By John Kell and Alan Murray
October 21, 2015

It is innovation week in China – part of the Chinese government’s effort to prove it can lead, not follow, in the high-tech race. But can it?

 

That’s the topic of a report being released later today by the McKinsey Global Institute. The study goes beyond the eye-popping numbers of China’s innovation effort – $200 billion spent annually on research, 30,000 PhDs graduated each year in science and engineering, more patent applications than any other country, etc. – and looks closely at what is really happening in 30 different Chinese industries.

 

The conclusion: China is already showing significant leadership in two areas – customer-focused innovation (appliances, internet software, consumer electronics) where it benefits from a large and demanding consumer base, and efficiency-driven innovation (solar panels, industrial machinery, generic pharmaceuticals), where it benefits from its massive manufacturing ecosystem. But Chinese companies still lag far behind in the more challenging areas of science-based innovation (biotechnology, branded pharmaceuticals, specialty chemicals) and engineering-based innovation (automotive, aviation, medical devices.)

 

The report says China has some significant advantages in the high-tech competition, including strong government support and a massive supply of low-cost researchers. That may be offset, however, by an economy overly reliant on state-owned enterprises. “The phrase ‘high-tech state-owned enterprise’ is an oxymoron,” Jonathan Woetzel, author of the report, told me last week. “It is hard for a sector, if it has a large number of state-owned enterprises, to be competitive,”

 

Still, McKinsey’s bottom line is that China will emerge over the next decade as a dominant force in global innovation. The consulting firm’s advice to other multinationals: locate more R&D in China. That could explain why Google, which avoided China in the past because of its internet restrictions, yesterday announced an investment in the Beijing-based artificial intelligence startup Mobvoi.

 

Enjoy the day. And take the time to read Shawn Tully’s piece about how First Data reinvented itself and became the year’s biggest IPO. It’s in the November issue of Fortune, but out online this morning.

 

 

Alan Murray
@alansmurray
alan.murray@fortune.com

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