A boy wearing a Peking Opera mask waves a Chinese national flag on Beijing's Tiananmen Square, March 1, 2011. (JASON LEE/REUTERS)

American policy makers worry about the dramatic increases in the number of academic papers being published and patents being filed by Chinese researchers. They believe that these will give China a formidable competitive advantage when it comes to innovation. After all, China is now only second to the U.S. in academic publications, and by 2015 it will file more patents annually than the U.S. does.

Our policy makers are right to worry, but they are worried about the wrong things.

The Chinese academic papers are largely irrelevant or are plagiarized. They do little more than boost national pride. Almost no innovation is coming from government-funded research labs. Meanwhile, Chinese patents aren’t an indicator of innovation, but are tollbooths that the country is erecting to tax foreign companies that come to China. The Chinese have learned to play the same games that American tech companies and patent trolls do: Use patents to extort licensing fees from other industry players.

China’s real advantage lies in its next generation — the students who graduate from its top colleges and become entrepreneurs. These kids are very similar to their counterparts in the West. They are smart, motivated, and ambitious. Whereas the children of the Cultural Revolution—who now work in government research labs and lead the State enterprises that dominate industry learned not to challenge authority and to play strictly by government rules, the new generation knows no bounds. They are not even aware of the atrocities of the previous era. They don’t hesitate to think outside the box, to take risks, or to have ambition. Unlike their parents, this new generation can innovate.

The changes I have seen in the entrepreneurial scene in China during my visits over the last six years are dramatic. It used to be that Chinese graduates strove to join Western multinationals. And because of the taboo associated with failure and the low social esteem granted to start-ups, parents discouraged their children from becoming entrepreneurs. No longer. With the success of entrepreneurs such as Jack Ma and Kaifu Lee and the fortunes being reaped by the earlier generations of technology startups, Chinese youth have role models, and parents are becoming more accepting of entrepreneurship. Joining a startup is now the “in thing” in China—just as in Silicon Valley. And it’s becoming acceptable to fail and start again.

There are start-up incubators springing up in all of China’s major cities. According to Lux Research, China venture capital investments reached $5.4 billion in 2010—an increase of 79 percent from the year before. There is so much Angel and Venture Capital available that investors have to compete for investment. One incubator I visited last week, in Beijing, called Garage Café, is offering free office space and Internet connectivity to start-ups just so that it can jump to the front of the line on investments.

During my most recent trip this past week, I also I taught classes at Tsinghua University, for an entrepreneurship program run by UC-Berkeley’s Center for Entrepreneurship. The students there were very much like those I teach at Duke and Berkeley. They were hungry for knowledge, connections, and ideas. The only difference I noted was in the answer to one question: Why do you want to become an entrepreneur? American students usually talk about building wealth or changing the world. The Chinese said they saw entrepreneurship as a way to rise above “the system,” to be their own bosses and to create their own paths to success. They clearly did not cherish the idea of working for a stodgy state enterprise, an autocratic government, or what they deemed to be an opportunistic foreign multinational.

The tens of thousands of highly educated immigrants who return home to China every year from the U.S., give China’s entrepreneurial ecosystem a major boost. These returning immigrants are teaching locals how to build Silicon Valley–style companies.

Take Robert Hsiung, who graduated from Stanford in 2008. He received several job offers in Silicon Valley, Singapore, and Hong Kong. But he chose to become an entrepreneur and to move to Beijing, because the economy was booming and the number of Chinese Internet users was increasing rapidly. Robert’s first start-up, a social-media company called OneCircle.cc, was a moderate success. His next company, FoxFly, failed because larger players moved into his market space. In August, he launched his third start-up, which is building a professional-networking application. Robert told me that he had absolutely no problems recruiting top engineering students. And even though he had failed, Chinese investors readily invested hundreds of thousands of dollars in his latest start-up.

China has a chance to harness all this new energy and lead the world in innovation. But that doesn’t mean that it will. I asked students and local entrepreneurs about the obstacles that they expected to face. Nearly all of them cited two fears: That a bigger company, such as Baidu or Tencent, would steal their technology—because Chinese intellectual property laws are ineffective—and that once they achieved significant success, government officials would swoop in to control the company or demand a cut of the action.

Until China’s rule of law is strengthened and entrepreneurs are given the freedoms that they need, China may see a lot of start-up activity, but world-changing innovation won’t happen. Once China clears away those final obstacles, though, watch out.

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