The China That Can’t

China, which graduates at least 10 times more engineers than the United States and files far more patents, still is not anywhere near becoming an innovative nation.

The US will remain ahead technologically for the foreseeable future and in fact, according to a new report by China First Capital, Hong Kong-based M&A firm,, is now more dominant in high-technology than it has been at any time in history. The US is home to most of the companies earning high margins, market shares and license fees for their proprietary technology and appears likely to stay there.

“While China is making strides, the reality is sobering,” according to the report, issued this week, which in the main is highly optimistic about China despite its pessimism about the country’s high-tech ambitions.“For all the hype, the government policies, encouragement and cash, China remains a high-tech disappointment, more dud than ascending rocket.”

One of the most important problems China faces is the creation of a transparent judicial system, not only for protecting intellectual property but for managing the contract process that allows companies to put money at risk over long-periods to achieve a return, China First Capital says. “Non-Disclosure and Non-Compete agreements, a backbone of the technology industry in the US, are basically unenforceable in China. Anywhere this is the case you can about wave goodbye big-time to technology innovation.”

China is hardly alone, however, in finding difficulty in creating and nurturing a globally-competitive indigenous technology industry. Japan has struggled vainly for decades to produce a jetliner. As the report points out, countries with different political systems including France and the United Kingdom have poured vast government subsidies into the attempt to foster domestic innovation, but have basically failed.

China has been unable, “despite strenuous effort across more than a decade, to reach even the first rung of advanced high-tech competence: designing and serially producing jet engines.” It still buys them from Russia despite growing concerns that Russia is finding other markets and that China could face a jet engine shortage.

Overall US military supremacy, the report continues, rests as much on Intel and Broadcom as it does on Lockheed Martin fighter jets and GD nuclear submarines. “The US has a huge, fast-adopter civilian technology market with strong competitive dynamics, something China is without. This means US military then and now can procure the best chips, best integrated software and systems cheaply and quickly from companies that are mainly serving the civilian market. The Soviets had no civilian high-tech industry, no market forces. The Soviet military was exposed as a technology pauper by the 1989 Iraq War.”

China does manufacture a lot of the world's most advanced civilian high-tech electronics products, a major advantage the Soviets never had. But to this day, China relies on Russia, using Soviet-successor technologies, for its advanced jet engines. Russian jet engines are generally considered at least a generation behind the best ones manufactured now in the US, France, UK.

The failure to manufacture an advanced jet engine casts light on problems other China has, and likely will continue to have, developing a globally-competitive indigenous technology base. In the case of jet engines, the problems are at the manufacturing level (difficulty to serially produce minute-tolerance machinery), the material level (lack of special alloys) the industrial level (only one designated monopoly aircraft engine producer in China, so no competitive dynamic as in the US between GE and P&W) for the design, monitoring and lifecycle management of civilian and military jet engines.

A recent report on China's jet engine industry puts the technology gap in stark terms. "In some areas," it concludes, "Chinese engine makers are roughly three decades behind their U.S. peers." The Comac C919, China’s major bid for a passenger jet, is being produced in conjunction with the Irish airline Ryanair but is using foreign-made jet engines and technological and production problems have pushed the plane’s launch back until at least 2016.

“This challenge, to bring all the parts together in a high-technology manufacturing project, is also evident in China's failure, up to now, to develop and sell globally domestically-developed advanced integrated circuits, pharmaceuticals, new materials,” the report notes.

In drug development, China by some estimates has spent over US$10 billion on pharmaceutical research and up to now has had only one domestically-developed drug accepted in the global market, the anti-malarial treatment Qinghaosu (artemisinin). Interestingly, it is derived from an herbal medicine used for 2,000 years in China to treat malaria. Sadly, as the malaria parasite mutates, artemisinin is losing its ability to fight the disease.

While ignoring the troubling lessons of China's failure to produce a jet engine (as well as jet brakes and advanced radar systems) the boosters of China's bright tech future these days most often cite two mobile phone-related businesses as proof of rising innovation. The two are Xiaomi mobile phones, and Tencent's WeChat service. Both have had success in the last year, including getting some traction in markets outside China. But, the report continues, “Look a little deeper and there's less to be positive about.”

Xiaomi is a handset manufacturer that now has a market valuation of over US $10 billion, higher than just about any other mobile phone manufacturer. But it relies mainly on the same group of US companies (Broadcom, Qualcomm, Google) for key technology in its phones. They, along with UK chip-maker ARM and Japanese screen manufacturers, are the ones making the real money from Android phones. In addition, Xiaomi's phones are manufactured by Taiwanese company Foxconn.

As of now, China First Capital says, “China has no domestic company that can achieve Foxconn's levels of quality at low manufacturing cost. Foxconn does this from factories in China. Its superior management systems for high-volume high-quality production also underscore another area where China's domestic technology industry is weak.

While WeChat has signed up more than 300 million users, the basic application is similar to that of Facebook's WhatsApp and others. It would be hard to suggest Tencent has demonstrated technology leadership in this area. Its real technology strength, though, is in its back end, in building and managing the servers to store all the content that is sent across WeChat, including billions of video and audio files.

Whatsapp doesn't have similar capacity. In fact, it points with pride to the fact it doesn't backup for storage any Whatsapp customers' conversations, the report notes. Tencent does this because it's required to do so by Chinese internet rules, and government's policies to monitor internet content. Tencent might be able to commercialize and sell globally its backend storage architecture, but it's not clear anyone would be interested to own it. It's a technology that evolved from specific Chinese requirements, not market demand.

Last month CFC's chairman spoke on a panel at a conference for the global bio-manufacturing industry. Bio-manufacturing is precisely the sort of high-tech endeavor where China most needs to up its game. Bio-manufacturing relies on a mix of first-rate science, cutting-edge manufacturing techniques and capable management.

“After all the talk and the establishment of dozens of government-funded high-tech science parks across China, the simple verdict was China has yet to achieve any real success in this industry.”

Certainly China’s achievements in industry and society are astonishing. AS the report notes, in the course of a single generation, it has achieved the highest-ever sustained rate of growth, and so lifted hundreds of millions of its citizens out of poverty.

“This achievement shows the capability of the Chinese people, the wisdom of its policy-makers. Both will continue to deliver benefits for China across generations to come.For China, becoming a tech power is neither certain nor impossible. Progress can be hurt, more than helped, by those who engage more in hype, in predicting certain outcomes, rather than critically assess the impediments, and learn lessons from the failed efforts so many other countries have had in developing a technology industry. New thinking about innovation, and how to encourage it in China, is still lacking.”