Innovation is key to Chinese growth due to urbanization.

Innovation has been identified in the new five-year plan as a key to boosting China's flagging economy, with the leadership vowing to give greater financial incentives to research and development talent in Chinese institutes. "Innovation will be the No 1 driving force of development. Under the 'new normal', the biggest challenge we face is to escape the middle-income trap, and an ultimate solution is innovation," National Development and Reform Commission head Xu Shaoshi said. Despite tremendous technological advances made over the past years, a "considerable" gap remained between China and other developed countries in terms of innovation capabilities, proprietary technology, well-known brands and commercialisation, Xu said. To tackle this, China would retool its intellectual property system and financing and investing mechanism, set up national laboratories in key fields and launch pilot reforms in some regions, according to a paper detailing proposals for the five-year plan. Steps would be taken to lower internet fees to facilitate the integration of online start-ups and new technologies with traditional sectors. Research and development talents would also receive more financial incentives, allowing them to reap greater rewards from their innovations. "Innovation is the way to go. But the effects are likely to be limited if China relies mainly on just its universities and research institutions," Beijing economist Hu Xingdou said. "Many universities have set up industrial parks, but very few have been successful … Instead of relying on university researchers, China should be counting on its private firms and small- and medium-sized enterprises to innovate." The leadership has stressed the need for innovation since 2013, with Premier Li Keqiang encouraging mass entrepreneurship and urging firms to use the internet and big data to revamp business models and enhance services. Chinese industries spend more than US$200 billion on R&D each year, second only to the United States, official data shows. R&D as a proportion of gross domestic product has increased fourfold in two decades, rising to 2.1 per cent, compared with the US' 2.8 per cent. China leads the world in patent applications, with more than 820,000 filed in 2013. Many Chinese firms had "learned to read the needs of a rapidly urbanising nation and to quickly scale up new products and services to meet those needs", according to a recent report by international research firm McKinsey Global Institute. The report cited smartphone and internet-ready TV maker Xiaomi as one such customer-focused innovator. "The China effect on innovation ... could reshape global competition," MGI director Jonathan Woetzel said. The view of mainland manufacturers as "low-cost industrial suppliers, lacking innovation and R&D prowess" was dated, Citi analysts wrote in a recent research note.