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When confronted by claims that its swelling trade surplus reflects unfair treatment of overseas goods, China has long had a ready comeback: that foreign-invested firms account for at least half of its exports.

Chinese officials argue that foreigners use China simply as their final point of assembly in Asia, making use of its cheap labour and land while keeping most of their profits and the manufacturing of high-tech inputs offshore.

This argument, however, is starting to look increasingly frayed, with a sea change in recent years in the attitude of many multinationals, who now view China and its huge emerging market as a future hub for science and technology.

The trend was confirmed in a lengthy paper released this week at a conference in Beijing by the Paris-based Organisation for Economic Co-operation and Development in conjunction with Chinese researchers.

“The time when foreign investors invested in China only to take advantage of cheap manufacturing platforms is over,” the report says.

The OECD said “its best guess” was that foreign research and development now accounts for about 25-30 per cent of all business R&D in China. In this respect, the foreign share of R&D in China is similar to that in many European countries.

Multinationals’ R&D is focused on information technology because of China’s strength in mobile communications and the manufacture of computers. But it is also spreading into other sectors, including biotech, drugs and autos.

Companies that have established research bases in China, or have announced plans to, include Novartis, General Electric, Microsoft, Intel and Motorola.

With China’s emphasis on innovation, the centres have long made for good public relations and government relations for the multinationals. As with Chinese companies, much of the work by foreign companies was initially focused more on “D” than “R”, with little basic research.

The OECD’s findings back this up, with the multinationals surveyed by the researchers saying many centres had initially been used to modify existing products for the Chinese market ahead of exploring new ideas for the rest of the world.

But the survey also found that this is starting to change, with an increasing number of multinationals beginning to see China as a base for genuine research.

Although the OECD said reliable information on this trend was difficult to find, “anecdotal evidence, firms’ surveys and experts’ judgments suggest it is gaining momentum and is likely to amplify”.

The Chinese market and its consumers and their likely influence in the global economy in the near future are the greatest drawcards, especially in the information technology sector. The dimensions and competitiveness of the Chinese mobile phone market, for example, means it naturally has the potential to become a source of global innovation.

Chinese engineers are also relatively cheap compared with much of the rest of the world. And politically speaking, “window dressing” R&D centres no longer work for multinationals.

In a sense, foreign firms are simply tracking industry trends in China. R&D spending overall in China “has increased at a stunning rate of 19 per cent a year since 1995, and reached $30bn in 2005, the sixth largest in the world,” the OECD says.

Patent applications are doubling every two years. The R&D-to-gross domestic product ratio has doubled in a decade, during a period of spectacularly strong economic growth, to 1.34 per cent in 2005, from 0.6 per cent 10 years earlier.

The multiple barriers to foreigners investing heavily in genuine R&D in China are much the same as the disincentives that have held up innovation in China itself, in spite of the drive by the government to lift the country’s indigenous technological prowess.

An uncertain legal system that offers poor protection for intellectual property, a lack of experienced professionals and a frail financial environment in which banks are most comfortable lending to state enterprises have all undermined innovation.

The recent ramp up in R&D by foreign firms has been so pronounced that it has even produced a backlash from locals, who see multinationals crowding out local firms in the search for talent.

China also feels hemmed in by foreign domination of technology-standard setting and the valuable licensing fees that can flow from that.

“Foreign firms are seen as dominating standards and technological platforms and reducing Chinese companies to the role of producers with low profit margins,” the OECD says.

Conversely, the decision by multinationals to begin to spend serious money on R&D in China has brought a backlash in their own countries, especially in Europe and the US, which worry that such investments will be made at their expense.

For a template on such tensions, there is no better example than Germany. Angela Merkel, the president, who is visiting China this week, has complained strongly to Beijing since taking office about firms investing in China being forced into technology transfers. Partly as a result, relations between the two countries have cooled.

Copyright The Financial Times Limited 2017. All rights reserved.
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