Policy Brief Analysis: The Sources of China’s Innovativeness Why China’s “Unstoppable” Innovation Powerhouse Might Falter
By Dr. Tim Rühlig, Published in German Council on Foreign Relations
Analysis By Abhilasha Semwal, Deputy Director- Operations & Programs
Dr. Tim Rühlig, Senior Research Fellow at the German Council on Foreign Relations, discusses China's innovation powerhouse and potential to become an unstoppable force in future technologies.
He identifies five virtues that have made China an innovation powerhouse: skillful modulation of protectionism in large markets, attracting knowledge into the country, liaison with Western actors, party-state guidance instead of control, and domestic competition with Chinese characteristics. However, all these virtues are being challenged by domestic policies and deteriorating international conditions. An effective Western policy response requires a proper understanding of the diverse risks inherent in China's innovation power in different technologies. Geopolitics, global markets, and technological characteristics must all be considered.
The European Union, including Germany, must invest in reducing dependencies on China and its strengths to remain technologically indispensable to China. China's emergence as a technological power represents a reality it did not anticipate. At least five distinct features of Western innovation ecosystems that stand in sharp contrast to China were widely assumed to be a guarantee of Western technology leadership: open markets in the West contrast with Chinese protectionism, democracies providing freedom that is crucial for creativity, innovation is prized and comes with adequate protection of intellectual property rights and legal certainty as a result of the West's rule of law. However, China's innovation is not solely due to IP theft but rather a combination of domestic policy choices and international developments.
The Chinese Communist Party (CCP) practice of capturing key concepts in combinations of numbers and nouns, known as China's Five Virtues, has made the country an innovative powerhouse. China's innovation is attributed to its ability to utilize its market size, scale its semi-protectionism, and remain flexible in adapting the regulatory environment to market conditions. The second virtue is its ability to attract technology and knowledge to China. As income and living conditions improved, Chinese scientists who had previously worked in the West and then in innovative companies in Europe, the United States, or elsewhere became more likely to return to China. This accelerated return of Chinese scientists was not just due to China's increased attractiveness but also the numerous talent programs that incentivized the relocation of researchers to the PRC.
A second means for gathering technology and knowledge has been forced technology transfers to China. The PRC has exploited its market potential by requiring foreign technology firms to agree to China's requirements for technology transfer, such as Joint Venture (JV) requirements and foreign investment law. China has also become an integral part of the global supply chains, incentivizing Western actors to collaborate with China. China's innovativeness is attributed to its deep ties with private sector actors and Western research institutions. The country's political goal is to become self-reliant by replacing foreign manufactured technologies with domestic sources. However, many Chinese tech giants continue to import Western-made cutting-edge technology, knowing its superior quality. This trend became apparent when Western sanctions constrained Chinese technology firms, leading end-customer industries like Oppo, Vivo, and Xiaomi to turn to domestic suppliers. Between 2019 and 2022, UNISOC's global chipset market share tripled. Huawei, a sanctioned tech giant, now has access to 7nm logic produced exclusively using deep-ultraviolet (DUV) equipment, which is more complex, expensive, slower, and has lower yields and higher defect rates. Collaboration between private sector technology firms has benefited China's technological development.
Standalone 5G offers no advantages over non-standalone 5G for mobile phone subscribers. Still, the lower latency and higher number of devices connected to standalone 5G open up the possibility of new uses, from machine-to-machine communication to self-driving cars. China has socialized risk to provide the public infrastructure that offers the best conditions for innovation, leading to a competitive environment on the scale.
The fifth virtue that has made China innovative is fierce competition within the PRC, even if it takes a different shape than competition in the West. China's digital technology advance has been driven by privately owned companies founded by private sector entrepreneurs. State capture is essential for corporate success in the PRC, and the entrepreneurial decisions of their founders have been most important to the success of these companies. China's party-state involvement does not hinder competition; it is an integral part of it. Different segments of the party state's political economy compete not just over influence but also over revenue.
China's per capita GDP has grown more than 30-fold since 1990, and its unique competition involves the Chinese party-state. This competitive culture meets a society thirsting for innovation and willingness to adapt and adopt more quickly than most other societies worldwide. China's Five Virtues – scaling of protectionism and the market, attracting technology and knowledge to China, liaison with private technology and research, a guiding, not controlling role of the party-state, and competition with Chinese characteristics – have made the PRC the innovation powerhouse it is today. However, five obstacles, one for each of the Five Virtues, put the sustainability of China's evolution into an innovation powerhouse at risk. Analyzing these obstacles helps to evaluate the PRC's prospects for remaining innovative.
China's tightening control over its semi-protected market and increasing market entry barriers challenge its First Virtue. The First Virtue is being challenged by domestic policies and international attempts to diversify away from the PRC, such as the US and EU reducing their dependency on the Chinese market to "de-risk." This could lead to international firms operating in less regulated and more predictable markets. The Second Obstacle to Chinese innovation is the securitization of economic affairs in China, which has led to increased market access requirements and limitations on exports and investment guarantees for Western companies. The revised version of the Counterespionage Law 2023 drastically expands the law's definition of espionage, penalizing traditional business activities. This could have chilling effects that reduce cross-border cooperation that requires significant amounts of data, including economic and technological exchange.
China's innovation faces several obstacles, including rectifying private sector companies, increasing insecurity, and centralization of control. The Third Obstacle involves amended Chinese intelligence rules and defensive instruments enacted by Western countries, such as FDI screening and export controls. The Fourth Virtue faces the obstacle of centralized domestic control and sharper instruments by Western governments to counter preferential treatment and unfair competition practices. China's innovativeness is attributed not solely to its "sin" of IP theft but to its Five Virtues. To address these risks adequately, at least four different risks must be differentiated: 1. Risks to global supply chain resilience: The global value chains of many emerging and foundational technologies are characterized by a transnational division of labor. Western governments should carefully analyze global supply chains and identify bottlenecks and how diversification could increase the resilience of global supply chains.
China's innovation power is influenced by the Five Virtues and Five Obstacles, and Western governments should consider their policy options while considering domestic factors that shape the country's innovation power. An effective policy should not solely rely on imitation, as China's innovation journey is complex and differs significantly from the Western approach. Policy responses should not replicate China's successes, as our political and economic systems differ. The German Council on Foreign Relations (DGAP) is committed to fostering impactful foreign and security policy.