China ’ s Path to Indigenous Innovation

China’s Path to Indigenous Innovation William Lazonick and Yin Li Conference on Finance, Business Models, and Sustainable Prosperity New York City, NY December 7, 2012

Outline of the paper • Productive capabilities and economic development in China • Infrastructure investment • Physical infrastructure • Human infrastructure • Technology transfer • Sino-foreign joint ventures • Reverse brain drain • Indigenous innovation • Computers, Automobiles, Telecom Equipment, Semiconductors • China in comparative economic development

China’s path: the framework • The analysis of China’s path to indigenous innovation considers dynamic interaction among • Technology transfer from advanced nations • (State) investments in physical and human infrastructure • The formation and growth of indigenous companies

The Theory of Innovative Enterprise: Key concepts and questions Strategic control • Who makes innovative strategy? • importance of the abilities and incentives of those who exercise strategic control in the firm Financial commitment • How is investment in the innovation process sustained? • sources of financial commitment that sustain technological transformation and market access Organizational integration • What types of innovative investments do they make? • need for the organizational integration of skill bases that can generate collective and cumulative learning

China’s Path in Cross-National Historical Perspective An understanding of China’s path to indigenous innovation is important • to China: Will China’s path result in equitable and stable economic growth, i.e., sustainable prosperity? • to developing economies: They can learn from China, and must seek to develop in the presence of China. • to advanced economies: The challenge for the advanced economies is how to remain innovative themselves. For example, major US corporations that are making ample profits in China are failing to reinvest them to upgrade their innovative capabilities in the United States

Outline • Productive capabilities and economic development in China • Infrastructure investment • Physical infrastructure • Human infrastructure • Technology transfer • Sino-foreign joint ventures • Reverse brain drain • Indigenous innovation • Computers, Automobiles, Telecom Equipment, Semiconductors • Comparative economic development

Physical Infrastructure Investment • Investment through government programs and state-owned enterprises (SOEs) • The surge of infrastructure investment in China started in 1993 with the restructuring of ministries into state-owned enterprises • The case of the automobile industry: government investment in road construction and SOE’s capacity of steel production enabled the car industry • The world’s largest steel producer is dominated by SOE steel mills • Highway expansion driven by government programs: National Trunk Highway System (1990), National Expressway Network (2004)

Physical Infrastructure Investment • Increased automobile production enabled by investment in road infrastructure

Human Infrastructure Investment • Education • A commitment of 2% of GDP in education since 1952 except the years of Cultural Revolution (1966-1976) • Compulsory nine years of schooling in the 1990s • Rapid expansion of tertiary education in the 2000s, particularly in engineering

Human Infrastructure Investment Post-secondary school completion rates and average years of schooling, selected nations. Source: Barro and Lee 2010

Human Infrastructure Investment • S&T system • A small elite S&T system established in the 1950s • In the 1980s, establishing national R&D programs • Allowing spin-offs from PROs since 1984 • Transformation of research institutions to business entities (1980 - 1995) • Reorganizing S&T programs and increasing funding (1997- )

Human Infrastructure Investment

Technology Transfer through JV • “Trading Markets for Technology” (1980-2001) • Goal: import substitution and technological learning • Method: foreign companies were invited to invest in JVs with Chinese SOEs in exchange for market access to China • First JV in telecom equipment manufacture approved in 1984 • Heavy investment from the Chinese government in terms of financial and human resources put in • Technology transfer via • Product localization • Training engineers

Technology Transfer through Reverse Brain Drain

Technology Transfer through Reverse Brain Drain • As an outcome of economic development, the inflow of returnees sharply increased in the 2000s • Internet boom in late 1990s brought back the first wave of returnee entrepreneurs • Government strategy of competing for returnees • Liberalization of migration control in the 1990s • Central government’s investment in S&T system created demands for returnee scientists and engineers starting in 1997 • Local governments compete for high-tech ventures founded by returnees

On the path to indigenous innovation China now dominates US Advanced Technology Product imports • China’s share of US ATP imports increased from 5.5% in 2000 to 33.5% in 2011, primarily because of China’s position in US-dominated global value chains • In 2011 China absorbed 7.0% of US ATP exports, after NAFTA nations Mexico (11.1%) and Canada (10.6%) • In 2011 China accounted for 54.0% of ICT imports,30.3% of opto-electronic imports, and 17.1% of weapons imports to the United States • In 2011, ICT represented 88.4% of US ATP imports from China, followed by opto-electronics at 6.1%

China central to globalization of US high-tech US ATP Imports, 2000-2011: % shares, top 10 nations, 2011 Source: www.census.gov/foreign-trade/statistics

China absorbs US high-tech exports US ATP Exports, 2000-2011: % shares, top 10 nations, 2011 Source: www.census.gov/foreign-trade/statistics

Importance of US ATP imports from China, especially ICT and Opto-Electronics Source: www.census.gov/foreign-trade/statistics

Concentration of US ATP imports from China in ICT Source: www.census.gov/foreign-trade/statistics

Indigenous innovation in China Pioneering study of China’s emerging ICT sector, published in 2000 by the late Qiwen Lu Studies of Stone Group, Legend Computer (Lenovo), Founder Group, China Great Wall Computer See the summary of Lu’s work in W. Lazonick, “Indigenous Innovation and Economic Development,”Industry & Innovation, 11, 4, 2004. In 2006, “indigenous innovation” became the centerpiece of China’s Medium and Long-Term Plan for Science and Technology

Indigenous Innovation in the 1980s-- Computer Electronics • The cases of Stone, Legend, and Founder • Non-government S&T companies were autonomous business enterprises allowed by early reform • Availability of S&T infrastructure provides technological resources for indigenous innovation • Stone: electronic printers with Chinese-character output capability • Legend: Chinese word-processing add-on card • Founder: EPS with Chinese-character capability • Restraint from the state in extracting rents from enterprises • Strategic control over revenue allowed firms to invest in R&D and organizational capabilities, while luring key employees from the state sector

Indigenous Innovation in the 1990s-- Automobiles • The cases of SOE and JV automakers • The goal of technological learning in auto JVs was practiced as product localization. • Massive expansion in capacity as a result of this strategy • Neglecting product development resulted in ceding strategic control to foreign partners

All the cars in China • In 2010 China produced 13.9 million cars, 23.8% of the world total, about 37,000 cars greater than the combined production of Japan (8.3 million) as number two and Germany (5.6 million) as number three. • In 2010 no indigenous Chinese companies were represented among the top 16 car producers in the world, although combined the top 16 companies (six Japanese, three each German and American, two French, and one each South Korean and Italian) produced 8.6 million cars in China. • Of the next 27 largest car producers in the world, however, 19 were Chinese, with a total output of 5.9 million cars, or 42% of China’s car production. (Note: There is some double-counting between foreign and indigenous producers because of JVs.) (www.oica.net)

Indigenous Innovation in the 1990s-- Telecommunications Equipment • The cases of Huawei and ZTE • Huawei and ZTE were non-governmental companies excluded by TMFT, but which stressed an indigenous innovation strategy • The indigenous discovery of “HJD-04 ” digital telecom switch model in 1991 • Tapped into technological resources provided by JV investments as well • They grew by committing to technological learning as well as investing in organizational capabilities neglected by MNCs and JVs to cater to the growing Chinese market.

Innovation and competition in the communication technology industy Source: iSuppli

Indigenous Innovation in the 2000s--Semiconductors • The case of SMIC • Returnee entrepreneurs and technologists were allowed to take strategic control of domestic firms • Through the returnee entrepreneurs’ global contacts, such firms are able to tap into a very large pool of engineering and management talent – the expatriate community • Global recruiting accelerates the process of absorption of foreign technologies • Competing local governments are major early investors

Conclusions • China’s Path as an Unfolding Phenomenon: Catching up with History • A case of the success of the developmental state in fostering a dynamic of growth depends on the emergence of innovative enterprises • Future studies should integrate the case of China into cross-national comparative-historical analysis of the process of economic development and changes in international economic leadership • With the framework that we have presented, informed by a theory of innovative enterprise, we can follow China’s development in real time, a process that we call “catching up with history”

Thank you!

China ’ s Path to Indigenous Innovation