China's plan to change itself from a major manufacturer to a leading global source of innovation poses an enormous challenge for U.S. companies whose competitive edge depends on coming up with the next big idea.

Those firms may be able to breathe a little easier after China pledged during President Hu Jintao's visit to Washington this week to delink its indigenous innovation policies from its $88 billion-plus government procurement market.

This issue has been one of our top advocacy priorities for the past year, said John Frisbie, president of the U.S. China Business Council, which represents more than 200 American companies that do business with China.

China's commitment is potentially very significant depending on how it is implemented, Frisbie said.

China's indigenous innovation drive refers to policies intended to spur its domestic firms to develop technologies and products as good as or better than those offered by the United States, Europe and Japan.

U.S. industry has feared being locked out of the vast Chinese central, provincial and local government procurement markets unless companies agree to develop and maintain their intellectual property in China.

Last January, 19 U.S. business groups representing aerospace, telecommunication, software, clean energy and other high-tech sectors put those concerns into a letter to U.S. Secretary of State Hillary Clinton, Treasury Secretary Timothy Geithner, Attorney General Eric Holder, Commerce Secretary Gary Locke and U.S. Trade Representative Ron Kirk.

What prompted that action was a Chinese central government proposal to establish a national catalog listing which products would be eligible for preferential treatment in government procurement contracts.

The groups told the five U.S. Cabinet officials that they were alarmed by criteria that would require products included in the catalog to contain intellectual property that is developed and owned in China and that any associated trademarks are originally registered in China.

'NEARLY IMPOSSIBLE'

This represents an unprecedented use of domestic intellectual property as a market-access condition and makes it nearly impossible for the products of American companies to qualify unless they are prepared to establish Chinese brands and transfer their research and development of new products to China, the groups said.

The issue also surfaced at the provincial and municipal level in China.

Shanghai issued its own catalog of innovative products in late 2009, and of the 530 on the list only two were made by foreign-invested companies operating there, Frisbie said.

And the two happened to be from joint ventures that had majority-Chinese ownership too, Frisbie added.

More than a year later, Shanghai has not updated its catalog -- which U.S. industry thinks illustrates the folly of using product lists to promote innovation, Frisbie said.

U.S. industry has urged China instead to use other tried-and-true government policies such research and development tax credits.

U.S. officials raised the concerns with the Chinese and made some progress in high-level talks with them last May in Beijing and more at the U.S.-China Joint Commission on Commerce and Trade in December in Washington.

At the second meeting, China pledged not to make the location where cutting-edge technology is developed or owned a condition for access to its government procurement market.

But it saved its promise to completely sever its indigenous innovation goals from government procurement for this week's high-profile summit with President Barack Obama.

Even so, the devil is in the details -- and U.S. business will be watching closely in the coming months to see how China implements the commitment.

We hope China will make concrete changes to its indigenous innovation regime at the central and provincial levels to live up to this positive pledge, said Myron Brilliant, senior vice president at the U.S. Chamber of Commerce.

Follow-through will be important because China has a habit of taking action on one barrier only to erect another that is just as formidable, said Bill Reinsch, president of the National Foreign Trade Council business group.

The thing to watch for is not them overtly ignoring their promise, but trying to slip something else in through the back door, Reinsch said.

In a speech on Thursday, U.S. Commerce Secretary Locke said he hoped for a future in which Chinese and American innovators work side-by-side to develop breakthrough technologies in sectors ranging from energy to biotechnology.

But Derek Scissors of the Heritage Foundation think tank expressed skepticism.

If we could wish for the moon, it would be an unconditional pledge not to try to force technology transfer from U.S. to Chinese companies in any way, Scissors said.

(Additional reporting by Paul Eckert; editing by Will Dunham)

China