The Rise of Chinese Innovation
On 11 August, startups have gathered in London’s Google Campus to compete to win the opportunity to fly to Shanghai for the International Innovation Competition. This will pitch finalists from competitions around the world and it aims to find the “most disruptive startup”. Events like this one are increasingly frequent in major Chinese cities, incubators and accelerators for startups are springing up around the country, and venture capital (VC) in China has been skyrocketing, growing seven-fold in the last 5 years. The Chinese government, despite already backing around 780 VC funds with roughly $330 billion of combined capital, has recently announced the imminent creation of an additional $30 billion VC fund.
Why China needs to innovate, in which way it has been innovating, in which places and sectors Chinese innovation is rising, and what challenges China has to confront are the main focus of this article.
The Innovation Imperative
What was worldwide known as the land of cheap and low-quality manufacturing is now turning into an “innovation powerhouse”. Since 2012, President Xi has carved a path towards the transformation of the Chinese economy. The 13th Five Year Plan reaffirms his policy vision for China based on innovation. One of the main reasons of such a fundamental change in economic policy is the fact that China has to innovate. Chinese traditional forces of growth are fading: due to the “one child” policy the labour force is no longer growing, returns on fixed asset investment is declining, and investment is also constrained by China’s gigantic debt (currently around 282% of its GDP). Moreover, the competitiveness of the “made in China” will be further diminished if China fails to innovate, since the rest of the world is entering the new era of the Industry 4.0. Therefore, to sustain 5.5-6.5% growth rates through 2025, innovation would need to contribute up to 50% of GDP growth, from the current 30%.
While the innovation imperative is a national challenge for China, innovation itself is not a uniform process. It springs up and develops in urban communities that are home to important universities, research centres and wealthy investors. It is certainly not by chance that the Silicon Valley was born where Stanford and the University of California are. And it is not by chance that Kendall Square (Cambridge, US) became a world epicentre of innovation in pharmaceutics and biotechnology: it is around 1.5 km away from the worldwide renowned MIT and around 5 km away from the Harvard Medical School.
Chinese Innovation Hubs
A similar pattern can be detected also in the case of the first Chinese innovation hub: Beijing (or more specifically Zhongguancun). In the 1980s, Chen Chunxian (member of the Chinese Academy of Sciences), after visiting the US, came up with the idea of transforming Zhongguancun in the Chinese Silicon Valley. And surely the proximity of the Academy of Sciences to Zhongguancun has been a driving force for the transformation of this area. As also the proximity and participation of China’s two most prestigious universities, Tsinghua University and Peking University, have been. Universities, education and research are the fundamental pillars on which innovation hubs arise.
However, most of the other Chinese hubs have followed a different path. Innovation in Shenzhen and Chengdu is the product of national and local government policies. In fact, no top universities were present at the time of the establishment of the Development Zones in either city. Even now Chengdu is home to several universities, but none of them can be regarded as a leading institution. On contrary, the government of Shenzhen has embarked upon a major effort to convince leading Chinese and international universities to establish campuses in the city. Important results have been already achieved: Shenzhen is now home to campuses of Tsinghua and Peking Universities, and of the Harbin Institute of Technology.
Shanghai developed in a hybrid way: while national and local governments’ policies have been essential in starting the process of innovation, Shanghai is home to renowned universities such as Fudan and Jiao Tong Universities, which have also played a pivotal role.
With the exception of Beijing and partially Shanghai, innovation in China can thus be mainly regarded as a top-down and state-backed process, rather than a bottom-up and spontaneous one as it has originally been in the US.
Not Only Universities: the Role of Local Governments And Industrial Enterprises
Universities and research institutions are not the only players. In China, the central government sets broad policy guidelines, while considerable autonomy is given to local governments on how to act upon those guidelines. Thus, local governments have a broad range of tools at hand to further innovation in their city. For instance, Shanghai’s government has approved a new policy that promises to compensate investors as much as 60% of any actual losses suffered from early-stage investments in technology startups in Shanghai.
Apart from specific policies, local government’s support to innovation can be compared in terms of their expenditure on science and technology. Both in absolute terms and as a percentage of local government’s budget, Beijing’s government is the most supportive of innovation, investing a high 6.3% of its budget on S&T, in 2014. In the same period, Shanghai and Shenzhen’s local governments both invested almost as much as Beijing in absolute terms, but only 5.3% and 3% of the corresponding general expenditure. Finally, Chengdu’s government invested a much smaller amount of money than the other three cities, investing only 1.2% of its budget. However, Chengdu’s public expenditure on this sector has grown by an astonishing 78.7% in the period 2011-2014.
Another driving force of innovation hubs is the business sector. Could have Kendall Square become what it is without the massive investments of Big Pharma companies, such as Novartis? Could have the Silicon Valley become what it is without the support of major companies such as Intel, HP, EA and Tesla among the others? In 2014, Shenzhen’s industrial enterprises have collectively invested a record-high $21 billion in R&D, 53% more than in 2011. Shanghai as well performed really well, with $6.7 billion invested in R&D by industrial enterprises in 2014. Both Beijing and Chengdu lag behind with investments around $3,5 billion and $3 billion. Again, however, Chengdu outstands in terms of growth: in 2011-2014, industrial enterprises’ investments in R&D have increased by an extraordinary 88%.
From A Favourable Environment to a Startup Ecosystem
Universities, research centres, and investments in R&D are all fundamental factors in creating a favourable environment for innovation to spring up and for startups to emerge. Once startups are born, however, what they need the most is funding. In the early stages this can come from friends and family, crowdfunding, angel investors, or accelerators. Nevertheless, when it comes to scaling up, the most common source of funding is Venture Capital (VC). Last year will be remembered as the Eldorado for startups: 2015 has seen an amount of global VC worth $148 billion through 8,381 deals – the highest VC activity in nearly 2 decades.
In China, Beijing has been the city that secured the most venture capital funding both in terms of number of deals and capital, followed by Shanghai. In 2015, 677 deals were signed in Beijing, for a total value of around $20 billion. In Shanghai, on the other hand, $12.2 billion were raised through 365 deals.
While all major innovation hubs in China can count on VC companies, not all of them can count on a physical presence of the main ones. Ranked in order by number of deals signed in 2015, the top VC investors in China are Sequoia Capital, IDG Capital Partners, Matrix Management Corporation, Zhen Fund and Northern Light Venture Capital. All of them have a branch in Beijing and all of them but the Zhen Fund also have a branch in Shanghai. On the other hand, Shenzhen is home only to IDG and Northern Light, and Chengdu to none of them.
What All This Has Lead to
Beijing Zhongguancun Science Park was the first special area to be formally established in 1992. Nowadays, Zhongguancun is the largest and most important centre of innovation in China. In 2014, over 2 million people were involved in the 15,645 high-tech companies based in Zhongguancun. Beijing is also home to 19 unicorn startups, such as Xiaomi and Didi Kuaidi just to name a couple of them.
Shanghai can count on two development zones, namely Zhangjiang Hi-Tech Park and the smaller Shanghai Zizhu Hi-Tech Industrial Development Zone. These two zones combined were home to 3,881 high-tech enterprises in 2014, which engaged a total of almost 780 thousand people. Shanghai can be therefore defined as the second hottest hub in China, however lagging quite far behind Beijing. Moreover, according to Fortune, in 2016 Shanghai has been home to 8 unicorns so far (Lufax, Ele.me, and China Rapid Finance are the biggest ones).
Shenzhen and Chengdu show a strong performance, but still lagging behind Beijing and Shanghai. In 2014, their development zones were home respectively to 1,435 and 1,724 high-tech companies, involving respectively around 442 thousand and 291 thousand people. No Chinese unicorn companies listed on Fortune were based in Chengdu, while Shenzhen is home to the unicorn company DJI.
How Innovation Hubs Differ From One Another
In the early stages, innovation hubs tend to be centres of research and innovation on a wide and diverse array of sectors, while in later stages they tend to specialise and excel in fewer sectors on the basis of their comparative advantages.
That has been the case of Shenzhen. Thanks to its very strong ecosystem in manufacturing, Shenzhen is increasingly specializing in hardware: some people already call it the “Silicon Valley of hardware”. Indeed, the easy availability of hardware components makes it a great place to develop IoT products: the average time needed to prototype in Shenzhen’s design firms is 8-12 weeks less than in-house (and at a much lower cost). Shenzhen is now home to the first and largest hardware accelerator in the world (HAX), which invests up to $100,000 in each of 30 startups a year. Shenzhen has also been the worldwide leader in ICT patents filing in 2013, filing slightly less than 8 thousand new patents in the sector, overtaking Tokyo and San Francisco–San Jose–Oackland. In 2013, Shenzhen was also the city filing the highest total number of new patents in China, accounting for 41% of all new patents in China (Beijing accounted for 19%, Shanghai for a much lower 7% and Chengdu only for 1%). Shenzhen has become a major innovation hub and is growing at a very high pace, catching the interest investors, multi-national companies, and startuppers.
In the meantime, Beijing is leading the way in biotechnology and biomedicine (while also achieving good results in other high-tech sectors, such as electronic information, energy and environmental protections, new materials, aerospace, and advanced manufacturing). In 2013, Beijing accounted for more than 20% of all new patents in the field of biotechnology in China, overcoming Shenzhen and Shanghai, which both stopped at around 15%. While Beijing surely remains the most important innovation hub in China, it is growing less rapidly then Shenzhen.
Shanghai is standing out as a national leading hub in pharmaceuticals. More than 300 drugs are being developed at Shanghai’s Zhangjiang tech park. One in every three new drugs in China comes from this tech park and 25% of new patents in this field in China come from this tech park. Pharmaceutical research in Zhangjiang, however, is mainly led by foreign multinational corporations. Just a few months ago, the Swiss pharmaceutical giant Novartis unveiled a seven-building research centre in Shanghai’s tech park. While the pharmaceutical sector is highly developed and the presence of a strong financial district translates in easier access to funding sources, Shanghai seems falling behind its main counterparts (i.e. Beijing and Shenzhen).
Finally, Chengdu cannot yet be described as a totally formed innovation hub: it is still in the early stages of development, which are characterised by a not-yet-specialised innovation activity. Early stages are also synonym of impressive growth rates in the main statistics (and great opportunities), but also by high uncertainty on its future as an innovation hub.
The Main Challenges
The path of innovation, however, is not clear of challenges. At its root, innovation arises out of new ideas. Then, why would a person with a new idea develop a startup in a place where anyone can easily simply copy her idea? The lack of intellectual property protection and the lack of rule of law are two great issues that the Chinese government has to work on, if it really wants to transform China in a global innovation leader. On the investors’ side, one of the main problems is the lack of transparency and reliable information, which makes it difficult for local companies to even pass the initial screening, which includes careful assessment of the company to be funded. Finally, it is hard for companies to scale up through the stock exchange. It can take years for the Chinese Securities Regulatory Commission to review an IPO application, and by August 11 686 companies were still waiting for approval.
China has realised that it has to innovate; it has embarked on a major effort to innovate, thus bringing many and various hubs to life; and if it manages to clear the path of innovation from some main issues, it has a great chance to catch-up (if not overtake) the US in the innovation race.