If a Chinese person who died 30 years ago were to reappear in China today, what would surprise him or her most? Would it be the Chinese digital mobile network, or the iPad? Or would it be the position that China now occupies in the world? I think that what would astonish our recent ancestors most would be the variety of food on display in Chinese supermarkets (of course, there were no Chinese supermarkets in 1982), and the quantity of food that Chinese families eat every day. Since 1980 a dramatic increase in Chinese prosperity has lifted more people out of poverty than anywhere else, at any other time in history.

But if we were to return to China in 30 years from today would we be as amazed as our ancestor of 1982? The economy is now at a crossroads as the government tries to rebalance it by switching growth away from exports toward domestic demand, and from investment-intensive growth to private consumption. The economy has reached middle-income status. The list of countries that stagnate after reaching this intermediate level of economic development is a long one. Can China break through this middle-income plateau?

Let us turn to a thinker who explained the true origins of national wealth. The Scottish economist Adam Smith begins the 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations as follows: "The annual labor of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes, and which consists always either in the immediate produce of that labor, or in what is purchased with that labor from other nations."

Notice that when Smith is talking about the source of wealth, he talks about labor. He does not mention real estate, or stocks of precious metals and commodities like corn and oil. The idea that a country's wealth does not depend on the country's natural endowment of resources (say of oil, land or even gold) but on its capacity for productive work amazed Smith's contemporaries. No country illustrates the profound truth of Smith's observation better than China, which, handicapped by its poor and limited agricultural land and its enormous population, still succeeded in raising its annual output per person from $251 in 1980 to $7,519 (5,758 euros) in 2010, a 30-fold increase in 30 years. These numbers provided by the International Monetary Fund are expressed in dollars and based on purchasing power parity, which adjusts for price differentials in different countries.

From Smith's observation, we know that this massive wealth increase in China must have come principally from huge increases in productivity, defined as the increase in economic output per worker. Innovation is the most important factor of all in increasing productivity, and therefore in creating wealth. Many of these productivity gains in China have been shown by recent studies as having taken place mainly in the export part of the economy.

A study by World Bank researchers between 2002 and 2006 in a number of Chinese export companies showed that large annual productivity increases of 20 percent and more were enough to cover increases in wages of 10-15 percent, as well as rising commodity prices that drove up the cost of inputs. But the export part of the Chinese economy is an area where foreign firms, many of them suppliers to Western multinational giants like Walmart, have been mainly responsible for introducing new working practices and technology. Meanwhile, productivity growth and innovation in many purely Chinese firms has lagged behind.

Steady increases in the Chinese labor force since 1980 have been another important factor that has helped the country to increase its wealth. By some estimates these labor increases account for as much as one quarter of the increase in Chinese GDP per head that occurred between 1980 and 2010. But now China's favorable demographics are reversing themselves. After 2015 the rate of China's ageing will increase. By 2020 the labor force will start to decline and the median age of 38 will be the same as Australia's. By 2050 China's median age will be 45.

For economic growth to continue to provide the increases in wealth that China's people have come to expect, gains in productivity will have to be large enough to compensate for significant falls in the number of workers and increases in the retired population. China must raise its domestic productivity substantially to continue generating the economic gains the country will need.

A report last year, Can China Innovate? focused on the most important part of the productivity equation. Written by a US scholar, Alexandra Harney, based in Hong Kong, the report concluded that although China increased its spending on research and development by 23 percent each year from 2000 to 2008, with a very few exceptions, Chinese factories remain as technological copy-cats or labor-intensive links in global supply chains. Paper, gunpowder and the magnetic compass were all invented in ancient China, giving Chinese society a reputation for inventiveness. Harney asked the question: could Apple's iPod have been invented in China? She concluded that it could not have been. The reasons?

One is the prevailing business culture in China of quickly copying successful new products. A lack of regard for intellectual property rights gives new products a very short time to recover the money spent on developing them. For this reason most Chinese companies compete on price, not on quality or innovation. Another reason is the Chinese education system, which emphasizes rote memorization and testing, and encourages people to think in the same way.

Harney's report identified a few Chinese companies, like Huawei and ZTE, that have learned to compete globally and that are among the world's major producers of applications for new patents. But even in China's Internet industry, considered to be a world leader, the main products of two of the biggest companies are based on copies of foreign ideas. Tencent's QQ instant messaging service is based on Israel's ICQ, and Baidu's search engine is a copy of Google's.

Recent OECD research shows that Chinese companies have started to increase their share of value added in exported products. But there is a long way to go. In 2010 the value share of imported products in China's textile exports was the same as that of the US, 16 percent. But the imported value share in China's exports of computers and precision machinery was much higher, 45 percent, against 16 percent for the US. China, as the world's largest textile producer and with a long history in this industry, is able to capture most of the value in its textile production, but lags technically in high-tech industries. Apple's iPhone4 is made in China, and the export price is $194. But China only earns $6.50 from each phone. Apple gains 45 percent of the value of each iPhone 4 sold, by designing it and guaranteeing the quality.

For China to impress us in 30 years' time, much has to change in the way that its companies compete and operate their business. The raw material is there. In 2009 the OECD carried out an international student assessment in 74 different economies focusing on 15 year-olds in reading, science and mathematics. Shanghai came out top, with 27 percent of students tested reaching the highest level of proficiency in maths, almost 10 times the OECD average.

But the Chinese business environment has to strengthen the factors that underpin innovation: enhanced intellectual property protection, more competition, with an increased role for the private and service sectors, and continued improvement in corporate governance. Will China be able to reinvent itself?

The author is a visiting professor at Guanghua School of Management, Peking University. The views do not necessarily reflect those of China Daily.