state research institutes to enhance their R&D capabilities. These institutional reforms were supported by incentive policies that gave promoted groups preferential access to state bank finance and capital markets.<sup>30</sup> At the same time the government was promoting its more expansive policy of “grasp the large, let go the small,” the government adopted the goal of becoming an “innovation economy” (Gu et al 2009). To meet this goal, the government began reforming its national innovation system by radically increasing R&D expenditures as a share of GDP<sup>31</sup> , funding a number of new S&T programs<sup>32</sup> , while also converting a large number of government research institutes (GRIs) that were a legacy of central planning into non-government S&T enterprises that had to fend for themselves.<sup>33</sup> As Naughton (2003) and Zweig (2001) argue, the restructuring of GRIs was aimed at forcing them to become market-oriented, “demand-driven” technology support institutes that serve the technology upgrading and learning needs of firms.

Chinese policy makers also experimented with ways to increase technology transfers and spillover effects associated with foreign investment (Gu, et al 2009: 373). Initially, the government adopted a self-reliant (“we will make it on our own”) policy toward state of the art industrial technologies.<sup>34</sup> Once the drawbacks of this autarkic strategy became evident<sup>35</sup> , the government shifted to buying foreign technologies in turnkey factories.<sup>36</sup> Once that strategy proved to be too expensive<sup>37</sup> , the government shifted to tough negotiations with foreign investors for specific technology transfers in exchange for access to the Chinese market. While the 30 Unfortunately, very little is known about the impact of these preferential financial practices on promoted enterprises’ performance. The tiny bits of evidence we do have is somewhat contradictory. On the positive side, in an admittedly early study, Keister (1998: 423) demonstrates that ‘national champion’ enterprises that created their own internal finance companies after being urged to do so by the government have higher productivity than nonpromoted enterprises in the same industry without internal finance companies. In the same vein, Sutherland (2007) shows that China’s ‘national team’ enterprises have grown fast, are substantial exporters, have higher R&D expenditures and higher profitability than large non-national team enterprises. On the other hand, because all large enterprises in China are also dependent on inefficient state banks (Allen et al 2008: 514) for capital expansion, the large size of non-performing loans in these banks’ portfolios (Allen et al 2008: 522-526) suggests that preferential access to finance may undermine efficient use of capital. As discussed in the Appendix, these reforms raise several other important questions. Chief among them are two key questions: Have the reforms been successful in meeting the government’s objectives of creating a small number of large technologically sophisticated enterprises that have come to dominate in several pillar industries? It is equally important to ask: What has been the impact of these policies on competition.

31 R&D expenditures as a share of GDP rose from .6% of GDP in 1994 to 1.4% of GDP in 2006 (Hu and Jefferson Forthcoming: 16).

32 This include the 863 Program and the 973 Program which focus on basic research and frontier technologies; the TORCH Program which supports high tech industries and the SPARK Program which is aimed at developing S&T to revitalize the rural economy (Hu and Jefferson Forthcoming: 16).

33 Some GRIs closed, others merged, while still others were absorbed by enterprises (Hu and Jefferson (Forthcoming: 15). Under these new conditions virtually all of the GRIs were forced to become more market oriented to survive.

34 What follows draws on Naughton 2007: 356-361).

35 In the late 1970s, China’s premier cement research and design institutes set out to design, engineer and construct large, modern rotary kilns, but none of these ever worked (Interviews at Sinoma International).

36 After the failure in indigenous innovation in cement, the old Ministry of Building Materials imported 4 turnkey cement plants that were subsequently reverse engineered (Interviews at Sinoma International).

37 This policy was based on the assumption that China would pay for these imports by exporting oil, once oil exports failed to develop, the strategy collapsed (Naughton 2007: 357).

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