Pernicious innovation?

Is China being nasty to foreign companies? GE (GE.NYSE) Chairman Jeffrey Immelt, certainly thinks so. "I really worry about China," he told an audience of top Italian executives in Rome in July. "I am not sure that in the end they want any of us to win, or any of us to be successful."

Immelt’s concerns – which have also been voiced by other leading executives – are rooted in China’s policy of "indigenous innovation," designed to turn the country into a technology powerhouse by 2020.

Officially, the policy is supposed to guide China up the technological value chain so that economic growth is driven more by home-grown innovation and less by copying. Domestic companies rather than foreign businesses, so the thinking goes, should take the lead in this technological upgrading.

For Chinese policy makers, this shift is crucial to reducing the country’s dependency on expensive foreign technologies. The vast majority of the country’s manufacturing profits accrue as royalties to the foreign owners of patented technology rather rather than to the Chinese workers who snap the widgets together.

In this sense, indigenous innovation is all about creating a stronger, modern economy.

Foreign businesses, however, suspect that indigenous innovation is a fancy way of justifying economic nationalism by way of local protectionism. The worst case scenario is as follows: Foreigners are granted market access on the condition that they hand over intellectual property; this IP is picked up by local competitors who then take over the market by undercutting foreigners with like-for-like products or leveraging China-specific technical standards that favor local enterprises. The American Chamber of Commerce has branded it "a blueprint for technological theft on a scale the world has never seen."

So whom should we believe?

Foreign firms have a handful of examples to support their argument. Perhaps the most egregious case of local protectionism is in the wind turbine industry. Not a single foreign turbine maker has won a national bidding project since 2005, despite their superior technology. The foreigners’ market share fell from 75% in 2004 to just 14% in 2009.

Yet complaints about local protectionism and unequal treatment are overdone, for two reasons.

First, for all the nationalistic bluster of its announcements, Beijing has been quick to back down from discriminatory policies. When the Ministry of Science and Technology announced a series of rules in November 2009 limiting government procurement to home-grown IP, it took only a few months of foreign protests before the most contentious regulations were dumped.

Second, neither trade nor profit data support the case that foreign firms are being systematically discriminated against. In 2009, 71% of companies surveyed by the American Chamber of Commerce said they were profitable. Moreover, more than half of China’s exports in 2009 were produced in foreign-invested companies, a figure that climbs to 85% for high-tech exports.

If anything, these numbers support Beijing’s case that much more needs to be done to give domestic technology companies a leg-up.

The fact of the matter is that foreign companies in China are doing rather well. True, the price of market entry is rising and the business environment for some technology companies will get tougher. But it is far too early to conclude that indigenous innovation policies are as pernicious as GE’s Immelt claims.