China's Development Model: An Alternative Strategy for Technological Catch-Up

Date March 22, 2005
Speaker Xielin LIU(Research Fellow and Professor, National Center for Science and Technology for Development, Ministry of Science and Technology, Beijing, China)
Moderator MOTOHASHI Kazuyuki(Faculty Fellow, RIETI / Associate Professor, Research Center for Advanced Science and Technology, The University of Tokyo)


It has been 20 years since China has had an open policy as well as political and economic reform, and it is now on a path of very rapid, high economic growth. This has awakened the interest of many people in China's development and the dynamic forces behind its progress. In my presentation I will look at China's rise and its catch-up process from a technological perspective.

There are basically two different approaches in the theory of catching up. One is closer to a neoclassical growth model such as Solow (1956) wherein technology is considered very important for economic growth and it can freely spill across countries. Thus, in a certain sense, developing and developed countries grow more toward convergence. In contrast, from a technological perspective, advocated by economists such as Nelson and Freeman, who see the catching up process as a more historical, institutional and evolutionary tradition, the emphasis is that it is not easy for technology to shift from one place to another, which necessitates a more contextual and institutional understanding of what is happening in one country.

History has shown us many examples of countries lagging behind using a "window of opportunity" to catch up, such as the United States in the 19th century, Japan in the 1960s to 1980s, and more recently Korea and Finland. The more recent research is focused on Asia because the region is more dynamic. In Asia, there are also different perspectives on catching-up. One is a macro approach, such as that of the World Bank, which studies the catch-up along the lines of governments and markets. But this viewpoint is criticized by those with a more technological perspective, who base their approach on technological innovation or the national system of innovation, such as Freeman. These scholars include Lee and Lim, who would claim that the technological regime is a very important framework to understand why Korea was even quicker than Japan in catching up. In industries in which technology is predictable or innovation occurs more frequently, such as ICs and automobiles, developing countries can catch up very efficiently and quickly, while they may fail in the PC and consumer electronics industries, as was the case with Korea. However, the opposite is the case in China.

There are three basic assumptions made in the Japanese and Korean model of catching up. The first is the late development advantage. This is an old theory that states that countries that are late to catch up can target more progressive and dynamic industries, and bypass some of the problems that developed countries face, to achieve a faster economic growth rate. The second assumption is that the institutional setting is very important. Especially for Japan, this was key to its experience. Freeman has done a lot of very good work to explain why Japan was so good in catching up. He noticed the role of institutions, in particular how Japan made factories function as research labs and implemented job rotation in firms; and also the role of government, such as the very important role played by MITI in setting the technological direction, and its foresight in guiding the business community. The third assumption is related to product cycle theory. This is an old theory, but has been criticized more recently. It holds that leading companies in developed countries will have more dense R&D investment, which can lead to radical innovation and give rise to a product innovation space. After the industry comes to maturity, it will then shift production to developing countries. For example, 30 years ago, Japan was said to be following a "flying-geese model," taking technology from the United States, then shifting technology and production to Korea, China and Taiwan.

Additionally, there are three stages in the Japanese and Korean model from the imitation stage to the innovation stage. The first involves acquiring mature technology from developed countries, as Japan and Korea did for a long time. China is now importing technology not just from the U.S. and European countries but also from Japan, Korea and Taiwan. This sort of technological importation still plays a very important role. In the second stage, a more incremental process will occur in developing countries. For example, Kim (1997) would say, based on the Abernathy-Utterback model, that developing countries or firms catching up will have process innovation first and product innovation later. This is the reason that Japan, despite being a developed country, still imports radical product innovation; likewise in Korea, China and other late catch-up countries. Certainly, Japan is very unique in that reverse engineering and investment in in-house R&D have top priority in industrial policies. One could almost say that Japanese companies nowadays invest more in R&D than U.S. companies. In the third stage then, companies will do more R&D work and enhance their capability to engage in product innovation.

When we look back at why Japan and Korea were fairly successful at the time, there are three basic context points. The first is the product cycle theory. That is to say, radical product innovation was brought in from the U.S. and followed, and based on that direction, more in-house R&D and process innovation was introduced. This applies to consumer electronics (TVs, video recorders, cassettes, et cetera) and even automobiles. The second very important point is that they restricted the foreign direct investment (FDI) coming in. This is very different from China. By so doing - importing technology but keeping FDI away - Japan invested more outside, while the inward FDI flow was very small. Kimura and Schulz, for example, have argued that FDI played a very limited role in Japan. Included in this last point is the question of the ability of each industry to catch up. In Japan, industries are more integrated, and the more complex manufacturing industries and modes of innovation can be better matched up into categories, such as shipbuilding, electronic appliances, automobiles and machine tools. Owing to the good inter- and intra-industrial collaboration in Japan, its seniority system (both in industry and academia, as now emulated in places like China) and its management innovations (lean production and total quality management), the complex manufacturing industries in Japan have succeeded in accumulating knowledge, and establishing training and seniority over a long period.

The rise of China in some sense is a catch-up based on macroeconomic indicators. For example, China's GDP based on purchasing power parity (PPP) is second only to the U.S. Therefore, in considering China's economic catch-up process, it has to be said that it is occurring in a new environment. It is one in which, firstly, information technology plays a greater role than before and this has changed the game of catch-up, making the product cycle theory outdated. Many economists consider it more relevant to use the life cycle of technology systems because a lot of the latest technologies in China may be in their early stages and could shift to China very swiftly. With the information technology revolution, the situation has totally changed. In the IT industry, a lot of firms are more specialized on one activity and not integrated. Therefore, better use is being made of global procurement of goods, and mobility of human resources has become possible. Taking advantage of such network externalities seems to supersede the Japanese closed networking system.

Secondly, in the new environment, modularity of manufacturing or modular production has become popular in some industries, especially in automobiles and the IT industry. This enables Chinese companies to outsource design and production of components and subsystems to different companies overseas, allowing China to be quicker in responding to technological progress.

Lastly, the new environment allows global technology outsourcing, without which China would not be doing as well as it is now. In terms of the technology "buy or make paradigm," China is more of a buyer and outsourcer of technology, collecting it from Europe, Japan, Korea and the U.S. Following China's accession to the World Trade Organization and increased interest by foreign countries in collaborating with Chinese companies in order to gain a share of the sizeable Chinese market, Chinese companies with their own local knowledge advantage can also get technology from outside.

This is part of China's alternative catch-up model, which, realizing that Chinese companies are not good at technological innovation, instead adopts market-oriented innovation. Although this is an American invention, as clearly demonstrated by the market share held by Dell, which spends less in R&D than IBM, this market-oriented innovation model is used very efficiently in China.

Various factors have led Chinese companies to use this approach. The first is that their capability in terms of in-house technology development is limited, which is a historical remnant of China's state-planned economy. Therefore, it takes Chinese companies a long time to build up their own R&D systems, although a lot of improvements have been seen in the last 20 years. The leading Chinese companies nowadays are actually very young and will have to build up their R&D systems. To give an example, Haier sells over 400 refrigerator models in China, creating greater market differentiation based on stratification, style, region and use in overseas or local markets. In this way, by creating more product models to match different market needs rather than being technology-intensive, Chinese companies can compete against foreign brands. Looking at the number of invention patents, China is still very weak, with the share of domestically owned of patents decreasing from 1991 to 2002. However, Chinese companies dominate the field of utility model and external design patents.

Market-oriented innovation in China has to be linked with technology outsourcing for a company to retain competitiveness and to procure the latest technology. The method of doing this is different in China than in Japan and Korea. Although technology imports still play an important role in China and the share of expenditure on technology importation via expenditure on R&D is still high, international technology alliances have become more important. For example, while Huawei may still lag behind foreign brands, it has set up a lot of joint laboratories with Texas Instruments (TI), Motorola, et cetera, and a joint venture with 3COM, thereby catching up with the latest technology. Looking at the technology market, China is buying less technology from university and research institutes than before and is now outsourcing its technology procurement to foreign companies. Once leading Chinese companies reach a certain size, they will enter a second stage: merging to get the latest technology from multinationals. There are various examples of this, such as the merger of TCL with Thomson or Legend with IBM.

The model of China's two-stage catch-up is as follows: Stage 1 is based on modularity and global technology outsourcing, good local knowledge and cost advantage. In stage 2, Chinese companies will have more technology merging to create more global brands, with more domestic as well as overseas R&D.

To demonstrate the workings of this framework, there is some empirical data on modularity and innovation. Kodama published a paper on modularity in Japanese industry. Some of the macro data for China on processing industries (chemicals, pharmaceuticals) and modular industries (electronics, automobiles) demonstrate that new product sales in the processing industries are catching up, but progress is insufficient. In terms of patent applications, the electronics industry has increased its numbers significantly. These differences show that the performance of the processing industries is completely different from the electronics and automobile industries. This goes to show that global outsourcing, modularity and the IT revolution have greatly impacted the electronics industry in China.

As an example, I will present the case of the mobile phone handset industry, which is a very new industry in China. It should be noted that the Chinese market has the highest annual market growth in the world: over 50 percent annually and over 270 million users. In terms of domestic and foreign companies, while more than 92% of the market in 1999 was dominated by foreign brands, especially Motorola and Nokia, in 2003 Chinese companies fought back and they now have a higher market share than foreign companies. In this case, the industry transitioned from an integrated manufacturing process led by Motorola to a more modularized industry over a period of several years. For example, in the design of handsets, more Japanese and Korean companies were used, and other companies emerged in determining the software and standards (Qualcomm) and in chip manufacturing (TI, Philips). In this way, the more modularized handset industry in China was formed with technology and design obtained from different sources.

To illustrate a case of catching up, the Bird company, the largest handset maker in China in terms of production volume, initially outsourced its design to a UK company in 2000, but later shifted to Korea's Sewon in 2001, before finally settling on a partnership with Korea's ATEX in 2002. It set up a design house in Korea and invested a lot of resources in setting up quality control of its product with the help of European experts. At the same time, it began to do its own product development and set up alliances to cooperate with companies from different regions around the world. The same can be said about many other leading Chinese companies (TCL, Haier, ZTE, Eastcom, Kejian, et cetera). While the technology is still dominated by foreign countries, Chinese companies are in a good position in terms of manufacturing and market-oriented innovation.

To conclude, first, the Chinese catching up process is one of more market-oriented innovation and more outsourcing of technology. The latest issue of Business Week described this as "outsourcing innovation," which employs a global network of partners to cut costs and reduce lead times for new product development. Second, modularity, globalization of technology, and IT are the three key factors in the new Chinese development paradigm. Third, Chinese companies will be more aggressive in merging technology in the future to strengthen their R&D function and they will also increase their in-house R&D work. Last, the Chinese catching up model is applicable only to certain industries, such as electronics, based on the structure of a particular industry's technology system. Chinese companies could be better in catching up in other industries, such as pharmaceuticals and chemicals, which are still lagging behind.

Questions and Answers

Q: It seems to me that what you are trying to do is have an orchestra by employing all the instrumentalists. If that is what you mean, that process will continue forever. If you do not do R&D yourself, because you can employ someone to do it, you could employ someone for each and every thing.

A: The process will not continue forever. As I said, there are two stages. In the first stage there may be very little in-house R&D, but later on Chinese companies will have their own R&D divisions. Initially, merging with foreign companies will serve to give them more R&D capability quickly and it takes time, but eventually they will gradually have their own in-house R&D so as to remain globally competitive with their own technology.

Q: At some stage when you become a front-runner, you must invest more in R&D. Is that what you mean? However, you could still buy everything from the world by outsourcing.

A: This is merely talking about the role of innovation in one industry as it matures. This was labeled "outsourcing innovation," by Business Week. Different aspects were outsourced to different companies throughout the world. As for Chinese companies, they have a cost advantage and knowledge of local market needs. These are also important for companies seeking to gain expertise and grow.

Q: You talked about merger activities, but buying a company and managing the company is not necessarily the same thing. Looking back at the recent acquisition of divisions of foreign companies, what is your assessment of their relative success in managing those divisions after acquisition?

A: I agree with you that while it is easy to merge two companies, to merge their capabilities takes time. I think that up until now, for example, since TCL's merger with Thompson, the picture has been very positive and not negative. It will take time. I am not able to give you a positive answer right now. It will take several years to reach a solution.

Q: You talked about technology outsourcing, but that is based upon the assumption that other companies outside of China will continue to be willing to provide technology. Do you see any signs that other companies are less willing to share technology?

A: This is based on a fascinating phenomenon, which is that technology is progressing very quickly. We are seeing that, for example, for mobile phone handsets, Nokia and Motorola are not willing to sell their technology to Chinese companies because then a competitor could emerge. However, a lot of mid-sized companies in Korea supply the technology to Chinese companies. This is a sign of the modularity that I spoke about.

Take the example of watchmakers. In Japan, the industry may be traditionally integrated, but if you try to supply not just the final product but the parts to Chinese companies, Japanese companies too can make extra money. In this way, Chinese buy not the core technology, but parts, and they can make the watches themselves. This is becoming a more globalized world, and the technology can be shared more openly.

Q: You basically argue that the Chinese market is so big that it is attractive enough for companies in terms of raising productivity that they provide some technology to Chinese companies. Essentially, however, that kind of company would not be willing to share technology because they could sell their products in China themselves. Could you share your thoughts on that?

A: If we try, we can find some examples of these kinds of cases. Even in the case of Toyota's late investment in China, one could say that the proximity of China to Japan allowed for joint ventures between Toyota and Chinese companies to help them catch up in the automobile industry. However, more companies are now coming in from other countries as well, but Japanese companies will still have their share of the market in China. Even Motorola at first was not willing to have joint ventures in China. They preferred to have a wholly-owned company.

I would say that it depends on the industry and how quickly technology can progress. If the pace of technological progress is very slow or some company has a monopoly over the industry; if the Chinese cannot get their hands on that technology, they cannot be successful in that industry. If an industry has very rapid technological progress and also more modularity, then I think that Chinese companies can win.

In the pharmaceutical industry, for example, it is not easy for Chinese companies to catch up because leading companies in the world still have their patent protections and there is no modularity. Therefore, the performance of Chinese companies is still very poor, and the majority of drugs are manufactured by Western companies.

Q: Although you have not said anything about it, China has a very bad reputation for protecting technologies. I presume that at some point you will reach a point of diminishing returns, where after you get to a certain level, people will simply not sell you anything because they know that you will be stealing it from them ultimately, unless you improve your protection of technology and intellectual property (IP). What are your plans for the future on that? Are you not worried about your reputation in not protecting technology?

A: I understand that it worries people but I do not think that it is a huge concern. It will take time for Chinese companies to learn to protect others' innovations. For example, in recent years, the government improved the law concerning intellectual property rights, so there are efficient ways being put in place to protect other companies' technologies. However, I would have to say honestly that it is not just in IP rights, but also in other legal and economic affairs that China is still lagging. Government efforts take time, but it will also take more education and more upper management with a better understanding of IP rights to improve the situation. Right now, all I can say is that it will take time and that it is not easy to solve the legal issues. The price and the difficulty for the government, in consideration of the massive size of the country and its outlying regions, are very high.

Q: On the last point that you mentioned, other than the violations of IP rights, the government also has neglected to protect or intervene in the market as much as it should. The competition among the enterprises or manufacturers is so intense that profit margins are rather narrow. Therefore, with regard to investments in R&D, for one, investing in R&D made little sense because most of the technology was not legally protected. Second, there is not enough money to invest in R&D. Since you talked about the Japanese model and how government policy played prodding roles in developing technology, I wonder whether you could tell us what the main technology policies are in China. Also, what kind of changes is the government thinking about; or what is it doing apart from the private, entrepreneurial activity?

A: I think that the central government has not traditionally paid much attention to domestic R&D capabilities. More money, for example, from the Ministry of Science and Technology, was spent on universities and research organizations. However, in business, it is still quite undeveloped. Therefore, there are a lot of affiliated companies involving university professors from Peking University or Tsinghua University. This shows the effects of the Chinese government's long-term investment in R&D in universities.

More recently, the latest report by the Chinese premier cited "autonomous innovation" as the government's top priority. This focuses not just on outsourcing and importing of technology but also on technology coming from in-house R&D and universities. This will take a long time and is not an easy task, but the way in which companies operate is different from the government and easier to control. There should be some government tax incentives to encourage companies to foster R&D. Based on the availability of global technology, cost advantage and modularity, I do think that it will take a long time to happen in China.

Q: You mentioned that the Japanese adopted the strategy of "reverse engineering" and that the Chinese opted not to employ that technique. It seems that the Haier way of marketing is similar to reverse engineering. What is the difference between the Chinese and the Japanese way? And, how do you see the future role of reverse engineering?

A: I think that from the 1950s to the 1970s, China also used reverse engineering more to try to acquire technology. As I said in my paper, Japan and Korea used reverse engineering to master technologies and could thus enter into an innovation stage. In China, however, because of the state-owned companies, there was less incentive to invest in R&D. The government did say that there was a need for reverse engineering, but it failed. The reverse engineering method requires a lot of time, and additional features, as in the Japanese model, such as job rotation, an emphasis on training, and the seniority system. In China, reverse engineering is not popular or dominant. Instead, we are more willing to collaborate with foreign companies if they are willing to do so.

Q: Regarding external design patents, you mentioned that their number is increasing sharply, but the designs are closer to imitation. I would think that it is difficult for an original designer to register a variety of designs, during which time the Chinese can apply for a number of similar designs. In that regard, can you explain the role of external design patents?

A: For external design, I think that design is comparatively easier to master than core technology. Given the big population in China, most of the buyers, especially of IT products are young people who care about design and utility. European companies are not good at design for the Chinese market because the market needs are different. We have to come up with more fresh designs to appeal to our young buyers. In that sense, China remains open to learning about how to enrich the users' lifestyles.

*This summary was compiled by RIETI Editorial staff.