BRUCE MCKERN China’s innovative nation and what it means for Australia China is emerging as an innovation superpower. Can Australia benefit from this disruptive transformation? The rapid rise in China’s economy over the last government following its opening up in the late 38 years is an extraordinary phenomenon with 1970s, the unleashed energy and drive of its private- profound implications both for disruption of sector companies and the vast unfulfilled market the geopolitical balance of power and economic demands of the Chinese people. A key priority of the relations worldwide. This is in large measure Chinese government throughout this transformation attributable to the very clear ambition of China’s has been creating an innovation ecosystem. Disruptive Asia 01 CHINA’S INNOVATIVE NATION AND WHAT IT MEANS FOR AUSTRALIA By innovation I mean the creation of a commercially In the third and most recent phase, Chinese useful product, process, service or business model companies are deploying the capabilities they that serves human needs in a new or improved acquired in China together with the cash they have way. Innovation is often incremental, but a creative earned, to invest in the markets of the developed business model based on technology can be world. Their emphasis now is on securing brand- disruptive when it provides value in a radically names, market access, global managers and different manner. The foundations of an innovation technologies where needed. They are expanding ecosystem include not only research institutions beyond China to become competitors inside the in science and engineering, but also mechanisms markets of the developed world. Established to allocate funds to high-quality research, taxation multinational corporations (MNCs) now have policies to stimulate business investment including to compete with them in their home markets. venture capital, incentives to commercialise ideas, and strengthening of a culture supportive of science How foreign companies can learn and entrepreneurship through education. from China China’s success has been built on all of these An important lesson for business anywhere is that foundations. It spends today 40 per cent of what there are capabilities that foreign companies can the US spends on R&D, has built 146 high-tech parks strengthen by operating inside China. We identified across the country1, exceeds the US in domestic the following: patent applications, has almost caught up with the US in publications in scientific and engineering • Bold experimentation and rapid iteration journals, leads the world in high-tech manufacturing • Innovation through creative adaptation output and exports and has bred companies that • New category creation are now formidable global competitors. • “Lean value” focus • Development of mixed teams and global leaders Chinese firms’ evolving innovation capabilities These are addressed in detail in our book and a recent Forbes article3. Although the ideas are not In our three-year study of innovation in China, my revolutionary, Chinese companies practice them colleague George Yip and I identified three phases in as a matter of course and other companies should the development of China’s be applying them, even if not operating R&D facilities innovation capabilities2. in China. A key priority of the In the initial phase firms Chinese government got started by copying has been creating products from the West to The specific implications for Australia an innovation satisfy exploding demand. Government: China’s innovation drive demonstrates ecosystem. Their products were often that there is an essential role for government in shoddy, but customers establishing the context in which innovation can take soon demanded better place. Government funding of basic research, as quality, forcing firms to provide products that were well as applied research, provides technologies that fit for purpose: with only essential features and can be tapped by companies, generating spill-overs reasonable in price. into private sector innovation4. The caveats are that In the second phase, companies aspired to reach when government funds research, it should focus world standards so as to enter new sectors and on three priorities: creating an innovation ecosystem; deal with foreign competitors. Examples of such supporting fundamental research; and ensuring there companies are: Alibaba.com (successful in forcing are incentives and mechanisms to commercialise eBay out of the China market); internet-based ideas generated by researchers. giants such as Baidu, Alibaba and Tencent; telecoms The task of supporting fundamental research equipment suppliers Huawei and ZTE; domestic in Australia rests primarily with the federal appliance makers Haier and Joyoung; and a host government. In 2014–15 Australia’s GERD (Gross of entrepreneurial start-ups. Expenditure on R&D by government, business and institutions) was $33.5 billion, or 2.1 per cent 1 State Council, PRC, August 6, 2016. http://english.gov.cn/news/ top_news/2016/08/05/content_281475409885715.htm 3 George S. Yip and Bruce McKern, 5 Strategy Lessons 2 George S. Yip and Bruce McKern, China’s Next Strategic Companies can learn from China. Forbes Asia, June 6, 2016 Advantage: From Imitation to Innovation. Boston, MA: 4 Marina Mazzucato, The Entrepreneurial State: Debunking Private MIT Press 2016. vs. Public Sector Myths. London: Anthem 2013. 02 Asia Society Australia CHINA’S INNOVATIVE NATION AND WHAT IT MEANS FOR AUSTRALIA of GDP5. While comparable to the EU average, Innovation is in the public eye and scientists and this percentage is a reduction from its peak of engineers are receiving publicity8 – a positive move 2.25 per cent in 2008 and less than the US GERD towards changing Australian culture. But the support of 2.7 per cent of GDP. Of the 2014-5 amount, has not yet translated into increased funding. In $10 billion was funded the 2015-16 Commonwealth budget $9.7 billion by the federal government was allocated to R&D support, a decrease from the China’s innovation to support R&D. The previous year. Funding of medical research, where drive demonstrates balance (56 per cent of Australia has undoubted strengths9, was reduced that there is an total GERD) was performed from the previous year by 10 per cent. by the business sector essential role for Many small countries invest more intensely in R&D and mostly funded by government in than Australia: Israel spends 4.1 per cent of GDP, it. As in other countries, establishing the Sweden and Finland each spend 3.2 per cent and business spends most context in which Denmark 3 per cent. Innovative companies based of its R&D expenditure innovation can in these countries have become global leaders. So on development. take place. Australia’s R&D budget should be increased to at Why is fundamental least 3 per cent of GDP. This would mean total R&D research important? investment reaching $47 billion, including a further Can’t we simply rely on ideas created by researchers $5 billion in government spending. Equally important elsewhere in the world and license what we need? would be an increase in private sector investment The answer is that we do this; it is one reason why of roughly $9 billion. Foreign corporations have deep firms in Australia have less incentive to perform R&D pockets: one US pharmaceutical company, research locally. But even if we were to use only Merck, spent US$7.2 billion on R&D in 201510 – ideas from abroad, we would still need the capability as much as the Australian government and half as to absorb foreign inventions, adapt them to our much as the entire corporate sector. Encouraging market, and improve on them. That requires the private sector to increase its development local researchers. spending locally would not be easy, but achievable. More importantly, Australia needs engaging and Another issue for government is Chinese foreign remunerative employment for more of its people, direct investment (FDI) in Australia. In principle, FDI from companies in Australia. That requires a scientific is beneficial to the host economy if it is additional to base to generate ideas entrepreneurs can turn total investment. The caveats have to do with pricing, into local innovations, which can also be licensed monopoly, taxation, where business decisions worldwide and exported as products and services. are made and how they can affect local output, Breakthrough technology is not essential for every employment and tax revenues. innovation, but technology coupled with new It is therefore appropriate that the Australian business models is a foundation of new businesses. government has a review process for inward FDI on Prime Minister Malcolm Turnbull has made a case-by-case basis. While investments by private innovation a priority with incentives for collaboration entities, including Chinese, enjoy high thresholds, for and business access to research; refocusing of the state-owned enterprises the threshold is zero. China Cooperative Research Centres (CRC) programme also has an approval process for inward FDI which towards commercialisation; an Industry Growth is more restrictive than that of its major trading Centres Initiative aimed at strengthening industry partners and not highly transparent. The Australian clusters in five sectors of the economy6; nine approach is more transparent and the chief criterion National Science and Research Priorities7; and for approval in Australia is the national interest, actions to foster education in science, technology, in that respect not too dissimilar to China’s. engineering and mathematics subjects. 5 Gross expenditure on R&D (GERD), 8104.0 – Research and Experimental Development, Businesses, Australia, 2013-14. Canberra: Australian Bureau of Statistics, 19 April 2016. 8 The naming of Emeritus Professor Alan Mackay-Sim, a pioneer 6 The five sectors are food and agribusiness; mining in the field of adult stem cell research, as Australian of the Year equipment, technology and services; medical technologies in 2017, sent an important message. and pharmaceuticals; advanced manufacturing; and energy 9 Australia was ranked number 3 in publications in the Health resources.