China is far behind in innovation now and IP theft ensures they’ll continue to be

This totalitarian system, along with its other more pernicious consequences, also discourages and depresses innovation, which in turn encourages IP theft. Jeremy Haft exhaustively catalogs the failures of most businesses in China to innovate. Most of what Americans think is made in China is merely assembled in China. For example, the Chinese do not make the iPhone; they assemble American, German, Taiwanese, South Korean and Japanese components for a Taiwanese company located in China. Per Haft, Chinese companies lack the skills to manufacture those components independently. Many of the smaller Chinese companies that do try to innovate at U.S. levels find their work appropriated by larger, better politically connected Chinese companies. This is not to say that the Chinese do not innovate. They clearly do. The point is that they innovate less than they could because of the negative incentives the Party-State imposes. Innovation is simply too risky, too expensive, and too time consuming compared to theft.

Aside from the well-founded, ever-present fear of appropriation by better connected rivals, four other factors also conspire to discourage innovation in China, especially within small companies: (1) the requirement to pay bribes as protection; (2) a political culture that values deference and hierarchy; (3) the Chinese government policy of subsidizing SOEs; and (4) lack of capital for small and medium sized companies.

Guanxi (connections), baohusan (umbrellas), and bribes cost money that smaller companies cannot afford. Desmond Shum describes paying thirty percent of his projects’ revenues to Zhang Beili, the wife of Prime Minister Wen Jiabao. Shum asserted that such a fee was not unusual. Assuming this kind of fee is typical, then larger, better funded firms can afford to pay bribes, while smaller, lesser funded companies cannot. Without political protection, innovating simply becomes too great a risk.

A second factor discouraging innovation is the CCP value system or culture, that is, the habits, traditions, and values specifically and explicitly articulated by the CCP and transmitted through the Chinese educational system. These include deference to tradition, hierarchy, and authority; censorship and fear of censorship; reverence for harmony; suspicion of nonconformity, transparency, and conflict; and an arbitrary and politicized enforcement of rules.

Innovation as practiced in much of the world is incompatible with all of these elements. Innovation in the Western sense is nonconformist, open, anti-hierarchical, conflictual, transparent, and decidedly unharmonious. The first stage of this innovation process begins with the free exchange of new ideas. Censorship and fear of censorship, which permeate in the Communist Party-State, depress innovation. In addition, the standard for evaluation and selection of ideas must be transparent and based on rules and standards accepted by all. Zhao argues that this is not the norm in China. Instead, the education created and directed by the CCP focuses the one right way to solve problems, which is dictated from above. Furthermore, Chinese students do not spend as much time learning to work in teams or seeing the benefits of constructive conflict. Thus, they enter the workforce already acculturated to a set of values incompatible with innovation.

The third factor stifling innovation is the Party-State policy preference for SOEs over private firms. President Xi celebrates innovation but simultaneously insists on values incompatible with innovation, including deference to the CCP and conformity. He also supports increased investment in SOEs, and decreased emphasis on exports in favor of domestic consumption. The last element is noteworthy because instead of having to compete internationally to meet the higher requirements of many export markets, Chinese companies need only satisfy the lower demands of the domestic market. This dynamic becomes yet another disincentive for innovation.

Xi’s hostility to the private sector and strong preference for SOEs deprive smaller, privately owned companies of necessary capital directly. His policies also work indirectly to steer capital away from private sector innovators by frightening investors away. China has suffered net capital outflows for more than a decade. This is yet another factor disincentivizing innovation.