This was my undergraduate honors thesis on Chinese entrepreneurship and innovation, inspired by China’s rise over the last decades to the global economy. I thought I’d share it, in case anyone would be interested to read parts of it, or use it as a foundation for their own work. Please attribute where appropriate.

Introduction

One of the great phenomena over the last thirty years has been the rise of China, or rather the return of China as one of the world’s preeminent powers. It has seen annual economic growth of ten percent over the past thirty years, ranks first in the number of foreign exchange reserves with over $1 trillion, and ranks second in terms of direct investment behind the United States. (Bergsten, Gill, Lardy, and Mitchell 2006) However, according to the CIA World Factbook (2012), China is still poor with its average per capita income still being much lower to that of its American counterparts. It was an anomaly that for the past two centuries, China’s economic power was minuscule compared to that of the West. As for eighteen of the last twenty centuries, China was in fact the largest economy in the world. What triggered the return to Chinese ascendancy? Surely market reforms are one answer and are accountable for China’s spectacular rise. Before market reforms were in place, bureaucrats were running China, and it was only when Deng Xiaoping took the reign of China’s leaders, he set up a new path for China and transformed his country through reforms and embracing market principles.

The bureaucrats that were in charge of China’s political system before Deng Xiaoping had no respect for the market and instead of letting the market determine prices; they — the bureaucrats — were setting them. (Bergsten, Gill, Lardy, and Mitchell 2006) The new leader Deng Xiaoping, turned the situation around by creating a system that through reforms, became more responsive to supply and demand, while also improving efficiency. What further accelerated the process was China’s open policy by which foreigners were enabled to come into the country and take advantage of opportunities there. An example is Apple, which has moved its entire supply chain to Asia. This has been accelerated by a shift in foreign investment flows since the recent recession, in which faster growing economics have become more appealing to investors and businesses. (Hannon and Reddy 2012)

This helped to transform China and bring forth a new era of economic success in China. Deng Xiaoping liberalized trade, and created a framework by which investments increasingly flowed into the country. This has made China one of the world’s open economies, in which trade accounts for over two thirds of its GDP. (Bergsten, Gill, Lardy, and Mitchell 2006) This has also made Chinese companies more competitive as foreign companies have increased the operational standards. The West has dominated China and other East Asian nations over the past two centuries, but with debtor nations now in the West and creditor nations in the East, that picture might soon be about to change. Within the next thirty years, likely sooner, China will have overtaken the United States as the world’s largest economy. That is an event that has not occurred since the end of the 19th century when the United States took the reign for the world’s largest economy.

China’s challenges are numerous. Its political system is inadequate, at least to Western people that value democratic principles very highly, and it may be put into question to what extent citizen will allow its government to have so much power in the future. The gap that has widened between rich and poor needs to be addressed, and urbanization problems will be popping on a scale unimaginable in the West. China’s hunger for commodities will continue to rise, and China’s current engagement in Africa is testament of that. For example, the Chinese have planned to build an entire road from Cairo to Cape Town. Africa is a continent abundant with commodities, and increasingly Chinese businesses have gone there to take advantage of the rising need that China needs to meet. In addition, China’s cities are polluted, and energy is wasted like it is in few countries. More than one hundred million migrants are moving into cities seeking jobs, which is likely to cause further strains on local governments and lead to more political demands. China’s labor is not that cheap: its wages are 1/30 that of the US, and productivity is even lower. Neither is China abundant with labor as a rapidly aging population translates into labor shortages. (Bergsten, Gill, Lardy, and Mitchell 2006)

The consumer market is changing rapidly as China begins to develop a middle class. (Hexter 2007) This will bring in a new era, and innovation may be the key to that transition. In fact, China is in the transition of transforming itself yet again, in which they are moving away from their export driven growth towards more consumption driven growth. Innovation is a top priority on the agenda of the Chinese, and this makes it an appropriate topic to study. Once upon a time China was among the world’s leading countries of inventors, but that picture has changed over the last few centuries, and especially recently where China is more known for its cheap, mass manufacturing than its creative ideas. It will be this shift that is underway that this thesis seeks to capture.

The structure of this thesis will be as follows. As this thesis will heavily focus on technology innovation, it is appropriate to discuss what innovation really means. The first chapter will be about defining innovation, and setting a model from which further analysis can build. The following chapter will tell the story of the status quo, of how products are made in China, but assembled in California. It will use the interplay of Apple and technology with China as a method to tell this story. The third chapter will put the thesis into the framework of whether or not the US is in decline and discusses the economic shift to the East, and the next chapter will tell a story of Chimerica. The substantive part will focus on both sides of the innovation coin, and analyze to what extent China can deliver its promise on becoming a more innovative nation. Lastly, in the conclusion I will briefly summarize and offer further questions that need to be answered for further research.

What is innovation?

It seems appropriate in a discussion of innovation to set up a framework as to what exactly counts as innovation. There is often confusion between innovation and invention. While the two are somewhat related, they could not be more different. The Merriam-Webster dictionary defines an innovation as a new idea method, or device or the introduction of something new, while an invention is being defined as a productive invention. To capture the essence of innovation, a broader definition is necessary:

[It] converts ideas, inventions and discoveries into new products, services, processes and business models. It is important to emphasize that innovation is more than research and product development: that users must perceive an advantage to pay for the innovation: and that innovators are not just founders of Internet start-ups, but that they continue to play a critically important role in manufacturing, including seemingly low-tech industries like textiles or bulbs. (Ernst 2011, 3)

These definitions may not be useful though in distinguishing invention from innovation apart. Invention is usually associated with the creation of something new, a product that comes into existence for the very first time, while innovation has more to do with the process of improving upon an existing product. This goes back to the old discussion of reinventing the wheel. While the very first wheel probably constitutes the invention, reinventing the wheel and improving upon it can be considered innovation. Therefore, innovation is much more common phenomena as history shows nothing is truly new and is always building on something that already exists. As Isaac Newton has exclaimed, if he has seen further it is only by standing on the shoulders of giants. One good example of innovation is Steve Jobs’s iPhone. While the introduction of the iPhone was not the first phone, let alone smartphone that has been brought to the marketplace, by combining certain features Apple was able to achieve something new regardless. It introduced a phone that was simple to use, but had an attractive user interface at the same time. In order to understand the distinction between invention and innovation better, this analogy below makes it quite clear:

If invention is a pebble tossed in the pond, innovation is the rippling effect that a pebbles causes. Someone has to toss the pebble. That’s the inventor. Someone has to recognize the ripple will eventually become a wave. That’s the entrepreneur. (Tom Grasty 2012)

Balasubramanian (2012) has identified five dimensions of the framework for conceptualizing an idea. First, competitive advantage, or the key differentiating factor that makes the idea different from that of its competitors. Second, business alignment, which means that the innovation needs to be in alignment with the direction of the company. Third, customers, meaning in order to be innovative one needs to understand one’s customers and what they need. Fourth, execution, for an idea to take fruit it needs to be executed, and fifth, business value, estimating the value that the product will bring to the company.

As we can see innovation is not something that is particularly tied to one region. It can happen anywhere, and the purpose of this thesis is to see whether or not, and to what extent innovation will be arising from other countries, in particular China. In the past, the West may have had predominately been in the driver’s seat of innovation, but that may be about to change, or at least the gravity just as the economic gravity already has may begin to shift towards the East. This does not necessarily mean that innovation will cease to happen in the West, but merely that as other are catching up economically, it is logically the next step become more innovative in order to increase the output of the economy even further, and be part of a larger portion of the global value chain.

Made in China, Designed in California

If there is one region in the world that epitomizes innovation in the world, it is without a doubt Silicon Valley. Especially in terms of technology innovation, the companies that have come out of that region are truly phenomenal. Its shining star, Apple has been so successful in the last decade that at one point last year it had briefly surpassed Exxon Mobile as the world’s largest corporation. Apple’s profits in 2011 alone have been $400,000 per employee, which is even more than that of Goldman Sachs. One major factor behind Apple’s success can be found at the back of any of Apple’s devices such as the iPhone, which bears eight words: assembled in China, designed by Apple in California. Rewind back one hundred years to 1912. Manufacturing and design were not separated to the same degree that they are today. Neighborhoods such as the Garment or the Meatpacking district were places as the names already suggest of manufacturing. Adam Smith (1776) argued that one of the ways to improve a product is being able to see how it is assembled. Today, although design and manufacturing are geographically separated, it scarcely seems to matter, or at least for now as the United States remains the most innovative country in the world. It was not so long ago that Apple was manufacturing their products in the United States, and it has been only over the past few decades with the rise of Asia, especially China, that the supply chain for companies such as Apple has been completely outsourced. The constellation by which innovation comes out of the West, and manufacturing out of Asia may therefore not necessarily stay fixed, and may shift in a similar way as manufacturing has shifted in the past decades. The economy that is poised to overtake the United States as the largest economy in less than a decade is not regarded as a nation of innovators, and many people regard China as a country where companies go to in order to produce goods cheaply. Many regard the Chinese as people who are only able to copy technology from the West, and not as people who can invent and innovate. The hypothesis of this thesis is then to test to what extent the constellation of “assembled in China, and designed in California” will be shifting. However, before we can analyze to what degree innovation is shifting, we need to understand why Apple has moved those manufacturing jobs to China in the first place. And the answer is not cheap labor, as many would assume.

It was in February last year when President Obama convened a dinner with technology leaders to discuss the shared goal of promoting American innovation. (Charles Duhigg and Keith Bradsher, 2012) Ever since the financial crisis, many Americans have been wondering why companies such as Apple are not bringing back those jobs to the United States. So when President Obama asked Steve Jobs during that dinner what it would take to make iPhones in the United States, he was barely alone in asking such a question, especially considering the high unemployment rate. It seems puzzling to many Americans why they cannot do the same work. While many assume that companies such as Apple have outsourced their manufacturing due to the low wages in those emerging markets that is only a small part of the answer. In fact, labor constitutes only a small fraction of the final price of a technology product. (Duhigg and Bradsher 2012) Steve Jobs’s answer that those jobs are not coming back must not have been a satisfying one to the President. The obvious reason why American jobs or for that matter many jobs in the West have been outsourced to countries such as China is that wages in China are only a fraction of what they are in the West. And that is probably true to a certain extent. However, instead of cheap labor, what draws companies such as Apple to move their entire supply chain to China is “the vast scale of overseas factories as well as the flexibility, diligence and industrial skills of foreign workers.” (Duhigg and Bradsher 2012, 1) There is one telling story that the authors disclose that demonstrates why it goes beyond cheap labor. It was in 2007 when Steve Jobs was working on the new iPhone, and requested a glass screen that would not scratch, when it became apparent that a US manufacturer that initially received the contract would not be able to do the job of a Chinese manufacturer. Duhigg and Bradsher explain the dilemma:

Apple had already selected an American company, Corning Inc., to manufacture large panes of strengthened glass. But figuring out how to cut those panes into millions of iPhone screens required finding an empty cutting plant, hundreds of pieces of glass to use in experiments and an army of midlevel engineers. It would cost a fortune to prepare.

The Chinese plant eventually got the job, according to Duhigg and Bradsher, because they were able to provide glass samples, free of charge and an on-site dormitory filled with engineers that were available around the clock willing to experiment how to cut the glass precisely at a very small price to their American counterparts. One Apple executive that was being interviewed explained: “The entire supply chain is in China now… You need a thousand rubber gaskets? That’s the factory next door. You need a million screws? That factory is a block away. You need a screw made a little bit different? It will take three hours.” (Duhigg and Bradsher, 2012, 5) Another executive said: “the scale is unimaginable” when he was stuck in a river of employees streaming by. Duhigg and Bradsher further report that the scale at which China is providing engineers cannot be matched by the United States. (Duhigg and Bradsher, 2012, 6) To find the same amount of engineers, which will take nine months to find in the United States, took fifteen days in China. This shows the sheer scale, which is just not comparable to that of the United States. Another supply demand manager of Apple said: “They [Foxconn Technology] could hire 3,000 people overnight… what U.S. plant can find 3,000 people overnight and convince them to live in dorms?” (Duhigg and Bradsher, 2012, 6) Therefore, as we can see through many observations of Apple executives, the reasons stretch beyond cheap labor. Duhigg and Bradsher summarize that it would require much more than hiring Americans to bring back those jobs. In summary they say that through their many interviews with Apple executives they have learned that the American workforce with the skills that Apple requires is not large enough and factories in Asia are much faster and more flexible. (Duhigg and Bradsher, 7)

Therefore, as Apple represents many other U.S. companies that have outsourced their manufacturing operations to Asia, we can safely assume that in the near-term future, it will be difficult to overhaul the entire industry in favor of returning those jobs to America. Most likely if a process is brought back from China to the US, then it will probably be done by machines, not by hand. (Forbes July 2012 Now Apple’s Manufacturing Is Leaving China)

The more interesting question is to ask what will happen to the other side of Apple’s coin of success, namely the creative part that is responsible for the innovation that is happening within Apple. Will innovation slowly shift in the same manner as manufacturing has over the past decades? Today only few would bet that designed in California could some day read designed in Beijing or Shanghai, but it may not be as far off as is commonly believed. Assuming that the shift in economic power towards Asia will continue, for the purposes of this thesis, the thesis will explore how this will affect the global landscape of innovation. In order to do that, we first need to explore the economic shift that has taken place over the past decade, from what some people call a transition from a unipolar into a multipolar world. Therein lies the debate whether the US is in decline or not, which may help us to determine whether the US is losing its edge on innovation or not.

From a Unipolar to a Multipolar World

One of the greatest trends of the last decades has been the economic shift to the East, in which the center of economic gravity is slowly shifting away from the West. A shift in power is interesting for a discussion of innovation, as innovation leads to economic growth, while economic growth leads to power. That trend has brought forward much discussion about whether the United States is in decline or not. In fact, there are two pieces of conventional wisdom pertaining to the debate whether the US is in decline or not. The declinists view sees the US being in relative decline to China, and this being the result of globalization. An alternative view suggests that US power is not in decline, and the US is deriving advantages from globalization and using it to its benefit. The purpose of this chapter is then two-fold. In the first part, I will acknowledge that the world is slowly shifting away from a unipolar towards a multipolar world, or a Post-American world as Fareed Zakaria (2008) sees it. Historian Niall Ferguson calls this the economic power shift from West to East. An ascending China alone may signal the end of the unipolar moment. In the second part, I will demonstrate that the United States should not be underestimated as it is now by many declinists, and that it will likely remain in the pole position in the race for globalization. US power may be constrained, but it will not diminish. Even though there are promising contenders to US power on the horizon, the US for the next decade or two is likely to remain leader of the global world. Therefore, we are witnessing a transformation in the world by which power becomes dispersed, not only between nation-states but also between different stakeholders in society. American primacy is then not in demise, but instead being redefined.

The term unipolar moment refers to the period, immediately following the collapse of the Soviet Union, in which the United States as the unchallenged superpower constituted the center of world power. (Cox 2007) Declinists emphasize the value of history, and assert that the global economy resembles those of past eras, by which the US will decline just as British power has declined in the 20th century.

The likely contender to replace the US as the hegemonic power seems to be China. Kissinger (2011) admits that China’s quest for equal partnership with the US is no longer an outsized claim of a vulnerable country given its increasingly financial and economic capacities. This seems to validate the declinists view, and there is a strong case made that with China catching up economically, it will be able to challenge US power. Joffe (2009) refers to a study by Goldman Sachs, which estimates that the Chinese economy will have overtaken the US as the largest economy by 2050. Goldman Sachs recently lowered this figure to 2027, however. “We are living through one of the most astonishing shifts there has ever been in the global balance of financial power; this the end of an era, stretching back more than a century, when the financial tempo of the world economy was set by English-speakers, first in Britain, then in America.” (Niall Ferguson 2008, 285) The recent growth in China seems to confirm this trend. The Chinese economy over the past thirty years has grown at an annualized rate of 9–10%. (Ferguson, 2004, 136) Many argue that America’s fear of China is unwarranted, and they point to Japan, which was predicted to overtake the US by the turn of the last century. However, the rise of China is much more credible if we consider China more as a continent than as a country. (Ferguson, 2007, 287) China constitutes one fifth of world population, and is the third largest country by territory. Even if China’s political system might not be regarded as sustainable, its economic machine based on capitalism is functioning. This makes China even more threatening in a way than the Soviet Union, which did not have a functioning economic model. David Li (2011) thinks that this trend, which was started by Deng Xiaoping when he opened up and reformed the country, is likely to continue because the new generation of Chinese people are not satisfied with the progress that has been made. China is already asserting influence, and this is testament of the transition that we are witnessing from a unipolar to a multipolar world. China’s rise has lifted millions of people out of poverty, and Li contends that in international relations China is looking for peace and collaboration. (Li 2011, 165) This has given hopes to the poor in the world, and China’s model of social and economic institutions gives the world an alternative model to the Western way of governing a country. After the financial crisis, trade patterns were shifted and China discovered that its most dynamic market is its internal one. (Ferguson 2008, 289) All this suggests that the unipolar moment is slowly eroding. China is likely to grow in magnitude over the coming decades, and not rely so much on exports but instead develop its own domestic market.

The issue is two-fold: how China uses its growing capacities and secondly, whether the US and its allies have the willingness to adjust to the new international environment. (Kissinger 2011, 234) This shows that even though the unipolar moment might come to an end, this will not necessarily undermine US power. To Kissinger, the challenge is whether America can redefine itself after its century of progress and similarly how China redefines itself when it absorbs its economic growth. (Kissinger 2011, 255) By cooperatively accommodating China into the international system, the US can potentially reaffirm its global leadership. History suggests that a clash between a rising and a stagnating or declining power is not necessarily peaceful, but it is hard to make predictions, especially in a rapidly changing globalized world, on whether China’s rise will precipitate a decline in US power or rather strengthen it.

Even if we take China’s rise as a given over the next few decades, and acknowledge that China will be a credible contender to the US’s status as a superpower, and further discount any other internal problems such as political ones that might stop China’s rapid growth rate, we should still not underestimate the United States. China’s rise does not necessarily mean the demise of American primacy. At the moment, the US remains entangled in one of the worst economic crisis since the Great Depression, and is the largest debtor nation in the history of the world. Moreover, the recent partisan standoff over raising the debt ceiling suggests the American political system is losing the capacity for compromise on basic issues, let alone on large-scale problems. (Michael Beckley 2011, 20) But Winston Churchill once said that the Americans would always do the right thing after having exhausted all the alternatives.

There is good evidence to suggest that the US will maintain its leadership position in the world. The United States now formally guarantees the security of more than fifty countries, has fought twice as many wars after the Cold War as during it, and spends 25 percent more on defense today than it did in 1968 at the height of combat in Vietnam. (Beckley 2011, 24) China’s military spending in comparison is miniscule. The World Bank recently calculated that 80 percent of the wealth of the United States is made up of intangible assets, most notably, its system of property rights, its efficient judicial system, and the skills, knowledge, and trust embedded within its society. (Beckley 2011, 27) This is something that declinists often do not price into the relative decline of the US to China. In effect, the United States is more like a sponge, steadily increasing its mass by soaking up ideas, technology, and people from the rest of the world. (Beckley 2011, 30) At the moment it seems that the United States’ economic, technological, and military lead over China will remain an enduring feature of international relations, not a passing moment in time. It will be a deeply embedded condition that will persist well into this century. (Beckley 2011) Globalization, then, may not be a neutral process that diffuses wealth evenly throughout the international system, but a political process shaped by the United States in ways that serve its interests. Beckley (2011) concludes that the US does not face a hegemonic rival, and the trends favor continued U.S. dominance. Therefore, there are still presently strong indicators, which suggest that despite the rise of China, the US has a good chance of fulfilling the leadership position within that newly designed international architecture.

Most IR theorists did not foresee the end of the Cold War in Eastern Europe, nor the collapse of the Soviet Union, nor the East Asian Crisis, nor Japan’s swift transformation in the 1990s. Therefore, any prediction on whether the US is in decline or not is really hard to make. Will historians look back at the recent global financial crisis as a trigger that shifted economic gravity away from the US, or will it be seen as an opportunity that redefined and rejuvenated America? Only time can tell. For now it seems reasonable to assume that China’s rise will continue, and the US power will endure and not falter. Therefore, innovation, a subset of power, may not shift from one country to another, but rather disperse among many countries.

Chimerica

It is by studying the relationship between the United States and China that will give us one major clue to why China is poised to become a more innovative nation. As China will need to move away from its export-driven growth towards one that stimulates their domestic market and consumption, it will be necessary for China to become more innovative in the process. In their analysis of “Chimerica”, a coin termed by Niall Ferguson and Moritz Schularick in 2007, conclude that Chimerica cannot persist much longer in its present form. Building on their research, we can infer given the current economic power shift towards Asia that the next logical step to fuel China’s growth will be to become more innovative. Chimerica is being defined as the dual country of China plus America, “which accounts for just over a tenth of the world’s land surface, a quarter of its population, a third of its economic output and more than half of global economic growth in the past eight years.” (Ferguson 2008, 336) Ferguson and Schularick in their analysis compare Chimerica as a marriage, in which Americans did the spending and Chinese did the saving. According to their view, for the past decade the world economy has been dominated by that economic constellation, which combined Chinese export-led development with US over-consumption. That was a remarkable period leading up to the financial crisis of 2008 when interest rates due to the enormous excess savings by Chinese was being kept down, and allowed American consumers to receive loans that they otherwise would not have been qualified for. Ferguson and Schularick argue that this relationship may end in the future and it already has changed due to the financial crisis, as exchange rate imbalances may no longer be sustainable in the long run.

This analogy is appropriate, as it seems to show a pattern by which capital flows between the largest two economies are in the process of changing. From this we can at least suspect that the current paradigm of made in China, designed in California may also be in the process of changing. Ideas generally follow the flow of capital, and with China being the largest creditor nation in the world, we can infer that this will translate into innovation sooner rather than later.

Innovation made in China

Even though innovation in technology is still predominately coming out of Silicon Valley, there are nevertheless encouraging signs coming out of China that indicate that China is in fact no longer a place where products are only being manufactured. One has to keep in mind though, that in any country as large as China, the need for innovation will remain limited until the country has been further developed. In their race to catch-up, China is still predominantly occupied with bringing their own economy to the same level as that of Western economies. Naturally it will not be able to be at the forefront of cutting edge technology innovation over the next five years, but innovation is likely to be possible coming from within China sooner than many people assume. For example, in a study done by McKinsey they have found that “breakthroughs… generally go unrecognized by the broader global public.” (Gordon Orr and Erik Roth 2012, 2) They subsequently argue that when European and US consumers think about what China makes, they think of basic items such as textiles or toys, and not necessarily innovative products.

But China is already innovating. The global percentage of patents granted to Chinese inventors has doubled since 2005. (Orr and Roth 2012) They also further report that China has due to the government’s emphasis on the innovation already created the seeds of 22 Silicon-Valley like innovation hubs. McKinsey makes a specific example of how innovation in China is sometimes missed because it is unique to China:

Look, for example, at the online sector, especially Tencent’s QQ instant-messaging service and the Sina corporation microblog, Weibo. These models, unique to China, are generating revenue and growing in ways that have not been duplicated anywhere in the world. QQ’s low, flat-rate pricing and active marketplace for online games generate tremendous value from hundreds of millions Chinese users. (Orr and Roth 2012, 3)

Thus, China has already learned to take innovation from the West and tailor it to their domestic market. In terms of renewable energy technology, McKinsey predicts that China will soon become the world’s largest market. The report further acknowledges the joint venture between GM and Shanghai Automotive, which has resulted in a Chinese version of a US minivan. Victor Kwok-King Fung (2012) recognizes China’s potential by referring to China’s large domestic market, which resembles the US market. This means that companies can scale quickly. Further, a business can expand rather quickly since buyers across regions use the same products. For example, buyers in New York and Los Angeles are almost identical, and so the same goes for buyers in Shanghai and Shenzhen. Fung also refers to the improved physical infrastructure that is likely to draw in more entrepreneurial activity. The high-speed train that connects cities such as Beijing and Shanghai in less than five hours with trains running at a speed of 300 km/h is only of the few railway tracks that are now connect major cities along the coast in China. When one lands in Beijing or Shanghai airport, one has more the impression one is landing in a developed country. Airports are equipped with high-speed Internet, boast state of the art design and conveniently connect to the city. Over the next decade China is planning to expand its number of airports by one hundred. China is also attempting to rethink how it is using its vast rivers and waterways to provide an additional low-cost model to transport goods. Fung (2012) also refers to the access that Chinese entrepreneurs have to venture capital and private equity. These Chinese networks may not be equal to Silicon Valley, but do constitute a real way for Chinese entrepreneurs to turn their ideas into reality by having access to funding.

Sue-Lin Wong (2012) tells the story of entrepreneur Lei Jun, who is considered to be one of the more successful entrepreneurs among the Chinese: A billionaire and an engineer by training, Mr. Lei co-founded Kingsoft, one of the best known Chinese software companies, more than 20 years ago and remains its chairman. He has also been a successful investor in several other Chinese start-ups. One of the firms Mr. Lei founded, Joyo.com, largest online retailer of books, music and movies in China, was sold to Amazon for $75 million in 2004. (Sue-Lin Wong 2012, 2)

In terms of a more macroeconomic picture, China’s spending on research and development is phenomenal. According to Orr (2012), China’s is spending upwards of 1.5% of GDP on R&D, which accounts for 12% of global R&D spending. It is often said that innovation cannot be imposed from the top down, and the Chinese government is somewhat aware of that. As a result, increasingly this research flows into large- and medium-sized enterprises. One successful example of a company that has turned research into a successful piece of innovation is Huawei, a leading global information and communication technology solution provider. The company is credited for having developed the first 100G technology that is capable to deliver large amounts of data wirelessly over long distances. Orr (2012) describes China’s path towards an innovation nation as a policy challenge, which is possible to be overcome if China can provide the right incentives, develop its scientists, engineers and entrepreneurs in a way that will make them ready to compete in the global market. When the CEO of Coca Cola recently criticized the US tax rules, he also mentioned that China has now become a better place to do business than the US. This increasingly shows the awareness of global companies that to be able to grow and compete in the 21st century, one has to be in China. (Rappeport 2011) DreamWorks Animation has recently partnered with China’s largest media firms to open Oriental Dream Center, an initiative to create an entertainment hub in Shanghai. (Verrier 2012)

There is much distrust in the West towards China, and many hope that China will stumble eventually. It is also often said that China is simply capable of copying Western technologies. Quelch (2011), however, argues that when the Chinese can no longer make easy money imitating, they will start innovating. He argues that over the past decade China has delivered economic growth, citizens’ trust in government is high, and equally high school math scores in Shanghai rank among the highest in the world. They are also aware that under the current situation, China is not capturing most of the value. Even though China is still predominately manufacturing products for Western brands, the Chinese know that it is much more profitable to be innovative and have a brand such as Apple that is globally recognized. On a different note, Quelch has also observed that Chinese know much more about America, and Americans know about Chinese. The Chinese understand that in order to be more competitive like America, they need to strive towards a similar culture that embodies the entrepreneurship, innovativeness and wealth creation that is happening in the United States. In addition, whether or not China is able to profit from its enormous domestic market may largely be independent of how the global economy is developing.

There is also much talk about potential rivalry forming between the United States and China. There has been a historical precedent with China’s challenges might be good news in the short-term. As China is currently busy building its own economy, it will not be inclined to look for troubles elsewhere, and in building its own economy it will be in need of technology, expertise and assistance from other countries. (Bergsten, Gill, Lardy, and Mitchell 2006)

There is a historical analogy with England and Germany prior to WWI. These two countries have also been economically interdependent, but that was not reason enough for the two countries to prevent them from being engulfed in a war later on. This is always a possibility, but for now it seems likely that due to the fact that a) China is still economically inferior to America in terms of GDP per capita and b) China is heavily invested in the US due to its purchase of U.S. treasury bonds over the past years. China and US have shared interest: nuclear proliferation, countering terrorism and avoiding an outbreak of war over Taiwan. Both benefit from financial stability, so both have an incentive to reduce imbalances and distortions. Beijing’s security priorities are “to preserve China’s independence, sovereignty and territorial integrity.” (Bergsten, Gill, Lardy, and Mitchell 2006, 87) Its handling of relationships in Asia has shown that China is seeking to focus on economic issues and peace. Therefore, we can assume that China for now does not want America to stumble any time soon.

In a study by Deloitte, they found that the American Dream that has originated in the United States after World War II has now become global. So what that probably means is that many prospective immigrants who have historically come to the United States may now instead stay in their home countries because opportunities there are equally good. According to Deloitte there are now dozens of countries have innovation agendas that are very sophisticated. This means that innovation is becoming globalized, as well. For example, there has been an innovation coming out of rural poor India that has yielded an EKG machine that can be purchased for less than one thousand U.S. dollars. An article from the Economist (2012) pinpoints to China’s advantage of scale. That means that when there is an increased demand for a product, China is able to add thousands of extra workers in a few hours. As far as this relates to innovation, that scale can help companies to experiment with new products in a much quicker way than other companies.

An often-neglected point in innovation is that innovation does not necessarily mean invention. Thus, China’s Internet start-ups such as Tencent and Alibaba were able to take business models from companies in the West and adapt them to the Chinese market. The amazing thing about China these days is that when the Chinese government decides to do something, it embraces that decision one hundred percent.

Ironically when respondents of a study by the Cheung Kong Graduate School of Business conducted a study in which they asked participants to choose which phrases they associate with Chinese brands, the top 3 responses were: mass-produced, cheap and poor safety standards (Iris Mir 2012) However, a survey of global executives from KPMG found that 45% of respondents the next technology innovation center in the world. This is not surprising, as historically China has been once upon a time one of the world’s greatest inventors. It has invented technologies such as the compass, printing, gunpowder, banknotes or papermaking. However, unlike the West it has not always been able to capitalize on its inventions. For example, while the Chinese have invented gunpowder, it was the West that harnessed application in weaponry. Herrero and Chen also find that CEOs from companies of developed markets such as the United States should not assume that in terms of innovation capability Chinese companies will not be able to compete.

Further, Herrero and Chen (2012) argue that simply due to the fact that China is world’s largest market for so many things, there must be room for innovation. It is the world’s largest market for smartphones, groceries, automobiles, energy consumers, the second largest for new airplanes and the largest consumer market and luxury market by 2015. They also argue that as a China is trying to rebalance its economy yet again technology is destined to play a much bigger role than previously as technology can help China to increased productivity and move the country north of the global value chain. Although Chinese CEOs are not entirely sure yet how to solve the innovation gap that exists between developed and developing markets, they view this challenge as another required change to transform China. As testament to this international companies have set up 1,400 research centers over the last few years. Fabre and Grumbach (2012) have observed that China’s manufacturing capacity has already surpassed that of the US, and innovation may only be the next logical step. According to them, China will work hard to become a country that is driven by innovation, and is poised to change the R&D landscape. The CEO of Dow chemical also shares that sentiment:

Innovation has followed manufacturing to China… over time when companies decide where to build R&D facilities it will make more and more sense to do things like product support, upgrades and next generation design in the same place where the product is made. (Fabre and Grumbach 2012, 8) Leadbeater and Wilsdon (2007) have found that if China wants to position itself as a leading economy in the world it will have to create its own technologies that can take China to the next level. The authors have identified four reasons as to why China has positioned itself as a country, in which innovation will take off soon. First, Chinese leaders have understood that innovation is crucial and Chinese policy is starting to reflect that as it becomes increasingly more sophisticated. Second, traditional forms of state planning are being replaced with new frameworks that make it easier for entrepreneurs and enterprises to become more innovative. Third, the university sector has improved drastically, both in quantity and quality. So it is not only that the number of engineering has increased, but also the quality of their education. Fourth, China has begun collaborating with other countries such as Europe, Japan and the US, and Chinese presence in international journals and conferences has increased. The authors therefore conclude that China is likely becoming a growing force in global science and innovation in the future. A lot will depend on how China is going to play out its set of tensions:

Between the planned economy and the market; national and global priorities; the hardware of research infrastructure and the software of culture and ethics; and the skills and creativity of the scientific workforce and the entrepreneurialism and networks of returnees. (Leadbeater and Wilsdon 2007, 25)

In terms of R&D, China is now ranked among the top five global R&D leaders. For example, Huawei is the second largest applicant at WIPO. Ernst (2011) draws on the World Patents Database, and is observing that from 2003 to 2007, Chinese invention patent application grew at a rate of 30% annually, overtaking Korea and Europe, and quickly catching up with the US and Japan.

All in all, as Hexter (2007) suggests China can become a hub for innovation that can give companies a competitive edge not only in China but globally. China is becoming paramount in securing a global hegemony for any company that wants to be ahead of the game.

China’s Creative Challenges

China’s rise towards an innovative nation is far from being a fait accompli. There are many challenges ahead, and it will depend on how Chinese leaders can overcome them. Orr and Roth (2012) have argued that Chinese companies do not really understand what customers want, and the corporate culture that is encouraging risk taking is rather absent. However, in order to develop new ideas one needs an environment in which risk-taking is being encouraged. Orr and Roth have also found that Chinese companies lack an incentive to go abroad since their domestic market is so large. In fact, they have identified three particular reasons as to why China’s companies are not really global. First, skills and capabilities are geared toward the domestic market imposing obstacles for these companies. Second, many Chinese executives lack the comfort doing business outside of China. This may be due to the fact that fluency among Chinese executives is not the norm. Third, Chinese companies heavily rely on local resources such as low-cost labor. In addition, in going abroad many Chinese companies would find intellectual property rights issues.

Orr and Roth have suggested four priorities that they need to focus on to overcome the innovation obstacles. First, a deep understanding of how Chinese customers tick is required. A successful example of this is Alibaba’s trading platform, Taobao that arose from understanding the needs of the Chinese customer. Second, attracting managers, as according to a study by Heidrick & Struggles, is a big issue within Chinese companies. Thus, without enough human resources, the equipment and facilities are useless. Third, risk-taking needs to become a component that is required in order to create ideas that are innovative and new. Fourth, cross-company collaboration seems to be lacking, and cultural barriers prevent exchanges between international and Chinese companies. Therefore, what is required is more collaboration.

Victor Kwok-King Fung (2012) recognizes that China is sometimes a difficult place to start a business, due its competitive market and fragile environment of intellectual property rights. However, whenever a company emerges successfully out of this competition, it is likely that it can weather the global competition. Another challenge is language. Even though allegedly there are more Chinese speaking English than there are people living in the United States, it can be questioned to what degree Chinese master the language. However, in order to emerge as entrepreneurs that can compete on a global level and are able to build global brands, Chinese entrepreneurs will need to sharpen their English speaking skills.

Additionally Orr (2011) is lamenting that within consumer electronics innovation is derivative rather than inventive. Instead of developing new products, Chinese tend to improve upon existing products. Its policy towards research and development look encouraging. Herrero and Chen (2012) project 2.2% of GDP spending on R&D by 2015, and 2.5% by 2020. However, Huang (2012) has pointed out that despite the huge investments into R&D, the payoff is uncertain and the impact is little. Huang suggests that what China needs is a rule-based system, an environment in which intellectual property is protected and a framework by which thought is free, authority can be challenged, and a government that has limited power. The Economist has noted that elsewhere government has not been the ideal agent to spur innovation, and the question is if China is really that different. In its attempt to replicate an environment that is reminiscent of Silicon Valley, it has yet to show signs of success. A less top-down approach is maybe needed to give entrepreneurs room to experiment, but the Chinese government at the moment has still major control over entrepreneurial activities of its Chinese citizen. Fabre and Grumbach (2012) also question whether the top-down model of R&D by giving too much power to bureaucrats will turn out to be a successful one in the long run.

Herrero and Chen (2012) point to the mismatch between China being the largest manufacturer of high tech products, but at the same time only capturing the low end of the value chain. For example, Herrero and Chen give an example of the iPhone sales to show this mismatch. In 2009, China exported roughly 26 million iPhones, with a value of $4.6 billion in total. However, the value added by China was a mere 3.6%, or $6.5 million, meaning the majority of profits still went to Apple itself. Thus, if China wants to gain a larger chunk of the value chain, it will need to align its priorities towards innovation.

Even though the quantity of Chinese patents is astonishing, and is set to outpace the numbers of patents that the US is filing, the question remains to what degree these Chinese patents are up to international standards. For example, Herrero and Chen (2012) estimate that 95% of patents filed domestically were filed domestically, which speaks of potentially low quality.

Leadbeater and Wilsdon (2007) are more neutral in its assessment by arguing that Chinese science is experiencing the best and worst of times. It has structural vulnerabilities, according to the authors, such as the estimate that less than one percent of Chinese firms own intellectual property to the technologies they use. This constraints profitability as we have seen and allows Chinese companies only to capture a small part of the global value chain. They also argue that reform is needed within state-owned enterprises, in which the party still chooses the head of the company, something, which may be detrimental to the creativity of the company as we have to consider that politicians do not always have the best interest in mind.

Leadbeater and Wilsdon (2007) also draw a historical analogy to Japan, which a few decades ago was due to overtake the US as the largest economy, something that has not yet happened though. They refer to the same fears that arose back then when commentators and analysts feared that Japan as a technological superpower would overtake the Western powers. Today, few people are complaining about the rise of Japan, as there have been many companies such as Sony that benefited society at large all around the world. The authors believe that when it comes to China, we should think of it not necessarily different because as much as it is a competitor, it is also a trading partner and represents an enormous market that brings with it opportunities for American and European goods and services. A study by IBM (2007) has also shown that the challenges are not only to be borne by Chinese companies. Foreign companies will also need to overcome obstacles such as IP protection, the availability of right talent and experience in China.

Fabre and Grumbach (2012) have observed that there are “contentious trade disputes and inflamed political rhetoric” between the US and China. One debate is whether or not China should devalue its currency. Many US commentators contend that China is in fact manipulating its currency. This misunderstanding, or rather miscommunication between those two countries may be the beginning to more severe issues. These disputes may turn into serious problems between the two countries that would halt progress on innovation on either side.

Ernst (2011) has highlighted a few barriers that China might face along its road of innovation. China has not only a long way until it closes the gap with the West, but also quality problems ranging from education to plagiarism, coupled with the common known obstacles towards entrepreneurship and lack of efficiency in R&D investment. Another problem becomes apparent with the ownership of worldwide stock of intellectual property. Of the almost seven million patents, the US and Japan owned almost fifty percent, while China owned a mere 2%, and of that little stake over ninety percent were only in force in China. Ernst highlights the strength of the US innovation system that make China’s weakness in innovation to date more visible. First, the US has a presence of world’s leading research universities such as Harvard and Stanford. China also a few world-leading institutions, such as Peking University, but generally in list of the best universities, the United States still has the largest share. Second, in terms of R&D projects it has an unrivaled exposure to leading management practices and third, a high mobility that enables diffusion of knowledge among workers. Bergsten, Gill, Lardy, and Mitchell (2006) estimate that only ten percent of science students that are graduating in China meet international standards, and within the technology sector China is mainly exporting commodities.

Shifting Landscape of Global Innovation

While the United States and Japan are still the leaders of global innovation, the area of innovation is due to disruption as research and development spending in Asia, and in particular China is rapidly increasing. China’s R&D has already exceeded the level of the EU in 2005, and while across G7 markets R&D to GDP remained flat at 2.1%, China’s share has doubled to 1.5%. (Gilman 2012) One factor that is telling is the number of science and engineering students in China. While countries such as the United States rely and in the future will heavily rely on foreign skilled labor in the science and engineering field, in China 40% of all university graduates have a S&E degree. (Gilman 2012)

Along with a shift in R&D investment we find that emerging markets are home to a rising share of global patenting activity, improved high-tech trade balances and strong labor productivity growth, which further affects incentives for R&D investment and employment. The global dispersion of innovative activity enables companies across a range of sectors to rethink where they operate and invest, making several markets, including China and India, increasingly attractive to corporate R&D investment and employment. (Gilman 2012, 3)

While the US remains the world’s leader of R&D investment, China’s annual growth of 20% in its R&D is impressive, and along with its Asian neighbors seems very impressive in terms of surpassing US one day as the leader of total research and development spending. According to a study by Goldman Sachs, China’s goals for R&D also suggest that China’s spending can triple over the next decade to $300 billion. (Gilman 2012) Gilman also recognizes that the new geography of global innovation can also be observed within the private sector R&D of US multinational companies. For example, IBM has launched a China Analytics Solutions Center in 2009, and equally Intel has had a China Research Center since 1998. Gilman further notes that as R&D investment shifts to growth markets, global scientific output, patenting activity and improved high-tech trade balances are also on the rise.

A crucial ingredient of innovation is higher education, and for many decades and still today the US has been at the forefront of higher education. However that may be about to change, or at least higher education is beginning to pick up in many growth countries such as China. For example, due to globalization and since 1990 university enrollment has been increasing and now stands at more than 150 million. (Gilman 2012) This will likely change the distribution of skilled labor, and as a result alter the landscape of global innovation. Especially within the science and engineering field, the US is particular lagging behind where 70% of US doctorates are received by foreign-born students. This is one of the great advantages of the US, that it is allowing many bright people to come into the country and pursue individual ambitions. However since the recent financial crisis there are many calls to protect American jobs, and in fact the number of H1B visa has been decreasing. The US is relying on much foreign-born skilled labor, but it is not always aware of that. In fact, this is what the study of Goldman Sachs recommends:

Current low levels of native student interest in S&E fields suggest that G7 markets are likely to have difficulty replacing an aging cohort of native-born scientists and engineers. Reliance on foreign-born skilled labor is set to rise further as the world’s S&E skill base shifts toward Asia, including China and Korea, where S&E fields represent 40% of all new university degrees awarded. The yawning gap is most evident in engineering, the leading field of study for CEOs of S&P 500 companies, where student interest in most countries is now higher than it is in the United States. (Gilman 2012, 19)

In the meantime, China is forging ahead and churns out many engineering and science students every year. The quality of Chinese education may not be up to US standards yet, but its slowly and continuously improving. There is much evidence that the global landscape of innovation is beginning to shift towards growth markets such as China. This does not need to mean that the US is losing in this shift. As a matter of fact it can be a win-win situation for countries in the G7 as well as economies in Asia and other growth markets. It does not need to be a zero-sum game.

Conclusion

This thesis has made innovation its focus as it provides an excellent laboratory to study the underlying trend that is taking place whereby the world’s economic center of gravity is slowing shifting towards the East, of which its implications will be enormous. As a result of the relative economic power shift to the East, in particular China, we can expect the current global landscape of innovation to shift, as well. The hypothesis that products are made in China, but designed in California may therefore change over the next few decades, and that was the central focal point of the thesis, to test to what extent the status quo of innovation will change. In the beginning chapter, the thesis has defined what innovation really means, and in the following chapter briefly discussed the economic power shift that is taking place. This served as a foundation for the rest of the thesis. The economic shift is necessary to understand in order to determine whether or not innovation will follow a similar pattern that manufacturing has followed over the last few decades.

In the past there was a similar situation when Japan was economically catching up to the West, and many commentators in the West feared that it would overtake the United States. Today, only few people would lament of Japan’s rise as millions of consumers have profited from products made from Japanese companies such as Sony or Canon. We can envision a similar scenario with China, although China might be an altogether different caliber than Japan.

We are likely to see the continued trend that innovation will be dispersed across the globe, and not arise necessarily predominately from one region. As for right now, and the short-term it is likely that the West will hold the reign on cutting-edge innovation, but that picture might shift in the long-run when developing countries such as China have fully re-emerged. Discussions of whether China will overtake the United States are fruitless at the moment, and the US is likely to sit at the pole position for some time in the future. Nevertheless, Chinese innovation can enhance global innovation patterns and be to everyone’s benefit.

If there is one thing that is decisive in terms of the results that have arisen out of this research it is that innovation is no longer a phenomena that is arising solely out of the West. In fact, it never has historically been a phenomenon that is particular to one region. Innovation has been coming from every kind of corner in the world, and it was only an anomaly for the past two hundred years that most innovation arose exclusively out of the West. That might not sound like a great insight, but the implications of global dispersion of innovation have not been fully appreciated by the mainstream media, the press and others. The implications of this are enormous: as we know that innovation is one of the main drivers of economic growth, we can infer that economic growth is no longer coming out of one region but rather from everywhere. In a world of BRICS, emerging and frontier markets this is not news, but the repercussions of a shifting global innovation landscape have not been fully appreciated. A product that is manufactured today can be divided into its counterparts and most of the time it originates from many different countries.

Instead of being fearful we should be excited that many more countries now are equipped with the tools and skilled labor to create innovation for their own countries. It should be seen as a win-win situation rather than a zero-sum game. Ultimately if Chinese innovation will one day be at the cutting edge or at a similar level of US innovation, then this will bring enhanced productivity to millions of people all over the world. For now, the West rules innovation still, but the global landscape of innovation has already begun to tilt towards the East.

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