China's Innovative Capacity Is Underestimated — and the Stakes Are Growing
Governments, markets, and analysts in the United States and around the world frequently find themselves surprised by China’s capabilities in industries central to economic and national security—from artificial intelligence and robotics to pharmaceuticals, advanced manufacturing, and strategic supply chains. Episodes widely described as “DeepSeek moments” reflect more than isolated breakthroughs; they reveal a systematic failure to understand how China builds technological capacity and scales it with speed. At the Stanford Center on China's Economy and Institutions' third annual China Conference, leading academics and policy experts examined both the phenomenon and the repercussions of those assumptions. A common thread emerged: the world’s prevailing frameworks for assessing China’s innovative capacity often underestimate it, and the consequences of that blind spot are growing.
A Sweeping Tech Ambition with Self-Sufficiency at the Core
Barry Naughton, a leading economist of China at UC San Diego, framed the stakes: China’s innovation apparatus, he argued, is not simply a set of R&D programs—it is part of an “across-the-board commitment” to recreate within China’s borders all of the sophisticated inputs required to run a modern economy. The goal, embedded in successive five-year plans, is what China’s policymakers call a “modernized industrial system”: an economy in which technological spillovers are captured domestically rather than leaking out to foreign suppliers and partners.
This ambition carries enormous costs. Fiscal revenues as a share of GDP have fallen by roughly seven percentage points since 2015, Naughton noted, as resources have been channeled into industrial priorities. Local governments—many of them carrying deep deficits—continue to fund showy high-tech parks and innovation consortia in response to signals from Beijing. The result, as Naughton and others put it, is a system producing “impressive achievements alongside an enormous amount of waste.”
Semiconductors: The Limits of Containment?
The conference returned repeatedly to America’s use of export controls—and whether they are working. The verdict was nuanced. Philip Wong, the Willard R. and Inez Kerr Bell Professor of Electrical Engineering at Stanford, argued that in the semiconductor space the strategy has plainly backfired. By cutting China’s firms off from American chip-making equipment and advanced logic chips, the controls created a large captive domestic market for China’s equipment suppliers who previously had no customers. “It basically enabled the indigenous supply chains to have a wonderful set of customers within China,” Wong said, “and so they were able to climb up the learning curve really quickly, much more quickly than before.” Other speakers suggested that may be a tolerable cost as long as export controls allow the US to reach certain frontier capabilities first—as has been the case with Anthropic’s Mythos model.
Wong pushed back on both alarmism and dismissiveness about China's broader technological rise. China, he argued, has genuine world-class talent and infrastructure across multiple sectors—a peer competitor, not a pretender. "If you are among the best athletes, sometimes you win, sometimes other people win. That happens all the time." To treat any given Chinese breakthrough as proof of American collapse, or to wave it away as a fluke, both miss the point: China is, in his words, "a bona fide good athlete."
Wong’s recommended alternative to export controls was direct: rather than trying to slow a competitor, the United States should focus on “how do we make ourselves run faster.” That sentiment echoed throughout the day, particularly after he noted that the National Science Board had recently been dismissed and that American R&D funding continues to be primarily focused on defense-oriented research.
Biotech: From Follower to Leading Force
Physician-scientist Chenjian Li, a research fellow at the Hoover Institution, offered striking data on China’s advancement in biotech. In the active pharmaceutical ingredients that form the basis of medicines taken by hundreds of millions of Americans daily, China has achieved near-total global dominance—some categories are 100% Chinese-sourced. “Medicine, be it advanced experimental drugs, high-end prescriptions or just daily over-the-counter pills, are actually much more impactful than weapons of mass destruction,” Li said, “because they affect 80% of the United States and global population.”
At the cutting edge of drug discovery, the picture is more nuanced but equally notable. Chinese biotech startups are increasingly producing competitive "me-too, me-better" drugs that improve on existing treatments, and pushing into "first-in-class" drugs—the crown jewels of pharmaceutical innovation. Major multinational corporations (MNCs) are paying billions to acquire them. The fact that Pfizer, Merck, and Eli Lilly are spending at this scale, Li argued, says something important: “The MNCs buy those new therapeutic assets because they are solid and unique, and because the MNCs don’t think that they can be as fast and as good in those lines.”
Economist Ruixue Jia of UC San Diego connected this pharmaceutical surge to China’s education system, which has spent decades steering enormous numbers of students toward engineering and STEM fields, including biology and life sciences. The founder of one of last year’s biggest biotech deals—a $5.6 billion transaction—fit a pattern Jia’s research keeps finding: educated in China, PhD in Canada, postdoc in the United States, returned to China in 2008. “It’s not just a success story of Chinese education,” she noted. “It’s also a success story of North American education.”
Fragmentation and the AI Race
A central tension runs through the broader debate: what do the world’s two largest economies actually gain or lose from their escalating technological confrontation?
Tsinghua economist Hong Ma argued that, measured by its own goals, the American trade war has largely failed. US import dependence on Chinese value-added has remained roughly constant despite years of tariffs, as goods simply reroute through third countries. Beyond tariffs, he warned of a longer-term cost: fragmentation into two separate innovation ecosystems, neither large enough to fully benefit from the other. The US would lose access to the Chinese market, Chinese engineering feedback, and the scale that sustains rapid innovation. “On both sides,” he said, “this is not the optimal equilibrium.”
Panelists pointed to China’s open-weight AI models as evidence of a different kind of competition playing out below the frontier. China’s models from Alibaba, Moonshot AI, and others are being used across the globe—often simply because they are cheaper and good enough for most applications. In this way, big US labs may be ahead on raw benchmarks, but that advantage does not automatically translate into leading global adoption.
Impressive Achievements, Costly Failures
Another useful synthesis came from Scott Kennedy of the Center for Strategic and International Studies. Kennedy’s “bumpy success” framework holds that China’s innovation trajectory is clearly positive—it now ranks tenth globally on the Innovation Index, ahead of Japan in the Asia-Pacific—but deeply uneven across sectors. He described China as a “slow tech dragon”: vast misallocation of resources produces genuine breakthroughs alongside enormous waste, and that waste is a real drag on the broader economy. Commercial aviation was one such example—despite being a signature priority for China’s leadership and the single largest recipient of state investment, the result is, in Kennedy’s words, “an American plane with Chinese paint.” The lesson is not that China cannot innovate, but that state-directed industrial policy produces highly variable results.
That framework—impressive achievements, structural waste, uneven outcomes—runs as a quiet undercurrent through the broader debate. Structural challenges remain: a domestic market that cannot yet absorb the premium prices of cutting-edge drugs; an education system optimized for solving known problems rather than identifying unknown ones; and an economy in which the benefits of technological investment are not yet reaching ordinary households.
The picture that emerges resists easy predictions, but carries a clear message: the old frameworks—China as technological follower, export controls as sufficient means to maintain America’s remaining technological edge, global supply chains as something susceptible to political redirection—often no longer fit the evidence. The task now is building better ones.
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SCCEI brought together leading China scholars this spring for its third annual China Conference under the theme “Understanding ‘DeepSeek Moments’ and China’s Innovation Ecosystem.” Conversation centered around the idea that the world’s prevailing frameworks for assessing China’s innovative capacity often underestimate it, and the consequences of that blind spot are growing.
