In his latest State of the Union address, President Obama urged America to step up its game. To revive their economy, he said, Americans will have to “out-innovate, out-educate and out-build the rest of the world.” They will need to make bigger, better, and more strategic investments into the long-term future of jobs and industry. Areas such as education and emerging sectors of green technology will be key to tomorrow’s economic success. But it is precisely in those areas, Obama worried, that Americans seem to be falling behind. “‘Behind who, exactly?”’ was a question. Scattered throughout his speech were faintly veiled references to China. The Chinese are investing into exactly those areas where Americans are lagging. Americans need to catch up in the international race to innovate.

When Austan Goolsbee of the White House Council of Economic Advisors later appeared on “The Daily Show” to promote Obama’s new plan for “winning the future” through education and innovation, host Jon Stewart nearly laughed him out of the room. “How badly do we trail the future right now?” he wanted to know.

The Chinese seem to see things differently. For them, the race to innovate and “win the future” isn’t so funny. In fact, many of the views articulated by Obama have been at the very heart of China’s centralized plans for years.

Hardware to Software

In March, China’s National People’s Congress inaugurated its 12^th Five-Year Plan for National Economic and Social Development, to cover 2011-2015. The 12^th Plan is, in many ways, a continuation of the recently completed 11^th. It seeks to balance growth across the economy, foster sustainable development, and increase domestic consumption. In context of some of China’s other recent centralized plans, such as the 2010 “Talent Plan,” however, the Plan reveals a development strategy of stunning coherence. The Chinese are taking a two-pronged approach to bring about economic transformation, by simultaneously building up human capital through education and investing in strategic industries that make use of their skills.

To take China into the next phase of development, its leaders understand the need to climb up the international value-added chain of globalized production. They realize that it is not enough to be low-end manufacturers. To win the game of international economics, you need toinvent the products; not just manufacture them.  To use a rough analogy, building hardware is not enough, software needs to be created too. This fundamentally means developing cutting edge technologies in strategic sectors and at the heart of this is fostering innovation.

The new Five Year Plan, therefore, places a special focus on innovation. The Party hopes to promote research and development, especially within seven key “Strategic Emerging Industries,” or “SEIs.”  These include biotechnology, new energy, high-end equipment manufacturing, energy conservation and environmental protection, clean-energy vehicles, new materials and next-generation information technology. They are all high-tech by China’s standards, and reflect an urgent drive to take China into the next phase of development, from manufacturing into innovating.Or, as one visiting fellow to the Brookings Institution recently put it, “from hardware to software.”

Over the next five years, these SEIs are slated to receive upwards of RMB 4 trillion (USD $568 billion) in government funds, with the goal of increasing their share of China’s total economy from approximately 5% of GDP in 2011, to 8% by 2015, and 15% by 2020.

Teaching Innovation?

To complement the surge in investment, China’s Talent Plan promises to raise national education spending to 4% of GDP by 2012, aimed at increasing the proportion of citizens with college degrees in the work force from 9.2% in 2008 to 20% by 2020.

Those figures are impressive. Already, the Chinese higher education system has grown from being nearly non-existent thirty years ago, to becoming the largest system in the world. But one should be wary of drawing too linear a relationship between education investment and future growth. China, after all, faces no shortage of challenges. As Nicholas Eberstadt, a political economist, and senior advisor at the National Bureau of Asian Research, has noted, China’s working-age population is expected to fall by around 100 million people over the next 20 years. That’s about a 30 percent decrease – a scary prospect for a country that relies so heavily on manpower to fuel its growth. With its fast-aging population, China is already home to nearly 168 million people over the age of 60, and its one-child policy will result in an increasingly higher percentage of the population comprising those over 60. This means, as Eberstadt explained in Foreign Affairs, “persistent, and now extreme, sub-replacement fertility is the demographic driver shaping the China of tomorrow”. Given China’s demographic trend, sustained growth will require each Chinese worker to be more productive, which means China has no alternative but to focus on education.

Robert Fogel at the University of Chicago thinks that China’s higher education drive will be enough to keep the economy growing at current rates. In a Foreign Policy article last year, he estimated that “college-educated workers are three times as productive, and a high-school graduate is 1.8 times as productive, as a worker with less than a ninth-grade education.”

Considering the dismal quality of most Chinese universities, however, it is unclear whether the Chinese strategy of centralized planning will be enough to generate the changes China’s economy demands. Unlike quotas for steel production or energy conservation, education, and the critical thinking expected to go along with it, cannot be developed heavy-handedly.

Even if China is able to successfully fulfill its goal of raising the number of college-degree holders from 98.3 million in 2010 to 195 million by 2020, it is unclear that China will be able to foster innovation. Promoting the development of cutting-edge technology is easier said than done. The key question is whether the massive expansion of Chinese universities, coupled with government investment into Strategic Emerging Industries will be enough to light a creative, innovative spark within the Chinese economy?

It is true that the number of Chinese patents has risen dramatically, and strategies to attract investment into Research & Development have been fairly successful to date. And yet, studies on innovation rarely mention the correlation of a university degree with ingenuity. At the heart of these policies lies a fundamental assumption of the causal relationship between higher education and innovation that probably does not exist.

On Innovation, and the Creative Spark

When Malcolm Gladwell sought to deconstruct the creative process behind key innovations in technology, his task drew him to Silicon Valley. He found that innovation is ultimately about “the evolution of a concept.” Ideas build on one another. Each phase of the process inspires the next. More so than formal education and college degrees, innovation requires the free flow of ideas. This may prove to be the main problem for China. Creativity is too unpredictable to fit well into its planned model.

Gladwell pinpoints five key conditions necessary for successful innovation. 1) Enough resources, but not too many – scarcity is important. 2) Imagination to see the bigger picture of where an idea fits in. 3) Creativity to dream up how a plan can be executed. 4) Bold individuals, self-assured enough to voice their opinions and not take ‘no’ for an answer, and 5) Free flow of ideas. In this view, what is needed for innovation is not a society filled with university graduates. Instead, you need people who are “disruptive, stubborn, and independent-minded,” in the right conditions to turn their ideas into action. The best thing for innovation, apparently, is to have what Gladwell calls, “wild geysers of creative energy,” and let them run amuck.

What does this mean for China? Well, mostly that real creativity cannot be dreamed up in a centralized plan. It is messy, and depends on culture. This is not to say that the Chinese Talent Plan is bad, or doomed to be ineffective per se. Simply, it does not tell us all that much. The one thing for which centralized plans in China are valuable is the fact that they set a vision for progress. The central leadership uses these plans to suggest to local level leaders how they should behave if they are interested in being promoted. Investing in schools and education is not a bad thing. The question is whether investment alone will make China into a leader in innovation and creation on par with the United States? This does not seem likely over the next five years.

In the long term, winds of change are in motion. Gordon Orr at McKinsey recently described the quality of output resulting from China’s innovation drive as ranging “from the world-class to the awful.” It may be true, as the CEO of Foxconn famously commented, that 90% of patents coming out of China are useless. Even so, these numbers may not be as bad as they seem. Quality, after all, is a probabilistic function of quantity. Ultimately, failures do not matter so long as they eventually lead to something great. Considering the sheer volume of innovative output starting to flow from China, Obama is probably right in asking Americans to step up their game.