Size Matters: Economy-Wide Scale Effects

Size matters in an innovation economy. On the supply side, a large country usually has a higher GDP and large population. A higher GDP means that both its public and private sectors can commit more resources to innovation, hence higher R&D spending. On the demand side, a large population can contribute to large domestic demand. Domestic demand from large countries benefits innovation through economies of scale, economies of scope, and wealth effects. The first channel is through economies of scale. Demand from large countries helps reduce R&D costs per unit of output and enhances incentives for production-side R&D investment. Second, economies of scope can be better achieved through sizable demand, which also contributes to innovation. Diversified demand is conducive to the success of product differentiation strategies, which in turn encourages firms to increase their investment in innovation. Lastly, wealth effect affects consumers’ participation in innovation, and also facilitates technological advancement. As consumers’ spending power continues to improve, the proportion of consumers directly participating in innovation is also rising. This raises the overall investment in R&D resources. In addition to domestic demand (consumption) and supply (R&D spending), international trade is also a key driving force for innovation. We believe trade can foster innovation via three channels: Economies of scale, learning, and competition. First, trade allows companies to expand business scale and generate more profit, which is conducive to diluting the fixed cost for R&D and innovation. Second, companies learn advanced technologies and improve production efficiency through trade. Third, international competition encourages innovation. In our view, the boost from learning is likely stronger when companies lag behind in technological knowhow, while the momentum from competition is likely more important for groundbreaking innovations. However, changes in the external environment in recent years may pose challenges for China. We believe deglobalization, including trade protectionism, will hinder corporate development, and make it more difficult for companies to develop advanced technologies. The US has managed to lead key technological revolutions such as semiconductors, personal computers, and mobile internet. We believe this is because US companies have leveraged the global market to promote new products and support high R&D spending, and kept improving themselves through international competition. Despite changes in the external environment, we expect the rise of the digital economy to offer new opportunities through trade. Because of the replicability of data, the cost of data duplication is close to zero. Therefore, scale effects can be better leveraged in the digital world. We think the digital economy will also help improve human resources and talent development, strengthen the scale effect, and thus benefit technological innovation. We think the digital economy can help expand the scale of trade in both goods and services, and enable more companies to benefit from trade. Digital economy also offers new opportunities in demand-driven innovation. We expect the digital economy to accelerate consumption-led innovation. In a digital economy, products and services are more closely integrated, further underscoring the importance of local demand. Big data helps companies effectively understand consumer needs and facilitate technological innovation. A digitalized economy provides consumers with new models of product innovation for consumer goods. A digital economy also reduces the cost of consumer participation in technological innovation and helps increase the proportion of consumers participating in innovation.