Chinese Innovation Policy: Achieving the “Harmonious Society”

After its tremendously rapid growth and incredible rise to one of the top economies in the world, China now has to face the challenge of ensuring continued progress. Over the past 15 years the Chinese economy has expanded by an average of around 10% a year. It’s hard to say yet whether this will be a sustained “normal” growth path, though Chinese manufacturers seem to continue to have markets, as this remarkable export driven boom has yet to show any major signs of receding. Given this however, the Chinese government has still been putting immense effort towards the sustainability of development: economic, social and environmental, a sentiment clearly stated in the OECD Review for Innovation Policy for China.

FDI Flows to China

From MOFCOM FDI Statistics; OECD

How to Sustain Growth?

China is aware of its new challenge as its recent capital sourcings and restructurings have indicated. GDP growth in recent decades has been mainly due to this factor, together with the increasing quality of education. The next step is a shift towards a higher technological macroeconomic curve, the one that collects the whole set of capabilities and skills of the sector, the one that enables the full exploitation of labor and capital previously accumulated, capital that was imported from abroad as technology was. In fact, until recently, scientific and technological capabilities in China have comparatively lagged behind the process of development in the country.

China has relied heavily on technology imported from abroad, and the development of its scientific and technological capability has until recently lagged behind its economic growth. This trend was reversed towards the end of the last decade and since then, significant progress has been made towards developing the country’s innovative capabilities. This is the core point: innovation policy must promote these features, as growth must be underpinned by economic reform.

China Sources of Output Growth

Breakdown of the sources of growth from 2005 OECD Economic Survey of China

Increases of these factors and their sustainability must be achieved, along with a push in Innovation Policy. Efforts are –and were- spent to change Chinese economic framework: the major efforts being in shifting from state driven to private and entrepreneurial driven. It is clear from the graph below (from the OECD Review of Innovation Policy in China Report) how much, and in a very few number of years, the process has been taking place. The private economy is what makes an economy self sustainable, and allows it to grow. Both quickly and efficiently, China has increased the size of the contribution of its “entrepreneurial economy”, subsequently also becoming a more efficient economy overall, as the Chinese suppliers of growth are primarily from the private sector, rather than state driven.

Still, some key issues remain. As we can see in the table from OECD Report below there are pros and cons, for, for example, someone wanting to establish an R&D facility in China.

Motivations for and barriers to foreign RandD in China

Source: OECD on the motivations for and barriers to foreign R&D in China

Benefits of Growth

Despite the drawbacks, new actors have been allowed to emerge alongside the state-owned enterprise. Reforms are aimed at transforming the economic system into being more modern, market-oriented, and corporate based. The increasing role of market forces has facilitated the country’s integration into the global economy, with mutual benefits for China and for the rest of the World:

  • Overall, openness has helped China make better use of its comparative advantages and become a major trading nation, thus putting Chinese manufacturers in high demand all over the world.
  • Openness to international trade and FDI has allowed China to become a major export platform for multi-national enterprises, in particular for Chinese suppliers of manufactured goods (being dubbed “the workshop of the world” as companies continue to increase China sourcing efforts), but increasingly people around the globe are not just looking to buy direct from China but also for other activities.
  • Openness has generally led to greater competition in product markets and increasingly in markets for services. More vigorous competition forces discipline on Chinese firms, helping to lower prices and ensure better quality and a wide variety of goods. This therefore tends to strengthen incentives for innovation in the Chinese economy.
  • While the foreign-invested sector of the economy is relatively small in terms of its share in total employment, its labor productivity is high. As a consequence, it makes a large contribution to the aggregate output of all China suppliers, accounting for more than half of China’s exports. Foreign-invested enterprises therefore contribute significantly to China’s economic growth.
  • FDI (Foreign Direct Investment) has provided access to technology, know-how and skills.


Drawbacks of Growth

Again, a lot of issues remain unresolved as there are still changes that need to be made. Mainly we talk about path-dependencies that make it hard to achieve the goal of equality and sustainable growth, or what can be known as the “harmonious society” that the Chinese government aims for. Consider the following:

  • China’s GDP is unevenly distributed, particularly between the wealthier coastal provinces where most of the Chinese manufacturers are located and the less developed western parts of the country. In fact, income disparities between urban and rural areas have only continued to increase with growth. In a most rural areas, poverty remains a serious challenge.
  • China is undergoing a fundamental demographic change, owing to a rapidly aging population. It may be difficult to maintain the current high savings rate as the population ages, and indeed – in contrast to the developed world – China might be aging before it reaches the levels of GDP/capita of developed countries.
  • China’s export growth has been largely based on the expansion of low-wage manufacturing, mainly from coastal Chinese suppliers, utilizing imported components, equipment and technology.
  • Large migration flows have contributed to rapid urbanization, which in turn has exerted pressure on the social fabric and the social environment of the country.
  • China’s economic growth has induced high demand for energy and raw materials. Moreover, rapid economic growth, industrialization and urbanization are leading to environmental degradation damaging the population’s health. Ecological challenges may eventually limit China’s further economic development.

Innovation Investment

At US $73.5 billion in purchasing power parity (PPPs), China’s GERD (Gross Expenditure in R&D) was the third largest worldwide in 2006, after the United States and Japan. This is a remarkable achievement. The mission is nowhere near accomplished however. The most pressing tasks include:

  • Setting framework conditions that are conducive to innovation. Some, such as well-functioning markets, sound corporate governance and financial institutions, may not be specifically aimed at fostering innovation but may have a significant, indirect impact. Others, such as the legal protection of intellectual property rights and the setting of technological standards, may have a more direct effect on innovation, as well as further encourages those from abroad to buy direct from China if their IP is protected.
  • Developing and implementing policies to encourage science, technology and innovation in the presence of market or systemic failures, such as provisions of financial support for R&D.


The 2006 “Medium-to-Long-Term Strategic Plan for the Development of Science and Technology” (also referred to as “The S&T Strategic Plan 2006-2020” in the quoted OECD Synthesis report) sets out the key objectives and priorities in science and technology. The main goal is to make China an “innovation-oriented” society by the year 2020. And the Chinese government does not hide its aim of achieving this status of the world’s leading “innovation economy”. A framework of conditions for innovation has been laid out setting up a large scope for improvement. Goals to achieve and key points of the policy are:

  • Education
  • Competition
  • Corporate governance (to achieve the goals of transparency and efficiency)
  • Financing innovation
  • Intellectual property rights protection
  • Technological standards
  • Public procurement (currently about 2% of GDP, it is still far below the levels in more developed countries)
  • The regional dimension (to combat against geographical inequalities)
  • Human resources for science and technology (initiatives to make returning to China for Chinese nationals more attractive by loosening restrictions, such as granting special permits for entering and leaving the country so that returnees can continue to work abroad while also working in China, development parks and incubators, tax incentives and project funding..)
  • Domestic business sector (The most R&D-intensive firms have usually emerged from the public research sector, indicating a need to continue pushing in this area)
  • Foreign firms (These have been important actors involved in the development and catch-up process. Spillovers of knowledge and capabilities can benefit the Chinese)

The results, up to this point, demonstrate that China recognizes the challenges it faces. The country is aware of its actual condition and knows what it has the potential to achieve. This promises a bright future of continued growth in China, a pattern that can only be sustained through continued investment in innovation and technological improvements.

  • Marco Tommaso Rossini- CPG Marketing Intern

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