The Mysterious Divergence In China's Productivity And Innovation Patterns

by Alexander B. Hammer and Jennifer Bernard

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Economic theory suggests that innovation and productivity are inextricably linked. The intuition, backed by empirical evidence and typically restricted to goods production, suggests that the more a country innovates and commercializes new technology, the more efficiently it will use its resources to produce its goods. This briefing describes China’s puzzling developments in this regard. Although conventional indicators (e.g., R&D expenditures, patent filings, global innovation rankings) suggest that China is innovating rapidly, total factor productivity suggest that China’s productivity growth has been sluggish―especially since the 2008-09 global financial crisis. In this briefing, we showcase these diverging trends using empirical analysis and information collected from the literature, and find that traditional indicators may be overestimating China’s growth in innovation. This may be attributable to the poor quality of filed patents, the government-directed nature of lending and R&D spending, and China’s broad misallocation of capital, especially since the financial crisis.