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Misuse of research subsidies weakens innovation policy

Philipp Böing and Bettina Peters, ZEW

Over the past two decades, business expenditure on research and development (BERD) has been the main driver of R&D growth in China. The annual BERD growth rate was consistently higher than the average growth rate of OECD countries. At the same time, government support for R&D spending in China officially reached only 4.3 percent between 2003 and 2018, well below the OECD average of 6.7 percent. To become more innovative, China’s R&D spending is expected to increase by at least 7 percent annually over the next five years, supported by government R&D subsidies. However, this is not enough: As a recent study by the ZEW (Leibniz Centre for European Economic Research) in Mannheim shows, R&D subsidy misuse has been widespread in China in the past and has long stood in the way of efficient use of state subsidies.

For this reason, a reorientation of China’s innovation and industrial policy was already accompanied by numerous measures in 2006, both to improve funding instruments and to curb their misuse. If such measures take even better effect in the future, China will become an increasingly innovative competitor on the global market and at the same time gain in popularity as an R&D location for foreign companies.

China’s subsidy policy reveals deficiency

The share of subsidy beneficiaries among listed companies in China has increased enormously since the turn of the millennium: While it was 32 percent in 2001, it was already 90 percent in 2011. On average, about 10 percent of total government subsidies to enterprises were specifically earmarked for R&D activities. However, our study shows that about 42 percent of R&D subsidy beneficiaries spent all or at least part of these government funds on non-research purposes between 2001 and 2011. This form of subsidy abuse was measured by comparing the R&D expenditures published in each firm’s annual reports and R&D subsidies received. Overall, 53 percent of all subsidy payments earmarked for R&D went to other, i.e. non-research, purposes. For example, subsidies are often misappropriated to cross-subsidize non-R&D-related investments, which can also lead to rapid reductions in production costs and distort competition on international markets.

The study results indicate that R&D spending did increase as a result of subsidies, but the increase among subsidized companies could have been more than twice as high as it actually was. The government R&D subsidy also led to the increase in investment in fixed assets, employment, and sales among companies. Furthermore, the analysis also reveals optimization potential in the selection of eligible companies. So far, R&D subsidies had no effect on state-owned companies, and support for the high-tech sector should also be more differentiated in the future. According to study results, in addition to misuse of subsidies, payments occurring too frequently or at too high a rate could also lead to inefficiencies.

Partial improvements in design and implementation

Further, we find that misuse is declining significantly over time, from 81 percent in 2001 to 18 percent in 2011. The Chinese government also achieved this decline through its “Medium- to Long-Term Plan for the Development of Science and Technology”. Through it, China has already been able to address some structural problems in its innovation system and implement necessary improvements. In addition, the administration of subsidy programs has been restructured in such a way that companies can now be selected more precisely and the use of subsidies can be better controlled. These reforms were already having a significant impact. However, in 2020 there was still extensive misuse of state support in semiconductor manufacturing, a key industry for the technological sovereignty China is striving for.

China has not yet proven that it is more capable of generating innovation and cutting-edge technology than the world’s leading innovation systems in the United States. However, if China succeeds in further improving the design and implementation of its innovation policy with the 14th Five-Year Plan, it can be expected that future business productivity will also increase, resulting in higher economic growth due to “Innovation Made in China”. Politics and business in the US and Europe should already be gearing up for a further intensification of competition, especially in high-tech sectors.

Bettina Peters is Deputy Head at ZEW’s “Economics of Innovation and Industrial Dynamics” Research Department, Honorary Professor in Innovation at the Faculty of Law, Economics, and Finance at the University of Luxembourg. Philipp Böing is Senior Researcher at ZEW

This article is part of the Global China Conversations event series of the Kiel Institute for the World Economy (IfW). On Thursday, Philipp Böing, Senior Researcher at ZEW in Mannheim, and Wolfgang Krieger, Deputy Managing Director of the Federation of German Industries (BDI) in China, will discuss the topic: “Innovation Made in China” – How effective is Beijing’s innovation policy? China.Table is a media partner of the event series.

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