​Will China’s Tech Titans Be Heavyweights or Overweights?

The Wall Street Journal
2019-06-28 16:13

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China’s path to technological supremacy has put companies such as Huawei in the Trump administration’s crosshairs, but China has even more burning issues in the long run.

If the country can produce more globally competitive champions like the giant telecom-equipment firm, then it has decent odds of keeping its rapid growth trajectory going, even with an aging labor force that will raise costs and burden public finances. If not, the next decade could witness a further sharp slowdown in growth.

This series asks what may well be the most important economic question of our time. China stands at a crossroads, approaching income levels at which most countries experience a sharp growth slowdown as they can no longer rely on cheap labor. It may struggle to innovate without strong intellectual-property protection and a more efficient way of financing companies. The ball is in Beijing’s court.

President Trump and his allies think the success of Chinese homegrown technology champions such as Huawei and ZTE is mainly due to lavish state support and sometimes outright industrial espionage. Supporters say such companies succeed because, as with Apple, customers love their products.

The reality is more nuanced.

China does have a thriving information-technology sector and is beginning to notch successes in areas such as artificial intelligence. But it still hasn’t produced many global technology titans outside network equipment. The country’s huge, heavily protected internal market can incubate big companies, but it can also coddle them and encourage waste—particularly without an efficient financial system to make sure the best entrepreneurs have a fair shot.

The sheer amount of money being marshaled is impressive. China plans to invest more than $100 billion in its chip-making industry. Research and development as a percentage of China’s gross domestic product is above 2%, up from 1.4% in 2006. That is more than, for example, the U.K. On a purchasing-power parity basis it spends more than the European Union or Japan.

And China’s state-led technology drive has produced some notable successes—high-speed rail, for example. Lured by China’s big market, German and Japanese companies transferred technology to Chinese counterparts that have built an extensive rail network and taken on projects abroad.

Such maneuvers, however, are getting more controversial as China’s economic heft grows. They are also more difficult in concentrated industries such as memory chips or aerospace, where it is harder to play competitors off each other by demanding technology in return for market access.

China’s state-led, brute-financial-force approach to fostering innovation has other clear downsides. Local companies pile into subsidized sectors such as robotics, electric vehicles or clean energy, while local governments do their best to shield local champions from competition. The result is often massive overcapacity, which sinks margins and makes innovation even harder. China’s attempt to dominate solar panels is one clear example that resulted in enormous debts and poor investor returns, as some of the largest panel makers, including Suntech and LDK Solar, filed for bankruptcy. Such policies also risk prematurely picking winners among competing technologies.

Priming the pump with cash can work. South Korea and Taiwan have developed semiconductor champions such as Samsung Electronics partly by showering state money on the industry. But such companies were also directly exposed to the discipline of the global export market since their domestic markets weren’t large enough to feed them on their own. Chinese phone makers including Huawei and Xiaomi now ship around 40% of smartphones globally because they design phones that consumers actually want to buy.

Allies are under U.S. pressure to shun Huawei. But the company's prevalence in existing telecom networks and dominance in 5G technology make that nearly impossible. Illustration: Crystal Tai
In contrast, companies such as Tencent, Alibaba and Baidu have grown up feeding on the huge Chinese market—well protected from foreign competitors—but haven’t really gone big outside China. That suggests that “indigenous innovation,” banking solely on China’s big domestic market to produce global tech leaders, is a risky strategy.

Chinese intellectual property enforcement also remains a weakness. It has made meaningful changes to regulations and stepped up enforcement efforts in recent years but still leaves much to be desired in areas such as technology transfers and licensing. Last year, the U.S. Chamber of Commerce still ranked China 25th out of 50 countries in intellectual-property protection, behind the likes of Malaysia and Morocco, even though its scores have improved steadily since 2012, when the ranking first came out.

It would be a mistake for President Trump and his political allies to assume that China can’t innovate without stealing foreign technology. U.S. firms are starting to buy up Chinese software startups. The nation possesses abundant resources, both human and financial. It also, however, appears in some ways to be turning inward again—back toward Mao Zedong’s ideal of self-reliance. That could be dangerous without a sufficiently competitive internal market to foster innovation and a politicized financial system that tries, and often fails, to back winners.

Chinese companies could be the next generation of global tech heavyweights. A more self-absorbed China without further financial and legal reforms, however, might end up producing more flabby giants than rock-hard contenders.

Source: The Wall Street Journal
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