Wednesday, April 25, 2018

China’s innovation problem

It might be Black Friday in the US today, but as far as shopping frenzies go the American version has been outdone by China’s Singles Day in recent years.

On November 11, Alibaba alone sold roughly US$25 billion of products, mostly on mobile devices. Accompanying many of those sales were insurance policies that cover the cost of returning unwanted, damaged or fake goods. But does any of this represent innovation?

It is a question that has long dogged China’s economic development. As with Japan in the past, it is often asked whether China has the maturity and knowhow to originate new ideas.

China’s insurance industry has seen tremendous growth in the sale of micro-insurance products to Chinese online shoppers, enabled by mobile platforms, but it remains to be seen if this is a profitable line or rather a cost of doing business in a country where consumer protections are non-existent.

Alex Wolf, senior emerging markets economist at Standard Life Investments, is among those asking the question about the quality of Chinese innovation. “Statistics highlighting China’s rapid increase in patents, or the fact that one out of three unicorns [start-ups valued at more than US$1 billion] is in China, are often held up as proof of China’s innovation surge,” he says. “But how much is China truly innovating?”

Despite facing similar questions in the past, it is certainly the case that few people today wonder if Japan can innovate. While the first wave of exported Japanese cars and electronics were dismissed as cheap junk, they are now world leaders in both sectors.

But comparisons to Japan may not be appropriate. Despite its supposed communism, China is far more dynamic and entrepreneurial than conservative and egalitarian Japan. If you compare income inequality in the two countries, for example, China looks like the capitalist society and Japan like the socialist one. And if ruthless capitalism encourages innovation, China may exceed Japan.

One caveat in comparisons to Japan — which is often overlooked in discussions of the Japanese “economic miracle” — is that it industrialised at around the same time as the advanced economies in Europe. Post-war Japan was not an emerging market in any meaningful sense and already had significant industrial capacity and, perhaps more important, well-established institutions.

China is clearly catching up fast, but it is also the case that it had a lot of catching up to do after several decades of self-inflicted isolation and poverty.

“As usual with China, most opinions fall into one of two extremes: either Chinese innovation will soon present an existential threat to western tech companies, or that China can’t innovate,” says Wolf. “The truth is somewhere in the middle. Saying China can’t innovate is as undoubtedly untrue as saying that China will rapidly leapfrog incumbents at the technological frontier.”

Wolf uses the example of Chinese patents to illustrate some truths about its innovation. Chinese domestic patent applications rose from 1.2 million in 2010 to 3.5 million in 2016, and the number of patent grants doubled during the same time period. This is impressive, but most of these are awarded for small design tweaks or incremental innovations and are the result of top-down government incentives to encourage patent filing. When judged by stricter international standards, Chinese patents often do not hold up.

This has important implications. “China is successful in industries where innovation is about meeting consumer needs or driving efficiencies in manufacturing such as appliances or solar panels,” says Wolf. “However, China has a small share of the global market in industries where innovation requires original inventions or engineering breakthroughs, such as semiconductors and autos, despite an intensive government effort.”

This is evident in China’s insurance innovation. At the consumer level there is clearly some innovation happening with regards to online shopping, but when it comes to pure insurtech innovations that rely on technological advances, there are fewer signs that it is a significant player.

So, can China innovate? Yes and no. It is already an impressive achievement to have cultivated such a vast consumer marketplace and this is an obvious advance over just a decade ago. Who’s to say it can’t make the leap to genuine technological innovation in the coming decade?

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