All Wheels in One Direction: China’s Unique System for Innovation

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The Chinese character xīn (新) means ‘new’. Another character pronounced xīn (心) means ‘heart’ or ‘where the consciousness lies’.

Brazen, unapologetic in its nationalistic fervor and gripping, the Middle Kingdom’s heart and consciousness lie in the ‘new’. Founded on a revisionist narrative of China as the great Middle Kingdom, backed by State apparatus capable of pushing big policies and funded by deep pockets, China is fast emerging as a technological superpower.

Ten years ago, if you were to walk across the shopping arcades of Zhonguancun, the electronics hub in northwestern Beijing, you would find a swath of products that were clones of western gadgets.

Not anymore. Wiped by decree, Zhonguancun has become China’s innovation hub with real estate venture capitalists and innovation parks working closely with researchers from the neighboring Peking and Tsinghua universities and co-working spaces flooded with advanced computing start-ups.

Zhongguancun, the electronics hub in Beijing

From Made in China to Created in China

China has always presented a curious case for economists.

Its exports reflect an economy that should have roughly three times its per capita income. It has managed to pull roughly 700 million people out of poverty in the last 30 years (the details are debatable, but the trend is real). It has time and again proved doomsday predictors wrong about its economy.

Conventional economic wisdom in isolation can’t get anything related to China right! To really understand China’s rise as a technological superpower, one needs to first understand how China works.

Imagine a giant company. The people in the company argue among themselves, it is ridden with internal politics and bonuses are based on merit and bootlicking. But to its stockholders, the company presents a hunky-dory picture with a skillfully crafted bottom line. Different departments in the company take up different tasks – but all are in line with the leadership’s singular vision.

China functions something like this company.

State apparatus is deeply embedded everywhere that market forces drive the economy to ensure they do so only in accordance with State directives. While such a framework has multiple flaws, it allows China to push through sweeping policies that can cause a complete industrial overhaul of the economy.

Tsinghua Holdings Corp, Ltd offers an example of how this functions. The corporation is a wholly owned subsidiary of Tsinghua University, one of China’s leading universities for STEM courses and often referred to as the ‘MIT of China’.

Tsinghua Holdings controls a 51 percent stake in Tsinghua Unigroup, which owns multiple subsidiaries that design, develop and market wireless system-on-chip and radio-frequency semiconductors for cellular, connectivity and broadcast use. The remaining 49 percent stake is owned by Beijing Jiankun Investment Group, an asset management firm led by Zhao Weiguo, deputy director general of the China High-End Chip Alliance and who Forbes called the “Man Spearheading China’s Chip Ambition.”

Tsinghua Unigroup in turn is partly funded – to the tune of $1.6 billion – by China’s National Integrated Circuit Investment Fund (National IC Fund). In 2015, Tsinghua Unigroup made a $23 billion bid for Micron Technologies, a US based world leader in memory chip manufacturing (a deal scraped by the US Committee on Foreign Investments) and continues to invest in strategic IC industries.

Additionally, there is the Chinese American Semiconductor Professional Association (CASPA), which holds dozens of events per year in China and Silicon Valley to recruit foreign talent and overseas Chinese students who studied in the west and gained experience in Silicon Valley.

When the State and the Party – overlapping, yet separate – announced its intent to turn China into a semiconductor superpower, all wheels were set in motion in the same direction. Private capital and entrepreneurs aligned themselves accordingly because having government support is the best way to succeed in China. Such is the nature of Chinese industrial policy making.

What we see in the above example is a coordinated action combining three key strategies: indigenous scientific research and human capital from universities; access to strategic foreign technologies through State backed capital; and institutional investment vehicles strategically investing to support not just domestic product innovation but also process innovation.

One can argue that such actions are “inconsistent with the liberalization agenda of WTO rules that aim to restrict discriminatory, arbitrary and non-transparent trade actions by member states,” but when has that stopped China? Made in China 2025, which aims to grow 10 advanced high-tech industries by the year 2025, is explicitly labelled by the Chinese Ministry of Industry and Information Technology as “not an official policy target”, but for all practical purposes, it very is.

source: subchina.com

Research and Development

One of the key factors essential for successful technological absorption in an economy is a strong absorptive capacity. For high-tech industries, it is essential to have domestic research facilities. Even if they cannot produce breakthrough innovations, they are essential to absorb foreign knowledge.

In India, such knowledge passes through increased FDIs and international collaborations. I remember going to the offices of DJI Drones, the world leader in innovative drone manufacturing, in Shenzhen and finding that almost half the company staff – some 6,000 employees – were engaged in research and development. This was a particularly high ratio seen only in mature companies and representative of strong innovation capability.

DJI drones

The trends are apparent at the macro level as well. Preliminary calculations from the Chinese National Bureau of Statistics show that research and development spending in China rose 11.6 percent year-on-year to 1.75 trillion yuan ($280 billion) in 2017, which is roughly 2.12 percent of China’s GDP. Just to highlight the magnitude of this ratio – India’s expenditure on education is 3.7 percent of its GDP.

Source: National Bureau of Statistics

It is also interesting to note that the focus of this research is mostly on experimental development, not on applied or basic research. Such research is often based on theoretical scientific discoveries made in the west, and helps advance the necessary domestic industrial growth.

Source: National Bureau of Statistics

Deep Pockets and Strategic Investment

Two close friends working on AI policy design visited a Chinese think tank based out of Shanghai and presented their research findings. After their presentations, the think tank asked them to sign an agreement to accept a hefty payment for sharing their findings.

Startled by the offer, they refused, stating that their motivations were entirely academic in nature. This evoked a certain disappointment among the hosts: the think tank had been receiving giant sums of money from the local government to support its research on AI and had nothing on which to spend that money. The leaders wanted to disburse the funds to avoid a slash to their budget.

This experience describes the nature of many ‘strategic investments’ – it is not always a smart use of capital.

Nevertheless, the strategy to acquire foreign firms in strategic industries using State-backed credit can be called a smart one. The same Chinese practice is also responsible for its high debt to GDP ratio. Between 2010 and 2017, Chinese investments in early stage Artificial Intelligence companies in the US accounted for roughly $1.3 billion when spread across 81 deals.

No wonder Donald trump is obsessed with China.

Trump’s obsession with China

Civil-Military Fusion

Looking back, one can see the close relationship between military engineering and technological invention.

GPS was built by DARPA (Defense Advanced Project Research Agency), the US Pentagon’s far out research agency, during the Cold War to aid in evacuation of cities in case of a nuclear attack.

SIRI, the voice assistant on our iPhones, was also developed by DARPA as CALO (Cognitive Agent that Learns and Organizes) alongside the Stanford Research Institute to provide military generals with a virtual office assistant. Apple ended up buying the technology.

The CIA formed In-Q-Tel, a non-profit, to support commercial technologies that collect and analyze intelligence. Since 1999, the company has grown to support 59 IT companies in Silicon Valley. In fact, Silicon Valley was set up during the Second World War by the US Department of Defense and DARPA – with support from Stanford – to focus on research and development of new advanced technologies.

China understands the importance of civil-military technological fusion.

In January 2017, Xi Jinping launched the Central Commission for Integrated Military and Civilian Development to coordinate civil-military fusion efforts in key technologies under Made in China 2025. At the third meeting of this committee, Xi emphasized the strategic importance of unifying China’s commercial economy and defense industrial base. As the second largest military spender in the world, the Chinese are investing heavily in military innovations. They are not just buying equipment – which offers little return on investment to the technological and absorptive capacity of the country.

Xi at the meeting of Central Commission for Integrated Military and Civilian Development

Looking from China – the Case for India

Technological upgrade and innovation are key drivers of any modern economy.

As an Indian living in China, it’s hard not to feel distressed when I compare Internet commentary about the Internet existing during the times of Mahabharata with jingoistic narratives of politicians eager to turn China into a technological superpower.

The technological temperament of India is antithetical to the administration’s desire to convert the country into a hub for advanced manufacturing and innovation. As India prepares to announce its new industrial policy by midyear – the first update since 1991 – it will face a series of challenges to achieve its goals.

The most difficult of these will come from within.

Ravish Bhatia is a Yenching Scholar at Peking University and a Frédéric Bastiat Fellow at the Mercatus Centre of George Mason University. He writes on innovation economics, China and India. He tweets at @RavBhatia.

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