Blog From Adaptor to Innovator – How China is Leading Global Innovation

From Adaptor to Innovator – How China is Leading Global Innovation
China has made great strides in catching up with its global peers in developed markets in terms of innovation over the past 15-20 years, thanks to its aggressive push in Research & Development (R&D) spending, both in the government and private sector.

Nonetheless, China still has some way to go before its R&D spending is on a par with that of the US. China’s Gross Development Expenditure on Research and Development (GERD) was USD236 billion in 2016. Based on 2016 data from the Global R&D Funding Forecast published by the US Industrial Research Institute (IRI) and R&D Magazine, China’s GERD, after adjusting for purchasing power parity, was USD373 billion, about 25% less than that of the US.

The Chinese government is committed to driving innovation and is targeting an increase in R&D spending to 2.5% of GDP by 2020, further closing its gap with the US.

Credit Suisse estimates that this would represent an increase of 73% compared to 2015, meaning the US will likely be surpassed (adjusted for purchasing power).

Growth of major technology areas 2015-2020E

Source: CEIC, MIIT, IMS 36Kr, iResearch, IDC, Credit Suisse estimates, “Ecosystem of Innovation and Technology in China – From adaptation to innovation” , October 26, 2016 (“Ecosystem”), p1

Compared with its emerging market peers in the BRIC group, China clearly stands out, as its R&D spending has accelerated since 2003, along with economic growth. The business sector, which accounts for 77% of GERD, is the major driver behind the rise in the R&D ratio. The business expenditure of R&D (BERD) rose from 0.5% in 2000 to 1.6% in 2014, surpassing the European Union’s 1.3% and catching up with the US.

Total R&D spending of major economies

Source: OECD, “2016 Global R&D Funding Forecast” published by US IRI and R&D Magazine, from “Ecosystem” p10

Education reform, such as the expansion of tertiary education over the past two decades, has helped to boost China’s pool of human capital. In addition, a positive social attitude towards science and engineering (S&E) as the pathway to socio-economic success, as well as the government’s strategic goal to promote S&E, have attracted the high, albeit falling, engagement of students. These translate into a strong pool of S&E students and researchers, relative to other countries. 

Natural sciences and engineering doctoral degrees, by selected country (2000–2012)

Source: Science and Engineering Indictors 2016, National Science Foundation, from “Ecosystem” p52

Attracting overseas talent constitutes a key part of a country’s innovation and technology drive. Taiwan’s electronics miracle, for instance, is often attributable to those who returned to Taiwan, mostly engineers from Silicon Valley during the late 1980s and 1990s. In the US, over half of the start-ups in Silicon Valley are founded by at least one person who was born outside the country. The same is true for the UK, where London is another hub for international researchers and entrepreneurs.

Although China has yet to become a magnet of global talent, it has a large pool of potential resources of mainland scientists overseas. In order to attract them to return, the government has offered attractive financial remuneration, career pathways, research facilities and funding under various schemes such as the Recruitment Program of Global Experts (also known as the “Thousand Talents Plan”) offered by the Central Government. Since its initiation in December 2008, over 500 talented Chinese, including a few internationally acclaimed scientists, have been recruited from overseas.

The surge in the number of researchers is keenly felt in the quantity of academic papers publishing in high impact journals, which is one of the key performance metrics (KPIs) of academics and researchers. China has seen a significant surge in academic S&E articles written by Chinese academics over 2003-13, growing at a compound annual rate of 19%, ranking closely behind the US.  In addition, the number of most cited scientific research coming out from China has also been on the rise and is now ranking second after the US.

Compared with other countries, China’s publications are heavily skewed towards engineering, and, to a lesser degree chemistry, with the area of medical research being under represented. This stands in marked contrast to advanced economies where biomedical (especially medical) research grabs the largest share of the market. This underscores the government's strategic focus (and hence, research funding allocation) on mega projects, many of which are engineering-related or applied research, in its drive to “catch up” with the developed world. On the other hand, medical research is of a relatively low priority in the national research agenda and has been hampered by weak downstream/industry linkage caused by a tight regulatory regime as well as industry dynamics where generics continues to dominate. This, however, is not true in biotech research such as stem cell and genetics. There, due to a relatively lax regulatory (including ethical review) regime, China has been at the forefront of research that uses embryonic stem cell and in deploying the latest gene editing techniques such as CRISPA-cas9 to bring about new gene therapies.

Chinese government's support for technology and innovation has been directly translated into tax benefits and subsidies. In China, 150% of R&D expenditure could be tax deductible, and once enterprises achieve the status of "high-technology enterprises" (usually based on their R&D spending as a percentage of sales, adjusted for sector and size), their income tax rate could even drop from 25% to 15%. This is rather competitive compared to other major Asian economies. 

Comparison of tax incentives across select Asian economies
Source: “Ecosystem”, p61

China – R&D tax allowance

150% tax deduction for eligible R&D activities. Certify High and New technology enterprises to pay 15% instead of 25% income tax rate.

Hong Kong – R&D tax allowance

100% deduction for direct R&D expenditure or payments to approved research institutes. Does not include sub-contracted out research.

Singapore – R&D tax allowance

A standard 150% tax deduction on qualified R&D expenditure, and can increase to 200% for EDB approved projects. The allowance is further enhanced to 400% for the first SGD400,000 with a cap of SGD1.2 million applied.

Australia – Tax credit

40-45% tax offset on income tax payable for eligible R&D entities. Direct government grants and loans for projects in renewable energy, energy efficiency and clean coal technologies.

Korea – Tax credit

20% tax credit for R&D expenditure incurred by qualifying new, high-growth companies with original technology, and 30% tax credit for SMEs.

Japan – Tax credit

8-12% tax credit on qualified R&D expenditure, up to a maximum amount equal to 30% of the corporate tax due for the relevant fiscal year.

Also, governments at different levels will directly grant subsidies to selected science research projects. Usually these projects will be in line with the themes heavily promoted by the central government, such as wind and solar power a few years ago and electric vehicles now. In many cases, these government-funded research projects are jointly conducted by enterprises, universities and/or public research institutions, and the participatory enterprises will be able to use the research results for their commercial purposes with the government paying for them, which is a very big advantage compared to their competitors from other countries. 

Based on the data of over 2,800 A-share listed companies, the effective tax rate of three knowledge-intensive sectors—consumer discretionary (auto, media and household appliance companies), healthcare, and information technology—is much lower than in other sectors, and direct government subsidies to these sectors are also higher than average.

With the development that has taken place over the past two years since China launched the “Made in China 2025” initiative to transform the country into a high-tech manufacturing powerhouse, China could become a global market leader in areas such as: Biotech – both genetics and stem cell technology; Big Data and Artificial Intelligence (AI); internet of Things (IoT); New Energy Vehicle (NEV) and Nuclear Technology. 

In this conference, we aim to provide a snapshot of China’s competitiveness in these spaces.  

I, Vincent Chan, am licensed under the Securities and Futures Ordinance to carry on Type 4 (advising on securities) regulated activity for Credit Suisse (Hong Kong) Limited.