China: Policies for Technology Development Kaoru Nabeshima DECRG World Bank September 21, 2006

The Need for Strengthening Innovation Capability In the past 25 years, China’s growth has averaged 9%. Three quarters of the growth came from increase in inputs, labor and capital. China invests close to 45% of GDP, more than any other country in the world. Manufacturing industries have so far relied upon low input costs, scale of production, and technology absorption. Medium to long term growth potential will depend upon development of broad-based innovation capabilities.

Objectives and Programs Building technological capability has been one of China’s foremost objectives for almost two decades. In support of this, a number of major cross- sectional technology development programs have been launched, including “SPARK,” “Torch,” “863,” “973,” and “985.” In support of this, a number of major cross- sectional technology development programs have been launched, including “SPARK,” “Torch,” “863,” “973,” and “985.”

Policies to stimulate innovation activities A number of public policies are available to stimulate innovation activities through the use of taxes, subsidies, direct financial support, and other incentive mechanisms. The purpose of these policies are: –To raise overall R&D spending –To affect the distribution of R&D spending among industrial sectors –To directly support technology development activities that have large social returns –To encourage capital investment in imported equipment –To attract FDI

Global Trend in Policies Governments, especially in OECD, are now moving away from direct grants for R&D. Instead opting for tax credits for R&D spending so that private firms can choose what to research. –Private firms accounts for the majority of R&D spending, especially MNCs which account for more than half of the global R&D spending. Governments are reducing support for defense-related research and support for public research institutes. Similarly, direct public support for venture capital has been in decline although it accounts for significant shares in Singapore and Korea.

Tax Policies R&D tax credits –Generally positive findings from the literature –Although design issues remain (volume-based vs. incremental, temporary vs. permanent, simplicity and speed of reimbursements, and whether there is a cap). Capital gains tax –This is most important if the intention is to stimulate the entry of new firms that are increasingly high-tech. For these firms, IPO is a significant source of wealth creation. Lower capital gains tax will stimulate the birth of these firms. Investment tax credits –Stimulates investment in equipment which may embody advanced technologies that domestic firms can adopt, absorb, and assimilate.

Tax Policies Structure of direct taxes and loss carry-forward provisions –Low corporate taxes will induce incorporation of businesses. The loss carry-forward provisions will encourage more risk-taking behavior, and stimulate innovation activities. Subnational-level incentives –Such national level incentives can be complemented by tax policies at subnational governments in a decentralized fiscal arrangement.

Other Policies Tax policies can be complemented by other policies: –Direct public support for R&D to private firms, public research institutes, or universities, especially for basic, blue-sky research (although there is a danger of crowding out). –Increasing the supply of S&T workers to facilitate the expansion in R&D activities. Such supply can come from both domestic and foreign sources.

The Case of China Fiscal instruments used: –Tax holidays, preferential tax rates, accelerated depreciation, import duty exemption, export subsides, reduced tax rates, and tax rebates, etc. Direct supports –National high-tech R&D program (863 program) –National Key Technologies R&D program –Torch program –National Program on Key Basic Research Projects –Small and Medium-Sized Enterprise Fund –National Key Laboratories –973 program –China Technical Innovation Fund –Various sector specific industrial funds –Various Technology Development Zones

The Case of China Increasing the supply of S&T workers: –Since 1970s, many students have studied in foreign countries. By 2003, over 700,000 students studied abroad, over 500,000 still studying. –Overseas Study Fund to sponsor Chinese students and scholars. In 2004, sponsored 3,630 students to study aboard. –Special fund to attract back those who studied abroad, especially in high-tech areas to work for domestic firms or public research institutes or to startup a new firm. Venture capital industry –Established 300+ venture capital firms with 50 billion yuan portfolio. –Preferential tax treatments for foreign investment and venture capital firms.

The Case of China Incentives to attract FDI in R&D facilities –Close to 700 R&D facilities were set up by MNCs (such as IBM, Motorola, Dell, Siemens, Nokia, Samsung, Intel), mainly in Beijing and Shanghai. –Abundance of academic think-tanks, universities, research institutes are major draws for these firms. –Combined with fiscal incentives such as exemption from import duties and related VAT for R&D purposes; Tariff and import-related VAT exemption for acquisition of new technologies; exemption from corporate tax for services related to technology transfer and technical development activities; reduction in income tax payment if R&D spending increases by more than 10% annually; and the same preferential treatment as foreign funded enterprises Fiscal incentives to attract high-tech FDI –Tax holidays, preferential tax rates, import duty exemption, accelerated depreciations, tax credits, and others to attract FDI in 11 areas of focus.

Some Results These programs have augmented S&T skills, created new institutions and helped to raise R&D spending to 1.4 percent of GDP. China’s high tech industrial sectors have expanded as have the exports of their products—now almost a third of China’s total exports. Numerous science parks and high technology industrial zones have been created in major cities. China’s researchers have rapidly increased the output of scientific articles published, the number of patents registered in China has exploded, patents registered in the United States is increasing, and China is making strides in the life sciences, nanotechnology and new materials development.

How International Experience can Inform China’s Efforts to Develop Technology  Effective research capabilities depend upon the acquisition of experience, tacit knowledge, heterogeneity of research teams and project management skills. Improving the quality of research capital is as vital as volume and quality accumulates slowly. A too sharp increase in R&D spending risks misallocating resources.

How International Experience can Inform China’s Efforts to Develop Technology With the globalization of research and the importance of interdisciplinary activities for innovation, Chinese corporate and university researchers need to form international networks and forge partnerships with S&T workers around the world. The leverage afforded by international alliances can significantly complement domestic research effort. Fiscal incentives and incentives provided through institutions (such as IP) can encourage more MNCs to locate major labs in China. Other incentives can also encourage the circulation of foreign knowledge workers through China, bringing fresh ideas and introducing heterogeneity into the pool of research skills.