Three key steps toward an innovative future

However, these figures do not tell the whole story. Less than 10 percent of China's R&D is in Information and Communications Technology industries. In knowledge-driven economies, the ICT sector typically accounts for 25-50 percent of R&D. In China, most R&D is conducted by government research institutions and State-owned enterprises. Private companies spend less. As a result, the link with manufacturing is weak, which makes it hard for the results of R&D to reach the marketplace.

Cutting-edge companies need to transform R&D into innovative production. China has some highly innovative companies, particularly in telecommunications and consumer electronics, such as Huawei and Lenovo. But most Chinese companies focus on process and production improvements rather than breakthrough innovation.

And third, innovative companies need a dynamic financial sector and policy environment. Innovation is driven by the private sector. Policies and incentives should encourage companies to innovate. The marketplace should offer innovative companies financing options.

In China, small and medium-sized enterprises generate 65 percent of patented inventions and 80 percent of innovative products. But SMEs have insufficient access to credit and rely heavily on informal financing. Limited access to capital, in turn, restricts their access to skills and technology. Encouraging banks to lend to SMEs, and providing policies to support entrepreneurship, would unleash their dynamism.

The current leadership has taken important measures to open the financial sector and limit shadow banking. But more needs to be done. Liberalizing the financial sector and capital markets would broaden companies' access to finance while lowering the cost. Deeper capital markets would allow for an expansion of private equity and venture capital, which would in turn increase financing for innovative companies.

Robert Wihtol is adjunct faculty at the Asian Institute of Management and former Asian Development Bank country director for China, and Robert Koepp is a consultant and author of Betting on China: Chinese Stocks, American Stock Markets and the Wagers on a New Dynamic in Global Capitalism.