Scientific development

Amid all the fevered speculation about how fast China can continue to grow, whether it is in a bubble, whether high investment will keep expansion alive or eventually crush it under a mountain of debt, one key issue is often forgotten: the impact of research and development (R&D) spending in raising productivity and global competitiveness.

No one seriously doubts that China’s achievements over the past 18 years owe a huge amount to foreign investment and accompanying foreign technology. Equally, many industries were built as assembly line operations simply making goods to specifications laid down by overseas firms with lots of Chinese labor but little or no intellectual input.

But things change rapidly in China, and one of them is R&D investment, as a recent report by Shanghai-based Research-Works, an independent foreign investment research company, makes clear.

For sure, China likes headline-making achievements in science and technology such as space walks, record high-speed train runs and the like. These can readily be dismissed in some quarters as government-directed show-offs absorbing huge amounts of money for little commercial gain.

But in fact these are just the tip of a rapidly expanding iceberg. Even more important is that the momentum is increasingly coming from the corporate sector rather than the government or academia.

Top down leadership

The focus on the central role of science and engineering in national development mirrors what happened in Germany and then Japan in the late 19th century and in Korea in the second half of the last century. It is particularly remarkable given the intellectual losses that China suffered as a result of the Cultural Revolution and the stultifying impact that one party rule can have on a society. But China is fortunate in that its current and recent leaders have mostly been trained in engineering and related fields, experience that in some ways offsets the negative aspects of a single party bureaucracy.

This is not public relations hyperbole. The proof is in the data that come not just from the often unreliable government sources but from the accounts of some of China’s best-run companies.

As recently as 1995, only 0.6% of China’s GDP went into R&D, and most of that was government-funded. But by the start of the new millennium it had reached 1% and has been expanding rapidly ever since. It should reach 2% this year and is expected to hit 2.5% by 2020. It has already overtaken the EU, at 1.7%, and at this rate will catch the US – 2.6% – soon after 2020. That would leave it behind only Japan (assuming an aging Japan keeps its current 3.3% level) and South Korea.

Willing investors

It’s not just about percentages, though. The sheer size of the Chinese economy and its ability to grow rapidly for at least the next decade should ensure that money is available to enable China to get to the top rank in a wide range of industries.

Already, according to Research-Works, 75% of China’s R&D is carried out by enterprises and only 19% by government and 9% by universities. The enterprises include foreign-invested ones that have chosen to do R&D in China because of the quality and quantity of expertise available here. There are now more than 1,600 foreign-invested R&D operations in China compared with just 100 in 2000. Furthermore, roughly one-third of China’s graduates, now numbering nearly 5 million a year, have engineering degree – compared with less than one in 10 in the US.

One might argue that the quality of some R&D spending in China is low compared with that in Japan or the US, and that some is devoted to minor improvements in production technology rather than more fundamental research that will bring China to the top of the innovation league.

One might also argue that the Soviet Union in its heyday pumped similar, or even greater, amounts into scientific and technological development, which paid off mainly in terms of military and space achievements. Although China does invest heavily in those areas too (probably rather more than Beijing admits), at the corporate level it operates in an open and competitive marketplace. By comparison, the Soviet bloc was largely closed to industrial competition from the outside world and the intellectual developments taking place elsewhere.

China is thus following the Japanese and Korean models, rather than the Soviet one – encouraging R&D, forcing local companies to compete against each other while providing them with only limited protection from outside competitive forces. It is reflected in the sheer number of patent applications being filed by Chinese companies. Indeed, Huawei, already established as a global leader in telecoms and network equipment manufacturing, was ranked first in the world for patent applications in 2008 and second in 2009.

The number of names with world-class technology is as yet quite small but has grown from a nil base. Whereas giants like Caterpillar and Komatsu have huge global markets to support their own massive R&D, China’s equivalents such as Sany Heavy Industry (600031.SH) have a huge domestic market as well as being driven by entrepreneurially minded technical people.

The sheer scale of railway building, port development, bridge-building and steel-making is spurring not just turnover for companies like Shanghai Zhenhua Heavy Industry (600320.SH), China South Locomotive (1766.HK) and Baosteel Group (600019.SH), but strong cash flows – and in many cases net cash positions – are enabling them to pour money into R&D. The commercial merit of some of China’s investments is debatable – for instance, an extensive high speed rail network and ambitious bridge, tunnel and canal projects – but they all endow equipment suppliers with work and an incentive to innovate.

So whatever the course of the Chinese economy over the next decade any failings are unlikely to be attributable to inadequate focus on R&D.