Saturday, October 2, 2010

Innovation in China

China's Innovation Wall
Beijing's Push for Homegrown Technology
Adam Segal
Foreign Affairs, September 28, 2010

In a bid to end its dependence on foreign intellectual property and become a global power in science and technology, China is attempting to foster indigenous innovation. Are the U.S. government and business community right to be worried about threats to free trade and intellectual property rights?

If you want to get to the bottom of indigenous innovation, the Chinese policy so deeply aggravating Western businesses and governments, look at the bottom of your DVD player. Most likely, the machine was made in China. For Beijing’s leaders, that is part of the problem: for every Chinese-made DVD player sold, the Chinese manufacturer must pay a large royalty fee to the European or Japanese companies that patented various components of the unit, such as its optical reader. These foreign firms reap substantial profits, but the Chinese take is extremely small -- and is shrinking further as energy, labor, and commodity prices rise. Policymakers in Beijing, looking to strengthen China’s economy, are no longer satisfied with the country’s position as the world’s manufacturer. Their solution is to break China’s dependence on foreign technology, moving from a model of “made in China” to one of “innovated in China.”

The Chinese phrase for indigenous innovation, zizhu chuangxin, was introduced in a 2006 state-issued report, “Guidelines on National Medium- and Long-Term Program for Science and Technology Development.” The paper contained a curious mix of top-down, state-directed policies alongside bottom-up efforts meant to foster technological innovation. The top-down measures echo China’s old state planning system. They include 20 state-driven megaprojects, including initiatives to develop nanotechnology, biotechnology and new drugs, high-end generic microchips, and aircraft. The bottom-up efforts seem to follow a Silicon Valley model and are centered on university-industry collaboration, small start-ups, and venture capital.

If these guidelines leave the government’s approach to technological innovation somewhat ambiguous, they are clear on ultimate objectives: China will become “an innovative nation in the next 15 years and a world power in science and technology fields by the middle of the twenty-first century.” By 2020, the report states, China should reduce its “degree of dependence on technology from other countries to 30 percent or less” (down from 50 percent today, as measured by the spending on technology imports as a share of the sum of domestic R&D funding plus technology imports). Noting that reliance on other countries--especially the United States and Japan -- is a threat to Chinese national and economic security, the paper calls for China not to purchase any “core technologies in key fields that affect the lifeblood of the national economy and national security,” such as next-generation Internet technologies; high-end, numerically controlled machine tools; and high-resolution earth observation systems.

New Chinese policies prompted by the report have raised the hackles of foreign governments and technology enterprises. In 2009, for example, China’s government, a massive consumer of high-tech products, announced that in order to be a recognized vendor in the government’s procurement catalog, a company would have to demonstrate that its products included indigenous innovation and were free of foreign intellectual property. Yet since R&D is a global, collaborative process, no individual high-tech product is completely independent of technology from outside of China. In April 2010, Beijing ordered those high-tech companies seeking to be listed on its procurement catalog to turn over the encryption codes to their smart cards, Internet routers, and other technology products.
Chinese policymakers are no longer satisfied with the country’s position as the world’s manufacturer. Their solution is to break Beijing’s dependence on foreign technology, moving from a model of “made in China” to one of “innovated in China.”

In addition, China’s failure to protect intellectual property rights (IPR) in the Chinese market -- leading to massive theft and piracy -- is constantly in the background. As Senior Director for Greater China at the U.S. Chamber of Commerce Jeremie Waterman testified before the International Trade Commission in June, a weak legal environment allows Beijing to “intervene in the market for IP [intellectual property] and help its own companies ‘re-innovate’ competing IPR as a substitute to foreign technologies.”

The U.S. government has raised the issue in public. U.S. Treasury Secretary Timothy Geithner, Deputy Secretary of State James Steinberg, and Trade Representative Ron Kirk have openly denounced indigenous innovation and put it on the agenda for discussion at the annual Strategic and Economic Dialogue, the most important meeting between the two countries, and the U.S.-China Joint Commission on Commerce and Trade. U.S. businesses, which typically embrace quiet diplomacy with Beijing, have also publicly voiced their concerns. In a speech in Italy in July, General Electric CEO Jeffrey Immelt said, “I really worry about China. I am not sure that in the end they want any of us to win, or any of us to be successful.” And in a report for the U.S. Chamber of Commerce, business consultant James McGregor wrote that the guidelines are a “blueprint for technology theft on a scale the world has never seen before.”

In the face of this uproar, China has made some concessions. In May, Cao Jianlin, a vice minister at the Ministry of Science and Technology, noted that the 2009 procurement policy was an early draft and that future revisions would address concerns over IPR protection. Beijing has also announced that it intends to join the World Trade Organization’s Agreement on Government Procurement, a treaty that ensures nondiscriminatory access to government purchases for foreign companies, “as soon as possible.”

The problem for the United States is that these concessions are more tactical than real shifts in underlying policy. China’s leadership is broadly committed to the goals of reducing dependence on foreign technology, producing Chinese intellectual property, and creating Chinese technology champions. Even if China reverses certain policies under U.S. pressure, it will remain dedicated to those goals. U.S. policy is likely to become a game of Whac-a-Mole, beating down one Chinese initiative on indigenous innovation only to see another pop up.

That parts of China’s bureaucracy still advocate raising the country’s technological capabilities through trade-friendly policies, such as providing greater transparency and enforcing IPR-protection regulations, provide some glimmer of hope. They have not forgotten that China’s gradual opening to the world economic system brought with it billions of dollars in foreign investment, access to customers and distribution networks worldwide, and technology transfers from the West and Japan. In addition, many Chinese firms are looking to expand abroad, realizing that their global competitiveness will be severely curtailed if the Chinese market is isolated as a result of indigenous innovation initiatives. The challenge for the United States will be to identify and support these kinds of actors as they push against mercantilist policies.

Disputes over indigenous innovation may eventually cast a pall over the broader Sino-U.S. relationship. It is not hard to imagine battles over intellectual property and market share derailing collaborative efforts to address climate change, energy security, or global public health. If both sides fail to develop some common understandings of technology development and trade, the next decade is bound to be one of conflict and competition between them.

ADAM SEGAL is Ira A. Lipman Senior Fellow in Counterterrorism and National Security Studies at the Council on Foreign Relations and the author of the forthcoming book Advantage: How American Innovation Can Overcome the Asian Challenge.

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