China’s Innovation Dilemma: on the way to a miracle or a paper tiger?

Last month, the scandal of Chinese start-up Redcore raised the question of innovation once again. The start-up, branding its browser as the one and only innovative and world-leading browser created all by itself, managed to raise $60m from venture capital investors over the past four years. However, the browser then turned out to be a version of Google Chrome after a series of decompressing. Despite China’s resplendent achievements, it seems that it still has a long way to go when it comes to innovation.

Innovation and development: A virtuous cycle

A brief glance at history reveals that when moving from developing countries to developed ones, countries would normally experience a transition from a focus on low skilled to high skilled/innovative sector. The interacting force behind it is not hard to see: a developed country is more conducive to human capital, which gives it a comparative advantage in the high skilled sector; on the other hand, the high-skilled sector yields a high added value, which accelerates economic growth.

But this virtuous cycle is not automatic, at least now for China.

While China has been proud of its sustained and high economic growth, people are also worried about its long-term sustainability. For the past several decades, there are two overwhelming man-made forces behind China’s economic miracle: real property and infrastructure. The former was the solution for the declining trade due to 1997 Asian Financial Crisis and the latter was for the 2008 global financial crisis. Currently, China is facing the trade dispute with the US, people wonder how much it could stand the potential impacts.

Nevertheless, the general trend of declining trade in the low-skilled sector when China’s labor becomes more and more expensive has forced China to rethink its path. The government has made several attempts, including the Thousand Talents Program, which seeks to recruit leading experts and researchers. The founder of the Redcore is, ironically, a member of the program. Many people argue that the key is not in the hands of a few government initiated programs.

The Innovation Dilemma

One crucial factor behind innovation is intellectual property (IP) protection. China has been charged with stealing US firms’ IP including film, software, and counterfeiting of pharmaceuticals or luxury goods. The lack of a mature IP protection mechanism in China does not only harms the fairness of trade but also hinders the growth of domestic innovative companies. The absent of IP protection give false incentives to people to make counterfeits, and many start-ups in China will necessarily have to compete unfairly with them.

In addition, ignoring IP protection is likely to foster a rent-seeking and speculative culture. Investments in the real economy (the parts of the economy that actually concerned with the production of goods and services, as opposing to buying and selling at the financial market) would become less attractive when the benefits of top performers are not secured. Instead, with the help of loose regulations in the financial market, investors turn to short term gains from speculations (or even manipulations) in the stock market. The large volatility of China’s stock market is part of the indicator of such trend.

Such culture for rent-seeking and speculation would finally result in a misallocation of resources. The best students are flocking to finance or economic institutions when the rewards of financial industries become exorbitantly high compared to others. Within the industry, rent-seeking behavior reduces the ability of the competition mechanism to rule out the bad firms. Across nations, there is also an outflow of human capital, where many potential scientists leave to study in the US and then finally settle down there.

A Culture for knowledge, rules, and morals

Hua Min, a professor at Fudan Institute of World Economy, states in a speech on China’s economy that the rising of capitalists may only benefit a few, but the rising of entrepreneurs is certainly a good thing for the majority. Currently, there is an undersupply of scientists, researchers and entrepreneurs in China, which ultimately lead to an undersupply of innovation.

Instead of a culture of speculation, short-term gains, and cheap labour, the path of China’s road to a more developed economy is innovation.

IP protection should be enforced to ensure that the innovators can secure its rewards in the private sector, which is a much more efficient and cost-less measure than largely supporting researchers using government funding. Innovation, therefore, would be rewarded through market mechanism when firms are playing by the rules. Such measures will certainly bring painful short-term costs, since with IP protection prices of many products would have to rise to reflect its actual value, and how to buffer the negative impacts would be important for China to consider.

However, in the long run, firms are incentivized to consider its long-run sustainability through innovation and providing better products. It is very likely that a fair and stable environment for firms to compete would have positive spill-over effects on the society in the form of a higher valuation for knowledge, rules, and morals, all of which would be the fundamentals of the virtuous cycle.

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