The Latest in the China-U.S. Race for Global Domination

News headlines suggest the U.S. is lagging behind China in R&D... 

Some media pundits think the U.S. is falling behind China in innovation and suggest that China is blowing past the U.S. in artificial intelligence ("AI"), clean energy, and biotechnology.

Last week, the New York Times' "The Morning Newsletter" reported:

The U.S. now spends a smaller share of national output on research and development than many other countries. China is notably ambitious in this area, essentially copying the American strategy for building a strong economy, even as the U.S. has abandoned that strategy.

And the Wall Street Journal cited a Harvard report in its December 7 op-ed on how "China Will Soon Lead the U.S. in Tech" – concluding that China is making extraordinary leaps as a "full-spectrum" peer competitor.

But is that an accurate portrayal of U.S. spending on innovation? 

China directs 1.3% of its gross domestic product ("GDP") every year to research and development (R&D). Once the beacon of innovation, U.S. government-sponsored R&D spending has dropped from a peak of 1.8% of GDP in the mid-1960s to a measly 0.65% today.

That pure R&D budget helped create the now-ubiquitous semiconductor, led to the invention of the Internet, and even led to the creation of the technology used for the COVID-19 vaccines.

Some experts say pure early-stage R&D needs to be funded by the government. But companies simply won't take it on for several reasons: 

• It takes too long for this type of R&D to pay off.
• The possibility of it failing is too high.
• The probability that the innovation will not be relevant for the industry you originally planned for is too high.

The narrative glosses over many key details as they were getting in the way of the story...

I've been called by the Pentagon, the Marine Corps, and the FBI to present Altimetry's insights on the U.S.'s competition with China because our data breaks through the noise.

First, let's jump into that 1.3% versus 0.65% of GDP figure. Yes, it sounds terrifying. On the surface, it appears like the Chinese government is investing 2 times what the U.S. is investing in R&D.

But context is a powerful tool, and we need to step back to see the full picture.

As of 2020, China's GDP is still only 70% of the U.S.'s, so the U.S. government is spending a lot more than half as much on pure R&D. 

The federal government spends about $135 billion on R&D, versus China's $190 billion. It's still a $55 billion gap, but it's not as dire as the headlines may suggest.

While the U.S. government is underinvesting in R&D relative to China, it's not nearly as much as most headlines imply.

Pure R&D is not only a job for governments anymore...

While many examples point to how so much of our pure R&D has come from government funding historically, private financing is a lot more important to investing in innovation now than it was back in the 1960s.

For instance, Alphabet (GOOGL) spent $30 billion on R&D in the last 12 months, and that alone makes up more than half of the gap between the U.S. and Chinese government-funded R&D.

Alphabet isn't spending $30 billion on optimizing Google Search, YouTube's "next video" feature, or figuring out how to finally make lookup work in Google Sheets. It is spending it on homerun ideas. There's a reason it used to have a group called moonshots, now called X Development.

Alphabet has invested and continues to invest in pure R&D ideas, like Waymo for autonomous vehicles, Dandelion in geothermal energy, Malta in salt-based energy storage solutions, Taara and Loon in ubiquitous networking access, and DeepMind in complex AI innovation, just to name a few areas it has and is investing.

Some of that is funded by the government. Waymo competed for Defense Advanced Research Projects Agency ("DARPA") funding. But far more of that funding comes from Alphabet's legacy businesses than from DARPA.

Alphabet isn't the only public company investing in moonshots that used to only come from government funding.

Intel (INTC) is regularly seeding future innovation. Boeing (BA) and Airbus (AIR.PA) invest billions of their own money in creating technology for planes that might not fly for a decade or more.

Last year, public Chinese companies spent $190 billion in total R&D. They effectively doubled the government's R&D spending.

U.S corporates spent $540 billion in total R&D. That doesn't just make up for government funding differences. That investment alone blows away the Chinese government and corporate spending combined.

And the important thing about R&D is that it's a long-term investment. A one-year snapshot doesn't do justice for understanding how R&D can fuel innovation.

That's why under Uniform Accounting, we capitalized R&D and looked at the total investment corporations are making over time. That is a far better indicator of future innovation and revenues. And it paints an even more powerful picture.

U.S. corporate R&D investment dwarfs Chinese corporate R&D. As of last year, there was $2.4 trillion in useful R&D innovation as an asset sitting on U.S. balance sheets and only $700 billion on Chinese balance sheets. 

That is a $1.7 trillion gap. And Chinese companies aren't catching up... They're falling behind more, year after year. In 2019, they were only $1.6 trillion behind. In 2011, they were only $1 trillion behind. 

That doesn't even paint how far behind China's curve relative to the U.S. on the innovation that will fuel the next 10 and 30 years of economic growth.

Some of the most important innovation happens in the world of venture capital ('VC'), where China badly lags the U.S...

While our analysis generally focuses on public companies, we pay close attention to the pipeline of innovation heading toward the public market. 

When you look at the largest companies in the world, five of the top six and six of the top 10 are U.S.-listed companies that were VC-funded, and only two are Chinese companies.

Venture capitalists help fund and seed the next big ideas, which will be some of the biggest companies decades from now. It's not just current innovation that the U.S. leads on... It dominates here too.

In the first quarter of 2021, there were $62.1 billion in U.S. venture investment deals. That was a new record, and it was more than double the highest levels pre-pandemic. From the beginning of the pandemic until the end of the first quarter, $167 billion was invested. 

In 2020, Chinese startup investment was roughly $125 billion in today's dollars. That looks like they're closer in this field, but it hides an important point.

While U.S. venture funding continues to grow, the number of Chinese VC deals has been dropping every year for five years running. Total deal volume in 2020 was less than half the deal volume in 2015 and 2016. Chinese innovation is going the wrong way.

So rest assured, contrary to what some members of the media may want you to believe, U.S. innovation is alive and well... 

We're so bullish about U.S. innovation and our outlook for 2022 and the next few years that Rob Spivey and I are hosting a special investment summit on our perspective this Thursday at 8 p.m.

In it, we're going to highlight our outlook for 2022 and why we think that it could be a banner year for U.S. equities. We're even going to give away our best picks right now and explain why we are so bullish.

Make sure you get into the event at 8 p.m. on Thursday, December 16. You can register for it right here – it's something you won't want to miss. 

Regards,

Joel Litman
December 13, 2021