What China's innovation gap tells us

Earlier this week I posted to Light Reading about the almost total absence of telecom start-ups in China, despite it being the world’s largest supplier of telecom gear.

It’s the one high-tech sector where the country can claim leadership, and the lack of start-ups is a significant gap in what Chinese call the 'industry chain’. Not that start-ups are the sole engine of innovation – far from it – but they are a great way of concentrating resources and attention on specific issues and technologies.

The industry structure is at the heart of the problem. The oligopoly in the services market means operators have little incentive to innovate, and this in turn puts market power in the hands of vendors, who make sure small vendors stay small.

Other factors also come into play, such as the weak research sector and corruption and plagiarism in science, compounded by the government's ham-fisted attempts to micro-manage innovation.

There’s an interesting analogy in the aviation sector, another vertical where China has great ambitions. Citing a new Rand Corp report, the Wall Street Journal points to the tension between the airlines, who want the most efficient aircraft possible, and the state-owned manufacturer trying to find buyers for its dud planes. (For those interested, James Fallows’ excellent China Airborne examines China’s innovation and wider economic potential through the lens of aviation.)

China’s telecom sector of course works far better than that, benefiting from a genuinely competitive supplier market, but similar strains between vendors, operators and government ambitions exist, as demonstrated by the mandating of TD-SCDMA and TD-LTE.

In the short-term this hardly matters for the telecom sector. Start-ups aren't the be-all and end-all of innovation, and there is plenty of global competition both to challenge the vendors and ensure operators get the technology they need.

But it's a problem for China, which aims to refashion its economy through science and innovation. Its inability to extract more innovation out of its massive telecom industry reminds that it is still a developing country and that achieving manufacturing scale is not the same as achieving thought or technology leadership.

China spends more on importing chips than oil

China spends a lot more on importing chips than oil.  According to iSuppli, China last year imported $192 billion in integrated chips and a mere $120 billion in oil.

This matters in China - and in the telecom sector in particular - because despite tipping all of that cash into semiconductor industry's pockets, domestic handset firms are well back in the queue for the Qualcomm and ARM chips that power top-range devices.

More than half of China Mobile’s recent TD-LTE handset tender went to devices using Qualcomm chips. Among Chinese firms, only Huawei's Hisilicon chip unit won a share.

A paper by State Council Research Office a month ago said 80% of China’s chips come from abroad, China Business News reports.  A touch sourly, the report notes that:

China in one year produces 1.18b handsets, 350m computers and 130m colour TVs - all no. 1 worldwide. But the high-end patent fees embedded in these reduces all of us to manual workers for the international vendors.

In truth China industry lacks the scale as well as the expertise of the big US, Korean and Taiwan chip players.

iSuppli senior semiconductor analyst Vincent Gu points out to China Business News that Taiwan fab TSMC has annual sales of $10 billion, greater than China's top four companies combined. TSMC and Intel are investing $10b each year, and China just $400-$500m.

In this thoughtful blog on the topic, Dieter Ernst, a senior fellow at the East-West Center, says the gap between China’s chip consumption and production grew from $5.7b in 1999 to $100.5b in 2011, aided in particular in the last few years by steepling imports of advanced wireless chips. He writes:

China remains way behind the technology frontier in both fabrication and design, reflected in a weak portfolio of essential semiconductor patents. China still has a long way to go before it can shape, or even co-shape, the industry’s technology trajectory.

One reason is that while China is deeply integrated into the global semiconductor production chain, “China’s leadership views such deep global integration primarily as a threat to its domestic innovation capacity, rather than an opportunity.”

Additionally, the sector is caught between by two disconnected drivers - the government’s indigenous innovation policy and the industry’s own real-world practice of global technology sourcing.

The result is “a fragmented innovation system that is ill-equipped” to respond to the challenges of the global value chain.

Innovation, China-style

Here’s an insight into how Chinese leaders think about innovation.

Xi Guohua, China Mobile chairman and one of the country's most influential ICT officials, believes the digital divide between China and the rest of the world is growing.

That’s interesting, but just as revealing is his solution. No, it’s not to help private firms access bank loans or to revitalise the IPO market, or further deregulate the economy.

Xi's solution: more committees.

He called on the government to emulate the successful atom bomb and aircraft carrier programmes with national hi-tech projects in “core technologies” such as  electronic devices and high-end chips.

Speaking in Beijing last week, Xi urged the Communist Party to strengthen the country’s top ICT policy body, the party 'informatization leading group’ ('informatization’ is local jargon for ICT adoption) and for central and provincial level governments to put ICTs high on the agenda.

Xi's views may not be universally supported but they are doubtless influential. Until two years ago he was vice-minister and ranking party member of the Ministry of Industry and Information Technology (MIIT).  His current post heading up the giant mobile carrier is a position reserved for senior party officials.

A World Bank report issued 12 months ago called for liberalisation and urgent structural reforms to break out of the middle income trap. Xi neglected to mention any of those, nor any of the difficulties faced by startups and other businesses, such as red tape, unhelpful banks, state-owned monopolies, and the heavy burden of the Great Firewall.

Xi said the ICT gap between China and developed countries had widened since 2007, and that the country was not internationally competitive in developing core technologies. He also called for more efforts in cyberspace security and development.

Xi isn't the only ex-MIIT official fretting about the digital gap. Former MIIT boss Li Yizhong last week made the same point, noting that Chinese spent just $192 a year on information services, compared with $3,400 by Americans.