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China’s Innovation Policies – The Real Danger for the U.S Economy???

China’s Innovation Policies – The Real Danger for the U.S Economy???

U.S. experts and politicians are starting to hone into the ‘dangers’ of R&D and technology transfers to China, as the most serious long-term threat to the U.S. economy and national security.  U.S. comparative advantage (innovation and new technologies) is being undermined by outsourcing of manufacturing to China, the relocation of R&D facilities to Chinese tech-parks, the forced technology transfers required for access to the Chinese market, and the continuing theft and lack of government enforcement of intellectual property rights (IPR)… all this according to witnesses testifying at a U.S.-China Economic and Security Review Commission (USCC) hearing last week.  (Testimonies available at the USCC website – transcripts of the hearing to follow)

The path to China’s industrialization is well documented, as is the role of foreign companies and the government’s industrial policy.  Once China was the proverbial ‘wild west’ where multinational corporations could move production, use China as an export platform, and enjoy enormous profits.  With time, Chinese officials have learned how to use multinational companies to advance the Communist Parties objectives for growth and technological development.  First they forces multinationals to form joint ventures with national champions and transfer their latest technology to Chinese companies in exchange for current and future access to the domestic market.  Now they demand that companies transfer to China their cutting-edge research and development labs (R&D) along with manufacturing and production.

The WTO has broad prohibitions on forced technology transfers and local content requirements, but these provisions are complex and easy to subvert.  Couple that with China’s absence from the WTO Government Procurement Agreement (which requires that government companies and entities engaging in commercial activity do not discriminate on the basis of nationality) and the dominant role of State Owned Enterprises (SOE’s) in China, and Beijing can do whatever it wants in terms of innovation policy.

Most China experts in the U.S. believe that China’s hi-tech achievements are based upon foreign investment in the country, government procurement regulations, compulsory licensing of patents or improvements of existing foreign patents.  However, Alan Wolff testified at the USCC hearing that China uses a variety of promotional measures to spur innovation, most of which do not differ that much from those of its trading partners.  “It fosters STEM education, and graduates a prodigious number of engineers each year.  It supports research consortia and builds enormous science and technology parks.  It is increasing public spending on R&D.

And then there was ‘Indigenous Innovation’ –

Even China’s ‘Indigenous Innovation’ policy is viewed with suspicion and objection, considered by most U.S. experts and politicians to be either forced technology transfer or technology theft.  It originates from its National Medium- and Long-Term Program for Science and Technology Development (2006-2020), and it is identified as a guiding principle for China’s “great renaissance”.  For China, “indigenous innovation” is defined as “enhancing original innovation, integrated innovation, and re-innovation based on assimilation and absorption of imported technology” through the creation and use of Chinese intellectual property owned by Chinese companies to improve China’s national innovation capability.  (For more see: “China’s Perceived Threat to Transatlantic Security” by Mei Gechlik)

China has already been very successful at extracting technologies out of multinational companies, building the internal capacity of its own SOE’s, and then excluding the foreign companies from the Chinese market.  Notable examples include high-speed rail equipment and systems, wind, solar, telecommunications hardware, and auto-parts (soon to include whole cars).

The U.S. Office of the Trade Representative (USTR) considers China’s ‘Indigenous Innovation’ policy highly controversial and harmful to U.S. interests and international trade.  It has consistently demanded concessions from the Chinese government, and during recent meetings has gotten commitments from the Chinese: to delink innovation policies from government procurements preferences, make innovation policies consistent with WTO principles of non-discrimination, ensure strong IPR enforcement, and to allow technology transfer and production process agreements between individual entrepreneurs free of ‘government interference’ and consistent with WTO rules.

The U.S. perspective –

On the other hand, the USCC has been highly critical of the lack of urgency on the part of the U.S. government officials in recognizing the link between outsourcing of manufacturing and technological innovation, as well as the long-term implication for the U.S. economy and national security if China overcomes America’s comparative advantage.  During last week’s hearing, Commissioners pondered the appropriate U.S. government response to China’s innovation tactics.

Witnesses testifying at the USCC hearing last week offered the usual recommendations on how the U.S. should content with China’s innovation policies.  They recommended that the U.S. government monitors more closely Chinese policies that cause competitive harm to U.S. commercial interest, and litigate WTO cases more aggressively.  They also recommended a more intensive and continuous dialogue with the Chinese government, with prompt, effective and full compliance by China of its existing commitments.

However, the stronger recommendation was directed towards domestic U.S. policies, and the need to develop a comprehensive and strategic approach both towards China and with regards to innovation.  Simply put, if the U.S. government wants to maintain its competitive advantage in innovation and new technologies it will have to adopt some of its competitor’s policies: develop national champions, better target venture capital, fund basic R&D, improve universities and facilitate science parks, improve retention of high-skilled immigrants, and better fund and promote STEM education

On the other hand, some Commissioners asked whether now was the time to be tough with China, considering all the recent political and economic developments.  Due to rising prices and the rising inflation in China, the leadership transition that is taking place in the next couple of years, and the influence of the ‘Arab Spring’ on people’s minds and attitudes, now might be the best time to push the Chinese government on IPR and currency manipulation.  Therefore, a lot of experts have been advocating for a tougher U.S. policy towards China, one that includes high (punitive) tariffs for IPR violations and the continuing manipulation of the Chinese currency.

China is still a developing country –

As a national strategy, China is trying to build an economy that relies on innovation rather than imitation.  Chinese leaders recognize that real economic value lies with design and promotion of advanced high-tech products rather than being the world’s low-cost workshop for assembling.

Last year, the State Intellectual Property Office of China published the National Patent Development Strategy (2011-2020).  According to the patent office, it is China’s goal to drastically increase the nation’s production of patents to as much as 2 million annually by 2015.  In 2009 alone, China produced close to 600,000 patents, while the U.S. only produced 480,000 during the corresponding 12 month period.  Quality of patents aside, the Chinese government has introduced an array of incentives to lift its patent count.  They include cash bonuses, better housing for individual filers and tax breaks for companies that are prolific patent producers.  (When Innovation, Too, Is Made in China)

From Beijing’s point of view, China has paid a huge amount of royalties for technology import while the U.S. is still hampering China’s development with restricting on hi-tech exports to the country.  China’s ‘Indigenous Innovation’ policy will no doubt affect the old order and tip the old balance as technology exporting countries lose their leverage in the market.  China has to pursue innovation any way it can, in order to further develop and grow, and if the U.S. cannot rebalance the situation by adjusting its domestic policies, it will only end up like all the other countries which lost their competitive advantage to a new emerging power.

On the other hand, a new book about Chinese innovation (Run of the Red Queen), analyzed in a recent article by the Economist (Bamboo innovation), argues that it is wrong to equate innovation solely with the invention of breakthrough products.    “In an emerging economy, other forms of innovation can yield bigger dividends.  One is ‘process innovation’: the relentless improvement of factories and distribution systems.  Another is ‘product innovation’: the adaptation of existing goods to China’s unique requirements.”  Therefore, China’s current ‘comparative advantage’ is as the world’s middleman: being both part of product innovation and production, and being proficient at adopting new ideas for the mass market and global distribution.

In Conclusion –

China’s development efforts and its pursuit of ‘indigenous innovation’ are only natural, and a part of the countries evolution in the ever changing world we leave in (thank you globalization).  Those in the U.S. concerned with China’s innovation policies should look at the growth and evolution of Japan during the past 30 years.  Inventing new products and new technologies has always been the result of free enterprise and creative imagination (requiring a culture which tolerates risk and embraces uncertainty), something that command and control economies (like Japan and China) do not possess.  Therefore China, like Japan, is great at perfecting existing products and improving production methods, but not at creating new technologies and new innovations… at least not yet!



Nasos Mihalakas

Nasos Mihalakas has over nine years of experience with the U.S. government as a trade policy analyst, covering U.S trade policy, globalization, U.S.-China trade relations, and economic growth through trade. Mr. Mihalakas holds an LLM from University College London, and a JD from the University of Pittsburgh, with a BS in Economics from the University of Illinois. He has worked for both a Congressional Commission advising Congress on the impact of trade with China and for the U.S. Department of Commerce investigating unfair trade practices. Mr. Mihalakas expertise's also include international trade law, international economic law and comparative constitutional law, subjects which he has taught as an adjunct professor during the past couple of year. Currently, he is an Assistant Professor of International Business at SUNY Brockport.

Areas of focus: China, International Trade, Globalization, Global Governance, Constitutional Developments.
Contact: [email protected]