Without Drastic Changes, China Could Become Japan

Front page news concerning Chinese economic weakness and accusations of large-scale cyber-espionage against the U.S. both involve the capacity to innovate. Cyber-stealing other people's knowledge, rather than developing it yourself, helps right away but discourages the innovation at home that can contribute to national wealth for the long term.

Vice-President Biden repeated last week that he believes China doesn't innovate, which is an oversimplification. It is true, though, that China still relies almost entirely on foreign technology. Becoming a truly innovative nation is the key to China eventually becoming a rich one, since its other sources of growth are slipping away. And at the moment, the outlook is dim.

The economy has been weakening and may continue to weaken. Natural resources are inadequate, the population is aging, and the country is starting to sink into debt. China in 2014? Yes, also Japan in 1994. The conclusion many observers drew then was that Japan had to sharply boost innovation to renew economic expansion. Unfortunately, it hasn't happened yet.

It is important to note that Japan is not a failure when it comes to innovation; in fact, it ranks fairly high. Japan is a rich country with a generally sound education system and it protects intellectual property well. But Japanese innovation has not been nearly enough to carry the economy forward against the dead weight of public debt and demographic contraction.

Consider China's challenge in comparison. At $3000 per head in disposable income last year, China is far from rich. Providing education to a huge, disparate population on a continent-size land mass is an enormous task for a poorer country. Chinese IP protection is fairly weak, even beyond the massive cyber-theft, which reduces the incentives to innovate.

It is not therefore surprising that China does considerably worse than Japan in most innovation rankings. And, while such rankings are imprecise, they may actually overrate China. Money spent is an unwise indicator of innovation capacity. Spending can just as well be an attempted substitute, rather than a spur, for successful innovation and China is the current king of wasteful spending.

Defenders of Chinese innovation point to examples of successful technology companies. China has shown the ability to adopt foreign technology, whether licitly or illicitly acquired, and produce at a low cost. It also has the advantage of a huge domestic market where competition is often sharply curbed and domestic firms are thus able do very well. The Japanese case was similar.

Limiting competition can lead to large companies but it does not help consumers or the economy as a whole. It certainly does not constitute innovation. Copying or stealing and then adapting technology is innovation of a sort and can help the economy a great deal, but only up to a point.

China may soon approach that point. It is still not a technologically advanced country but it is much closer to being one than it was 35 years ago, or even 15. The benefits of just adapting others' technology are shrinking. The economic risks of being stuck as a technology follower - having to wait for others to innovate and then copying them - are rising.

Chinese growth was unlocked by pro-market reform, first in land then in capital and labor. But the country's land base has since been battered by unsustainable use, the labor force is shrinking, and corporate debt is on a frightening path. For China to continue its economic rise, innovation must first become a more important factor, then a much more important factor.

The ability and willingness to steal from others instead creates a culture of dependence. A nation that needs to violate intellectual property can never quite catch up, much less lead. It is no comfort to those inventors, firms, and workers who are targeted by cyber-thieves but China faces a very difficult transition from what it does now to driving its economy by creating its own technology.

Japan has never quite made that transition and the idea of Japan as global economic leader, once popular, seems very odd. Without drastic changes in its approach to innovation, China faces the same fate.