China today is no longer just copying Western technology, but piecing together its own innovation system. With its expanding economy and a stronger role by government, the new technology strategy is raising competitive issues for Silicon Valley companies — and policy issues for the nation.

Innovation can be transformative, which is often science-based and creates new industries or disrupts old ones, or incremental, which improves existing products or services. Both create value. China still lags the U.S. in engineering-based innovation, but excels in process innovation. With aggressive government policies to promote innovation, and growing investment in R&D, however, its innovative capacity will advance.

China has succeeded in developing enormous, world class companies that are aggressively pursuing innovation: Alibaba, Tencent, Baidu, Huawei and others are global leaders. China leads Asia by a large margin in the unicorns it generates. It is also the world leader in mobile commerce, leveraging massive amounts of data and investment in AI.

China boasts a robust entrepreneurial scene, with ample venture capital, proliferating accelerators and hungry startups. It is now embedding itself in the world’s leading innovation centers, Silicon Valley in particular. Chinese investors have taken major stakes in leading companies such as Lyft, Airbnb and Uber and are investing in local startups. Accelerators such as 500 Startups, RocketSpace and Founders Space are expanding their China footprint.

China’s technology presence in the Bay Area can be beneficial, bringing both capital and access to Chinese markets for portfolio companies. Most investment here is by private (not state-owned) companies, which generate jobs and behave much like other foreign investors.

But issues are growing. Under current conditions, Facebook, Google and Twitter can’t operate in China. Government policies are explicit in their goal of dominating a long list of strategic industries, and of replacing foreign technology with Chinese. Where it can’t meet these goals by generating its own technology, it buys it. Required technology transfer, including the mandatory transfer of source code by foreign companies, is common. Data generated in China must be stored there. Internet technologies must MENU  Sign In  Account  be “secure and controllable” — meaning the government must have access to the information. This inherently benefits Chinese companies, which are aligned with government priorities, and disadvantages foreign ones.

As one result, Chinese investment in U.S. technology companies is getting more scrutiny. Until now the Committee on Foreign Investment in the U.S. (CIFIUS), which reviews foreign investment for national security concerns, only looked at major acquisitions such as semiconductor firms. Investment in startups with cutting-edge technologies may be added to its list.

The years ahead will be complex for US-China relations, with China more assertive and Chinese investment under the microscope. Trade, reciprocity in investment opportunity and security will be on the table. Recently announced U.S. tariffs on steel and aluminum imports are a harbinger of things to come.

How this trend plays out will depend on decisions in Washington and Beijing, but its impacts will be most visible in the Bay Area. U.S. technology companies will be weighing both the risks and rewards of the China market. Managing China’s technology engagement with Silicon Valley in a way that delivers long-term benefits for both countries can provide an important model, and contribute to a balanced, positive relationship.

Sean Randolph is Senior Director at the Bay Area Council Economic Institute and author of a new report, Chinese Innovation: China’s Technology Future and What It Means for Silicon Valley