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Can China's billions spur the next big idea? Add to ...

In 2006, China launched policies designed to make it a technology leader. Among other things, they call for China to replace foreign technology in key sectors with locally developed intellectual property. Incentives to innovate include tax deductions for R&D expenses, government-backed loans and discounted interest rates for R&D investment.

The latest innovation push is a plan to dominate seven "strategic" sectors, ranging from alternative energy and green cars to advanced manufacturing. The government plans to devote $1.5-trillion to the sectors over the next five years. Some of this is likely to be direct government spending, and much of it will come off the balance sheets of large state-owned enterprises. While that spending is bound to produce some benefits, it's an open question whether it will result in the new, world-leading technologies China's planners aspire to.

"Inevitably, a lot of that money is going to be wasted," said Breznitz, who has co-authored a new book on innovation in China, "Run of the Red Queen".

"A lot of it will be spent on big players that either don't know the market or feel so secure that they won't compete as hard."

He points out that some of the companies picked by the government to be champions of the telecoms sector have faded into obscurity. "China's great companies ZTE and Huawei were not supposed to be the national champions. Those who were just spent all that money."

Similarly, while government efforts have helped produce a veritable flood of patents in recent years - China will surpass the United States and Japan as the world's biggest issuer of patents by 2011, according to a Thomson Reuters report - there may be less there than meets the eye.

Nearly half of these patents are so-called "utility patents", ones that offer a shorter period of protection and are easier to obtain than regular patents issued in the United States or Japan.

China's innovation shortcomings are not merely the product of a preference for central planning over entrepreneurship, of course. Barriers include poor enforcement of intellectual property rules, an educational system that stresses rote learning, and a relative lack of independent organizations that can evaluate scientific projects and help police instances of plagiarism.

"There's a political constraint, too," said Arthur Kroeber, managing director of GaveKal-Dragonomics in Beijing. "In the long run, innovation arises in societies that are really open, where you can discuss anything. And China doesn't have that kind of political culture yet."


One feature that sets the headquarters of TechFaith Wireless Technology apart from the other office buildings lining an industrial park south of Beijing is the $750,000 black Rolls Royce parked in front.

The car belongs to Dong Defu, the 39-year-old founder of the Nasdaq-listed mobile phone designer and software company.

Dong, a former employee of Motorola, started his company in 2002 as an outsourced provider of design services to other mobile phone makers, including Nokia, Philips, NEC and his former employer.

"Doing that kind of work, the margins are too low, and you are under constant pressure to cut your prices," said Dong, a fast-talker with close-cropped hair. "Even if you have great technology, you have no pricing power."

After the company's IPO in 2005, he set off on a different course, designing and building white-label phones for other companies to brand as their own, and developing handsets under its own brand, tailored for different types of users.

Those include a phone with software to help soft drink makers keep track of what visits its promoters make to stores, water- and shock-proof phones for policemen and encrypted phones for use by government entities.

Not all of the company's designs seem original - one model looks remarkably like the RIM Blackberry. But the company's engineers - 600 out of a total staff of 1,100 - are constantly devising new features and applications, including a mobile phone that doubles as a motion controller for video games and a Disney-branded phone equipped with GPS, so that parents can track their children's whereabouts.

"We can do anything that the foreign handset makers can do," said Dong. "But we have our core engineering team here in China. Our costs are lower."

Broadly speaking, academics put innovation into two categories. One kind is typically associated with Silicon Valley - the bold new idea that creates a new market where one didn't exist before. Think, for example, of Apple's iPad, or Google's business model for selling targeted online ads.

The other kind is incremental, or second-generation, innovation, where a company takes a design and improves upon it, typically through cost cutting or some redesign.

Chinese companies have done well with this second kind. Baidu, for instance, began as an imitator of Google, but differentiated itself with features like music downloads and search algorithms better suited to Chinese.

And then there are China's famous pirate mobile phone manufacturers, known as Shanzhai, or "mountain bandits" in Chinese. Concentrated in southern China's manufacturing hub, the Shanzhai have engineered their own versions of iPhones and iPads, often with extra features like double SIM-card slots or ultraviolet lights that help users check for counterfeit money, a common problem in China.

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