Innovation in China: Promise or Pipedream?

If China fails to turbocharge its capacity to innovate, the country will experience a hard economic landing and social stability will be threatened. But can China evolve into an innovation powerhouse? The jury is out.
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If China fails to turbocharge its capacity to innovate, the country will experience a hard economic landing and social stability will be threatened. But can China evolve into an innovation powerhouse? The jury is out.

Innovation elevates labor productivity which provides resource flexibility -- air cover -- to implement fundamental structural reforms which center on two inter-related planks: a) shifting reliance from exports and increasingly-inefficient investment to value creation in service and consumer sectors, and b) maintaining smooth urbanization in an era of pinched labor supply.

The success of companies such as Alibaba, the world largest business-to-business e-commerce site, not to mention a dynamic private sector boasting millions of new online enterprises, are grounds for optimism. WeChat's micro-lending and customer relationship management (CRM) services are testaments to corporate experimentation and economic dynamism.

But a commercial landscape still dominated by sclerotic state-owned enterprises locked in cozy relationships with opaque government entities suggests otherwise.

The Chinese have always been masters of "incremental" innovation.

More than ten years ago, I was taken on a tour of the product development laboratories of Lenovo, now one of the world's largest producers of mobile phones and personal computing devices. Engineers were proud of product enhancements such as spill-proof keyboards to 360-degree swivel screens. Chinese products' relentless crawl up value chains -- from unreliable commodities to affordable and dependable goods with new features -- is proof of intelligent perseverance.

Huawei, a leading telecommunications component manufacturer, has achieved success around the world through what Joy Tan, President of Global Media and Communications, terms "step by step" innovation. In a recent panel discussion sponsored by the American Chamber of Commerce in Hong Kong, she attributed her company's overseas 3G penetration to a "small invention" that lowered site acquisition costs by reducing the size of component boxes.

Lei Jun, the quintessentially imperial chief of gadget maker and "China Dream" brand du jour Xiaomi, is also a proponent of incremental -- or micro-targeted -- innovation. In a recent Wall Street Journal interview, he asserts, "In the past you made a phone, hoping to sell it to billions of users in the world. Now you can't think in this way. You'll have to design different phones for different crowds in different scenarios." In the same article, Lei Jun cites Xiaomi's newly launched model 4C, which enables better Internet connections on high-speed trains, and newly announced virtual SIM cards that offer cheap roaming rates for international travelers. He then asks, "Wouldn't you call this innovation?"

Well, yes and no. It's innovation alright. But not the type of mould-breaking, value-creating innovation Lei Jun claims to admire in brands such as Muji and Uniqlo, Japanese companies that redefine "everyday style" in home furnishing and fast fashion.

China needs non-incremental innovation to escape a middle-income trap and living standard stagnation. The country's growth model is bogged down by structural tensions -- recently manifested as abrupt exchange rate lurches, worrying capital outflows and ham-handed stock market interventions.

"Innovation traditionalism" is no longer enough.

China's economy, not to mention its burgeoning middle class, demands qualitative, not quantitative, evolution. This will require a gradual, albeit fundamental, shift corporate mindset that reveres low price as the ultimate competitive advantage. Industry and government leaders must now focus on margin elevation.

This is not happening, even in new generation sectors. Scores of "online to offline" apps have lost funding because of price war burn out. Theoretically, these services put excess human capital to more productive use and could become platforms of mold-breaking innovation. But most still root appeal in satisfying the Middle Kingdom's most timeless urge: bargain hunting.

I am neither economist or political scientist. Many are more qualified to limn the structural barriers that preclude liberation of China's creative spirit. They are omnipresent, baked into the warp and woof of China's social, political and industrial fabric. They include: non-existent intellectual property protection; defanged commercial courts beholden to local party interests; ambiguous eminent domain regulations; a rigid financial system designed to advance state interests; massive state-enforced capital misallocation; and media controls that pre-empt free flow of information, the life blood of creativity ideation.

China's elemental problem, however, is cultural -- a national "trust deficit." For thousands of years, China has been closed society and, today, so are its corporations. The Middle Kingdom lacks dynamic "networks" that stimulate new ideas and the dynamic collaboration required to harvest them. A few years ago, New York Times columnist David Brooks put his finger on an enduring American competitive advantage:

"The United States is a universal nation. There are already people there with connections all over the world. A nation of immigrants is more permeable than say, Chinese society...Americans build large, efficient organizations that are not bound by the circles of kinship and clan. Study after study finds that Americans are not hierarchical. American children are raised to challenge their parents. American underlings are relatively free to challenge their bosses. In this country you're less likely to have to submit to authority."

The Chinese, defensive and protective, are culturally -- and, therefore, institutionally -- averse to ideas that buck against convention. Chinese CEOs surround themselves with yes-men, allied by blood or geography. The boards of, say, Fujian-based private enterprises are dominated by Fujianese. Within organizations, territorialism is rife. Sales managers vigilantly protect turf, minimizing cross-department teamwork. Resources are rarely pooled for innovation, leading to chronic short-termism. Subordinates, anxious about losing face, never counter senior managers, particularly on "subjective" matters impervious to "proof." Deals with foreign joint venture partners are tortuously negotiated because a win-win mindset is never taken for granted.

China's ossified institutions are reinforced by Xi Jinping's anxiously aggressive regime. But sustainable value creation will depend on the Communist Party resisting an instinctive urge to control -- to have the final say on -- every matter of strategic significance.

Today it's still, "Patents, yes; ideas, no so much."

It can only be hoped the China's summer of tribulation has spurred the central government to reassess is current repressive -- and actually fear-driven -- course.

In Confucian societies, the need to maintain stability is not up for debate. Jeffersonian democracy, born of the Enlightenment, has little relevance, even among internationalized "Post 9os" youth. But the country's institutions need to evolve with the times, lest the Chinese people lose faith in government's ability to slowly but surely implement an economic agenda that bets on genuine innovation to improve the lives -- and the economic prospects -- of both the ambitious middle class and the striving masses.

In paternalistic China, change has to start at the top. If Xi Jinping can be, against all odds, persuaded to dilute Party omnipotence, China might indeed become a place where new ideas flourish to achieve critical mass. If not, let's fasten our seat belts and prepare for a bumpy ride.

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