China really has problems with innovations

China's Communist Party must unleash the innovative forces

With government guidelines, ever new plans and programs as well as heavy subsidies, China's government wants to make the country the leading technology power in the world. However, in order to really take the lead globally, the country's companies and institutions need less control and more freedom.

In his now famous speech at a high-profile financial conference in Shanghai in late October, Jack Ma attacked China's financial regulators head-on. The founder of the tech giant Alibaba called the regulators sleepy and compared them to an old man's club.

But that wasn't all. Ma also used his appearance for a general settlement with China's research and innovation policy. "Innovations arise primarily in markets, innovations arise at the grassroots level, innovations come from young people," he called out to his audience. The problem in China: The regulatory challenges and regulations are getting bigger and bigger, Ma added.

He provided the solution right away: "So that real innovations can happen, nobody is allowed to show you the way." Rather, the individual has to take responsibility, because mistakes can always happen when innovating. Trying to minimize risks only slows down innovation, Ma railed. Since then he has probably not disappeared completely voluntarily from the scene.

Attack on research policy

Ma's digression on proper research and development (R&D) funding was a barely veiled attack on the Chinese government's research policy. Beijing has been trying for some time to catapult China to the top of the world technological level with ever new plans, state strategies and specifications. For example, the “Made in China 2025” plan adopted in 2015 provides that by 2025, China will provide around 70 percent of the core materials itself and no more in ten key technologies, including aerospace technology, semiconductor technology and the pharmaceutical industry should be dependent on foreign suppliers. According to the will of the planners in Beijing, the country should have established itself in the middle of the industrial nations by 2035; In 2049, just in time for the 100th birthday of the People's Republic, China is set to be the world's leading industrial nation.

The conflict with the USA and the accompanying race for global technological supremacy have accelerated planning at government headquarters once again. The head of state and party leader Xi Jinping decided in the fall that China must become a leader in new technologies, including artificial intelligence, by 2035. At the annual meeting of the National People's Congress, which is expected to begin on March 5, the project is to be adopted as part of the 14th five-year plan.

China is under enormous pressure to produce more of its own innovations, because international comparisons reveal glaring weaknesses. According to a study by the World Bank, the productivity level of the Chinese economy is only around a third of that in America. At the beginning of the 2000s, total factor productivity in China was still growing at 2.8 percent per year. But between 2009 and 2018 the average growth was only 0.7 percent per year. "Since the reform and opening-up policy began in 1978, the contribution made by total factor productivity to Chinese economic growth has fallen continuously," writes Philipp Boeing from the Leibniz Center for European Economic Research (ZEW) in Mannheim. The decline has been compensated for by increasing investments in physical capital.

The danger of the middle income trap

If China fails to switch from an investment-driven growth model to an innovation-driven model, the current locomotive of the global economy could end up in the so-called middle income trap, in which an emerging country can no longer grow out of a medium level of development. The falling birth rate increases the risk even more.

Until now, China has relied on state control in many cases to increase its innovative strength. The state provides direct subsidies, builds industrial parks, grants loans on special terms and forces foreign companies to enter into joint ventures with Chinese partners and to release technologies. At first glance, China's balance sheet is impressive. The country's R&D expenditures amount to around 2.2 percent of economic output and are thus at the level of the EU. In absolute terms, only the US now spends more money on research. While China's share of global R&D spending was 5 percent in 2001, it is 24 percent today.

The number of patent applications has been one of the - superficial - successes to date. In 2019, China overtook the US and is now the country with the most registrations. One of the reasons for this: anyone who applies for a patent receives public aid. However, the situation is different when it comes to the number of patents granted: China is still lagging behind many industrialized countries. The picture is not much different when it comes to the number of scientific publications: China ranks first ahead of the USA. In terms of the quality of the papers, however, there is still some catching up to do. In terms of the number of citations, for example, China is still lagging behind.

Backlog in basic research

China also has some catching up to do in basic research. Only six percent of Chinese R&D spending goes into basic research. In many developed countries the proportion is 15 percent. So far, China has relied on foreign purchases for complex technologies, such as memory chips, and sometimes also on industrial espionage, instead of following the arduous and tedious path of its own development. Now, in the crisis, it takes revenge.

Many innovations are created in China in the private sector, especially in tech companies such as Alibaba. Bytedance with its video platforms Tiktok and Douyin as well as Tencent with its super app WeChat and the search engine Baidu are further examples. Of course, the companies have also benefited from the extensive exclusion of the large American tech companies from the Chinese market. But with their integrated ecosystems, which combine chat and payment functions, shopping channels and even services for booking doctor's appointments, the companies have finally created something genuinely new. The Chinese people's extreme affinity for tech fueled the development. In recent years, China has made progress in, among other things, pharmaceutical research and battery cell technology.

Certainly - just like in the West - tech companies must be controlled with the help of the applicable laws because of their threatened dominant position. The Ant Group, the financial arm of the Alibaba Group, also represents a systemic risk because of the gigantic volumes involved in lending and asset management. However, as the political climate worsens, the party is increasingly governing directly into private companies. According to media reports, the authorities placed government officials in numerous technology companies in the city of Hangzhou as early as 2019. Alibaba also has its corporate headquarters in Hangzhou. So far, it seems, the companies have not produced their innovations as a result of state intervention, but in spite of state interference.

Xi is of course aware of the important role private companies play in research and innovation. But like many other rulers in autocracies, he too is confronted with a dilemma: How to strengthen political control without stifling innovative forces in the economy? The picture is similar at the state's universities, where political influence is also increasing. A good year ago, several of the country's top universities had to delete the passages on academic freedom from their charters. Instead, they now invoke unity and patriotism.

Jack Ma has left the well-trodden path

But how should creative processes flourish against the backdrop of the dominance of political ideology? How can scientific breakthroughs come about without real competition of ideas? Innovations emerge when young people, driven by their courage and spirit of discovery, leave the well-trodden paths, not by walking on predetermined paths. Jack Ma broke new ground when founding Alibaba in 1999.

As the party and state expand their role in research, the risk of distortions and misallocations increases. Subsidies lead to false incentives and deadweight effects everywhere. In China, however, the extent is particularly large. When the government announced a few years ago that it would encourage start-ups in the e-mobility sector, hundreds of new e-car manufacturers emerged within a very short time. Most of the companies have since disappeared; many of the founders had no automotive experience. It simply attracted the money - capital destruction on a large scale. Something similar could happen now in the chip industry. Former finance minister Lou Jiwei described the program “Made in China 2025” as “a waste of money”.

China certainly does not lack talent - on the contrary. China is teeming with ambitious, creative minds, with curious tinkerers and inventors. The many startups that are emerging in the country are proof of this. If the party let the innumerable talents off the political leash one day and gave them more freedom, things would get really tight for western industrialized nations.