Calibrating Chinese creativity

“YEAH, the Chinese can take a test, but…they’re not terribly imaginative. They’re not entrepreneurial. They don’t innovate—that’s why they’re stealing our intellectual property.” So declared Carly Fiorina, a former boss of Hewlett-Packard, shortly before announcing her candidacy for America’s presidency earlier this year. Ms Fiorina’s provocation fuelled a global debate over one of the big business questions of the age: can China innovate?

Sceptics make two arguments. They point to the historically lax protection of intellectual-property (IP) rights and the proliferation of copycat business models in China as evidence that Chinese companies cannot create for themselves. An article published in MIT Sloan Management Review last year claimed that Chinese theft of IP costs American firms $300 billion a year. Nay-sayers also argue that the heavy-handed approach taken by China’s government to promoting innovation is in fact retarding it.

Two new publications bang the drum for the opposite side of this debate. “The China Effect on Global Innovation”, a study by the McKinsey Global Institute (MGI), the think-tank of the eponymous consulting firm, argues that Chinese companies do indeed show promise. MGI does not fall into the common trap of conflating innovation with invention: “The proof of successful innovation is the ability of companies to expand revenue and raise profits,” as opposed to filing lots of patents that never get used, or releasing a stream of novelty products that fail to generate a return. And “China’s Disruptors”, a book out on July 14th, by Edward Tse, a management consultant, argues that China’s dynamic private sector has risen with the help of, not despite, government policies on innovation.

The MGI team scrutinised financial data on 20,000 firms from China and elsewhere, to see if they create value for customers and shareholders. It weighed up the extent to which they do so through such things as basic research, by throwing large numbers of engineers at problems (as firms like Huawei, a telecoms-equipment maker, are good at doing), by improving manufacturing processes, and so on. China has spent years, and large sums of money, trying to be an “innovation sponge” that absorbs foreign technologies. Despite this, notes the MGI report, it still lags the West in creating world-class medicines, civil aircraft and cars.

However, it finds that in many other sectors, China is now taking a global lead in two areas of innovation: in improving consumer products and the business models used to sell them; and in making manufacturing processes cheaper, quicker and better. As a result, Chinese firms now outsell foreign rivals in such things as household appliances, internet software and consumer electronics. They are helped by the fact that their home market is so huge. But they are also fleet of foot. Chinese consumers are ready adopters of smartphones, social media and e-commerce, as well as being value-conscious and brand-licentious. If consumer firms can make it in China, they can make it anywhere.

Chinese firms are inventing new business models. The West’s online firms generate most of their revenue from advertising. But China’s advertising industry is only about one-eighth the size of America’s, so Chinese digital firms have had to find new ways to monetise their users’ eyeballs. Tencent generates 90% of its revenue from online games, sales of virtual items on social platforms and e-commerce. Average revenue per user in 2014 was $16, which was $6 more than Facebook. YY.com, an online-video platform, lets viewers buy electronic “roses” to shower upon video artists whose shows they enjoyed. YY says its top performers, who get a cut of the revenue, can earn more than 20,000 yuan ($3,200) a month, seven times the average factory worker’s pay.

What about the other argument, on the role of the state? The pessimists argue that China’s bureaucrats are bad for private-sector innovation. In a sense Mr Tse is an unlikely person to be challenging this view. He was the top China man for the Boston Consulting Group and then for Booz & Company (two rival consulting outfits). His book chronicles in compelling detail the rise of the mainland’s entrepreneurial economy from the ashes of Maoist policies. And yet this arch-capitalist insists that, “Companies alone cannot make the massive long-term commitment of resources needed to drive innovation in many crucial areas.” Just as American public spending on universities and defence research boosted Silicon Valley’s early stars like HP, in China too, “the state has to lead the way.” He is encouraged by the fact that China now spends more than $200 billion a year on research and development (public and private), putting it above the European Union as a proportion of GDP, though still behind America.

Mr Tse also points to evidence that, he argues, shows how China’s regulatory and legal infrastructure is becoming more “innovation-friendly”. Baidu, China’s biggest internet-search firm, used to be notorious for hosting pirated music and videos. Thanks to regulatory crackdowns and legal challenges from rights holders, it has cleaned up its act and has become a big, legitimate distributor of foreign TV shows.

Setting the stage

Ms Fiorina is right that most Chinese firms are not at the cutting-edge of technology, but she is wrong to say they are incapable of value-creating innovation. HP itself has been overtaken by Lenovo of China as the world’s leading computer-maker, helped not just by its bold acquisitions of Western businesses but by its impressive in-house product development. And Mr Tse is right that there is a role for government in setting the stage for innovation. However, in civil aviation and carmaking, the government is also dictating the structure of the industry: in planes, through a state-owned national champion, AVIC; and in cars, via forced partnerships with foreign firms. Chinese firms can innovate. But its government has not yet learned to distinguish between helpful support and counter-productive meddling.