China faces challenges in innovation
China will become a global leader in innovation if Chinese companies enhance the strengths in markets that require creative science and engineering talents, according to a newly released report by the McKinsey Global Institute.
MGI identified four archetypes of innovation — sciencebased, engineeringbased, customer-focused, and efficiency-driven.
Some of China’s greatest successes have come in industries that require customerfocused innovation. As measured by share of global revenue, Chinese firms are growing rapidly across sectors such as household appliances —in which they now account for 39 percent of global revenue — Internet software (15 percent) and smartphones (10 percent).
Meanwhile, China’s strength in efficiency-driven innovation has also allowed it to consolidate its position as a pre-eminent global manufacturing hub and is helping Chinese manufacturers rise in the industry value chain.
“Although Chinese companies are good at customerfocused and efficiency-driven innovation, they still lack research and talent to stand out in industries that rely on science and engineeringbased innovation,” said Chen Yougang, partner and head of MGI in China.
According to MGI’s analysis, China is not yet a top global competitor in three industries that depend on science-based innovation. It has less than 1 percent share of global revenue in branded pharmaceuticals, 3 percent in biotech, and 3 percent in semiconductor design. In these markets, Chinese firms still tend to focus on lower-value-added products and strategies, such as making generic pharmaceuticals.
This record reflects both how long it takes to build capacity in science-based innovation and how much catching up China still has to do despite its large investments in R&D. In fact, there are no Chinese companies with strong brand names in science-based innovation.
“Chinese companies need to shift from ‘sourcing innovation’ to ‘driving innovation’ by putting in place robust management systems that solve market needs with differentiating technology and winning business models,” said Erik Roth, senior partner at McKinsey.
He added that policies that encourage entrepreneurship, the development of more core science and engineering skills and having a greater tolerance to take risks and learn from failure will be essential ingredients to China’s continued development as a global innovation leader.
A rapidly aging population, increasing debt and declining returns on investment are placing new burdens on China’s economy. Given these trends, MGI argues that innovation is essential to China’s long-term sustainable growth. While China has over the past 30 years relied on absorbing and adapting technology from other countries, innovation should now play a larger role across all sectors of the Chinese economy.
“By better understanding the way innovation works across industry sectors, Chinese business leaders, academics and policy makers can effectively focus efforts to promote innovation,” said Chen.
However, as MGI’s analysis shows, the contribution of innovation to economic growth (as measured by multifactor productivity) has declined in recent years.
MGI’s analysis shows that from 1990 to 2010, multifactor productivity (which is defined as GDP growth minus the input factors of energy, labor and capital) contributed between 40 and 48 percent of GDP growth. Over the past five years, multifactor productivity has contributed just 30 percent of GDP growth, or about 2.4 percentage points of GDP growth per year, the lowest level in 35 years.
The MGI report states that in order to maintain GDP growth of 5.5 to 6.5 percent per year through 2025, China will need to generate 35 to 50 percent of GDP growth (2 to 3 percentage points) from multifactor productivity.
Jonathan Woetzel, senior partner and director of the McKinsey Global Institute, said that while the government has pledged good support to innovation through economic development policies and investments, continued reforms, particularly in State-owned enterprises, are needed to speed up the innovation drive.