In a bigger context, the Internet business, and Google in particular, is a product of a free, liberal society. It couldn't have existed without freedom. Thus freedom is linked with success. So, as long as Google is innovative, it has that inherent advantage over its Chinese competitors.
I would argue that the basic design of the Internet is the most efficient way to build a large-scale, general-purpose computer network; this is why it has subsumed or is in the process of subsuming every other system. Had China been the world's largest economy at the time I think they would have developed the Internet too -- maybe they would have tried to build some kind of censorship in, but they would have quickly discovered that it is just more efficient to censor at the edges (I think they are already aware of this fact, given the amount of censorship they require from social media websites and the last-resort role the Great Firewall plays; there is also the general tolerance of businesses using VPNs to avoid the Great Firewall).
For what it's worth, there is innovation coming out of China, and it is happening at an increasing pace as the Chinese economy grows. The freedom to criticize your government or to organize a protest movement is not really necessary for technical innovation.
Besides, Internet, being as wide open to anonymity as it is, simply never would never have been developed in a country like China, it would be deemed too dangerous. They may compete these days in electronics, but it doesn't mean they can compete in everything. Totalitarian society is always rotten in one way or another, and it manifests in all its output, including business, science, technology and culture. I'm saying this as a person born in the USSR.
The US started a game of Civilization on easy mode.
Incidentally, this is precisely where your Civilization analogy goes wrong: the real newly formed states have way more powerful centrifugal factors than those embedded into mechanics of the game.
Sure, a measure of freedom is necessary to allow an economy to grow, but not nearly as much freedom as people enjoy in the USA. China is a case-in-point: their economy has rapidly expanded as the communist party has started to understand how far a bit of economic freedom goes. For all the freedoms people have in Japan, China managed to unseat Japan as the world's second-largest economy, and is on track to become the world's largest economy within our lifetimes.
China is not the USSR. China has embraced certain capitalist approaches -- like capital markets. The Chinese have figured out what the USSR never fully grasped: economic freedom is not the same thing as political freedom. The USSR tried to micromanage every aspect of the economy, but the Chinese have figured out that it is good enough to have a party member seated on the board of directors.
Very much agreed. And I'd add that by offering that choice they're making Chinese internet users strictly better off, rather than worse off. By operating in China, Google isn't making any _less_ information available to Chinese internet users, since Baidu, Bing etc are already censored anyway. If anything, it will likely be a net win in terms of access to information and user experience as we'd finally see some meaningful competition to Baidu.
Singling out Google for not opting to exclude a fifth of the population of this planet from their products is a bit overkill. I'd rather they offer choice to the Chinese people on their terms than opting to not be in China at all. Google has huge stakes in China with Android, related production of many Android devices, and a lot of their other products. I imagine pulling out of China is not very practical for them at this point nor is selling phones without Google search.
When I was still working on search Nokia Maps (now Here maps) we had to comply with all sorts of rules internationally, including for China. In addition to being weird about certain POIs (e.g. Tien an mien square) we also had to deal with their obfuscated GPS coordinates. They use some weird shifting algorithm that you have to license from them. The point is not the algorithm (you can find it online if you dig hard enough) but the fact that you had to talk to them to get a license. It's a control point for them.
Another weird thing was that Iran insisted on referring to the Gulf as the Persian Gulf. One nice edge case there is the inflight maps of planes flying over their territory.
The point here is that doing business internationally is hard and taking the moral high ground basically means not doing business with a lot of countries.