The institutional foundations of innovation in China

In recent years, innovation research has clearly shown that innovation-driven economic development relies on a broad foundation of benign cultural, social, political, and economic framework conditions. Institutions based in various social regimes must incentivize innovation creating behavior as well as the acceptance and diffusion of these very innovations in society. There exists no “one-fits-all” institutional set-up outlining the preconditions for successful innovation-driven development. Cultural idiosyncrasies, variations in the availability and costs of specific resources and competencies, specific goals of ruling elites etc. all lead to specific manifestations and combinations of institutions that in their totality promote innovation in varying intensity and on differing social and technological trajectories.

Against this background, China constitutes a highly interesting case study for the analysis of the institutional requirements as well as evolutionary genesis of innovation-driven economic development in a large non-Western society. After three decades of highly successful catching-up economic development based on the emulation of foreign institutions, business models and technologies, the Chinese economy has now reached a stage where it needs to foster more endogenous innovation in order to evade (relative) stagnation in what has become known as the “middle income trap”. This requires substantial alterations not only in the structural set-up and incentive systems governing the Chinese economy, but also in the fabric and underlying norms and values structuring society as well as the self-understanding of the political elite and its organization of political processes.

The Chinese business sector is already responding to the need for more endogenous innovation in all sectors and segments of the economy. By doing so, it is exerting pressure for changes in the social fabric. At the same time Chinese government and the Chinese Communist Party appear to be highly committed to transforming the economic system and promoting an innovation-friendly institutional set-up – while upholding an unwavering claim to power. The Hayekian postulate according to which only free (democratic and market-based) societies can feature dynamic, innovation-driven development dynamics instantly comes to one’s mind as a “belief” of Western institutionalism and “Ordnungspolitik” that needs to be reflected upon in the Chinese context.

The Chinese state-business nexus

When China joined the WTO in December 2001, it agreed that other countries, notably the European Union (EU) could continue to treat it as a “non-market economy” for the purposes of trade defense measures. The background to this special arrangement lay in the fact that at the turn of the century the Chinese economy was still in transition from a centrally planned economy to a market economy based on scarcity prices and free competition. There neither existed a comprehensive set of institutions that could support comprehensive market exchanges in the economy, nor was the government willing and give up its claim to directly steer economic development of the economy, its sectors as well as its major firms.

In expectation of substantial progress of China’s transition towards a full-fledged market economy in the coming years, the Protocol of Accession of China to the WTO outlined that 15 years after its accession China’s status might be upgraded to a “market economy”. While China interpreted the wording of these paragraphs as guaranteeing it an automatic transition to “market economy” status, the EU upheld the position that China would have to demonstrate that it complies with the five criteria defining the “market economy” status. With all economic observers agreeing, that China did not fulfil these criteria (by a wide margin) at the end of 2016, the dispute focused on juridical exchanges on the existence of a guarantee or not. Eventually, the dispute was solved with some diplomatic genius that neither awarded China the status of a “market economy”, nor inflicted a massive loss of face to one of Europe’s most import trade partners and thereby might have provoked an open trade war. The solution found is to completely give up the differentiation between “market” and “non-market” economies – not only with regard to China, but all economies. Instead, for all trade defense measures the normal reference value will be the domestic prices. However, if significant distortions (e.g. caused by state interferences) affecting domestic prices can be shown to prevail, international benchmark prices can be used instead. In order to make this new mechanism operational, the European Commission is going to publish specific reports identifying such distortions in on an economy-wide or specific sector level. EU manufacturers can then refer to these reports in order to determine the basis for complaints and to calculate what the normal reference prices should be.

Research is being conducted in order to assess the degree to which Chinese industries are operating according to competition-based market standards or are subjected to market-distorting governmental interventions.

Economic implications of the “Belt and Road Initiative”

A major impulse for economic development in the Eurasian continent as well as a restructuring of the global division of labour might be created with the unfolding of what has become known as the “One Belt, One Road” or “Belt and Road” initiative. Proposed by Chinese government in 2013 the initiative aims at creating a comprehensive networks of transport corridors and an integrated industrial fabric spanning from China via the Middle East and Central Asia to Europe. In the course of this multilateral industrialization programme new regional and multilateral institutions that complement or compete with existing regional/global governance systems can be expected to evolve. Their shape as well as the concrete impact of the potentially emerging new regional value chains on global goods flows, investment activity, local as well as international labour markets, local and supra-national institution building, however, remains undetermined. The disruptive changes brought up by the “Belt and Road” initiative cannot result in a win-win for all parties, but will entail some a reorganization of absolute and relative wealth, income generation possibilities and economic as well as political power projection capacity. New research initiatives are required to better understand the parameters at play and identify potential local/regional/global development patterns.