Illustration: Liu Rui/GT

Editor's Note:

Long known as the world's factory, China faces a bottleneck in its efforts to upgrade its manufacturing and climb the industrial ladder. Meanwhile, "innovation" is the buzzword of the day. How can China make better performance in innovation? Global Times (GT) reporter Yang Lan talked with George S. Yip (Yip), co-director of the Center on China Innovation at China Europe International Business School (CEIBS), and Bruce McKern (McKern), visiting professor at CEIBS. They co-authored the book China's Next Strategic Advantage: From Imitation to Innovation.

GT: Why do you write in your book that innovation is China's next strategic advantage? Before this, what was China's strategic advantage?

Yip: China's strategic advantage was low-cost manufacturing. This allowed this huge export success. But it was the success of either low- to mid-tier products or original equipment with other people under other people's brands. So to move up and earn a bigger share of the value added, China has to innovate itself and start selling higher quality and more differentiated products. China is starting to do this. This has been a huge priority of the national government in the last three five-year-plans.

McKern: In the past China has been relying on moving people from unproductive agricultural work into manufacturing. We have seen China applying surplus labor and capital to new activities. That has been the main engine of growth since the reforms of Deng Xiaoping. This has also been driven by an export orientation. That has been a very successful strategy, but it is becoming less possible for China because the value added that has been captured in China is not as much as it could be. The technology used often comes from foreign countries, and China would like to use its own technology and keep more value in China.

The source of competitive advantage has not been innovation or technology but low labor costs. That was fine for China in its growth stages, but now China wants to capture more value added because that is the only way she can improve people's living standards rapidly. So in the next 20 years China wants to move toward being a manufacturing powerhouse, like Germany when it was in its middle stage of its growth. In order to do that there has to be greater productivity, and greater productivity means greater innovation.

Previously China's strategic advantages were the low labor cost and a large domestic market. But they are not enough for the future. We know that innovation is a major priority of the government.

GT: What are the obstacles for China to upgrade its manufacturing industry? How can Chinese companies improve their core competitiveness and their branding ability?

Yip: The upgrading goes hand in hand with innovation and more valued-added products. If you look at companies like Haier, it is gradually upgrading the quality of the products that it makes. One interesting opportunity for Chinese companies is with the acquisition of foreign companies.

One good example is Geely buying Volvo. Geely has built a factory in China to manufacture Volvos. I think the quality of the Volvos made in China will be the same level as those made outside. Soon they are going to sell these in the rest of the world. The quick win for China is to buy foreign companies, transfer that technology and that manufacturing techniques to China using lower Chinese costs, and then produce world-class quality goods.

Chinese companies have to upgrade the skills of the labor force. I have great faith in the Chinese labor force because they are willing to learn and to work very hard. For example, Foxconn is a company run by Taiwanese and its customers are Westerners. The labor force comes from the Chinese mainland. No body complains about the quality of the Foxconn products.

China is still not yet able to design its own cars. Cars are the most difficult products in the world for a developing country to imitate. Surprisingly China is doing very well with high speed trains and aircraft. Automobiles are both industrial products and customer products. Pure industrial products like aircraft may actually be easier for China to build.

The Chinese companies that are going international have started to learn the markets. Geely told me that before the acquisition of Volvo, Geely cars in China had many different models, but did not have a common look. One thing they learned from Volvo is the importance of branding and styling. You can see any model of Volvo and recognize it by seeing the tail light. Geely is learning this from Volvo.

In terms of branding and differentiation, in addition to technical innovation, the next thing Chinese companies have to learn is design, the user interface and the appearance, which some Western companies are very good at.

GT: In May 2015, China's State Council unveiled the 10-year national plan "Made in China 2025" designed to transform China into a global manufacturing power. How do you see the future of the national plan?

McKern: I think it is a very ambitious plan. It is in the right direction. The idea is to make a concerted strong effort to increase productivity in manufacturing. Manufacturing is very important to China because of its huge population and the need for infrastructure and housing and development and now also more and more for consumer-oriented products and services.

China now also wants to shift to higher value-added manufacturing so that the value retained in China will be greater. And so a big part of the new plan for 2025 is to improve the productivity of manufacturing, which also means innovation. It also means shifting to some new areas where China has not been so active in the past. So there will be more emphasis on high technology products and on internal consumption, including services such as health, insurance and financial services, rather than exports.

The other aspect is also very important, the internal management of innovation and the incentives offered to companies and people to come up with new ideas. This is where I think China still has more to do.

The government has done a wonderful job in setting up science and technology parks, research centers and helping the universities to strengthen their research efforts. China is now investing about 2 percent of GDP in research and development which is about the same percent of GDP on innovation as the EU. But in addition to these, there also needs to be more encouragement and tangible incentives for businesses and companies to set up and be enabled to succeed.