Innovation is widely seen as the engine of future economic growth and wealth creation. With this in mind, policymakers around the world seek ways to encourage and incentivise innovation and reward innovators.
The challenge is how to encourage and incentivise the right kind of innovation? Innovation for innovation’s sake is not necessarily valuable or even particularly beneficial.
To put it another way, not all innovations are created equal — so can government-backed incentives encourage innovations that are actually useful and of high quality?
In 2006 the Chinese government launched a nationwide campaign to develop an “innovation-oriented” society, aimed at moving China’s economy from being a manufacturing powerhouse to the next stage of value creation.
Increasing spending on research and development (R&D), rapid advances in technology and China’s growing linkages with other global economies were all factors that would help to support this effort.
In order to spur the process along, the government campaign introduced an incentives policy to reward domestic Chinese firms, particularly state-owned enterprises, for indigenous innovation, which is largely measured using the number of patents they produced.
...the sharp increase in the quantity of patents resulting from the incentives policy is actually associated with a reduction in the novelty or quality of the patents.
The result has been a surge in Chinese patenting. Data from the World Intellectual Property Organization (WIPO), shows that by 2012, China had overtaken the US in terms of the total number of patents filed domestically.
But how novel are these innovations?
In a recent study published in 2019 in the Academy of Management Journal (co-authored with Nan Jia and Cyndi Zhang), we found that for Chinese state-owned enterprises, in particular, the sharp increase in the quantity of patents resulting from the incentives policy is actually associated with a reduction in the novelty or quality of the patents.
This puts into question the effectiveness of government or state-led efforts to promote innovation through such incentives.
For our study, we looked at data between 2000 and 2012 on all Chinese domestic patents and the governance information of publicly listed state-owned firms. This covered the period for six years before and six years after the innovation incentives policy was introduced.
...a senior manager could decide to pursue incremental technologies or even break up a sophisticated, novel technology into multiple smaller parts so they can be covered by multiple patents in order to maximise the patent count,
In particular, we wanted to focus on how the corporate governance of different firms affected their production of patents in response to the government’s pro-innovation incentives.
What we found was that whilst the total number of patents produced by firms increased sharply after the 2006 policy change, significant variations emerged between firms.
Drilling deeper we found that the firms that suffered most from the issue of the management team seeking to further personal interests — for example, to maximise their own welfare including salary increments, bonuses and promotions — produced the largest numbers of patents, but with fewer novel patents, comparing the periods after and before the policy change.
In other words, the managers of these firms seem to have sacrificed novelty of patents in favour of sheer number of patents in order to boost personal gain. This is because developing genuinely novel patents that contribute to firm value is often laborious and time-consuming for managers.
With that in mind — and lured by the policy of incentives — managers who cared more about their own private interest than the firm value found ways to game the system. This involved disproportionately developing incremental technologies in order to rapidly increase their total patent counts at the expense of novel technologies.
For example, a senior manager could decide to pursue incremental technologies or even break up a sophisticated, novel technology into multiple smaller parts so they can be covered by multiple patents in order to maximise the patent count, instead of pursuing a novel breakthrough technological innovation.
As a result, whilst the number of patents spiked upwards, they were doing little to benefit the competitiveness and long-term growth of their firms.
The lesson for governments is to be wary about incentivising innovation through numbers of patents...
The message from this is innovation is much more than a simple numbers game. Policies which focus purely on quantity of innovation (whether intended or unintended) can create what we call a perverse incentive and actually backfire on their intended outcome, reducing quality.
Whilst our study focused on state-owned enterprises in China, we believe the lessons remain valid for firms and policymakers in other contexts where the government plays a strong role in driving innovation efforts.
The lesson for governments is to be wary about incentivising innovation through numbers of patents, because managers' self-interests can prompt them to trade quantity for quality.
To encourage innovation of value, policymakers should structure incentives to be more nuanced and sophisticated, focusing on the real impact that innovations have and reward them accordingly.