There is no innovation in China. I recently finished reading a study--by CLSA Asia-Pacific Markets, a Hong Kong-based brokerage house--that draws this dire conclusion. It may tick off a few Chinese, but many would probably agree--and worry. China can serve as the world's factory floor for only so long--till 2016, by one estimate, when its working-age population begins to shrink. So it will need to switch from assembling widgets to creating the next big gadget.

Although innovation is a buzz word in certain Chinese academic and government circles these days, it is not a core component of many business plans. First, China needs to get moving on some key reforms.

Its education system needs a kick. Most of its brain power is being wasted--only 5 percent of people aged 25 to 64 have a higher education, compared with 24 percent in South Korea and 34 percent in the United States. China's university system relies too heavily on entrance exams, and on a curriculum that's heavy on theory and light on practical problem solving.

Although small and midsize enterprises now control about 70 percent of China's production, fewer than 10 percent of them have access to credit from the state-controlled banks. They have even less access to the nation's nascent capital markets, where state-owned enterprises--less likely to be innovative, if history serves as a measure--gobble up most of the new listings.

Rule of law, or the lack thereof, is another drain on innovation. Although foreign companies often complain about intellectual-property infringement in China, one could argue that Chinese companies suffer the most. Usually confined to their home market, they have little incentive to innovate when their government does not consistently enforce its own IP protection rules.

China is moving in the right direction, but its greatest threat is from within. The government must focus less on big infrastructure projects, like sponsoring fabs, and more on the problems cited here. Solving them would do more for China's innovation than a hundred fabs.

By Mike Clendenin (mclendenin@cmp.com), Taiwan bureau chief for EE Times