Chinese Stocks Offer Hint at Innovation Prowess

(Bloomberg View) -- The potential for a trade war between the U.S. and China may be intensifying, but don't forget the innovation war. Although the U.S. has stopped short of labeling China a “Strategic Competitor,” the Trump administration has effectively perpetuated the myth that China only excels by stealing intellectual property from others. Investors shouldn't believe the rhetoric.

With the world's largest cashless transaction volume, fastest big-data computing capability, largest electric-car market share, and most advanced high-speed rail network, the stereotype of China as a copycat is outdated. In certain areas, China is a trendsetter and a formidable competitor to Silicon Valley. With a 41 percent concentration in the information-technology sector, the MSCI China index has been outperforming the Shanghai Composite Index, which has more of a concentration in the financial sector.

Plagued by an aging population, mountains of debt and narrow profit margins from low-value-added manufacturing, China depends on enhanced productivity through innovation to produce growth. Here are some developments that should challenge widely held views:

• China successfully cloned a pair of monkeys in January.
• Of the 4,500 exhibitors at the annual Consumer Electronics Show in Las Vegas on Jan. 8, more than a third were from China,
• In 2016, China's mobile payments totaled $9 trillion, dwarfing the $112 billion in the U.S., according to the Wall Street Journal.
• Many Chinese nationals who worked in Silicon Valley are returning to China to take advantage of the government's “Thousand Talents Program,” which provides venture capital funding, higher pay, and free housing to startups.  
• World Intellectual Property Organization statistics for 2016 show China's volume of patent filings and research papers trails only those of the U.S. and Japan.
• As of September 2017, China ranked No. 2 in the number of unicorns, or startups valued at $1 billion or more, behind only the U.S.

China Daily reported that there have been "four great new inventions” developed in China in recent years: dockless shared bicycles; the world's longest high-speed rail network; Alipay -- the world's largest mobile and online payment service, provided by Alibaba; and the worlds' largest and fastest-growing e-commerce market.

Chinese policy makers have encouraged companies to become globally competitive in high-value, high-margin sectors by providing state-funded research and development and innovation incubators, promoting overseas acquisitions and inviting multinationals to set up R&D centers in China. China's share of global R&D spending is second only to the U.S. A favorable 15 percent tax rate for high-tech companies has been a boon. However, the government's role as the “Visible Hand” is a double-edged sword. The government's protection of Chinese firms from foreign competition can leave them isolated from global innovation and foster backlashes.

China also benefits from a large and cheap talent pool. About 7 million graduates are produced every year, and those with STEM skills come cheaper than their U.S. equivalents. The lack of entrenched legacy systems like credit-card usage has enabled the fast adoption of internet and mobile technology. Large amounts of data on Chinese customers who are nonchalant about privacy make them the ideal testing ground for e-commerce. At the same time, high household and corporate savings are a good source of funding for venture capital.

Innovation is the new religion in China, and it's just getting started. There's no reason to think it can't transition from incremental innovation to disruptive innovation.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tracy Chen is a portfolio manager at Brandywine Global Investment Management.

To contact the author of this story: Tracy Chen at tchen59@bloomberg.net.

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net.

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