To assess the available strategies, it helps to distinguish between ‘Business class’, ‘Economy class’, and ‘Cargo hold’ positions, as outlined in the above chart. Those in business class, with strategic technologies that are much more advanced than local options, tend to get generous inducements to invest, from 100 percent foreign ownership deals to easier access to land, subsidies, tax incentives, plus measures more directly linked to innovation support. Such measures include better support in IP disputes, positive signals to help attract local and international talent, including soft infrastructure like housing support, access to international schools and more.
Foreign technology firms face ‘up or out’ competition to stay ahead of local companies
These positions are not static. For instance, foreign companies who lose their technological edge over local ones risk sliding into the ‘cargo hold’ class, where they may struggle for market share. Once there, an uncaring Beijing leaves them to wither or, worse, may even actively push them out. The trip from ‘business class’ to ‘cargo hold’ is a direct one, there is no connecting flight through ‘economy class’, because the strategic nature of a technology rarely changes, even if the technology gap does.
Importantly, there is no single line of demarcation between these two categories. Rather, there is a grey zone where Beijing may decide that, though a technology gap remains, a local firm has ‘good enough’ technology to tilt the playing field in their favor. Once that threshold is crossed, Beijing seeks to push foreign players out, so market share can shift to domestic firms, which thereby gain the scale and momentum to become efficient and globally competitive. This basic playbook has proved successful with high-speed rail, telecoms equipment (5G), and electric vehicles. Some types of industrial machinery, industrial software, medical devices and legacy semiconductors are also on this trajectory.
Firms in ‘economy class’ tend to have less uncertain fates. Beijing is largely ambivalent about foreign investment in their sectors – typically downstream in value chains and consumer-oriented goods – as the investment bolsters employment, tax revenue, HR development, etc. without taking market share from local firms that could be used to fund R&D in a strategic technology.
Market share saturation is a policy-driven path to closing China’s technology gap
China’s industrial policy seeks to close technology gaps with incentives to expand production capacity. Beijing sees this as indirectly boosting innovation because production scale leads to lower prices, larger global market share, faster product iteration and increased R&D budgets, which in turn lead to better products and production processes.
First, the more China can expand its production and global market share, the more that it will capture revenue bases and profits that can be funneled back into optimizing and innovating products and production processes.
Second, the concentration of manufacturing in China generates all kinds of clustering and spillover effects that hugely speed up innovation. China’s complete industrial clusters have repeatedly come up in interviews during our three-year study as strengths that facilitate innovation there. The ability to work at so-called “China speed” is largely due to shorter, more direct links between different actors in the industrial ecosystem, including upstream and downstream suppliers – from startups to multinational corporations (MNCs) – and a range of service providers in contract research, digital modeling and talent development. The World Intellectual Property Organization ranks the top 100 global science and technology clusters; in 2024, China had 26, the most of any country, and the global top ten included the Shenzhen-Hong Kong-Guangzhou corridor (2), Beijing (3), Shanghai-Suzhou (5) and Nanjing (9).2
Third, growth in production scale also leads to faster product iteration cycles. Innovation is not confined to researchers in labs doing basic research: it frequently happens on factory production lines with technical engineers and process managers experimenting to finetune their work, sometimes even leading to breakthroughs. The Asia Growth Partners Innovation in China Survey found the most common sources for innovation ideas in China were sales team input (76 percent), competitor benchmarking (71 percent), customer/user interviews (55 percent) and only then R&D centers (55 percent).3
Foreign firms squeezed out in China will eventually suffer globally
Foreign competitors are also likely to get crowded out. China’s playbook leads to overcapacity and shrinking profit margins for everyone, which eat into foreign firm’s ability to finance R&D investment and maintain their technological lead.
China’s growing market share across lower and mid-tier value chains creates an underappreciated risk: European companies left to occupy only the upper end of value chains are unlikely to generate enough revenue to maintain this lead. Deindustrialization can slow down innovation, especially if EU firms lose access to economic value and deep production knowledge within the production segment in the supply chain. In the AGP survey, when asked where companies were experiencing pressure from local competitors, 95 percent said they felt high pressure on price and 66 percent said they felt high pressure on sales and service speed – pressure on quality was the lowest, with only 11 percent saying pressure was high, 42 percent saying it was medium, and 47 percent saying it was low.4
This of course does not suggest that there are no paths for foreign companies in China to remain competitive and profitable. Beijing is happy to have foreign companies with the right technologies as they grow the global market share of ‘made in China’ products and enrich China’s industrial clusters. Many firms surveyed and interviewed for this study engage extensively with local innovation partners, which helps the overall ecosystem. The efforts made by European firms to help their Chinese suppliers achieve global quality standards are a disregarded form of technology transfer encouraged by Chinese policies on promoting local content.
China’s central government, which ultimately sets many of the rules, focuses on national interest. It shuns open innovation and the free flow of technology in favor of mechanisms to ensure more technology flows in than out. The innovation model that the Chinese state has rolled out is based on intense pragmatism and realpolitik that prioritizes geopolitical goals above all and frames foreign companies’ options accordingly. China’s most successful innovation clusters display open, inclusive and cosmopolitan business environments that are equally created and constrained by this framework.
