Mother of invention?

Innovation is high on the government's agenda. But can Beijing really plant the seeds and then let the garden grow on its own?

Mother of invention?

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Running across the length and breadth of China, connecting 167 institutes and departments at 25 universities in 20 cities, is an Internet network that could be the blueprint for a new era in online activity.

The China Next Generation Internet (CNGI), set up in 2003 and known as CERNET2, passed its core tests at the end of September. Running off Internet Protocol version 6 (IPv6) as opposed to the standard IPv4, it can transfer information at 2.5-10 gigabytes per second, 100 times faster than current Internet speeds.

CERNET2 is said to be the most advanced network of its kind in the world and it could put China in a strong position to direct the future of the Internet.

"IPv6 is the most important technology in the history of the world and China is the only one really doing something with it," said Alex Lightman CEO of Innofone, the only public company focused solely on IPv6. "China knows IPv6 is where millions of its people will be making phone calls, playing games and doing transactions."

Put simply, IPv4 supports 4.3 billion 32-bit addresses, the framework through which information is carried across the internet. This is insufficient to service a growing online population as well as the rapidly expanding number of internet-enabled devices. The 128-bit IPv6 provides addresses to spare (an undecillion - 36 zeros) as well as offering significant advances in terms of security and support for more sophisticated applications.

Strong core, no edge

But despite having the world's leading IPv6 backbone, China has little in the way of applications to run off it. Lightman believes this is suffocating the technology's commercial potential as there is nothing out there to generate consumer demand.

IPv6 is an innovation acid test for China - it has laid the foundations but must now nurture a creative community on top.

"Chinese companies will have the first chance to develop applications and hardware that is based on IPv6," said David Wolf, president of Beijing-based technology, media and telecom consultancy Wolf Group Asia. "It will be new ground for China to capitalize on these advantages and run the downstream effectively."

Innovation is vital to China. The way in which other Asian nations are eating away at the country's comparative cost advantages suggest it cannot rely on being the world's factory forever. Furthermore, its current growth model has pushed the environment to the brink. Water scarcity, land degradation and desertification and air pollution are becoming ever more serious.

A State Environmental Protection Agency official said earlier this year that pollution costs China 10% of its GDP.

"If you look at the major dilemma of the current economic model, it is that it is resource and energy intensive," said Dr Denis Simon, director of the New York-based Levin Institute's Center for Science, Technology & Innovation in China (CSTIC). "Rather than focus on brawn, China wants to focus on brain."

To climb the product value chain, China must create its own intellectual property. But its track record here is patchy.

"I would say it's a pretty low innovative level," said Dr Adam Segal of the Council on Foreign Relations in Washington. "There is no example of cutting edge technology coming from China."

Figures that point to China as an emerging high-tech powerhouse are deceiving. The country's high-tech exports totaled US$145.1 billion for the first half of the year, according to the Ministry of Commerce (MOFCOM). This is well on course to surpass the 2005 full year figure of US$218.2 billion, which was itself four times the 2001 total. Over the same period, official statistics show a 133% increase in research and development (R&D) spending, which went from US$13.2 billion in 2001 to US$31 billion in 2005.

However, the majority of these high-tech exports were generated by the local branches of multinational corporations (MNCs). They were responsible for 82% of exports in 2001 and 87.9% in 2005.

China remains merely an assembler of others' products rather than a creator of its own. Illustrating this point in a recent report on innovation, CLSA China macro strategist Andy Rothman looks at global output of notebook computers, 75% of which are produced by Taiwan firms that have shifted all but the design stage of the production process to the mainland.

Rothman also picks holes in patent activity as evidence of innovation in China. The State Intellectual Property Office registered 53,305 patents in 2005 compared to 16,291 in 2001. Although domestic patents grew fourfold over the period, foreigners still lead, registering nearly two-thirds of all new patents in 2005. Japan was responsible for 36% of these, the US 24%.

"Most of these patents are for modifications to the use, or appearance, of existing goods or technologies. Only 30% of Chinese patents are for new inventions," Rothman noted, citing an official at the Chinese Academy of Sciences.

Commenting on the Chinese tendency to copy rather than create, Kiam Choo, founder of search website BBMao.com observed: "There is a lot of talent out there and not necessarily enough good ideas." (See: Same, same, same: Copycat culture)

Anti-innovative climate

The main problem is that China doesn't have a climate conducive to innovation.

A large part of this can be put down to a flawed education system. A tendency to focus on learning by rote imposes obvious limitations on creativity, the effects of which are exacerbated by external factors. The halt to schooling during the Cultural Revolution has robbed today's 45-55 age group of much talent while a brain drain that began in the 1970s has cherry picked many of the best that have followed.

A CSTIC study established that China had 3.48 million people engaged in science and technology activities in 2004, 2.25 million of them trained scientists or engineers. It estimated that there were 2.38 million scientists and engineers in 2005, 260,000 short of the required amount. The deficit is only going to rise with 3.48 million scientists and engineers projected for 2010 against a demand of 3.85 million.

The study also highlights a decline in the quality of available talent.

Newly qualified science and technology professionals are often ill-equipped to perform their duties - Simon ties this to the higher education system doubling in size from 1999 only to see standards fall - and there is still no culture of creativity despite various policy initiatives.

"People talk about recent graduates as being smart in terms of book knowledge but not in the practical sense," he said. "They are not creative; they are not risk takers; they are not entrepreneurial."

The CSTIC study admits that the growing number of returnees - Chinese who return home from the West armed with an education, experience and a business plan - are something of an unknown factor.

Certainly this group is behind much of the nascent innovation taking place in China, but in many cases, projects get off the ground in spite - not because - of the system. Having an idea is useless if there are no funds available to develop it and China is infamous for under servicing the financial needs of its smaller companies.

Research by McKinsey Global Institute found that small- and medium-sized enterprises receive just 16% of bank credit, less than a quarter of the funds lent to state-owned or partially state-owned firms.

"The Chinese have very good technology and the only real impediment to their success is the financial structures in the country," said Mahesh Jayanarayan, CEO of London-based technology firm New Medium Enterprises, which has been working with domestic operators on China's answer to the DVD. "By being behind in this area they are being held back."

VC dependency

Foreign private equity and venture capital have been the lifeblood of tech startups in China (BBMao.com's Choo freely admits that he would never have got his search site off the ground without overseas backers that include MySpace founder Brad Greenspan). As Beijing moves to introduce efficiency to its financial sector, investors could do without being tripped up by red tape as they make their exit from an established venture via overseas capital markets or mergers and acquisitions.

Dr Christopher Savoie, CEO of biotech firm GNI, noted that his company's acquisition of Shanghai Genomics in 2005 went smoothly because the Chinese investors were keen to grab a rare exit route (See: Science saves lives: The biotech boom).

Larger scale foreign involvement through MNCs can also play a valuable role in stimulating domestic innovation. According to MOFCOM, there are more than 750 MNC R&D facilities in the country and these can serve to raise the bar in terms of creative output.

Admittedly, not all the research centers are a positive addition - "more 'PR&D', doing low level work for publicity purposes," was how one tech watcher put it - but the majority can help enrich the creative environment. Employees will leave the MNCs able to develop their own ideas within their own companies and a new breed of tech start-ups will be born.

It is this dynamic - the emergence of innovation from the periphery not the core - that forms the crux of China's engagement with new ideas. In IPv6 as in every other field, the underlying structure must be made freely accessible to commercial operators. They take innovation to the next stage and actually make money from it.

"China is very good at saying we will develop a microprocessor but it will always be a generation or two behind Intel," said Wolf. "It is reactive rather than proactive. It needs to create a system in which people who innovate are rewarded."

History suggests this is best achieved in an open and competitive environment rather than the top down process China copied from the Soviet Union, in which R&D institutes were separate from manufacturers, effectively severing ties between the ideas men and the marketplace.

Time to let go

"Governments try to impose standards all the time but most useful things are done by trying to get around governments," said Lightman. "China is much better at stopping this than other countries but now it just has to let go in ways it hasn't before."
The question is: can Beijing do this?

The government has launched numerous initiatives promoting innovation, including the Torch, 863 and 973 programs. Its most recent offering, the National Medium- and Long-term Science and Technology Development Plan for 2006-2020, unveiled at the start of the year, is seen by some as a step in the right direction.

"I think there are some good things in the plan," said Segal. "There is a focus on shifting R&D from government research institutions to commercial enterprises."

To others, the fact that it originates from the government undermines much of what the plan might achieve. "The government is most effective in driving innovation when it creates the infrastructure and gets out of the way," said Wolf. "China's government is not comfortable with that."

Nevertheless, he is positive about the country's future prospects for innovation. The legal and financial frameworks underpinning enterprise are slowly slipping into place and there are signs that official attitudes will undergo similar changes.

"I think they are asking the right questions," said Wolf. "We have not heard the final word yet from the government on what it will do to encourage innovation and from that aspect I am quite optimistic."

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Time to lead?

China wants the power and money that come from setting technology standards. The jury is out on how effectively it can achieve this

The shift from assembly point to creative hub that China is trying to engineer within its economy has been accompanied by a growing interest in the technological standards upon which high-tech trade is built.

The principal reason is obvious: money. China makes 90% of the world's DVD players but, for every one sold, around US$20 goes to the foreign firm that holds the patent on the technology. Only US$1-2 of the profit remains in China. The story is similar for notebook computers with manufacturers receiving only US$15 out of a US$700 export price.

If China could export goods based on its own technology standards, the money would stay at home. Digital television, mobile communications, wireless networking, video discs, radio frequency identification, audio/video compression - China is focusing on domestic standards right across the board, regardless of what established systems stand in its way.

"They are saying, 'We have a market that is large enough to support our own domestic standards'," said David Wolf, president of Beijing-based technology, media and telecom consultancy Wolf Group Asia. "The royalties that are paid to use other people's standards are huge and they see it as money that they don't have to spend."

If the swift investments made by the likes of Siemens and Nokia into China's domestic third-generation (3G) mobile telecom standard is anything to go by, access to the country's growing markets is tempting enough to make foreign firms adapt.

Standards equal status

But, as far as China is concerned, it is about more than cash: these standards represent a seat at the technology table alongside the US and Japan. What remains to be seen is how far China is willing to go to get there - will its strategy be positive and inclusive or overly mercantilist and obstructive?
Either way, the country looks set to have a much greater say in the development of global technology.

"The reality is that this was coming all along," said Dr Denis Simon, director of the Levin Institute's Center for Science, Technology & Innovation in China in New York. "Why should we have expected the Chinese to sit idly by?"
China's commitment is certainly borne out by its involvement with the bodies responsible for endorsing global standards. The Standards Administration of China (SAC) currently provides the secretariats of five technical committees and five subcommittees as well as the conveners of 19 working groups for the Geneva-based International Organization for Standardization (ISO).

From the ISO's point of view - and that of its fellow standards organization, the Institute of Electrical and Electronics Engineers (IEEE) - China's participation is vital as it represents such a large slice of the world market, in technology experts and consumers.

"China has expressed ambitions to go beyond manufacturing to become an innovator of technology," said Alan Bryden, secretary-general of ISO. "As ISO standards are vehicles for disseminating innovation, then we can expect increased Chinese participation in developing standards for new technologies."

But when it comes to developing its own standards for key sectors, China's track record is not strong. The country undermines its efforts by failing to win global support for standards due to an unwillingness to share details on how technologies are developed, or by just sitting in the blocks, allowing other countries to move ahead and take both the glory and the profits.

Of the major, commercially lucrative standards under development, only China's high definition DVD technology has actually completed the transition from blueprints to product on the shop shelves (See: EVD: China's answer to the DVD).

The waiting game

The country's 3G mobile telecom standard, TD-SCDMA, is a classic example of the all talk, no action approach. 3G has been around for several years and networks using established international standards WCDMA and CDMA2000, developed by Japan's NTT DoCoMo and US-based Qualcomm respectively, are ready to roll. But China has yet to distribute 3G licenses and it is thought that delays in perfecting TD-SCDMA are behind this.

"We are already five years into 3G as a commercially operable service and now countries are looking beyond the three basic channels," said Dave Carini, co-founder of Beijing-based telecom, media and technology consultancy Maverick China Research.

"It's going to be a while before they have even a single TD-SCDMA network ready to run and show the world that it does work. China is not so much late in coming to the table; they were early but waited too long. Maybe they were just not able to do it as fast as they'd hoped."

Unlike TD-SCDMA, China's wireless networking (WLAN) standard, WAPI, was not slow in pushing itself forward. Introduced in 2003, Beijing said the standard would be compulsory for all WLAN products sold in China, forcing the likes of Intel to team up - and share technology and royalties - with local players. After intense lobbying, and the possibility of WTO action, China agreed to back off.

When WAPI was proposed for global standard status to the ISO, alongside the IEEE's 802.11i standard, the Chinese believed they had the superior technology.

"802.11i is an immature standard ? It contains many security loopholes and structural weaknesses," the Broadband Wireless IP Standards Working Group (BWIPS), the body tasked by the Ministry of Information Industry to coordinate WAPI development, told CHINA ECONOMIC REVIEW. "WAPI's technological innovation and structural strength makes it a far superior security solution."

Burned in the ballot

However, in March of this year the ISO ruled against WAPI. Voters said they were unhappy at the Chinese candidate's refusal to disclose the full technical specifics of WAPI, which has to a large extent been developed behind closed doors.

The Chinese claim that 802.11i prevailed because the IEEE didn't play fair.

"There were numerous ethical and procedural problems which created an unfair situation for WAPI in the whole ballot and after ballot process," BWIPS said. "We have provided a detailed list of those violations. So far, we have not seen any detailed counter arguments against our complaints."

Steve Mills, chair of the IEEE Standards Association Board, insists that the accusations are unfounded.

"Everything we did came under proper review and was done in open session," he said. "We believe there is a lot of good stuff in WAPI. Making WAPI a standard in its own right was not the question for us. The question is always: how do we make the most of the technology we see?"

BWIPS claims that it is "very unlikely" that 802.11i will be accepted as a Chinese national standard. It believes the domestic standard will be pushed forward by the government, citing the establishment of the WAPI Industry Alliance as evidence of this. The 22-member group, intended to represent "a complete industrial chain" includes China's four major telecom operators as well as Lenovo and Huawei.

Tech industry watchers say that China is neglecting to learn from its failure.

Not only must Beijing master the politics of the ISO, it also needs to respond to the principal concern raised by ISO voters about WAPI: that it was built behind a veil of secrecy. Unproven standards, developed outside of the competitive sphere, will inevitably struggle to win global approval.

"Where is China's track record for standards," said Alex Lightman, founder of next generation Internet company Innofone. "China hasn't grasped that competition is necessary for standards to emerge."

Wolf added: "China has not mastered the game of getting an ecosystem in which standards can be developed apart from by compelling it by law. Unless you build an ecosystem from the start you are not going to build the best standards."

Both TD-SCDMA and WAPI have their merits but, as Wolf observes, this is no guarantee of survival.

"We have seen endless cases where a technologically superior product has failed on the market. I just need to say the word Betamax [the Sony-backed videocassette format that was overwhelmed by VHS]."

He thinks it is unlikely China will turn itself into a technological island through the pursuit of domestic standards but, by ignoring the IEEE and going it alone, it will lose the opportunity to sell its domestic standards to the rest of the world.

The ones who would be hit hardest by this shift away from global compliance are the original equipment manufacturers. Politically obliged to pursue standards that have little or no following beyond Chinese borders, they couldn't focus so much on more lucrative export markets for products based on rival standards. Torn between standards and at cross purposes with the government, business would likely suffer.

"If a group of individuals chooses not to participate on a standard, it has an impact," said IEEE 802 Committee Chair Paul Nikolich. "From a manufacturer's perspective, you don't have as large scale."

Stuck in the middle

This appears to be the case for China Mobile, which is keen to adopt WCDMA as its 3G standard and could probably start rolling out handsets within hours of being granted a license. But Wolf believes it will - at the very least - have to set up municipal TD-SCDMA networks in major cities.

As further evidence of dueling standards, Maverick China's Carini points to how Huawei Technologies and ZTE Corporation, the country's premier innovators, have targeted the international market almost at the expense of unproven TD-SCDMA. Despite this insurance strategy, both companies are still paying the price of Beijing's tardiness on 3G.

"The lack of 3G has prevented them from getting major contracts," said Carini. "Hebei province is bigger than most European markets. If you can win a contract like that then maybe it's easier to break into the European and North American markets."

South Korea has no such problems. A decade ago Seoul decided to throw its backing behind CDMA2000 and invest heavily in providing the foundations on which 3G could be built. As a result, the likes of Samsung have prospered and are now looking beyond 3G.

"South Korea is now far ahead of the US for mobile phones," said Carini. "It shows that if you take someone else's standard and roll with it, things do work out."

Operating in a world of competing domestic and international standards, Chinese manufacturers will have to maintain a careful balance between their commercial needs and Beijing's requirements.

But Dr Leonard Liu, founder of Chinese software outsourcing firm Augmentum and a veteran of IBM and Acer, is not worried. "The Chinese will not be constrained by standards. Anything they can make money on, they will do."