
Asia is slowing down. Growth will struggle to top 4 percent in 2022, with China growing at under 3 percent. Given that China has been the most powerful locomotive of Asian growth in recent decades, the implications of this are highly significant, not least for the world economy.
Most explanations for the slowdown have focused on short-run pressures from China’s zero-Covid policy and the unfolding fall in real estate values. The implications for financial and government institutions’ balance sheets are potentially serious. Whether the policy response is to try to stabilize the situation by raising debt further while continuing along the high investment, low consumption path is yet to be seen. Some have even suggested that China runs the risk of being the next Japan.
Lurking not so far beneath these challenges lies an even more fundamental question: Can China become a successful location for broad-based innovation? That challenge is not particular to China; the rest of emerging Asia will have to move away from its reliance on extensive growth — based on adding ever more capital and labor — towards innovation as the main driver of future prosperity. China has put in place many of the fundamentals for innovation-led growth. The question now is whether Beijing can realize its ambitious plans to become an innovation powerhouse.
Some innovation rankings — such as World Intellectual Property Organization’s Global Innovation Index – place China below, but close to, the U.S. for every component, bar the quality of its institutions… But these statistics are not all they seem.
The evidence is mixed. For sure, Chinese policymakers have understood the importance of innovation. That is reflected in the targets set by various Five-Year Plans and other strategic documents, such as Made in China 2025. The government has picked strategic sectors and goals, and while these have changed over the years, the emphasis on technology has always been clear. Artificial intelligence, electric vehicles and batteries, aerospace, fintech, next generation IT, robotics and biotechnology are among Beijing’s priority areas, with both civilian and military dimensions. Recent targets include 12 percent growth annually in the number of patents, 7 percent annual spending growth on R&D and enhanced shares — often 50 percent or higher — for domestic production in favored industries.
Some of these goals have been met. Patents have grown exponentially and patent applications per million of population have exceeded the U.S. every year since 2017. R&D spending has also grown to around 2 percent of national income each year, mostly by private businesses (although the boundaries between private and public are very blurred). That is below the U.S. or South Korea but is still significant. Some innovation rankings — such as World Intellectual Property Organization’s Global Innovation Index – place China below, but close to, the U.S. for every component, bar the quality of its institutions. So far, so good.
But these statistics are not all they seem. For a start, the boom in patenting is mostly for applications: only a quarter to a third are ever granted, a share far lower than in the U.S. The flood of applications likely reflects a response to government targets, a form of virtue signaling. Most patents are for improvements to existing products or incremental innovation for the domestic market. High quality patent applications, which seek international protection, have been increasing but are barely 5 percent of the total. And looking at how R&D translates into high quality patents — a measure of efficiency — China under-performs a large sample of countries, based on our recent research.
What of the strategic sectors that the Chinese government has selected? Again, the story is mixed. For example, although China now accounts for around 15 percent of the global supply of industrial robots, their quality is lower than those produced elsewhere. Large investments in aerospace and civil aviation have finally resulted in the construction of a domestic aeroplane (COMAC’s C919), although over 40 percent of its core components are imported and deliveries to local airlines — the only likely market — have yet to happen. Other parts of the long shopping list of priority sectors have similarly failed to register much progress — an outcome familiar from the Soviet Union’s experience.
For sure, considerable progress has been made in some activities and sectors. Aggressive targets and subsidies have helped to drive sharp increases in electric vehicle and battery production. There are now over ten major Chinese EV producers and one, BYD, recently overtook Tesla for the largest number of sales globally. Chinese EV exports more than doubled between 2020 and 2021. In Thailand, for example, Chinese manufacturers’ market share is expected to top 80 percent by 2023. This rapid growth has been based on low operating margins, large government subsidies and very supportive policies for promoting EVs in large cities, although China is unlikely to have its own way for long: Those government subsidies will likely decline, as they are time-limited, while foreign competitors are now strengthening their product lines.
For batteries, Chinese companies’ position appears even stronger. Across the battery supply chain, their market share ranges between 60 and 80 percent. The largest EV battery makers — CATL and BYD — have achieved huge scale and lower unit costs than their competitors, not least because of substantial support from government.
…the continuing reliance on government and its shifting priorities risk making broad-based innovation through the economy a chimera.
In AI, China is now the second largest investor globally after the U.S. and accounts for the largest share of journal citations along with over half of all AI patents filed globally. Big Chinese companies, such as Baidu and Tencent, are leaders in corporate AI research and applications. This reflects the explicit government strategy of trying to concentrate AI in a few large, and compliant, companies. Public funding is also skewing AI research towards security priorities, such as facial recognition and monitoring systems.
Chinese innovation, still largely driven by government set goals, has undoubtedly come a long way. Yet there are three factors that are likely to hold it in check in the future. The first — and most profound barrier — flows from the political context. Put simply, autocracies are not good places for invention and creativity, the wellsprings of innovation. Those thrive in more tolerant settings where risk-taking and experimentation are also accepted.
Second, policies aimed at raising domestic market shares for production, such as China has been pursuing with semiconductors, can be hostage to external relations: witness the recent and harsh U.S. sanctions on chip-related exports to China. Third, the apparent shift back towards a more state-directed economy carries the risk of a reversion to earlier failures. Having done much hard work in creating science and research capacity, along with some of the infrastructure for innovation, the continuing reliance on government and its shifting priorities risk making broad-based innovation through the economy a chimera.

Simon Commander is Managing Partner of Altura Partners and Visiting Professor of Economics at IE Business School.

Saul Estrin is Professor of Managerial Economics at the London School of Economics.