China: Policies for China: Policies for Technology DevelopmentTechnology Development

Kaoru NabeshimaKaoru Nabeshima

DECRGDECRG

World BankWorld Bank

September 21, 2006September 21, 2006

The Need for Strengthening The Need for Strengthening Innovation CapabilityInnovation Capability

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

Objectives and ProgramsObjectives and Programs

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

Policies to stimulate innovation Policies to stimulate innovation activitiesactivities

A number of public policies are available to stimulate A number of public policies are available to stimulate innovation activities through the use of taxes, subsidies, innovation activities through the use of taxes, subsidies, direct financial support, and other incentive mechanisms.direct financial support, and other incentive mechanisms.The purpose of these policies are:The purpose of these policies are:– To raise overall R&D spendingTo raise overall R&D spending– To affect the distribution of R&D spending among industrial To affect the distribution of R&D spending among industrial

sectorssectors– To directly support technology development activities that have To directly support technology development activities that have

large social returnslarge social returns– To encourage capital investment in imported equipmentTo encourage capital investment in imported equipment– To attract FDITo attract FDI

Global Trend in PoliciesGlobal Trend in Policies

Governments, especially in OECD, are now moving Governments, especially in OECD, are now moving away from direct grants for R&D. Instead opting for tax away from direct grants for R&D. Instead opting for tax credits for R&D spending so that private firms can credits for R&D spending so that private firms can choose what to research.choose what to research.– Private firms accounts for the majority of R&D spending, Private firms accounts for the majority of R&D spending,

especially MNCs which account for more than half of the global especially MNCs which account for more than half of the global R&D spending.R&D spending.

Governments are reducing support for defense-related Governments are reducing support for defense-related research and support for public research institutes. research and support for public research institutes. Similarly, direct public support for venture capital has Similarly, direct public support for venture capital has been in decline although it accounts for significant been in decline although it accounts for significant shares in Singapore and Korea.shares in Singapore and Korea.

Tax PoliciesTax Policies

R&D tax creditsR&D tax credits– Generally positive findings from the literatureGenerally positive findings from the literature– Although design issues remain (volume-based vs. incremental, Although design issues remain (volume-based vs. incremental,

temporary vs. permanent, simplicity and speed of temporary vs. permanent, simplicity and speed of reimbursements, and whether there is a cap).reimbursements, and whether there is a cap).

Capital gains taxCapital gains tax– This is most important if the intention is to stimulate the entry of 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 new firms that are increasingly high-tech. For these firms, IPO is a significant source of wealth creation. Lower capital gains tax a significant source of wealth creation. Lower capital gains tax will stimulate the birth of these firms.will stimulate the birth of these firms.

Investment tax creditsInvestment tax credits– Stimulates investment in equipment which may embody Stimulates investment in equipment which may embody

advanced technologies that domestic firms can adopt, absorb, advanced technologies that domestic firms can adopt, absorb, and assimilate.and assimilate.

Tax PoliciesTax Policies

Structure of direct taxes and loss carry-forward Structure of direct taxes and loss carry-forward provisionsprovisions– Low corporate taxes will induce incorporation of Low corporate taxes will induce incorporation of

businesses. The loss carry-forward provisions will businesses. The loss carry-forward provisions will encourage more risk-taking behavior, and stimulate encourage more risk-taking behavior, and stimulate innovation activities.innovation activities.

Subnational-level incentivesSubnational-level incentives– Such national level incentives can be complemented Such national level incentives can be complemented

by tax policies at subnational governments in a by tax policies at subnational governments in a decentralized fiscal arrangement.decentralized fiscal arrangement.

Other PoliciesOther Policies

Tax policies can be complemented by Tax policies can be complemented by other policies:other policies:– Direct public support for R&D to private firms, Direct public support for R&D to private firms,

public research institutes, or universities, public research institutes, or universities, especially for basic, blue-sky research especially for basic, blue-sky research (although there is a danger of crowding out).(although there is a danger of crowding out).

– Increasing the supply of S&T workers to Increasing the supply of S&T workers to facilitate the expansion in R&D activities. facilitate the expansion in R&D activities. Such supply can come from both domestic Such supply can come from both domestic and foreign sources.and foreign sources.

The Case of ChinaThe Case of China

Fiscal instruments used:Fiscal instruments used:– Tax holidays, preferential tax rates, accelerated depreciation, import Tax holidays, preferential tax rates, accelerated depreciation, import

duty exemption, export subsides, reduced tax rates, and tax rebates, duty exemption, export subsides, reduced tax rates, and tax rebates, etc.etc.

Direct supportsDirect supports– National high-tech R&D program (863 program)National high-tech R&D program (863 program)– National Key Technologies R&D programNational Key Technologies R&D program– Torch programTorch program– National Program on Key Basic Research ProjectsNational Program on Key Basic Research Projects– Small and Medium-Sized Enterprise FundSmall and Medium-Sized Enterprise Fund– National Key LaboratoriesNational Key Laboratories– 973 program973 program– China Technical Innovation FundChina Technical Innovation Fund– Various sector specific industrial fundsVarious sector specific industrial funds– Various Technology Development ZonesVarious Technology Development Zones

The Case of ChinaThe Case of China

Increasing the supply of S&T workers:Increasing the supply of S&T workers:– Since 1970s, many students have studied in foreign countries. Since 1970s, many students have studied in foreign countries.

By 2003, over 700,000 students studied abroad, over 500,000 By 2003, over 700,000 students studied abroad, over 500,000 still studying.still studying.

– Overseas Study Fund to sponsor Chinese students and Overseas Study Fund to sponsor Chinese students and scholars. In 2004, sponsored 3,630 students to study aboard.scholars. In 2004, sponsored 3,630 students to study aboard.

– Special fund to attract back those who studied abroad, Special fund to attract back those who studied abroad, especially in high-tech areas to work for domestic firms or public especially in high-tech areas to work for domestic firms or public research institutes or to startup a new firm.research institutes or to startup a new firm.

Venture capital industryVenture capital industry– Established 300+ venture capital firms with 50 billion yuan Established 300+ venture capital firms with 50 billion yuan

portfolio.portfolio.– Preferential tax treatments for foreign investment and venture Preferential tax treatments for foreign investment and venture

capital firms.capital firms.

The Case of ChinaThe Case of China

Incentives to attract FDI in R&D facilitiesIncentives to attract FDI in R&D facilities– Close to 700 R&D facilities were set up by MNCs (such as IBM, Close to 700 R&D facilities were set up by MNCs (such as IBM,

Motorola, Dell, Siemens, Nokia, Samsung, Intel), mainly in Beijing and Motorola, Dell, Siemens, Nokia, Samsung, Intel), mainly in Beijing and Shanghai.Shanghai.

– Abundance of academic think-tanks, universities, research institutes are Abundance of academic think-tanks, universities, research institutes are major draws for these firms.major draws for these firms.

– Combined with fiscal incentives such as exemption from import duties Combined with fiscal incentives such as exemption from import duties and related VAT for R&D purposes; Tariff and import-related VAT and related VAT for R&D purposes; Tariff and import-related VAT exemption for acquisition of new technologies; exemption from exemption for acquisition of new technologies; exemption from corporate tax for services related to technology transfer and technical corporate tax for services related to technology transfer and technical development activities; reduction in income tax payment if R&D development activities; reduction in income tax payment if R&D spending increases by more than 10% annually; and the same spending increases by more than 10% annually; and the same preferential treatment as foreign funded enterprisespreferential treatment as foreign funded enterprises

Fiscal incentives to attract high-tech FDIFiscal incentives to attract high-tech FDI– Tax holidays, preferential tax rates, import duty exemption, accelerated Tax holidays, preferential tax rates, import duty exemption, accelerated

depreciations, tax credits, and others to attract FDI in 11 areas of focus.depreciations, tax credits, and others to attract FDI in 11 areas of focus.

Some ResultsSome Results

These programs have augmented S&T skills, created new institutions These programs have augmented S&T skills, created new institutions and helped to raise R&D spending to 1.4 percent of GDP.and helped to raise R&D spending to 1.4 percent of GDP.

China’s high tech industrial sectors have expanded as have the China’s high tech industrial sectors have expanded as have the exports of their products—now almost a third of China’s total exports of their products—now almost a third of China’s total exports.exports.Numerous science parks and high technology industrial zones have Numerous science parks and high technology industrial zones have been created in major cities.been created in major cities.China’s researchers have rapidly increased the output of scientific China’s researchers have rapidly increased the output of scientific articles published, the number of patents registered in China has articles published, the number of patents registered in China has exploded, patents registered in the United States is increasing, and exploded, patents registered in the United States is increasing, and China is making strides in the life sciences, nanotechnology and China is making strides in the life sciences, nanotechnology and new materials development.new materials development.

How International Experience can How International Experience can Inform China’s Efforts to Develop Inform China’s Efforts to Develop

TechnologyTechnology

Effective research capabilities depend Effective research capabilities depend upon the acquisition of experience, tacit upon the acquisition of experience, tacit knowledge, heterogeneity of research knowledge, heterogeneity of research teams and project management skills. teams and project management skills. Improving the quality of research capital is Improving the quality of research capital is as vital as volume and quality accumulates as vital as volume and quality accumulates slowly. A too sharp increase in R&D slowly. A too sharp increase in R&D spending risks misallocating resources.spending risks misallocating resources.

How International Experience can How International Experience can Inform China’s Efforts to Develop Inform China’s Efforts to Develop

TechnologyTechnologyWith the globalization of research and the importance With the globalization of research and the importance of interdisciplinary activities for innovation, Chinese of interdisciplinary activities for innovation, Chinese corporate and university researchers need to form corporate and university researchers need to form international networks and forge partnerships with international networks and forge partnerships with S&T workers around the world. The leverage S&T workers around the world. The leverage afforded by international alliances can significantly afforded by international alliances can significantly complement domestic research effort.complement domestic research effort.Fiscal incentives and incentives provided through Fiscal incentives and incentives provided through institutions (such as IP) can encourage more MNCs institutions (such as IP) can encourage more MNCs to locate major labs in China. Other incentives can to locate major labs in China. Other incentives can also encourage the circulation of foreign knowledge also encourage the circulation of foreign knowledge workers through China, bringing fresh ideas and workers through China, bringing fresh ideas and introducing heterogeneity into the pool of research introducing heterogeneity into the pool of research skills.skills.