How Government Policies and Processes Are Hurting Innovation in China

While China’s development over the last 30 years has been widely characterized as catching up to other, more advanced economies, some observers suggest that continued growth going forward will depend on the country’s capacity to innovate. According to Ernst & Young’s 2012 report, China’s Productivity Imperative, China’s total factory productivity fell from 4.7% during 2001-2007 to 2.8% during 2008-2010. As the opportunities for increased employment of capital and labor decrease — according to China’s National Bureau of Statistics, the size of the country’s labor force shrank for the first time in 2012 — economic theory suggests that sustained growth rates can be achieved only through increased productivity or a higher value produced per unit of input.

Well aware of the changing environment and the new challenges the economy faces, Chinese leaders are heavily promoting innovation. In fact, in 2006, the government released the Medium to Long-Term Plan for the Development of Science and Technology (MLP), its first such plan since joining the World Trade Organization. This key document made indigenous innovation a national strategy for the first time. Over the last few years, these guidelines were supported by further landmark policies, such as the 12th five-year plan released in 2011. A study by Weiguo Pang and Jonathan Plucker of EastChinaNormalUniversity and the University of Connecticut, respectively, found that the frequency of the use of terminologies related to innovation and creativity more than tripled between the 10th and the 12th five-year plans, indicating the government’s increased emphasis on innovation.

Over the last few years, signs of innovation have increased steadily, suggesting that government policies are working. For example, in 2011,China filed more patents than any other country, and in 2012 it became the second-largest publisher of scientific content. In addition, data from the Research Centre for Global R&D and Research (GLORAD) at TongjiUniversity in Shanghai suggest that 255 new R&D facilities opened in China between 2001 and 2010, more than in any other major economy.

While these numbers are clearly impressive, the policies promoting the advances do not support, and might even hurt, the development of innovation.

Patent Quantity over Quality, and Academic Fraud 

In 2011, China claimed the number one spot globally for the number of patents filed. This was attained, in part, after China set targets for the number of patents and tied subsidies to local governments for generating them. However, this “brute-force” strategy has led to skepticism about the quality of these patents. Most of the analysis indicates that patent quality in the country lags behind quantity.

“Certain patent policies in China hamper innovaton in a number of ways. Most significantly, they create incentives for firms to seek more patents without much concern about their quality and sometimes make it difficult to defend against, or invalidate, low-quality patents,” says Dan Prud’homme, a manager with the EU Chamber of Commerce in  China. “This raises the cost of doing business in China and unnecessarily encourages behavior unrelated to innovation.”

A 2013 report in The Economist analyzed the number of places where inventors filed for a technology patent. The theory is that, if the idea has high value, the inventor would want to file in many countries, whereas a low-value patent to obtain a local subsidy would not be filed internationally. Not many Chinese inventors seek to patent abroad — fewer than 5% between 2005 and 2009 — versus 27% and 40% in the U.S. and Europe, respectively. Other analyses from the EU Chamber of Commerce show low scores of patent citations and demonstrate that foreign enterprises typically do not file breakthrough innovations in China. Among most major provincial and national level policies in China, there are more than 80 references to initiatives to improve patent quality. This need for improvement has been raised both internationally and domestically.

Most of the analysis indicates that patent quality in the country lags behind quantity.

Moreover, in less than a decade,China became a major contributor to scientific research, second only to the U.S. in terms of the volume of academic papers published in journals tabulated by the Science Citation Index (SCI). The growth of China’s publication numbers is the result of reformed research incentives. A key policy, for example, ties funding for universities directly to quantifiable indicators, such as the number of citations an institute’s research receives in respectable journals. Hence, many universities have implemented “publish-or-perish” contracts for their academic employees, making publication citations a significant factor for Chinese scholars in their appointments, promotions, and remunerations. A decade ago, publishing was not a key focus area for many Chinese academics. One professor in China noted that he alone was responsible for more than 15% of all the papers published by his university in a certain year prior to the implementation of above-mentioned policies. At that time, many contracts specified a target of one international publication per year; contracts today might stipulate three such publications.

While the policies obtained the targeted effect of increasing the number of publications, their true contribution to science has been less impressive. China ranks only 14th in average citations per SCI paper — perhaps a better indicator of the true scientific value. More importantly, however, the publication pressure generated by the new legislation led to widespread academic misconduct. A recent study by the China Association for Science and Technology found that more than 50% of employees were aware of academic misconduct in their professional proximity. At best, misconduct is the publication of a paper in multiple journals; at worst, it includes plagiarism and falsification of data. During 2012 alone, a leading international science journal had to retract 70 papers from 2007 by two academics from China because all their findings were falsified.

The increasing problem of academic fraud was recognized by the Chinese government as early as 2002, leading the Ministry of Education to publish a series of national policies aimed at eradicating academic misconduct and promoting scientific achievement. In addition, the publishing industry itself is trying to clamp down on misconduct. In 2012, the China Association for Science and Technology issued a new policy under which the editors and presidents of its 1,050 journals must adhere to strict academic guidelines.

Skeptics point out, however, that these policy interventions are not achieving satisfactory results in China, in part because a huge market for fake academic research and commercial papers, generated by an army of ghost writers, places profit far above academic integrity. According to the report in The Economist, this market in China was worth US$150 million in 2009, up 500% from 2007.

Observers contend that unless China reforms its academic-research incentives, which are currently aligned primarily with objective measurements and reward quantity over quality, the country will face major challenges in trying to increase the value of its academic output and attaining the desired level of true contributions to innovation and progress. 

These examples clearly show that many policies related to innovation might have unwelcome consequences that will ultimately hurt the development of China’s innovation capabilities and intellectual capital. With that in mind, the government needs to carefully craft and evaluate any new policies it intends to put in place. This is particularly true for a new policy on inventor-employee remuneration, for which the government released guidelines in 2012. An analysis of the draft rules by international law firm Foley & Lardner titled, “A Proposed Inventor-Remuneration Policy for Innovation Places a Greater Burden on Employers,” suggests that the new rules might have a negative effect on innovation.

In November 2012, the State Intellectual Property Office (SIPO) released new rules on inventor-employee remuneration that increased financial incentives for employees who develop new innovations. While this policy might have a positive effect on strengthening the inventor-employee’s position vis-à-vis the employer, if implemented as proposed it might actually hurt innovation. Foley & Lardner’s analysis identified three key reasons for this:

Increase in the scope of what constitutes an innovation: While previous rules cover innovation in the form of patents, the new rules include, for example, new plant varieties, integrated circuit layout design and technical secrets.

Increase in the financial reward and remuneration: Both reward and remuneration for the inventor-employee are increased significantly under the new draft rules. For example, the financial reward for a patent under the new legislation must be at least RMB8,000 (US$1,300), up from the previous  minimum of RMB3,000 (US$480). Remuneration is increased in a similar fashion.

Less room for contractual exceptions: The new rules limit the possibilities for entities to reduce the right to remuneration if certain conditions are not met. As an example, an employer previously could require the inventor-employee to work for the entity for a certain period of time before earning the right to remunerations and rewards. Under the new rules, such a contractual agreement might be invalid, increasing the financial burden of invention for the entity.

The triple effect of broadening scope, increasing financial reward, and limiting exceptions will increase the burden of innovation for employers. The end result will ultimately not increase but, rather, decrease innovation efforts.

Foreign Talent and Technology

While certain policies might have actually hurt innovation in China, many success stories abound about innovation in the country. This is not a contradiction: Innovation in China is possible despite these policies.

One of the most effective ways that Chinese firms have been able to move up the value chain is by leveraging foreign talent and technology. According to the Brookings Institute, there have been more than 500,000 “returnees” to China — that is, Chinese nationals who studied overseas but have since returned to work in China in academic, science, or business settings. According to a study by the Administrative Committee of Zhongguancun, which oversees the startup scene in Beijing, 25% of startups in the area have been founded by returnees.

One of the most effective ways that Chinese firms have been able to move up the value chain is by leveraging foreign talent and technology.

The Chinese government has instituted programs to tackle the “brain drain” aggressively. In 2008, it launched the Thousand Talents program to attract primarily Chinese-born experts, academics, and entrepreneurs to China. The program provides generous research funding along with substantial housing and tax-free education allowances. In 2011,China expanded the program to non-Chinese-born through the Thousand Foreign Experts program, which is designed to attract up to 1,000 foreign academics and entrepreneurs.

Chinese acquisition of foreign companies as a way to import technology and know-how has increased considerably over the past five years across a number of industries — from Lenovo’s US$1.75 billion acquisition of IBM’s PC business to Shuanghui’s US$4.7 billion acquisition of U.S.-based Smithfield Foods. In 2012, for example, Sany, a Chinese construction-equipment company, acquired the German company Putzmeister, which makes high-tech concrete pumps. Putzmeister was widely regarded for its superior technological capabilities, and, following the acquisition, Sany took deliberate steps to bring the German company’s technological know-how and innovative talent to China.

This acquisition was only part of Sany’s strategic push to focus on innovation by looking abroad. The year before, it opened a greenfield US$100 million R&D plant near Cologne so it could “reach the best global manufacturing and engineering talent to become a world-class company,” according to a January 30, 2012, article in the Financial Times. Although it is hard to judge the long-term success of this strategy after such a short time, Sany has been able to achieve some early gains. For example, joint Sany and Putzmeister engineering teams have already introduced two new innovative products. In addition, the Putzmeister brand continues to perform well financially, with a 30% increase in year-on-year sales in fiscal year 2012.

Another exceptional case of a company that was able to move up the value chain successfully is GE China. Unlike many other multinationals that have relied on “glocalization” — the process of taking products developed in wealthy markets such as the U.S. and making only minor changes to fit the local Chinese market — GE has invested heavily in local R&D in China. Between 2010 and 2012, it spent more than US$2 billion on innovation there, including US$500 million on innovation centers and US$1.5 billion to fund joint ventures with Chinese state-owned companies in the high-tech sector. GE also holds an annual US$100 million green-energy innovation competition in China.

These efforts are part of GE CEO Jeff Immelt’s strategy to rely on organic growth in developing markets such as China. To do this, GE has had to create products that fit the smaller budgets of its Chinese customers and are price-competitive with its local Chinese competition. “The key drivers of GE’s success in innovation in China [include] getting closer to the customer and speaking the same language as the customer,” says Hans Chia, director of market development for GE China. “We find that if we can really understand the needs of customers in China, then we can build the functionality that the Chinese customer really wants and reduce cost over time. Since we do this process in China, the cost of innovation in China is lower than if we had done this in the U.S. or elsewhere. It will take some time, but the early results have been quite encouraging.”

Because local innovation is embedded in its global strategy, GE China has been successful in moving up the value chain in China and has also reaped financial benefits. In 2002, it developed a portable ultrasound device that sold for 15% of the price of GE’s highest-end model. The product not only took off in China, but also entered the U.S. market, where it is used at accident sites and in emergency rooms. According to a Harvard Business Review case study from October 2009 titled, “How GE Is Disrupting Itself,” the company increased its portable ultrasound revenue from US$3 million in 2002 to US$278 million in 2007. GE also has spent hundreds of millions of dollars hosting innovation competitions in China. This began with the launch of GE’s Ecomagination Challenge in 2011, which awards US$100 million annually to innovations in gas power, and has since expanded to a similar challenge in breast cancer detection. These initiatives have reaped significant financial benefits for GE, and they highlight the importance of market mechanisms, rather than government policies, in driving successful innovation.

Where innovation policies and success stories are concerned, one could conclude that the misguided policies are primarily the result of state-led innovation, while the successes are the result of market-based entrepreneurship. It suggests that the current model of centrally identified prioritization, funding, and research should be amended to include stronger market mechanisms. For example, it is often noted that the system for allocating funds should be geared toward deserving companies that are small- to medium-size enterprises rather than state-owned enterprises. Along these lines, the Chinese government recently announced construction of the Shanghai Free Trade Zone, a testing ground where the government is expected to allow for the liberalization of investment, foreign exchange, trade, and manufacturing. Although details have yet to emerge, the Xi-Li administration has stressed its desire to have the government limit its scope. The new experiment in Shanghai could herald the beginning of a new round of market-led innovation in China.

Yet the state should still have processes for measuring the growth of innovation in China. These processes, however, should be based less on quantitative targets for the number of patents and more on other aspects that gauge innovation, such as the European Union’s Regional Innovation Scoreboard, which measures a wide range of metrics that include the percentage of small- to medium-size enterprises introducing a product, and patent revenue derived from abroad, as noted by the European Chamber of Commerce. Additionally, financial incentives for patents should be based on criteria reflective of quality. “Financial incentives for innovation should not be tied to the front-end for having a patent approved. Incentives should be rewarded on the back-end,” says Tony Chen, a partner in patent litigation at Jones Day based in Shanghai. These alternative measures could encourage a long-term perspective on risk taking that is necessary to drive break-through innovations in China.

In addition, scientists also argue that the state must do more to protect intellectual property rather than merely promote the increased creation of knowledge. According to The Global Competitiveness Report 2005-2006, countries with strong intellectual property protections are more innovative than those with weak protections. Intellectual-property protection reduces the risks associated with innovation. Without these protections, those who invest in innovation — be it inventors, companies, or investment funds — are less likely to take the gamble.

This article was written by Lori Hu, Lorenz Kazda, and Cathy Li, members of the Lauder Class of 2015.

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