Technological leadership: A looming financial crisis could shift the confrontation between the US and China.

Monetary tightening initiated by major market economies is reducing the ability of technology companies to finance innovation. These new financial terms also affect the evolution of the new champion ecosystem. China does not respond to this market logic. It remains a planned economy capable of making huge sacrifices to its population in order to achieve the goals set by the central government.

Current conditions for financing innovation in a market economy.

An increase in interest rates leads to a fall in the present value of the future earnings of listed companies. Technology companies have been particularly hard hit, with the Nasdaq shed more than 22% of its value since the start of 2022. In this context, it seems difficult to carry out large-scale research and development that will not be appreciated by the markets. Thus, the tightening of monetary policy reduces the ability of companies to externally finance innovation. They must allocate a large share of their cash flow to continue their innovation efforts. It will be very interesting to follow the choices made by the big tech companies in the coming months. Meta has already announced a 30 percent reduction in its 2022 engineer hiring target. For its part, Microsoft is revising its revenue forecast for the current year downward. It is possible that savings can be found in R&D budgets.

Venture capital is also an important player in technological innovation. Although it accounts for less than 5% of corporate R&D spending, it is almost entirely responsible for the technology boom of the 1990s and the massive increase in funding for young innovative companies during this period.

However, venture capital investment in tech startups is also halfway there, with venture capital funding recording a 19% drop in the first quarter of 2022 compared to the last quarter of 2021. mergers and acquisitions, the two preferred exit routes for venture capital, leads us to believe that the decline in venture capital investment should continue in the coming semesters.

Financing conditions for innovation in China

China remains a fundamentally planned economy. The conditions for financing innovations do not depend on the state of financial markets. The priorities set by the central government in multi-year plans determine the access of companies to the financial or intangible resources necessary for their development.

To achieve all of its goals, the Chinese government uses ten key policy instruments, including forced technology transfer in exchange for market access, market access restrictions and government procurement for companies with foreign investment, participation in the development of international standards, subsidies, financial policy, state-supported investment funds, local government support, foreign investment in technology, mergers and politicization of state-owned enterprises, and public-private partnerships (PPPs). State-owned enterprises are encouraged to make acquisitions and mergers to obtain key technologies and necessary resources. Foreign investment and M&A in China have been declining since 2017, while M&A investment in countries along the New Silk Road increased by 32.5% compared to 2017, according to the Chinese Ministry of Commerce.

The Chinese state is responsible for funding innovation in sectors considered strategic and for guiding companies’ R&D efforts. It also organizes the collection of new knowledge outside the national territory. It also ensures that the results of national and foreign R&D are extended to the entire economic fabric through mergers and acquisitions and public-private partnerships. Finally, the state is a key player in the internationalization of Chinese technological standards, especially in countries along the new Silk Road (One Belt, One Road).

Program Made in China 2025 compiled in 2015, identifies 10 areas of activity, the development of which is considered strategic.

At the forefront of these sectors, information and communication technologies, including AI, the Internet of things and intelligent applications, occupy the first place.

In addition to grants, the central government and local governments have established many investment funds to support R&D in strategic business sectors. 780 state investment funds have been created. They have a capital of 331 billion dollars. In addition, the China Development Bank is invited to cooperate with the Ministry of Industry and Information Technology to provide financial services worth about $45 billion. Many other government entities, state-owned enterprises or large corporations such as Tencent and Alibaba are also directly involved in venture capital transactions.

In addition, the Technological Innovation Fund for Small and Medium Enterprises (SMTE “Innofund”) is one of China’s early-stage research and development funding initiatives. This fund was established by the State Council in May 1999. Its mandate is to “facilitate and encourage the innovation activities of small and medium technology enterprises (SMEs). InnoFund is also providing financial support for the commercialization of this research. It also aims to raise external funding for PMET’s investment in research and development. Eligible candidates are companies with fewer than 500 employees, at least 30% of which have a university degree.

The company’s annual investment in R&D must exceed 3% of total revenue, and the number of R&D employees must be at least 10% of the total workforce. Over 10 years, the fund has allocated more than 19.2 billion yuan (about $3.1 billion) for 30,537 projects. The program has created more than 450,000 new jobs and generated 209.2 billion yuan in sales, 22.5 billion yuan in tax revenue, and 3.4 billion yuan in exports, according to the fund’s records. By the end of 2008, 82 of the 273 companies listed on the SME Board of the Shenzhen Stock Exchange had already benefited from Innofund’s support. Thus, this innovation fund contributes to the emergence of new technology champions, capable of displacing former leaders in markets with high technological content.

In light of these few figures, China appears to be fully focused on seeking global excellence in ICT, and in particular in artificial intelligence, the Internet of Things, and smart applications. A Pwc survey of Chinese business leaders confirms this sentiment, with 76% of executives surveyed citing big data as one of the most influential new technologies for business development and product innovation.

Freed from the cost-return questions associated with AI development, Chinese managers are responding to central government commitments and incentives. Unlike its Western counterparts, the Chinese state has the financial means necessary to rapidly develop AI. As long as they direct their R&D efforts in this direction, Chinese companies have significant financial resources and knowledge transfer. Their ability to forge partnerships and internationalize the technologies they own is also expanding.

However, we are far from praising central planning for at least two reasons. Above all, in the face of a massive financial crisis, market economies try to maintain social consensus and allocate resources to those who will be most affected by this situation. In a planned economy, individual well-being and freedom are sacrificed for the goals of the plan. Further, the innovation funding method chosen by the Chinese state is similar to relational funding, in which institutions must support companies that meet the objectives of the plan.

In addition, these institutions do not have the necessary expertise to assess the quality of the links between the business model of the company they finance and its investment strategy. Relationship financing has already been the subject of experimentation in the past. In particular, the catastrophic precedent of Japan in the 1970s and 1980s raises doubts about the sustainability of the financial system, where lenders are required to finance projects without regard to return on investment (Aoki et al., 2007). In Japan, this system collapsed in 1997, and Japan still pays tribute to these past mistakes.


The tightening of monetary policy, which has begun in major market economies, should be accompanied by a fall in R&D investment. As with the financial crisis of 2007, China should take advantage of this situation to take its place as a world leader in technological areas that it has identified as strategic. Among these areas, AI, IoT, and smart applications take the lead, and it’s safe to say that the major innovations of the next decade will come from China. Should we therefore question our financial system? This has provided funding for much of the technological progress since the first industrial revolution.

The current situation in the financial markets may fuel debate about the possible replacement of private investment with public funding. However, the new forced march imposed by the Chinese state on its own country cares little about public consent, and funding innovative projects without limiting profitability may well create a speculative bubble that will eventually burst. In this regard, the example of financing relations in Japan is indicative. This prompted institutions to fund zombie firms that owe their survival only to regular capital injections. The consequences of relational finance are still disastrous today. Covering losses in the financial system costs Japanese taxpayers at least 100 trillion yen (20% of GDP).

In Asia, as in the West, money is not for nothing. Whatever the current financial system, only one question should be asked: who will pay?

Article written:

Eric Brown – Associate Professor – Bachelor of INSEEC

Pascal MONTAGNON – Director of the Department of Digital Technologies, Data Science and Artificial Intelligence – OMNES EDUCATION