Is Entrepreneurship Missing in Shanghai?

The start-up spirit is surprisingly lacking in the Chinese megacity

Shanghai is commonly viewed in the West as having the most developed market economy in China—and for good reason. Though Shanghai has just 1.3 percent of China’s population, it accounts for 5.4 percent of China’s GDP and 6.9 percent of the country’s total industrial output.

But, according to new research from Yi Qian, an assistant professor of marketing at the Kellogg School of Management, and Yasheng Huang, a professor at the Massachusetts Institute of Technology, Shanghai’s might in such heavy industries as chemical fibers, automobile production, power-generating equipment, and personal computers obscures an extraordinary weakness in entrepreneurship. Because entrepreneurial businesses are important drivers of job creation, the absence of entrepreneurship in China’s richest city carries an economic cost that has implications for longer-term growth, according to Qian.

“Shanghai is very dynamic and attracts a lot of foreign investment and has a lot of business opportunities, but these opportunities are not in indigenous businesses,” Qian says. “Ultimately, the country has to grow with domestic innovation and not just investments from foreigners.”

A Pioneering Look at Entrepreneurship in Shanghai

The study is among the first to assess entrepreneurship in Shanghai. The authors examined the Chinese Industry Census, a dataset that provides detailed information about industrial firms in China with sales values in excess of 5 million yuan ($764,500 at today’s exchange rates). Their analysis covers the years 1998–2001.

Their statistical analysis of the data shows that Shanghai had fewer private businesses than the national average, after controlling for economic and industry characteristics. Despite being the richest city in China, Shanghai underperformed on other measures of entrepreneurship—its private firms tended to have fewer employees and lower sales and assets than the national average.

Although the analysis did not take very small businesses into account, Qian does not believe that limitation affected her result. In addition, she says, there is little evidence that Shanghai has a large informal economy that would skew her results. The most common unregistered businesses in China are sole proprietorships, or mom-and-pop businesses. These account for 16 percent of all unregistered businesses in Shanghai, the lowest proportion in the country and well below the national average of 45 percent, according to the study.

Qian, an expert on entrepreneurship and a native of China, was surprised to discover entrepreneurship was underdeveloped in Shanghai. Besides its international reputation as a vibrant economic center, Shanghai has a long history of entrepreneurship, she notes. During the early part of the twentieth century, Qian writes, Shanghai was a major business and financial center and home to China’s largest textile firms and banks. As recently as the late 1970s, Shanghai business interests controlled 25 of the 30 cotton spinning mills located in Hong Kong at the time.

Qian believes that government policies enacted in the late 1980s to attract foreign investment and promote development of Shanghai’s industrial sector undermined growth of entrepreneurial businesses. The development program had two key elements, Qian says. First, the program called for an internationalization of Shanghai’s economy, with an emphasis on advanced technology and global brands. Second, the program called for eliminating anything that undermined a modern image of Shanghai. This included peasant-operated food and vegetable stalls, which are ubiquitous in China.

To purge Shanghai of these small businesses, the city centralized urban planning decisions, according to the study. It purchased land below cost from rural households and auctioned it at market prices to targeted industries. The proceeds were used to finance infrastructure development, and other government obligations, according to Qian’s research.

Myriad Obstacles

Shanghai entrepreneurs and lawyers, in interviews with co-author Huang, reported other government-imposed obstacles to entrepreneurship. For example, until 2005, university professors, workers for non-profits, and general managers of state-owned enterprises were not allowed to launch private businesses. Another policy prevented residential apartments from being used for commercial purposes. In addition, private businesses were prevented from bidding on the big infrastructure projects that drove much of Shanghai’s growth during the late 1990s. Meanwhile, tax regulations favored so-called foreign-invested enterprises—businesses with at least 25 percent foreign equity. “Entrepreneurship wasn’t encouraged,” Qian says.

The effect of these policies on sole proprietorships was striking. In 1985, before the policies took effect, sole proprietorships accounted for 10 percent of total fixed-asset investment. By 2004, sole proprietorships’ share of total fixed-asset investment had sunk to 0.2 percent, the authors write.

The social cost of the development program became evident in the late 1990s, when Shanghai undertook a massive restructuring of its state-owned enterprises. Qian argues that Shanghai suffered high unemployment during this period in part because there was no entrepreneurial sector to create jobs as state-owned businesses downsized or retrenched. Between 1995 and 2000, employment in Shanghai fell 15 percent, she notes.

“Entrepreneurship—new entrants and privately owed businesses—create jobs and promote growth at a time when state-owned businesses are restructuring,” Qian says. “Is Shanghai’s growth model ideal if it has some of the anti-entrepreneurial consequences?” she asks. “With any growth policy, there are going to be pros and cons. My philosophy is to design policies that could help certain sectors and firms without sacrificing the rights of the others.”

Kellogg Insight - Yasheng Huang and Yi Qian