If you believe everything you read in the New York Times, you’d think that China is about to wrestle away the technological leadership position from Western firms (see China Drawing High-Tech Research from U.S.). There is no doubt that foreign firms are increasingly conducting research in China. But that stylized fact does not tell us anything about the kind of research activities that Western firms are undertaking in China, or its likely impact on the technological dominance of Western firms.

According the Times article:

For years, many of China’s best and brightest left for the United States, where high-tech industry was more cutting-edge. But Mark R. Pinto is moving in the opposite direction.

Mr. Pinto is the first chief technology officer of a major American tech company to move to China. The company, Applied Materials, is one of Silicon Valley’s most prominent firms. It supplied equipment used to perfect the first computer chips. Today, it is the world’s biggest supplier of the equipment used to make semiconductors, solar panels and flat-panel displays.

In addition to moving Mr. Pinto and his family to Beijing in January, Applied Materials, whose headquarters are in Santa Clara, Calif., has just built its newest and largest research labs here.

OK, solid reporting of the facts. The article then continues:

It is hardly alone. Companies — and their engineers — are being drawn here more and more as China develops a high-tech economy that increasingly competes directly with the United States.

Competes with the United States in what exactly?

Jobs? OK, I get that. These are research jobs that might otherwise be located in the U.S. But the fact remains that they could just as easily be located in other countries if not China – Malaysia, Indonesia, or India for example. So just because the facility is located in China doesn’t mean that it’s a zero-sum job competition with the U.S. This is acknowledged in the article:

Mr. Pinto said that the company was readjusting its work force as manufacturing shifted to Asia, but that the Xi’an facility involved a new approach to researching the design of an entire assembly line and was not replacing laboratories elsewhere.

So if it not a direct competition for U.S. jobs, is the article then suggesting that China is increasingly competing with the U.S. in the technological knowledge race? I think that is part of the implication. However, I am likewise skeptical about this conclusion, …and several key nuggets from the article itself discredit such an inference. Allow me to elaborate:

1. The fact remains, an American firm (Applied Materials, Nasdaq: AMAT) is making the investment. The shareholders of AMAT own the rights to the residuals of the local subsidiary. So the profits belong to the American investor. Not only that, but theoretically (although I realize it does not always work this way in practice), any productive knowledge that is developed at that facility likewise belongs to the American parent. AMAT has the right to use that knowledge however it wants and wherever it wishes. The counter-argument has been that knowledge invariably spills over to local firms, the local economy, and even AMAT’s Chinese employees. However, research is increasingly calling those knowledge transmission mechanisms into question. The host country does not benefit nearly as much as some have suggested, precisely because foreign firms are very careful about the types of knowledge they are willing to bring to the foreign country and are keen to protect their most valuable knowledge (not allowing it to leak).
2. Speaking of the types of activities (even if R&D activities) that foreign firms conduct in host countries like China, Western firms often bring low value-added activities to their foreign research facilities. The most valuable knowledge remains in the domestic research facilities (see Globalization Discontents and Globalization Revisited). Even the author of the New York Times article recognizes this: “Applied Materials continues to develop the electronic guts of its complex machines at laboratories in the United States and Europe. But putting all the machines together and figuring out processes to make them work in unison will be done in Xi’an.” So the assembly (low value-added activity) will be performed and researched in China. The design (high value-added activity) will be done in the West. This is consistent with the theory of comparative advantage.
3. The Chinese government is subsidizing the investment. According to the Times, “Locally, the Xi’an city government sold a 75-year land lease to Applied Materials at a deep discount and is reimbursing the company for roughly a quarter of the lab complex’s operating costs for five years, said Gang Zou, the site’s general manager.” You certainly can cry foul and argue that buying (artificially subsidizing) foreign investment is tantamount to unfair competition; but  again, at the end of the day, who is appropriating the value of the investment, China or AMAT (and by extension, it’s mostly U.S. shareholders)? I vote for the latter, as research is increasingly demonstrating that countries that buy foreign investment often do not receive the hoped-for benefits.

So while this article provided a nice read and some interesting factual nuggets about Western firms making R&D investments in China, I am not so sure I agree with the conclusion that, “Of course, China will lead everything.” No doubt, China is a country with a tremendous amount of potential and an increasingly skilled labor force; however, the fact remains that it is many, many years away from closing the technological capability gap with the West.

This entry was posted on Thursday, March 18th, 2010 at 12:51 pm and is filed under Corporate Strategy, International Business, International Strategy. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.