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Indigenous growth: Peter Murmann on innovation and institutional trust in China

June 15, 2016



​​Peter Murmann is a professor of management at UNSW Business School and an Australian Graduate School of Management fellow. He has recently co-edited China's Innovation Challenge: Overcoming the Middle-Income Trap (Cambridge University Press), a compilation of chapters by leading Chinese and other international scholars examining the potential course of China's economic future. Murmann spoke to Julian Lorkin for BusinessThink.​

An edited transcript of the interview follows.

BusinessThink: The growth rate in China has decelerated quite markedly during the past few years. It's now down to about 7%. Many Western economies would consider that a great rate of growth but it's quite low compared with China's growth rate during the past 30 years. Can China develop an indigenous growth model centred on innovation to combat this decline? Is there any way China can come back from this decline?

Peter Murmann: This, of course, is the billion-dollar question that everybody is asking. And what we have been doing [in preparing the book] during the past two years is to ask precisely that question. Some people are very, very optimistic. The previous chief economist of the World Bank, who was one of the intellectual leaders of the transformation of the Chinese economy, is very optimistic. He believes, for instance, there's no reason why the Chinese economy cannot grow for another 20 years at 8%.

Other Western scholars are deeply sceptical and let me tell you a chief reason. If you look at economic history, if you look at the performance of countries during the past 20 years, you have, for instance, many countries such as Argentina. Argentina had a growth miracle, not as big as China's but also a big miracle, between 1870 and 1900. And then from 1900, for the next 100 years, Argentina has not been growing. It was stuck in the middle-income trap. Brazil had the same experience since the 1980s.

​China moved and grew for 30 years at a rate no one has seen before. It now has about 25% of the US GDP. The big question is, can it move to the income levels of America? And that's the debate.

'I think people ​have an outdated view that somehow the Chinese government is condoning wholesale copying of Western products. That is a bit outdated' – PETER MURMANN

 BusinessThink: I want to ask about the middle-income trap. It seems to be when a country expands quite dramatically – it starts to develop its own economy, growing quite well, and then it sort of just plateaus. It just can't get any further. What's the real problem? What's the hurdle for many of these countries?

 Murmann: The real problem is that, qualitatively, the way the economy needs to be organised is very different from when you are at the bottom of the income pyramid in the world, where your economy has essentially very little income [and] labour is very cheap. All you're doing essentially, if you're at the bottom, [is] if you can pacify society, if you can build some stable political framework, then a low-income economy can catch up by simply using cheap labour and Western technology to produce goods for the world market at a cheaper cost.

[But] when you come to middle-income levels, as China now has, one thing, for instance, [is that] your labour cost is no longer that cheap. China now has labour costs that, if you really take everything into consideration, are almost 90% of the US labour cost, which means at that moment you cannot simply have relatively cheap products for the world. You need to have high-value-added products which command big margins and that requires you to have strong technological capabilities to really participate in high-tech sectors and sectors where innovation is essentially what differentiates companies, as opposed to just imitation.

BusinessThink: But doesn't it also require the will to take on innovation, which by its very nature involves some risk? Is there that will in China?

Murmann: The Chinese government for the past 10 or 15 years has been very focused on trying to upgrade China's technological capabilities. I should also point out that the Chinese government is fully aware of the danger of the middle-income trap. In fact, they have done studies together with the World Bank to lay out what China needs to do to not get stuck in the middle-income trap but to overcome it. But there is a big difference between [that and] upgrading, for instance, your science capabilities. All the indicators show that Chinese science has improved dramatically. The share of publications in the world has gone up. The number of students ... no other country in the world produces as many engineers and scientists as China.

But coming back to your question of risk, the level of risk-taking of individual entrepreneurs is also very high. But it's short-term risk-taking. Right now, during the past 10 or 15 years, the low-hanging fruits of making money were so plentiful that entrepreneurs figured out how to essentially make a quick buck by producing something more cheaply than the West, [to] capture Western markets in low-end goods.

So the problem is that to have true innovation – which is innovations new to the world – you need to make long-term investments. And the problem of Chinese entrepreneurs is that no one is really willing to make long-term investments as the Western companies such as IBM, GE, or Siemens have been doing for the past 50 or 60 years. And that of course comes back to the difference in the institutional contexts of China and the Western countries.

BusinessThink: If a country's innovating, it also needs tight laws, [such as] tight laws about IP and ensuring that there is a regulation and a framework of law for those companies that do risk and do innovate. Is China ready for this, and is there the political will for it?

Murmann: Yes. China has been strengthening IP laws and regulation for the past 10 or 15 years. Essentially this was in part mandated by China joining the World Trade Organisation. So I think people have an outdated view that somehow the Chinese government is condoning wholesale copying of Western products. That is a bit outdated. In fact, one of the things that we have in this book is a chapter on IP regulations and that chapter is laying out further initiatives the Chinese government is taking in order to strengthen IP laws.

I don't think that IP law is at all the problem. I believe, based on the research in this book, that the real challenges have to do with politics, have to do with institutional trust –  [so] that individuals do believe "if I make an investment into innovation which will take 10 years to flourish, that in five years from now I still own my company and they haven't taken away the company from me, or they have not nationalised that company, because it's doing so well".

​So I think the real problem laid out by the pessimists in our book is that there is a lack of institutional trust. So in the West, when you make an investment, either as an entrepreneur or a company, you can be sure that in 10 or 15 years from now, if you happen to develop a new drug, that you can really benefit from the investment and that you will reap the benefits. And that sort of institutional trust in the long-term stability of the political and institutional framework is not guaranteed in China in the way it's guaranteed in the West.

'I believe, based on the research in this book, that the real challenges have to do with politics, have to do with institutional trust' – PETER MURMANN

BusinessThink: And have we got any indicators at the moment? Have we got any initial figures on how China is doing?

Murmann: Yes. I am personally quite impressed. I've started to dig into this. One of my co-editors believed that one of the things that is holding China back is a lack of autonomy of the Chinese universities. We can all from the West think, "Oh, the Chinese Communist Party is controlling these universities". And when I then did a comparative study, I looked at indicators of autonomy of universities in different Western countries, and then I had scholars who know China construct an index for China. I think Chinese universities are as autonomous as many Western universities.

So that's an indicator that is clearly not going to be a problem.

On the other hand, institutional trust – a simple way of measuring this is how many people are willing to trust a stranger? China is very low on this indicator. Institutional trust is also important if I have to collaborate with another company to do innovation. If I don't trust a stranger, if I don't trust other people, another company, people outside my family and network circle, it is very difficult.

So all of these complex technologies which require collaboration of many different individuals, many different companies, are a lot harder to do in a society that has low institutional trust.

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