The first part of this two-part series examines China's sustained prioritisation of innovation,  a relatively new factor in the global knowledge economy that for the last half century has been dominated by the Western countries and Japan, and to a smaller extent in recent years by South Korea and Taiwan. Read part two here.

The recently announced raft of Australia-China joint research initiatives align with the Turnbull government's focus on innovation as an economic driver. They also fit with Beijing's new blueprint to move Chinese manufacturing up the global production chain by encouraging engineering- and science-based innovation. Weaning China off its dependency on foreign knowledge is a long-standing official goal, embodied in successive policies to promote technology transfer, research output and patent filings.

But what progress has China actually made in transitioning from a low value-add assembly hub — 'the world's preferred subcontractor', reliant on inputs developed and owned by firms in high-income countries — to innovating on the technological frontier?

In a sample of 44 industries open to foreign competition in China, domestic firms now dominate 25. But of the 13 sectors where research and development (R&D) costs exceed 6% of revenue, 10 are led by foreign multinationals. China's consumer electronics industry leads the world in exports, but accounts for only 15% of value added to the final product, and is still heavily reliant on chip imports and licensed use of foreign technology. And in strategically critical fields such as aerospace engineering, the performance of China's indigenous products still lags significantly. Yet several trends suggest that China’s subordinate role in the global knowledge economy is starting to change, although slowly and unevenly.

The processing share of China's foreign trade has been falling for a decade, due to the rise in domestic production of intermediate components. While a large share of this domestic content still derives from intellectual property owned by foreign firms, Chinese firms are expanding the range and sophistication of their activities. Even within the export processing sector, domestic firms have been moving from pure assembly to control of the whole production process, including product specification and design. This transition accounts for the shift within China's technology imports from capital goods to licensing and patent transfers. Such upskilling has allowed Chinese firms to start competing with foreign companies in higher value-added industries, the standout examples being telco giants Huawei and ZTE (which have broken into the ranks of China's top exporters).

Chinese patent filings have risen rapidly, both domestically and internationally. China is the largest growth source for filings with the World Intellectual Property Organisation, Huawei and ZTE coming first and third respectively in last year's figures. While the average quality of Chinese patents is dubious, with the state-led incentive system still promoting quantity of filings over inventiveness and commercial applicability, these institutional distortions are starting to be corrected. And the gulf between China and advanced economies in international patents may imply less about the quality of Chinese innovation than often assumed, given the incentives to file at home in a country that now conducts a fifth of world manufacturing. Abroad, the gap is closing even in triadic patents (filed in the US, EU and Japan), viewed as the 'gold standard' and cited as proof of China's technological lag, China could on the current trend catch up with the US within two decades

Chinese innovation is supported by the world's fastest growing R&D budget. This is on track to surpass the US one by 2020, a trend ringing alarm bells in the US scientific community. A key driver is the rapid growth in R&D spending by foreign firms within China. This spending is aimed at accessing not just the Chinese market but the local knowledge ecosystem, based on one of the world's largest pools of STEM graduates. Basic research — generally regarded as critical to technological innovation — still accounts for a smaller share of China's R&D spending than in advanced economies, but has been emphasised in the 13th Five Year Plan and could on one projection double to 10% by 2020, closing the gap with most developed countries. However, simply throwing more money at Chinese innovation will not make it globally competitive; the key limiting factors now are the research environment and evaluation system, which still privilege quantitative metrics and quick results over long-term fundamental research and efficient collaboration. As China's economy slows, caution must also be exercised when extrapolating linear trends in funding.

Nonetheless, there has been quantifiable improvement in output quality. Chinese researchers now hold second place in aggregate on the Nature Index, which measures contributions to the world's leading science journals, and citation rates for Chinese-authored articles have also risen steadily. China is driving growth in international scientific collaboration, having displaced Germany as the top location of foreign partners for US researchers. Germany, for its part, recently published a strategy for scientific cooperation with China. Australia-China research collaboration has also steadily expanded, supported by federal funding to universities and to the CSIRO. And China's long-running state-led incentive programs to lure home Chinese scientists and technology entrepreneurs residing in Western countries are also finally starting to show some results

Part two of this series focuses on China's success to date in converting its innovation potential into viable technologies, and its future capacity to compete with the developed nations at the innovative frontier.

Photo: Getty Images/VCG