The days when cost leadership was the key competitive advantage for China’s industrial players are long gone. Today, the country’s top manufacturers are betting on innovative technologies, smart product design, and the ability to respond at speed to changing customer needs. That pivot required significantly increased R&D investment across all parts of the economy. From 2009 to 2019, gross R&D expenditures in the country rose threefold, to almost $515 billion. Since the turn of the millennium, China has overtaken Germany and Japan to become the world’s second biggest R&D spender, after the United States (Exhibit 1).

China’s transition to an innovation-driven economy has strong support from the top. In the 14th Five-Year Plan, published earlier this year, the government has stepped up targets for growth in R&D investment, patent ownership, and value generated by the digital economy. The plan’s target—7 percent annual growth in R&D  investment—would set the country on the path to become the world’s largest R&D spender.

At the heart of this strategy lies the desire for technological independence. Chinese companies don’t just want to make innovative, distinctive products; they want to build those products without needing to import core technologies from overseas competitors. The country is already reaping significant rewards for its strategy, rising from the 29th position in the Global Innovation Index in 2015 to 14th in 2020, for example, and from fourth to first in the global league table for patent registrations over the same period. It has also become the world’s fifth-largest intellectual-property (IP) exporter, just behind South Korea (Exhibit 2).

Success in R&D depends as much on quality as on quantity, however. To translate effort into results, companies must invest in the right technologies and turn their ideas into products that match customer