Why China Can’t Innovate

Given the hype over Chinese products, from cars to solar panels, it may seem obvious to ask whether the Chinese economy can innovate. In reality, the answer is not so simple.
An economy that innovates becomes more productive and efficient. In the language of economists, this is called the growth in total factor productivity. Put another way, can we produce more with less? Technology and capital allow us to become more productive by extending our capabilities.
It may seem obvious that the Chinese economy innovates, but we must distinguish between whether individual firms or sectors innovate and whether the economy innovates. Even deeply flawed economies such as the old Soviet Union or North Korea can produce innovative products. That does not mean, however, that they can produce an innovative economy.
In reality, the Chinese economy has been suffering from years of low innovation; even Chinese economists have publicly worried about low factor productivity. The growth that most people marvel at comes primarily not from increased innovation, efficiency, or a higher-skilled workforce but from capital in the form of higher debt levels.
Products, from Chinese high-speed rail to operating systems and airplanes, come from foreign technology, which is then advanced and built by local companies with the help of enormous subsidies. In reality, the only way economies advance is by becoming more productive, but the Chinese economy relies on centralized planning and direction, which creates perverse incentives.
We witness a similar dynamic in modern China. Beijing announced it wanted to stimulate semiconductor manufacturing, and there was a flood into semiconductor manufacturing. Companies of all types, whether related to technology, flood into semiconductors seeking government assistance. That is followed by the inevitable collapse and wave of bankruptcies. Even the surviving firms continue to demand large-scale subsidies to stay afloat.
This gets to one of the primary issues of China’s inability to innovate as an economy. In a centrally planned economy, innovation and product quality are less valued than securing the favor and largesse of the public sector. This actually matches what economic research shows. Young firms in China demonstrate high levels of innovation and efficiency. The older a firm gets, the more it stagnates and becomes dependent on financial investment and state funding.
As the Chinese say, much of the innovation in China revolves around the Chinese Communist Party (CCP). For example, with the Party mandating increased focus on “Xi Jinping Thought,” workers take time out of their day to study his ideology rather than the needs of their business and how to improve.
The problem is not that the Chinese, either as people or as a country, are incapable of innovating and doing great things. The problem is that the incentives and structures of the Chinese authoritarian economy discourage and make innovation incredibly hard.
Speaking at a national science and technology conference last month, state-run media China Daily reported that Xi underscored the importance of “improving the centralized and unified leadership of the Party Central Committee over sci-tech work.” The dual nature of submitting innovative activity to Party control contradicts the nature of innovation itself and the rigid authoritarianism of the Party.
Faced with a stagnating economy and falling productivity, the CCP seems unlikely to do anything other than demand more control.