1. Graduate University of Chinese Academy of Sciences,
The Role of Transnational Corporations in the National Innovation Systems – The Case of China
Li Yanhua
Graduate University of Chinese Academy of Sciences,
Beijing, China
August 20, 2009

2. Opening-up and Innovation: China is Facing Opportunities and Challenges
Hot topics in China, which may be or will be confronted with by other LDCs
Be more open or be more self-reliance?
How to develop from economic growth-oriented country to innovation-oriented country?
How transnationals have played and will play in the technology innovation of domestic firms?
How to cope with the opportunities and challenges under globalization?

3. Objectives This paper:
Focus on the role of TNCs in China national innovation systems, including recent evolution and perspectives.
Give some implications for policymakers of large and fast growing economies.

4. Outline Analytical framework and evolution of China’s NIS 1
The position and evolution of TNCs 2
The local factors affecting innovation by TNCs and local enterprises 3
The spillover of TNCs and linkages with local enterprises 4
Out-forward FDI and domestic TNCs 5
Conclusions and implications 6

5. Institutional Arrangement
Analytical Framework
Government
Institutional Arrangement
Local Firms
Foreign subsidiaries
Multinational R&D
Universities
Domestic R&D
Intermediaries
Domestic Financing
channels
Overseas Financing
Elementary education, Infrastructure, Basic R&D Platform and NISs Platform
National innovation system with the participant of Transnationals

6. The position and evolution of TNCs
Overall trends: China has remained the largest FDI recipient among all developing economies, attracting $92 billion in 2008.
Although there are many dissimilar opinions, strengthening the introduction of foreign capital is continuing without interruption.
(100 millions of US dollars)

7. The position and evolution of TNCs
Industry distribution: Relatively stable, but more investment has been to capital-intensive or technology-intensive industries.
2000
2006
Manufacturing
Real estate
Leasing& business service
electric power, fuel gas and water
Wholesale&retail
Transport, storage and communications
Others
Figure : Inward FDI stock, by industry, 2000, 2006 (percent)

8. The position and evolution of TNCs
sources of FDI: South, east and south east Asia has been the main region of inward FDI, accouted for 84% in Japan, United States are the main investors of developed countries.
Figure 2: Share of main Investors in China, actually utilized FDI, 1995, 2005, 2008 (percent)

9. The position and evolution of TNCs
Effect of TNCs on economy:
In a macro perspective, TNCs have promoted robust growth in all economic indicators (GDP, exports, investment, employment and R&D).
One-third of industrial output, one half of export, a quarter of tax revenue comes from inward FDI.
The effect of FDI in high-tech manufacturing industriesis more remarkable than other industries.
Figure 2: Share of Top 10 Investors in China, actually utilized FDI, 1995 and 2005 (percent)

10. The position and evolution of TNCs
Effect of TNCs on economy
Added
value
Export
Employment
R&D
expenditure
employees
Technology
import
pharmaceuticals 23 21 16 22 14 20
Electronics and
telecom 81 93 73 42 38
Computer and
office equipments 95 99 91 82 64
Medical equipments
and instruments 55 88 36 27 19 33
Table : The importance of Foreign Investment Enterprises in Chinese high tech industries, 2004, (Percent)
Source: Lundin et al., 2006
Foreign firms import high-tech components (e.g. advanced semiconductors, engineered plastics, and software) into their subsidiary plants for final testing, packaging before exporting them to their final market destinations.

11. The position and evolution of TNCs
Effect of TNCs on economy
The share of new product output and export of foreign companies is increasing in recent years. About 42% new product output come from foreign firms and the percentage in high-tech industry is more prominent.
Manufacturing industry
High-tech industry
New product output
New product export
1998 27 44 43 81
1999 32 52 79
2000 35 57 83
2001 38 63
2002 37 53 59 70
2003 41 58 78
2004 42 67 68 88
Table : The position of foreign companies in new product output and export, , (Percent)
Source: Lundin et al., 2006

12. The position and evolution of TNCs
New trends: transition of investment strategies
Main motivation
Rank
(2001)
(Rank)
2005
Pursue more expecting profit 3 1
Develop manufacturing base 2
Extend market share in China
Maintaining competitive advantage of low cost 4
Compet with transnational competitors 5
Improve R&D capability in China 7 6
Follow with existing customers
Source: Zhao jinghua, 2002, 2006
Four kinds of strategical roles of TNCs’ subsidiary companies: manufacturing base, market exploiting, risk avoidance, knowledge acquisition.

13. The position and evolution of TNCs
New trends:
Speeding up localization
Strengthening control to affiliates
Acquiring Chinese firms

14. Local factors affecting innovation by TNCs
Government policies towards TNCs
The Law on Sino-Foreign Equity Joint Ventures
Equity-based joint ventures (JVs) were the dominant entry mode
Favorable policy packages, non-national treatment to TNCs
1993-
Industry guideline for FDI, determine encouraged industries
Promoted middle&west investmet of FDI
Grant the national treatment to TNCs

15. Local factors affecting innovation by TNCs
Government policies towards TNCs
Year
Stage
Policy
Main Sources of FDI
Industry distribution of FDI
Prudent
Gradual opening-up and accumulation of experience
Hong Kong, Macao, main SMEs
The tertiary industry, textile and Clothing
Active
Encouraging exportation and introducing technologies
Taiwan, Japan and South Korea
Middle and large-scale projects including energy, transportation, electronics and machinery
Adjusted
FDI industrial adjustment, emphasis on technologies, talents and managerial experience
Large-scale TNCs of the Asia, U.S. and Europe
Infrastructure, basic industries and technology-intensive industries, modest opening-up of finance industry
2001-
More Deep and widly
Promoting indigenous innovation, learning from TNCs
More deep opening-up of all industries except individual ones (e.g. railway transportation)

16. Local factors affecting innovation by TNCs
2001：Formal Entry into WTO
2002：Category for Guidance for Foreign Investment Industries
2004：Revise Category for Guidance for Foreign Investment Industries
2007：Revise Category for Guidance for Foreign Investment Industries
2008：Revise The law of People’s Republic of China on Enterprise
Income Tax
2001－
Comprehensive
Opening-up
1995：Revise Category for Guidance for Foreign Investment Industries
1995：Category for Guidance for Foreign Investment Industries
1997：Revise Category for Guidance for Foreign Investment Industries
1999：Encourage technology development and innovation of
foreign-funded enterprise
1993－2000
Positive
Opening-up
1986：Provisions for The Encouragement of Foreign Investment
1987：Interim Provisions on Guiding
the Absorption of Foreign Investment Direction
1988：Law on Chinese Foreign Contractual Joint Ventures
1990：Open the Pudong New Area of Shanghai
1991：Rules for the Implementation of the Income Tax Law
for Enterprises with Foreign Investment and Foreign enterprises
1986－1992
Active Opening-up
1979：Law on Sino-Foreign Equity Joint Ventures
1980：Open four special economic zones
1984：Open fourteen coastal port cities
1985：Establish economic open zones successively
1978－1985
Prudent Opening-up
Unit: $ 100 Millions
FDI
GDP
Figure 3：Main Policies On Foreign Investment Of China

17. Local factors affecting innovation by TNCs
Government policies towards TNCs
supportive policies for assimilating innovative foreign technologies
Key national projects are required to develop a plan to build indigenous innovation capacity by assimilating imported advanced technology.
The list of technologies that are encouraged or restricted for import will be adjusted.
Support innovations based on assimilation of imported advanced technologies by giving high priority to key national projects.
Support cooperation among industries, universities, and research institutes as they assimilate imported advanced technologies.

18. Local factors affecting innovation by TNCs
The role of local universities
The extensive involvement of public research in industry R&D in China constitutes an important character of her National Innovation System.
Most of resouces concentrate on national or local leading universities.
Promoting science-industry cooperation has been a crucial innovation policy, but the effect is still unsatisfying.
Joint R&D projects or organizations between TNCs and leading universities concentrate on more advanced R&D than domestic firms, beside this, talent development and training are also main functions.
Local firms often lack abilities to compete with TNCs in signing such projects: crowding-out effect?

19. Local factors affecting innovation by TNCs
The role of local universities
Joint R&D organizations
TNCs
Home country
Qinghua-BP Clean Energy Research and Education Center BP
U.K.
Freescale Singlechip and DSP Applying and Development Research Center
Motorola
U.S.
Qinghua-Toyota Research Center
Toyota
Japan
Qinghua-Daikin Research Center
Daikin
Qinghua-AREVA Controlling Research Center
AREVA
France
Qinghua- Mitsubishi Joint R&D center
Mitsubishi
Qinghua- Renesas Integrate Circuit Designing research institute
Renesas Technology
Qinghua-Intel Joint R&D Center
Intel
Delphi-Qinghua Auto System Research Center
Delphi
Qinghua-Tianshi Software R&D Center
Hongkong Tianshi
Hongkong, China
Table : Some Joint R&D organizations of Qinghua University with TNCs

20. Local factors affecting innovation by TNCs
Other factors
IPR
Since China joined the WTO and signed the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS agreement), the Chinese patent system is in line with international standards.
Still weak. Infringement of intellectual property rights, particularly of copyright and trademarks, remains a concern.

21. Local factors affecting innovation by TNCs
Other factors
Education and S&T human resources
China has been the largest countries in terms of the number of enrolled undergraduates and post-graduates.
Since the early 1990s China has made substantial progress in developing S&T human resources.
The density of scientists and engineers engaged in R&D per million people in China is still relatively low

22. Local factors affecting innovation by TNCs
Other factors
Education and S&T human resources
Table : scientists and engineers in R&D personnel

23. The spillover of TNCs
The role of TNCs remain controversial in China. The empirical evidence on whether FDI facilitates technology spillovers is ambiguous in China.
Productive technology spillovers
There are positive productivity spillovers from foreign firms to their local suppliers in upstream sectors in China (e.g. Buck, Liu, Wei, & Liu, 2007; Buckley, Clegg, & Wang, 2002; Kueh, 1992; Li, Lam, Karakowsky, & Qian, 2003; Wu, 1999; Zheng, Siler, & Giorgioni, 2004; Zhu & Tan, 2000).
Local firms have improved and expanded production capabilities rather than innovation capabilities.

24. The spillover of TNCs Core or advanced technology spillovers
When it comes to the effect of TNCs on domestic innovative technological development, the study proved not so optimistic.
Auto production is almost fully carried out under license from foreign manufacturers. Most product development is based on reverse engineering, and no significant indigenous technological development has yet occurred.
Table : scientists and engineers in R&D personnel

25. The spillover of TNCs Training spillovers
Mobility of trained labor is a very important channel for technology spillover in China.
The main channel of TNCs’ technology diffusion is the mobility of human resources, especially senior managers and researchers, who came into domestic firms for development, or operated their own start-ups (R&D institute of Motorola in China).
Table : scientists and engineers in R&D personnel

26. The spillover of TNCs Linkages between TNCs and local firms
Technical cooperation
The top 3 technical cooperation partners of TNCs is: parent company, clients, foreign suppliers (A survey performed to TNCs in Shanghai high-tech park,2007 ).
75% TNCs didn’t set technology alliances with local firms, 67% TNCs had no intent to give technological support to local firms (A survey performed to 400 foreign companies ,2005 ).
Some local companies with strong R&D abilities (like Huawei, Haier, Chang’an and Little Swan) have cooperated with TNCs in recent years to form positive and interactive know-how exchange.

27. The spillover of TNCs Linkages between TNCs and local firms
CaseⅠ: Knowledge transfer between local suppliers and TNCs
City
Wuxi City
the most important integrated circuit design and manufacturing centers in China;
has attracted prestigious foreign firms, such as Siemens, Panasonic, Toshiba, Sony, General Electric, etc.
Industry
the electrical and electronics
Attracted the highest amount of FDI with a growth rate of 25% annually;
the demand for parts/components from suppliers is significant.
Data
a survey distributed to 50 TNCs, by Duanmu and Fai (2007)

28. The spillover of TNCs Linkages between TNCs and local firms
CaseⅠ: Knowledge transfer between local suppliers and TNCs
Findings:
56% firms have purchasing arrangements with suppliers in China, only 23.7% suppliers were indigenous Chinese firms; the others (76.3%) were foreign suppliers.
Demonstration effect: FDI introduces an “existing proof” of viable paths of development. Imitation usually happened.
There are technology spillovers between backward linkages from TNCs to local suppliers, but the transferred knowledge are mainly basic managerial and technological knowledge.
Knowledge transfer are mainly one-way pattern that mostly dominated by the TNCs, interactive transfer is seldom.

29. The spillover of TNCs Linkages between TNCs and local firms
CaseⅠ: Knowledge transfer between local suppliers and TNCs
Findings:
knowledge transfer between TNCs and local suppliers
Stage
Knowledge type
Knowledge
Linkages
initiating stage
Basic codified information
Product blueprints and manuals
Dominated by the TNC
developing stage
Managerial knowledge
Business culture
Quality control, product cost controls, materials management, etc
intensifying stage
Tacit knowledge
Joint problem solving , Cooperation
Interactive knowledge transfer

30. The spillover of TNCs Linkages between TNCs and local firms
CaseⅠ: Knowledge transfer between local suppliers and TNCs
Findings:
The relationship is mainly determined by local suppliers’ capability and TNCs’ strategy. Technically, the gap between the two is huge as Chinese firms lack sophisticated technological knowledge.
The nationality of the TNC: Japanese TNCs are more passive in their assistance to the suppliers whereas American and European firms seem to be more proactively.

31. The spillover of TNCs Linkages between TNCs and local firms
CaseⅡ: Linkages in the industry culster
Suzhou industry cluster:
A quite typical industry cluster in China’s manufacturing landscape
The driving power of the cluster is large-sized TNCs
Export orientation, very open.
Suzhou new development park
Suzhou industrial garden
Establishing time
1990
1994
GNP (up to 2002)
20.4 billion RMB
25.2 billion RMB
Inward FDI (up to 2002)
7.1 billion US dollars
5.43 billion US dollars
Representative industries
Computer assembly
Semiconductor IC industry

32. The spillover of TNCs Linkages between TNCs and local firms
CaseⅡ: Linkages in the industry culster
Findings:
The entrance of TNCs promoted the forming of industry cluster in Suzhou.
Great contribution to local employment (more than 80%) and labor training.
The cooperation and backward linkages between foreign and domestic firms is unsatisfying. Low local procurement level
Innovative activities of MNCs: recipient and user of technologies according parent company
Domestic firms: Manufacturing capability has been developed, innovation capacity is still limited

33. The spillover of TNCs Linkages between TNCs and local firms
CaseⅡ: Linkages in the industry culster
Findings:
TNCs have hold the upper-end of value chain in IT and semiconductor industry, local companies are still competing in the lower value chain excepting some fast learning firms.
Suzhou new development park
Suzhou industrial garden
Industry
IT manufacturing
Semiconductor
Value Chain
Electronic components, computer equipment, digital products
IC design, production, packaging and testing
Key Player
Benq (Taiwan), Logitech (Switzerland), Siemens (Germany), Panasonic (Japan), Yamaha (Japan), Philips (Holland)
IC Design: Innosis, ESMT, VeriSilicon, AMD (United States)
Packaging and Testing: Samsung (Korea), Hitachi (Japan), Fairchild Semiconductor (United States)

34. The spillover of TNCs R&D activites in China
China is now the most promising R&D investment destinations for TNCs, topping the United States and India (A.T.Kearney 2006 and UNCTAD 2005).
R&D institutes: 200 in 2001, 1160 in 2006
Motivation: make use of a growing pool of skilled engineers and technicians to cut their research expenditure
government pressure

35. The spillover of TNCs R&D activites in China
Some R&D centers invested in China by TNCs
ICT industry
Biopharmaceutical industry
Automobile Industry
IBM
AstraZenenca
Shanghai GM
Sun
Novo Nordisk
Shanghai Volkswagen
Nokia
Eli Lily
Nissan
Ericsson
Roche
Daimler Chrysler
Microsoft
DSM
Honda
Fuji
Lonza
Toyota
Motorola GE
Hyundai HP
Siemens

36. The spillover of TNCs The negative role of FDI
Industry Control & market monopoly
Foreign firms have introduced leading-edge, branded products that many Chinese vastly prefer to those made by domestic firms.
90% of China’s export has been foreign brands or OEM.
Top 5 companies in every industries that has been opened are almost foreign firms

37. The spillover of TNCs The negative role of FDI
Industrial Control & market monopoly
Through joint venture, many domestic brands have vanished and become OEM plants of TNCs.
Beverage: 7 of 8 domestic brands have vanishied, which have changed to produce Coco cola or Pepsi cola.
Cosmetics: almost all primary brands are foreign brands.
Others: Camera, Bicycle, Cleaning product, Auto……

38. The spillover of TNCs The negative role of FDI Crowding-out effect
Industrial structure similarity coefficient of FDI: in 1985, in 1995
More fierce competition
If TNCs introduce more new technology and products to China, rather than invest in exsisting manufacturing industries, crowding-out effect will decrease.

39. The spillover of TNCs The negative role of FDI Technical control
Utilizing advanced technology to control high-end market
Build production base through joint venture, call off R&D centers of Chinese partners
Local firms are more dependent on TNCs technology
Brain drain of R&D talents

40. Out-forward FDI and domestic TNCs
General trend
China’s outflows increased to $52.15 billion (include offshore financial investment) in 2008, and its outward FDI stock reached $170 billion.
521.5
2008
Source: Ministry of Commerce of China, 2008

41. Out-forward FDI and domestic TNCs
General trend
Industry distribution: Wholesale & retail, Trade related services, Transport and storage, Mining, Manufacturing
Destination: main to developing economies in Asia and Latin America, but the investment in developed countries has increased.
Top 15 destination of Chineses outward FDI, by stock, up to 2007 (100 millions of dollars)
Rank
Country/ area
Value
Share to all 1
Hongkong
687.8
58% 9
Korea
12.1 1% 2
Cayman Islands
168.1
14% 10
Pakistan
10.7 3
British Virgin lslands
66.3 6% 11
England
9.5 4
U.S.
18.8 2% 12
Macao
9.1 5
Australia
14.4 13
Germany
8.5 6
Singapore 14
South Africa 7
Russia
14.2 15
Indonesia
6.8 8
Canada
12.5
Subtotal
996.5
85%
Total
1179.1
100%

42. Out-forward FDI and domestic TNCs
Local TNCs
China has 3429 parent companies in 2005 (UNCTAD, 2006).
Most of them are relatively small TNCs with a limited geographical reach.
But the number of large TNCs is on the rise.
M&As (mergers and acquisitions) has become a major mode of entry into developed-country markets by TNCs from China.

43. Out-forward FDI and domestic TNCs
Local TNCs
Typical outward FDI cases deals by Chinese TNCs to developed economies
Year
Local TNCs
Invested project
Host economy
Entry mode
FDI value
1986
CITIC
Wood and wood products
U.S. JV
40 millions of RMB
Paper and paper products
Canada
M &As,
50% share
60 millions of
Canada dollars
1987
CMIEC
Mining
Australia
1999
Haier
Household electronic appliances
Wholly owned
2001
Huali
Mobile communication
M &As
$1 million
2003
CNOOC
Natural gas
Great Britain
$0.615 billion
TCL
TV, DVD
France
0.3 billion Euro dollars
2004
Lenovo
Personal computer
$ 12.5 billion

44. Conclusions and implications
FDI has been a crucial role in China’s development (GDP, industry structure, employment, export, technology import)
Opening-up is a effective channel for the learning of latecomers
Most technical standard are holded by TNCs
Only by learning, can latecomers catch the opportunity for shorten technology gap with developed countries.
Many Chinese firms have accumulated productive, managerial, and R&D knowledge through demonstration effect, competition effect, or direct and indirect learning from TNCs.

45. Conclusions and implications
BUT:
Technology spillover is unsatisfactory
Cooperation between TNCs and other parts of NIS is limited
Technical linkages between TNCs and local suppliers are limited
Productive capability has been significantly improved, but not the innovative capability
Negative effect of TNCs
Lacking of absorptive capacity or unwillingness to learn through technology import or joint venture with TNCs, is a main reason for low innovative capability of Chinese firms.

46. Conclusions and implications
Main mode of Joint ventrue in China is based on capital or land, and is wholly owned by TNCs. Such mode will be very effective for the country that lack of capital and experience, but its marginal effect will decrease with the increasing capital size of inward FDI.
Nowadays, improving innovative ability of firms should be a main objective through FDI for developing economies in international situation.
So, how to design FDI policies and made them adaptive to constantly changing of situation?

47. Conclusions and implications
Improving impartial competition environment for domestic and foreign firms
Focusing on the investment in strategic industries, guiding the flow direction of FDI
Facilitating technology transfer through linkages, promoting transnational technical cooperation
Building local firms’ absorptive capacities, make enterprises to be the main body of NIS, not the publich research system.
Learning to compete in international rules

48. Thank you