System Reform, Competition, and Innovation in China

China’s economic reform and openness have promoted innovation through intensifying competition. A cross-regional analysis shows that innovations in terms of research and development intensity, patents, and sales of new products are all positively and significantly correlated with the degree of marketization, share of private ownership, and foreign investments. However, China is far away from an innovative economy. The high growth of the past four decades is mainly a result of improvement in allocative efficiency driven by entrepreneurial arbitrage. As the potential of pure allocative efficiency is exhausting, future growth will be more and more dependent on entrepreneurial innovation. For Chinese entrepreneurs to be really innovative and for China to be a real innovative country, abolishing the dominance of the state sector and putting the government under law are urgently called for.