Innovation with Chinese characteristics

The night skyline of the Bund in Shanghai.
The night skyline of the Bund in Shanghai.ST PHOTO: CAROLINE CHIA

SHANGHAI • China's slowing growth has dominated global economic news this year - and for good reason. Beyond being the world's second-largest economy, China is the largest manufacturer and consumer of raw materials; so any sign of weakening there is bad news for the global economy. But, while concerns about growth certainly merit attention, they should be viewed in the context of China's longer-term economic trajectory, especially its emergence as a global hub of innovation.

China is not given enough credit for how far it has come as an innovator. And yet, over the next decade, China could become not only the place where global companies conduct research and launch new products, but also the source of a low-cost and nimble approach to innovation that affects competition everywhere.

This conclusion is based on an in-depth research project by the McKinsey Global Institute, which aimed to gauge where China stands in terms of innovation, by measuring innovation's true impact - that is, how commercialised ideas actually fare in markets worldwide.

Using a database of 20,000 public companies representing about 30 per cent of global gross domestic product, we looked at global revenue in industries that fit four innovative "archetypes": customer-focused, efficiency-driven, engineering-based, and science-based. A Chinese industry was classed as strong in innovation if Chinese players were capturing more than 12 per cent of global revenue, the equivalent of China's share of global GDP, in that sector.

The data shows that China has built considerable strengths in industries fitting two of these archetypes: customer-focused and efficiency-driven. The first category includes industries like appliances, in which China has captured 36 per cent of global revenues, and Internet services and software, where China accounts for 15 per cent of global revenues. The second includes the solar-panel industry, where Chinese players have 51 per cent of global revenue, and the textile industry, in which Chinese companies claim 20 per cent of global revenue.

Over the next 10 years, China has a chance to move beyond merely absorbing and adapting global technologies to become a true innovation leader. If it succeeds, fears of a prolonged slowdown that hampers global growth will prove unwarranted.

Chinese companies have prospered in customer-focused industries because they have learnt to tailor their goods to the needs of their country's emerging consumer class. Whereas Chinese companies used to focus on designing products that were "good enough" - not quite matching the standard of Western products, but offering huge cost savings - they are now out to create products that are cheaper and better, in order to satisfy wealthier consumers. The sheer size of China's market - comprising more than 100 million mainstream consumer households - also helps, as it enables companies to commercialise new ideas rapidly and on a large scale.

In efficiency-based industries, China's prowess is rooted in its role as the "world's factory". The country's massive manufacturing ecosystem - 150 million factory workers, five times the supplier base of Japan, and modern infrastructure - enables process innovations that cut costs, raise quality and shorten time to

market. Chinese manufacturers are also moving up the

value chain, building more "knowledge-intensive" products (for example, communications equipment) and developing flexible approaches to automation that blend labour and machinery to maintain responsiveness, while reducing cost.

As for the other innovation archetypes, China has some work to do. To be sure, in engineering-based industries, Chinese companies have had some success.

Indeed, while it takes time to build up a base of knowledge and experience strong enough to thrive in this area, some Chinese industries have learnt fast, partly owing to the government's efforts to facilitate technology transfer with global partners.

Examples include high-speed trains (41 per cent of global revenue), wind turbines (20 per cent), and communications equipment (18 per cent). But plenty of industries have not fared so well. China's car industry, for example, commands just 8 per cent of global revenue.

China has the most catching up to do in science-based innovation, which includes industries like specialty chemicals, semiconductor design and branded pharmaceuticals.

Despite significant investment in technical capabilities - the country spends more than US$200 billion (S$284 billion) annually on research and development (second only to the United States) - no Chinese industry in this area has captured more than 12 per cent of global revenues.

One key problem for China's science-based industries is the long time horizon for new discoveries to be perfected and commercialised. So companies are developing uniquely Chinese approaches to such innovation. For example, to speed up the 15-year process of taking a new drug from the lab to market, Chinese pharmaceutical companies are implementing industrial-style approaches.

Over the next 10 years, China has a chance to move beyond merely absorbing and adapting global technologies to become a true innovation leader. If it succeeds, fears of a prolonged slowdown that hampers global growth will prove unwarranted.

We estimate that innovation in China's service industries could create anywhere from US$500 billion to US$1.4 trillion in economic value per year by 2025.

In manufacturing, where China can use its vast resources to lead the world in an era of digitised manufacturing, innovation can add US$450 to US$780 billion in value each year. This would go a long way toward raising productivity enough to offset challenges like an ageing population.

Most important, China's emergence as a true innovator could turn it into a global R&D hub. After all, unlike today's leading innovators like the US, China offers low costs and proximity to large - and largely untapped - markets, including its own, which enables the rapid deployment of new products. Even with rising wages, Chinese researchers receive only 10 to 20 per cent of what their advanced-country counterparts earn.

With a combination of a massive market, low costs, flexibility and ambition, China offers innovative companies from all over the world the chance to transform their ideas into commercial products more quickly and at lower cost. As more of them recognise this, and move their operations to China, all sorts of markets could be disrupted. And, eventually, the Chinese model of innovation could become the global standard. PROJECT SYNDICATE

  • Martin Neil Baily, Chairman of the United States President's Council of Economic Advisers under Bill Clinton, is Chair in Economic Policy Development at the Brookings Institution. Jonathan Woetzel is a director of the McKinsey Global Institute and co-author of No Ordinary Disruption: The Four Global Forces Breaking All the Trends.
A version of this article appeared in the print edition of The Sunday Times on November 08, 2015, with the headline 'Innovation with Chinese characteristics'. Print Edition | Subscribe