On its way to becoming the world’s second-largest economy, China’s growth was characterised by low-skilled manufacturing and the export of such basic consumer goods as clothing and shoes.
While these remain important, but shrinking, parts of its economy, China recently has focused on fostering innovation and intellectual property. This has spurred on an ecosystem of new, rapidly growing companies and opportunities for investors.
As part of its ‘Made in China 2025’ plan, the country is moving up the value chain – with government and private investment supporting significant progress in many areas. These include advanced information technology, leading-edge manufacturing, software, automated machine tools and robotics, modern rail transport equipment, new energy vehicles and battery technology, as well as biotech and advanced medical products.
While it will take time for China to approach the level of sophistication found in some advanced economies, it has separated itself from other emerging markets in terms of innovation. It is already playing a leading role in such areas as mobile payments, online gaming and commerce, high-speed rail, smartphones, surveillance cameras, telecom equipment and social media.
AI is a strategic Chinese priority
In artificial intelligence (AI), China’s leading technology companies – such as Baidu, Alibaba and Tencent – are challenging US goliaths Google, Microsoft, Amazon and Facebook.
The Chinese firms have been bolstered by generous government support, abundant engineering talent, substantial private sector investment and huge amounts of digital data for developing machine learning applications. However, it must still import the semiconductors crucial for AI advancement.
The Chinese government has made AI a strategic priority and plans on becoming the dominant force in this advanced technology by 2030. China accounted for more than 600 AI-related patent applications last year compared with 130 from the US. A similar patent gap has opened up in deep learning – the technology driving the rise of AI.
A leader in internet innovation
There are many other developments reflecting the growth of China’s innovation economy, such as the rise of the internet. With a surge in private equity and venture capital investment, partly fuelled by the venture capital of technology titans Alibaba and Tencent, China is home to a significantly growing number of so-called unicorns, or private companies with valuations of at least $1bn, many of them internet-related.
China had about $71bn invested in venture capital in 2017, almost catching up with the United States in that year’s investment total. The downside, however, is with so much venture capital available for start-ups, many are staying private longer.
E-commerce is another. Without a competitive brick-and-mortar retail establishment, e-commerce as a percentage of retail sales and digital advertising as a share of overall advertising spending in China now exceed that in the United States.
Demographics powering biotech
Aside from tech and the internet, China has also made great strides in healthcare. We maintain a positive view of China’s growing pharmaceutical industry. Within the last decade, China doubled the provision of healthcare coverage to 95 per cent of the population, fuelling rapidly growing demand for quality drugs – mostly generics. However, a new generation of Chinese biotech start-ups are developing homegrown innovations and attracting record investment.
Over the last decade, China has attracted 250,000 of its citizens to return from careers overseas in the life sciences by providing initial funding to start their own businesses and other incentives, thereby forming a foundation of biotech entrepreneurs. China’s large pool of patients is a structural advantage for drug development in terms of cost and time to market. It is estimated more than 20 Chinese biotech companies will list on the Hong Kong stock exchange in the coming quarters.
Admittedly, China biotech is still behind Western incumbents in many aspects, and the industry experiences long cycles with periodic bubbles. The first wave of biotech in China is producing drugs for the domestic market, but the next wave will focus on drugs with genuine global appeal.
Quality over quantity from here
The scale and sophistication of innovation we see in China may be surprising. But we expect it to continue gaining momentum, buoyed by a supportive government policy, a market of more than one billion people and industry clusters that will continue to evolve and progress.
Chinese president Xi Jinping has made it clear there will be no significant changes to China’s economic strategy, with the emphasis remaining on quality over quantity and on gradual progress towards a more market-driven, entrepreneurial economy.
There will certainly be roadblocks and misallocation of capital. The US is still the most important innovative engine – followed by China, which is leading the rest of the world.
Justin Thomson is chief investment officer for international equity at T. Rowe Price. The views expressed above are his own and should not be taken as investment advice.