies. In November 2005, the National Development and Reform Commission (NDRC) announced the Guiding Catalog for Industry of Renewable Energy, in which it specified 88

656   Huang and Lema development and manufacturing programs in six areas to be subsidized by the government, including wind, solar, biomass, geothermal, marine, and hydro energy (Shen and Luo 2015). Operating along with the FIT system, subsidies were provided in the form of a renewable energy electricity surcharge paid by the government as subsidies. Originally in 2006, the NDRC set the renewable electricity surcharge at 0.001 RMB/​kWh (Lo 2014), which was increased to 0.019 RMB/​kWh in 2016 (NDRC 2015). Direct subsidies were provided through initiatives such as demonstration programs. For instance, to support the solar PV industry, the Golden Sun Demonstration project was launched in 2009, which provided 50% of the total cost for on-​grid systems and 70% for off-​ grid systems in rural areas (Lo 2014). In addition, tax-​preferential policies were applied to biomass energy, wind power, and solar PV. For instance, for solar PV, the Ministry of Finance (MOF) published Announcement of Value-​Added Policies for PV Generated Electricity in 2013, in which it was specified that a taxpayer who sells electricity generated by his or her own PV power plant will get a 50% discount in value-​added tax (Shen and Luo 2015).

Urban Energy Transition Initiatives Provincial governments are also key drivers of energy transitions, on both the production and the consumption side. On the consumption side, large cities, which are under the jurisdiction of provincial governments, are at the frontier for forging low-​carbon and sustainable transitions, and they possess tremendous potential as “innovation hubs” toward sustainability (Castán Broto and Bulkeley 2013; Ernstson et al. 2010). Recent years have seen the proliferation of urban experiments in Chinese cities. The well-​ known Sino-​Singapore Tianjin Eco-​City, for instance, was launched early in 2007 and was considered a relatively successful model for low-​carbon urban development (Chang et al. 2016). The aim for this city is for renewable energy to account for at least 20% of the energy utilized. With sustainable development becoming a national priority, governments at several levels have provided both financial and institutional support for urban experimental initiatives. In particular, local governments, under pressure from higher-​level governments, have demonstrated strong incentives and are open to many newly emerging technologies. However, accomplishing an urban energy transition involves nontrivial processes of material adjustment through which new governance arrangements are fitted to the actual landscape of intervention (Castán Broto 2015). Urban energy transition is a multifaceted process that entails the engagement of multiple urban actors and interacts closely with local economic and socio-​spatial contexts. For instance, on the one hand, urban development priorities might define local governments’ decisions regarding transition pathways; on the other hand, the decarbonization of the urban energy system would inevitably reconfigure urban infrastructure and reshape residents’ social practices (Huang et al. 2018b). Therefore, the dominance of a top-​down approach in China’s energy transitions might result in a lack of diversity, openness, and inclusiveness, which are imperative for the thriving of urban experimentation. A typical example is the mandatory implementation of building-​integrated solar thermal (BIST) systems. Since 2005, under the ambition of accelerating the low-​carbon energy transition process, mandatory installation policies for BIST systems have been enforced in many Chinese cities. However, the outcome was mixed. In many cities, it was reported that installed BIST

Green Innovation   657 systems were left unused, mainly due to a mismatch between local contexts (e.g., building orientation and residents’ energy use habits) and the targeted technology (Huang et al. 2018a). This indicates that top-​down policy measures might bear more risks of and higher costs for transition failure, and it is imperative for political visions to fit into local contexts to induce real changes. Seen from this viewpoint, local governments need to play a more active role in urban energy transitions, because they have sufficient information to identify technologies best suited to local contexts. Meanwhile, national strategies from the central government that give local governments more autonomy and allow for a more context-​ based technological selection could be more effective.

Building Innovation Capabilities in Renewables There are substantial pressures and ambitious initiatives for greening the economy in China. Whereas the prior section sought to shed light on motivation and initiatives, this section aims to show how these drivers and pressures translate into renewable energy diffusion on the ground. We start by providing an overview and then move into specific sectors of renewable energy technology.

The Significance of China in Renewables China has made remarkable achievements in both consumption and production of renewable energies, and the country is aiming to become a global technology leader, particularly after the United States announced its decision of withdrawing from climate change initiatives. International organizations such as the IEA predict that China will continue to lead the world in renewable energy development (Institute for Energy Economics and Financial Analysis [IEEFA] 2017a). Under influential policy initiatives, financial resources have been channeled into the industry. As shown in Figure 7.1.2, China’s new investment in renewable energy exceeded that of both the United States and Europe in 2013. Despite a significant fall in 2016, China still leads in renewable energy investment, making up 32.4% of global new investment. China not only is the world’s largest domestic investor in renewable energy but also is positioning itself as a global leader in overseas clean energy investment, operating along with the country’s “Belt and Road” initiative (IEEFA 2017b). China dominates the global growth in renewables. In 2016, it surpassed the United States to become the largest producer of renewable power. The total renewable installed capacity of China reached 570 GW, with hydro power, 332 GW; wind, 149 GW; solar PV, 77 GW; and bioenergy, 12 GW (NEA 2017b). In 2016, the total global renewable capacity addition amounted to 165 GW. China, with new installations of about 68 GW, accounted for approximately 41% of total global renewable capacity additions (IEEFA 2017a). Figure 7.1.3 shows power generation from renewable sources (including wind, geothermal, solar, biomass, and waste) from 2007 to 2017. China has made significant progress in the

658   Huang and Lema 140 120

(Billion USD)

100 80 60 40 20 0

2006

2007

2008

2009

2010

United States

2011 Europe

2012

2013

2014

2015

2016

China

Figure 7.1.2  Renewable energy new investment of the United States, Europe, and China (2006–​2016). Source: Bloomberg New Energy Finance

180 160

(Million toe)

140 120 100 80 60 40 20 0

2007

2008

2009

2010

2011

United States

2012 Europe

2013

2014

2015

2016

2017

China

Figure 7.1.3  Renewable energy consumption in power generation (not including hydropower) of the United States, Europe, and China (2007–​2017). Source: BP (2018)

Green Innovation   659 Table 7.1.4 China’s Share of First Filings of

Selected Renewable Energies (1975–​2011) Percentage (%) Technology

1975–​2005

2006–​2011

Solar thermal Solar PV Wind energy Biofuels

18 2 9 8

57 23 41 46

Source: World Intellectual Property Organization (WIPO).

utilization of renewable energies, from merely 3.5 million tons of oil equivalent (toe) in 2007 to 106.7 million toe in 2017 (BP, 2018). China’s share in global consumption increased from 3.27% in 2007 to 21.92% in 2017. Statistics show that China is increasingly taking a leading role in renewables. Rapid expansion of the renewable energy sector not only is a result of massive government financial support and extensive regulatory measures but also relies on China’s increasing innovation capacity in many renewable technologies, such as solar PV and wind. Since 2000, a substantial amount of science and technology funding in China has been devoted to the renewable energy sector (Huang et al. 2012). A growing number of clean energy research centers are being established, and more funding is provided for the R&D of early-​stage and high-​risk new energy technologies. Technology innovation capacity is key in increasing China’s global competitiveness and securing China’s leading role in the renewable energy technology sectors. With strong governmental push for technological innovation, the past decade has seen growing innovation capacities in a variety of green sectors in China. Table 7.1.4 shows China’s share of first filings of patent applications for four renewable energies. Before 2005, China possessed relatively weak innovation capacities within the sectors of the four technologies, while from 2006 to 2011, China’s patent applications significantly increased, making it the country with the most patents in solar thermal, wind energy, and biofuels (Helm et al. 2014). Taking biofuel as an example, before 2001, there were fewer than 10 biofuel inventions annually in China, while in 2011, the number increased to 931 (Albers et al. 2016).

Wind Energy Since 2009, China has been the largest market for wind power in the world. Over almost 10 years, it has maintained its leadership position in installations. Figure 7.1.4 shows the new and cumulative installed capacity of wind energy in China from 2006 to 2016. In 2017 China installed an additional capacity of 19 GW of wind energy and continues its position

660   Huang and Lema 180000 160000 140000

(MW)

120000 100000 80000 60000 40000 20000 0

2006

2007

2008

2009

2010

New installed capacity

2011

2012

2013

2014

2015 2016

Cumulative installed capacity

Figure 7.1.4  New and cumulative installed capacity of wind energy in China (2006–​2016) Source: Chinese Wind Energy Association

250

(TWh)

200

150

100

50

0

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Electricity generation from wind

Figure 7.1.5  Electricity generation from wind energy in China (2006–​2016) Source: China Electricity Council

Green Innovation   661 as the world’s wind power leader, with a cumulated wind capacity of 188 GW (GWEC 2016; WWEA, 2018). Figure 7.1.5 presents the trend of electricity generation from wind energy in China, in which a significant and steady increase can be observed. To understand the reasons for such an achievement in wind, it helps to observe how China was able to increase its share of the global market. Here one can distinguish four sources of wind energy competitiveness that need to be distinguished individually but that also significantly reinforce each other (Schmitz and Lema 2015). The first is the strength of the home market. The Chinese government—​understandably concerned with energy security—​has fostered the production of renewable energy. The REL of 2005 was the central piece of legislation. Along with other complementary policies, it helped to create a rapidly expanding internal market for wind power. Foreign enterprises were not prevented from competing in this market, but Chinese enterprises were favored, receiving government support through various means, some visible (e.g., local content requirements in place during 2005–​2009) and others less visible (e.g., the difficulty encountered in attempting to win via competitive bidding for state-​funded projects). Since the Chinese market was large and fast growing, success in this market had a major impact on global market shares (Lema, Sagar, and Zhou 2016). The second source of Chinese competitiveness is producer power. The large size and rapid growth of the Chinese market enabled Chinese turbine manufacturers to adopt a model of industrial organization geared toward economies of scale. A turbine is a complex product typically consisting of over 10,000 parts. While leading European firms—​such as Vestas of Denmark and particularly Enercon of Germany—​produced many of these parts in-​house (seeking to constantly improve design and quality), their Chinese counterparts relied much more on buying components from suppliers that also supplied other turbine makers and were thus able to achieve economies of scale and reduce costs. The third source of competitiveness is financing power. This is as yet little explored in the literature but is of increasing importance. The essential point is that Chinese firms can offer supplier credit, but this is much more difficult for Western firms. This matters greatly for their customers since investment requirements for wind farms are high and timeframes are long. Project finance may become particularly important for competing in export markets. Compared with their Western counterparts, Chinese companies have deep financial pockets. Sinovel, for example, has a US$6.5 billion line of credit from government-​owned banks (Schmitz and Lema 2015). China Exim Bank has injected capital into Goldwind and Ming Yang to support foreign expansion. Such support opens up the possibility of an export model that has not been directly utilized by European firms—​the twinning of wind farm project finance and turbine exports. Many new projects undertaken abroad by Chinese turbine firms have been implemented with tag-​along finance. The fourth source of competitiveness is innovation power. The extent of China’s buildup of innovation capabilities in wind energy is contested and difficult to specify with precision. Some analysts question China’s ability to get high-​utilization efficiency out of their turbines (Physicsworld 2018), and critics point out that key innovations such as Goldwind’s permanent magnet direct-​drive (PMDD) technology was in fact invented by Goldwind’s German subsidiary, Vensys. Although it is clear from patent analysis that Chinese turbine firms have less advanced innovation profiles than do their European and North American counterparts (Zhou et al. 2016), it is clear that the pace of learning is unprecedented, with

662   Huang and Lema advances from production to innovation capabilities within a 10-​year time span (Hansen and Lema 2019).

Solar Photovoltaics In the solar PV industry, the local Chinese market became important only more recently. This industry started out as an export-​oriented industry, and by “learning from exporting,” Chinese producers have moved from supplying components to building complete solar panels in a short time span. By the late 2000s they undercut European and American producers, leading to major job losses and prompting a trade war (Fischer 2012). China has caused major disruption and driven down costs in the solar panel industry, but the dynamics were different from how the wind sector evolved. Here Chinese firms managed to build up producer power by catering to the world market; initially the domestic market—​and reducing greenhouse gas emissions domestically—​played less of a role. Solar PV production was driven by exports during industry take-​off. Exports enabled China to emerge as the new leader (replacing the European Union) in producing solar PV equipment (Fischer 2012; Lema, Fu, and Rabellotti 2020). However, in contrast to the wind sector, in which Chinese manufacturers still produce predominantly for the Chinese market, the Chinese PV sector has emerged partly on the basis of policy support for solar energy deployment schemes outside China, mainly in Europe. The development of China’s PV sector originated from the production of PV cells and modules. By focusing on these elements, enterprises concentrated on the steps in the PV value chain where they had competitive advantages due to low labor costs, economies of scale, and comparatively weak environmental standards applied to production processes. The development of the Chinese PV sector and exports to key markets have also been facilitated by modularization and comparatively low transportation costs. In China, government support for these activities was driven by local economic considerations and was similar to support given by local governments to other export-​ oriented industries (Iizuka 2015). Support schemes for the use and deployment of PV energy technology in China evolved during the global financial crisis when export-​oriented producers of PV cells and modules faced falling external orders, particularly in Germany. Hence, when the central government started to support PV energy use within China in 2009, the Chinese PV industry was already a highly capable producer and a fierce competitor in global markets. Figure 7.1.6 and Figure 7.1.7 show increasing applications of solar PV energy in China since around 2009.

Solar Thermal Energy China has been leading in the global solar thermal market (Islam et al. 2013). At the Copenhagen Conference in 2009, Premier Wen Jiabao referred to China as leading the world in the application of solar water heaters. In 2015, China accounted for 71% of the total installed capacity in the world, followed by the United States (4%), Germany (3%), and Turkey (3%) (Weiss et al. 2017). Figure 7.1.8 shows the annual output and total installation area of solar water heaters in China from 1998 to 2016.

Green Innovation   663 80000 70000

(MW)

60000 50000 40000 30000 20000 10000 0

2008

2009

2010

2011

New installed capacity

2012

2013

2014

2015

2016

Cumulative installed capacity

Figure 7.1.6  New and cumulative installed capacity of solar PV in China (2008–​2016). Source: European Photovoltaic Industry Association, National Energy Administration of China

70 60

(TWh)

50 40 30 20 10 0

2010

2011

2012

2013

2014

2015

2016

Electricity generation from solar PV

Figure 7.1.7  Electricity generation from solar PV in China (2010–​2016). Source: China Electricity Council

664   Huang and Lema 50000 45000 40000

(104m2)

35000 30000 25000 20000 15000 10000 5000 0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Annual output

Total installation area

Figure 7.1.8  Annual output and total installation area of solar water heaters in China (1998–​2016). Source: Solar Vision

The driving factors behind China’s dominance in the global solar thermal market are multiple. First, during the early-​stage path creation, key indigenous innovations made large-​scale industrial production of solar water heaters possible. In combination with huge domestic demand for hot water use, a niche market was successfully opened up. In 1984, Professor Zhiqiang Yin at Tsinghua University patented the evacuated glass tubes, marking the beginning of large-​scale industrial production of water-​in-​glass evacuated tube solar water heaters in China. Since then, the market has experienced a steady increase. Second, leading enterprises of solar water heaters place technology innovation at the center of their development strategy and devote substantial financial and labor resources to R&D activities. In addition to R&D capacity building within the enterprise, cooperation with research institutes and universities is another important mechanism for the establishment of innovation capacity. For instance, in 2007, a research center was jointly established by Linuo Paradigma, a leading solar thermal enterprise in China, and Tsinghua University. Later in 2010, another solar research institute was jointly formed by Linuo Paradigma and Shanghai Jiao Tong University. Cooperation between enterprises and universities can advance the R&D of solar thermal technologies. It is estimated that Chinese enterprises patented more than 95% of global solar water heater technologies (Chinadialogue 2014). Third, government support played a significant role in further deployment of solar water heaters in both rural and urban China. In 2009, solar water heaters were included in the national Home Appliances to the Countryside (HATC) Scheme, which aimed to use the unexplored rural market to offset the impacts brought on by the 2008 global financial crisis, through providing rural residents government-​subsidized home appliances. Under the HATC scheme, a large rural market was opened up. On the other hand, starting from 2005, mandatory policies for the installation of solar water heaters in buildings have been enforced in many Chinese cities. Initially implemented in low-​or multistory buildings, the mandatory policy was later extended to high-​rise buildings, which opened up a new

Green Innovation   665 market segment for solar water heaters, namely the “construction project market” (Huang et al. 2018b). Contracts are often directly signed between real estate developers and manufacturers to install solar thermal products for a whole newly built neighborhood. The mandatory policy has boosted market expansion in urban areas. However, many problems emerged. For instance, to meet the government’s requirements while at the same time controlling construction costs, many real estate developers chose to purchase low-​cost, low-​ quality solar water heater products, leading to bad user experiences and thus jeopardizing the healthy development of the industry as a whole (Yu and Gibbs 2018).

Bioenergy Bioenergy refers to energy generated from the conversion of solid, liquid, and gaseous products derived from biomass. Biomass is organic matter available on a renewable basis, such as feedstock derived from animals or plants and organic waste from municipal and industrial sources (IEA 2017). In China, the use of biomass resources was officially encouraged in the REL in 2005. Bioenergy has been applied in various sectors including electricity generation, transportation, and heating. Currently, the biomass power industry and the liquid biofuel (mainly bioethanol and biodiesel) industry have reached a significant scale, while the biofuel industries such as biomass briquettes are still in the early stages of development. China has a long history of biofuel innovation and utilization. As early as the Eighth Five-​Year Period (1991–​1995), some research institutes started to conduct experiments on biodiesel (Yuan et al. 2009). Later, during the 10th Five-​Year Period (2001–​2005), biodiesel technology was included in the National High Technology R&D Program of China (863 Program) funded by the Ministry of Science and Technology (MOST). In 2006, the NDRC established approximately 30 demonstration projects for bioenergy technology nationwide. In the 12th Five-​Year Development Plan for Biology Technology and the 13th Five-​Year Special Plan for Biology Technology Innovation published by the MOST, bioenergy technology was listed as one of the key strategic areas. The focus was placed on supporting and promoting the R&D of key bioenergy technologies such as nongrain fuel ethanol, biodiesel, and biogas, as well as of specialized equipment for production processes of bioenergy products (Chen et al. 2016). Two national R&D centers, the National Energy R&D Center for Liquid Biofuel and the National Energy R&D Center for Non-​food Biomass, were established in 2010 and 2011, respectively. In October 2016, the NEA announced the 13th Five-​Year Plan for Bioenergy Development. Specific targets were set for the development of different biofuels till 2020 (Table 7.1.5). For instance, the total installed capacity of biomass power is expected to reach 15 GW, and the annual production of liquid biofuel 6 million tons. To promote the application of bioenergy, the Chinese government has resorted to various policy instruments, including subsidies and tax reduction. For instance, since 2010, new agricultural and forestry biomass power generation projects can benefit from the FIT of 0.75 RMB/​kWh. Similarly, subsidies have been provided for bioethanol production. In 2012, the amounts of subsidy for the grain ethanol and nongrain ethanol were, respectively, 500 RMB/​ton and 750 RMB/​ton. Government support has significantly driven the diffusion of bioenergy technology and the expansion of the biofuel industry. However, a number of challenges exist, such as low levels of specialization and marketization for biomass briquette

666   Huang and Lema Table 7.1.5 Targets of Bioenergy Development in China by 2020 Bioenergy

2020 Target

2015 Level

Biomass power installed capacity (GW) Biomass briquette annual consumption (million ton) Bioethanol annual production (million ton) Biodiesel annual production (million ton)

15 30 4 2

10.3 8 2.1 0.8

Source: 13th Five-​Year Plan for Bioenergy Development.

and biogas technology and a lack of comprehensive standards such as testing and certification standards.

Emerging Renewable Energy Sectors In addition to conventional renewable energies such as wind and solar, China is also exploring new territories in other new energy technologies. A must-​mention technology is the NEV. According to the State Council of China, NEVs include plug-​in hybrid electric vehicles, battery electric vehicles, and fuel cell vehicles. As early as the Eighth Five-​Year Plan (1991–​1995), the Chinese central government started to support the development of NEVs in China. Ever since, the implementation of the NEV industry is articulated in many national plans and strategies. Targets have been set for each phase of technology development from basic R&D and applied R&D to demonstration and commercialization. After nearly three decades, China has established a relatively comprehensive technological system, with more than 3,000 patents and 30 energy-​saving and NEV technology innovation platforms (MOST 2012). The rise of leading NEV enterprises such as BYD demonstrated China’s increasing technology capacity. NEVs produced by BYD are nowadays running in more than 200 cities in 48 countries, including Japan, the United States, and the United Kingdom (IEEFA 2017b). China has also made significant progress in smart grid development. In China’s 13th Five-​ Year Plan for Power Sector Development (2016–​2020), accelerating the development of the smart grid is specified as a main task. Smart grid is also listed as one of the major projects in the Science and Technological Innovation 2030. The period between 2011 and 2015 was a stage of comprehensive construction of the smart grid (H3C 2010), led by major power grid corporations. By the end of 2014, the State Grid Corporation of China (SGCC) had initiated 358 smart grid projects, of which 305 projects had been completed (State Grid 2017). In the next stage, China aims at further improvement of the smart grid system, including the development of smart power transmission and transformation technology and improvement of grid connection and integration technology for large-​scale renewable energy resources (Han et al. 2017). The building sector is another focal area. In the 12th Five-​Year Plan for Economic and Social Development, the development of green building was first formally proposed (Zhang et al. 2018). In 2017, the 13th Five-​Year Plan for Building Energy Efficiency and Green Building

Green Innovation   667 Development was published, in which it requires that by 2020 50% of all new urban buildings will be certified green buildings. Till the end of 2015, the total construction area of green building in China exceeded 0.47 billion m2. China has paid special attention to the improvement of the innovation capacity in green building and the government has supported many scientific projects on green buildings. The technology of energy-​saving building is also a major focus in the 13th Five-​Year Plan on Scientific and Technological Innovation. Partnerships have been formed with countries such as United States that possess more advanced technologies in the area (Ministry of Housing and Urban-​Rural Development [MHURD] 2017). Compared to other technologies, the development of concentrating solar power (CSP) is relatively new in China. CSP refers to technologies that “use mirrors to focus and concentrate sunlight onto a receiver, from which a heat transfer fluid carries the intense thermal energy to a power block to generate electricity” (US Department of Energy, 2014, 34). Although CSP was listed as a key and prioritized technology in both the Summary of National Mid-​& Long-​Term Science and Technology Development Plan (2006–​2020) and the Mid-​and Long-​Term Development Plan for Renewable Energy, China is still in the early stage of CSP commercialization. Till the end of 2012, merely 6 demonstrative CSP stations had been constructed, 3 stations were under construction, and 14 other projects were under preparation (State Grid Energy Research Institute [SGERI] 2013). In September 2016, the NEA announced the Notice on the Construction of Solar Thermal Power Demonstration Projects. This notice marked the beginning of large-​scale demonstration of CSP projects in China, and in the first round 20 projects were selected as national demonstration projects. However, the implementation of these projects did not go smoothly, and four were eventually terminated (Economic Daily 2018). To address the situation, in May 2018, the NEA further released the Notice on Promoting the Construction of Solar Thermal Power Demonstration Projects, extending the deadline for completion of demonstration projects from the end of 2018 to the end of 2020 and establishing a claw-​ back mechanism for subsidized electricity prices. Overall, the development of CSP is still at an early stage in China. The success of national demonstration projects would be key for commercialization of this technology and the channeling of private financial resources.

Conclusion: Green Innovation in China China has become a major actor in global green transformation. This chapter set out to address the buildup of green innovation capabilities in China. The emphasis was on hard and soft innovation processes involved in the diffusion of renewable energy and their genesis in changing institutional frameworks. The second section examined central and provincial-​level policy initiatives that are key to the diffusion of renewable energy. The main point is that green innovation in China was not just a technological innovation. Equally or even more important were the policies and regulations that created incentives and opportunities for renewable energy generation, distribution, and consumption. On the demand side, these included subsidies (FITs) and mandatory purchase regulations; on the supply side, they included dedicated R&D funds for renewable technology, not least through the national funding programs for supporting

668   Huang and Lema the activities of universities and research institutes in renewable energy development and demonstration projects. China has had unique opportunities to implement highly effective sustainability-​oriented innovation systems. Undoubtedly, China’s version of directed capitalism is an advantage in the current situation where the green transformation is dependent on government action to make emerging renewable energy technologies competitive with fossil fuels. But just as China’s rapid growth cannot be attributed to state capitalism alone (Fu 2015), nor can the recent advances in renewable energy diffusion. As shown in this chapter, the process had multiple drivers that combined for rapid advances; they included government policy and investment, investment by various types of enterprises (state-​owned and private; local and global), and knowledge generation and sourcing from both local and global knowledge pools. The third section substantiated these points. It sought insights from sectoral experiences and showed how (soft) policy learning and innovation were countered by and combined with (hard) technological innovation in enterprises. This led to the development of new products and services, based on internal investments in R&D combined with external sources of learning, such as licensing, acquisition of machinery, consultancy services, etc. With local technological effort and government support, including local content requirements on foreign firms operating in China, local firms have made a significant and successful entry into the sector and its subsequent upgrading (Lema and Lema 2012). It is crucial, however, that such hard innovation capabilities were implemented not only at the level of the core technology (solar water heater, solar PV panel, or wind turbine) but also at the wider level of deployment (i.e., in installation, systems integration, operation, and maintenance). In other words, this chapter has also emphasized capabilities not only for “innovation” in green energy sectors but also for “diffusion” of the outputs into the economy. The discussion of specific sectors explains the differences in the local demand and the responses that arose as a result—​influenced by the context of market demand and government policy. Consistent with that perspective, we explain the impetus to innovate as well as the factors influencing diffusion across the country. In sum, this chapter—​like other chapters in this Handbook—​has emphasized the importance of China’s innovation system in developing its innovation capabilities. The interplay between supply and demand has been a key force in the creation of China’s industry-​wide innovation system since the opening of the market economy in the late 1970s. Demand grew very fast after the opening of the market economy, and government has been a critical actor in stimulating demand, due to both macro-​and microeconomic policies. Government’s prime focus on establishing a market-​based and innovation-​led economy helped the private sector to develop rapidly and enabled firms to respond to demand (Yip and McKern 2016). It has changed radically China’s innovation capabilities, including in the green sectors. As shown in this chapter, in green energy sectors, this system includes both the public and private sectors, hard and soft infrastructure, and demand and supply side mobilization of resources and knowledge. The Chinese approach has built an extensive capability to respond to local environmental pressures, while at the same time forming the basis for global leadership in a new industry.

Green Innovation   669 Several questions for further research arise out of the analysis presented in this chapter, particularly about the wider implication and lessons. We set out three important questions. First, China’s transition experience, rising from a low-​income country to the world’s second-​largest economy, and its environmental challenges faced during the development process, may provide important insights for many other emerging countries in their pursuit of economic development combined with green transformations. The Chinese experience offers rich and varied empirical cases for investigating catch-​up in emerging economies. But given the unique nature of China (e.g., in terms of size of the home market or economic governance), what can other developing countries learn from the Chinese experiences? Second, there is worldwide concern that China’s rapid growth is polluting the planet and harming the climate. While China has indeed contributed more than any other nation to the recent increases in carbon dioxide emissions, it has also become the number one investor in renewable energy (Frankfurt School-​UNEP Centre/​BNEF 2016). This chapter suggests that these investments are being used productively to establish competitive green sectors. Mathews even suggests that China may be on its way to developing a “green model of industrial capitalism” (Mathews 2013; Mathews and Tan 2017). Examining the reality of this proposition requires research that compares the growth rates of investment in low versus high carbon industries and compares the strength of alliances supporting low versus high carbon industries. Third, it is clear that global benefits are emerging because China’s entry into renewables is lowering the costs of green technology. Whether the lower equipment costs will speed up the deployment of green technology in other parts of the world is, however, not yet clear. Other considerations influence the deployment of renewables, in particular reliability and energy output. Lifetime costs and actual electricity generation capacity are more important than upfront costs and nominal capacity. This depends on the demand preferences of different markets. The big unknown is the preference in new markets. How effective will Chinese firms be in bringing down the cost of energy and opening up new markets?

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Chapter 7.2

In novating for t h e P o or The Inclusive Innovation System in China Xiaobo Wu and Linan Lei Introduction Innovation brings economic growth through new or improved technologies or new business models. However, when considering social growth, innovation might cause social exclusion, which leads to inequality (Hall, 2012). This argument is consistent with Chinese practice. China has experienced unprecedented economic growth for several decades, along with many development issues. However, the income disparity in China, especially in the rural areas or the western part of China, is still significant for imbalanced economic development. In the perspective of traditional welfare economic theory, the poverty problem can be solved by sustainable economic growth and effective secondary allocation (Treasury, New Zealand, 2001). However, under the context of the developing economy, the institutional environment is more complex and people in the bottom of pyramid have not benefited from the economic growth. Thus, some literature that focuses on the inclusive innovation practice in the context of a developing economy examines the growth process in those particular societies. A growing number of scholars point out that social exclusion is one of the most important factors that leads to poverty issues (Hart, 2005; Wu and Jiang, 2012). Social exclusion blocks access to opportunities for some individuals to participate in value creation activities. Without opportunities to participate, these individuals will not benefit from economic growth, and they could become trapped in poverty. Scholars point out that inclusion is the key bridge linking development and equality, and inclusive growth, which aims at achieving both social and economic growth by reducing inequalities, should be the goal of development. Many governments have promoted various policies to achieve inclusive development. For example, the Chinese government invested in railway construction to reduce the geographic exclusion of rural areas. However, many believe that organizations and even the disenfranchised individuals can also engage in social innovation, which leads to inclusive growth. Inclusive innovation is an efficient way to diminish the trade-​offs between economic growth and inequality (Gerard et al., 2012). Some multinationals initiate inclusive innovation directed at the bottom-​of-​the-​pyramid

676   Wu and Lei (BOP) market, pursuing profit as well as poverty alleviation outcomes. For example, GE Healthcare introduced an electrocardiogram machine that was particularly designed for the rural population in the Indian market. GE’s business initiatives not only brought substantial profit to the company but also improved healthcare in the rural area. Despite considering the excluded as consumers, some scholars emphasize the long-​term interactions between the excluded and organizations. By building a bridge between disenfranchised individuals and the market, the excluded can create value by producing goods and services. In this chapter, we offer an integrative perspective of the literature on innovation that leads to inclusive growth in developing economies. Since existing innovation modes are usually presented based on practices, an overview starting from an initial conceptualization of existing research work will provide a more valuable contribution. This chapter is organized as follows: First, we describe the conceptual framework of inclusive innovation and its implications on economic and social growth. Second, we summarize the inclusive innovation system in China. In the last part, we consider the Chinese context and figure out the role of inclusive innovation in Chinese economic development and discuss its challenges.

Conceptual Framework of Inclusive Innovation In the past few years, China has continuously improved people’s living standards and made decisive progress in poverty reduction. From 2012 to 2017, the number of people living in poverty has decreased by over 68 million, with a reduction of the incidence of poverty from 10.2% to 3.1%. Within 40 years since the reforming and opening up, more than 700 million Chinese people have been lifted out of poverty, accounting for more than 70% of the global total. In addition, household income has expanded an average of 7.4% a year, which exceeded the economic growth rate and made China the most populous middle-​ income group in the world.

Drivers for Inclusive Innovation in China Income Gap Rural-​Urban Income Gap Since the reform and opening up, China’s per capita disposable income has been continuously rising at a significant rate, from 343.4 RMB to 36,396.2 RMB in urban households and 133.6 RMB to 13,432.4 RMB in rural households. However, in terms of absolute value, the rural-​urban income gap has continued to widen and dramatically ascended from 209.8 RMB to 22,963.8 RMB (Figure 7.2.1). The excessive income gap between urban and rural areas restricts the level of the rural labor force. With the development of efficient production techniques, the modern industry is far more advanced than the traditional industry. Due to the low-​quality labor force of rural residents, it is hard for them to engage in production activities in the modern sector, and this not only leads to a lack of labor force for

Innovating for the Poor    677 40000

11.23%

35000 30000

31194.83 8.89%

28843.85 26467.00

12%

36396.20 33616.25

10%

8.65%

8.24%

8.98%

25000

8.15%

8%

8.27%

7.76%

20000

6%

15000 10000

9429.59

10488.88

11421.71

12363.41

13432.40

2%

5000 0

4%

2013

2014

2015

Urban Rural

2016

0%

2017

Growth Rate (Urban) Growth Rate (Rural)

Figure 7.2.1  Per capita disposable income of urban and rural households (RMB). Source: Statistical Yearbook of China

3.40 3.30

3.33 3.28 3.21

3.31

3.33 3.23

3.22

3.20

3.13

3.10

3.10 3.00 2.90

2.81

2.80

2.75

2.73

2.72

2.71

2014

2015

2016

2017

2.70 2.60

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Figure 7.2.2  Disposable income ratio of urban and rural households. Source: 2018 Statistical Yearbook of China

the modern industry but also restricts the improvement of production efficiency (Chao and Shen, 2014). Meanwhile, the rural-​urban income gap usually contributes to unfairness, which will further worsen the situation, such as widening gaps in infrastructure, education, healthcare, employment opportunities, and housing (Luo, 2010). Although the urban-​rural income ratio has declined in recent years from the peak of 3.33 in 2009 to the stable point of 2.71 in 2017, compared to the ratio of 2.52 in 1979, it remains relatively high (Figure 7.2.2). On the one hand, the decline of the urban-​rural income ratio

678   Wu and Lei 50,000

14% 44783.55

45,000 40,000

37298.27

9.76% 35010.09 32476.50 8.78% 30,000 7.80% 25,000 20,000 12695.62

13809.98

10%

9.97%

35,000

15,000

12%

41018.64

11.46%

9.18% 8.14%

7.48%

6.54% 5.01% 14501.89

8% 6%

15682.82

16856.16 4%

10,000 2%

5,000 0

0% 2013

2014

2015

2016

2017

Eastern Region

Growth Rate (Eastern Region)

Western Region

Growth Rate (Western Region)

Figure 7.2.3  GDP in eastern and western regions (billion RMB). Source: 2017 and 2018 Statistical Yearbook of China

reflects the supportive national policies for rural areas. On the other hand, the result may be confused by population factors. In the progress of urbanization, lured by higher salaries, a large amount of the rural labor force has been pouring into cities and towns, which results in an oversized urban population and decreasing growth rate of the urban economy (Tian et al., 2009). As these populations that transfer to cities and towns do not receive higher income, the per capita disposable income of urban households will be lowered and the income ratio will decline.

Regional Income Disparity Although increasing policies have been issued to support the central and western regions, a big gap and unbalanced development still exist among different regions. From the perspective of gross domestic product (GDP), the gap between the east and the west is fairly obvious. In 2017, the total GDP of western regions was 16.86 trillion RMB, while that of eastern regions was 44.78 trillion RMB, which was about 2.7 times that of the western regions (Figure 7.2.3). In terms of GDP growth rate, that of the western regions, which deserves our attention, declined by about 6%, from 11.46% in 2013 to 5.01% in 2015. Although the growth rate has rebounded to 8.14% in 2016, it is lower than that of eastern regions. Moreover, compared to the huge gap of GDP, the growth rate of GDP in the western regions is not significant. In terms of per capita GDP, in 2017, that of the western regions reached 44,717.22 RMB, while that of the eastern regions reached 83,920.90 RMB, about twice the per capita GDP of the western region (Figure 7.2.4). The growth rate trend is consistent with that of GDP in

Innovating for the Poor    679 90,000 80,000

83920.90 77465.29

10.82%

9.00% 67109.23 62673.05 8.18% 60,000

71018.72

10%

70,000

40,000

9.08% 8.33%

34652.52

37487.16

5.83% 39055.55

41916.97

6.68% 44717.22 6%

4.18%

30,000

8%

7.33%

7.08%

50,000

12%

4%

20,000 2% 10,000 0

2013

2014

2015

2016

2017

Eastern Region

Growth Rate (Eastern Region)

Western Region

Growth Rate (Western Region)

0%

Figure 7.2.4  Per capita GDP in eastern and western regions (RMB). Source: 2017 and 2018 Statistical Yearbook of China

recent years. Thus, it can be predicted that in the short run, the total GDP gap and per capita GDP between eastern and western regions will not change significantly. As far as the disposable income of residents is concerned, that of the eastern regions is generally higher than that of the western regions (Figure 7.2.5). In 2017, the disposable income of residents in Beijing, Shanghai, and Zhejiang all exceeded 40,000 RMB, which is much higher than that of the western provinces. The per capita disposable income of the western provinces ranged from 21,000 to 26,000 RMB, the highest of which is Inner Mongolia, reaching 26,212.2 RMB, which is the only province in the western regions higher than 25,000 RMB. The situation indicates not only that the current development of eastern and western regions has not reached an inclusive result but also that there is a certain gap of capital holdings between the two main regions, which may lead to a widening economic gap between the east and the west.

Income Disparity among Industries According to investigation of the average wage bill of employed persons in urban units by sector, employees of some industries with a monopolistic nature and high-​tech industries tend to have high incomes, while those of labor-​intensive industries characterized by fierce competition, low added value of products produced, and low entry threshold tend to have low incomes. The former mainly includes information transmission, software and information technology (IT), financial intermediation, scientific research and technical services, and production and supply of electricity, heat, gas, and water. The latter mainly includes agriculture, forestry, animal husbandry and fishery, manufacturing, hotels and catering services, services to households, and repair and other services. In accordance with the data from

680   Wu and Lei 12%

40000 10.47%

35000

9.70%

30000 25954.0

25000 23658.4 20000 15000

13919.0

15376.1

9.70%

9.12% 30654.7

28223.3 8.74%

16868.1

33414.0 9.36%

8.61%

18406.8

10%

9.00% 8% 20130.3

6% 4%

10000 2%

5000 0

2013

2014

2015

2016

2017

Eastern Region

Growth Rate (Eastern Region)

Western Region

Growth Rate (Western Region)

0%

Figure 7.2.5 Per capita disposable income of nationwide households in eastern and western regions (RMB). Source: 2017 and 2018 Statistical Yearbook of China

2017, information transmission, software, and IT was the industry with the highest average wage, reaching 133,150 RMB, while agriculture, forestry, animal husbandry, and fishery was the industry with the lowest average wage, reaching only 36,504 RMB. The income gap between these two industries was up to 96,646 RMB in 2017, and the income ratio reached 3.65. To sum up, with the large number of low-​income groups in rural areas, there is an obvious income gap between urban and rural areas and eastern and western regions and industries. Therefore, it is necessary to carry out inclusive innovation in practice.

Industry Upgrading The staged changes of economic development reflected in the new era are as follows: from the low-​income stage to the middle-​income stage (Ren, 2018). The optimization and upgrading of industrial structure include realizing the upgrading and rationalization of industrial structure (Zhang and Jiang, 2016). A low level of industrial structure will cause a country to be locked in the “middle-​income trap.” According to data, the Chinese industrial structure has been advancing. Shares of the contributions of primary, secondary, and tertiary industries to the increase of the GDP have changed from 4.6%, 46.4%, and 49.0% to 4.9%, 36.3%, and 58.8%, respectively (Figure 7.2.6). However, the secondary industry is still dominant in most provinces, indicating that there is still a gap between the Chinese industrial structure and that of developed countries. Meanwhile, the Chinese manufacturing industry has always been at the low end of the global industrial value chain with low profit margins and difficulties in upgrading. There is no competitiveness in research and development (R&D), technology, patents, standard setting, brand, sales, and other high value-​ added links.

Innovating for the Poor    681 57.9

60 50 40

52.3 51.8 50.5 49.7 50.1 48.6

49.0 49.4

57.5

57.4 52.0

49.9 48.5 47.8

58.8

52.9 42.4

46.4 46.5 39.0

40.8

44.3

45.9 47.3 46.2

43.8 44.9

43.7

47.2 47.5

38.2

36.3

39.0

30 20 10 4.6 0

4.1

7.3 3.1

5.2

4.4

2.7

5.2

4.0

3.6

4.2

5.2

4.3

4.7

4.6

4.3

4.9

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Primary Industry

Secondary Industry

Tertiary Industry

Figure 7.2.6  Share of the contributions of the three strata of industry to the increase of the GDP. Note: Share of the contributions of the three strata of industry to the increase of the GDP refers to the proportion of the increment of the value added of each industry to the increment of GDP. Source: 2018 Statistical Yearbook of China

The new stage of economic development has new economic characteristics and requires a more suitable industrial structure model. Considering the accelerated adjustment of the international industrial structure and development of world science and technology, it is urgent for China to adjust its industrial structure. From the perspective of inclusive innovation, innovation of technologies, markets, institutions, and organizations, to a certain extent, can realize a transformation from extensive production and operation to intensive production and operation and promote industrial upgrading.

Inclusive Growth and Inclusive Innovation Growth creates new opportunities that are unevenly distributed among different sectors in the society. Inclusive growth was first indicated by the Asian Development Bank (ADB) in 2007, aiming at ensuring members of society can participate in value creation activities and benefit from economic growth. Compared to other similar concepts, inclusive growth has two distinctive features: a wide range of people should have the opportunity to participate in the process of growth, and a large percentage of people should benefit from the outcome of growth, both economically and socially (Klasen, 2010). To improve inclusiveness, more opportunities should be created; in other words, sustainable growth and improvement of productivity are the basis of inclusive development (Ali and Son, 2007). Most research on

682   Wu and Lei inclusive growth focuses on the design of top-​down public policy, ignoring the bottom-​ up innovations performed by organizations and individuals. For example, Prahalad (2012) pointed out that there are many creative entrepreneurs from the BOP who improve inclusiveness by doing business in extremely limited conditions. Moreover, organizations that connect disenfranchised members of society and business opportunities can also achieve inclusive growth. Early research on inclusive growth always has been associated with the BOP. The BOP consists of the group of people with low income and who live below the poverty. As a result, the concept of inclusive growth is very similar to the pro-​poor studies. However, inclusive growth has a broader concept because of the large BOP population.

Obstacles of Inclusive Growth and Social Exclusion The first use of the term “social exclusion” (attributed to Lenoir, 1974) referred to those who were not protected by the welfare state and were considered social misfits (Levitas, 2006). Individuals who are socially excluded usually have a high probability of gradually losing their ability to participate in normal economic and social activities including consumption, production, and other political and social activities (Gordon, 2002). In the existing research, the constraints of inclusive growth can be analyzed through the perspective of social exclusion, and scholars usually combine social exclusion and poverty. The general consensus of the relationship between social exclusion and poverty is that poverty is not only the result of social exclusion but also the reason for it (Gordon, 2002; Silver, 1994). Aside from poverty, social exclusion can also result from political, geographical, and social circumstances (Percy-​Smith, 2000). Scholars have addressed poverty and social exclusion challenges by combining corporate self-​interest with global enlightenment. London and Hart (2004) and Prahalad (2007) argue that mature markets in industrialized nations are becoming increasingly saturated; new business opportunities should thus increasingly be sought in BOP markets, where there are considerable needs but they are currently underserved by the global market system because incomes are too low. Although appropriate innovations can indeed address the needs of this population as consumers, it seems that the more enduring benefit of inclusive development is to enable the poor to better engage in entrepreneurial activities to enhance their income as well as well-​being on their own. Therefore, Karnani (2007) suggests the poor population should be treated as producers rather than consumers, cognitively changing their role from passively waiting for economic development to actively participating in market system. However, the BOP is also faced with many challenges in entrepreneurial activities, including the limitation of raw material resources, financial resources, and production resources. Furthermore, they are also faced with a low degree of market access, market power, and market security (London, Anupindi, and Sheth, 2010). They also have lower risk tolerance, which makes them more dependent on the macroeconomic environment (Sinkovics, Sinkovics, and Yamin, 2014). Apart from the external factors, when competing in an open market, BOP entrepreneurs have also been restricted because of their own subjective shortages such as lack of technology, capability, and information, which constrain them from participating in the business activities and benefiting from trade. Based on social exclusion theory, exclusion is both the reason for and result of poverty. That is to say,

Innovating for the Poor    683 poverty reduction can be regarded as the process of eliminating social exclusion (Wu and Jiang, 2012). These characteristics of BOP groups lead to a certain particularity of their entrepreneurial behavior, which should be addressed when exploring the mechanism to reduce poverty through entrepreneurship.

Process towards Inclusive Growth The understanding of inclusive development or inclusive growth can be divided into inclusiveness and development dimensions. Inclusiveness advocates equal opportunity, equal and capable participation, and equal share of economic growth. Development is associated with society and economy benefits and achieving sustainable development. Inclusive innovation is defined as “the development and implementation of new ideas which aspire to create opportunities that enhance social and economic wellbeing for disenfranchised members of society” (George, McGahan, and Prabhu, 2012: 663). Foster and Heeks (2013) identified two aspects of the definitions that should be further discussed: the first is the boundary of marginalized or excluded groups, and the second is which aspect of innovation should be included in. We place a higher concern on the poor, in other words, the BOP communities (Prahalad and Hammond, 2002; London and Hart, 2004; Sinkovics, Sinkovics, and Yamin, 2014). Corresponding to the content of inclusive development, inclusive innovation has two dimensions: process innovation and product innovation. Contrary to the pure pursuit of economic development, equal opportunities and equal participation are related to process inclusive innovation, and product inclusive innovation refers to the equal share of outcome. Although the static view of inclusive innovation improved by institutional innovation has been deeply studied (Padilla-​Pérez and Gaudin, 2014), we overlooked dynamic inclusive innovation, which underlines increasing the ability of excluded social groups and economic regions (Lim, Han, and Ito, 2013; Silvestre and Silva Neto, 2014). Thus, we developed an inclusive innovation conceptual framework (Figure 7.2.7), further enhanced by a series of empirical works grounded on practices (Wu and Jiang, 2013) Firms from BOP communities usually do not have the required capabilities, stocks of knowledge, and resources to innovate by themselves. Thus, taking the resource-​limited setting and the capability constraints into account, BOP producers probably deserve more attention because they act in a provider role in the market system but are faced with higher barriers and more challenges throughout their involvement. To adapt to the fast-​changing markets, these producers have to find efficient ways to explore and build their capabilities as well as organize their business activities. While appropriate innovations can also indeed address the needs of this population as consumers, it seems that the more enduring benefit of inclusive development is to enable the poor to better engage in entrepreneurial activities to enhance their income as well as well-​being on their own. Sequentially, a market with higher efficiency would make the BOP producers attain greater value from their outputs, while investing in capability and productivity upgrading would enable the BOP to have access to more opportunities. Then the institutions have been considered as the “deep cause” of development. Institutional innovation in both formal and informal ways allows the whole society to support the development of inclusive growth, which encourages broad segments of the

684   Wu and Lei

Capability building

Inclusiveness happens

Institution innovation

Barrier remove

Barrier remove and fairness of institution

Capability in obtaining and search

The balance between input and output

Performance of inclusiveness Acquisition of opportunity and participation

The fairness of outcome sharing

Figure 7.2.7  Conceptual framework for inclusive innovation. population to participate in inclusive innovation by lowering or removing the barrier for the BOP communities to engage in innovative activities. It also creates incentives and possibilities for learning, education, and, more generally, organizational and technical change, encouraging inclusiveness. The performance of inclusiveness highlights process-​based opportunity and participation and outcome-​based sharing, the contents of inclusiveness. In order to trade-​off static and dynamic inclusiveness, the way to improve inclusiveness is categorized into two types, where institution innovation reduces entry barriers through building sectoral innovation system or providing social security, and capability building helps decrease capability threshold by including sensing, seizing, and transforming capabilities (Teece, 2007). Our framework places much emphasis on static and dynamic inclusive innovation, which may be neglected in the models from existed literature.

Inclusive Innovation System in China The innovation system concept may be regarded as a practical tool for designing innovation policy, but it might also be seen as a synthesis of analytical results produced by scholars working on understanding innovation. In this section, we will show the inclusive innovation system in China (Figure 7.2.8) and then examine the concepts of BOP entrepreneurs, institutions for inclusive innovation, infrastructures supporting inclusive innovation, and emerging governance of inclusive innovation in China. The inclusive innovation system in China has gone through three significant changes. At the early stage,

Innovating for the Poor    685 • National • Provincial • Local

Public sector

Higher education, research institutions

Infrastructures NPOs and platforms

BoP entrepreneurs

• Taobao, Pinduoduo, etc • Local hybrid organizations

• Universities • Research institutions

Urban and rural consumers

• Necessity-based innovation • “Taobao Villages”

Figure 7.2.8  Inclusive innovation system in China. BOP entrepreneurs met challenges of value creation and value capture with production and market constraints. Although the emergence of the information and communications technology (ICT) platform has helped to mitigate this problem, how to make use of emerging ICT platforms became a new obstacle for poorly educated BOP entrepreneurs. Fortunately, some Non-​Profit Organizations (NPOs) or rural e-​commerce hybrids play an essential role in training, and infrastructures like logistics as well as supporting infrastructures also contribute to the development of ICT platforms in rural areas. The roles of universities and research institutions should be further emphasized in the future, however.

BOP Entrepreneurs in China BOP refers to the poor who live at the base of the world’s economic pyramid (Prahalad, 2009). These people are often faced with inequality and exclusion in different economic and social contexts. With entrepreneurship, BOP members are able to provide for basic needs and accumulate capital and capability (Thurik et al., 2006). In other words, BOP entrepreneurship is a proactive action to break through their social exclusion. Hence, entrepreneurship has been identified as a method to reduce poverty especially when it is related to the BOP group (Peredo and Chrisman, 2006). The entrepreneurship of the BOP differs from normal entrepreneurship because it occurs in a different financial and social environment. BOP members usually have less social connection and education, which makes it difficult for them to find a job in the labor market. In that case, entrepreneurship is the choice for them because self-​employment is more profitable than what they can earn in the labor market (De Mel et al., 2008). As a result, BOP entrepreneurship is more likely necessity based rather than opportunity based (Bradley et al., 2012). Compared to opportunity-​based innovation, necessity-​based innovation is more likely to engage in imitation rather than innovation, especially radical

686   Wu and Lei innovation (Matin et al., 2002). In addition, due to the limitation in capabilities and capital, BOP entrepreneurship is more likely to engage in several specific sectors that are less capital and technology intensive. Also, compared to normal entrepreneurs, BOP entrepreneurs are usually faced with serious challenges because of social exclusion mentioned. For example, London (2010) identified the productivity and transactional constraints faced by BOP entrepreneurs in value creation and value capture. BOP entrepreneurs have to start their business under particular conditions with limited resources including raw materials, financial resources, and other production resources like equipment and storage space. Moreover, BOP producers are also faced with hurdles in market access, market power, and market security, which bars them from selling their goods and services to consumers at a reasonable price. In conclusion, BOP entrepreneurs face more difficulties in starting and expanding their business. It is widely accepted that China’s digital economy has contributed to the development of BOP entrepreneurship. “China is already standing at the global center of the digital economy,”1 said Jonathan Woetzel, director of the McKinsey Global Institute and a senior managing partner worldwide. BOP entrepreneurs in China are gradually seizing the window of opportunity of digital technology to eliminate social exclusion (Wu and Jiang, 2013). The growth in e-​commerce driven by digital technology promoted the formation of “Taobao Villages,” administrative villages where the total annual e-​commerce transaction volume is at least 10 million RMB (US$1.6 million); at least 10% of village households actively engage in e-​commerce and at least 100 active online shops have been opened by villagers (Gao et al., 2014). Based on the research report of “Taobao Villages” in China by Alibaba, over 4,310 Taobao Villages had emerged in China by June 2019,2 providing more than 6.83 million direct employment opportunities in one year. In 2018, state-​level poverty-​stricken counties realized more than 63 billion yuan online sales, among which more than 100 poor counties obtained more than 100 million yuan online sales. Additionally, Pinduoduo, which is one of the largest Chinese agricultural product uplink platforms, has helped farmers sell 10.9 billion jin of agricultural products with a total transaction value of 51 billion yuan from 2016 to 2018, thereby creating a huge income for BOP entrepreneurs. According to the National Bureau of Statistics of China, China’s e-​commerce trading volume of agricultural products will increase from 150 billion yuan five years ago to 800 billion yuan by 2020, with a compound annual growth rate of 39.8%. Rural e-​commerce has opened a new path for poverty alleviation. In addition to BOP entrepreneurs’’ practices, some scholars emphasize the design of the top-​down policy in BOP entrepreneurship and use policy interventions to reduce the negative effects in innovation diffusion and entrepreneurship caused by market failures (Bergek et al., 2008). There is a distinctive perspective looking into the social innovation accompanied by BOP entrepreneurship. This perspective holds that BOP entrepreneurship itself is accompanied by institutional and social innovation, business model innovation, and technology innovation based on market opportunities. Social innovation conducted by organizations and the BOP can diminish the trade-​offs between economic growth and inequality, but it is also more complex and ambiguous than other business innovations because it has

1 

2 

Digital China: Powering the economy to global competitiveness, McKinsey. China’s “Taobao Villages” top 4,000: AliResearch—​Xinhua, English.news.cn (xinhuanet.com).

Innovating for the Poor    687 to meet the needs of a wider range of stakeholders (Lettice and Parekh, 2010; Hall and Vredenburg, 2003).

Institutions for Inclusive Innovation in China Since the 1970s, the Chinese government has attached great importance to inclusive innovation and issued relevant policies and institutions to facilitate improvements in people’s livelihood, agricultural and rural development, regional development, industrial development, and growth of small and medium-​sized enterprises (SMEs) (Table 7.2.1). It has gone through three stages. The first stage is from 1978 to the early 1990s. As the Chinese economy started to recover, attention was mainly paid to the recovery of infrastructure and production, with limited attention to inclusive innovation. At this stage, the government mainly relied on science and technology to preliminarily explore poverty alleviation. For one thing, mature, advanced, and applicable technologies were imported into the rural areas and agricultural technology training was conducted to increase the income of farmers. For another thing, rural economy was promoted with the active cultivation of township enterprises and development of regional characteristic products and industries. The second stage is from the 1990s to 2002. Under the circumstance of substantial growth of Chinese economy, the Decision of the Central Committee of the Communist Party of China on Several Issues Concerning the Establishment of a Socialist Market Economy System was issued at third plenary session of the 14th Central Committee of the Communist Party of China in 1993, which clearly put forward an income distribution system with a revenue allocation principle for primarily considering the efficiency in combination with justice. During this period, the government allocated limited resources and funds to the major innovative projects but was less focused on the livelihood of people. The third stage is from 2002 to now. China’s economy has entered a period of steady and rapid growth. At this stage, the central government clearly regards scientific and technological innovation as an important strategy to promote people’s livelihood. Agriculture, the environment, population health, and other projects related to people’s livelihood have been set as key areas in the Long and Middle-​Run Plan for and Outline of the National Science and Technology Development (2006–​2020) (Research Group of China Academy of Science and Technology Development Strategy, 2015). According to the 13th Five-​Year Plan on Scientific and Technological Innovation, the technological system should be improved to support improvement of people’s livelihood and sustainable development and to break through bottlenecks in the fields of resources, the environment, healthcare, and public safety. The plan calls for a more perfect mechanism of regional synergistic innovation, more intensive efforts to alleviate poverty through science and technology, and more dynamic grassroots efforts.

Infrastructures Supporting Inclusive Innovation in China The main obstacle for BOP entrepreneurs to start up a new business is the high transaction cost that is one classic theory proposed by Williamson (1975) to explain why one specific

688   Wu and Lei Table 7.2.1 Policies for Inclusive Innovation in China Project

Start Year

Department

Main Content

Poverty Alleviation 1986 through Science and Technology (PAST)

Ministry of Science and Technology

Aiming at the actual needs of poorer areas; implementing actions such as promoting special industries of science and technology in poverty-​ stricken rural areas, poverty alleviation by science and technology information, popularization of science and technology, etc.

Spark Program

1986

Ministry of Science and Technology

Importing mature, advanced, and applicable technologies into the rural areas; carrying out technical training for farmers; developing products and industries with regional resource advantages; promoting scientific and technological progress of township enterprises

Technology Innovation Fund for Technology-​ Based SMEs

1999

Ministry of Science and Technology, Ministry of Finance

Providing financial support for technological progress and project development of SMEs by means of loan discount, free subsidy, and capital investment.

Rural Sci-​tech Special Commissioner System

2002

Ministry of Science and Technology

Every year, selecting a number of scientific and technological personnel as science and technology commissioners to go deep into grassroots, to carry out innovation and entrepreneurship services, and to form an economic interest community with farmers

Special Program for 2005 Enriching the People and Strengthening the County through Science and Technology

Ministry of Science and Technology, Ministry of Finance

Focusing on the underdeveloped areas in the central, western, and eastern regions; launching a number of pilot cities each year to implement a number of key scientific and technological projects and integrate and popularize about 500 advanced and applicable technologies

Program That 2012 Benefits the People through Science and Technology

Ministry of Science and Technology, Ministry of Finance

Implementing a number of major science and technology projects for people’s livelihood, such as national health science and technology projects, public safety science and technology projects, ecological environment science and technology projects; improving people’s living quality through scientific research and transformation of achievements

Source: Ministry of Science and Technology of the People’s Republic of China.

transaction happens. Both consumers and producers that belong to BOP communities are faced with the high transaction cost problem (Roxas and Ungson, 2012; Prahalad, 2012). As consumers, they cannot buy basic and essential goods, services, and consumption alternatives due to availability and/​or affordability (Karnani, 2007). They are usually

Innovating for the Poor    689 handicapped by transportation and logistics facilities (London et al., 2010), which means that BOP consumers have higher costs than other consumers. BOP producers who create value by producing goods and services for sale in nonlocal markets have to cope with high transaction costs attributed to value creation and value capture constraints (Ramachandran, Pant, and Pani, 2012). One milestone in the way of reducing transaction costs is the emergence and deployment of ICT, which supports a more efficient market system (Mendoza and Thelen, 2008; Mair and Marti, 2009). As an affordable infrastructure, ICT could mitigate BOP problems by reducing four types of market separations: spatial separation, temporal separation, informational separation, and financial separation (Tarafdar et al., 2013), which are the traditional barriers that trap BOP consumers and producers (Prahalad and Hammond, 2002). Specifically, poor transportation facilities put tremendous pressure on BOP entrepreneurs who are geographically dispersed, but the development of ICT infrastructure helps BOP communities have easier access to products and services through reduction of spatial separation. Temporal separation implies that production and consumption of goods and services are separated in time, which is a serious challenge for some perishable and seasonal commodities. ICT-​based communication facilitates timely sale of perishable products through increasing speed and accuracy matching between production and consumption quantities. ICT product and process innovations also deliver relevant information about products to reduce information separation that arises from asymmetrical information between consumers and producers, given their low level of education and information sources. What’s more, the low marginal cost of electronic product distribution and shared service cost make it possible for BOP entrepreneurs to tackle the financial separation problem, which emphasizes the inadequate purchasing power of BOP entrepreneurs. A growing number of ICT-​enabled innovations are believed to be the contributing factors to the development of BOP entrepreneurs (Futterman and Shuman, 2010; Ali and Kumar, 2011; Madan et al., 2016). ICTs can empower individuals or organizations and promote capability expansion (Ali and Kumar, 2011; Tarafdar, Singh, and Anekal, 2013). Based on a capability approach, differences in poor people’s information capabilities means whether they have the capability to transform ICT technologies into opportunities for entrepreneurship. There are four components of information capabilities: ICT capability, information literacy, communication capability, and content capability (Gigler, 2011). Additionally, the informational capabilities set the foundation for other capabilities and bring a positive “multiplier effect” to human capabilities. To adapt to fast-​changing markets, these entrepreneurs have to find efficient ways to explore and develop their capabilities as well as organize their business activities. Turulja and Bajgorić (2016) applied IT capability to answer the question “Why do some firms persistently outperform others?” Firms’ success is largely dependent on IT capability, which includes selecting, accepting, configuring, and implementing IT. China has experienced a surge in the diffusion of ICT infrastructure construction such as computers and mobile phones. According to the National Bureau of Statistics of China,3 the number of internet users in China reached 771,980 by the end of 2017, an increase of 5% over the previous year. Every 100 persons had 115.91 mobile phones in 2017. Significant progress

3 

https://​data.stats.gov.cn/​.

690   Wu and Lei has been made in ICTs. Alibaba, which is China’s biggest online commerce company and one of the most valuable public companies in the country, has developed cutting-​edge ICTs. Faced with a dramatic change in demand on November 11, 2018, the annual Singles Day, Alibaba’s payment platform processed 491,000 transactions per second, showing an increase of 51% compared with the previous year’s figures. Hence, ICTs are valued greatly in e-​commerce success, especially for the rural e-​commerce aimed at poor alleviation.

Emerging Governance of Inclusive Innovation The ideal governance form of inclusive innovation is that which minimizes transaction costs (Williamson 1975). Successful marketing of products used to depend on the traditional role of assembling a variety of sellers in one location and the related supported services, including product information, customization, quality assurance, after-​sales service, and logistics (Rangan and Maier, 1992). However, the emergence of the ICT platform provides a better transaction form, facilitating direct exchange between producers and consumers and leading to the economies of scope and scale, creating “friction free” markets with less inefficiency and cost (Bakos, 1998). The roles of the ICT platform are aggregating buyer demand or seller products, matching buyers and sellers, and providing trust and interorganizational market information (Bailey and Bakos, 1997). Sometimes one ICT platform may aggregate different types of intermediaries, which can help others use ICT (Majchrzak, Markus, and Wareham, 2016). Brown and Lockett (2004) argue that technology, enterprise, and community intermediaries are required to provide services to the eTrust platform, conceptualization of roles required to provide e-​business services to online small and medium-​sized enterprises aggregations, in more complex e-​business applications. The technology intermediary focuses on hosting and communications. The enterprise intermediary serves a service function, such as consultancy of applications software. The community intermediary is related to the governance role. Intermediary roles are played not only by organizations but also by individuals. For example, people who are responsible for transferring information among firms are identified as intermediaries (Hussler, Muller, and Rondé, 2010). Microentrepreneurs are regarded as the intermediaries in the eKutir case, a for-​profit social enterprise group that provides economically sustainable solutions. They are given tools and training by eKutir entrepreneurs to deliver agricultural services to Indian farmers. eKutir has addressed multiple facets of smallholder farmer poverty and formed a self-​sustaining ecosystem. In addition to the formal intermediaries, there exist informal intermediaries, overlooked easily by scholars. They also influence ICT use and its outcomes. Venkatesh et al. (2016) investigated infant mortality across 10 villages in rural India where an eHealth kiosk, an ICT intervention, was implemented. As informal intermediaries, friends and family members who affect women’s willingness to make use of the eHealth kiosk were also studied. Intermediary roles evolve when the implicit requirements of ICT use are shown to not be lacking (Majchrzak, Markus, and Wareham, 2016). Leong et al. (2016) proposed the concept of digital empowerment to study evolving roles of intermediaries in Alibaba’s Suichang and Jinyun Taobao (e-​commerce) Villages in remote China. In particular, Suichang, which has a typical ICT platform pattern in rural China, has gained increasing academic attention.

Innovating for the Poor    691 As the earliest internet platform to explore rural e-​ commerce in China, the e-​ commerce poverty alleviation model of Suichang turns the relations with villagers to be closer. The current business model is a three-​in-​one combination of one association and two companies: the Suichang online shop association, Suichang Suiwang E-​commerce Company Limited, and Zhejiang Ganjie E-​commerce Company, in charge of e-​commerce entrepreneurship service, agricultural e-​commerce service, and rural information service, respectively. The Suichang online shop association is a nonprofit association that provides business information and professional training for its members free of charge. Suichang Suiwang E-​commerce Company Limited integrates BOP online store owners, product suppliers, and service providers, setting up a distribution platform. Ganjie has its own logistics (e-​commerce service stations) and supply chain (distribution members), supporting the downlink of consumer goods and uplink of agricultural products, respectively. Thereby, Suichang creates a new way for small and medium-​sized farmers to increase their income and rise from poverty through hybrid intermediaries.

Challenges for Inclusive Innovation System in the Chinese Context From the aforementioned analysis, we find that the inclusive innovation system in China is turning from formal institutions to the interpenetration of both formal and informal institutions. Because the formal institutions are less forceful within the BOP group for implementation gaps, the rich informal institutional system shapes behavior in and around this group and is complementary to the formal institutions. But with the dynamic development of the economy and institutional environment in China, there are still some challenges for inclusive innovation in the Chinese context.

Quality-​Related Challenge for Inclusive Innovation Inclusive innovation for the BOP markets is often complex and fragile, where user needs are less clear and users are more vulnerable. Given this, innovations that focus on these groups have articulated the importance not only of firm profit but also positive impacts upon the conditions of low-​income groups, in order for them to grow to full scale and be accepted. But it is difficult for firms pursuing “inclusive innovation” to balance the challenge of providing “affordable” products at low cost and high quality, which causes some of them to attain low price by reducing product quality. Management perspectives discussing low-​income final markets within BOP strategies have taken the most optimistic approach around quality. Such perspectives argue that firms will only succeed in low-​income markets through rebuilding innovations from the ground up. This is necessary to integrate cost savings that fit in with the price needs of low-​income groups, and this process will not lead to decline in quality. As Prahalad (2012) put it, quality retention leads to disruption in low-​cost innovation. Thus, for companies that recognize the

692   Wu and Lei opportunity to provide the poor with goods and services that are both affordable and high quality, the cost performance rapidly becoming a necessary core competence.

Missing Role of Universities in Inclusive Innovation System The role of the university in the transformation of society includes economic, political, social, and cultural aspects. Although the current inclusive innovation system considers the nature and dimensions of inclusion, the marginalized should be seen not only as potential customers but also as business partners and hence knowledge producers. As new knowledge and advanced skills increasingly drive economic development, universities are assumed to be critical sources not only for learning and innovation for firms in developed economies but also for integrating the excluded and poor into innovation systems in developing country contexts. However, currently the role of universities in the inclusive innovation system has been ignored. The universities have been proven to enhance the regional inclusive innovation system, and their role in inclusive development is largely determined by fundamental social needs, including entrepreneurship education, serving rural areas, R&D collaboration, and knowledge dissemination.

Institutions for Platform-​Based Inclusive Innovation Discussion on the platform economy has focused on topics such as its potential to enable more efficient resource use. The emergence of platform-​based business mode innovation for inclusive growth has greatly increased communication of information between transaction parties and reduced the cost of marketing; the attribute of cumulative population size for the platform has also contributed to transaction matching of the buyers and sellers, in turn reducing the search costs of each side. Additionally, the increased scale of buyers makes reduction of transaction risk and cost due to information asymmetry possible. E-​commerce occurs in the online space, and its transaction behaviors differ from those in the offline transaction system. As business history has demonstrated, many technologies have been turned down by users or been overridden by emergent competitor technologies. Accordingly, whether or not certain technologies as well as firms are accepted may differ depending on the rationales desired by the given societies. Hence, the development of Chinese platform-​based inclusive innovation calls for legitimacy building, vision development, platform organization, and institution reconfiguration.

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Chapter 7.3

M anufactu ri ng P ow e r Strate g y Advanced Manufacturing

Jörg Mayer and Huifeng Sun Introduction Rapid economic growth since the late 1970s propelled China to become the second-​largest economy in the world in 2010 and to lift millions of its citizens out of poverty. This rise can be attributed to increases in labor force participation and sizable structural transformation that entailed a large-​scale shift of labor from agriculture to manufacturing and services. China’s development trajectory was piloted by policies that focused on investment-​driven and export-​oriented growth and on support from industrial imitation and the adoption of imported technologies. But an approach heavily relying on investment, exports, and a large low-​cost labor force has its limits, exemplified by the numerous developing countries that have become stuck on the middle rungs of the development ladder (e.g., Zhang and Chen, 2017). To avoid this fate, China has embarked on a new and more balanced strategy that assigns a greater role to domestic demand and to improvements in indigenous innovation capacity, especially in its industrial sectors. The government is pursuing this new strategy through a focus on strategic industries with a high content of innovative technology, supported by a range of industrial policy instruments and state-​owned enterprises (SOEs). The outcomes of this strategy will be a crucial determinant of whether and when China can attain high-​ income status and will be of great importance also for China’s relationship with developed countries and the future shape of globalization and the world economy more generally. The Manufacturing Power Strategy and a range of key policy initiatives incorporated in the 13th Five-​Year Plan, such as Internet Plus, are the strategic components of China’s new innovation-​focused industrial policy. The next section presents the Manufacturing Power Strategy and other recent key measures for indigenous innovation and examines what of it has been implemented so far. The third section sets the initiative in the context of China’s development trajectory and of its

Manufacturing Power Strategy    697 external economic environment. The fourth section discusses views from both Western and Chinese scholars on the Manufacturing Power Strategy. The final section concludes.

Manufacturing Power Strategy and Other Key Measures for Innovation It has sometimes been argued that overt industrial policy emerged in China only in the late 1970s when the country embarked on its reform process (e.g., Heilman and Shih, 2013). Others (e.g., Chen and Naughton, 2016), by contrast, also consider earlier forms of economic and spatial planning, as reflected in Table 7.3.1. This latter view holds that the objectives, instruments, and target industries of China’s industrial policy have evolved over time in a pragmatic and flexible way, depending on the specific time-​bound conditions of China’s domestic economy and its external economic environment. The Manufacturing Power Strategy faces challenges in both these dimensions as it comes at a turning point in China’s development path. On the internal side, the initiative faces major demographic changes, environmental challenges, and slowing economic growth, and its industrial restructuring objectives and innovation policies are therefore

Table 7.3.1 Industrial Policy in China: Objectives and Target Industries Period

Objectives and Policies

Target Industries

1950s–​1970s

Import substituting industrialization

Heavy industry

1980s–​1990s

Reform experiments; special economic zones

Light industry

1990s

Socialist market economy; restructuring of state-​owned enterprises; incentives for foreign direct investment; industrial policy for automotive industry; export-​oriented manufacturing

Automotive, electronics, machinery, steel, and petrochemical industries

2000s

WTO membership; home-​grown innovation program; enterprise internationalization; industrial restructuring; tackling overcapacity; export-​ oriented manufacturing; anticyclical policies following onset of global financial crisis in 2008

Automotive, electronics, machinery, petrochemical, and biopharmaceutical industries

2015–​today

Industrial restructuring toward higher value added and energy efficiency; more balanced growth strategy aimed at better economic, social, and ecological sustainability; innovation-​driven development strategy

New energy vehicle, aerospace, biopharmaceutical, high-​end CNC machinery, rail transit, and information and communication industries

Source: Authors’ elaboration, partly based on Brandt, Rawski, and Sutton (2008); Heilmann and Shih (2013); and Chen and Naughton (2016).

698   Mayer and Sun more ambitious than any of the previous approaches. On the external side, structurally weak growth in the global economy provides a less propitious external economic environment, and established economic powers may view the initiative’s greater ambition as challenging their global technological leadership, making them react in less cooperative ways than in the past. The Manufacturing Power Strategy puts forward nine major tasks: improving the innovation ability of the national manufacturing industry, promoting deep integration between informatization and industrialization, strengthening industrial basic ability, reinforcing quality brand building, implementing green manufacturing in an all-​round way, promoting breakthroughs of the key areas vigorously, deepening structural adjustment of the manufacturing industry, actively developing service-​oriented manufacturing and producer services, and improving the internationalization of the manufacturing industry. Compared with “Industry 4.0” in Germany and the “National Strategic Plan for Advanced Manufacturing” in the United States, the Manufacturing Power Strategy will focus on improving the innovation ability and the quality of the manufacturing industry in accordance with the basic and realistic conditions of the development of China’s manufacturing industry. It does not make the goals and tasks too “high-​end and unreachable,” but more based on transformation and upgrading of traditional industry. According to the aforementioned tasks, specific measures have been formulated: 1. Improve the ability of innovation. The specific measures include strengthening the core technology research, improving innovative design ability, promoting the industrialization of scientific and technological results, perfecting the innovation system of the manufacturing industry, forming a batch of manufacturing innovation centers, strengthening the construction of the standards system, and reinforcing the application of intellectual property rights. To abandon the dependence on the traditional path, China needs not only to introduce and utilize the international advanced technological innovation results but also to attach importance to the promotion and industrialization of technological achievements of independent innovation, to form an atmosphere in which the whole society encourages and attaches importance to innovation. 2. Promote the integration of informatization and industrialization. The specific measures include developing intelligent equipment and intelligent products, promoting the intelligentization of the production process, cultivating new modes of production, and improving the level of intelligentization of research and development (R&D), production, management, and service in an all-​round way. Integrating the internet and manufacturing industry leads to transformation and upgrading of the manufacturing industry to “digitalization, networking, and intelligentization,” pushing for an increased integration between the Internet of Things + industry, cloud computing + industry, mobile internet + industry, network crowdsourcing + industry, and so on. 3. Brand building. The specific measures include generalizing advanced quality management technology and methods, speeding up the quality of products, improving quality supervision systems, guiding enterprises to make brand management systems, improving internal quality, and building a solid foundation of brand development

Manufacturing Power Strategy    699 around the whole process of R&D innovation, production and manufacturing, quality management, and marketing services. 4. Implement green manufacturing. The specific measures include accelerating the upgrading of the green manufacturing industry, promoting efficient recycling of resources, and building a green manufacturing system. China should create green products, green factories, green industrial parks, and a green enterprise standards system. It should also carry out green evaluation; strengthen green supervision; improve energy conservation, environmental protection laws and regulations; strengthen supervision of energy conservation and environmental protection; carry out the report system of enterprise social responsibility; and guide all producers to engage in green production. In addition, developing service-​oriented manufacturing and producer services, promoting the internationalization of the manufacturing industry, strengthening the industrial base, and pushing forward breakthroughs in key areas are important for promoting the Manufacturing Power Strategy. On this basis, the platform for action has also put forward 10 key areas of development and five key projects. The 10 major areas are generation of a new information and communication technology industry, high-​grade computerized numerical control (CNC) machine tools and robots, aeronautics and astronautics equipment, marine engineering equipment and high-​tech ships, rail transit equipment, energy-​saving and new energy vehicles, power equipment, new materials, biomedicine and high-​performance medical equipment, and agricultural machinery equipment. The five key projects include the construction of a national manufacturing innovation center, intelligent manufacturing, a strong industrial base, green manufacturing, and high-​end equipment innovation. At the same time, China has put forward safeguard measures to promote the Manufacturing Power Strategy, including deepening the reform of the management system, creating a fair competition market environment, improving the multilevel personnel training system, improving the policy on small and medium-​size enterprises, expanding the opening of the manufacturing industry, and improving organization and implementation mechanisms. In particular, it is important to point out that in the implementation of the Manufacturing Power Strategy, China should encourage the innovation of its development model, and avoid cut-​throat competition, especially avoid price dumping in the international market. The Manufacturing Power Strategy has a long way to go and requires the joint efforts of the government, the market players, and people of various fields.

Manufacturing Power Strategy in Context The Manufacturing Power Strategy responds to both domestic and external factors that pose risks to the continuation of the country’s rapid economic development. Regarding domestic factors, macroeconomic shocks from potential turmoil in the financial sector, disruptions from income and wealth inequality, and/​or a sudden decline in real estate

700   Mayer and Sun prices and a sharp contraction in construction and investment may pose short-​term risks. But arguably of greater and long-​term concern is the so-​called middle-​income trap (MIT) that will make innovation-​driven development of prime importance. External forces that may pose challenges to China’s continued rapid development include digitalization and the new technological revolution, as well as structurally weak growth in the world economy that, combined with declining support to globalization forces in many of the advanced economies, is set to hamper global flows of trade and foreign direct investment. Moreover, while Chinese policymakers may consider China’s emergence as a proactive stakeholder in the global economy as shaping the global governance agenda with a view to preserving the features of multilateralism and globalization that have been instrumental for both supporting China’s rapid economic development and maintaining a peaceful global economic order over the past few decades, there may be resistance from established economic powers to China’s more assertive stance.

China’s Development Strategy and the MIT China has achieved a remarkable economic expansion over the past four decades. Its economy grew in real terms by an average annual rate of 9.5% between 1980 and 2018, peaking at 14.2% in 2007. Moreover, there has not been any sustained marked slowdown of economic growth, with decadal average growth rates hovering around 10% between 1980 and 2010. As a result, per capita income in 2011 purchasing power parity terms exceeded 16,000 international dollars in 2018, implying a transition from being among the poorest countries to attaining middle-​income status in just one generation. More recently, however, China’s economic growth rate has seen a steady and sizable deceleration, falling from 10.6% in 2010 to below 7% over the period 2015–​2018, that is, the lowest rates since 1991.1 Moreover, average growth over the period 2013–​2030 has been estimated to decline to around 6.4% (World Bank and Development Research Center of the State Council, People’s Republic of China [DRC], 2013), while the International Monetary Fund (IMF) projects China’s growth to slow even more sharply and drop below 6% by 2022. This raises the question as to whether China’s economy is now in what has been described as the MIT and what it would take for its growth rate to reaccelerate. The MIT relates to the observation that over the last half century, (1) rapid economic growth has allowed many developing countries to reduce levels of absolute poverty but very few among them succeeded in attaining the high per capita income levels of developed countries (e.g., World Bank and DRC, 2013); (2) the probability of a marked growth slowdown is higher in middle-​income than in low-​or higher-​income countries (e.g., Aiyar et al., 2013); (3) breaking up this period between 1950 to 1980 and 1980 to 2010 indicates that it has become more difficult for developing countries to catch up and easier to fall behind during the latter period (e.g., Eichengreen, Park, and Shin, 2012) and that structurally weak growth in the global economy since the global financial crisis that started in 2007–​2008 poses the risk that even previously dynamic middle-​income economies may experience prolonged

1  Unless otherwise mentioned, all numbers mentioned here are calculated from the IMF’s World Economic Outlook database, accessed May 23, 2019.

Manufacturing Power Strategy    701 slow growth (e.g., Zhuang, Vandenberg, and Huang, 2012); and (4) that the probability of slowdown is highest when per capita GDP reaches 16,740 international dollars (measured in 2005 prices) (Eichengreen, Park, and Shin, 2012), that is, a level that closely corresponds to China’s current level of per capita income.2 At the same time, a range of studies do not support the notion of an MIT (e.g., Barro, 2018). They hold that it fails to recognize that different initial conditions and policy responses tend to cause different growth trajectories. Indeed, some middle-​ income economies, mostly located in Asia, have continued growing rapidly, whereas others, often those in Latin America, have not. But given that the successful Asian economies are much smaller in size than China, the issue also is whether what worked for small-​or medium-​ sized Asian economies will also work for the large Chinese economy. This issue may be particularly important because in a relatively large economy, moving toward a high-​income stage may depend less on large-​scale exports and relatively more on domestic consumption. To sustain this, a relatively large middle class with a high propensity to consumption and an olive-​shaped income distribution would be required (Li, 2017), for whose creation wage increases and tax policies promoting mass consumption would appear important steps. Nevertheless, the development literature points to reasons for thinking that growth may indeed slow as countries reach middle-​income status. One argument relates to the “turning point” described by Lewis (1954), when the pool of surplus labor from agriculture gets fully absorbed into the modern industrial sector, so that a shrinking labor force and/​or further economic expansion generates rising wages. Evidence on wage growth and demographic developments suggests that China may have attained the Lewis turning point or, at least, is rapidly approaching it (e.g., Huang and Cai, 2014). This may be a problem if wage growth is not accompanied by at least as rapid productivity growth and if exports are the main engine of growth. In this case, the middle-​income economy will no longer be able to compete in low-​wage labor-​intensive goods, but also not yet have the capabilities to export high-​wage technology-​intensive products. Reduced exports earnings would also make it difficult to continue relying on advanced technology imported from abroad, forcing the economy to move up the technology ladder and develop innovative technology on its own. However, to the extent that internal demand is an important growth driver, wage growth can offer new sales opportunities as domestic markets expand, and higher production costs will not be the defining constraint on growth in a middle-​income economy (e.g., UNCTAD, 2016). In that case, measures strengthening domestic innovative capacity (e.g., Kim and Park, 2018) and technology-​intensive production patterns, as well as transiting from export-​led growth strategies relying on cheap labor toward a more balanced growth strategy with relatively greater importance of domestic consumption, will be crucial for successfully navigating the transition to high-​income status. Independently of whether one subscribes to the notion of an MIT, the key question is what it will take for China to reaccelerate its economic growth and attain high-​income-​ country status. There is widespread agreement that “to sustain growth through and beyond the (upper) middle-​income phase, the PRC will need to rely on productivity improvements

2  Parts of the discussion here draw on recent special issues on China and the middle-​income trap in Asian Economic Papers, 2012, 11(1); China & World Economy, 2016, 24(5); Emerging Markets Finance & Trade, 2018, 54(6); and Glawe and Wagner (2020).

702   Mayer and Sun through innovation and upgrading. The transition ‘from low cost to high value’ is a key imperative for the economy” (Zhuang, Vandenberg, and Huang, 2012, viii). This transition will need to include a wide range of policy areas—​such as ensuring macroeconomic, political, and social stability and undertaking public investment in infrastructure and education—​ with some observers also suggesting accelerated structural reform with measures toward enterprise reform and factor market liberalization, strengthened intellectual property rights protection, greater market competition, and a reduced role of the state (e.g., Woo, 2012). But in any case, stepping up innovation, including through a focused industrial policy, may be at the top of the list of required policy objectives.

The Synergy between Adopting Advanced Technology from Abroad and Strengthening Indigenous Innovation Regarding China’s technology trajectory since the late 1970s, there is wide agreement that (1) foreign businesses and the adoption of advanced technology from abroad played a critical role especially at the initial stage of the reform process, (2) the channels used for technology transfer have evolved with the rapid development of China’s own technological base, and (3) indigenous innovation capacities have become increasingly more important sources of China’s technology trajectory. There is, however, some disagreement as to when and to what extent indigenous innovation has made significant contributions to China’s technology trajectory. Some are downplaying this role (e.g., Hu and Jefferson, 2008; Brandt, Rawski, and Sutton, 2008), arguing that competition from foreign businesses and imported technology has motivated Chinese firms to raise R&D expenditure and innovation activities in an effort to survive, and others emphasizing it (e.g., Fu, Woo, and Hou, 2016), including because an appropriate indigenous technology base is required to reduce implementation lags and increase the efficiency of imported technology. The latter view on how China has combined acquisition of foreign technology and indigenous innovation is reflected in Figure 7.3.1. The beginning of the reform period in the late 1970s marked a diversification of the sources of technology from reliance on the former Soviet Union toward a rising importance of Western countries and Japan, as well as from the purchase of turnkey plants and equipment toward greater use of licensing, technical consulting, and services and coproduction. At the same time, domestic efforts remained limited to learning how to use imported technology. A new focus on technology transfer through inflows of foreign direct investment appeared in the mid-​1980s, sometimes trading market access for technology, and the mid-​1990s marked a shift toward increasing attention to more rapid advancement of indigenous science and technology. This new focus was accompanied by a series of large-​scale science and technology programs, which the state initiated during the period 1980–​2000 with a view to improving the infrastructure for indigenous innovation, and which include the Key Technologies R&D Program (1982), the Spark Program (1986), the National High-​Tech Research and Development Program (1986), the Torch Program (1988), the Innovation Program for Technology-​Based Small-​and Medium-​ Sized Enterprises (1993), the “Revitalize the Nation through Science and Education” campaign (1995), and the National Key Basic Research Program, also known as the 973 Program (1997) (Hu and Jefferson, 2008; Fu, Woo, and Hou, 2016).

Manufacturing Power Strategy    703 EXOGENOUS (open up diverse external channels) Acquiring technology from Soviet Union Before 1980

Identifying foreign technology as one of the main sources: expandion of inward FDI 1980–1990

Diversifying external sourcing channels: outward FDI; international cooperation, etc. 1990–2000

Attracting skilled returnees Thousand talent program

After 2000

Key technologies R&D Program; Spark Program Torch Program

Revitalization the Nation Indigenous innovation strategy; through Science and Education medium- and long-term Progr. 973 Program of S&T; Strategic Emerging Industries Program

Help absorption of foreign technology

Help 1) absorption of foreign technology; 2) establish innovation infrastructure

INDIGENOUS Remove dependence on foreign technology

Multiple driving forces: state, private sector, and MNEs; supportive institutional setting

Figure 7.3.1  The synergy between imported technology and indigenous innovation. Source: Authors’ elaboration, based on Fu, Woo, and Hou (2016)

Indigenous innovation became a strategic priority in 2005–​2006. This has been reflected in the Medium-​and Long-​Term Program of Science and Technology (2005–​2006) and the Program of Strategic Emerging Industries (2010), as well as in incentives for highly skilled migrants to return to China, and in a shift in the source of foreign technology toward participation in international innovation collaboration and increased outward foreign direct investment (OFDI) designed to acquire foreign technology companies (e.g., Fan, 2014). Starting from the mid-​2000s, China has also significantly increased its OFDI, including with a view to acquiring leading-​edge technologies. China was second in total OFDI rankings in 2016 but fell back to third place in 2017. Total OFDI from China was $125 billion in 2017, marking the first reversal since 2003 and implying a drop by almost one-​third from its level in 2016. This decline followed policies clamping down on OFDI, in reaction to significant capital outflows in 2015–​2016, mainly in the areas of real estate, hotels, and entertainment (UNCTAD, 2018). The available evidence indicates a positive association between OFDI and firm performance measured by R&D expenditure and sales of new products (Chen and Tang, 2016); this positive impact is strongest for OFDI in developed countries, which serves as an “innovation springboard” for Chinese firms to overcome internal constraints and leapfrog to the technology frontier (Fu, Hou, and Liu, 2018). China’s current level of innovation capacity may be assessed by looking at multidimensional indices that measure innovation capabilities across countries. Several of them show that China’s performance is rapidly improving. In a ranking of 40 countries from the Chinese Academy of Science and Technology, China moved four places higher from 2013 to rank 17th in 2017. The European Innovation Scoreboard compares China’s performance on several benchmarks with the members of the European Union (EU). The 2018-​Report

704   Mayer and Sun concludes that the EU remains ahead of China but that this lead is decreasing rapidly as since 2010 China has improved almost three times faster than the EU. The Global Innovation Index published by Cornell University, INSEAD and the World Intellectual Property Organization ranks 127 countries using measures of innovation inputs and outputs and put China 22nd, up from 43rd place in 2010.3 This economy-​wide evidence of China’s rapid development of its technological capabilities is supported by case studies (e.g., Fu, 2015; Kang, 2015; Zhang and Gallagher, 2016), which illustrate the importance of indigenous innovation capacities for China’s recent technology trajectory. These case studies may also indicate that successful companies such as Huawei, ZTE, and Suntech could serve as role models for other domestic companies seeking to become more innovative.

Manufacturing Power Strategy in the Context of Global Developments The effectiveness of China’s growth policies and its rapid economic development have benefited from a supportive global environment, whose key elements included steady growth in China’s major export markets, a rules-​based and relatively open multilateral trading regime, a relatively stable monetary environment, sizable flows of foreign direct investment, and the organization of rising shares of world trade through global value chains, powered by rapid reductions in the cost of transport, communication, and information management. The beginning of the global financial crisis in 2007–​2008 marked an unraveling of an increasing part of this supportive external environment, with attendant effects for China’s policies, including the implementation of the Manufacturing Power Strategy. The sharp economic slowdown in most advanced economies and the great trade collapse in 2008–​2009 triggered China’s policymakers to adopt a huge emergence stimulus package in 2008–​2009. The package was initially focused on public investment in infrastructure and an expansion of existing production structures but became subsequently characterized by an increasing number and substantial broadening of sector-​specific and intersectoral programs to develop new strategic and innovative industries, as well as by strong involvement of SOEs. Particularly the strong involvement of SOEs in China’s recent industrial policy agenda may at least in part be associated with a credibility crisis of Western-​style market systems in the aftermath of the 2007–​2008 global financial crisis. It may have weakened the influence of Chinese policymakers that argued for a greater role of competition, strict separation of government and enterprises, and decision autonomy for enterprises. The current new industrial revolution, the associated opportunities for manufacturers to counter wage pressure through robotization, and the attendant impacts on the geography of global manufacturing are also affecting the objective of the Manufacturing Power Strategy to triple robot use from 2015 levels. This is because robotization is one way in which 3  For the various indices, see http://​english.cas.cn/​newsroom/​china_​research/​201708/​t20170821_​ 182108.shtml; http://​ec.europa.eu/​growth/​content/​european-​innovation-​scoreboard-​2018-​europe-​must-​ deepen-​its-​innovation-​edge_​en; https://​www.globalinnovationindex.org/​gii-​2017-​report.

Manufacturing Power Strategy    705 employers can react to an aging labor force and a scarcity of middle-​aged workers (e.g., Acemoglu and Restrepo, 2018). Doing so would reduce wage pressure and curtail concerns about China falling into the MIT. Tripling robot production from 2015 levels would reduce balance-​of-​payments problems that could arise from expanding imports of machinery and equipment in the face of declining export revenues. At the same time, early presence in this new technology area would tend to face fewer obstacles from established intellectual property rights.

Assessments of Manufacturing Power Strategy Assessments in North America and Western Europe China’s rising innovation and technological capabilities have been observed with great interest especially in advanced economies that are concerned about an erosion of their global technology lead. In the United States and the EU, the Manufacturing Power Strategy has been met with skepticism, incomprehension, and, increasingly, antagonism. One source of skepticism relates to a perceived lack of implementation and measurement details—​such as regarding policy evaluation, financing allocation, and human resource management—​that further increase genuine difficulties in gauging and evaluating the direction and progress of technological advancement and innovation (e.g., Tong and Kong, 2017). Therefore, much of the success of China’s innovation initiatives will depend on how flexibly and skillfully policymakers can respond to various successes and failures during their implementation. One challenge will be that the different strategic industrial sectors are at different levels of development, whereas their planned development depends on the industrial complementarities of all sectors upgrading at a uniform pace. This requires significant industrial policy coordination, which, some argue, may be difficult to ensure (Kenderdine, 2017), while others hold that China’s political system has developed an increasingly routinized and structured consensus model of policymaking that can handle these matters in effective ways (Chen and Naughton, 2016). Moreover, policy strategies during China’s reform era have generally been characterized by relatively unspecific general guidelines combined with room for local experimentation of policies that are adjusted and modified before being generalized and put into law (Heilmann and Shih, 2013). Most skepticism relates to doubts as to the degree of state involvement and of government planning, as well as SOEs and industrial policies being effective drivers of innovation.4 Wübbeke et al. (2016, 8) expect the initiative to allow for a small but impactful group of global leaders in smart manufacturing to be created but also its effectiveness to be “limited by the mismatch between political priorities and industry needs, the fixation on quantitative targets, inefficient allocation of funding and campaign-​style overspending by local governments. The lack of bottom-​up initiative and investment is a profound weakness of

4 

For this general view, see, for example, Perkins and Rawski (2008) and Zhang (2017).

706   Mayer and Sun Made in China 2025.” This skepticism is based on extrapolating to China the failure of the former Soviet Union’s planned approach to technology development. This is also expressed by World Bank and DRC (2013, 172), stating that the innovation systems in the leading technology powers rely on the public sector merely playing a “facilitating role, seeding experimental research with a long-​term payoff, providing the legal and regulatory institutional scaffolding, and establishing enforceable standards. China is some distance from this model of an open, cosmopolitan, market-​directed innovation system.” Others may argue that this view neglects that in the United States, agencies such as the Departments of Defense, Energy, and Agriculture and the Defense Advanced Research Projects Agency (DARPA) have played a central role in boosting innovations that have created the internet and many other recent technologies (e.g., Mazzucato, 2013). Incomprehension relates to nonconformity of China’s approach to Western political economy models. These see economic success closely associated with accelerated moves toward privatization and more Western-​style open societies and markets. This perspective was formulated most clearly in the end-​of-​history view that appeared following the collapse of the Soviet Union (Fukuyama, 1992). It holds that self-​organizing capitalist systems are more robust and the only ones able of achieving sustained technological innovation. It was therefore widely expected that at least with an increased emphasis on innovation-​based growth, China would accelerate its move toward free markets and open societies (e.g., World Bank and DRC, 2013). However, the recent economic problems and social and political tensions in Western societies have raised doubts as to the presumed interdependence between liberal political and economic systems and their supposed supremacy in spurring innovation. These doubts may well persist until Western policymakers can reinvigorate their system’s problem-​solving capacities, social cohesion, and international credibility and appeal (e.g., Heilmann, 2018). Antagonism to China’s policy strategies was initially mostly related to findings of a link between the sharp decline in US manufacturing employment and the granting of permanent normal trade relations (PNTRs) to China in 2000 (Pierce and Schott, 2016), and that local labor markets in the United States that experienced larger increases in ensuing import competition from China exhibited larger job displacement and wage erosion (Autor, Dorn, and Hanson, 2013). Such trade-​related job displacement and wage erosion questions the traditional view that international trade may have adverse distributional effects in theory that, however, in practice are relatively benign and can easily be corrected. This view may hold at aggregate national levels but has proved too complacent about adjustment pressure and distributional effects on labor markets with a concentration of economic sectors that are exposed to international competition. Yet, the decline in manufacturing employment in the United States is a longer-​term phenomenon (e.g., Lawrence and Edwards, 2013). The observed trade-​related job displacement may have been time bound, as it is not observed over longer time horizons (Feenstra, Ma, and Xu, 2017) and it reflects an abrupt reversal of trade policies that triggered similarly abrupt adjustment (Pierce and Schott, 2016). Granting PNTRs to China appears to have benefited the United States as a whole (Handley and Limão, 2017). But antagonism to the Manufacturing Power Strategy has mostly and increasingly related to perceived threats to the United States and general Western technological supremacy, especially in the automotive and machinery sectors (Wübbeke et al., 2016). Perhaps most importantly, there are concerns that the aforementioned lack of implementation and

Manufacturing Power Strategy    707 measurement details reflects an attempt to avoid open violation of World Trade Organization (WTO) obligations, with self-​sufficiency quotas for core components being communicated to enterprises through internal and semiofficial documents and with localization targets being implemented through broad and diverse measures, including direct capital injections and preferential loans, as well as closing off public procurement to foreign enterprises (e.g., Wübbeke et al., 2016, 20–​21; European Union Chamber of Commerce in China [EUCCC], 2017). This is seen to be combined with an aggressive strategy of acquiring advanced technology in critical high-​tech sectors through a strategy of forced transfer of cutting-​edge technology and foreign acquisitions subsidized from government-​backed investment funds (e.g., EUCCC, 2017). Indications that the Manufacturing Power Strategy will lead to a global pushback from China’s trade and investment partners (e.g., Segal, 2018) have been rapidly accumulating and include both protectionist trade and proactive technology policies. Regarding trade, the president of the United States directed in August 2017 the United States Trade Representative (USTR) to determine whether any of China’s laws, policies, practices, or actions may be harming American intellectual property rights, innovation, or technology developments. Based on the USTR’s report (USTR, 2018),5 issued in March 2018, President Trump demanded that China stop “forcing” foreign companies to share core technology with Chinese enterprises; protect American intellectual property; remove restrictions on investments and activities of firms from the United States in China; reduce state support to high-​tech industries and abandon the goal of self-​sufficiency in key technologies and products in high-​value industries, especially those associated with the Manufacturing Power Strategy; and control investment by Chinese companies to obtain cutting-​edge technology and intellectual property, and alleged unauthorized intrusion into, and theft from, the computer networks of US companies. To force these changes, and pointing to the bilateral trade deficit of the United States with China, the US government directed stepwise tariff increases on a widening range of Chinese goods and demanded higher imports by China from the United States;6 tightened controls over Chinese investment in US tech companies; imposed import controls on several Chinese tech companies including Huawei, a major Chinese telecommunications and network equipment manufacturer that aims to be a supplier of 5G network infrastructure; and considered controls on technology exports to China in sectors including artificial intelligence (AI), biotechnology, microprocessors, and robotics. China responded in a tit-​for-​tat fashion to the rise in tariffs, while agreeing to purchase more agricultural products from the United States, easing ownership restrictions on foreign direct investment in China, and banning “forced” technology transfer.7 To end these trade frictions, bilateral talks were launched in December 2018. While attaining much common ground, disagreement as to how to implement and enforce an

5 

For a critical assessment of the evidence provided by the report see, for example, Roach (2019). For a timeline, see https://​piie.com/​blogs/​trade-​investment-​policy-​watch/​trump-​trade-​war-​china-​ date-​guide. 7  See The US-​China Business Council, Foreign Investment Law of the People’s Republic of China, March 15, 2019, https://​www.uschina.org/​sites/​default/​files/​foreign_​investment_​law_​of_​the_​peoples_​ republic_​of_​china_​-​_​unofficial_​translation.pdf. 6 

708   Mayer and Sun agreement rendered concluding the talks difficult. They reached a roadblock in May 2019, caused, according to the United States, by China’s sudden backtracking on previously agreed-​upon elements of the deal, and, according to China, by the United States’ inflexible insistence on requests that China felt would undermine its sovereignty, including that (1) the United States could unilaterally impose punitive tariffs if it felt that China violated the agreement and that China could not retaliate with its own tariffs or challenge the action at the WTO, and (2) China would reduce levels of state support to SOEs and translate agreed measures into law, rather than administrative instructions.8 At the same time, the trade frictions have been subsumed into a contest for technological supremacy.9 On February 11, 2019, President Trump signed an executive order launching the American Artificial Intelligence Initiative, titled “Maintaining America’s Leadership in Artificial Intelligence.”10 The initiative asks federal funding agencies to (1) prioritize investments in AI research; (2) create resources by making federal data, computer models, and computing resources available to AI researchers; (3) establish standards that foster the development of reliable, robust, trustworthy, secure, portable, and interoperable AI systems; (4) build the AI workforce by prioritizing the building of STEM skills; and (5) engage internationally such that AI develops in a way consistent with American values and interests. While the initiative has been criticized for being short on direct action and lacking new funding, it counts on entrepreneurial spirit and gives the private sector the lead in AI. Moreover, it is but one governmental AI initiative currently underway.11 For example, the day after the executive order was issued, the US Department of Defense (DOD) launched its own AI Strategy,12 whereby the DOD continues to see its funding growing—​with more and more of the money focused on AI—​and DARPA is undertaking a multiyear investment of more than $2 billion in new and existing programs called the “AI Next” campaign.13 Europe has also begun to rethink its China policies, with the overall thrust of change being convergence on the new US approach.14 In March 2019, European heads of state debated a new European Commission strategy paper that describes China as an “economic competitor in the pursuit of technological leadership, and a systemic rival promoting

8 

https://​w ww.cnbc.com/​2019/​05/​27/​china-​is-​digging-​in-​its-​heels-​on-​protecting-​a-​state-​r un-​ economy.html 9  For a contrasting appraisal of where the United States and China stand in the AI race, see Wolf (2019). 10   https://​ w ww.whitehouse.gov/​ p residential-​ a ctions/ ​ e xecutive- ​ o rder- ​ m aintaining- ​ a merican-​ leadership-​artificial-​intelligence/​ 11 The United States’ governmental AI initiatives currently underway are listed at https://​ www. whitehouse.gov/​ai/​. For a summary of AI strategies adopted in 2017–​2018 by a wide range of other countries, see https://​medium.com/​politics-​ai/​an-​overview-​of-​national-​ai-​strategies-​2a70ec6edfd. 12  See US Department of Defense, DOD Unveils Its Artificial Intelligence Strategy, February 12, 2019, https://​dod.defense.gov/​News/​Article/​Article/​1755942/​dod-​unveils-​its-​artificial-​intelligence-​strategy/​. 13  See DARPA, AI Next Campaign, https://​www.darpa.mil/​work-​with-​us/​ai-​next-​campaign. 14  At the same time and despite considering banning Huawei and ZTE from involvement in the EU’s 5G networks, the joint EU-​China 5G-​Drive project that focuses on the interoperability between the EU’s and China’s 5G networks (see https://​5g-​drive.eu/​about-​5g-​drive/​) is going ahead as planned (see https://​www.msn.com/​en-​sg/​news/​newstechnology/​china-​eu-​5g-​research-​project-​to-​continue-​despite-​ growing-​concerns-​about-​huawei/​ar-​BBTq0uf).

Manufacturing Power Strategy    709 alternative models of governance” (European Commission, 2019, 1). Also referring to China as a “systemic competitor,” the Federation of German Industries had already called for a much tougher approach to China, saying that Germany’s open model was increasingly in competition with China’s state-​dominated economy and needed to protect itself more effectively from Chinese companies (Federation of German Industries, 2019). Partly in response to this call, Germany’s economy minister unveiled, on February 5, 2019, his “National Industrial Strategy 2030” (Federal Ministry for Economic Affairs and Energy, 2019). The strategy’s main propositions include (1) a state investment fund that would acquire—​for a limited period and in very important cases—​stakes in big German companies, whose technology is crucial to Germany’s future competence in critical new technologies such as AI and electric vehicles, to protect these companies from foreign takeovers, and (2) an easing of European competition law to allow for “national and European champions” that could more easily compete with non-​European tech giants. Germany also lowered the threshold for screening foreign takeovers if the deal raises national security concerns, especially with a view to protecting essential parts of the digital economy, such as 5G technology, from Chinese firms.15 While concurring with the perspective of France,16 it is uncertain whether the new national industrial strategy will gain traction in Germany. There, many perceive it as departing too far from the ordoliberal principles that have shaped Germany’s economic policy since World War II.17 These have seen industrial and innovation policy relying on infrastructure provision, ensuring functioning competition and a lean regulatory framework, combined with offering incentives for innovation that is supposed to be driven by private small and medium-​sized enterprises, rather than heavily-​state-​supported national champions. Taken together, the Manufacturing Power Strategy may well mark the end of an era shaped by the end-​of-​history view (Fukuyama, 1992) and that had a liberal multilateral trading regime managed by the WTO as a main characteristic. Only time can tell whether the antagonism that the Manufacturing Power Strategy has sparked will usher in an era of economic Cold War, with bifurcated and mutually incompatible technology supply chains and bilateral trade pacts crippling the multilateral framework for handling trade disputes and the WTO as “collateral damage,” or whether it will allow for constructive competition that delivers the next true general purpose technology and a shift toward inclusive trade with gains to all countries and all citizens and, as “collateral benefit,” a rewriting of multilateral trade rules that provide a mechanism for redress when trade threatens to undercut established labor and environmental standards and that gives countries the policy space to pursue strategies that suit their economies and societies.

15 See

Federal Ministry for Economic Affairs and Energy, “Strengthening our national security via improved investment screening,” December 19, 2018, https://​www.bmwi.de/​Redaktion/​EN/​ Pressemitteilungen/​ 2 018/​ 2 0181219-​ staerkung-​ u nserer-​ n ationalen-​ s icherheit-​ durch-​ verbesserte-​ investitionspruefung.html. 16  See “Altmaier and Le Maire adopt joint Franco-​German Manifesto on Industrial Policy,” https://​ www.bmwi.de/​Redaktion/​EN/​Pressemitteilungen/​2019/​20190219-​altmaier-​and-​le-​maire-​adpot-​joint-​ franco-​german-​manifesto-​on-​industrial-​policy.html. 17  “Germany’s new industrial strategy under fire,” Reuters, February 2, 2019, https://​www.reuters.com/​ article/​us-​germany-​industry/​germanys-​new-​industrial-​strategy-​under-​fire-​idUSKCN1PQ5ZA.

710   Mayer and Sun

Assessments in China The Manufacturing Power Strategy can be considered a 10-​year action guidance of the transformation and upgrading of China’s manufacturing industry. From the date that the Manufacturing Power Strategy was proposed, the document has been in the process of self-​enlargement over time, and has derived a more comprehensive and grand expression. Chinese scholars believe that the Manufacturing Power Strategy should return to its position when it was issued, that is, offering long-​term guidance on the transformation and upgrading of China’s manufacturing industry. But it is not in the dominant position in the global industrial division and value chain. The challenge that China’s manufacturing industry is facing is that the overall level of technology is insufficient and the core competitiveness of enterprises is not strong enough. The effectiveness of industrial policy needs to be further observed. Industrial policy covers many fields such as industrial structure and industrial organization theory. Some scholars describe the transformation and upgrading of China’s economy as “curve overtaking.” All the stages, from mechanization, automatization, and informatization to intelligentialization are essential. China may need to promote automation, information, and intelligence differently in different industrial fields according to the actual situation. Innovation in the field of advanced manufacturing has great uncertainty, risk, and even contingency. It is still not easy to comprehensively assess whether the industrial policy is accelerating or slowing down the transformation and upgrading of China’s manufacturing industry. China needs to pay attention to the Western countries’ feelings and worries about the Manufacturing Power Strategy. China should observe and find out the reasons that Europe and the United States are worried. For the path of development, the Western countries are concerned about whether China’s economy has strengthened the state’s will and “state capitalism”. If there is a debate on the choice of development paths, it is likely to be generalized into a more intense debate on values, patterns of consciousness, and the right to independent development, which usually does not yield constructive results. Western countries worry about government subsidies, intellectual property protection, and the status of foreign-​funded enterprises in China. This may reflect that they are not worried about the promotion and development of China’s manufacturing industry, as well as the growing domestic demand market, but rather about whether a more powerful China could provide wider, credible, and sustainable opportunities for Western enterprises and products.

Conclusions The Manufacturing Power Strategy is the key element of China’s longer-​term strategy aimed at closing the technology gap with advanced economies and at deriving more of its growth impetus from higher indigenous innovation–​based productivity. These two achievements would allow the Chinese economy to overcome what has been called the MIT and acquire high-​income status. Recent gains in indigenous innovation capacity and the emergence of some Chinese firms as global technological leaders suggest that China can embark on an innovation-​and productivity-​led growth path.

Manufacturing Power Strategy    711 The speed of this transition and the contribution from the Manufacturing Power Strategy will depend on several factors. One is how Chinese policymakers approach the delicate choice between, on the one hand, a large-​scale push toward economic restructuring and transiting to an innovation economy, and on the other hand, the need for countercyclical stimulus to existing industry structures to avoid an excessive deceleration of growth and investment, as well as short-​term economic challenges posed by a less supportive external economic environment. Another challenge is providing tertiary education and vocational training such that there are a sufficient number of appropriately skilled workers for innovation. Perhaps the greatest challenge will be finding the right mix between state guidance and private sector involvement, including with a view to making the Manufacturing Power Strategy fully effective while addressing antagonism from China’s trade and investment partners. This mix would strive (1) to ensure that SOEs realize the full innovation potential that physical assets and human talent provide, such as through improved organizational structures and incentives and through better integration of research, production, and marketing activities (e.g., World Bank and DRC, 2013), and at the same time (2) to strengthen institutions that provide incentives to entrepreneurs, scientists, and research institutions to spur innovation, such as creating a strong intellectual property rights institution, innovation funds targeted to support particularly innovative enterprises, and information support systems (e.g., Fu, Woo, and Hou, 2016). While these challenges regard the national level, regional disparity in innovation capacity will affect income disparities across Chinese regions. To address distributional issues, policymakers may need to consider strengthening social safety nets and adopt measures designed to achieve more equal income and wealth distribution. These measures would include macroeconomic policies that encourage growth of domestic household consumption, which in turn would positively affect indigenous innovation that meets the needs and desires of Chinese citizens.

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Chapter 7.4

Facing the Fu t u re of China’s Sci e nc e a nd Technol o gy Dev e l opme nt Jiaofeng Pan, Guanghua Chen, and Xiao Lu In the face of its new situation in a global economy recovering from the pandemic and still affected by trade tensions, China needs to make full use of the supporting and guiding role of science and technology innovation in eight socioeconomic foundations and strategic systems:

1. Sustainable energy and resources 2. Advanced materials and intelligent green manufacturing 3. Ubiquitous information network 4. Ecologically high-​value agriculture and bioindustry 5. Universal healthcare 6. Ecological and environmental conservation and development 7. Space and ocean 8. National and public security

China is committed to promoting the modernization of science and technology governance, improving the science and technology decision-​making consultation mechanism, re-​engineering the science and technology plan management system, optimizing scientific research projects and capital management systems, promoting the open sharing of scientific and technological resources, and creating a deeply integrated open innovation environment that emphasizes incentives for innovation. In the long history of global scientific and technological development, China has long stood out among ancient civilizations for its technological inventions, well ahead of Europe for a millennium. In modern times, for various reasons, China repeatedly lost opportunities to keep pace with technological and industrial revolutions (Landes, 1998), but the founding of the New China marked the beginning of a new period for Chinese science and technology. In 1978, China implemented the reform and opening-​up policy, which ushered in a “spring of science,” and since then, China’s scientific and technological innovation system has undergone earth-​shaking changes. China has made science and technology innovation a key national strategy, and its overall technological capabilities have continued to improve.

Facing the Future of China’s S&T Development    715 Today, China has built a comprehensive and systematic scientific research infrastructure and has become an important technological power in the world. In the 70 years of development of the People’s Republic of China, especially since the reform and opening-​up and the construction of China’s science and technology ecosystem, the country has broken through barriers, established new systems, proceeded through catching up and comprehensive improvements, and finally achieved independent innovation, leapfrogging competitors in key areas, and shaping and leading entire industries. Now, at a new historical starting point and facing the grand goal of building China into a world-​class science and technology power, we must look forward to global development trends and plan China’s science and technology development strategy. As argued by Dosi and Yu in Chapter 1.1 of this Handbook, a national innovation system includes not only a developed system of scientific knowledge and technologies but also an “economic machine,” comprising the mechanisms for production, investment, income distribution, and structural change and a system of social relations and institutions, including public agencies and policies. This chapter systematically describes in three sections the goals and plans for China’s future scientific and technological innovation development, the eight socioeconomic foundations and strategic systems for China’s technological growth, and the key points and paths of China’s organization and governance of a modern science and technology innovation system.

Future Prospects for China’s Science and Technology Innovation Development China’s Scientific and Technological Innovation Achievements in Recent Years The Chinese government has always regarded science and technology innovation as a means of strategic support for improving social productivity and overall national strength. It sits at the core of the country’s overall development and forms a set of innovative theoretical systems and action outlines for everything from new ideas and new strategies to new outlines, new plans, and new actions. The main achievements of China’s scientific and technological innovation in recent years are as follows: First was the top-​level design for implementing innovation-​driven development. The National Science and Technology Innovation Conference issued a call to build China into an innovative country and a world-​class technology powerhouse. The “National Innovation-​ Driven Development Strategy Outline”1 was promulgated and implemented, and the “Three-​ Step” strategic goal of innovation-​driven development was established. A comprehensive

1  In May 2016, the CPC Central Committee and the State Council issued the “National Innovation-​ Driven Development Strategy Outline,” which represented the top design of the innovation-​driven development strategy.

716    Pan, Chen, and Lu science and technology innovation plan was formulated and implemented at the national level—the “13th Five-​Year National Science and Technology Innovation Plan.”2 Second was continuously increasing investment in science and technology innovation. In 2017, annual research and experimental development expenditure was 1.76 trillion yuan, an increase of 12.3% over the previous year, accounting for 2.13% of gross domestic product (GDP); private enterprises accounted for 77.6% of the total research and development (R&D) expenditure (National Bureau of Statistics, 2017a). A total of 488 national key laboratories, 131 national engineering research centers, 194 national engineering laboratories, and 1,276 national enterprise technology centers have been built (National Bureau of Statistics, 2017b). Third has been the remarkable results achieved by innovation-​driven development. In 2017, the contribution rate of China’s scientific and technological progress to economic growth increased to 57.5%, and the added value of high-​tech industries accounted for 12.7% of the added value of industrial enterprises above a designated size. Breakthroughs were achieved in the industrialization of major scientific and technological accomplishments such as high-​speed railways, hydropower equipment, ultra-​high-​voltage (UHV) power transmission and transformation, hybrid rice, earth observation satellites, the BeiDou Navigation Satellite System, and electric vehicles. Fourth, breakthroughs were made in key areas of scientific and technological innovation. As it approaches the cutting edge of international science and technology, China has achieved a number of major original achievements in the fields of basic research and applied basic research such as quantum communication and computing, high-​temperature superconductivity, and neutrino oscillation. In primary economic battlefields, major national science and technology projects have realized a series of technology and engineering breakthroughs, including multiple leaps forward in the mobile communication field from “following in 2G” to “leading in 5G”; the successful testing of the C919 large passenger aircraft; and extending China’s reach to deep space, deep seas, deep underground, cyber space, and other strategic areas. China has created a number of landmark scientific and technological innovations with international influence. Fifth, China’s international influence has been greatly enhanced. In the past five years, China’s innovation index and competitiveness rankings have jumped sharply. China ranks first in the world in the number of invention patent applications, the number of trademark applications by science and technology enterprises, and the total number of R&D personnel, and second in the output of scientific papers, the investment in R&D and the added value of high-​tech manufacturing (National Science Foundation of China, 2018). Sixth, formation of the new high ground for regional innovation and development has accelerated. The construction of Technology Innovation Centers in Beijing and Shanghai has been fully launched, the eight regional comprehensive innovation reform pilot zones have been further promoted, 168 national high-​tech zones have maintained rapid development, and a number of internationally renowned “unicorn” enterprises have emerged in the private economy. 2  In August 2016, the State Council issued the “13th Five-​ Year National Science and Technology Innovation Plan” (http://​www.most.gov.cn/​mostinfo/​xinxifenlei/​gjkjgh/​201608/​t20160810_​127174.htm).

Facing the Future of China’s S&T Development    717

China’s Future Scientific and Technological Innovation Strategic Goals In 2016, the Communist Party of China (CPC) Central Committee and the State Council issued the “National Innovation Driven Development Strategy Outline” (hereinafter referred to as the Outline) (Central Committee of the Communist Party of China, 2016), and it held the National Science and Technology Innovation Conference, the Two Academies Academician Conference, and the Ninth National Congress of the China Association for Science and Technology. It also proposed the “Three-​Step” strategic goal for China’s scientific and technological evolution. The first of the Three Steps is to “enter the ranks of innovative countries by 2020” (Central Committee of the Communist Party of China, 2016), which is to basically complete the construction of a national innovation system and effectively support the realization of comprehensively building a well-​off society. According to the Outline, the goals of the First Step include: • Ensure that the initial pattern of an innovative economy takes shape. A number of key industries have entered the high end of the global value chain, and a number of innovative enterprises and industrial clusters with international competitiveness have developed. The contribution rate of scientific and technological progress has increased to more than 60%,3 and the added value of the knowledge-​intensive service industry accounts for 20% of GDP. • Greatly improve the ability to independently innovate. An innovation system should be formulated to face the new scientific and technological revolutions, to support the industrial transformation, and to achieve breakthroughs in bottleneck technologies that constrain socioeconomic development and national security. The Outline has pointed out that a number of core technologies in China have been dependent on outside technology for a long time, that the situation is expected to be partially reversed within Step 1, and that unique advantages should be formulated in certain strategic areas to provide reserves and spaces for the country’s prosperity and development. R&D expenditures should account for 2.5% of GDP. • Establish synergistic and efficient innovation systems. The Outline expects that within the First Step, science, technology, and the economy would be more profoundly integrated. The innovation systems would be improved with elements of active innovative actors, interconnecting innovative processes, scientific governance, and enhanced efficiency.

3  In the 2018 National Conference on Scientific and Technological Work, the minister of the Ministry of Science and Technology announced that the contribution rate of scientific and technological progress had reached 57.5%. The number was expected to rise to 60% by 2020 according to the goal of Step 1 in the Outline. According to the China Statistical Yearbook on Science and Technology, the “contribution rate of S&T progress” is an index measuring the percentage of science and technology development contributing to the economic growth on a given year. The other two elements driving economic growth in the index were considered to be capital and labor input.

718    Pan, Chen, and Lu • Build a more optimized innovation environment. Sounder policies and regulations to encourage innovation and more stringent intellectual property protection should be established to create a value-​oriented and cultural atmosphere that advocates, encourages, and incentivizes innovation and entrepreneurship. The Second Step is to move to the forefront of innovative countries by 2030. The driving force of development will be fundamentally transformed, and the level of socioeconomic development and international competitiveness will be greatly enhanced, laying a solid foundation for building China into an economic powerhouse and a commonly prosperous society. According to the Outline, the goals of the Second Step include: • Major industries should enter the high end of the global value chain. New technologies and products, new models and formats, and new demand and markets should continuously be created to achieve more sustainable development, higher-​quality employment, higher income, and higher quality of life. • The situation of trailing in science and technology innovation should be generally reversed. In a number of strategic areas, China should move from a parallel to a leading position, and form influential academic schools, which would retain original academic achievements that have an important impact on global science and technology development and the progress of human civilization. The primary bottlenecks that constrain national defense technology should be overcome. R&D expenditures should account for 2.8% of GDP. • The national innovation system should be more complete. Deep integration and mutual promotion of science, technology, and the economy should be achieved. • The culture of innovation and the rule of law should be strong, and the whole of society should foster an environment in which innovation and competition are vital and new sources of innovation continue to appear. The Third Step is to build China into a global science and technology innovation powerhouse by 2050, become the world’s primary scientific center and high ground for innovation, and provide strong support for the effort to build China into a strong, prosperous, democratic, civilized, and harmonious modern socialist country and realize the Chinese nation’s great rejuvenation. According to the Outline, the goals of the Third Step include: • Technology and talent should become the most important strategic resources for national strength, and innovation should become a core factor in policy formulation and institutional arrangements. • Labor productivity and social productivity improvement should mainly rely on scientific and technological progress and comprehensive innovation. Economic development should be high in quality and low in consumption of energy and resources, and have strong core industry competitiveness. National defense technology should reach the world’s leading level. • A group of world-​class scientific research institutions, research universities, and innovative enterprises should emerge that produce a number of major original scientific

Facing the Future of China’s S&T Development    719 achievements and international top-​level scientific prodigies and become important gathering places for high-​level innovation and entrepreneurial talents. The goal is expected to be achieved by the construction of world-​class universities and world-​class disciplines, which was one of the major decisions made by the CPC Central Committee and the State Council in 2015. • The institutional environments, market environment, and cultural environment for innovation should be optimized. Respecting knowledge, advocating innovation, protecting property rights, and inclusive diversity should become a common concept and value orientation throughout the entire society. The “Three-​Step” strategic goal is China’s major strategic choice for the future, and for modernization. It outlines China’s path and plan for supporting and leading modernization and the great rejuvenation of the Chinese nation through innovation.

China’s Future Science and Technology Innovation Development Plan Science and technology planning should be guided by a science and technology development strategy, based on an understanding of the processes of science and technology innovation, and managed according to the current state of science and technology development. The planning outline should contain comprehensive, directional, and principle-​ level arrangements for scientific and technological activities, formulate supporting plans and specific implementation rules according to the overall planning outline, and form a planning system consisting of intermediate-​to long-​term and short-​to intermediate-​term science and technology planning, as well as general-​to-​specific planning. China’s practice and its science and technology development to date show that intermediate-​to long-​term development plans at the national level, such as the “National Medium-​and Long-​Term Science and Technology Development Plan (2006–​2020)”4 and the “National Innovation-​ Driven Development Strategy Outline,” are important for guiding and promoting scientific and technological innovation. In the future, through the implementation and evaluation of the “National Medium-​and Long-​Term Science and Technology Development Plan (2006–​2020),” it will be possible to initiate two 15-​year long-​term development plans for science and technology innovation (2021–​2035, 2036–​2050), which will be successively implemented. However, technological breakthroughs are often unexpected and uncertain, so the formulation and implementation of the plan should also be dynamically adjusted according to new scientific and technological developments.

4   In 2005, the State Council issued the “National Medium-​and Long-​Term Science and Technology Development Plan (2006–​2020).”

720    Pan, Chen, and Lu

China’s Eight Major Socioeconomic Foundations and Strategic Systems From 2007 to 2013, the Chinese Academy of Sciences undertook strategic research into China’s scientific and technological development for 2020 and 2050 and successively released the Innovation 2050: Science and Technology and China’s Future series of strategic research reports, including Technology Revolution and China’s Modernization: Considerations for China’s Technology Development Strategy for 2050 (Chinese Academy of Sciences, 2009). Eighteen sector technology roadmaps were also released, for energy, water resources, mineral resources, oceans and marine resources, oil and gas resources, population health, agriculture, biomass resources, ecology and the environment, regional development, outer space, information technology (IT), advanced manufacturing, advanced materials, nanotechnology, large scientific installations, and major cross-​sector interchange points. These are summarized in a research report entitled New Trends in World Science and Technology Development and Strategic Choices for 2020 (Chinese Academy of Sciences, 2013). The study postulates that China’s modernization is a comprehensive modernization of political, material, social, spiritual, and ecological civilization alongside opening up to the outside world. In the historical process of realizing this grand vision, China faces both the opportunities presented by a new scientific and technological revolution and severe challenges in energy resources, ecology and the environment, population health, air and sea, and traditional and nontraditional security. The country must rely on scientific and technological innovation to build eight socioeconomic foundations and strategic systems that will support China’s construction of a moderately well-​off socialist society and its modernization. These foundations are sustainable energy and resource systems, advanced materials and intelligent green manufacturing systems, ubiquitous information network systems, ecologically high-​ value agriculture and bioindustry systems, a universal healthcare system, ecological and environmental conservation and development systems, expansion of space and ocean capabilities, and national and public security systems, which together are focused on solving a number of strategic scientific and technological issues affecting China’s modernization process (Chinese Academy of Sciences, 2009). We discuss each of these next.

The Systems of Sustainable Energy and Resources China’s sustainable energy and resource systems primarily include sustainable energy systems, mineral resource development and recycling systems, and water resource protection and efficient utilization systems. The overall goal is to guarantee the effective supply and efficient use of energy and resources at all stages of China’s modernization process. By 2020, China will effectively alleviate the existing energy and resource bottlenecks that constrain China’s development; by 2030, China will be able to rely on its independent energy and

Facing the Future of China’s S&T Development    721 resource innovation capabilities to ensure its safe transition through the peak of resource and energy demand. By roughly 2050, a sustainable energy and resource system, composed primarily of independently innovating entities will take shape, China’s energy and resource industry will be internationally competitive, and its technological innovation capabilities will be at an internationally advanced level. To build a sustainable energy and resource system within China, it is essential to greatly improve the efficiency of energy and resource utilization, develop strategic resources on the continental shelf and with deep earth exploration and development, and develop new energy, renewable energy, and alternative energy resources. Research priorities should be given to 10 key technology directions, including technologies for high-​efficiency non-​fossil fuel ground transportation, coal purification and high value-​added utilization, grid safety and stability, biomass liquid fuel and raw materials, large-​scale renewable energy power generation, enhanced geothermal systems (EGSs), hydrogen energy utilization, natural gas hydrate development and utilization, new nuclear power and accelerator-​driven systems (ADSs) for nuclear waste treatment,5 and potential advanced energy technologies (including ocean energy, new solar cells, and nuclear fusion). Great effort should be made to achieve breakthroughs in key technologies and promote related technology integration, experimental demonstrations, and commercial applications. For the development of solid mineral resource technology by 2050, China’s roadmap is based on a systematic understanding of the unique evolution and history of China’s lithosphere and focuses on solving three major scientific problems: the accumulation process of massive ore-​forming materials, the temporal and spatial distribution of mineral deposits, and the relationship between metallogenic models and prospecting models. The roadmap also focuses on breakthroughs in four major technological directions in deep mineral resources: detection, efficient and clean utilization, replacement resources for key minerals, and recycling of mineral resources, as well as strengthening relevant technology integration, demonstrations, and applications. For oil and gas, China’s roadmap for resource technology development by 2050 is based on a systematic understanding of the complex tectonic setting of China’s oil and gas resources and the unique evolution of superimposed basins. It aims to deepen understanding of oil and gas enrichment principles, develop new fields and new layers of oil and gas exploration, develop oil and gas distribution prediction technology, greatly improve recovery, achieve breakthroughs in exploration and development technologies, and develop advanced equipment and software technology with independent intellectual property rights. Also, on the basis of systematic awareness of water resources, water environment, water ecology, water disasters, and water management, major scientific problems should be solved, key technology breakthroughs should be achieved, and comprehensive integration platforms should be built.

5  Accelerator-​ driven technology is a proposed process for separating long-​lived radioactive waste from used nuclear fuel by a high-​energy particle accelerator and transmuting it into shorter-​lived radionuclides. Radioactive waste can be reduced and additional energy can be recovered.

722    Pan, Chen, and Lu

Green Systems of Advanced Materials and Intelligent Manufacturing Advanced materials and intelligent green manufacturing systems mainly include three areas of advanced materials, advanced manufacturing, and green processes. The overall goal of building these systems is, after more than 40 years of effort (from 2010 to 2050), to complete the building of an intelligent and green manufacturing industry. This aims to realize low-​cost design and application of materials with comprehensive consideration of energy resources and environmental factors, ensure efficient and clean recycling of resources and energy and minimize their environmental impact, realize the transition of manufacturing systems from the era of man-​machine interaction to machine-​based autonomous operation, guarantee the effective supply and efficient use of materials and equipment in China’s modernization, and establish a resource-​saving and environmentally friendly society. To build China’s advanced materials and intelligent green manufacturing system, it is necessary to accelerate the implementation of green, intelligent, and renewable recycling of materials and manufacturing technologies; promote strategic adjustment and the upgrading of China’s materials and manufacturing industry structure; and guarantee the supply of materials and equipment for modernization processes and efficient, clean, renewable utilization. China’s roadmap for the development of science and technology in this field by 2050 will focus on technology breakthroughs in six areas, which include traditional materials upgrading and new material development and application, green materials preparation and processing, accurate design and control of material structure and utilization behavior, efficient recycling of materials, integration of material structure and function, and material analysis and characterization.6 These will form a low-​cost design and application system for materials that comprehensively considers resources, energy, and environmental factors. China’s roadmap for smart manufacturing and green process by 2050 will focus on two central scientific problems: efficient material conversion and engineering scale-​up, and mass manufacturing information processing and intelligent manufacturing methods, to achieve breakthroughs in the four key technologies of efficient resource cleaning and recycling, green product design, major equipment design and manufacturing, and intelligent control.

Systems of Ubiquitous Information Networking Ubiquitous information network systems primarily include IT penetration, network capability, and IT service capability. The overall goal of building these systems is that China will fully transform itself into an information society, at a level roughly equivalent to that of developed countries. To build China’s ubiquitous information network systems, it is necessary to develop and upgrade intelligent broadband wireless networks, network supercomputing, advanced sensing and display, and advanced and reliable software technologies and

6  Characterization, when used in materials science, refers to the broad, general process by which a material’s structure and properties are probed and measured.

Facing the Future of China’s S&T Development    723 eliminate the digital divide, thereby creating a universally beneficial, reliable, and low-​cost information path for citizens. China’s roadmap for IT development by 2050 will require strategic arrangements across four levels of ubiquitous information science and technology: focusing on IT applications; upgrading basic information infrastructure; transformative breakthroughs in information devices, equipment, and software; and new information science and cutting-​edge cross-​sector science. Around 2020, there will be breakthroughs in low-​cost device and system design techniques, new physical sensory mechanisms, semantic retrieval and analysis technologies, etc. Around 2035, there will be breakthroughs in network information theories, network algorithm theories, and network computing models. Around 2050, a universal information science should be established, and computing should be the fundamental mindset in the fields of natural systems, man-​made systems, and social systems; sustainable computing infrastructure and application services should be in place; and following the integration of computing with networks and computing with physical systems, there will be major breakthroughs in brain and cognitive sciences, which will achieve the integration of computing and intelligence, allowing more mature information sciences to take shape.

Systems of Ecologically High-​Value Agriculture and Bioindustry Ecologically high-​ value agriculture and bioindustry systems primarily include four aspects: agricultural product safety, sustainable agriculture, intelligent agriculture, and high-​value agriculture. The overall goal of building these systems is to continuously meet the growing domestic demand for agricultural products, as well as the demand for quality, safety, and versatility. Over more than 40 years of effort, the quality, nutrition, and functionalization of agricultural products7 should be fully realized; the informatization, digitization, and precision control of agriculture should be realized; and an industrial system with high-​value conversion of agriculture should be in place. Together these will form a sustainable virtuous cycle within a new type of agricultural industry that binds the ecosystem, beautiful landscapes, functionality and diversity, and urban and rural areas. To build these systems will require upgrading China’s agricultural industrial structure and developing high-​yield, high-​quality, high-​efficiency, and ecologically sound agriculture, as well as related bioindustries to ensure the safety of food and agricultural products. China’s roadmap for the development of science and technology in agriculture and bioindustries by 2050 focuses on germplasm resources and modern breeding for plants and animals, resource-​saving agriculture, safety in agricultural and food production, intelligent agriculture, and experimental demonstration applications. Around 2020, database sharing platforms for animal and plant ecological communities, germplasm resources, and other special resources will be complete; a multifunctional agricultural information network platform will be established; and the networking of agricultural information services will be

7  Functionalization of agricultural product refers to retaining the health functions of agricultural products through biological nutrition enhancement or other biotechnological means.

724    Pan, Chen, and Lu realized. Around 2030, various types of animal and plant resource distribution and population prediction maps will be drawn up; breakthroughs in animal and plant molecular design, breeding technology, and animal cloning will be achieved; and the successful networking of agricultural information services and digital production management in major regions will be achieved, allowing intelligent and precise management. Around 2050, through the intersection of molecular design breeding technology and genomic IT, the whole genome will be able to be optimized and assembled, the digitalization and meshing management of agricultural resources with precise management of the animal and plant production process will be achieved. However, it is noteworthy that some research has shown a certain degree of consumer resistance and public skepticism toward genetically modified (GM) food. For example, when Chinese consumers were surveyed for their awareness, knowledge, and opinion on GM food, the survey resulted in 11.9%, 41.4%, and 46.7% of respondents having a positive, neutral, or negative view, respectively, of GM food (Cui and Shoemaker, 2018). Similar reactions have occurred in Europe over the introduction of genetically modified foods and there will be a need for educational efforts for the population to appreciate the low risks.

The System of Universal Health Insurance The main purposes of the universal health insurance system are as follows: with a mission at its core to prevent and control major chronic diseases; to advance the frontline of combating diseases; to promote the transformation of medical models from disease treatment to predictive intervention; to achieve the transition from a single biomedical model to a “biological-​environmental-​psychological-​social” convergence medical model; to achieve the world’s most advanced levels of biological safety, food safety, health, nutrition, and lifestyle support systems; and to establish public health emergency and biohazard prevention systems in order to realize nationwide healthcare and comprehensive physical and mental health services. A large-​scale pharmaceutical R&D industrial chain led by innovative drug R&D and advanced medical equipment manufacturing should take shape, which will greatly enhance the international competitiveness of China’s biomedical industry. To build a universal health insurance system that meets the needs of China’s more than 1 billion people, it is necessary to promote the transformation of medical models from disease treatment to prediction and prevention, integrate the frontiers of contemporary life sciences with the advantages of traditional Chinese medicine, and bring our health sciences to the forefront of the world. In China’s roadmap for population health science and technology development by 2050, the core tasks of the universal health insurance system are to build a biomedical research system, solve four major scientific problems and achieve breakthroughs in several key technologies. The major scientific problems would include the relationship between genetic and environmental factors of major chronic diseases, transmission and infection mechanisms of major infectious diseases, molecular and cellular regulation of ontogeny, and basic processes of brain and behavior and cognitive impairment. Around 2020, a revolutionary research system integrating basic research and clinical application research will be basically established. Around 2030, a systematic biomedical system that integrates modern life sciences with traditional Chinese medicine will be established. Around 2050,

Facing the Future of China’s S&T Development    725 a converging medical system of “biological-​environmental-​psychological-​social” factors should be constructed. There will be a focus on solving major scientific problems such as the basic processes of brain and behavior and cognitive impairment, and a new generation of biomedical technology systems that integrate advanced instrument technology, nano-​ biomedical technology, minimally invasive technology, and device and combination drug technologies.

The Development Systems of Ecological and Environmental Conservation Ecological and environmental conservation development systems primarily include four aspects: global climate change response, watershed environmental quality, urban environmental quality, and biodiversity and ecosystems. The goals of building such systems are to basically curb China’s ecological and environmental degradation by around 2020, to achieve the restoration of degraded ecosystems and polluted environments around 2030, and to achieve a beautiful environment and ecological health around 2050, at parity with the medium level in developed countries. To build ecological and environmental conservation development systems that support the harmony between Chinese people and nature, it is essential to systematically understand the laws that govern environmental change; enhance China’s ecological and environmental monitoring, protection, resilience, and ability to cope with global climate change; enhance China’s ability to predict natural disasters; enhance its forecasting, disaster prevention, and mitigation capabilities; and continuously develop relevant technologies, methods, and means to provide systematic solutions. China’s roadmap for ecological and environmental science and technology development by 2050 will focus on the following four areas: recognition of changes in environment quality at different temporal and spatial scales, development of ecosystem restoration and pollution control technologies, establishment of a three-​dimensional monitoring network for changes in ecosystems and environmental quality, and deployment of classic experimental demonstration conservation areas. Around 2020, China’s earth system model and climate change monitoring and prediction systems should be initially established, which will reveal the atmospheric pollution mechanisms of urban agglomerations and the process of water pollution in river basins. Around 2030, China’s earth system model will be further improved and biogeochemical processes and urban metabolic regulation technologies developed in river basin ecosystems. Around 2050, a mature climate change prediction system will be established to improve the theoretical and technical systems for risk control and risk management of the water environment.

The Expanded Systems of Space and Ocean Exploration Capability The core of building an expanded system for China’s space and ocean capabilities is in five areas: ocean exploration and application; ocean development and utilization; aerospace

726    Pan, Chen, and Lu science and detection; aerospace technology; and earth observation and comprehensive application capabilities. In science, the focus is on the direct detection of black holes, dark matter, dark energy, and gravitational waves; understanding the origin and evolution of the solar system; understanding and predicting the impact of solar activity on the earth’s environment; the search for extraterrestrial life; and the implementation of space science satellites and exploration plans. In the field of earth observation and comprehensive information applications, the focus is on developing advanced earth system observation systems, as well as building digital earth science platforms and earth system network simulation platforms. In space technologies, breakthroughs should be made in key and bottleneck technologies in six important fields: high spatial resolution ability, ultra-​high precision of spatial and time standards, near-​space flights, ultra-​high-​speed flights in deep space and autonomous navigation, high-​speed communications in space, and supporting human life and activity in space. The focus is also on the development of marine resources and ensuring the safety of the marine environment. In the four important scientific directions of the physical ocean, marine geology, marine life, and marine ecology, the focus will be on three important technologies: marine monitoring, marine biology, and marine resource development and utilization.

National and Public Security Systems China’s national and public security systems mainly include space security, maritime security, biosecurity, and information network security. The strategic goal is to ensure China’s effective access to and peaceful use of space, protecting the safety of the marine industry and strategic marine transportation channels, effectively preventing biological threats to people’s lives and the ecological environment, maintaining information and cyberspace security, expanding China’s national interests, safeguarding national sovereignty, and guaranteeing social stability. To build China’s national and public security system, it will be necessary to develop traditional and non-​traditional security technologies to improve monitoring, early warning, and emergency response capabilities. In the field of space security, the core significance of these systems will be to develop unencumbered and rapid space access; precise navigation and positioning; efficient information acquisition, transmission, and application; and early warning and evasive capabilities for spacecraft. In the field of maritime security, the core significance of these systems will be to develop sound marine and underwater capabilities for information acquisition and transmission, marine catastrophic climate warning and emergency monitoring, advanced offshore platform systems and safe shipping, and defensive capabilities to safeguard China’s territorial waters and maritime economic exclusion zone and the accessibility of strategic maritime transport corridors. In terms of biosafety, these systems will be developed in response to the massive threats posed to human health and social stability by emerging and recurrent infectious diseases, the real and potential harm caused by alien species to the ecological environment and economy, and the huge potential threat to group, society, and even ethnic survival posed

Facing the Future of China’s S&T Development    727 by bioterrorism and new biological agents. The focus will be on the development of potent pathogen detection technologies, the establishment of pathogen monitoring systems for new infectious disease, and the establishment of safety assessments of exotic biological species and new biological agents and technologies. The systems will also develop methods for the prevention and control of various infectious diseases and bioterrorism. In terms of information network security, as the scale and speed of network information dissemination continue to increase, hostile individuals or groups could trigger social unrest or quickly damage public information infrastructure in a low-​cost, flexible, and unconventional manner, including even organized terrorist attacks, which could cause a catastrophic impact on society. Therefore, it is necessary to accelerate the construction of early warning, analysis, monitoring, and emergency response systems based on network information.

China’s Modern Science and Technology Innovation Governance System In addition to the specific areas of science and technology discussed above, the Chinese government is focused on deepening reform of the science and technology system, promoting comprehensive innovation with science and technology as the core, promoting the modernization of the science and technology governance system and capabilities, and creating a market and social environment conducive to innovation-​driven development. It is also focused on stimulating mass entrepreneurship (see Chapter 3.3), igniting enthusiasm for the potential of innovation, and laying the institutional foundations for the fundamental transformation of the driving force of development. These goals are discussed next.

Improved Scientific and Technological Decision-​Making Consultation With leading guidance provided by the National Science and Technology Leading Group and the National Science and Technology System Reform and Innovation System Construction Leading Group, a decision-​making mechanism to coordinate science and technology, economic, and social affairs should be established. A department-​level innovation communication and coordination mechanism should also be established, to strengthen innovation planning, task priorities, project implementation, and other coordination capacities, as well as the national science and technology innovation decision-​making mechanism. A consultation mechanism should be established to allow scientific and technological communities and think tanks to play a supporting role in innovation decision making, and a national science and technology innovation advisory committee should be established that regularly reports to the Party Central Committee and the State Council on international trends. The authority and functions of central and local science and technology management roles should be further clarified, and an innovation policy investigation and evaluation system

728    Pan, Chen, and Lu should be established. Regular follow-​up analysis of policy implementation should also be conducted to make timely adjustments and improvements.

Reform of Science and Technology Plan Management Systems Management reform of central financial science and technology plans (special projects, funds, etc.) should be promoted, existing science and technology plans should be optimized and integrated, and five national science and technology plan categories should be established. These are a national natural science fund, national major science and technology projects, a national major research plan, technology innovation–​guiding projects and funds, and infrastructure and talent funds. These would be implemented, managed, and supported according to their classification. A unified national science and technology management platform should be established, along with a joint inter-​ministerial meeting system for national science and technology plans (for special projects, funds, etc.). A strategic consulting and review committee should be formed, under the leading group concerned with national science and technology system reform and innovation system construction. This will include formulation of rules of procedure, improved operational mechanisms, and overall coordination regarding major issues. A professional project management mechanism should also be established, with the aim to strengthen the third-​party evaluation of science and technology projects and plans.

Optimization of Research Projects and Fund Management Systems A five-​category science and technology plan management and funding system should be established covering all types of funding. Relevant plan management methods and fund management methods should be formulated and revised, project management processes should be improved and standardized, and efficiency of capital use should be monitored and improved. Indirect fee management systems for scientific research projects should be improved. Guiding policies for strengthening basic research should be formulated and support for basic research effectively increased. The distribution of research funding should not only be based on competitive applications from individual scientists and research institutes, but also consist of funding with certain degrees of stability, i.e., relatively long-​ term funding for some key research projects or toward individual researchers or institutes. To stimulate breakthroughs in basic research, innovative or even seemingly “bizarre” ideas and topics would also be funded. The credit management system, assessment accountability mechanism, and responsibility review system covering project decision making, management, and implementation should be established for improving research integrity and preventing misconduct. An institutional environment that encourages innovation and basic research to the largest extent is the most essential incentive.

Facing the Future of China’s S&T Development    729

Promotion of Open Sharing of Science and Technology Resources A unified national science and technology plan management information system and a central financial research project database should be established, and fully traceable whole-​ process management for science and technology plans implemented. A national science and technology reporting system should be fully developed with a scientific and technological report sharing mechanism, and the submission and sharing of scientific and technological reports should be used as the basis for follow-​up support of the project leader. The construction of a national innovation investigation system should be comprehensively promoted and monitoring and evaluation reports issued on the innovation capabilities of countries, regions, high-​tech zones, and enterprises. A unified and open national network management platform for scientific research facilities and instruments should be created, all qualified scientific research facilities and instruments should be integrated into the management platform, and an open national sharing system, including a large-​scale open scientific research instrument sharing system and subsidy mechanism, should be established.

The Construction of a Deeply Integrated Open Innovation Environment International scientific and technological cooperation should be conducted at a higher standard, with a wider scope, and at more levels. Universities, research institutions, and enterprises should be supported in their efforts to be more open and global. Foreign scientists should be allowed to participate in pilot projects for the implementation of national science and technology plan projects. In the fields of basic research and research dealing with global issues, major international science research plans and projects should be initiated, and China should actively participate in large-​scale international science and technology cooperation programs. Internationally renowned research institutions should be attracted to China to form part of an international science center. Chinese scientists should be encouraged and supported to serve in international science and technology organizations. It is noticeable that Chinese universities, research institutes, and enterprises have already hired foreign scientists on a tenured or temporary basis. To attract foreign talent, rules on the permanent residence management of foreigners should be formulated, the passage of legislation regarding the permanent residence of foreigners should be sped up, and the conditions for obtaining permanent residence permits for foreigners with technical talent should be standardized and relaxed. China should explore the establishment of a skilled immigration system, and in innovative activities such as the creation of technology-​ based enterprises, high-​level foreign talent holding permanent residence permits should be given equal treatment to Chinese citizens. The formulation of regulations governing the work of foreigners in China should be accelerated, work permits for qualified foreign individuals should be provided, and visas and residence permits should be provided to eligible foreigners and their accompanying family members. The age limit for work permits

730    Pan, Chen, and Lu in China for foreign scientists and technologists who meet certain conditions should be canceled. Enterprises should be encouraged to establish international innovation networks, dialogues with major countries further improved, and the participation of enterprises actively sought. Communication and dialogue platforms for enterprises in R&D cooperation should be established in the areas of technical standards, intellectual property rights, and cross-​border mergers and acquisitions. Comprehensive coordination mechanisms should be improved; domestic technology, products, standards, and brands should be supported in their efforts to go abroad; and enterprises should be supported in efforts to set up R&D centers overseas and participate in the formulation of international standards, so that cross-​ border flows of innovation can be encouraged.

The Creation of an Environment That Encourages Innovation China should actively work to create a fair, open, and transparent market environment to promote entrepreneurship and innovation. The protection of intellectual property rights needs to be strengthened; the adoption of new technologies, new products, and new business models in management and industrial systems should be improved; the reform of monopoly industries should be accelerated; a market-​based mechanism for determining the price of factors should be established where absent; and policy orientation should be toward the creation of an industry environment conducive to transformation, upgrading and encouraging innovation, as well as a cultural and social atmosphere that gives people the courage to explore, encourages innovation, and tolerates failure. A strict intellectual property protection system should be implemented to encourage entrepreneurship and protect innovators. Laws related to intellectual property protection should be improved, reducing the threshold for criminal responsibility should be studied, the standard of damage eligible for compensation should be reduced, and the implementation of punitive damages should be explored. Rights protection mechanisms for rights holders should be improved. The legal system for the protection of trade secrets should also be improved, the definition of trade secrets and infringements should be clarified, relevant protection measures should be studied and formulated, and the establishment of a pre-​trial protection system explored. Research should be conducted into intellectual property protection measures, especially for new business models. Industry monopoly and market segmentation that restrict innovation should be broken up, to stimulate a market for innovation. Reform of monopolistic industries should be accelerated, natural monopoly industries should be liberalized to allow competition, and a unified, transparent, orderly, and standardized market environment that encourages innovation should be established. Anti-​monopoly law enforcement should be practically strengthened, monopolistic agreements such as oligopoly collusion and abuse of market dominance should be discovered and stopped in a timely manner, and space for the innovation and development of small and medium-​sized enterprises should be expanded. Market access and supervision should be improved, as well as industrial technology policies that invigorate the market and stimulate innovation. The market access system should be reformed, and a negative list of industry access should be formulated and implemented. Unreasonable barriers that limit the development of new technologies, new

Facing the Future of China’s S&T Development    731 products, and new business models should be broken down. Convenient and efficient supervision models for innovative products such as pharmaceuticals and medical devices should be established, reform of the examination and approval system should be deepened, and the evaluation of resources across various channels should be increased, to help optimize the process and shorten development cycles, and the development of new organizational models such as commissioned production supported. More attention should be given to the legislation of new technology research and applications, such as information network technology, stem cell technology, biological product technology, etc.; relevant laws should be improved; ethical risks prevented; and guarantees provided for the healthy development of research and emerging industries.

Conclusions This chapter analyzes the achievements of scientific and technological innovation in China and the strategic arrangement of scientific and technological innovation for the years up to 2050 and summarizes its eight economic and social foundations. We are aware that every major change in modern society is closely related to a revolutionary breakthrough of science and technology. Such revolutions have profoundly changed the world order, the rise and fall of great powers, and the destinies of countries. The founding of the People’s Republic of China marked a new historical period for China, in which a modern scientific and technological system was built up. In 1978, China’s reform and opening-​up policy ushered in the “spring of science.” Since then, the overall capacity of science and technology has been continuously improved, and a comprehensive and systematic scientific research structure has been formed. With the issuance of the National Innovation Driven Strategy, China is intensifying its exploration in major scientific research fields, accelerating the construction of a modern scientific and technological governance system, and contributing to the world’s scientific and technological knowledge. Despite its progress, China is still at the stage of catching up in its science and technology capacity, with certain constraints on its development. For example, there still exists a disjunction between its science and technology sector and the business sector. Some institutional issues that have long plagued China’s science and technology development have not been fundamentally resolved. For example, China’s expenditure on basic research is relatively low, and major original achievements in science and technology are lacking; the business sector still has fewer incentives to invest in basic research; and China’s R&D and core technologies are insufficient in their effect on bottlenecks in industrial development. Institutional arrangements need to become more effective, and reform of the scientific research organization system is lagging behind. On the micro level, the system of talent development in China is still underperforming. The evaluation of individuals and organizations is still based mainly on Science Citation Index publications, while incentive mechanisms to stimulate talent innovation and create vitality are stifled, and top talented individuals and teams are relatively lacking. To achieve its strategic objectives to become an innovation-​oriented nation and a science and technology powerhouse, it is necessary to further focus on “breaking bottlenecks, overcoming key technologies, improving originality, and seizing the frontiers of science

732    Pan, Chen, and Lu and technology” (Central Committee of the Communist Party of China, 2016). This means planning, to optimize and systematically construct a modern new technology system, which includes construction of national labs and a science and technology innovation base. The required institutional arrangements mean creating new mechanisms and structures for organizing science and technology research. On the meso and micro level, this means optimizing the various science and technology plans and projects established by the central and local governments; further focusing on development of key technologies; establishing transparent and fair evaluation mechanisms for hiring, promotion, and rewards for scientists and engineers; and building an innovation culture and environment, both for basic research and for the business sector.

References China Office of the State Council. (2015). Implementation Plan for Deepening the Reform of Science and Technology Systems. People’s Daily, September 25. Chinese Academy of Sciences. (2009). Technology Revolution and China’s Moderni­ zation: Considerations for China’s Technology Development Strategy for 2050. Beijing: Science Press. Chinese Academy of Sciences. (2013). New Trends in World Science and Technology Develop­ ment and Strategic Choices for 2020. Beijing: Science Press. Cui Kai, Sharon P. Shoemaker. (2018). Public Perception of Genetically-​Modified (GM) Food: A Nationwide Chinese Consumer Study. npj Science of Food, 2(10): 1–​8. https://​ doi.org/​10.1038/​s41538-​018-​0018-​4 Landes David. (1998). The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor. New York: W.W. Norton. National Bureau of Statistics. (2017a). Statistical Bulletin of National Science and Technology Funds Input in 2017. http://​www.stats.gov.cn/​tjsj/​tjgb/​rdpcgb/​qgkjjftrtjgb/​201810/​t20181012_​ 1627451.html National Bureau of Statistics. (2017b). Statistical Bulletin on National Economic and Social Development of the People’s Republic of China 2017. http://​www.stats.gov.cn/​tjsj/​zxfb/​ 201802/​t20180228_​1585631.html National Science Foundation of China. (2018). Science and Engineering Indicators 2018. https://​www.nsf.gov/​statistics/​seind/​

Pa rt V I I I

C ON C LU SION A N D I M P L IC AT ION S F OR P OL IC Y

Chapter 8.1

C onclusi on

Innovation in China: Past, Present, and Future Prospects Xiaolan Fu, Bruce McKern, Jin Chen, and Ximing Yin Introduction Innovation is one of the most important drivers of industrial upgrading, long-​term economic growth, and sustainable development. Since the mid-​19th century, global technological leadership has shifted from Europe toward the United States, while today the world landscape of innovation is being reframed due to the rise of emerging economies, notably China. In the past decade, the world has witnessed the steady rise of China’s innovation capacity (Huang and Sharif, 2016; Someren and Someren-​Wang, 2014; WIPO, 2019). China has made great efforts in developing its technological capabilities, initially through import substitution and, since 1978, through export promotion, the opening-​up strategy, and inward foreign investment. Since 2006, the country has placed innovation at the core of its development strategy and has announced its aim to transform the country into an innovation-​driven economy (Fu, 2015; Yip and McKern, 2016; J. Chen, Yin, and Mei, 2018; Fu, Woo, and Hou, 2016). This Handbook, through the contributions of more than 60 leading scholars in the field, attempts to provide a contemporary, authoritative, and critical assessment of the current state of knowledge on the topic of innovation in China. It considers China’s past, present, and future prospects from the perspectives of macroeconomic policy, institutions, microeconomic policies, and managerial initiatives. The authors have examined the roles played by both the state and the private sectors, and by both domestic and international actors. This chapter summarizes the main findings of this Handbook, based on the insights from each of the chapters; discusses the policy implications for China and for other countries; and identifies areas for future research. In what follows, we group the findings under seven themes, which are: 8.1.1 China’s innovation achievements and their role in development; 8.1.2 Building innovation capabilities;

736    Fu, McKern, Chen, and Yin

8.1.3 Incentives and institutions; 8.1.4 Openness and acquisition of advanced technology; 8.1.5 Chinese “exceptionalism” in innovation; 8.1.6 China’s future-​and development-​oriented innovation strategies; 8.1.7 Major challenges to China’s evolution toward an innovation powerhouse.

Based on these analyses, the chapter examines the question of whether China will become a global innovation superpower.

8.1.1  China’s Innovation Achievements and Their Role in Development Development, catching up, and possibly achieving global leadership are dependent on the technological, institutional, and policy dynamics associated with a significant national transformation. Such a “Great Transformation” began in China in the early 1980s and required a fundamental process of accumulation of knowledge and capabilities, at the levels of both individuals and organizations. In turn, the rate and direction of knowledge accumulation during the catch-​up process and the ensuing effects upon the patterns of production and trade were shaped by the economic and institutional framework in which such processes are embedded. Transformation is hence a co-evolutionary process, as argued by Dosi and Yu (Chapter 1.1). Technological capability has been perceived for some time as one of the key elements to China’s success in innovation. At the beginning of the country’s industrialization, a minimum degree of technological capability was essential to help domestic firms assimilate foreign knowledge. Later, the accumulated capability enabled the country to embark on indigenous innovation and develop capabilities further. Dosi and Yu (Chapter 1.1) show that the lesson of the “Chinese miracle” is the crucial importance of “ensembles” of industrial policies and institutional building in nurturing capability accumulation and industrial development, which provide the basis for achieving world industrial leadership. Technological innovation and scientific progress are now a critical force to help China to avoid the middle-​income gap and make the transition to a high-​income economy (Lin and Zhou, Chapter 1.2). In the process of this great transformation, according to the Global Innovation Index published by the World Intellectual Property Organization (WIPO), China became among the top 20 most innovative countries in the world in 2018, and in 2019 it moved up further to 14th (WIPO, 2019). There are several indicators of China’s progression, a few of which are summarized here: • China has become the world’s second-​largest investor in research and development (R&D), second only to the United States. • It is the world’s leader in publications in international scientific journals, accounting for 18.6% of articles in the Scopus database in 2016 (Nature, 2018). (Adjustments made

Conclusion   737 for measurement shortcomings by Xie and Freeman, 2019, show that China now accounts for 36% of world publications and 37% of citations.) • China’s patent applications surpassed the United States in terms of total application numbers in 2012. • China has overtaken Japan and the United States in terms of the number of patents granted since 2015. (Despite these achievements in the quantity of patent applications and those granted, there is still room for China to improve the quality of its patenting activity1 since in 2016 utility patent grants [which require little novelty] were more than twice the number of invention patent grants2 [Santacreu and Zhu, 2018]). Jefferson and Jiang (Chapter 1.4) provide a detailed examination of China’s patenting activity, drawing on a considerable number of sources. Among their interesting conclusions is that “whereas government subsidies have encouraged the growth of patenting in China, the subsidies have generally distorted incentives and eroded patent quality.” They suggest that a study of carefully planned subsidy programs might tell a more promising story. Nonetheless, the authors conclude that regional disparities in innovation output as measured by patenting persist, despite some absolute strengthening of patenting innovations in many non-​coastal regions. The continuing growth of the Greater Shanghai region, in their view, limits the prospect of regional convergence. Mu, Chen, and Lyu (Chapter 1.3), who examine the development of innovation studies in China, find that while the conventional theory of technical change helps explain how China achieved economic growth via innovation, new concepts also need to be embraced. For example, innovation results in not only the creation of novel products or services but also the diffusion of existing ideas and techniques into markets not previously served (Fu et al., 2016). The experience of Japan and the Asian Tigers in the 1960s and China in the 1980s showed that comparative advantage need not be static and that technological change can create comparative advantage and accelerate growth. As demonstrated in China, government can play a role in creating comparative advantage, by building infrastructure, educating the people, improving living conditions, creating state-​owned corporations (although that role may change over time), and investing in science and technology (S&T). The experience cited previously also suggests modifications to theoretical approaches such as Porter’s pioneering work on competition between advanced industrial countries (Porter, 1990). While Porter’s “diamond” model acknowledged a role for government, it was primarily one of setting the context for a competitive industrial landscape and support for education and infrastructure. Among the criticisms of his work (Davies and Ellis, 2000), the role of government in creating capabilities for innovation does not receive enough emphasis, although relevant for developing countries. The other factor downplayed by Porter was national culture. Although it is difficult to demonstrate its connection to development with rigorous empirical analysis, culture appears to be very relevant to the rise of the Asian economies. In this context, national

1   https:// ​ r esearch.stlouisfed.org/ ​ p ublications/ ​ e conomic- ​ s ynopses/ ​ 2 018/ ​ 0 5/ ​ 0 4/ ​ w hat- ​ d oes-​ chinas-​rise-​in-​patents-​mean-​a-​look-​at-​quality-​vs-​quantity 2   https:// ​ r esearch.stlouisfed.org/​ p ublications/​ e conomic- ​ s ynopses/ ​ 2 018/ ​ 0 5/ ​ 0 4/ ​ w hat- ​ d oes-​ chinas-​rise-​in-​patents-​mean-​a-​look-​at-​quality-​vs-​quantity

738    Fu, McKern, Chen, and Yin culture can be thought of both in terms of the conventional concept of national identity, values, and behavior and in terms of the attitudes of government and business toward growth, entrepreneurship, and long-​term strategy. Chen and Wu (Chapter 4.6) describe an innovation endowment in traditional Chinese culture that they see as providing a valuable advantage for China’s future growth. In a study of innovation in Chinese companies, Yip and McKern (2016) proposed a framework that includes elements of Porter but that also included national culture, in both government and firms. These examples show that China is an interesting case study for scholars seeking to enrich the field of development studies. While there is an argument that China is an exceptional case in some respects (see Part VI), the chapters included here should provide guidance to other developing countries seeking to enhance their technological capabilities.

8.1.2  Building Innovation Capabilities The process of developing innovation capabilities in China since 1978 has been one of interaction between government and an emerging private sector, both testing and modifying their respective roles in the establishment of a modern state. The period from 1994 onward abandoned the detailed central planning approach and adopted reforms to allow markets to guide the allocation of productive resources. The initial reforms were driven by Deng Xiaoping’s realization that a necessary condition for overcoming the inertia inhibiting the country’s growth was adopting private sector strategies and institutions associated with capitalism. Without abandoning the centrality of state-​owned enterprises (SOEs), the “Socialist Market Economy” reforms adopted a new view of the role of the state, “Capitalism with Chinese Characteristics.” This view accepted the need to create a production sector driven by private interests by adopting principles of capitalism hitherto anathema to the Communist Party. Among the microeconomic reforms, township and village enterprises (TVEs) were freed to produce consumer and industrial products. In agriculture, the commune system was ended and household farming became the norm, greatly increasing agricultural output and productivity. SOEs were allowed to retain part of their profits for reinvestment and other purposes, while the barriers to establishing private enterprises were reduced and setting up R&D facilities across the country was given priority. During this early period there was little product innovation. What innovation occurred was in learning new organizational forms and practices, copying technologies and business models from abroad, and improving process efficiency and product quality. Nevertheless, from modest beginnings, Chinese firms learned to understand their customers’ needs and to adapt quickly, developing the capacity to use technology and in due course innovate more substantially. Xue, Li, and Yu (Chapter 2.1) chronicle in detail the evolution of China's national and regional innovation systems over four broad eras, from its early post-​revolution emphasis on SOEs and heavy industry to the major reforms following 1978 to the present. They explain the early recognition of the essential place of S&T in the future development of the country and the profound changes that were made in the organization and funding of research and commercialization over the years in a comprehensive process of consultation and research.

Conclusion   739 They explain that “throughout the four-​decade process of S&T reform . . . China followed a gradualism philosophy. . . . Reforms usually begin with a trial-​and-​error approach . . . which would be modified or supplemented by further mandates, or completely replaced by new laws.” A critical step, they argue, was the recognition of the systemic nature of innovation and the need for a national innovation system, incorporating not only basic research institutions but also the education sector, private business, and institutions and incentives oriented toward commercialization. This systemic view of the national innovation system is emphasized by many of the authors in this Handbook and is a view that underlies their views on its past success and the challenges faced today. While many of the new private firms were initially small and local, they grew dramatically by providing goods and services previously unavailable. There are many examples of small firms that were established in the early reform period that successfully managed the transition into substantial companies, which are household names today (Yip and McKern, 2016). Chen and Wang (Chapter 2.3) provide an overview of the initiatives introduced by government to facilitate the establishment of small to medium enterprises (SMEs). These include taxation and credit information reforms and intellectual property protection, which, according to the authors, have stimulated SME growth and performance. A related initiative is the creation of clusters of small firms, which are consistent with the government's more recent plan of greatly increasing concentration in key urban agglomerations throughout the country. (See also Li and Wei, Chapter 4.1.) More recently there has been a focus on encouraging SMEs into the digital economy and intelligent manufacturing. According to Chen and Wang (Chapter 2.3), SMEs are today responsible for 65% of domestic invention patents and 80% of new products. Despite this, the authors conclude that SME penetration of the digital economy is still relatively weak and firms suffer from availability of finance as well as talent. (Innovation in the digital economy is discussed in more detail by Yu and Zhang in Chapter 6.4.) Finance is a key factor for any innovative company, but conventional financial institutions have limited risk appetite for financing innovative new ventures. As Zhao and Jiang note in Chapter 2.4, financial innovations have historically evolved hand in hand with technological innovations. In China, a financial support system for new ventures was initially provided by the government, through national funding programs together with supportive taxation policies. A national venture capital institution was set up in 1985 and was followed by the establishment of private equity firms, both foreign and domestic, which have become an integral part of the new finance sector. Some 20,000 venture capital and private equity firms are now active, and the authors note that two-​thirds of the 3.6 RMB trillion invested by them has gone into SMEs. The authors describe, with specific examples, the wide range of new financing mechanisms that have arisen in China, which include technology microcredit, intellectual property (IP)-​backed loans, and instruments that mix debt and equity to create novel risk-​return profiles, such as bank and guarantee synergy loans and investment and lending synergy loans. Another significant development has been financial services platforms created by major companies such as Ant Financial, Tencent, and Baidu, which offer a range of financial products, including insurance. This has resulted in a multilevel capital market, comprising the stock exchanges of Shanghai and Shenzhen, the SME Board, the Growth Enterprises Market (GEM), and the National Equities Exchange and Quotations (NEEQ), and the regional OTC markets. However, the authors are concerned about the potential monopoly

740    Fu, McKern, Chen, and Yin power of the digital finance giants and the limited access SMEs still have to obtain finance from the capital market. A critical characteristic of the early years of market orientation was the opening to international trade. As Zhang (Chapter 3.1) explains, by 2005 China’s annual exports had reached 36% of gross domestic product (GDP) (considerably higher than today’s 19.5%). Likewise, it was recognized that foreign capital could make an important contribution. Initially foreign direct investment (FDI) came from Overseas Chinese firms based in Hong Kong and Taiwan, but foreign investment from US and European enterprises grew rapidly, under favorable incentives. These firms established R&D centers across China and contributed to the country’s technological base and indigenous capabilities through spillovers and imitation (McKern, Yip, and Jolly, Chapter 5.1). As with many developments in the political economy of China, these reforms were adopted cautiously and pragmatically, in a process of testing ideas, adopting those that were successful, and rejecting those that were not. Their broad impact is well known, but their influence on indigenous innovation has been less clear. According to Zhang (Chapter 3.1), China’s development to the present has depended more on improved efficiency of resource allocation rather than innovation. “China has had a three-​in-​one industrial revolution, built on the technologies of the advanced countries, without any important self-​originated innovation,” he argues. Zhang notes that the impact of reform on prices was substantial as early as 1993, and by 2005 over 95% of prices for most goods were set by the market, not the government. Other researchers are more positive about the improvement in innovative capabilities over recent years. Murphree and Breznitz (Chapter 6.2) explain in detail the acquisition and improvement of such capabilities in Chinese subcontractor firms that became embedded in global value chains (GVCs). While Zhang acknowledges the growth of innovative companies, he sees them as following the path of foreign-​developed innovations. In his view, for China to create breakthrough innovations, a necessary condition will include adopting more widespread freedom for private enterprise as well as “abolishing the dominance of the state sector and putting the government under law” (Zhang, Chapter 3.1). Fang Lee Cooke (Chapter 2.5) also sees a need for changes, particularly in education, a critical factor in shaping the attractiveness of entrepreneurship and innovative activities for future generations of Chinese. In her assessment of education for creativity and entrepreneurship, she evaluates primary and secondary education in schools and tertiary education in universities from this perspective. She concludes that parents, and society as a whole, need to embrace a culture to support entrepreneurship education and entrepreneurship, but that there are obstacles to making a major shift. Among these are the considerable sacrifices parents make for the education of their children and the reluctance to divert them to studying topics that are not clearly concerned with economic success. At the university level, there is considerable pressure for vocational education, but entrepreneurship is seen as risky and likely to divert students from more directly valuable employment. These concerns are not unique to China, but Cooke sees them as requiring substantial changes in the culture of Chinese society as a whole. Throughout the discussion of the building of China’s innovation capabilities, the role of government has been considerable. Yet the question arises as to whether China might have developed those capabilities even more quickly with less government intervention. This is an important policy question for China’s ambition to achieve global innovation leadership

Conclusion   741 in the future and one that Brandt and Thun take up in Chapter 2.2. They assert that industrial sectors that have been free from the “all too ‘visible’ and often distorting hand of the Chinese state” are those that have been the most dynamic. Industries in which there has been a low degree of state intervention have spawned firms that are fiercely competitive and that have developed innovative capabilities. Where government intervention and protection were heavy, enterprises have not been impelled to develop their competitive strengths. Their analysis of segments within specific sectors, such as heavy construction equipment and automobiles, demonstrates that the forces applying in different segments of an industry are different and that government intervention has a significant impact on the resultant competitive strength of local firms. While the authors acknowledge that there are reasons for Chinese state intervention to serve purposes other than economic efficiency, they are clear that this is at the expense of achieving the goals of innovation and global leadership. They believe that the inefficiencies associated with government intervention in the past are unlikely to diminish in the future.

8.1.3  Incentives and Institutions As discussed by many scholars and authors (such as Someren and Someren-​Wang, 2014; Dosi and Yu in Chapter 1.1; Brandt and Thun in Chapter 2.2; Li, Yin, and Shen in Chapter 4.2), micro-​level reforms and policies concerning the S&T management system have driven science and technology innovation (STI) progress in China in the past decades, especially since the reform and opening up. These reforms have achieved substantial breakthroughs, but Hu, Li, and Lin (Chapter 3.2) argue that the S&T foundation in China is still weak and its capability for STI needs to be enhanced. Therefore, the process of reform in China needs to accelerate and undertake critical future tasks, especially the management of scientific research institutions. Incentives resulting from system reform will not only drive science, technology, and innovation in China (Zhang, Chapter 3.1; Hu, Li, and Lin, Chapter 3.2) but also cultivate a better ecosystem for actors at several levels to participate in entrepreneurship. As other research in management and strategy finds, entrepreneurship is context-​based (Meyer, 2015); socioeconomic and cultural environments influence entrepreneurial activities. Even though the economic structure in China has been gradually transformed into a market-​ oriented economy since the opening up, the legitimacy of private firms was acknowledged only in 1988. According to research by Global Entrepreneurship Monitor (GEM), entrepreneurial activities in China have been more significant in the last 15 years, and the quality of entrepreneurship has improved. Entrepreneurship and innovation need institutional and social support, but social attitudes toward entrepreneurship and innovation are still relatively weak in China, as noted previously by Cooke (Chapter 2.5). With the intention to create a better environment for enterprises and individuals through delegation of power to lower-​level governments, Chinese Premier Li Keqiang proposed the concept of “mass entrepreneurship and innovation” in 2014 at Summer Davos. Mass entrepreneurship and innovation aim to stimulate business development and the entrepreneurial spirit among the general public, helping to expand employment opportunities and facilitate social and economic mobility. Gao and Mu (Chapter 3.3) provide a comprehensive understanding of

742    Fu, McKern, Chen, and Yin China’s movement toward mass entrepreneurship and innovation. They argue that the institutional mechanisms, finance, intellectual capital, services, and support have been the most significant elements in establishing new enterprises. Although they view the policies as comprehensive and effective, they consider the majority of them to be supply oriented. This emphasis, in their view, ignores the constraints and difficulties faced by new entrepreneurial enterprises. They advocate policies based on the specific needs of entrepreneurial firms and other participants in the entrepreneurial ecosystem. If innovation and entrepreneurship are the twin engines for economic growth, financial factors must be the oil for the engines to work. For an emerging economy, a multiple-​level pro-​innovation financial system, consisting of venture capital (VC), angel capital, initial public offerings (IPOs), and other financial mechanisms, is needed to support both STI and mass entrepreneurship. As typical of emerging economies, the current market and financial environment in China is underdeveloped. Low resource allocation efficiency and resource misallocation in the financial industry constrain start-​up firms (Yin, Hai, and Chen, 2019b). In Chapter 4.4, Lin focuses on the development of non-bank financial institutions, particularly VCs, and their role in funding entrepreneurial new ventures. The author concludes that despite China’s progress toward cultivating a favorable regulatory environment for VC-​backed exits via IPO and merger and acquisition (M&A), there remain institutional impediments within the stock market that hinder the growth of the VC industry. In contrast to Zhao and Jiang (Chapter 2.4), they believe that a wider range of complex institutions, including a robust stock market, an active M&A market, sophisticated financial intermediaries, strong investor protection, and effective dispute resolution by courts, is needed to develop the VC market in China further. Intellectual property rights (IPR) protection is another important institutional arrangement that is crucial to encourage innovation. Huang and Sharif (Chapter 4.5) discuss the development of IPR protection in China and its role in stimulating innovation by indigenous companies, as well as its effects on the transfer of knowledge from multinational corporations (MNCs) into China. Despite the forceful rhetoric of the “innovation driven” development strategy, however, China faces a number of serious challenges of implementation. Among the most vexing has been the widespread perception that IPR protection is inadequate and patent infringement rampant. Chinese universities and public research organizations have also faced legal barriers to transferring the technologies they generate to industrial and commercial applications (consistent with the discussions in Chapters 4.2 and 5.2). The authors conclude that further research is needed to evaluate the effects of Chinese IPR protection policies and legislation on the behaviors of researchers, firms, universities, and public research organizations. Insights generated from such studies would help policymakers and both firm and university managers develop more effective IP management strategies. Industrial clusters also play important roles in supporting community-​level innovation at a meso level. The cluster innovation system is defined as local networks of innovators located in narrow industrial districts. The cross-​ fertilizing effects of supporting systems, such as knowledge service organizations, local government, infrastructure, and other related institutions, are the key to promoting knowledge generation, exploration, diffusion, and application within the cluster, through formal or informal interactions (Li and Wei, Chapter 4.1). Li and Wei employ empirical research and case studies to capture the forces facilitating clusters’ success and the main features of a functioning cluster

Conclusion   743 innovation system. They find that technological followers fail to benefit from knowledge diffusion within the cluster; therefore, a support system is required to enhance the learning capabilities of clustering enterprises. They also explain that knowledge-​intensive business services facilitate the flow of knowledge among firms in the cluster network and affect the balance between local and non-​local search. They also argue that the imbalance of innovation capacities among the different elements of an industry value chain can devalue the technological competitiveness of a whole industrial cluster. For instance, there is often a lack of R&D institutions inside the cluster to introduce “bottleneck breaking” technologies quickly. Hence, firms need to cooperate with the best R&D milieus outside the cluster and usually at the national level. The authors conclude the chapter by proposing a conceptual framework of a cluster innovation system. As discussed earlier, China has become an increasingly attractive innovation destination for both innovators and investors from all over the world (WIPO, 2018). For the purpose of global sustainable development, China’s emergence and progress among the global innovation map should not be perceived as a threat to the Western world, according to Ernst (2011), Li-​Hua (2014), and Richard (2017). Rather, it should be seen as a model promising potential choices, especially for innovation development in emerging markets (Chen, Yin, and Mei, 2018; Fu and Gong, 2011; Lee et al., 2017; X. Li, 2009; WIPO, 2018). This issue is taken up by Li, Yin, and Shen (Chapter 4.2), who provide a comparative overview of China’s innovation performance in the global context, including inputs, outputs, performance and rankings, and typical firms and industry cases. They give an overview of China’s technology transfer mechanisms, with a focus on university technology transfer and policy changes. They also provide a short but comprehensive analysis of China’s opportunities and challenges in the near future toward these issues, noting five main drivers that drive commercialization. They argue that commercialization by the university sector is still relatively weak, due to flaws in the incentives for researchers, lack of university attention to commercialization, and ambiguity in the channels for transfer. They conclude that in the future China will need to continue investment in basic research, especially that leading to disruptive innovation, under the guidance of the national innovation strategy (as is also emphasized by Hu, Li, and Lin in Chapter 3.2; McKern, Yip, and Jolly in Chapter 5.1; and Pan, Chen, and Lu in Chapter 7.4). A relatively recent institution that was developed to support innovation and in particular the commercialization of new technology is the science park and high-​technology zone (SPHZ) concept. Science parks were envisioned as an economic development force from their inception, designed to provide employment geared toward a highly educated labor force. China learned from the success of this policy as enacted in more advanced countries, from Japan to Western Europe, as it began its own launch into modernization. In Chapter 4.3, Walcott reviews the development of SPHZs in China, with a focus on their impact on regional and national innovation. She holds that assessing the success of SPHZ policy must be viewed within the framework of the host of policies designed to launch China’s modernization in the late 1970s, covering various steps of this transition. (For a more detailed discussion of related aspects, please refer to Chapters 1.3, 1.4, 2.1, 6.2, and 6.3). She concludes with some critical areas for future inquiry. For example, measures of success for the SPHZ policy continue to be contested, and there is little reliable data to support a well-​substantiated assessment. Also, the heavy importance placed by the Chinese government on scientific innovations fueling economic development acts to distort unbiased evaluation. However, Walcott notes the growth in the contribution of SPHZs to China’s

744    Fu, McKern, Chen, and Yin exports, reaching 28% in 2016, and she concludes that they have been a successful element in China’s development. She concludes by suggesting research on the role of high-​tech firms in commercializing alternative energy and mitigation of pollution. As mentioned by Gao and Mu in Chapter 3.3, culture, norms, and self-​perceptions are very important factors that influence the motivation and social support of innovation and entrepreneurship. One of the long-​standing worries about China’s innovation future is how it will deal with the risk-​averse collective-​oriented traditional culture to encourage entrepreneurial risk-​taking. In Chapter 4.6, Chen and Wu undertake a thoughtful examination of Chinese traditional culture and philosophy, identifying innovation elements that can enhance adaptation to change. On the one hand, Chinese culture features dynamism, balance, comprehensiveness, and holism, they argue. On the other, contemporary Western scientific thinking is partial, static, analytical, and reductive. They contrast those elements of Western culture that define Western scientific method with aspects of Chinese culture that influence patterns of thinking. Chinese culture, in their view, embodies innovation elements regarding the mode of thinking, ideals, and beliefs, as well as approaches to organizations and institutions. Modernization, they argue, need not imply severance with Chinese tradition, as the road to modernization is diverse and traditional “cultural genes” have a lasting and far-​reaching impact. They believe that these unique characteristics will inspire China’s pursuit of modernization, exerting a more positive impact in the future. Both traditional Chinese culture and Western culture can contribute to future creative transitions and improvements in Chinese society.

8.1.4  Openness and Acquisition of Advanced Technology Acquisition of advanced technology is an important source of innovation, especially for developing countries. Without a doubt, external sourcing has played an important role in China’s catching up, as well as helping the country build up indigenous technological capabilities. Opening up to international trade, FDI, and cross-​border high-​skilled labor flows are regarded as important traditional channels for the acquisition of advanced foreign technology. In recent years, innovation has increasingly become an open and collaborative undertaking and international collaboration has emerged to be an important mode of innovation and knowledge co-production. This Handbook specifically examines four channels for innovation in China, described in the following paragraphs.

Inward FDI, Imports, and Technology Transfer It has been commonly acknowledged that the presence of MNCs has contributed significantly to the creation of intellectual capital in China. As a country initially lacking a technological base, despite its notable successes in ancient times, it was sensible for China to look for technology abroad and, after the market opening, FDI was embraced as a key vehicle to

Conclusion   745 attract technology and innovations. Our authors point out in several chapters that building indigenous innovation capabilities involves far more than acquiring IP: it requires a mature ecosystem of related elements that reinforce the absorptive capacity (e.g., McKern, Yip, and Jolly, Chapter 5.1). Meanwhile, a high level of openness and integration into the global economy by engaging in trade has allowed Chinese firms to acquire both tangible and intangible knowledge assets, which eventually led to the nation’s industrial upgrading and technological improvement. The strategic lesson from the Chinese model is that relying on dual sources (indigenous innovation and acquisitions of foreign knowledge) maximizes the benefits for the developing country (Fu and Hou, Chapter 5.2).

Outward FDI and Internationalization of R&D To achieve sustainable growth, China has actively invested in developed economies to obtain key strategic assets, resources, and leading-​edge technologies (Liu and Buck, 2007 Luo and Tung, 2007). The rapid increase in Chinese outward foreign direct investment (OFDI) represents an interesting case of the impact of OFDI on innovation. As an established mechanism for international knowledge acquisition (although new among developing countries), OFDI has been used increasingly as a path in Chinese companies’ pursuit of innovation technology upgrading (Amendolagine, Fu, and Rabellotti, Chapter 5.4). This is reflected in China’s increasing OFDI into developed countries and the increasing number of acquisitions of technology companies undertaken by Chinese MNEs in Europe and the United States. Its importance is supported by the findings from firm-​level surveys in Chapter 5.4 regarding the objectives of OFDI in the developed countries. There has also been a clear strategic direction adopted by Chinese firms when they seek new knowledge through overseas investments, specifically in establishing R&D centers outside China (Yip and McKern, 2016). Yet, so far the literature on this phenomenon is limited and little theoretical insight has been gained, despite the rise of Chinese R&D internationalization in scale and scope (Zedtwitz and Quan, Chapter 5.5).

Migration Adopted as another proactive learning channel during the past decade, the flow of global talent through international migration has increasingly become a critical source driving China’s innovation. As a nation with one of the lowest levels of foreign-​born population in proportion to its national population, there is a need for China to revise its approaches to international migration, with a focus on building comprehensive and effective policies to encourage returnees as well as attract much-​needed foreign talent (Wang, Chapter 5.3). Highly skilled returnees have played an important role in China’s development, and many of them have contributed to the growth of some of the most dynamic private firms in high-​technology sectors and emerging industries, such as the photovoltaic industry. Accordingly, China needs to play a greater role in establishing a person-​centered approach to global migration governance in international forums and, as Wang suggests, promoting the benefits of inward migration in key decision-​making bodies, both within China and outside (Wang, Chapter 5.3).

746    Fu, McKern, Chen, and Yin

Collaboration and Open Innovation Undoubtedly, international innovation collaboration and open innovation frameworks bring significant benefits to the advancement of innovation capability in China. They have been considered as inevitable choices for firms to adapt to globalization and seize its opportunities. Not only does international innovation collaboration reduce the risks but also it helps China establish and expand cross-​border innovation networks. Chen, Feng, and Fu in Chapter 5.6 assert that spontaneous collaboration between scientists and researchers through R&D activities should become a new force for innovation activities. They consider that it should be the most dynamic source of innovation beyond the government-​led level, as, for example, in universities, where there is already a good deal of collaboration. Having accumulated a level of capability in the past decades, Chinese firms have become increasingly capable of integrating innovation resources from foreign sources and have begun to “go out” to acquire global resources on a large scale. With the vision to integrate global R&D resources and markets, Chinese firms’ innovation capabilities have been greatly enhanced. In addition, with the support of China’s national innovation system and through the accumulation of technological capabilities, Chinese firms are growing into MNCs. In the meantime, challenges are emerging along with the trade tensions between China and the United States (Chen and Chen, Chapter 5.7). In particular, challenges to the exchange of technologies in the university sector have become more prominent, and it is not clear in 2021 how collaboration will develop.

8.1.5  Chinese “Exceptionalism” In its economic development path since 1978, China’s approach poses an intriguing question: to what extent is the development experience of China due to inherent factors exceptional to China? The costly, risky, and path-​dependent nature of innovation has forced some Chinese manufacturing firms to choose approaches to innovation that seem different from those of firms in the West. In this section of the Handbook, we attempt to address the question by examining several facets of its experience. We deal first with the concept of low-​ cost innovation, described by Zeng and Williamson (2007) as “cost innovation.” In the early stages of the great transformation, small-​and medium-​sized Chinese firms were stimulated by the potential domestic market demand and actively adopted low-​cost innovation, as exemplified by the so-​called Shanzhai phenomenon. Such innovation was facilitated by the involvement of early subcontracting firms in GVCs and globally specialized production networks, which enabled them to respond promptly to customers’ demands (Murphree and Breznitz, Chapter 6.2). Learning and imitation activities effectively allowed early-​stage Chinese information and communications technology (ICT) firms to accumulate technological capabilities that helped them to achieve accelerated innovation and eventually move to the forefront in digital business. The Shanzhai phenomenon, which was characterized by low-​cost and “good enough” products, has been actively adopted in China, especially among SMEs. This new type of alternative innovation became successful in China because it transforms previously

Conclusion   747 unaffordable goods into affordable products, in response to the vast domestic market demand (Williamson, Chapter 6.1). Similar innovative approaches have arisen elsewhere, especially in India, where Jugaad or “frugal innovation” has created very low-​cost products for its impoverished masses (Radjou, Prabhu, and Ahuja, 2012). In the Chinese case, growing prosperity has encouraged low-​cost innovators to respond to consumers’ demand for higher-​quality and more sophisticated products. The early experiences of the Shanzhai innovators and their understanding of customers helped them develop substantial innovation capabilities and ways of operating. Such capabilities distinguish some of the more successful Chinese companies from their Western counterparts and appear to indicate a specifically Chinese approach (Yip and McKern, 2016). Li, Zhou, and Yang (Chapter 6.6) provide several cases that suggest a particularly Chinese solution to the problem of limited resources faced by all startups. The solution is what they call “bricolage.” The sample is too small to draw firm conclusions about startups or established firms, but the concept would benefit from investigation of a broader sample. What is not clear is whether these characteristics represent a specifically Chinese philosophy of management, as intimated in the discussion of culture by Chen and Wu (Chapter 4.6), and if so, whether it will last as firms grow, diversify, and become more international. Perhaps the special characteristics will be lost in the process of finding ways to manage in more complex environments. As great effort was devoted to indigenous innovation, the main innovation strategy in China gradually shifted from low-​cost labor to “cost innovation,” based not just on low-​cost labor but on frugal thinking, part of the Shanzhai phenomenon, which led to the current “accelerated innovation” phase (Williamson, Chapter 6.1). During the transition process, participating in GVCs drove knowledge transfer and capability upgrading and provided incentives for innovation (Murphree and Breznitz, Chapter 6.2). For example, in the digital area, China has already taken advantage of a conducive environment and enormous demand to become a world leader in a number of these new technologies (Yu and Zhang, Chapter 6.4). As Murphree and Breznitz (Chapter 6.2) explain, while the Chinese environment of “structured uncertainty” had some negative effects on the new companies, such as a short-​term outlook, it forced them to be agile and responsive. The capabilities enabled within the network of GVCs made Chinese enterprises more competitive and better able to survive both domestic and foreign shocks (Murphree and Breznitz, Chapter 6.2). Turning to the market demand and consumer characteristics for Chinese firms’ innovation activities, there is a lack of a consistent and well-​developed demand-​side approach to studying innovation in China, which is a significant research gap for innovation and management scholars (Zhu and Wang, Chapter 6.3). Yet, successful innovations depend upon the ability of the firm to connect a technical advance with a market opportunity and to be responsive to factors such as the degree of technological discontinuity, the rate of market growth, and the nature of demand change. Accordingly, government intervention and technological capability building alone cannot fully explain the rise of the innovation capabilities of Chinese enterprises. Zhu and Wang (Chapter 6.3) see the nature of demand as a prime driving force in China’s transformation. They identify three unique characteristics of consumer demand in China: size, heterogeneity, and dynamics, and they provide a detailed analysis of the influence of these three characteristics on the innovation capabilities of Chinese firms.

748    Fu, McKern, Chen, and Yin They conclude that strategies based on consumer heterogeneity in such a large and dynamic market can result in competitive advantage, even if the firm has mundane resources. These advantages are consumer driven, rather than resource or technology driven.3 The authors’ research provides useful evidence for adapting the existing theory of firm-​specific advantages in advanced MNEs to the theory of MNEs from emerging markets (EMNEs). Their evidence implies that firm-​specific advantages of EMNEs are more associated with context-​specific advantages (CSAs), rather than ownership advantages, which are the traditional sources of competitive advantage in MNEs. Buckley asserts that the phenomenon of EMNEs can be accommodated in a framework based on internalization theory (Buckley, 2018). He summarizes four existing approaches to research on the theory of EMNEs: international investment strategy, domestic market imperfections, international networks, and domestic institutions. He applies each of these approaches to three EMNE cases—​Chinese OFDI, Indian foreign acquisitions, and investment by EMNEs in tax havens. He concludes that internalization theory plays a crucial role in all four research approaches. Future demand-​side work could generate new knowledge useful to scholars and managers and have broader theoretical implications for demand-​side research in innovation and international business theory, as suggested by Zhu and Wang (Chapter 6.3). In addition to becoming the main driver for the growth of Chinese manufacturing sectors, much innovation has taken place across services. Substantial innovations have happened in China’s financial sector over the past four decades as part of the country’s transition from a centrally planned economy to a modern market economy. Facilitated by digital technology, financial innovation has had profound impacts on China’s economic efficiency, financial stability, and social equality, as well as stimulating a wider range of financial instruments and services, some of which are quite positive while others are relatively negative (Zhang, Chapter 6.5).

8.1.6  China’s Future-​and Development-​Oriented Strategies Economic growth is not the only reason innovation is treated as the core concern in the development policy agenda. Innovation not only helps to enhance economic performance but also shapes the nature and trajectory of growth. China’s rapid economic growth over the past decades substantially reduced the numbers in poverty, but new challenges are also emerging, such as environmental sustainability, income inequality, and the risk of a middle-​income trap (Lewin, Kenney, and Murmann, 2016). These challenges have led to a growing concern about the extent to which innovation can embrace the concept of more equitable, inclusive, and sustainable forms of growth and development. This Handbook

3   Yip and McKern (2016) see demand as one of four key factors explaining the growth of innovation in China.

Conclusion   749 responds to this concern by discussing green innovation, inclusive innovation, advanced manufacturing, and S&T for the future.

Green Innovation China has become a major actor in the global “green” transformation. The government’s prime focus on establishing a market-​based and innovation-​led economy has radically changed China’s innovation capabilities, including in the green sectors. The Chinese experience suggests that the extent to which innovation can help to tackle the sustainability challenge depends upon both “hard” (technological) and “soft” (institutional) innovations, as well as diffusing the innovation outputs into the economy. Huang and Lema (Chapter 7.1) reject the neoclassical separation between “innovation” and “diffusion” as distinct processes; in the tradition of innovation studies, they argue that both are characteristics of the innovation process. China’s transition experience and the environmental challenges it faced during the development process are believed by the authors to provide important insights for many other emerging countries facing concerns such as global warming and the potentially wider deployment of green technology. At the same time, there are uncertainties as to whether China, as a major emitter of environmental pollution, can adequately offset its effects and show the way to other developing nations (Huang and Lema, Chapter 7.1). Also, as detailed by Brandt and Thun in their analysis of the development of wind turbines (Brandt and Thun, Chapter 2.2), not all of China's experience with green technology has led to a commanding position in global trade.

Inclusive Innovation Another aspect of sustainable development concerns the inclusiveness of growth, namely the extent to which it embraces a large mass of the population. In this Handbook Wu and Lei (Chapter 7.2) discuss a conceptual framework for inclusive innovation that includes process and performance. An inclusive innovation system, they believe, has the following four supporting elements: bottom of the pyramid (BOP) entrepreneurs, institutions, infrastructure, and the country’s governance system (Wu and Lei, Chapter 7.2). Given that the formal institutions are not designed for helping the BOP group, an informal institutional system would need to shape behavior in this group and be complementary to formal institutions. But in the environment of China, there continue to be three main challenges for inclusive innovation: First is the “quality-​related challenge”—​that of providing affordable products at low cost, yet with satisfactory quality. While Chinese Shanzhai companies excelled at this, for new BOP businesses, that balance is hard to achieve. Second is the missing role of universities, which the authors consider could play a much more significant social role, such as entrepreneurship education, by serving rural areas (Yin, Chen, and Li, 2019), R&D collaboration, and knowledge dissemination. The third challenge is expanding platform-​based innovation, based on the success of ICT technology platforms in facilitating the creation of small online businesses. Digital technology reduces transaction costs and information asymmetry for BOP entrepreneurs, but obstacles remain (Wu and Lei, Chapter 7.2).

750    Fu, McKern, Chen, and Yin

Advanced Manufacturing China’s transition from labor-​intensive to technology-​intensive growth, aimed at avoiding the “middle-​income trap,” requires the country to advance its technology intensity and the capability of the manufacturing sectors. “Manufacturing Power Strategy” is the key element of China’s longer-​term strategy aimed at closing the technology gap with advanced economies and deriving more of its growth from higher productivity based on indigenous innovation. The speed of this transition will depend on the right mix between state guidance and private sector involvement, including the challenge of antagonism from China’s trade and investment partners. This will require “a delicate choice between, on the one hand, a large-​scale push toward economic restructuring and transiting to an innovation economy and, on the other hand, the need for a countercyclical stimulus to existing industry structures” (Mayer and Sun, Chapter 7.3).

Science and Technology for the Future China has now moved considerably away from being an imitative technology latecomer toward being an innovation-​driven economy. China adopted the strategic goal of becoming an innovative country by 2020; the second step is to enter the group of leading innovative countries by 2030; and the third step is to become the world’s innovation powerhouse by 2050. The government has also given the outlines of the state of scientific and technological innovation for 2050, as well as the future organization and governance of a modern S&T innovation system. Nonetheless, China is still at the stage of catching up in its S&T capacity, with certain constraints on its development. To achieve its objectives, it is necessary to focus further on “breaking bottlenecks, overcoming key technologies, improving originality, and seizing the frontiers of S&T.” These goals call for more focus on constructing a modern technology system and creating new mechanisms and structures for organizing S&T research. They include establishing transparent and fair evaluation mechanisms for hiring, promotion, and rewards for scientists and engineers, and building an innovation environment for both basic research and the business sector (Pan, Chen, and Lu, Chapter 7.4). As several of the authors have indicated in this Handbook, achievement of these ambitious goals will require a substantial national effort, with both economic and social implications, during a period of considerable external uncertainty.

8.1.7  Major Challenges to China’s Evolution toward an Innovation Powerhouse Looking forward, China is entering a new Great Transformation period, which represents a major shift from catching up to competing for, and attaining, global innovation leadership. As is addressed by Dosi and Yu in Chapter 1.1, Pan and Lu in Chapter 7.4, and many other authors in this Handbook, as soon as China joins the “club of innovators,” the

Conclusion   751 coevolutionary processes, as well as institutional design and industrial policies, are bound to change profoundly. Catching up is quite different from maintaining and exploiting technological leadership. Institutions and relations among them are bound to change too, among science, technology, and industry, as are the mechanisms governing income distribution. Many scholarly works agree that China has begun moving away from a reliance on imported technology and equipment to using indigenous R&D efforts to innovate for the future market economy (Clarke, Chelliah, and Pattinson, 2018; Guan, Yam, Tang, and Lau, 2009; Van Someren and Van Someren-​Wang, 2014). It is clear that China faces policy challenges at every level when implementing its national innovation-​driven strategy and its manufacturing power upgrading strategy. According to a report by Clarivate, The State of Innovation Report 2017,4 “Although still on an upward trajectory, global innovation activity as a whole slowed down this year. . . . That slowdown was driven largely by China.” Challenges faced by China on this journey vary from the macroeconomic to the microeconomic and individual level, as many of the authors in this Handbook have discussed. As Clarke et al. (2018, p. 1) point out, “While Asian economies have achieved rapid industrial progress, as they reach the global technological frontier they need to develop new institutional capabilities for sustaining international competitiveness. Foundational institutions including education, research, law, and finance require coordination around coherent national innovation systems to sustain commitment to innovative products and processes.” Drawing on the views of the authors in the Handbook, and their analysis of China’s current socioeconomic situation, as well as global trends and other academic insights, we have identified seven major challenges that China has to deal with to realize its ambitions to become the most innovative nation. These are summarized in the following section of this chapter. In the final chapter of the Handbook, Chapter 8.2, we outline a series of implications for policymakers and researchers.

Encouraging World-​Class Basic Research and Original Innovations Basic research is seen as the basis for all other technological developments, but contrarily, most Chinese enterprises are involved in applied research (Sabir and Sabir, 2010). This is not unusual among economies, including the most advanced ones. China’s original innovation capability has markedly improved, and it has produced a number of influential research outcomes in basic, frontier, and strategic technologies, as well as in advanced applied technologies. However, compared with the US record in innovation, China has a competitive weakness in basic research (as is discussed by authors in Chapters 1.5, 3.1, 3.2, 4.2, 4.3, 4.5, and especially 7.3 and 7.4). China sees dependence on other countries as a weakness that runs contrary to its goal of innovation leadership.

4  See https://​clarivate.com/​news/​clarivate-​analytics-​2017-​state-​innovation-​report-​shows-​g lobal-​ innovation-​growing-​slower-​rate/​.

752    Fu, McKern, Chen, and Yin

Attracting the Best Talent and Ideas from All Over the World While the government’s call for “indigenous innovation” has led to significant development in China’s STI policy (such as the Spark 863 Project, 211 Project, Torch Program, and 973 Project) and building of collaborative relations between research institutions and industry (Lu and Etzkowitz, 2008), China still lacks sufficient skilled human resources, especially in SMEs (Sabir and Sabir, 2010). The core element of indigenous innovation is human talent, and the sources of talent are both inside the country and outside. So, a key challenge is attracting talent and human resources from all over the world (see also the discussions in Chapters 2.4, 5.3, and 7.3), a goal that has major implications for openness.

Solving the Paradox of Open Innovation and Indigenous Innovation Can China employ a dual model of combining its own capability building with acquiring knowledge from all over the world (as addressed by authors’ views in Part V of this Handbook)? The concept of open innovation has gained widespread attention (Bogers et al., 2017; Chesbrough, 2003; Kankanhalli, Zuiderwijk, and Tayi, 2017; Lichtenthaler, 2011), and many firms have implemented such activities (Lichtenthaler, 2011). However, the paradox is that creation of innovations often requires openness, but the commercialization of innovations requires a degree of protection (Laursen and Salter, 2014). In advanced Western countries there is a flow of technology both inward and outward, supported by IPRs that give innovators protection and the opportunity to earn a return. But there is never a perfect balance, as the outflow of IP depends on a nation’s domestic innovation capacity. Also, governments impose restrictions on exports of sensitive technologies, particularly dual-​use technologies with applications for both civilian and defense needs. As with other goods and services, international trade in IP offers opportunities to benefit all parties, but the distribution of the costs and benefits remains a matter for negotiation.

Building a Core Competence-​Based Innovation Ecosystem This Handbook includes discussions of the research dealing with all of the elements of the national innovation ecosystem in China. Both academics and practitioners hold the common view that in the highly competitive contemporary world, neither a country nor a firm can survive or obtain competitive advantage without a portfolio of basic science and technologies that can build core competencies (Fu, 2015; Gu and Lundvall, 2006; Chen, 2017; Prahalad and Hamel, 1990). From the perspective of an innovation ecosystem, the best way to build up a sustainable approach to innovation and obtain the advantages of the ecosystem is to have a comprehensive innovation strategy (J. Chen and Yin, 2019; J. Chen et al., 2018). This means building an ecosystem based on national goals and core competencies and intended to strengthen and make the best use of players both inside and outside the ecosystem, while at the same time protecting the rights and positions of focal entities—​firm

Conclusion   753

Policy side Government Supply side

Research Institute

University

Public institute

Boundary of innovation ecosystem Demand side Lead user

Supplier

Service institutes Non-tech elements Core technology and R&D Core Competence

Niche customers

Customer Competitor

Organizational boundary

Figure 8.1.1  A core competence-​based innovation ecosystem framework. Source: Chen (2017).

or country (Adner, 2017; Euchner, 2014). Firms and government need to align their internal processes to the external environment and they need to configure firms to enable successful absorption of knowledge (Cohen and Levinthal, 1990; Gkypali, Arvanitis, and Tsekouras, 2018; Martinkenaite and Breunig, 2016; Todorova and Durisin, 2007; Zahra and George, 2002). Figure 8.1.1 shows the interrelated elements of the ecosystem. So, the challenge following from this approach is: how does China build on its existing innovation capabilities to develop core competencies for the future and promote knowledge creation and knowledge commercialization?

Achieving Innovation for Poverty Reduction and Social Development Goals As addressed by Wu and Lei in Chapter 7.2, improving the incomes of the large numbers of the Chinese population who are not yet participating in the middle class is an important priority for China, which is also emphasized by the president, Xi Jinping, in several speeches, including at the second session of the 13th National People’s Congress in March 2019. During the 1980s and 1990s, the political and economic agenda was dominated by concerns with growth, wealth creation, productivity, and efficiency, for which the key measurement is GDP and GDP growth. But the GDP measures “everything except that which makes life worthwhile” (McGregor and Pouw, 2017, p. 1125). GDP ignores social costs, externalities such as environmental impacts, and income inequality (Costanza et al., 2014). China has more serious challenges ahead, including pollution and environmental damage, as well as eliminating poverty. The Chinese total population of the poor decreased from 100 million in 2012 to 16.6 million by the end of 2018.5 Despite such an extraordinary 5  National Bureau of Statistics of China, Statistical Communiqué of the People's Republic of China on the 2018 National Economic and Social Development, February 28, 2019.

754    Fu, McKern, Chen, and Yin achievement, there remained 373 million people in 2018 whose income was below US $2,000 per year (World Bank, 2019). The government needs a new paradigm or anti-​poverty theory that incorporates the role of innovation to achieve indigenous development of the poorer communities. At the same time, China has to shift the growth pattern to innovation for well-​being and embrace socially responsible innovation, so as to contribute to broad sustainable goals (Yin, Chen, and Li, 2019).

China’s Rise in Innovation and the Changing International Environment China’s emergence and progress in the global innovation system have attracted wide attention in the rest of the world among academics, policymakers, and business leaders. Some argue that China’s rise should not be perceived as a threat to the Western world (Ernst, 2011; Li-​Hua, 2014; Richard, 2017) but a useful model promising potential choices, especially for emerging markets (J. Chen et al., 2018; Fu and Gong, 2011; Fu, 2015; Lee, Chen, Li, and Kim, 2017; X. Li, 2009; WIPO, 2019). Nevertheless, some people regard China’s success in innovation as a threat, in particular to US leadership of the global economic order and to its technology leadership. For example, “Made in China 2025” is seen as circumventing World Trade Organization rules on subsidies and forced technology transfers, as expressed in a recent article from the Council on Foreign Relations (McBride and Chatzky, 2019). The rising protectionism that attributes China’s rise to stealing of IP, forced technology transfer, and its strength in some technologies, such as 5G, has led to a strategic change in policy, particularly in the United States. There is a growing presumption that the United States and China will undergo a “decoupling” of their economies, as asserted by, for example, Paterson (2018). The US-​China trade war and the banning of provision of key components to some Chinese companies are symptoms of these concerns. Other actions include the prohibition of collaboration with some Chinese high-​technology firms and other restrictions to the exchange of talented scientists and engineers between the two countries. Such significant changes in the international environment, which reverse the direction of globalization, present significant challenges to China. Responses and adjustments in China’s innovation policy and international diplomacy will be needed in China’s further pursuit of its innovation goals.

The Fourth Industrial Revolution, Ethics, and STI Governance in China In the 21st century, the world is seeing the arrival of the “Fourth Industrial Revolution,” which, some believe, will have an unprecedented impact on human society (Schwab, 2015). Technological progress in, for example, life sciences and artificial intelligence has greatly benefited people’s lives but is also accompanied by many social challenges such as job replacement, safety concerns, social inequity, and ethical dilemmas such as privacy.

Conclusion   755 As argued by Xue, Li, and Yu (Chapter 2.1), unlike the situation in the past industrial revolutions, where China was left behind and struggling to catch up, China has a head start in the Fourth Industrial Revolution. Hence, the resulting problems facing China would be the frontier problems of the world, and there will be few lessons that China can learn from other countries. China has to “cross the river by touching the stones” itself in the governance of emerging technologies. Under this landscape, it is singularly urgent for China to embrace the idea of responsible innovation (Stilgoe et al., 2013) and to develop a national innovation system that focuses not only on the technological feasibility (or advancement) of innovations but also on their impact on overall economic development as well as their ethical and social dimensions. China’s national innovation system should develop mechanisms of public engagement in policymaking so that policies reflect and incorporate inputs from various parts of society. Universities, research institutes, and enterprises should be expected and encouraged to incorporate more ethical norms in their research activities. Over the next decades China will face many challenges in its aspirations for innovation leadership, from domestic social and economic priorities to navigating a far more difficult international environment. In this Handbook we have brought together the research conclusions and informed opinions of a diverse group of scholars with a deep collective understanding of China’s economic, social, and political development and its implications for innovation. We believe these ideas will assist readers to form thoughtful judgments about the global contest for innovation supremacy and how constructive engagement among nations might be achieved.

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Chapter 8.2

P ol icy and M a nag e ria l Im plications for C h i na and Other C ou nt ri e s Xiaolan Fu, Bruce McKern and Jin Chen Introduction In this final chapter, the editors present a set of ideas arising from the analysis in the Handbook and other research, drawing implications and suggesting policies and actions oriented toward positive developments in innovation for China and other countries. Implications for government and business are discussed and areas for future research are identified. The chapter groups the implications of the research compiled in this Handbook under three headings that identify key groups of stakeholders.

Policy Implications for China and Other Countries The achievement, experiences, and challenges of China’s economic development are of great significance to China itself and the other developing countries (Lin and Zhou, Chapter 1.2). During the transition from the planned economy to the market economy, appropriate development policies and reforms helped the country minimize the transition loss and risk and contributed to today’s achievements. Yet, as globalization is the prevalent economic model in most of the world, despite recent challenges, China still faces many problems in its continuing transition. Therefore, exchanges of ideas and knowledge at the levels of both trade and ideology will continue to be of great value for developing countries to achieve prosperity (Lin and Zhou, Chapter 1.2). This will remain a foremost priority for China and many other countries. In this section we address seven topics, as follows: An open national innovation system The role of the state and the market

760    Fu, McKern, and Chen Developing technological capabilities in green technology and inclusive development Strategic priorities of China’s science, technology and innovation (STI) policy in the next phase From technological innovation strategy to STI strategy Strengthening STI governance for human development An emerging innovation paradigm

An Open National Innovation System Evidence reviewed by Fu and Hou in Chapter 5.2; McKern, Yip, and Jolly in Chapter 5.1; Amendolagine, Fu, and Rabellotti in Chapter 5.4; Chen, Feng, and Fu in Chapter 5.6; and Wang in Chapter 5.3 suggests that China’s catch-​up in technology and innovation has benefited greatly from technology transfer and spillovers brought by trade, inward and outward foreign direct investment, returnees, highly skilled migrants, and the Chinese diaspora, as well as international innovation collaboration following the reforms and opening up. At the same time, the Chinese government has made continuous and heavy investment in R&D and in encouraging university-​industry collaboration as well as mass entrepreneurship and innovation (Fu, 2015; Brandt and Thun, Chapter 2.2; Hu, Li, and Lin, Chapter 3.2; Chen and Wang, Chapter 2.3; Gao and Mu, Chapter 3.3). The government’s recent efforts in developing China’s manufacturing power also reflect strong support through a top-​down approach (Mayer and Sun, Chapter 7.3). Such state-​private dialogue, a distinctive feature of China’s approach to innovation, is a concept of great interest. While the debate has been going on regarding the role of state versus market regarding innovation in China, including the view that the market and entrepreneurship are the real drivers of innovation (Zhang, Chapter 3.1), there is evidence that government investment has been a positive factor pushing innovation forward in China, despite the problem of low efficiency (Fu, 2015). Overall, as argued by Fu (2015) and summarized by Xue, Li, and Yu in Chapter 2.1, evidence reported in the Handbook suggests that China has followed the path of an open national innovation system (ONIS) since the reforms and the take-​off stage in the 1980s. An ONIS is a national innovation system that is opened up to international knowledge, resources, and markets. China's experience suggests that to maximize the benefits from innovation and to accelerate catching up, explicit and well-​focused encouragement of indigenous innovation must work in parallel with acquisitions of foreign knowledge (Fu and Gong, 2011). Neither autonomous innovations nor foreign direct investment (FDI)-​reliant strategies can be used uniquely (Lall, 2003; Pietrobelli, 2000). How to select and shape the best combinations at different stages of development and for different countries and industries is a question of utmost relevance for future research (Fu, 2015; Fu and Hou, Chapter 5.2). At the sectoral level, examining China’s experience in green technology, Huang and Lema argue in Chapter 7.1 that China’s version of directed capitalism has been an advantage in the current situation, where the adoption of green technologies is dependent on government subsidy of emerging renewable energy technologies to help them evolve to be competitive with fossil fuels. But just as China’s rapid growth cannot be attributed to state capitalism alone (Fu, 2015), neither can the recent advances in renewable energy diffusion. As shown in this chapter, the process had multiple drivers that included government policy,

Policy Implications for China and Other Countries    761 investment by various types of enterprises (state-​owned and private, local and global), and knowledge generation and sourcing from both local and global knowledge pools (Huang and Lema, Chapter 7.1). The concept of openness requires examining the role of the multinational enterprise (MNE) in technology transfer. As McKern, Yip, and Jolly argued in Chapter 5.1, FDI has been an important policy for China and other developing countries in technology sourcing. While every nation has the right to formulate a policy toward FDI, and in practice policies range from benign neglect to stringent control, it is important for policies to consider how best to ensure appropriate levels of technology transfer. However, this entails viewpoints at opposite ends of the spectrum. That spectrum ranges from mandatory transfer (e.g., to a joint venture partner) in exchange for the foreigner’s access to the market, to contractual agreements for use of foreign intellectual property (IP), with protection of property rights and a range of mechanisms to effect transfer. Opinions on the best policies for effective transfer are influenced by the mixed evidence of spillovers from FDI into domestic capabilities, shown here. Mandatory transfer is not the best way, unless the market price being offered is extraordinary and there are technologically capable suitors to choose from. Building indigenous innovation capabilities involves far more than acquiring IP: it requires a mature ecosystem of related elements that reinforce the absorption capacity. For developing countries that want to encourage technology transfer and knowledge-​ intensive interactions between the MNEs and the host economy, there is a need for more to be done for multinational corporations (MNCs) to be confident about their legal IP position. This policy implication is consistent with the research in Brazil that MNEs will have greater engagement in R&D activities with local partners when there is a strong protection of IP, as reported, for example, by Mansfield (1994). China’s recent amendment to the law concerning FDI would be a useful opportunity for China to experiment with a market-​ oriented regime for technology transfer. The recent tensions between China and the United States demonstrate that an open innovation system that includes sourcing of technology from abroad must respect the ownership rights of foreign IP. A genuine two-​way traffic in IP is a desirable goal, and that requires an acceptable regime for international sources of IP, including assurances against forced technology transfer. It is hoped that the environment for MNCs in China will become more welcoming in practice, and one in which they will see benefit in entering into the local innovation ecology.

The Role of the State and the Market The relationship between government and market and the relationship between state-​ owned enterprises (SOEs) and private enterprises have always been core issues of China’s economic reform. The Chinese government has accepted that the market should play a major role in allocating resources and stimulating innovation, and at the same time government supports activities that are risky and have positive public spillovers, such as basic R&D. Academically, the debate about the role of the state and market in innovation is still ongoing. For example, Marcuzzo (2013) ascribes many useful US innovations to government. In China, some consensus on the role of the market has been reached only in recent years. Lin and Zhou argue in Chapter 1.2, “The Chinese government has clearly stated

762    Fu, McKern, and Chen recently that it must let the market play a decisive role in economic activities, while the government is playing a policy role”. However, Zhang in Chapter 3.1 argues for greater competition in free markets and less government participation. He writes, “Although China has made great effort and some progress in innovation, it is far away from an innovative economy. . . . Chinese entrepreneurs are, to a large extent, still incentivized in arbitrage much more than in innovation.” In their excellent assessment of the role of the state and market, Brandt and Thun find that “many sectors failed to produce dynamic national champions. . . . These failures were the result of excessive regulation and favoritism for state-​connected firms, both of which skewed incentives and dampened the incentive for innovation and upgrading” (Brandt and Thun, Chapter 2.2). Therefore, the policy implication for China and other countries is that both the market and state have a role in supporting innovation. However, there is a strong caveat on where the state should lend strong support and how such support, especially financial support, should be offered to industries. Government policy and financial support should be focused on risky and costly R&D activities where there is market failure. In the low-​risk commercialization stage of innovation, the state’s role should be restrained, and the market and free competition should be the main mechanism to allocate resources. In competitive industries, state support will not result in national champions or global leaders. Nevertheless, the Chinese government’s efforts to support innovation have caused great concern from its international competitors or potential competitors. As Mayer and Sun (Chapter 7.3) point out, “China needs to pay attention to the Western countries’ feelings and worries about the ‘Manufacturing Power Strategy.’ Logically, it does not mean that what Western countries worry about is what China should act upon. Western countries worry about government subsidies, IP protection, and the status of foreign-​funded enterprises in China. This may reflect that they are less worried about the promotion of China’s manufacturing industry, as well as the growing domestic demand, than whether a more powerful China could provide wider, credible, and sustainable opportunities for Western enterprises and products.” It is crucial for China to find the right mix between state guidance and private sector involvement, including how to make the Manufacturing Power Strategy effective, while addressing antagonism from China’s trade and investment partners. This mix would ensure that SOEs operate under better organizational structures and incentives and achieve better integration of research, production, and marketing activities, and that incentives would be carefully designed and directed to entrepreneurs, scientists, and research institutions to spur innovation (e.g., Fu, Woo, and Hou, 2016; Sun and Mayer, Chapter 7.3).

Developing Technological Capabilities in Green Technology and Inclusive Development China’s experience in developing capabilities in green technology suggests that green innovation is not only about technological innovation. Equally or even more important were the policies and regulations that created incentives and opportunities for renewable energy generation, distribution, and consumption. On the demand side, these included subsidies (feed-​in tariffs), mandatory purchase regulations, and consumer financial incentives; on

Policy Implications for China and Other Countries    763 the supply side, they included dedicated R&D funds for renewable technology, not least through the national funding programs for universities and research institutes and demonstration projects. Therefore, to effectively develop a country’s capabilities in green technology, a set of coherent policies covering not only technological innovation but also market-​related supply-​and demand-​side policies is needed. Technological innovation in China played a controversial role in inclusive development. In terms of income distribution, technological advancement that is biased toward capital and skilled labor increased the income gap between the skilled and the unskilled, and between the regions that have higher or lower technological capabilities and innovation manpower, for example, the coastal versus the inland regions in China. On the other hand, in terms of bridging the gaps in society, the world-​class digital infrastructure in China and the wide diffusion of digital technology and skills have made a substantial contribution. That has been in terms of not only income but also access to financial, education, and information resources and to some facilities, such as transport, housing, etc. Of course, the widening of the income gap is a problem not only in China but also in many other countries (Yin, Chen, and Li, 2019). Complementary social and regional policies are needed, as well as policies for developing digital infrastructure and skills. As a response to China’s national strategy on rural revitalization initiated in October 2017, Yin, Chen, and Li (2019) proposed a theoretical perspective for a rural innovation system; compared the similarities and differences between the urban and rural innovation systems; and provided a structural framework based on China’s rural innovation practices to improve inclusive development. As Mayer and Sun state, “Regional disparity in innovation capacity will affect income disparities across Chinese regions. To address distributional issues, policymakers may need to consider strengthening social safety nets and adopt measures designed to achieve more equal income and wealth distribution. These measures would include macroeconomic policies that encourage growth of domestic household consumption, which, in turn, would positively affect indigenous innovation that meets the needs and desires of Chinese citizens” (Mayer and Sun, Chapter 7.3). Reducing income inequality between nations is another major challenge facing the global community, including countries in Central Asia. Under its ambitious Belt and Road Initiative, the Chinese government has initiated a digital Silk Road, construction of substantial infrastructure, and a collaboration plan for scientific and technological innovation across Central Asia and other regions. These policy initiatives should be welcomed, but for them to be successful, China needs to strengthen communication with countries along the Belt and Road, promote the construction of STI bases, employ technical collaboration platforms and joint research centers, and expand training in applicable technologies. China should “initiate a ‘One Belt, One Road’ technology park collaboration, technology transfer collaboration, and joint laboratories, and promote international capacity collaboration with technological innovation with countries participating in Belt and Road Initiative (BRI)” (Chen, Feng, and Fu, Chapter 5.6).

Strategic Priorities of China’s STI Policy in the Next Phase Looking forward, while there is no doubt that China’s innovation performance has improved significantly, especially after 2000, given the challenges that we discussed earlier in this

764    Fu, McKern, and Chen chapter, China should continue to use the five sources of STI we have discussed previously, to continue its march toward becoming an innovative nation. However, to achieve global innovation leadership, China needs a set of new perspectives and strategies to realize that transformation. In addition to the five challenges discussed earlier, as Fu, Woo, and Hou (2016) noted, there are two bottlenecks in China’s innovation capabilities. One is creativity, because the Chinese education system emphasizes respect for and attention to existing knowledge and doctrine, rather than fostering critical thinking and challenging existing limits. Another is the inequality in access to innovation resources and the need for greater support of SMEs. Moreover, as for Chinese high-​technology clusters, there is excessive competition in some sectors and a lack of an innovation-​enabling environment, including a lack of trust and cooperation, which leads to high transaction costs. This has prevented many companies from developing their innovation ecosystem or collaborating with research institutes (Sabir and Sabir, 2010). Therefore, there are strategic priorities for China’s STI policy in its next stage of development. This requires policy efforts on many dimensions, which include the following:

1. Develop innovation policy support to ensure equal access to innovation resources to all firms and greatly enhance the support to SMEs. 2. Continue to strengthen the protection of intellectual property rights (IPR). 3. Ensure a world-​class environment of research, with high integrity. 4. Significantly foster creativity among society, to encourage free thinking and respect for and protection of IP. 5. Introduce policies to further strengthen the helix of science, technology, and innovation. 6. Encourage the priority and direction of STI efforts to promote inclusive and sustainable development. 7. Finally, develop a two-​way and win-​win interaction between China and the global partners that is embraced by all parties.

From Technological Innovation Strategy to STI Strategy Based on the challenges and strategic goals of China’s STI policy, the key strategic priority for China is to shift the focus of innovation policy from technological innovation to science, technology, and innovation. The former is a system with a focus on enterprises and university-​industry cooperation, while the latter is a new multidimensional system incorporating leading enterprises, universities, and research institutes, a key part of which is basic science. The firm is the most dynamic and powerful dimension of a national innovation system (Clarke et al., 2018). To cultivate world-​class innovative firms, government should encourage industry-​leading enterprises to formulate high-​level research institutes, build organizational R&D systems that collaborate with universities, and bring together top innovation talent. What’s more, the government needs to motivate leading enterprises to collaborate with SMEs and research institutes to expand the innovation chain, offering overall

Policy Implications for China and Other Countries    765 scientific and technological solutions to industry. The third priority is to cultivate a batch of innovation-​oriented enterprises with outstanding capabilities in core technology that can lead to major industrial development. Meanwhile, more Chinese firms need to strive to be among the top 100 innovation-​oriented enterprises in the world. That means much larger corporate investment in research, as well as development, and willingness to collaborate, using open innovation. At the industry level, STI policy has two parallel streams to further promote economic transformation and industrial upgrading. The first stream is exploitation oriented, helping to deepen the cultivation of traditional industries through lean innovation and adaptive R&D. The second stream is more exploration oriented and focuses on exploration of scientific discovery and emerging industries (e.g., artificial intelligence and Internet of Things) and tries to achieve original and disruptive innovation by combining basic and applied research (Table 8.2.1). As for the education dimension, STI policy should provide incentives to build world-​ class universities and first-​class disciplines as well as world-​class research institutes, to create more original and radical knowledge. More specifically, STI policy needs to guide universities to strengthen basic research and pursue academic excellence; build comprehensive cross-​disciplinary teams; form a batch of subject clusters and high-​level science, technology, and innovation bases; enhance abilities of original innovation in socioeconomic services; and promote a selective group of high-​level universities and disciplines to become first-​tier in the world. There may be four different types of universities in the future: the teaching-​oriented university, the teaching and research university, the research-​oriented university, and the entrepreneurial university. But all of these universities should aim to become innovative institutions. Besides the firm innovation system, the education system, and the research system, it is as important (if not more important) to build the national system for technology transfer. A more productive ecosystem not only should include university, industry, and government but also needs to include a linkage system of knowledge transfer that helps to improve the efficiency and efficacy of knowledge flow and knowledge commercialization. Under the guise of a triple-​helix “ecosystem” (the triple elements being university, industry, and government), interactions are core elements of regional economic growth within a knowledge-​ based economy (Leydesdorff, 2012). However, if there is a lack of financial services and business operations (such as branding, IP protection, and technology transfer platforms),

Table 8.2.1 Two Streams for Promoting Economic Transformation and Industrial

Upgrading Attributes

First Stream—​Exploitation

Second Stream—​Exploration

1 2 3

Deep cultivation of traditional industries Lean innovation, continuous improvement Adaptive R&D

Exploration of emerging industries Original and disruptive innovation Basic and applied research

766    Fu, McKern, and Chen the knowledge cannot be effectively transferred between the three parties. Therefore, STI policy should emphasize not only the creation of IP but also the business operations and commercialization of IP, from papers and patents to products and sales.

Strengthening STI Governance for Human Development The Fourth Industrial Revolution may have an unprecedented impact on human society (Schwab, 2016). As argued by Xue, Li, and Yu (Chapter 2.1), more emphasis should be placed on the ethical challenges and potential social risks with artificial intelligence in areas such as privacy and human dignity. It is urgent for China to embrace the idea of responsible innovation (Stilgoe et al., 2013) and to develop a national innovation system that focuses not only on technological feasibility (or advancement) but also on technology’s impact on economic development. It should also consider its ethical and social dimensions. Universities, research institutes, and enterprises should incorporate more ethical norms in their research activities. These policies would entail developing mechanisms of public engagement in policymaking so that policies reflect and incorporate inputs from various parts of society. Also, China needs to be more engaged with international science and technology (S&T) collaboration and to play a more important role in the global innovation system. In a context where a force of anti-​globalization is rising around the world, it is critically important for big countries, the United States, the European Union nations, and China in particular, to strengthen S&T cooperation to address the major challenges they are facing, such as climate change, environmental degradation, poverty reduction, food safety, infectious disease, and public health. China has greatly benefited from international S&T collaboration in the past four decades. It will need to get actively involved in the global governance of STI and play a more positive role in technology development, risk prevention, and formulation of ethical norms to advance development for a better future.

An Emerging Innovation Paradigm Based on Eastern wisdom and best innovation practices, J. Chen, Yin, and Mei (2018) propose a new paradigm of innovation that they call holistic innovation (HI). HI is a collaborative innovation process driven by strategic vision. This new innovation paradigm is a helix of strategic innovation, collaborative innovation, and open innovation, which the authors say reflects both the wisdom of Chinese context and Eastern culture (Andrews and Wall, 2017; Chen and Yin, 2019; Chen and Miller, 2010; Edquist, 2018). Its aims are to promote the management of technological innovation in enterprises in the context of open innovation and with a global perspective. In their view, innovation policy should be driven by strategic design and take into consideration S&T, education, economy, culture, and ecology to promote collaborative innovation. The goal is to systematically upgrade the innovation system and technology transfer processes so as to provide the nation with technical strength in major technological fields, strategic industries, and enterprises, toward achieving global innovation leadership. Holistic innovation is not yet a set of policies: it is rather a description of an aspiration. So the recommendation of the authors is for government and business in China to consider the merits of the idea and what policies and actions would be needed if it were to be pursued.

Policy Implications for China and Other Countries    767

Managerial Implications for the Private Sector Openness and In-​House Innovation As we have seen in Chapter 5.7, open innovation is an increasingly useful process for companies worldwide. Many firms with advanced technological capabilities have discovered that their existing mindset limits the creative potential to develop radical ideas. Firms have become aware of the “innovator’s dilemma” (Christensen, 1997), and open innovation is a way of resolving that problem. Innovative solutions may often arise from a domain outside the company’s traditional expertise, particularly in a world where digital disruption is commonplace, and several large Chinese companies have become strong proponents of this new approach (e.g., the appliance corporation Haier). The challenge companies have to face is to balance the value of innovation from outside against the vested interests of the firm’s own internal innovation organization. The experience of Chinese firms is that the leadership needs to make open innovation a strategic priority and provide incentives to encourage executives to seek it.

The Importance of Absorptive Capabilities Both resource endowment and comparative advantage can be developed, as the experience of Japan, China, and the Asian Tigers has shown. Learning capacity has become one of the most important sources of adjustment to achieve such a shift. With good learning capacity, the government and enterprises can take advantage of the existing factor endowment and convert latent comparative advantages into real advantages. Learning capacity in corporations depends on a host of factors described in previous chapters, including a deep understanding of their customers as well as their competitors. It also depends on the technological environment in which government can play a critical role. Shifting the basis of comparative advantage in a global competitive context requires a systemic approach.

Strategies for MNCs The position of MNCs in China has become more problematic in recent years and raises questions of long-​term commitment. As elaborated earlier, foreign MNCs have played an important role in China’s growth, especially during the period of China’s great transition from a centrally planned economy to a market-​driven economy. From China’s perspective, the growing number and scale of MNCs in China provided not only financial capital but also critical tangible and intangible technological resources, acquired through local R&D, greenfield investments, and joint ventures, which have been proven to be the key drivers for long-​term economic growth (Romer, 1986; McKern, Yip, and Jolly, Chapter 5.1). From the foreign MNCs’ perspective, establishing local R&D centers has enabled MNCs not only to implement their China strategy and extend their embeddedness in the economy but also to create novel products and IP to strengthen their competitive advantage in the global market, so-​called reverse innovation (Immelt et al., 2009). McKern, Yip, and Jolly (Chapter 5.1) review the role of MNCs in the creation of foreign intellectual capital in China and its transfer to China, including incentives and policy implications for indigenous innovation. They argue that for China, initially lacking a technological base, it was sensible after

768    Fu, McKern, and Chen the market opening to embrace FDI as a key vehicle to attract technology and innovation. In keeping with China’s pragmatic practice of experimenting with different trials, learning from experience, and adapting to results, its policies have evolved to a stronger emphasis on technology transfer. China is putting more and more emphasis on the protection of IP and adapting its IP regime toward technology transfer (as discussed by Huang and Sharif, Chapter 4.5). The considerable growth of its indigenous innovation capabilities and absorption capacity suggests the potential for a better IP and FDI investment environment for MNCs’ R&D and operations in China. Although MNCs consider that they have been under pressure to accept “forced technology transfer,” they may face less pressure as China’s indigenous capacity becomes stronger and if IP protection becomes more effective. There is much MNCs can learn from being part of the innovation ecosystem in China, provided they can protect their IP, as proposed by Yip and McKern (2016). However, MNCs must also adapt their strategy in the future to compete against the strong R&D resources of giant global Chinese companies, such as Huawei and Alibaba. Those foreign MNCs in China that have not succeeded in applying a global strategy in China, such as Amazon and eBay, will face continuing competition in China and worldwide in the near future (Li, 2019).

Digital Transformation of the Incumbent Firms, and Sustainability Chinese firms (and foreign firms in China) should take advantage of China’s world-​class digital infrastructure, the market’s acceptance of digitalized production lines, sales platforms and services delivery, and China’s large pool of information technology (IT) talent to accelerate their digital transformation. There is also growing interest in setting standards. China has a leadership position in 5G telecommunications technology and is seen by many countries to be the standard-​setter, despite concerns about potential security issues. As Yu and Zhang note in relation to telecommunications, “With the changing technological dynamics and related competitive landscape, we can observe the industrial upgrad[ing] at a national level, but also the policy shift toward ‘going out’ strategy to reposition its role in the global industrial system” (Yu and Zhang, Chapter 6.4).

Areas for Future Research The assessments of the state of the art in the field of innovation in China made in previous chapters of the Handbook also highlight a number of areas for future research. We outline several of these here.

A Rigorous and Scientific Assessment of the Role of the State in China’s Technology Catch-​up and Its Implications for Other Countries China’s remarkable development from the 1980s, as detailed by many of the authors of the Handbook, was notable for the stepwise introduction of a market system, with government support intended to create an innovation ecosystem with indigenous technological

Policy Implications for China and Other Countries    769 capability. When compared with other countries that developed rapidly in the postwar environment, the Chinese experience appears exceptional, but it is not completely clear what have been the differentiating characteristics of that experience. To what extent was the success due to the government’s industry and technology policy push on the supply side, or was it mainly because of latent market demand and adoption of markets, which greatly stimulated the private sector? To what extent were the sense of purpose and the policies of the government fortuitously coincidental to emerging entrepreneurship, or were the government’s vision and policy actions essential factors in providing free play to the energies of entrepreneurs? To what extent does China’s path to economic success imply an alternative economic to the model exemplified in the Washington Consensus? This is still a field of debate, as the chapters in the Handbook demonstrate. When, where, and how to use strong government policy to support innovation and what China’s experience can offer to the world are important questions for future research and policy advice. While the Chinese government’s strong investment in R&D has provided critical resources that are needed for innovation, the low innovation efficiency in China is a problem of wide concern. The possible distortion caused by unequal access to resources has become an important bottleneck for China’s innovation (Fu et al., 2016; European Commission, 2019). How can China ensure public funding is used efficiently and fairly in promotion of innovation? What types of policy tools, including funding type, support of SOEs, allocation mechanisms, funding management, and the project appraisal system, should be used? What reforms of existing policies should be introduced in China and other developing countries at a similar development stage? What are the characteristics of China that should be considered when applying policy tools used in Western countries? Should Western policies such as the competitive neutrality principle be applied strictly? Competition among local governments has been an important driver of economic growth in China. However, the lack of coordination between them has also been a source of duplication and even over-investment in China. What institutional reforms are needed to overcome this problem while ensuring the resilience of competition in the domestic market? China has developed its innovation capacity through an ONIS. The ONIS is a dynamic system that needs to evolve following the progress of a country’s development stage (Fu, 2015). But that evolution has led to tensions with foreign countries over IP and technology transfer. China has to allow it to evolve in a manner that fits the ambitions of the respective parties, and in fact the government has indicated its commitment to a “higher level of openness.” However, the global economic and political environment has changed significantly with the rise of protectionism, the COVID-​19 pandemic, and the technology cold war. This has had a strong impact on global capital, talent and knowledge exchanges, and STI cooperation. What is the impact of the changing international environment on innovation in China and in the rest of the world? What policy responses should the global community, including China, address so as to promote innovation and knowledge creation in human society? To what extent is a global consensus on the sharing of new beneficial technologies now possible? Should China develop its innovation capacity with a higher level of openness or rely increasingly on indigenous innovation? And should this be the policy of other nations? On the other hand, what is the impact of China’s innovation emergence on the rest of the world, in both the developing and developed countries? In what ways and to what extent

770    Fu, McKern, and Chen has the industry policy employed in China affected firms in other countries? What are the policy implications for China and other countries?

Policies and Management of International Innovation Collaboration Over the last decade, innovation increasingly became an open and collaborative undertaking. While openness seems likely to continue inside countries, open innovation between nations seems increasingly threatened by the rise of protectionism and the anti-​globalization movement. As this is a new emerging research area, a series of questions need to be addressed for future research. As discussed by Chen, Feng, and Fu in Chapter 5.6, these include:

1. Research in the field of international innovation collaboration 2. Exploration of the reasons for the differences in the benefits of international research collaboration in different countries 3. Analysis of factors and mechanisms affecting the output of international research collaboration 4. Explanation of the causal relationship between international research collaboration and high-​quality output 5. Comparison of the differences between international scientific collaboration and international technical collaboration 6. Research on the “One Belt, One Road” international innovation collaboration 7. Research on risk issues and remedies in international innovation collaboration 8. Research on further opening up in China’s national S&T plan

Policies and Management of Outward Direct Investment to Maximize Innovation Benefits for Source Countries, MNEs, and Host Economies As part of China’s goal to be an innovative nation and in its journey to converge on the industrialized countries, outward direct investment has been and will remain an important tool. As MNEs from emerging economies are still a new phenomenon, a set of issues are in particular need of future research (Amendolagine, Fu, and Rabellotti, Chapter 5.4). First, it is still too early to make a conclusive assessment about the innovation impact of Chinese outward foreign direct investment (OFDI), as this is a very recent phenomenon. Second, more empirical research on the causality between OFDI and innovation capabilities of the investing firms is needed, controlling for the identification problem with panel data and instrument variables. Third, our understanding of the process of OFDI from developing countries, the facilitating variables, and OFDI’s impact on innovation and capability building is still limited. More in-​ depth case studies of the process, conditions, and dynamic interactions between the host environment and the MNEs’ subsidiaries and headquarters, as well as the home country, should be carried out, with a view to understanding locational and firm-​specific advantages more fully. Finally, the impact of Chinese OFDI on innovation systems in the host countries is an important, under-researched area. Future research should explore this important area, as well as its impact on inclusive and sustainable development in the host economies.

Policy Implications for China and Other Countries    771

Skills, Creativity, and Education in Innovation and Entrepreneurship Creativity is one of the critical bottlenecks of innovation in China and in many other countries. With respect to education and training for innovation and entrepreneurship, it is important to understand the following, according to Cooke (Chapter 2.5):

1. Where and how are creativity and entrepreneurship skills best developed? What should be the role of schools in fostering creativity? Should university graduates be channeled into self-​ employed businesses as entrepreneurs? Is this the most effective use of resources for the nation? 2. For those who enter employment in corporations, what is the role of corporate human resource management (HRM) in facilitating a smooth transition between education and employment so that graduates’ creative talent can be better harnessed? 3. Are Chinese workplaces and managers sufficiently prepared to help graduates make the transition from education to work, so that their creative energy is not lost? What HRM practices are conducive to eliciting employees’ innovativeness and creativity? 4. What analytical techniques can be used to manage innovation? What may be the demographic differences (e.g., gender, age, education, and family background) in shaping employees’ expectations and innovative or creative behaviors? 5. What may be the "dark side" of innovation and creativity for individuals, organizations, and society, and how can these be mitigated? 6. How should state-​supported education and training be delivered effectively and efficiently to strengthen entrepreneurship?

Culture and Innovation On the one hand, traditional Chinese culture embodies innovation elements, regarding the mode of thinking, ideals and beliefs, organizations and institutions, and tools and technology (Chen and Miller, 2010; Chen and Wu, Chapter 4.6). On the other hand, it may be argued that the Confucian culture of respect and obedience, coupled with the traditional collective culture of China, may hinder individual Chinese from thinking differently and breaking the existing norms of S&T. What is the impact of culture on innovation in China? Is fostering a culture of individualism beneficial or desirable? This is a very important issue for the goal of transformation into a creative and innovative country, as implied by the concept of mass entrepreneurship discussed by Gao and Mu (Chapter 3.3).

Financial Innovation There are five important areas for future research to understand financial innovation in China (Zhang, Chapter 6.5).

1. In terms of the speed, scale, driving forces, and impacts of financial innovation, how much difference is there between China and other countries (especially developed countries)? How do we explain the differences and evaluate the role of the Chinese government in this regard?

772    Fu, McKern, and Chen



2. Although government intervention may have been a driving force for financial innovation, should not market-​oriented reform and institutional innovations be encouraged? If so, how should this be brought about? 3. The rapid development of shadow banking and internet finance since 2013 has shown that financial innovations can lead to financial instability and even chaos. How should China balance financial regulation and supervision with the play of market forces to encourage beneficial financial innovation? 4. It would be interesting and valuable to have deep research, both theoretical and empirical, on the economic consequences of financial innovation in China, as well as whether, like some developed countries, China may be facing excessive financial domination of its economy.

Green Innovation Green innovation is a topic of global relevance and importance. Several questions for further research arise out of the analysis presented in Chapter 7.1 by Huang and Lema. First, China’s transition experience may provide important insights for many other emerging countries in their pursuit of economic development combined with green transformations. But given the unique nature of China (e.g., in terms of size of the home market or economic governance), what can other developing countries learn from the Chinese experiences? Second, Huang and Lema (Chapter 7.1) suggest that China’s heavy investments in environmental technology are being used productively to establish globally competitive green sectors, in line with the concept of creating comparative advantage. Mathews even suggests that China may be on its way to developing a “green model of industrial capitalism” (Mathews, 2013; Mathews and Tan, 2017). Future research should examine the reality of this proposition by comparing the growth rates of investment in low-​versus high-​carbon industries and the strength of alliances supporting low-​versus high-​carbon industries. Third, it is possible that global benefits are emerging because China’s entry into renewables is lowering the costs of green technology. Given the various factors that may affect the global deployment of low-​cost green technology, how effective will Chinese firms be in bringing down the cost of energy and opening up new markets? How will the gains from green trade and FDI be distributed among China and customers?

Digital Technology and Inclusive Development Given the fact that digital technology will play a central role in the Fourth Industrial Revolution and has potentially profound implications for inclusive development, there are three more questions for future research.

1. The quality-​related challenge for inclusive innovation. It is often difficult for firms pursuing “inclusive innovation” to balance affordability and the quality requirement when they serve the bottom of the pyramid (BOP) market. How can companies develop the competence to provide the poor with goods and services that are both affordable and of high quality? Chinese firms grew rapidly in the past by managing

Policy Implications for China and Other Countries    773 this balance. As China's middle class grows, it will emerge as a core question to address for many firms (Wu and Lei, Chapter 7.2). 2. The missing role of universities in the inclusive innovation system. The role of the university in the transformation of society includes economic, political, social, and cultural aspects. However, currently the role of universities in inclusive innovation has been largely ignored. How can universities play a bigger role and make more contributions to inclusive innovation at national and regional levels? What policies should be introduced to engage universities in inclusive innovation and in what focal areas (Wu and Lei, Chapter 7.2)? 3. Institutions for platform-​ based inclusive innovation. Discussion on the platform economy has focused in the past on topics such as efficiency, cost, and new applications or business models. The emergence of platform-​based business model innovation may have a great role to play in promoting inclusive development, by reducing the barriers for the poor to enter business, and providing education, low-​cost solutions to housing, services, information networks, communications, and finance. Does the emergence of platform-​based inclusive innovation require new theoretical development to understand the phenomenon, its determinants, and its impact better? What are the impacts of these digital business model innovations on inclusive development? What are the transmission mechanisms? What regulatory and policy changes should be introduced to minimize the potential negative effect and maximize the developmental effects?

Technological Revolution, Research Ethics, and Human Development The rapid breakthroughs in emerging technologies, in particular, robotics, artificial intelligence, big data, gene engineering, molecular biology, and life sciences, have great potential to benefit the lives of human beings but also raise significant issues concerning research ethics and governance. Whom should technical progress ultimately serve? Who should be in control of technical changes with such profound implications? What is the role of policy and regulations in this technical revolution? While there has always been a tension between scientific discovery and its applications, these new questions are fundamental to the future of mankind and are just beginning to be considered globally. They are urgent and must be studied.

Acknowledgment The authors are grateful to Ximing Yin for valuable editorial assistance.

References Andrews, P., & Wall, K. J. (2017). Holistic Innovation: The New Driver for Excellent Enterprises. CreateSpace Independent Publishing Platform.

774    Fu, McKern, and Chen Chen, J., & Yin, X. (2019). Connotation and Types of Innovation. In J. Chen, A. Brem, V. Eric, & W. P. Kam, The Routledge Companion to Innovation Management (1st ed., pp. 6–​54). Routledge. Chen, M.-​J., & Miller, D. (2010). West Meets East: Toward an Ambicultural Approach to Management. Academy of Management Perspectives, 24(4), 17–​24. Christensen, C. (1997). The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail. Harvard Business Review Press. Clarke, T., Chelliah, J., & Pattinson, E. (2018). National Innovation Systems in the Asia Pacific: A Comparative Analysis. In T. Clarke & K. Lee (Ed.), Innovation in the Asia Pacific (pp. 119–​143). Springer. https://​doi.org/​10.1007/​978-​981-​10-​5895-​0_​6 Edquist, C. (2018). Towards a Holistic Innovation Policy: Can the Swedish National Innovation Council Serve as a Role Model? Lund University, CIRCLE-​Center for Innovation, Research and Competences in the Learning Economy. European Commission. (2019). China: Challenges and Prospects from an Industrial and Innovation Powerhouse. EC Joint Research Centre. Retrieved from https://​op.europa.eu/​ en/​publication-​detail/​-​/​publication/​c89434b2-​88cd-​11e9-​9369-​01aa75ed71a1/​language-​en Fu, X. (2015). China’s Path to Innovation. Cambridge University Press. Fu, X., & Gong, Y. (2011). Indigenous and Foreign Innovation Efforts and Drivers of Technological Upgrading: Evidence from China. World Development, 39(7), 1213–​1225. https://​doi.org/​10.1016/​j.worlddev.2010.05.010 Fu, X., Pietrobelli, C., & Soete, L. (2011). The Role of Foreign Technology and Indigenous Innovation in the Emerging Economies: Technological Change and Catching-​up. World Development, 39(7), 1204–​1212. https://​doi.org/​10.1016/​j.worlddev.2010.05.009 Fu, X., Woo, W. T., & Hou, J. (2016). Technological Innovation Policy in China: The Lessons, and the Necessary Changes Ahead. Economic Change and Restructuring, 49(2–​3), 139–​157. http://​dx.doi.org.proxy.library.cornell.edu/​10.1007/​s10644-​016-​9186-​x Immelt, J. R., Govindarajan, V., & Trimble, C. (2009). How GE Is Disrupting Itself. Harvard Business Review, October. Lall, S. (2003). Indicators of the Relative Importance of IPRs in Developing Countries. Research Policy, 32(9), 1657–​1680.https://​doi.org/​10.1016/​S0048-​7333(03)00046-​5 Leydesdorff, L. (2012). The Triple Helix, Quadruple Helix, . . ., and an N-​ Tuple of Helices: Explanatory Models for Analyzing the Knowledge-​Based Economy? Journal of the Knowledge Economy, 3(1), 25–​35. https://​doi.org/​10.1007/​s13132-​011-​0049-​4 Li, F. (2019). Why Have All Western Internet Firms Failed in China? A Phenomenon-​ Based Study. Academy of Management Discoveries, 5(1), 13–​37. https://​doi.org/​10.5465/​ amd.2017.0102 Mansfield, E. (1994). Intellectual Property Protection, Foreign Direct Investment, and Technology Transfer. International Finance Corporation discussion paper; No. IFD 19. World Bank. Marcuzzo, M. (2013). The Entrepreneurial State: Debunking Public vs. Private Sector Myths. Anthem Press. Mathews, J. A. (2013). The Greening of Capitalism. In Mikler, J. (Ed.). The Handbook of Global Companies, Wiley. (pp. 421–​436). Mathews, J. A., & Tan, H. (2017). China’s Continuing Green Shift in the Electric Power Sector: Evidence from 2016 Data. The Asia-​Pacific Journal | Japan Focus, 15(4). Romer, P. M. (1986). Increasing Returns and Long-​Run Growth. Journal of Political Economy, 94(5), 1002–​1037.

Policy Implications for China and Other Countries    775 Sabir, R. I., & Sabir, R. M. (2010). Managing Technological Innovation: China’s Strategy and Challenges. Journal of Technology Management in China, 5(3), 213–​226. http://​dx.doi.org. proxy.library.cornell.edu/​10.1108/​17468771011086238 Schwab, K. (2015). The Fourth Industrial Revolution: What It Means and How to Respond. Foreign Affairs. https://​www.foreignaffairs.com/​articles/​2015-​12-​12/​fourth-​industrial-​revolution Stilgoe, J., Owen, R., & Macnaghten, P. (2013). Developing a Framework for Responsible Innovation. Research Policy, 42(9), 1568–​1580. https://​doi.org/​10.1016/​j.respol.2013.05.008 Yin, X., Chen, J., & Li, J. (2019). Rural Innovation System: Revitalize the Countryside for a Sustainable Development. Journal of Rural Studies. Yip, G. S., & McKern, B. (2016). China’s Next Strategic Advantage: From Imitation to Innovation (1st ed.). MIT Press.

Index

Tables and figures are indicated by t and f following the page number. Abbasi, A., 519 Abrahamson, E., 330–​31 Academy for Discovery, Adventure, Momentum, and Outlook (DAMO Academy) (Alibaba), 124–​25 accelerated innovation chapter introduction, 18 China’s advantages in, 549–​50 in digital innovation, 550 industrializing the process, 545–​46 launch-​test-​improve rapid cycling, 547–​48 simultaneous engineering for, 546–​47 vertical hierarchy and horizontal flexibility combined, 548–​50 acquisitions chapter introduction, 13 OFDI, 469, 472f, 472–​74, 473t Action for SMEs to Integrate Industrialization and Informatization, 163 Action Plan for Internet+ Small and Micro Enterprises, 163 Action Plans to Promote Technology Transfer, 121–​22 Adner, R., 575 advanced manufacturing, 750 Advanced Manufacturing Partnership Program (US), 63 aerotropolis (Zhengzhou Airport Economic Zone), 347–​48 Agilent Technologies, 531 Agreement on Trade-​Related Aspects of Intellectual Property Rights, 372 Agricultural Bank of China (ABC), 611 agriculture ecologically high-​value, 723–​24 microeconomic reforms, 738

technology-​improved, 348 AI 2.0 project, 600 AI Next campaign (DARPA), 708 air pollution, 652 Aitken, B. J., 424 Alibaba Ant Financial, 177–​78 cloud service, 599 credit scoring system, 551 ESCROW program, 551–​52 ICT development, 689–​90 mobil payment platform, 550–​51 R&D spending, 124–​25 rise of, 566–​67, 601 service-​oriented ecosystem, 124 stretch goals, 626 Taobao Villages, 686 Amendolagine, V., 476, 477, 478, 479–​80 American Artificial Intelligence Initiative (US), 708 Amsden, A. H., 40, 47 The Analects: Civil Administration, 389–​90 The Analects: Zi Lu, 387–​88 Anderson, J., 475, 477 angel capital, 13, 355–​56 Ant Financial, 177–​78 Ant Small and Micro Financial Services Group (Ant Financial) (Alibaba), 177–​78 Apple, 549–​50 arbitrage to innovation, 222–​27 “Are Chinese Patent Applications Politically Driven? Evidence from China’s Domestic Patent Applications” (Lei et al.), 105

778   Index artificial intelligence (AI) global position, 132–​33 independent firms development of, 598 innovation in, 599–​600 national strategy for, 132–​33, 600 national support for, 316–​17, 551 public support for, 132–​33 research papers, 127f US initiatives in, 708 Arunkumar, N., 187–​88 Asian financial crisis, 209, 278, 611 Asian Infrastructure Investment Bank (AIIB), 615–​16 automotive sector, 136–​37, 144–​45, 345–​46   Baidu, 124, 600, 601 Bajgorić, N., 689 Balasubramanyam, V. N., 418–​19 banking sector. See also nonbank financial institutions commercial, 214 shadow banking, 614, 620–​21, 622 SOE banks, 65, 610–​11 banking sector reforms, 610–​11 Bank of China (BOC), 611 Bank of Communications (BCM), 611 Baosteel Group Corporation, 81–​82, 530 Baregheh, A., 74 Barney, Jonathan A., 97–​98 Bass model of diffusion of innovation, 582f Beenen, G., 629 “Behind the Recent Surge of Chinese Patenting: An Institutional View” (Li), 94 BeiDou satellite navigation system, 128 Beijing Aerospace, 541 Bellini, N., 282 Belt and Road construction, 156 Belt and Road initiative, 323, 415–​16, 427–​28, 657 Bernal, John, 391 Berry, C. J., 584 Bhaumik, S., 586 Bianchi, P., 282 big data, use of, 551 bioenergy, 665–​66, 666t biofuel industry, 665

bioindustry, 723–​24 biomass, 665 biomass power industry, 665 biosafety, 726–​27 Bosworth, Derek, 372–​73 bottom-​of-​the-​pyramid (BOP) entrepreneurs, 675–​76, 682–​83, 685–​89 bottom-​of-​the-​pyramid (BOP) markets, 682–​83 bottom-​of-​the-​pyramid (BOP) population, 682, 683–​84, 685 Breschi, S., 80 Breznitz, Dan, 2, 406, 407, 557–​58 BRIC countries, 493–​94 bricolage, concept and functions of, 625–​27. See also exploratory bricolage in achieving stretch goals British Industrial Revolution, 30, 56, 66 Brown, D. H., 690 Buck, T., 422 Buckley, P. J., 585 building-​integrated solar thermal (BIST) systems, 656–​57 business-​university collaborations, 196–​97 buyer-​driven value chains, 555–​56, 560, 564–​67, 568 BYD, 541   Campbell, J., 48 Canada, migration to, 443–​45, 445f capital market, 213–​15, 215f Car-​T (chimeric antigen receptor therapy), 551 Catalogue for the Guidance of Industries for Foreign Investment, 409 catching up drivers of, 126 economic, 415–​16 external sourcing for, 744 factors in, 48–​49 incentives, 47 latecomer status and, 141–​42 learning from MNCs through, 407–​8 policies, 44, 47–​48 present day, 60, 317, 325–​26, 416, 493–​94, 506, 731, 750 processes, 33, 38–​39 programs, 598 reform era, 141–​42

Index   779 requirements for, 116, 736, 760 strategies, 80 technology transfer to speed up, 410 trade wars and, 117 catching up, falling behind, forging ahead, 29, 30, 38–​39 catching up companies, 44 catching up countries, 44 catching up industries, 67–​68, 144–​45 cautious consumers, 584 Central Huijin Investment Ltd., 611 Central Research Institute, 245 Chandler, A., 39–40 Chang, H.-​J., 49 Chen, B., 377 Chen, D., 519–​20 Chen, J., 78, 324, 426, 479, 582–​83, 766 Chen, J. T., 187–​88 Chen, W., 476 Chen, Yuan, 612 Chen, Yunwei, 107 Cheng Hao, 385–​86 Chesbrough, Henry, 525 Child, J., 628 China energy resources, 652 refugee issue, responses to, 461 visitor diversity, 458–​59 China, foreign population businesspeople, 460–​61 entry and transit system improvements, 458–​59 illegal, 459–​60 permanent resident status, 456–​58, 457t sources of, 449f China, population aging of the, 131–​32 digital natives, 551 foreign born, 448f, 448–​49, 449f higher education, 331 labor force, 331 urban growth, 323f, 329 China Banking Regulatory Commission (CBRC), 611 China Commercial Aircraft, 124 China Construction Bank (CCB), 611 China Development Bank (CDB), 612

China Industrial and Commercial Bank, 610–​11 China Insurance Regulatory Commission (CIRC), 611 China Investment Corporation (CIC), 615 China Mobile, 601 China New Technology Venture Capital Company, 173, 357 China Securities Regulatory Commission (CSRC), 611 China’s embracing innovation model, 328 China-​Singapore Suzhou Industrial Park (SIP), 338–​39 “China’s Shifting Patent Landscape and State-​Led Patenting Strategy” (Prud’homme), 95 China-​US trade disputes, 384 China-​US trade relations, 707–​8 Chinchilla-​Rodríguez, Z., 519 Chinese Academy of Sciences, 245 Chinese medicine, 124 Chinese miracle, 29, 49 ChiNext, 358t chip value chain, 597–​99 Christensen, C., 575 Cimoli, M., 56 Circular Concerning Measures on Further Opening Up and Actively Utilizing Foreign Investment, 409 Clarke, T., 751 climate change, 652 cloud computing, 599 cluster innovation systems chapter introduction, 11–​12 collaborations, 292 conceptual framework, 307f, 307–​9 defined, 742 innovation and, 742 innovation system and industry cluster, 277–​83 introduction, 275–​77 research literature, 275–​76, 277 cluster innovation systems, geographic knowledge search innovation and, 300–​1 local and nonlocal search, 300–​1, 302–​6 summary, 306–​9 Zhejiang Province industry clusters, 301–​2

780   Index cluster innovation systems, technological learning among core-​level determinants, 285 among regional networks, 289, 290t, 291t Hangzhou software industry cluster, 286–​87, 290–​92 within the local network, 287–​89, 287t, 288t clusters advantages of, 277 characteristics of, 277 collaboration framework in technology acquisition, 746 collaboration network, international, 505–​6 collaborations business-​university, 196–​97 cluster innovation systems, 292 economic, 505 inter-​industry, 531 international. see collaborations One Belt, One Road, 517 R&D, 107 in technology acquisition, 746 with competitors, 531 Community of Common Destiny, Common Interests, and Common Obligations, 386 Community of Common Destiny for Mankind, 386, 389–​90 “Comparing Regional Innovative Capacities of PR China Based on Data Analysis of the National Patents” (Guan and Liu), 107 Compendium of Materia Medica (Li Shizhen), 391–​92 competence accumulation, 40 competition in China, 220–​22, 221f, 222f definition and measures of, 218–​20 driving financial innovation, 619 innovation and, 218–​20 competitiveness. See also cost innovation consumer heterogeneity, 748 labor costs, 492, 539 latecomer advantage, 66–​68, 76, 205–​6 wind energy, 661–​62 competitors, collaboration with, 531 compositional capability, 628–​29

The Comprehensive Strategy on Science, Technology and Innovation for 2017” (Japan, 2017), 169 “Comprehensive Strategy on Science, Technology and Innovation (STI) for 2017” (Japan), 502–​3 concentrating solar power (CSP), 667 Confucianism, 389–​90 conservative consumers, 584 construction sector, 144, 345–​46, 666–​67 consumers characteristics of, 19–​20, 582, 583–​85 demand characteristics, 747 GM food, skepticism toward, 723–​24 heterogeneity of, 575 stages of adoption, 581f, 581–​82, 583f types of, 584 Cooke, P., 276, 278–​79 Copyright Law, 371 cost-​driven R&D, 400–​1, 402–​3 cost innovation chapter introduction, 18 conclusion, 552 in digital innovation, 548–​52 globally, 549 introduction, 539–​40 Shanzhai phenomenon, 539–​40 shift to, 747 VCI investment, 552 vectors of, 540 cost innovation, accelerated China’s advantages in, 549–​50 in digital innovation, 550 industrializing the process, 545–​46 launch-​test-​improve rapid cycling, 547–​48 simultaneous engineering for, 546–​47 vertical hierarchy and horizontal flexibility combined, 548–​50 cost innovation examples counterfeits, 544 high technology at low cost, 540–​41 industrializing the process, 545–​46 launch-​test-​improve, 547–​48 simultaneous engineering, 546–​47 specialty niches into volume business, 543 variety and customization at low cost, 542 cost innovation strategies

Index   781 big data, use of, 551 counterfeits, 543–​44 fast-​following, 549–​50 fit for purpose, 142 good enough, 142, 401, 424–​25, 549, 580–​81, 746–​47 high technology at low cost, 540–​41 huddle-​and-​act problem solving, 548–​49 low costs, 540–​42 robotics, 551 specialty niches, 543 variety and customization, 541–​42 counterfeits, 543–​44 Cozza, C., 476 creativity/​innovation education, 189–​90, 192–​93 Crescenzi, R., 469, 478 Cross-​Border Interbank Payment System (CIPS), 615 Cuervo-​Cazzura, A., 574 cultural modernization, 384 culture components of, 385–​86 development and, 737 entrepreneurial, 258 future research proposed, 771 supporting entrepreneurship education and entrepreneurship, 740 of tolerance, 386–​87 Western and traditional Chinese, 384, 744 culture, traditional Chinese basis of, 385–​86 beliefs, innovation elements in, 386–​88 implementations and technology, 390–​92 innovation elements in, 14, 384–​85, 392 mode of thinking, 385–​86 notions and beliefs, 386–​88 organization and institutions, 388–​90 risk-​averse, 744 science-​based innovation, influence on, 391–​92 values in, 387–​89   Dahua, 124 Dang, Jianwei, 90–​91, 104–​5, 374 Darwin, Charles, 391–​92 Dawning, 540

Decision of the Central Committee of the Communist Party of China on Several Issues Concerning the Establishment of a Socialist Market Economy System, 687 Decision on Amending the VAT Provisional Regulations of China, 160–​61 Decision on Strengthening Technological Innovation and Developing High Technology and Industrialization, 180 Decision on the Key Points of Current Industrial Policies, 59–​60 Decision to Reform the Science and Technology System, 354 Deng, Yungeng, 339 Deng Xiaoping, 48, 79–​80, 117–​18, 168, 209–​10, 340, 562, 738 Denning, S., 555 design, dominant, 31–​32 Dewey, John, 191 Dhawan, S. M., 510 diamond model, 737 diffusion of innovation theory, 581–​83, 583f digital economy BOP entrepreneurship and the, 686 emerging giants in the, 601–​2 SMEs in the, 163–​64, 739 digital innovation competing in, 548–​52 cost innovation in, 548–​52 defined, 593 governance, 603–​4 Internet + action plan for, 604–​5 IT MNEs and the embedding process, 602–​3 market development, linking technology with, 603–​4 talent and education system for, 604 digital innovation, future of challenges and possible actions, 606–​7 global competitiveness, 605–​6 digital innovation, key sectors AI (artificial intelligence), 599–​600 chip value chain, 597–​99 cloud computing, 599 cutting-​edge, 597–​99 internet infrastructure, 599

782   Index digital innovation, key sectors (cont.) knowledge-​based service sectors, 597 smartphone industry, 596–​97 software industry, 597 telecommunications, 595–​96 digital innovators, 551–​52 digital natives, 551 digital technologies future research proposed, 772–​73 move to the forefront in, 20, 593–​95 Di Minin, A., 425–​26, 495 Ding, Jie, 622 domestic service industry, 453–​54 Dosi, G., 38, 56, 61–​62, 69–​70, 574–​75 Double First-​Class initiative, 188 Double-​First-​Class University Plan, 125–​26 Duan, Yibing, 103–​4 Dunning, J. H., 489–​90, 574 Duque, R. B., 519 Du Weiming, 384   Eberhardt, Markus, 94–​95 eco-​industrial” parks (EIPs), 343–​44 ecological chain strategy, 597 ecological civilization strategy, 391, 649 ecological conservation foundation, 725 ecologically high-​value agriculture, 723–​24 ecologies of knowledge, 276 ecology, 343, 346, 720, 721, 726 e-​commerce. See also mobile banking industry agricultural trading, 686 banks and, 619 basis of, 593 benefits from, 163–​64 funding, 355, 618 ICT for success in, 689–​90 poverty alleviation and, 686–​87, 691 rural, 259, 686–​87, 690–​91 e-​commerce companies, basis of, 601 economical consumers, 584 economic growth and development 1978-​2018, 56 1980-​2018 rate, 700 factors limiting, 696 factors underlying, 131–​32, 205, 222–​23, 696 impact of financial innovation on, 621 industry relocation labor costs, 131–​32

latecomer advantage, 205–​6 reaccelerating, 701–​2 S&T progress in, 716 slow down in, 700–​1, 704 economic reform, market-​oriented capital market, 213–​15, 215f enterprise reform and, 207–​10, 211f labor market, 213 liberalization of factor markets, 213–​15, 230f openness and, 206 openness and integration into the world economy, 215–​16 price liberalization, 207, 208f private firms, development of, 207–​10, 211f economic reform, new normal in, 415 economic transformation, streams for promoting, 765t Edamura, K., 476 education creativity and entrepreneurship, 740 creativity and innovation, 189–​90, 192–​93 IT-​related, 604 education, innovation and entrepreneurship challenges to, 192–​93 changes required, 195–​97 chapter introduction, 9–​10 conclusion, 197–​98 future research proposed, 771 implications for human capital development, 9–​10, 187–​88 maker education, 191–​93 mass entrepreneurship and innovation initiative, 258 stakeholder roles, 195–​97 state policy initiatives, 189–​90 educational injustice, 188–​89 Education Informationalization 13th Five-​ Year Plan, 191 “Education Revitalization Action Plan for the 21st Century”8 (MoE), 120 education system influences, 188–​89 overview, 188 student enrollment, growth in, 120 teaching resources, 193 traditional, criticisms of, 189, 192–​93 education system reforms, 120, 188–​89, 451

Index   783 Edwards, C., 420–​21 863 Program (High-​Tech Research and Development Program), 118–​19, 169, 242, 343, 665 Eisenhardt, E., 631 electrical and electronics (E&E) sector, 99–​ 101, 99t, 597–​99. See also information technology and electronics 11th Five-​Year Plan for the Implementation of International Science and Technology Collaboration, 507t emerging market multinational enterprises (EMNEs), advantages to competitiveness, 585 context-​specific, 574, 586–​87, 748 country-​specific, 585 firm-​specific, 574, 585–​86, 748 innovation performance, 586–​87 rise in, 586 energy security, 652 Energy Technology Revolution Innovation Action Plan (2016–​2030), 653 enterprise performance, VRIN resources in, 626 enterprise reform, economic reform and, 207–​10, 211f enterprise registration increases in, 267 requirements, 266 enterprises. See also firms compositional capability, 628–​29 foreign industrial, growth, 64f industrial technology development institutions, 245 R&D expenditure, R&D institutions vs., 244, 245f enterprise transformation system reforms, 246–​49 entrepreneurial capital, 354 entrepreneurial culture, 258 entrepreneurial ecosystem, 259, 263–​65 entrepreneurs average age of, 158–​59 bottom-​of-​the-​pyramid (BOP), 675–​76, 682–​83, 685–​89 education and training for, 258 industry sectors, 255–​56 necessity type, 255

opportunity-​motivated, 255 returnees, 262–​63, 452, 453 traditional influences on, 390 university graduates, 190, 195, 262, 267 young, characteristics of, 159–​60 entrepreneurship barriers to, 687–​89 college students, 262 education for, 740 enthusiasm for, increases in, 267 investment in, 268 job opportunities, 255–​56 literature on, 255–​57 necessity based, 685–​86 opportunity-​based, 685–​86 social attitudes toward, 741–​42 sources for, 257–​58 supports needed, 741–​42 technological innovation growth and, 330–​31 environmental conservation, 725 environmental industry, 345–​46, 612 environmentalism, 343 environmental pollution liability insurance, 612 Ernst, D., 317, 743 ethics, 754–​55 European Union AI strategy, 132–​33 European Union-​China relations, 708–​9 “Evaluating Patent Promotion Policies in China: Consequences for Patent Quantity and Quality” (Long and Wang), 105 exceptionalism, 746–​48 exploratory bricolage in achieving stretch goals chapter introduction, 21 conclusion, 640–​41 future research directions, 641 interplay, 638–​40, 639f introduction, 630–​31 research methodology, 631 “Exploring the Worldwide Patent Surge” (Fink et al.), 96 Export-​Import Bank of China, 612 export processing trade (PT), 406–​8 exports 1978, percent of GDP, 56 foreign-​funded, 216, 218f

784   Index exports (cont.) GDP, percent of, 740 industrial, growth in, 136–​37 market share, growth in, 137 ratio to GDP, 216, 217f SPHZs contribution to, 743–​44   factor markets, 213–​15, 230f Fang, Y. P., 188–​89 fashionable consumers, 584 fast-​following innovation, 549–​50 Fedoroff, Nina V., 505 financial crisis (2008-​2009), 486–​87, 491–​92 financial innovation chapter introduction, 20–​21 conclusion, 622–​23 drivers of, 617–​20 financial sector, 748 future research proposed, 623, 771–​72 impact of financial innovation on, 621–​22 introduction, 610 resource allocation, impact on, 620–​21 financial innovation, impacts of on economic growth, 621 on efficiency of financial resource allocation, 620–​21 on financial stability, 621–​22 on social equality, 622 financial innovation processes development financing, 612 foreign exchange reserves, 615–​16 green finance, 612 internet finance, 613 introduction, 610–​11 monetary policy instrument, 616 openness, 614–​15 reform of state-​owned commercial banks, 611 regulation, 616 RMB internationalization, 614–​15 rural finance, 612–​13 shadow banking, 614 financial sector, pro-​innovation, 741–​42 financial supervision system, 611 financing for innovation chapter introduction, 9 conclusion, 183–​85 globally, 169

graduate entrepreneurship, 195 insurance for S&T, 178–​79 introduction, 168–​70 loans for S&T sectors, 175–​78 multilevel capital market, 179–​82, 180f new mechanisms of, 739–​40 private equity funds, 173–​75 service platforms, 182–​83 financing for innovation, case studies Ant Financial, 177–​78 bank and guarantee synergy loan, 176–​77, 177f first set of technological equipment insurance, 178–​79 the GEM, 180–​81, 181t I&E bond, 181–​82 investment and lending synergy loan, 176, 176t policies for high-​tech companies, 172–​73 Startup Investment Guiding fund for Sci-​ Tech SMEs, 174–​75, 174t Winpower, 182–​83 financing for innovation, fiscal and tax policies high-​tech companies, 171–​73 National Key R&D Program, 171 National Natural Science Foundation of China (NSFC), 170 national science and technology major projects, 170–​7 1 R&D expenses deduction policy, 172 special fund for guiding technological innovation, 171 special project for S&T hub building and talent fostering, 171–​73 tax deferral treatment for commercializing S&T findings, 172 Fink, Carsten, 96 firm innovation system (FIS), 81–​82 firms. See also enterprises NIS component, 123–​25 OFDI and performance of, 703 quasi-​familial, 389–​90 VRIN resources and success of, 626 firms, foreign sectoral involvement, 144–​46 state control over, 136–​37 subcontracting startups, 565

Index   785 firms, high-​tech benefit and incentive policies, 564 fiscal and tax policies, 171–​73 firm-​specific advantages (FSAs) to EMNEs, 574, 585–​86, 748 First Action Plan, 245 First Industrial Revolution, 49, 168 Fisch, Christian O., 98–​99, 101–​2 fit for purpose strategy, 142, 401 “Five Permanent Principles” (Mencius), 387–​88 Five-​Year Plan on Strategic and Emerging Industry (SEI), 148 Fleming, L., 519–​20 floating population, 213, 214f, 459–​60 Fordism, 40 foreign direct investment (FDI) channels for, 418 conclusion, 411–​12 contracted projects, 418f conventional, 407–​8 evolution of, 408 global ranking, 532–​33 growth in, 64–​65 influences, 398 inward, 398, 409, 418f, 418–​19, 430, 474, 744–​45 inward, technology transfer and, 402, 423–​25 MNCs, 602 opening up to, 418 outward, 418f, 418–​19 patent production and, 236f policies for, 404–​10 processing trade (PT), 406–​8, 423–​24 in SEZs, 562 spillover effects, 330, 404–​8, 415–​16, 494, 556 state control over, 136–​37 foreign funds, 359–​60 foreign industrial enterprises growth, 64 statistics, 63–​64 Foster, C., 683 Four-​Confidence Philosophy, 384 Four Modernization campaign, 417 Fourth Industrial Revolution, 131, 132, 133, 754–​55, 766, 772

Freeman, C., 79, 575 Freeman, Christopher, 115–​16 Freeman, R. B., 736–​37 frontier technology, 410–​11 frugal innovation, 746–​47 Fu, X., 66–​67, 405–​6, 407, 418–​19, 421, 423–​24, 426, 427–​28, 431–​32, 474, 476, 477–​79, 481, 593–​94, 760 Fuchs, E. R. H., 555 fund management systems, 728   Galbraith, John Kenneth, 135 Gammeltoft, P., 490 Gary, S., 629 Gassmann, O., 400, 490 Geely Group, 124, 533, 534 the GEM, 180–​81, 181t General Electric, 541 Generic Technology Innovation Funds, 282–​83 Germany, migration to, 443–​45, 446f Gerschenkron, A, 49, 67 Ghauri, P. N., 481 Gill, I., 68 Gilsing, V., 640 Giuliani, E., 476, 477, 478, 479–​80 global economy, 66, 215–​16, 415–​16 Global Entrepreneurship Monitor (GEM), 255 global financial crisis (2007-​2008) development financing post-​, 618 development model post-​, 70 education system improvements, 120 entry rates post-​, 138 FDI pre-​and post-​, 358–​59, 358t, 418f, 418 GDP growth post-​, 494 global responses, 135 MPS and the, 704 patent applications, 321–​22 policy response, 148, 704 productivity pre-​, 8–​9, 137 R&D spending, 318, 326t re-​industrialization policy post-​, 61, 63 renewable energy and the, 662, 664–​65 returnee growth post-​, 452 returnees, growth in, 452 trade-​GDP ratios post-​, 216 global financial crisis (2009), 358–​59 global financial crisis (2018), 388

786   Index globalization, 330 global supply chains as innovation drivers, 19 global value chains (GVCs) buyer-​driven, 555–​56, 560, 564–​67, 568 China’s position in, 554 conclusion, 567–​68 domestic suppliers power in, 602 innovations by Chinese firms in, 565–​67 introduction, 554–​55 learning from, 560, 561 literature background, 555–​57 participation in, shifting investment and, 563–​65 producer-​driven, 555–​56, 559 root and beginning of, 559–​62 Sanlai Yibu policy, 560–​62 SEZs in, 562–​63 supplier-​driven, 566–​67 technology transfer and integration of, 426–​27 thin slicing, 556–​57 under structured uncertainty, 557–​59, 565–​66 Go Global strategy, 467–​68 Going Global initiative, 416 going out policy, 427–​28, 486–​87, 521, 596, 768 Golden Sun Demonstration project, 656 Gong, Y., 423–​24, 426 Goodbaby International Ltd., 542 good enough strategy, 142, 401, 424–​25, 549, 580–​81, 746–​47 government size, innovation and, 229–​32, 231f gradualism philosophy, 739 Graebner, G., 631 Grazzi, M., 69–​70 Great Leap Forward, 48 Great Transformation (success of the), 48 great transformation, the, 29–​30, 38–​39 green building, 666–​67 green economy, 651–​52 green finance, 612 green innovation chapter introduction, 22–​23 conclusion, 667–​69 drivers and pressures for, 652 future-​and development-​oriented, 749

future research proposed, 772 introduction, 649 investment in feed-​in tariffs (FITs) for, 655 financial incentives and subsidies, 655–​56 green innovation in renewable energy bioenergy, 665–​66, 666t deployment, 654 emerging sectors, 659–​67 future growth projections, 651–​52 global positioning, 650, 651–​52, 657, 658f investment in, 658f investment in, feed-​in tariffs (FITs) for, 655 legislating, 649, 654 patent applications, 659t power generation from, 657–​59, 658f significance of China in, 657–​59 solar photovoltaics, 655–​56, 662, 663f solar thermal energy, 662–​65, 664f subsidy programs, 655–​56 sustainable development and, 650–​51 targets, 654–​55, 654t wind energy, 659–​62, 660f green innovation policy initiatives clean energy technology, R&D investments, 654t documents outlining, 653–​56 energy technology, key areas for, 653t renewable energy planning, 655f renewable energy targets, 654t urban energy transition, 656–​57 green manufacturing, 722 green technology key areas for innovation in, 653t R&D funding, 653, 654t R&D investment, 650 renewable energy, diffusion of, 651 state policies, implications for, 762–​63 green transformation, 650 Griliches-​Schmookler demand-​induced model, 576–​79 gross domestic product (GDP) 1978, global position, 56 1978-​2016, 577f 2018, 56

Index   787 compared globally, 216, 217f domestic demand percentage of, 576 exports percent of, 740 growth rate, 577f imports/​exports ratio to, 216, 217f per capita, 577f per capita disposable income by region, 579, 580f R&D as a percent of, 224f, 224, 318, 417f regional, 660f, 678f, 678–​79 SMEs contribution to, 156–​57 three industry strategy contributions, 681f Gu, S., 48 Guan, Jiancheng, 100–​1, 103, 106, 107 Guideline for National Innovation-​Driven Development Strategy” (Central Committee), 121–​22 Guideline for the Medium-​and Long-​Term National Science and Technology Development Planning (2006–​2020),” 120–​21 Guidelines on Regulating Financial Institutions’ Asset Management Business, 359 Guidelines on the Risk Management for M&A Loans of Commercial Banks (2015), 366–​67 Guideline to Further Strengthen the Implementation of Innovation-​Driven Development Strategy and Reinforce the Spirit of Mass Innovation and Entrepreneurship, 258, 259–​60 Guiding Catalog for Industry of Renewable Energy, 655 Guiding Opinions on Conducting the Pilot Program of Loans for Innovative and Start-​up Businesses (CRC), 182 Guiding Opinions on Strengthening and Standardizing the Management of Objects List of the Trustworthy Joint Incentives and Untrustworthy Joint Punishment, 161 Gupta, B. M., 510 Gurry, Francis, 322   Haier, 81, 124, 598 Haken, H., 391

Hall, Bronwyn H., 91 Halstead, J. M., 189 Hamilton, Alexander, 43–44 Haneda, S., 476 Hao Fuqing, 453–​54 Harbin Development Zone, 348 Harrison, A. E., 424 Hart, S. L., 682 Hayek, F. A., 205–​6, 219 He, Ying, 100–​1 He, Z. L., 519 head tax system, 562 Heeks, 683 Heilman, S., 148, 150 Hennart, J. F., 477 High and New Technology Industrial Development Zone (HNTIDZ), 347–​48 high-​tech industry development zones, 119 High-​Tech Research and Development Program ( 863 Program), 118–​19, 169, 242, 343, 665 The High-​tech Strategy 2020 for Germany” (German Federal Ministry of Education and Research, 2010), 169 Hikino, T., 40 Hikvision, 124 Hisense, 487 Hisun, 532 Home Appliances to the Countryside (HATC) Scheme, 664–​65 Hong, Y., 48 Hong Kong Science and Technology Parks Corporation (HKSTPC), 348–​49 Hong Kong Special Administrative Region (HKSAR), 348–​49 Hou, J., 474, 476, 477–​79 household registration system, 213 Household Responsibility System, 59 Hsueh, T.-​T., 48 Hu, Albert Guangzhou, 94, 103 Hu, Albert G. Z., 96 Hu, Mei-​Chih, 101 Huang, C., 328 Huang, Kenneth G., 108 Huang, Z. X., 196

788   Index Huawei capabilities, 124 chipset design, 598 industrializing innovation, 545 manufacturing-​oriented ecosystem, 124 needle-​point strategy, 124 network hardware, 601–​2 patent applications, 601–​2 patents, 532 R&D internationalization, 487, 533 R&D investment, 425, 596, 605 R&D spending, 124–​25 stretch goals, 626, 634–​35 huddle-​and-​act problem solving, 548–​49 Hu Jintao, 148, 209 hukou system, 213, 262–​63, 338, 559 human development, future research proposed, 773 human nature, Chinese vs. Western perspective on, 387   I&E bond, 179–​80, 181–​82 imitation-​improvement-​innovation ( 3I) pattern, 76–​78, 124 “The Impact of Small World on Patent Productivity in China” (Zhang et al.), 107 Implementation Plan for Promoting Intellectual Property Strategy in SMEs, 161–​62, 247–​49 imports 1978, percent of GDP, 56 ratio to GDP, 216, 217f in technology acquisition, 744–​45 incentives entrepreneurship, 741–​44 industrial transformation, 47–​48 institutional development, coevolutionary dynamics, 43–​48 mass entrepreneurship and mass innovation, 262–​63 talent incentive mechanism, 248–​49, 260 inclusive development future research proposed, 772–​73 state policies, implications for, 762–​63

inclusive growth introduction, 681–​82 process towards, 683–​84 and social exclusion, obstacles of, 682–​83 inclusive innovation chapter introduction, 23 conceptual framework, 684f dimensions of, 683 future-​and development-​oriented, 749 introduction, 675–​76 policies for, 688t inclusive innovation, drivers for income disparity, among industries, 679–​ 80, 681f income disparity, regional, 678–​79 income gap, rural-​urban, 676–​78 industry upgrading, 680–​81 inclusive innovation system BOP entrepreneurs, 685–​87 challenges, 691–​92 challenges for, 749 components, 685f governance, 690–​91 infrastructures supporting, 687–​90 institutions for, 687 introduction, 684–​85 supporting elements, 749 income household, growth in, 676 percapita, disposable, 676–​77, 677f income gap. See also middle-​income trap regional, 678f, 678–​79, 679f rural-​urban, 68–​69, 676–​77, 677f indigenous innovation appropriate technology and, 429–​31 capacity, developing, 147 contributions of, 702 cultivating capabilities of, 280 developing, effective means of, 404, 405 development of, forces underlying, 405 foreign technology and, 398, 420 imported technology in synergy with, 702–​4, 703f in industrial development, 66–​68, 78, 124 for innovation, 415 leveraging, 370–​7 1

Index   789 second transition, 315 state support, 148, 328–​29, 340, 402, 417–​18 strategy for promoting, 372 indigenous innovation policy, 486–​87 Industrial and Commercial Bank of China (ICBC), 611 industrial development chapter introduction, 6 incremental reform, enterprise viability in, 58–​60 indigenous innovation in, 66–​68, 78, 124 introduction, 56–​57 latecomer advantage, 66–​68, 76 market effectiveness, 59–​61 market players, diversification and competition, 63–​65, 64f middle-​income trap, overcoming the, 68–​69 outlook, 69–​70 policies, historical evolution of, 60–​63 pragmatic reform approach, 57–​58 privatization and, 59–​60 R&D investment, 62 socialist market economy, development of the, 59, 60–​61, 63, 65 statistics, foreign, private, and state-​owned, 63–​64 summary, 69–​70 technology import in, 66–​68, 76, 124 industrialization, energy security and, 652 industrialization-​informatization integration, 164 industrial policies chapter introduction, 6 globally, 63 innovation-​focused, components of, 696 objectives, 697t target industries, 697t Industrial Revolution, 30 industrial revolution, 168, 170, 257, 348. See also specific resolutions industrial technology development institutions, 245 industrial transformation catching up policies, 44–​48 concluding remarks, 48–​50 domains of, 29–​30

government supports /​infant industry protections, 43–​48 incentive structures, 47–​48 institutional development, coevolutionary dynamics, 43–​48, 45t international asymmetries, 36–​39 microheterogeneity, 33–​36, 34f nonsubstitution, 33–​36 organizations, 39–​43 paradigms, 31–​33, 39–​43 production possibility sets in, 31–​32 restrictions, 49 routines, 39–​43 technical change, development and, 36–​39 technical change, properties of, 31–​33 technological dominance, 33–​36 industry. See also enterprises; manufacturing competitive advantages, 539 employee-​centric, 389–​90 new firm entries, growth in, 138–​39 pollution policies, 565 streams for promoting upgrading, 765t wage pressure, 704–​5 Industry 4.0 (Germany), 698 “Industry Evolution and Key Technologies in China Based on Patent Analysis” (Zheng et al), 99–​100 Industry of the Future” (France, 2015), 169 industry productivity gains origin of, 137 pre-​financial crisis, 137 sectoral differences, 139–​41 informationalization, 191, 329–​30 information and communications technologies (ICT) industry, 124, 594, 689–​90 information and communications technologies (ICT) platform, roles of the, 690–​91 information networking, 722–​23 information network security, 727 information service providers, 163 information technology and electronics, 345–​46, 563–​64, 597, 722–​23 infrastructure, 95–​96, 329, 345–​46

790   Index innovation achievements, role of development in, 736–​38 from arbitrage to, 222–​27 China’s journey to, 1–​4 competition and, 218–​20 creativity and, 82–​83 cutting-​edge, digital innovation and, 597–​99 definition of, 74–​75 development strategies, 241 drivers of, 218, 243 dual-​sourcing strategy for, 429f FDI and, 236f, 422 forces driving, 206 foreign contributions to, 415–​16 global open, 124 global positioning in, 736 government size and, 229–​32, 231f historically, 38–​39 marketization and, 227–​29, 228f micromanagement and, 575–​76 monopoly and, 218–​19 national strategy for, 75–​76, 131, 132t openness and, 232–​37, 429–​30 ownership structure and, 231f, 232 policies promoting, 121–​22, 135, 190 public policy fostering, 328–​29 purpose of, 324 regional variation in, 226–​27, 227f social attitudes toward, 741–​42 sources for, 257–​58 state emphasis on, 190 state vs. market debate, 135 top-​down approach to, 148 trade and, 236f innovation, types of cost, 746, 747 disruptive, 575, 628 entrepreneurial, 206 frugal, 746–​47 incremental, 142 integrated, 76–​78 low-​cost, 628 technological, 171 Innovation & Entrepreneurship Bond pilot program (NAFMII), 181–​82

innovation behavior, defined, 385 innovation capability building, 738–​41 chapter introduction, 4–​6 development of, research on, 404–​8 growth in, 116–​17 OFDI and improving, 468 scientific papers published reflecting, 116–​ 17, 320, 508, 716 state, role of the, 741 innovation capacity, 703–​4 innovation collaboration, international, 17, 515–​16 innovation ecosystem, 81–​82, 405, 752–​53, 753f innovation education, 189–​90, 192–​93 innovation environment, 729–​31 innovation management, 76–​78 innovation outcomes, fight for the middle in, 143 innovation paradigm, 766 innovation performance, OFDI and, 475–​80 innovation powerhouse, challenges to evolution toward an attracting best talent and ideas from all over the world, 752 best talent, attracting, 752 a changing international environment, 754 China’s rise in innovation, 754 a core competence-​based innovation ecosystem, 752–​53, 753f ethics, 754–​55 fourth industrial revolution, 754–​55 introduction, 750–​51 original innovation, 751 paradox of open innovation and indigenous innovation, 752 poverty alleviation innovation, 753–​54 social development, 753–​54 STI governance, 754–​55 world-​class basic research, 751 Innovation Program for Technology-​Based Small-​and Medium-​Sized Enterprises, 702 innovation research case studies approach, 576 demand-​side approach, 574–​76 innovation spirit, traditional, 386–​87

Index   791 innovation strategies, future-​and development-​oriented advanced manufacturing, 750 green innovation, 749 inclusive innovation, 749 S&T for the future, 750 innovation studies challenges, 84 conclusion, 737 defined, 75 evolutionary history of, China, 75–​78 future directions, 84–​85 interdisciplinary nature of, 75 introduction, 73 knowledge genealogy, 77f microfoundation for, 83 nature of, 74–​75 research framework, 78–​79, 83f, 83 innovation systems chapter introduction, 8 development of, ministry responsible for, 241 evolution of, 117–​22 firm innovation (FIS), 81–​82 individual-​level, 82–​83 KIBS role in, 292–​93 national system (NIS), 8, 79–​80 sectoral (SIS) and regional (RIS), 8, 80–​81 sectoral (SIS) and regional (RIS) systems, 79 Innovation 2050: Science and Technology and China’s Future, 720 Innovation 220 plan, 245 institutional learning, 39–​43 institutions, traditional, innovation elements in, 388–​90 insurance environmental pollution liability, 612 S&T, 178–​79 intellectual capital foreign, creation of, 397–​99 policies for MNCs, 404–​10 intellectual property (IP) categories of, 370 defined, 370 intellectual property (IP) licensing, 532

intellectual property (IP) management challenges to, 376–​77 for international innovation collaboration, 516 legislation, 374–​76 intellectual property-​backed loans, 175–​76 intellectual property rights (IPR) SMEs contribution to, 161–​63 violators, 96 intellectual property rights (IPR) protections background, 371–​73 benefits of, 370 chapter introduction, 13–​14 conclusion, 380 in developing countries, 44 enforcing, 378 to improve international innovation collaboration, 515–​16 innovation and, 742 international treaties, 372–​73 introduction, 370–​7 1 legislating, 371–​73, 379 legislation, 374–​76 patenting activity, 373–​74 strengthening, 371–​73 stronger, emergence of, 378–​80 intelligent manufacturing, 722, 739 Interim Measures for the Administration of National Key Research and Development Programs, 506, 507t International (Regional) Collaborative Research Project, 509–​10 International Collaboration and Communication Project (NFSC), 509f, 509–​10 International Copyright Act (US), 96 “International Patenting by Chinese Residents: Constructing a Database of Chinese Foreign-​Oriented Patent Families” (Wunsch-​Vincent et al.), 103 international research collaboration (IRC) by country, 518 global framework for, 502–​3 introduction, 502–​4 policy practices and experiences, 506–​10 policy practices and experiences of, 507t research on, 503–​4 S&T, 503

792   Index international research collaboration (IRC), future research directions causal relationship between IRC and high-​ quality output, 519–​20 differences in the benefits of IRC in different countries, 518–​19 factors and mechanisms affecting the output of the IRC, 519 in the field of IIC, 518 One Belt, One Road IIC model, 521 opening up the national S&T plan, 522 risk mechanism of IIC, 522 scientific and technical collaboration differences, 520–​21 international research collaboration (IRC), necessity of for constructing an innovative country with strong technological power, 505 high-​quality S&T development, 504–​5 integration into the global innovation network, 505–​6 S&T technological diplomacy, 505 international research collaboration (IRC), scale of by country, 512f growth in, 511f, 512f problems, 514–​15 statistics, 510 strength in, 513, 514f trends in, 513f international research collaboration (IRC), suggestions for improving intellectual property rights protection environment, 515–​16 national innovation collaboration, 517 network layout, 517 opening the national S&T plan, 516–​17 research integrity management, 516 source innovation collaboration, 515 internet finance, 540, 550, 597, 601, 613, 622 internet hyperscale giants, emergence of, 601 internet infrastructure, 599 Internet+, 163, 164 Internet+ action plan, 600, 604–​5 Internet+ policy, 156 Internet Plus AI Three-​year (2015–​2018) Action Plan, 600

Internet Plus policy, 156 Inui, T., 476 invention patents, 95, 101, 126, 224–​26, 225f, 373 invention patents applications, 716 IPOs, 13 IT MNCs, 602   Jaffe, Adam B., 91 Japan, 44–​46, 494 Jaworski, B. J., 586 Jefferson, Gary H., 94, 95–​96, 102 Jenkins, R., 420–​21 Jia, Junyi, 614, 621 Jiang, Renai, 102, 104, 107 Jiang, Shuxia, 621 Jiang Zemin, 119, 120, 562, 564 Jia Sixie, 391–​92 Jin, Libin, 378 Jinri Toutiao, 551 Jolly, D., 400, 401, 402, 403 junk patents, 373–​74   Kaihua Chen, 503 Kaldor, N., 70 Kang, C. P., 191–​92 Kaplan, S., 640 Karnani, A., 682 Katila, R., 629 Key Technologies Research and Development Program, 343, 702 Kim, S., 58 Kimberly, J. R., 74 Kivetz, R., 584 Knight, F. H., 557–​58 Know about Business (KAB) program (ILO), 194 knowledge ecologies of, 276 paradigmatic, 31–​33 technological, obtaining foreign, 418–​19 knowledge-​based service sectors, 597 knowledge capital, 106 knowledge-​driven R&D, 402–​3 knowledge exploitation, 525, 534 knowledge innovation system, 119–​20 knowledge sourcing, 430, 444f

Index   793 knowledge spillovers, 96, 106–​7, 120, 289, 329, 419, 424 knowledge transfer, 76, 419–​22, 480–​81, 555, 556–​57, 566 Kohli, A. K., 586 Kong, Yan, 103–​4 Korea, 47 Koricheva, J., 519 Kroll, Henning, 107 Kua Fu, 386–​87 Kuhn, T, 31–​32   labor costs, 559, 565–​66 labor force fueling digital innovation, 552 migrant professionals, 452–​54 restrictions on movement of, 262–​63, 338, 559 returnees, technology spillovers and, 428–​29 rural, 676–​77 skilled worker supply, 452–​54 SPHZs, 343, 347 statistics, 257–​58, 331 talent awareness and competitiveness, 461–​62 talent evaluation and incentive mechanism, 248–​49, 260 talent gaps, 452–​54 talent strategy, migration policy and governance, 456–​59 textile industrial cluster, 277–​78 urban labor, 213, 214f wages, 564–​65, 679–​80, 701 Labor Law, 564–​65 labor market, 213, 214f labor migrants Chinese, numbers of, 447t employment prospects, 448–​50 professionals, 452–​54 remittances, 446–​48, 447f, 450f, 450 labor mobility, 213, 230f, 262–​63, 338, 559 Lane, P. J., 479 Lang Xianpingm, 209 Lardy, Nicholas, 148 latecomer advantage, 66–​68, 76, 205–​6

latecomer firms, 580–​81 Latin America, 47 Law, M. T., 58 Law on Promoting the Transformation of Scientific and Technological Achievements, 324, 325, 376–​77 Law on Promoting the Transformation of Scientific and Technological Achievements, 248–​49 leadership, traditional values of, 387–​88, 389–​90 learner autonomy, 188–​89 legalism, 390 Lei, Zhen, 105, 106 Leibnitz, G., 391–​92 Leimu, R., 519 Lenovo Group Ltd., 124, 546, 605 Levitas, E., 575–​76 Lewis, A., 701 Li, Bo, 621–​22 Li, J., 477, 579 Li, X, 94 Li, X., 420, 421–​22 Li, Y. X., 196 Liang, Zheng, 373 liberalization of factor markets, economic reform and, 213–​15 Liefner, Ingo, 106 Li-​Hua, R., 743 Li-​Hua, Richard, 328 Li Keqiang, 190, 254, 257–​58, 262, 331, 455–​56, 461, 741–​42 Lin, J. Y., 67–​68, 576–​79 Lin, L., 361–​62 Li Shizhen, 391–​92 List, Friedrich, 43–44, 49 Liu, H. Y., 197 Liu, Jacqueline, 378 Liu, K.-​C., 374 Liu, Shunzhong, 106, 107 Liu, X., 422, 423–​24, 474, 476, 477–​79 Liu, Yue'er, 377 Liu, Y. B., 188–​89 Li Zhanshu, 455–​56 Lockett, N., 690 London, T., 682, 685–​86 Long, Cheryl Xiaoning, 105

794   Index Long, G., 404–​8 Long and Middle-​Run Plan for and Outline of the National Science and Technology Development (2006–​ 2020), 687 Lubatkin, M., 479 Lucas, Robert, 37 Luiz, J. M., 602 Lundan, S. M., 574 Lundvall, B. A., 48, 79, 115–​16 Lundvall, Bengt-​Ake, 115–​16 Luo, Y., 628   Ma, Jack, 626, 629 Ma, Zhenzhong, 103–​4 MacDonald, Stuart, 339 macro-​level management research, 575–​76 Made in China 2025 initiative, 131–​32, 148, 163, 348 Made in China 2025” plan, 600 Maintaining America’s Leadership in Artificial Intelligence (US), 708 Make America Great Again, 384 Make China Rise Again, 384 maker education, 191–​93 Malackowski, James E., 97–​98 Malerba, F., 80 management, policy implications for the private sector absorptive capabilities, 767 digital transformation of incumbent firms, and sustainability, 768 openness and in-​house innovation, 767 strategies for MNCs, 767–​68 Mansfield, E., 761 manufacturing. See also industry advanced materials and intelligent green, 722 dominance, 554–​55 export-​processing factories, 559 good enough strategy, 142, 401, 424–​25, 549, 580–​81, 746–​47 innovation in, 565–​66 intelligent, 163 Internet+, 164 labor-​intensive component production and assembly, 560–​62

new product sales, 226f, 229f, 235f offshore, 559 robotization, 704–​5 manufacturing output, global, 554 Manufacturing Power Strategy antagonism to, 706–​9 challenges, 697–​98 chapter introduction, 24 conclusions, 710–​11 development strategy and the MIT, 700–​2 global developments context, 704–​5 global pushback from trade and investment partners, 707 imported technology-​indigenous innovation synergy, 702–​4, 703f incomprehension related to, 706 introduction, 696–​97 key areas of development, 699 key projects, 699 major tasks, 698 requirement for, 749 response to risks for economic development, 699–​700 skepticism regarding the, 705–​6 Manufacturing Power Strategy, assessments of in China, 710 in North America, 705–​8 in Western Europe, 708–​9 Manufacturing Power Strategy, measures for brand building, 698–​99 green manufacturing implemented, 699 informatization and industrialization integration promoted, 698 innovation ability improvements, 698 manufacturing productivity FDI impact on, 422 gains, pre-​financial crisis, 137 growth, decline in, 150 knowledge-​based, growth in, 106 Mao Zedong, 343 March, J. G., 627 Marcuzzo, M., 761–​62 maritime security, 726 market demand chapter introduction, 19–​20 China Mobile case study, 574 consumer lifestyle in, 584

Index   795 demand pull vs. technology push, 573, 574–​76 demand-​side perspective, 574–​76 dynamic nature of, 580–​81 EMNEs, 574, 585–​87 growth models, 582f growth rate, 582f, 582 implications for innovation, 573–​74 market size, effect of, 578f summary and conclusion, 587–​88 supply-​ perspective, 574–​76 theories of, 574, 581–​83, 583f market demand, consumers and characteristics of, 19–​20, 582, 583–​85 stages of adoption, 581f, 581–​82, 583f with regard to innovation and consumption, 584–​85 market demand, domestic economic effects, 576–​79, 578f innovation and the, 576–​81 percent of GDP growth, 576 retail sales of consumer goods, 578f urban-​rural divide, 579f, 579 market demand research future directions, 588–​89 limitations of existing, 588–​89 market development, linking technology with, 603–​4 market-​driven R&D, 401–​2, 425 market economy, 257 marketization, innovation and, 227–​29, 228f market maker, 363–​64 market power, 219–​20 market segmentation, state policy and regulation shaping, 144–​46 Martin, B. R., 328–​29 Martinelli, A., 476, 477, 478, 479–​80 Mass Entrepreneurship and Innovation policy, 156, 356 Mass Entrepreneurship and Innovation strategy, 194 mass entrepreneurship and mass innovation chapter introduction, 11 conclusion, 268 entrepreneurial activity, characteristics of, 255–​56 funding, 259, 260

goal of, 741–​42 institutional context, 256 introduction, 254 research literature, 255 social network for the development of, 257 talent evaluation and incentive mechanism, 260 mass entrepreneurship and mass innovation, policies background, 257–​58 categories, 260–​62 college student entrepreneurship, 262 ecosystem perspective, 263–​65 government guidelines, 259–​60 government opinion, 258–​59 implemented, 264f incentives, 262–​63 migrant workers returning home to start up businesses, 262–​63 for people with different backgrounds, 262–​63 mass entrepreneurship and mass innovation, socio-​economics engines for future development, 257 increasing employment and enriching people, 257–​58 reinforcing entrepreneurial culture, 258 mass entrepreneurship and mass innovation initiative, benefits of governance system and capability promoted, 266 large enterprise prosperity, 259 for productivity, 259–​66 transformation of government functions accelerated, 266 mass entrepreneurship and mass innovation initiative, changes following, 265, 267–​ 68, 267t Massy, Doreen, 339 Mastrogiorgio, M., 640 Mathews, J. A., 489–​90, 669 Matthews, John A., 101 McKern, Bruce, 2, 405, 580–​81, 593–​94, 768 “Measures for the Implementation of First-​Class Universities and First-​ Class Discipline Construction (Provisional),” 126

796   Index Measures of the People’s Republic of China on Entry and Exit Administration and Regulations of the People’s Republic of China on Border Inspection for Exit and Entry, 458 Medium-​and Long-​Term Program of Science and Technology (2005–​2006), 703 Medium-​to Long-​Term Plan for the Development of Science and Technology” (MLP), 148 Mei, W. H., 194, 195, 766 Memorandum of the Chinese and U.S. Governments on Protecting Intellectual Property, 372 Mencius, 387–​88 Meng, Y., 194 mergers and acquisitions, 532–​33 microcredit companies, 612–​13, 622 microheterogeneity, industrial transformation and, 33–​36 micromanagement, 575–​76 Mid-​and Long-​Term Development Plan for Renewable Energy, 654, 655, 667 middle-​income economies, 700–​1 middle-​income gap, 736 middle-​income trap (MIT), 67–​69, 429, 680, 700–​2 migrant labor force Chinese, numbers of, 446–​48, 447t employment prospects, 447f remittances, 446–​48, 447f, 450f, 450 returnees, 262–​63 migrant populations, Canada, 445f migrant professionals, 452–​54 migrants, Chinese citizenship applications, 443–​45, 445f EB-​5 US visas, 442–​43, 444f in Germany, 446f H-​1B applications, 444f numbers of, 443f permanent resident status, 442–​45, 443f remittances, 446–​48, 447f migrants, Chinese, destinations by country, 441–​42, 442f Canada, 443–​45, 445f Germany, 443–​45, 446f UK, 443–​45, 445f

US, 442–​45 migrants, international by country, 448f to Canada, 443–​45, 445f to China, 448f, 448–​50, 449f destinations by country, 441–​42, 442f to Germany, 443–​45, 446f status and characteristics, 15–​16 to UK, 443–​45, 445f to US, 442–​45 migrant students international, outflows and inflows, 450–​52 numbers of, 455 returnees, 451–​52 migration introduction, 441 rural to urban, 213, 677–​78 for technology acquisition, 745 migration, summary and recommendations data systems, 462–​63 international organizations cooperation, 465 migrant services integration, 462–​63 openness and inclusiveness, 465 policymaking, 461–​62 refugee issues, 464 talent awareness and competitiveness, 461–​62 migration policy and governance foreign nationals, management of, 459–​61 international community governance, 459–​61 international level issues, 461 results in the context of international talent strategy, 456–​59 State Immigration Administration, 455–​56 migration policy and governance, recommendations for cooperative regional migration governance mechanism, 465–​66 global migration governance, 464 international migration norms and governance formation, 465 unconventional migration governance, 463–​64 militarism, 390 Military-​Civil Fusion strategy, 128 military-​civilian interactions, NIS, 128

Index   797 Mindray Medical International Ltd., 547 mineral resource technology, 721 Ming Zeng, 2 Ministry of Finance, 242 Ministry of Science and Technology, 241, 242 Miron-​Spektor, E., 629 Mobike, 551 mobile banking industry, 540, 550, 597, 601, 613. See also e-​commerce mobile phone business, 544, 689–​90 modernization, 384 monopolistic competition, 218–​19 monopoly, 218–​19 Moore, Kimberly A., 91 Motohashi, Kazuyuki, 90–​91, 104–​5, 374 multiethnicity, 389 multilevel capital market, financing for innovation, 179–​82, 180f multinational corporations (MNCs) chapter introduction, 15 competitive edge, 404 conclusion, 411–​12 embeddedness, 602–​3 FDI, 602 intellectual capital, 397–​99, 404–​10 state policies, implications for, 767–​68 technology base, 404 technology transfer, role in, 398, 410–​11 multinational corporations (MNCs), Chinese differences in, 495 rise of, 486–​88 multinational corporations (MNCs), Chinese, internationalization of R&D acquisitions, 491–​92 BRIC countries compared, 493–​94 challenges, 492–​93, 493t conclusions, 497 funding, 491–​92 global footprint, 488f implications, 496–​97 introduction, 486–​88 Japan compared, 494 literature on, 488–​89, 489t motivations, 489–​92, 491t particular differences, 494 summary, 495–​96 multinational corporations (MNCs), FDI

domestic market and local spillovers, 404–​8 policies for, 404–​10 processing trade (PT), 406–​8 multinational corporations (MNCs), R&D strategies and motivations, drivers of background, 399–​400 cost reductions, 400–​1, 402–​3 a dynamic view of, 403–​4 the government, 402 knowledge, 402–​3 the market, 401–​2 multinational enterprises (MNEs) emergence, requirements for, 585–​86 firm-​specific advantages, 748 R&D investment, motives for, 425 multinational enterprises (MNEs), Chinese competitiveness, 425 cross-​border R&D investment, 425–​26 foreign presence, 425–​26 Murphree, Michael, 2, 406, 407, 557–​58 Musical.ly, 551   Nakamura, H. R., 479, 480–​81 National Equities Exchange and Quotation (NEEQ) system, 359 National Exchange and Trading System (NET), 362 National Guidelines for Development and Promotion of the IC Industry, 599 National High-​Tech Research and Development Program, 702 National Industrial Strategy 2030 (Germany), 708–​9 National Innovation-​Driven Development Strategy Outline, 506, 507t, 715–​16, 719 national innovation system (NIS) beginnings, 79 building the, 119 development path, 116–​17 education system reforms, 120 foreign firms, role of, 115–​16 framework, defined, 115–​16 future directions, 131–​33 introduction, 115–​17 key elements, 116f performance and problems, 128–​31

798   Index national innovation system (NIS) (cont.) periods of the, 79–​80 R&D expenditure, 129f R&D output, 130f R&D personnel, 128–​29, 129f reforms, 80, 118 state policies, implications for, 760–​61 structure, 122–​23, 123f national innovation system (NIS), components firms, 123–​25 public research institutes, 125–​26 universities, 125–​26, 126t national innovation system (NIS), interactions military-​civilian, 128 university-​industry, 127–​28, 127t National Intellectual Property Strategy Guideline, 161–​62 National IP Strategy, 95 National Key Basic Research Program ( 973 Program), 118–​19, 242, 343, 702 National Key R&D Program, 171 “National Key R&D Programs of Intergovernmental International Science and Technology Innovation Collaboration/​Hong Kong, Macao, and Taiwan Science and Technology Innovation Collaboration Key Project (MOST), 505–​6, 508, 518 National Medium and Long-​Term Education Reform and Development Project Outline (2010–​2020), 188 National Medium and Long Term Plan for Development of Science and Technology 2006–​2020, 325 National Medium-​and Long-​Term Program for Science and Technology Development (2006–​2020) report, 180 National Medium and Long Term Science and Technology Development Guideline, 161–​62 National Medium-​and Long-​Term Science and Technology Development Plan (2006–​2020), 719 National Natural Science Foundation of China (NSFC), 170, 241, 242–​43, 508–​9

National Natural Science Foundation of China (NSFC), International Collaboration and Communication Project, 509f, 509–​10 National S&T Program (Draft) (1978-​1985), 117–​18 National Science and Technology Innovation Base, 247 National Science and Technology Major Project, 599 national science and technology major projects, 170–​7 1 national security, 725–​26 National Social Security Fund (NSSF), 358t National Strategic Plan for Advanced Manufacturing (US), 698 National 12th Five-​Year Plan for Science and Technology Development, 507t Nationwide Pilot Demonstration Program for Cloud Computing, 599 necessity entrepreneurs, 255 Needham, Joseph, 386–​87, 391 NEEQ system (new Third Board), 361–​64 Nelson, R., 69–​70, 79, 115–​16 Nelson, R. R., 56, 69 neo-​Confucianism, 385–​86 neoliberalism, 57 neuroscience, 82–​83 Neusoft Company, 531 NEV technology, 666 New Development Bank (NDB), 615–​16 new product sales, 226f, 229f, 235f New Silk Road development, 347 New Trends in World Science and Technology Development and Strategic Choices for 2020, 720 The Next Generation Artificial Intelligence Development Plan, 600 Ni, H., 190, 195 985 Project, 120, 188 973 Program (National Key Basic Research Program), 118–​19, 242, 343, 702 Ning, L., 477 nonbank financial institutions. See also banking sector angel investment, 355–​56 foreign funding, 359–​60

Index   799 IPO reforms, 355, 364–​65 IPO suspension, 359 NEEQ system, 361–​64 venture capital, 354–​59, 358t nonbank financial institutions, exits IPO, 361t M&As, 360, 361t, 365–​67 VC-​backed investment, 357–​58, 359, 365 via IPOs, 360–​61 nonsubstitution, 33–​36 Nord, W., 74   ocean exploration, 725–​26 Ofo, 551 oil and gas resource technology development, 721 oligopolistic competition, 218–​19 One Belt, One Road countries, 509–​10, 517 One Belt, One Road innovation collaboration community, 517 One Belt, One Road S&T innovation collaboration plan, 517 One Belt and One Road initiative, 131–​32 One Central Bank and Three Regulatory Commissions (CBRC) model, 617 one child policy, 192, 193 One Country, Two Systems, 348, 389 open-​indigenous innovation paradox, 752 opening-​up policies, 56, 116–​17 open innovation chapter introduction, 17 conclusion, 534 development process, 526, 527t, 528t introduction, 525 meaning of, 525, 526 open innovation, examples intellectual property licensing, 532 mergers and acquisitions, 533 overseas R&D branches, 533 supplier participation, 530 universities and research institutions, cooperation with, 532 user involvement, 529 open innovation, organizational models intellectual property licensing, 532 inter-​industry collaboration, 531 mergers and acquisitions, 532–​33

overseas R&D branches, 533–34 supplier participation, 530 universities and research institutions, cooperation with, 532 user involvement, 529 open innovation framework, 746 open innovation model, 526f openness economic reform and, 206, 215–​16 innovation and, 232–​37, 429–​30 Opinion on Establishing a Second Board by the Name of GEM, 180 Opinion on Significantly Promoting Mass Entrepreneurship and Innovation, 258–​59 Opinions on Establishing a Venture Capital Mechanism, 173 Opinions on Expediting China’s Venture Capital Investment (CNDCA), 173 Opinions on Implementing the Policy of Adding Knowledge Value-​Oriented Distribution, 249 Opinions on the Integration of Economic Construction and National Defense Construction,” 128 Oppo, 596 opportunity-​motivated entrepreneurs, 255 organizational learning, change and, 39–​43 organization and institutions, traditional, 388–​90 On the Origin of Species (Darwin), 391–​92 Our Plan for Growth: Science and Innovation” (UK Department for Business, Innovation & Skills, HM Treasury, 2014), 169 Outline of China’s Educational Reform and Development, 451 Outline of National Medium-​and Long-​Term Science and Technology Development Plan, 508 Outline of the National Industrial Policies in the 1990s, 59–​60 Outline of the National Science Quality Action Plan, 247 Outline of the National Strategy of Innovation-​Driven Development, 329, 603

800   Index outsourcing, 597 outward foreign direct investment (OFDI) 1990-​2016, 418f, 418–​19 to acquire foreign technology, 427–​28 acquisitions, 469, 472f, 472–​74, 473t chapter introduction, 16 conclusion, 481–​82 cross-​border, 425–​26 decline in, 703 firm performance and, 703 further research, implications for, 481–​82 globally, 467–​68 global ranking, 703 increases in, 467–​68 innovation capability, improving, 468 innovation impact, factors moderating, 477–​80 innovation performance and, 475–​77 introduction, 467–​68 knowledge transfer via, 480–​81 in R&D, 468–​69 R&D greenfield, 469–​72, 470f, 471t strategic asset-​seeking, 474–​75 in technology acquisition, 745 “Overall Plan for Coordinating the Advancement of World-​Class Universities and First-​Class Disciplines” (“Double First-​Class” University Plan) (State Council), 125–​26 ownership structure innovation and, 231f, 232 new product sales and, 235f patent production and, 234f R&D intensity and, 233f   Pacific Technology Venture Capital (China) Fund, 359–​60 panda bonds, 615 Paris Agreement, 652 Partnership Enterprise Law, 357–​58 Pasinetti, L., 69–​70 patent application pool, 95 patent applications CAS filings, 126 global context for innovation, 320–​22, 321f, 322f global positioning, 737 growth in, 373–​74

Huawei, 601–​2 performance measures, 374 renewable energy, 659t SPHZs, 350 subsidy programs, 373–​74 patent breadth, 91, 97–​98 patent claims, 97–​98, 97t Patent Cooperation Treaty (PCT), 95, 554–​55 patent filings, global context, 321–​22, 373 patent growth E&E sector, 99–​101, 99t SMEs contribution to, 158–​59, 162–​63 patenting S&T progress and, 7 subsidies, results of, 737 Patent Law, 371–​72, 379 patent law, 321–​22 patent licensing challenges, 376–​77 challenges to, 376–​77 transfer rate and, 327t patent litigation, 378–​80 patent production by specific sectors, 99–​101 conclusions and discussion, 108–​9 costs, 95–​96 decreases in, 101 domestic, 163 domestic index, 224–​26, 225f FDI and, 236f government, role of, 104–​6 government size and, 231f international sector, role of, 90–​91, 103–​4 introduction, 90–​92 labor mobility and, 230f overview, 92–​94 ownership structure and, 234f public employment and, 231f quality, 96–​99, 98t quality in, 91 regional variation in, 228f research institutes, role of, 101–​3 subsidy programs, 101–​2, 104–​6 technology diffusion, sectoral and regional, 106–​8 trade to GDP ratio and, 236f universities, role of, 101–​3 patent production, forward citations

Index   801 patent longevity and, 91, 91t patent value and, 91 quality and, 98–​99, 99t USPTO data, 98t, 99t patent production, growth in factors underlying, 94–​96 sectoral and regional, 106–​8 statistics, 90–​91 total count, 93t by type, 93t USPTO data, 97t patent promotion policies and programs (PPPs), 104–​6 patent rights, 44 patents expired, characteristics of, 93t protecting innovation, 566 SME, 739 patents granted, 321f, 321–​22, 737 patent value, 91, 93t Paterson, S., 754 Pearl River Piano Group, 546–​47 peer-​to-​peer (P2P) loans, 613 Peng, Mike, 96, 370, 379 People’s Bank of China, 610–​11, 615, 616–​17 perfect competition, 218–​19 personality doctrines, traditional, 387–​88 person-​to-​person (P2P) loans, 621 Persson, O., 519 Phan, P., 330–​31 pharmaceutical industry, 124, 401–​2, 724 Philips, 541 Pietrobelli, C., 426–​27, 469, 478, 480 Pinduoduo, 686 Piperopoulos, P., 476, 478 planned economy, 206 “Plans for Deepening the Management Reform of the Central Fiscal S&T Program (Special Projects, Funds, etc.)” (State Council), 121–​22 platform-​based inclusive innovation, 692 pluralism, 389 Polanyi, K., 29 Policies of Encouraging the Development of Software and Integrated Circuit Industries, 598 Policies on Supporting Technological Innovation in SMEs, 161–​62

politics, traditional elements in, 389 poor, innovating for the. See inclusive innovation Porter, M. E., 737 poverty, reductions in, 56, 676 poverty alleviation to become an innovation powerhouse, 753–​54 e-​commerce for, 686–​87 e-​commerce model, 691 ICT communication in, 689–​90 Poverty Alleviation through Science and Technology (PAST), 688t poverty problem, solving the, 675 Prahalad, C. K., 682, 691–​92 PRE-​M model, 582 price liberalization, economic reform and, 207, 208f Priem, R., 575–​76 private equity, 355, 360 private equity capital, 214 private firms constraints, 256 economic reform and development of, 207–​10, 211f innovation performance, growth in, 124 NIS component, 123–​25 private industrial enterprises growth, 64f, 64 statistics, 63–​64 privatization, productivity and, 138–​39 processing trade (PT), 423–​24 processing trade (PT) FDI, 406–​8 producer-​driven value chains, 555–​56, 559 production theory evolutionary approach, 37–​39 paradigm-​based, 33–​36, 34f paradigm-​based, conflicting evidence, 36–​37 Program of Strategic Emerging Industries (2010), 703 Program on Deepening the Management Reform of the Central Government’s Science and Technology Plan, 242 Program That Benefits the People through Science and Technology, 688t Project 211, 188 Project 909, 597

802   Index “Propensity to Patent, Competition and China’s Foreign Patenting Surge” (Hu), 103 Proposal for the Establishment of a State Immigration Administration, 455–​56 Proposal on China Joining the International Organization for Migration (IOM), 455–​56 Provisional Regulations on Self-​Funded Overseas Study, 452 Provisional Regulations on the Protection of Inventions Rights and Patent Rights, 371 Proxy Equities Exchange and Quotation system (PEEQ), 362 Prud’homme, Dan, 95, 410–​11 psychology, innovation and, 82–​83 public research institutes (PRIs) funding, 118 IP management, legislating, 374–​76 IP management challenges, 376–​77 NIS component, 125–​26 patent licensing, barriers to, 376–​77 R&D function, 117 reforms, 119–​20 technology transfer, legislating, 374–​76 public security, 725–​26 purchasing power parity, 56   Qimin Yaoshu (Jia Sixie), 391–​92 Qualcomm, 532 qualified domestic institutional investor (QDII) system, 614–​15 qualified foreign institutional investor (QFII) system, 614–​15 Qualified Foreign Limited Partner (QFLP), 358t Quan, X., 495   Rabellotti, R., 426–​27, 469, 476, 477, 478, 479–​80 regional innovation system (RIS), 80–​81 Regulations for Management of Renewable Power Quotas (Opinion-​Soliciting Draft), 655 Regulations of the National Equities Exchange and Quotations on the

Administration of Market Makers’ Market-​Making Business, 362 Regulations on the Examination and Approval of Foreigners’ Permanent Residence in China, 456–​58 Regulations on Universities’ Intellectual Property Protection and Management, 324 remittances, 446–​48, 447f, 450f renewable energy bioenergy, 665–​66, 666t deployment, 654 global positioning, 657, 658f investment in, 655, 658f legislating, 649, 654 patent applications, 659t planning, 655f power generation from, 657–​59, 658f solar photovoltaics, 655–​56, 662, 663f solar thermal energy, 662–​65, 664f subsidy programs, 655–​56 sustainable development and, 650–​51 targets, 654–​55, 654t wind energy, 659–​62, 660f Renewable Energy Development Special Fund, 655 Renewable Energy Law, 649, 654 Renewable Power Quota and Assessment Method (Opinion-​Soliciting Draft), 655 renewable power quota system, 655 research and development (R&D) collaborations, 107 cost-​driven, 400–​1, 402–​3 expenses deduction policy, 172 FIS, 81–​82 fiscal and tax policies, 171 foreign investment, labor cost advantage, 492 government-​driven, 402 higher education, 129f knowledge-​driven, 402–​3 market-​driven, 401–​2, 425 overseas branches, 533 patent growth and, 94 as a percent of GDP, 224f, 224 PRIs, 117 smartphone industry, 596

Index   803 SOE centers, 120 spending by industry, 102–​3 research institutes, 101, 102 research and development (R&D) expenditures by R&D institutions enterprises vs., 244, 245f higher education vs., 244f domestic, growth in, 318f, 318 global context of, 318f, 318, 319f green technology, funding, 653, 654t growth in, 716 national innovation system (NIS), 129f percent of GDP, 318, 417f private enterprise, 124–​25 SPHZs, 343 tax deduction on, 169 by universities, 101 universities, vs. R&D institutions, 244f research and development (R&D) greenfield OFDIs, 469–​72, 470f, 471t research and development (R&D), intensity industrial sector, 224–​26, 225f marketization and, 228f ownership structure and, 233f regional variation in, 230f research and development (R&D) internationalization for technology acquisition, 745 technology transfer and, 425–​26 research and development (R&D), internationalization of BRIC countries compared, 493–​94 challenges, 492–​93, 493t chapter introduction, 16 conclusions, 497 implications, 496–​97 Japan compared, 494 literature on, 486–​87, 488–​89, 489t motivations, 489–​92, 491t particular differences, 494 summary, 495–​96 technology transfer and, 425–​26 research and development (R&D) investment basic vs. applied, 69

China vs. US, 62 cross-​border, 425–​26 global comparisons in, 515 for global competitiveness, 605 global positioning, 716, 736 green technologies, 650 research and development (R&D), MNC strategies and motivations, evolution of cost reductions, 400–​1, 402–​3 a dynamic view of, 403–​4 government-​driven, 402 introduction, 399–​400 knowledge-​driven, 402–​3 market-​driven, 401–​2 research and development (R&D) output (NIS), 130f research and development (R&D) personnel global positioning, 716 national innovation system (NIS), 128–​29, 129f “Research-​Driven or Party-​Promoted? Factors Affecting Patent Applications of Private Small and Medium-​Sized Enterprises in China’s Pearl River Delta” (Liefner et al), 106 research ethics, 773 research innovation powerhouse, challenges to evolution toward an, 751 research institutions affiliations, 243–​44 collaboration for open innovation, 532 five categories of, 243–​44 numbers of, decline in, 243–​44, 244f research project optimization, 728 research publications, international collaborations. See also scientific papers by country, 512f global positioning, 736–​37 growth in, 511f problems, 514–​15 statistics, 510 strength in, 513, 514f trends in, 513f “The Resolution of the Structural Reform of the Science and Technology System (CPC), 118

804   Index “Restructuring China’s Research Institutes: Impacts on China’s Research Orientation and Productivity” (Jiang, Tortorice, and Jefferson), 102 returnees employment by sector, 452 entrepreneurship, 452, 453 increases in, 453 policies, 451–​52 professional, 453–​54 spillover effects, 428–​29 student, 451–​52 Revitalize the Nation through Science and Education campaign, 702 Richard, L.-​H., 743 RMB appreciation problem, 616 RMB internationalization, 614–​15 RMB Qualified Foreign Institutional Investors (RQFII) system, 614–​15 “Roads to Innovation: Firm-​Level Evidence from People’s Republic of China (PRC)” (Wang et al.), 96 robotics, 551, 704–​5 Rogers, Everett, 581–​82 Rogers, Juan D., 102 “The Role of R&D Offshoring in Explaining the Patent Growth of China and India at the USPTO” (Duan and Kong), 103–​4 “The Role of Research and Ownership Collaboration in Generating Patent Quality: China-​U.S Comparisons” (Jiang et al.), 102 Rosenberg, N., 60–​61 Rules on the Suitability Management of Investors on the NEEQ, 363–​64 rural finance, 612–​13, 622 rural market, solar hot water heaters, 664–​65 Rural Sci-​tech Special Commissioner System, 688t rural-​urban income gap, 676–​77 rural-​urban income ratio, 677f, 677–​78   Sako, M., 602 Sanfilippo, M., 476, 480 Sanlai Yibu policy, 563 sashimi theory, 549–​50

Scherngell, Thomas, 106 Schmid, Jon, 97 Schumpeter, J. A., 70, 74, 218, 219 Science and Civilization in China (Needham), 386–​87 Science and Technological Innovation 2030, 666 science and technology (S&T) education system, 117–​18 for the future, 750 plan management system reforms, 728 science and technology (S&T) administration personnel management, 118 resource allocation, 118 science and technology (S&T) development conclusion, 731–​32 future of, 24–​25 introduction, 714–​15 science and technology (S&T) diplomacy, 505 science and technology (S&T) innovation achievements, recent years, 714–​16 changes in, 714–​15 development plan, 719 ecological conservation foundation for, 725 strategic goals, 717–​19 science and technology (S&T) innovation governance, 241, 714, 754–​55 science and technology (S&T) innovation, socioeconomic foundations and strategic systems bioindustry, 723–​24 ecological and environmental conservation, 725 ecologically high-​value agriculture, 723–​24 green, of advanced materials and intelligent manufacturing, 722 introduction, 714, 720 national and public security, 725–​26 space and ocean exploration capability, 725–​26 sustainable energy and resources, 720–​21 ubiquitous information networking, 722–​23 universal healthcare, 724–​25 science and technology (S&T) innovation systems, recommendations for encouraging innovation, environments for, 730–​31

Index   805 fund management systems, 728 innovation environment, construction of open, 729–​30 open sharing of S&T resources, 729 research project optimization, 728 S&T plan management system reforms, 728 scientific and technological decision-​ making consultation improved, 727–​28 science and technology (S&T) management system reforms achievements, 251–​52 chapter introduction, 11 enterprise transformation, 246–​49 future directions, 251–​52 introduction, 241 investment, 242–​43 legislating, 248–​49 ministry responsible for, 241 policy hotspots, 247–​49 research bases, 250–​51 research funding, 246 research institutions, 243–​45 research talents, 249 science and technology (S&T) personnel evaluation of, 247, 249 government procurement service system, 249 numbers of, 245 reward system reforms, 249 talent evaluation and incentive mechanism, 248–​49, 260 science and technology (S&T) plans, five categories, responsibilities of, 242–​43 science and technology (S&T) progress (STP), 619 science and technology (S&T) research funding, 118 guiding principle, 118 open sharing of resources, 729 science and technology (S&T) revolution, 117–​18 science and technology (S&T) system reforms development planning, 120–​21 gradualism philosophy, 122 innovation-​driven development, 121–​22

in innovation system evolution, 118–​20 legislating, 121 science and technology (S&T) technological diplomacy, 505 Science and Technology Development Plan, 67 Science and Technology Industrial Park (STIP), 346 Science and Technology Progress Law, 121, 324 science-​based innovation, global context of capability ranking, 317 chapter introduction, 12 conclusion, 333 introduction, 315–​16 outlook, 333 R&D expenditure, 318f, 318, 319f science-​based innovation, traditional culture, influence on, 391–​92 science-​based innovation performance, global context of competitive, 317 overall, 316–​17 patent applications, 320–​22, 321f, 322f research and citation volume, 320f, 320 Science Parks and High-​Tech Zones (SPHZs) areas for future inquiry, 351 background, 337–​38 by location, 341t by scientific field, 345t by specialty, 341t chapter introduction, 12–​13 competition, 338–​39 development of, 340–​41 diverse focus of, 344–​46 economic benefits, 338 economic value, 349–​50 evolution of, 309, 346 exports, contribution to, 743–​44 foreign, 340 funding, 338 interior areas, 347–​48 labor force, 347 labor force requirements, 343 linkages, 309, 338–​39, 348 locating, 339, 344–​45, 346–​47, 349–​50 major issues in, 338–​39 major programs, 343–​44 ministries overseeing, 338

806   Index Science Parks and High-​Tech Zones (SPHZs) (cont.) numbers of, 337–​38, 340, 346 R&D requirements, 343 research positions and controversies, 349–​51 specialization, geographic and scientific, 343–​44 spillover, competition for, 340 state involvement, 344 urban areas, effect on, 349–​50 Scientific and Technological Cooperation Center, 348 Scientific and Technological Innovation 2030, 600 scientific papers. See also research publications, international collaborations global positioning, 716 innovation capability in, 116–​17, 320, 508, 716 scientific paradigm, 31–​32 SciPhone, 544 Second Industrial Revolution, 41 sectoral innovation system (SIS), 80–​81 Securities Trading Automated Quotation (STAQ), 362 semiconductor manufacturing, 597–​99 service industry, 453–​54 Several Opinions on Deepening the Reform of Institutional Mechanisms and Accelerating the Implementation of Innovation-​Driven Development Strategy, 506, 507t Severe, S., 475, 477, 479 Sha, K., 329 shadow banking, 614, 620–​21, 622 Shaikh, A., 69–​70 Shane, S., 629 Shanghai Manufacturing University Science Park, 346–​47 Shanghai Stock Exchange Science and Technology Innovation Board (the STAR market), 355 Shanghai Stock Exchange would set up the New Science and Technology Innovation Board (the STAR market), 365

Shanzhai phenomenon, 18, 539–​40, 543–​44, 746–​47 Shaoxing textile cluster innovation system capabilities, improving, 279–​80 knowledge generation and diffusion, 282 Shapiro, Daniel, 105 Sharif, N., 328 Shenzhen Hi-​Tech Industrial Park (SHIP), 346 Shenzhen/​Hong Kong Innovation and Technology Co-​operation Zone, 349 Shenzhen Science and Technology Industrial Park, 346 Shenzhen Stock Exchange Small and Medium-​Sized Enterprise Board (SME Board), 357–​58 Shih, L., 148 Silicon Valley, 275 Simon, H., 69–​70 Simonson, I., 584 SIM Technology Ltd., 548–​49 Sin, S. C. J., 519 Sino-​Singapore Tianjin Eco-​City, 656 Sitkin, S. B., 629 Siwei, Cheng, 357 small and medium-​sized enterprises (SMEs) contributions of, 156–​57 in the digital economy, 739 financing service platforms, 182–​83 funding, 739 initiatives to facilitate establishment of, 739 integration into digital innovation, 166 in intelligent manufacturing, 739 newly established, growth statistics, 156–​57 numbers of, 158, 158t percent of domestic invention patents, 739 small and medium-​sized enterprises (SMEs), entrepreneurship and innovation in achievements in the digital economy, 163–​64 chapter introduction, 9 development and contributions of, 156–​60, 158t, 159t financing for, 174–​75, 174t intellectual property strategy to promote, 161–​63 introduction, 156

Index   807 key policies, interpretation and review, 160–​61 legislating, 156 problems and challenges, 165–​66 tax reduction policies, 156, 160–​61 Small and Medium-​Sized Enterprises Promotion Law of the People’s Republic of China, 156 smart factories, 164 smart grid development, 666 smartphone industry, 596–​97 smartphone market, 579–​81 social development to become an innovation powerhouse, 753–​54 social equality impact of financial innovation on, 622 social exclusion, poverty and, 675, 682–​83, 686 socialist market economy, development of the, 59, 60–​61, 63, 65 Socialist Market Economy goal, 209 Socialist Market Economy reforms, 738 social network, 257 social welfare availability, 462–​63 social welfare research, 171, 246, 704 software advancement, 597 software industry, 597 solar photovoltaics, 662, 663f solar thermal energy, 662–​65, 664f solar water heaters, 662–​64, 664f Song Yingxing, 391–​92 space exploration, 128, 725–​26 space security, 726 Spark Program, 118–​19, 242, 343, 688t, 702 special economic zones (SEZs), 215–​16, 562–​63 special fund for guiding technological innovation, 171 Special Plan of 12th Five-​Year Plan on the International Science and Technology Collaboration (MOST), 508 Special Plan of 13th Five-​Year Plan on the International Science and Technology Collaboration, 506, 507t Special Plan of 13th Five-​Year Plan on the International Science and Technology collaboration,” 503

Special Plan of 12th Five-​Year Plan on the International Science and Technology Collaboration, 506, 507t Special Program for Enriching the People and Strengthening the County through Science and Technology, 688t special project for S&T hub building and talent fostering, 171–​73 spillovers FDI’s and, 330, 404–​8, 415–​16, 494, 556 foreign R&D, 494 negative, of SOEs, 232 R&D, 102 returnees and, 428–​29 SPHZs competition for, 340 technological, 102, 124, 428–​29, 477 in technology transfer, 423, 424, 428–​29 Startup Investment Guiding fund for Sci-​Tech SMEs, 174–​75, 174t startups subcontracting relationships with foreign-​ invested exporters, 565 venture capital investment, 552 State Administration of Foreign Exchange (SAFE), 615–​16 State Administration of Foreign Experts Affairs, 241 State Emerging Industries Venture Capital Investment Guidance Fund, 359 State Immigration Administration (SIA), 455–​56 state-​owned enterprises (SOE) advantages of, 256 banks, 65, 610–​11 financing, 213–​15 growth, 64f, 64 importance for industrialization, 65 reforms, 207–​10 statistics, 63–​64 taxes on, 65 state policies, future research proposed culture and innovation, 771 digital technology, 772–​73 education in innovation and entrepreneurship, 771 financial innovation, 771–​72 green innovation, 772 human development, 773 inclusive development, 772–​73

808   Index state policies, future research proposed (cont.) policies and management of international innovation collaboration, 770 policies and management of outward direct investment to maximize innovation benefits for source countries, MNES, and host economies, 770 research ethics, 773 a rigorous and scientific assessment of the role of the state in china’s technology catch-​up and its implications for other countries, 768–​70 technological revolution, 773 state policies, implications for green technology, 762–​63 human development, 766 inclusive development, 762–​63 innovation paradigm, 766 an open national innovation system, 760–​61 role of the state and the market, 761–​62 STI governance for human development, 766 STI policy, strategic priorities in the next phase, 763–​64 STI strategy from technological innovation strategy, 764–​66 state policies, managerial implications for the private sector absorptive capabilities, 767 digital transformation of incumbent firms, and sustainability, 768 openness and in-​house innovation, 767 strategies for MNCs, 767–​68 state vs. market advance of the state potential obstacles, 149–​50 unevenness in, 147–​48 catching up, 141–​42 chapter introduction, 8–​9 conclusion, 150–​51 domestic market leveraging the, 141–​43 sectoral differences, 144–​46 experimentation, decline in, 150 introduction, 135–​36 retreat of the state

productivity gains, origin of, 138–​41 unevenness in, 136–​37 self-​sufficiency, focus on, 148, 149 state vs. market, productivity gains origin of, 138–​39 sectoral differences, 139–​41, 141t STEAM education, 191, 193 Steinfeld, E., 555 Stephan, H., 602 sticky information, 529 stock exchanges, 179–​81, 214, 355, 611, 614–​15 Strange, R., 477 A Strategy for American Innovation: Securing Our Economic Growth and Prosperity” (National Economic Council, Council of Economic Advisers, and Office of Science and Technology Policy, 2011), 169 Strategy of Invigorating China through Science and Education and the Law on Promoting the Transformation of Scientific and Technological Achievements, 357 Strauss-​Kahn, D., 58 stretch goals defined, 626, 629 explorative learning for, 626 paradox of, 626 stretch goals, achieving under resource constraints by firm specific goals, 629 innovation of Chinese firms in, 627–​29 stretch goals, exploratory bricolage case studies Huawei, 634–​35, 637t summary, 635, 636t Taiping Life Insurance, 631–​33, 636t Yuanjia Village, 633, 636t ZBOM, 633–​34, 637t stretch goals, exploratory bricolage in achieving chapter introduction, 21 conclusion, 640–​41 future research directions, 641 interplay, 638–​40, 639f

Index   809 introduction, 630–​31 research methodology, 631 Ström, P., 479, 480–​81 student migrants funded, government and self-​, 451 international, outflows and inflows, 450–​52 numbers of, 455 returnees, 451–​52 “Suggestions for Deepening System and Mechanism Reform to Accelerate the Implementation of Innovation-​Driven Development Strategy” (Central Committee, State Council), 121–​22 Suggestions to Promote Mass Entrepreneurship and Innovation (State Council), 121–​22 Summary of National Mid-​& Long-​Term Science and Technology Development Plan (2006–​2020), 667 Sun, Guofeng, 614, 621 Sun, Z., 481 supplier-​driven value chains, 566–​67 Supporting Policies to Implement the Guideline, 121 sustainable development inclusive growth in, 749 renewable energy and, 650–​51, 749 sustainable energy and resources, 720–​21 Sutherland, D., 475, 477, 479 synergy loans bank and guarantee, 176–​77, 177f investment and lending, 176, 176t system reform chapter introduction, 10 conclusion, 237–​38 system reforms, competition in China, 220–​22 definition and measures of, 218–​20 system reforms, economic capital market, 213–​15, 215f enterprise reform, 207–​10, 211f introduction, 205–​6 labor market, 213 liberalization of factor markets, 213–​15 openness and, 206 openness and integration into the world economy, 215–​16 price liberalization, 207, 208f private firms, development of, 207–​10, 211f

system reforms, innovation from arbitrage to, 222–​27 government size and, 229–​32, 231f marketization and, 227–​29, 228f openness and, 232–​37 ownership structure and, 231f, 232 regional variation in, 226–​27, 227f system science, 391   Taiping Handbag Factory, 559 Taiping Life Insurance, 631–​33, 636t talent attracting, 752 awareness and competitiveness, 461–​62 evaluation and incentive mechanism, 248–​49, 260 gaps, 452–​54, 604 talent strategy, migration policy and governance, 456–​59 Tan, H., 476 Tan, Long, 377 Tang, H., 476 Tang, L., 519–​20, 557–​58 Taobao Villages, 686 Taoism, 389–​90 Tao Te Ching, 387–​88 tax reduction policies, SMEs, 156, 160–​61 tax revenue, 156–​57 Taylorism, 40 technological capabilities innovation success and, 736 institutional development, coevolutionary dynamics, 43–​48 technological dominance, industrial transformation and, 33–​36 technological innovation competitive advantages, 328 leadership in, 554–​55 programs in, 120 technological innovation, drivers of growth in entrepreneurship, 330–​31 globalization, 330 informationalization, 329–​30 infrastructure, 329 introduction, 327–​28 national STI policy and implementation, 328–​29 urbanization, 329

810   Index technological learning, 39–​43, 66–​67 technological learning, cluster innovation systems among core-​level determinants, 285 among regional networks, 289, 290t, 291t Hangzhou software industry cluster, 286–​87, 290–​92 within the local network, 287–​89, 287t, 288t technological paradigm, 31–​33 technological revolution, 773 technology imported, indigenous innovation and, 702–​4, 703f traditional, innovation elements in, 390–​92 technology acquisition collaboration and open innovation in, 746 IFDI in, 744–​45 imports in, 744–​45 internationalization of R&D for, 745 migration for, 745 OFDI in, 745 R&D internationalization for, 745 technology transfer and, 744–​45 technology imports expenditures, 422 in industrial development, 66–​68, 76 knowledge spillovers, 419 Technology Innovation Fund for Technology-​ Based SMEs, 688t technology insurance, 178–​79 Technology Microcredit Company” pilot program, 175 Technology Revolution and China’s Modernization: Considerations for China’s Technology Development Strategy for 2050, 720 technology transfer challenges, 374–​76 conclusion, 431–​32 construction equipment sector, 144 contracts, numbers and revenue, 324 effective, preconditions for, 424 expenditures, 422f forced, eliminating, 409 foreign, 15 in the global context, 12 GVC integration and, 426–​27

indigenous innovation in, 429–​31, 702–​4, 703f industrialization and, 40–​41 international diffusion in, 416–​19 introduction, 415–​16 inward, 402, 408 inward FDI and, 423–​25 knowledge-​driven R&D and, 403 legislating, 324, 325 licensing, 421–​22 MNCs role in, 398, 410–​11 patent licensing and, 377 policies, 410–​11 policies promoting, 121–​22 proactive approaches to OFDI, 427–​28 returnees, 428–​29 spillovers, 428–​29 quid pro quo for market access, 408 R&D internationalization and, 425–​26 reliance on foreign firms for, 147 spillovers, 404–​8 spillovers in, 423, 424 technology acquisition and, 744–​45 trade and, 419–​21 technology transfer, global context conclusion, 323–​24 introduction, 315–​16 outlook, 323–​24 overview, 323–​24 patent licensing and transfer rate, 327t UTT in, 325–​26, 326t telecommunications sector, 146, 595–​96, 601, 602–​3 Tencent, 124, 547, 550, 601 textile industrial cluster, 278 Textile Science and Technology Center (TSTC), 281–​82 thinking, traditional mode of, 385–​86 13th Five-​Year Development Plan for Renewable Energy (2016–​2020), 654, 655f 13th Five-​Year National Science and Technology Innovation Plan, 716 13th Five-​Year Plan for Bioenergy Development, 665 13th Five-​Year Plan for Building Energy Efficiency and Green Building Development, 666–​67

Index   811 13th Five-​Year Plan for Energy Technology Innovation, 653 13th Five-​Year Plan for innovation-​driven development, 75, 78 13th Five-​Year Plan for National Scientific and Technological Innovation, 653 13th Five-​Year Plan for Power Sector Development (2016–​2020), 666 13th Five-​Year Plan for Science and Technology Innovation, 131, 132t 13th Five-​Year Plan for the Integration of Economic Development and National Defense Construction,” 128 13th Five-​Year Plan on Education, 191 13th Five-​Year Plan on Scientific and Technological Innovation, 599, 666–​67, 687 13th Five-​Year Special Plan for Biology Technology Innovation, 665 Five-​Year Special Plan on the International Science and Technology Collaboration, 506, 507t Thom, R., 391 Thompson, V. A., 74 Thousand Talents Program, 452–​53 three-​in-​one industrial revolution, 205–​6, 704–​5, 740 Three Steps to Global Innovation Leadership, 329 Three-​Year Plan for Cloud Computing Development (2017–​2019), 599 Tiangong Kaiwu (Song Yingxing), 391–​92 Todo, Y., 476 tolerance, culture of, 386–​87 Torch Program, 118–​19, 169, 242, 343, 357, 702 Tortorice, Dan L., 102 tourism, 454–​55, 458–​59 township and village-​owned enterprises (TVEs), 207–​9, 213, 223, 738 trade. See also exports; imports 1978, percent of GDP, 56 1978-​2018, growth, 56 export processing trade (PT), 406–​8 GDP, percent of, 740 to GDP ratio, patent production and, 236f international, 66, 740 ratio to GDP, 216, 217f

technology transfer and, 419–​21 trademark applications, 321, 371, 716 Trademark Law, 371, 379 Trade-​Related Intellectual Property Rights (TRIPS) treaty, 44 traditional Chinese medicine (TCM), 344–​45, 385–​86, 391 Trajtenberg, Manuel, 91 TRIPS (Trade-​Related Aspects of Intellectual Property Rights)agreements, 49–​50, 372, 497 Trump, Donald, 409, 707, 708 Tucker, R. B., 529 Tucker, S., 74 Turulja, L., 689 12th Five-​Year Development Plan for Biology Technology, 665 12th Five-​Year National Independent Innovation Capacity Building Plan, 653 12th Five-​Year Plan for Economic and Social Development, 666–​67 2012 Lab (Huawei), 124–​25   uncertainty, innovation under, 557–​59, 565–​66 unicorn enterprises, 267, 267t, 716 United States AI strategies, 708 industrial policy development, 63 intellectual property rights, 96 R&D investment, 62, 63 trade disputes, 384 United States First, 386 universal healthcare, 724–​25 universities collaborations, business, 196–​97 collaboration with for open innovation, 532 Double-​First-​Class University Plan, 125–​26 graduates, statistics, 257–​58, 552 industrial technology development, 245 industry interactions, NIS, 126t, 127–​28 in innovation and entrepreneurship, 194–​95 innovation and entrepreneurship education in, 194–​95 linkages advantages of, 339 businesspeople, 196–​97

812   Index universities (cont.) NIS component, 45t, 125–​26 patent licensing, 376–​77 patent production, role in, 101–​3 R&D expenditures, 101, 244f reforms, 188 role in inclusive innovation system, 692 world rankings, 126, 126t university graduate entrepreneurs, 190, 195, 262, 267 university technology transfer (UTT) commercialization, 325–​26, 326t intellectual property rights (IPR) protection, 374–​76 key challenges, 331–​33 overview, 325–​26 urban areas, SPHZs in, 349–​50 urban energy transition initiative, 656–​57 urbanization, 323f, 579, 652 urban labor, 213, 214f urban population growth, 323f, 329   Vakili, K., 640 valuable, rare, inimitable, and nonsubstitutable (VRIN) resources, 626 Venkatesh, V., 690 venture capital (VC), 13, 354–​59, 358t venture capital (VC) investment, 173, 214, 359–​60, 491–​92, 552 Vernon, R., 493 Vivo, 596 Von Hippel, E., 529 von Zedtwitz, M., 400, 490   Wan, L. Y., 191–​92 Wang, C., 476, 478 Wang, Fei-​Ling, 97 Wang, Gangbo, 103 Wang, H., 48, 428–​29 Wang, Jun, 105 Wang, Xu, 96 Wang, Y., 324, 377 Wang, Yuandi, 99 Wang, Yusheng, 391–​92 Wang Huning, 455–​56

Washington Consensus, 57–​58 wealth management products, 614 “Welcome the Era of Knowledge Economy and Build a National Innovation System” (CAS), 119 Wen Jiabao, 120–​21, 662 Western Inscriptions (pinyin: xi ming) (Zhang Zai), 385–​86 White, R., 422 Wide Industrial Corporation, 547–​48 Wield, David, 339 Williamson, O. E., 687–​89 Williamson, Peter J., 2 Williamson, P. J., 539, 549, 746 wind energy, 659–​62, 660f wind turbine sector, 145–​46 Winpower, 182–​83 Woetzel, Jonathan, 685–​86 Woo, T.-​O., 48 World Trade Organization (WTO), 49–​50, 706–​7, 708–​9 World Trade Organization (WTO) membership, effects of economic, 66, 416, 418 on innovation, 223, 419 intellectual property rights (IPR), 372 international competition, 120–​21 on MNCs, 593 openness and integration, 216 patents, 92–​93, 372 private industry, 209–​10 on production, 330 tariff liberalization, 140–​41 technology transfer, 147 Wu, Ge, 621–​22 Wu, H., 479 Wu, J., 476, 478 Wübbeke, J., 705–​6 Wunsch-​Vincent, Sacha, 103 WuXi AppTec, 545   Xia, T., 423–​24 Xiaolan Fu, 2, 503 Xiaomi Company, 124, 529, 596–​97 Xie, Ping, 621–​22 Xie, Q., 736–​37 Xie, Z., 579

Index   813 Xi Jinping, 209, 257, 343–​44, 365, 385, 386–​87, 388–​89, 446–​48, 455–​56 Xing Tian, 386–​87 Xu, C., 576–​79 Xu, Q., 76–​78 Xu, X. Z., 195 Xue, Lan, 373 Xu Qingrui, 386   Yakob, R., 479, 480–​81 Yang, Deli, 372–​73 Yang, Y., 582, 586–​87 Ye, Y. H., 190 Yeltsin, Boris, 48 Yin, E., 549 Yin, Long, 621–​22 Yin, X., 324, 766 Yip, George S., 2, 405, 580–​81, 593–​94, 768 youth entrepreneurship, 158–​59 Yu, X., 43, 56, 76–​78 Yuanjia Village, 633, 636t Yulie, Lou, 385–​86 Yun Jong Yong, 549–​50   Zahra, S. A., 255 ZBOM, 633–​34, 637t Zeng, M., 539, 746 Zhang, Gupeng, 107 Zhang, J., 495

Zhang, Jingjing, 102 Zhang, Y., 424 Zhang Gaoli, 455–​56 Zhangjiang High-​Tech Park, 339, 344–​45 Zhang Zai, 385–​86 Zhao, X. Z., 195 Zhejiang Hisun Pharmaceutical Co., 531 Zheng, G., 76–​78 Zheng, Jia, 99–​100, 104 Zheng, Yawu, 621 Zhengfei Ren, 626 Zhengzhou Airport Economic Zone (aerotropolis), 347–​48 Zhiqiang Yin, 664 Zhongguancun High-​Tech Park, 346 Zhongke High-​Tech Park, 346 Zhongxing Medical, 541 Zhou, J., 330–​31 Zhou, P., 519 Zhu, C. Y., 189 Zhu, H., 580–​81, 582, 584 Zhuangzi, 385–​86 Zhuangzi: Egalitarianism (Zhuangzi), 385–​86 Zhu Rongji, 564 Zingales, Luigi, 623 Zoellick, R., 58 Zou, Chuanwei, 623 ZTE, 124 Zylberberg, E., 602