China cranks up the innovation machine

By Michael Elliott, contributor

FORTUNE -- If you visited the World Expo 2010 in Shanghai you'll know that the whole experience was one of those "only in China" gobsmacking superlatives. More than 60 million -- 60 million -- people visited the largest Expo site ever, with a one-day record on Sept. 23 of more than 631,000.

As I braved the crowds recently, however, it wasn't the metrics of modern China that I was thinking about. It was the mission to China in 1793 by Lord George McCartney, representing Britain's King George III. Britain was anxious to expand its trade with China, so McCartney, loaded with the manufactured wonders of the early Industrial Revolution, went to plead his country's case at the court of the Qianlong Emperor in Beijing. There, in the nicest possible way, he was given the bum's rush. "As your Ambassador can see for himself," the Emperor wrote to the King, in a letter he gave to McCartney, "we possess all things. I set no value on objects strange or ingenious, and have no use for your country's manufactures."

"That was then," you think as you wander the Expo, marveling at the crowd's appetite for the products of more than 200 nations and organizations. "Things are different now." China may run a huge trade surplus with the U.S., but its economy has been growing so fast that by 2008 it had become the third-largest market for U.S. exports.

But here's the question: Just as the closed China of 1793 didn't last, will the open one of today? The issue here isn't that a possible trade war with China will close its markets. It's the sense you get these days from corporate leaders who do business with China that the rules of the game are being stacked against them -- that everything from standards to government procurement policies to intellectual-property laws are being manipulated to benefit domestic Chinese producers over international competitors.

This set of policies has its own rubric. In a must-read new report, "China's Drive for Indigenous Innovation," James McGregor, a senior counselor to APCO Worldwide, and for years a sharp observer of modern China, says that the drive for so-called indigenous innovation "amounts to an all-hands-on-deck call to action for the Chinese nation to roll up its sleeves and complete the mission of catching up and even surpassing the West in science and technology." The campaign, writes McGregor, is "focused on employing China's fast-growing domestic market and powerful regulatory regime to decrease reliance on foreign technology and develop indigenous technologies."

What are we to make of this warning? I've been skeptical about whether Chinese companies can become global leaders without subjecting themselves to the discipline of competition in mature markets, the secret of postwar Japanese success. And Americans naturally doubt that any government can so organize affairs that its population becomes wildly innovative. But China's leaders make no secret of government's role in directing the economy. In Premier Wen Jiabao's recent speech to a World Economic Forum meeting in Tianjin, he started no less than 31 phrases or sentences with the two words: "We will." (As in, "We will further improve laws and standards" and "We will increase the forest carbon sink.") Did Wen's "we" refer to China, or to its government? If you think that matters, I have a U.S. Expo pavilion I'd like to sell you.

Wen, to be fair, went out of his way in Tianjin to welcome foreign multinationals to China and to promise them equal treatment there. Moreover, it is not clear that a command economy -- a "we will" economy, if you like -- can ever deliver the sort of broad-based innovation that China wants. China's governmental capacity is superbly suited to building magnificent highways and high-speed railroads. The crazy entrepreneurial genius of Silicon Valley, we like to think, has different wellsprings.

The Chinese, indeed, respect America's long record of innovation. No Chinese leader today is ever going to say, "We have no use for your country's manufactures." But there should be no doubt that China will go to extraordinary measures to build its own industrial and technological base. The question is how global corporations -- and their governments -- respond. To top of page