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Time of transition: Chinese President Hu Jintao, left, and former President Jiang Zemin at the 18th Communist Party Congress in Beijing on November 8.

Since 1978, the Chinese economy has seen phenomenal growth. While that’s not in dispute, the reason why China has managed to grow so fast and whether it can maintain that growth is far less clear. The consensus view among China scholars is that the country has grown by relying heavily on investments, exports, and its huge low-cost labor force. That formula has worked well so far, but evidence indicates that China is getting less and less from this approach lately. The country’s export growth is decelerating quickly, and China is already investing an amount equivalent to about half of its GDP—which is probably the highest level ever among any country in peacetime.

China has just completed its once-in-a-decade leadership transition.  An item that should be high on the new leadership’s agenda is changing the country’s strategy so that its growth wastes less energy, requires less investment, and is less reliant on exploiting cheap labor as a competitive advantage. We do not know the policy deliberations among the Chinese leaders; in fact we don’t know whether or not these policy discussions are taking place at the highest echelons of the Chinese government. What we do know is that a transition out of the rapid growth model of the last three decades will be fraught with technical uncertainties and political complexities. But it is critical that it happens.

The factors that drive a country to grow when its GDP per capita is $500 are totally different from the growth drivers when a country has a per capita GDP beyond $5,000. At $500—which was the case in China in 1994—you can copy the technology and production methods of other countries and drop them into your economy. Those premium features of a country’s political system, such as rule of law, intellectual property rights, labor rights, and democracy, are not that important. Indeed, they can be a hindrance, because at that low level of per capita GDP, these Western institutions inflict transaction costs rather than facilitate growth.

As a country gets richer, its growth formula changes. Innovations, technology, and productivity improvements become more important, as do domestic entrepreneurs and innovators. The problem is not that China doesn’t value science and technology. Many Chinese leaders are trained engineers, and there is no shortage of technocratic ideas and expertise in China. In the past 20 years, China has invested heavily in R&D. This year, China will likely invest 2 percent of its huge economy in R&D, a level attained by only a few fairly rich countries. But the payoff for this massive investment is not clear. Ongoing research, done together with my MIT colleague, Fiona Murray, shows that these massive technological investments have far less impact than one would expect.

One reason is that these investments are made in an environment of “republic of government” rather than “republic of science.” Universities in China are tightly controlled by the Ministry of Education. Compared with their U.S. counterparts, presidents and deans of Chinese universities are extremely powerful. Professors in China are like company employees, in contrast to their fiercely independent counterparts in the West. Research projects are often directed from the top down rather than being initiated by professors and researchers. Data sharing is difficult across bureaucracies, and the dissemination of research findings—especially in areas that have implications for policy, such as epidemiology—often has to take a back seat to the political needs of maintaining “stability.”

Chinese leaders want the country’s economy to grow on the back of technology and science-based innovations. This is not only a laudable goal but also an imperative need. China’s growth today is dangerously unbalanced. The environmental costs are astronomical. Government spending is extremely high. Labor exploitation is politically costly, as Chinese workers are increasingly conscious of their rights and demanding a bigger share of the economic pie. A ready outlet for the Chinese economy—the huge export markets in Europe and the United States—is shrinking on the demand side. 

But a technology-driven growth model is not a simple extension of China’s current growth model, plus a massive dose of R&D. China has invested heavily in R&D, but that investment has not fundamentally altered the nature of Chinese growth. That’s because technology-based growth drivers require more than simply copying other countries’ technology and business models. They require a rule-based system, IP protection, freedom to think and challenge authority, and a government with limited reach and power. In other words, they require Western institutions.

Now at roughly $5,000 in per capita GDP, and as the second-largest economy in the world, China needs to prepare for this institutional transition. It will require vision and political courage to acknowledge the shortcomings of China’s current growth model and lay the groundwork for a new approach. This will require political reforms, and not simply a tweaking of the existing system. Does the new leadership have what it takes to move the country in that direction? 

Yasheng Huang is the international program professor in Chinese economy and business at MIT Sloan School of Management and the founder of China and India Labs. His most recent book is Capitalism with Chinese Characteristics, which has been reprinted seven times since 2008. 

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Credit: AP Photo | Lee Jin-man

Tagged: Business, China, innovation

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