When the Chancellor Took the Wheel
Ola Källenius still remembers his first meeting with Cao Xudong in 2017. The Momenta founder was running a small autonomous driving startup in Beijing, barely known outside China. “After our conversation, I thought, ‘This looks like a really good team. Let’s invest,'” the Mercedes-Benz Group chairman recalled. That decision marked the German automaker’s first investment in a Chinese autonomous driving company. Less than a decade later, the partnership produced an intelligent assisted driving system impressive enough that German Chancellor Friedrich Merz declared it “amazing” during a test ride in Beijing on February 26, 2026. “This is one of the future technologies for mobility,” Merz said, praising the cooperation between German manufacturers and Chinese technology.
This collaboration represents more than a technical partnership. It signals a profound shift in how multinational corporations view China. The country is no longer merely the world’s factory or its largest consumer market. It has become a global innovation hub where foreign firms develop technologies for worldwide deployment. “We want to use this dynamic innovation market to drive our business in China and globally,” Källenius explained.
Automotive Partnerships Drive the Transformation
The automotive sector leads this transition from Made in China to Created in China. On March 13, 2026, the first vehicle model co-developed by Volkswagen Group and Chinese EV maker XPeng rolled off the production line, marking a milestone in the German giant’s deepening integration with local partners. Volkswagen has expanded its commitment further by opening its first overseas full test workshop in Hefei, Anhui Province. The 100,000-square-meter facility allows the company to develop new vehicle platforms and key technologies entirely outside Germany for the first time in its history.
The efficiency gains are substantial. Volkswagen reports that its software-defined vehicle development process shortens the overall vehicle development cycle by 30 percent compared with traditional workflows, while reducing costs by up to 40 percent in specific key projects. The company can now produce an electric vehicle entirely made in China for half the cost of manufacturing elsewhere, according to company reports.
Toyota has adopted a similar strategy at its R&D center in Changshu, Jiangsu province, where local engineers developed the bZ3X compact SUV and bZ7 sedan with Chinese-designed components. These vehicles feed into the company’s global electric vehicle strategy, demonstrating how innovations conceived in China now shape product portfolios worldwide. German supplier Bosch Group has committed approximately 10 billion yuan over five years to an intelligent driving control innovation project in Suzhou, focusing on full-stack intelligent assisted driving solutions.
Pharmaceutical and Industrial Giants Follow Suit
The trend extends far beyond automotive manufacturing. French pharmaceutical giant Sanofi has launched its first China Innovation and Operation Center in Chengdu, overseeing operations spanning research and development, clinical trials and supply chain services. The center plans to fill more than 600 professional posts by the end of 2026. Meanwhile, Sanofi is establishing a new translational medicine hub in Shanghai’s Jing’an district, which will become its largest such facility in China and connect with six other global centers.
Swiss drugmaker Novartis plans to invest more than 3.3 billion yuan to expand its R&D, manufacturing capacity and operations in China. AstraZeneca has announced it will invest more than 100 billion yuan by 2030, expanding pharmaceutical manufacturing and research capabilities. By 2023, innovations originating in China already accounted for 15 percent of Bayer Consumer Health’s global innovation portfolio, the highest share from any single market.
In the industrial sector, German adhesive technologies group Henkel opened a 500 million yuan innovation center at Shanghai’s Zhangjiang Hi-Tech Park, its second-largest globally. Danish industrial giant Danfoss announced an additional 2.7 billion yuan investment to build a second campus in Jiaxing, Zhejiang Province, an advanced zero-carbon industrial park integrating R&D, testing and production. This marks the company’s tenth capital increase in China over the past two decades. Tesla has also expanded its infrastructure, opening 55 supercharging stations in Chongqing, its largest single initiative in China in terms of service-area station construction.
The Innovation Ecosystem Advantage
Foreign companies are drawn to China by a combination of market scale, talent density and operational efficiency that is difficult to replicate elsewhere. China now possesses the world’s largest pool of scientists and engineers, with its full-time equivalent of R&D personnel ranking first globally. The country also offers something more intangible: speed. “Any parking scenario you can think of can probably be found in China,” Källenius noted. “If you can solve parking assist here, it’s ready for the global market.”
This speed translates into measurable business advantages. Academic research confirms that local government support positively moderates the effect of foreign firms’ R&D investment on their innovation performance in China, particularly for companies forming international joint ventures. The concentrated industrial clusters in the Shenzhen-Hong Kong-Guangzhou corridor, Beijing, Shanghai-Suzhou and Nanjing facilitate rapid iteration. According to industry surveys, the most common sources for innovation ideas in China are sales team input, competitor benchmarking and customer interviews, reflecting a market-driven approach to product development.
The cost structure also favors China. One study estimates that for every $100,000 spent on R&D, Chinese firms can employ 2.3 researchers, more than double the US figure. This efficiency, combined with comprehensive supply chains, allows companies to move from concept to commercial application faster than in other markets. Tesla, for example, has integrated more than 60 Chinese suppliers into its global procurement system, attributing the cost-effectiveness of its Shanghai Gigafactory to local intelligent manufacturing capabilities.
The Geopolitical Paradox
Ironically, efforts to restrict China’s technological advancement have accelerated its innovation capabilities. When the United States imposed export controls on advanced semiconductors beginning in 2022, the intention was to slow China’s progress in artificial intelligence and high-end chip development. Instead, the restrictions sparked a surge in domestic innovation. Research by Harvard Business School shows that directly affected Chinese companies increased R&D spending by 49 percent and boosted patent output by 41 percent compared to firms not subject to restrictions.
The DeepSeek AI breakthrough in January 2025 exemplified this unintended consequence. The Chinese startup released a generative AI program rivaling ChatGPT using half the computing power and developed at a fraction of the cost, triggering a $600 billion single-day loss in Nvidia’s market value. As one venture capitalist called it, this was “AI’s Sputnik moment.”
Similarly, in the semiconductor sector, Chinese domestic equipment suppliers have increased their market share from 10-15 percent before the controls to 25-35 percent by 2024-2025, exceeding targets set in the Made in China 2025 initiative. Chinese chipmakers are now designing out US equipment and accelerating toward self-sufficiency, with some analysts noting that after being tied up by US export controls and sanctions, it has become apparent that escaping this chokehold is more important in the long run than making any temporary advances.
Strategic Risks and Complexities
Despite the opportunities, foreign firms face significant strategic risks. According to analysis by the Mercator Institute for China Studies (MERICS), European companies engaging with China’s innovation ecosystem increasingly face an “up or out” dynamic. Beijing tailors its policy approach based on what foreign firms have to offer. Companies possessing strategic technology like advanced semiconductors receive generous inducements to invest and localize, but risk losing market share once Chinese competitors catch up. Those in less strategic sectors like automotive or consumer goods face fewer incentives but are more likely to be accepted long-term as providers of jobs and investment.
Intellectual property concerns remain pressing, particularly in strategically oriented sectors where Beijing seeks to capture technology capacities. European small and medium enterprises are especially cautious, as the loss of one or two core pieces of IP could doom their firms. Many companies now respond with protective localization, siloing China operations from global headquarters through onshoring, heavy localization of staffing, and separate data and IT systems. While protective, this strategy brings disadvantages, including instances of miscommunication between China operations and headquarters that have slowed operations or necessitated downsizing.
China’s industrial policy playbook also leads to overcapacity and shrinking profit margins, which erodes foreign firms’ ability to finance R&D investment and maintain technology leads. In the automotive sector, 95 percent of foreign firms report high pressure on price from local competitors, while 66 percent feel pressure on sales and service speed. As Chinese firms expand globally, foreign competitors risk being crowded out not just in China but in third markets and eventually at home.
Policy Environment and Future Trajectory
China’s government has created institutional conditions that support this innovation transition. The 15th Five-Year Plan, covering 2026 to 2030, designates businesses as the main entity of innovation and emphasizes fostering new quality productive forces. The plan calls for advancing the AI Plus initiative and building a new AI-driven economic model. In 2025, China became one of the top three countries of origin for patent applications at the European Patent Office for the first time, surpassing Japan, with applications growing 9.7 percent year-on-year.
Data from the Ministry of Commerce shows that 8,631 new foreign-invested firms were established across China in the first two months of 2026, up 14 percent year-on-year. High-tech industries attracted 63.21 billion yuan in foreign direct investment during the period, up 20.4 percent year-on-year and accounting for 39.2 percent of the nation’s total FDI. “For multinationals, investing in China has shifted from a discretionary choice to a strategic necessity,” said He Yongqian, a spokesperson for the Ministry of Commerce.
According to KPMG’s 2025 MNC China Outlook Report, 75 percent of multinational companies planned to maintain or increase their China investment in 2025, while 83 percent have already localized or plan to localize key aspects of their China operations, especially manufacturing, supply chains and R&D. This aligns with the observation by Liu Minghua, CEO of Deloitte China, that companies are upgrading China into a hub for R&D and industrial chain collaboration within their global strategies, shifting from In China, for China to In China, for the world.
Key Points
- Foreign multinationals are transforming China from a manufacturing base into a global R&D hub, developing innovations for worldwide markets rather than just local consumption.
- Automotive leaders including Mercedes-Benz, Volkswagen and Toyota are using Chinese technology partners and local engineering teams to develop electric vehicles and autonomous driving systems for global deployment.
- Pharmaceutical giants Sanofi, Novartis and AstraZeneca are expanding R&D centers in China, with the country now contributing 15 percent of Bayer’s global consumer health innovations.
- US export controls on semiconductors and AI technologies have paradoxically accelerated Chinese innovation, with domestic R&D spending increasing 49 percent among affected firms and breakthroughs like DeepSeek challenging Western AI dominance.
- Foreign firms face strategic risks including intellectual property concerns, up or out competition dynamics, and pressure from state-backed Chinese competitors, requiring careful navigation between localization and protection of core technology.
- High-tech foreign direct investment in China grew 20.4 percent year-on-year in early 2026, with 83 percent of multinationals planning to localize R&D and supply chain operations.
