Domestic SMEs need support from the government and financial system to advance sustainable development

As indicated by recent government documents and policy guidelines, alongside urbanization, innovation is seen as becoming a main driving force for China's sustainable economic growth in the years ahead.

As early as 2006, the Communist Party of China (CPC) Central Committee proposed the transformation to an innovation-driven growth model by 2020, in order to guarantee the sustainability of its long-term economic growth.

Due to its export-oriented economic structure, the technological progress of China's enterprises over the past decades has been realized mainly through introducing advanced technologies from abroad, and then digesting and absorbing them. In this process, foreign direct investment (FDI) has played a very important role.

In their cooperation with foreign ventures and multinationals, domestic enterprises have managed to position themselves in the global manufacturing chain, mastering new technologies and production methods, then developing products and services. This process has been dominated by multinationals with foreign markets as the main target.

As China becomes a middle-income society and the expansion of the domestic market becomes the main driving force of future economic growth, we should strengthen our ability to imitate the advanced technologies owned by foreign conglomerates and encourage more domestic enterprises to create innovative new products and services.

Such an innovation model does not necessarily require the creation of original or exclusive innovations. At its current development stage, China has still to develop the necessary conditions for the large-scale creation of original innovations, which are based on a long-term and large-scale input into elementary and applied research. In developing countries, many technological innovations are produced through creating an innovative production mode and flow. Products and services are made at a lower cost than in developed countries, which makes them more suitable for local consumers and foreign markets with similar income levels. This is a "frugal innovation" model.

A typical example is the Tata Nano, an inexpensive, rear-engined and four-passenger city car built by the Indian company, Tata. The Nano is the cheapest vehicle of its kind in the world. Some Chinese enterprises, such as Huawei, a leading global telecommunications solutions provider, and the Alibaba Group, China's largest e-commerce company, have had similar successful experiences in terms of technological innovation.

Because of the high fixed-cost investment, innovation produces some "spillover effects" and is of high risk. Some typical "market dysfunctions", such as monopolies, lack of coordination and information asymmetry, are likely to emerge. However, given the market's lack of an automatic ability to promote enough innovation, the government should play its full part in China's bid to build an innovative nation.

That does not mean that the government should directly get involved in some large projects, it should refrain from replacing enterprises as the innovator. What it should try to do instead is to create a good policy and infrastructure environment to motivate domestic enterprises to participate in innovation. For example, it should play a guiding and propulsive role in this process, from improving the quality of the labor force and promoting free information exchanges, to improving intellectual property rights (IPR) protection.

As a high-risk investment activity, innovation also needs an effective financial market to share its risks. In China, small and medium-sized enterprises (SMEs) are the main innovators but they have long faced difficulty in securing financing. This has extremely restricted the development and buildup of those SMEs with innovation potential and hampered the country's development in this regard.

To promote and encourage more innovation, China should try to improve its financial environment. To this end, the banking system badly needs to cater to the needs of domestic SMEs. As the catalyst and incubator of innovation, risk investment offers these companies not only the necessary funds, but also knowledge and technological support for the marketization of new products and services.

However, risk investment badly needs a well-developed stock market to ensure that it can exit at will and gain considerable returns. In this regard, China's banking system and capital market are yet to make the improvements needed to help the country further promote and push forward innovation.

The country should try to improve its innovation competition environment to promote more such activities among domestic enterprises. The administrative monopoly and restrictive barriers in those upper-stream industry or service sectors should be removed to ensure their free entry and exit.

In addition, a comprehensive policy framework should be institutionalized to ensure that the creative spirit and entrepreneurship be given full play.

The author is chairman of China Investment Corp and the article was first published in the Comparative Studies magazine.

(China Daily 02/09/2011 page8)