Is Entrepreneurship Missing in Shanghai

This PDF is a selection from a published volume from the National Bureau of Economic Research Volume Title: International Differences in Entrepreneurship Volume Author/Editor: Josh Lerner and Antoinette Schoar, editors Volume Publisher: University of Chicago Press Volume ISBN: 0-226-47309-0; 978-0-226-47309-3 Volume URL: http://www.nber.org/books/lern08-2 Conference Date: February 1-2, 2008 Publication Date: May 2010 Chapter Title: Is Entrepreneurship Missing in Shanghai? Chapter Author: Yasheng Huang, Yi Qian Chapter URL: http://www.nber.org/chapters/c8223 Chapter pages in book: (321 - 346) 321 10 Is Entrepreneurship Missing in Shanghai? Yasheng Huang and Yi Qian Economists and other scholars studying transition economies disagree with one another about the economic and political merits of mass privatization, fi nancial reforms, and foreign trade reforms. Few, however, dispute the vital importance of fostering the development of new, entrepreneurial businesses. Entrepreneurial businesses—defi ned as new entrants and as privately- owned—create jobs and promote growth at a time when state- owned enter- prises (SOEs) are being downsized and retrenched. The economic contribu- tions of new, entrepreneurial businesses in a transitional context exceed not only those of SOEs but also those of newly- privatized fi rms. It has been estimated that the vast majority of new jobs in transition econ- omies were created in the emerging private sector. McMillan and Woodruff (2002) provide detailed data. During the fi rst seven years of reforms in Viet- nam, net job creation by the new private sector was ten million, whereas job creation in the state sector was negative. In Romania and Slovakia, a higher proportion of new private fi rms created jobs than either SOEs or privatized fi rms. In addition, the new private fi rms grew faster and invested at a higher rate (although the evidence here is not uniform). McMillan and Woodruff also report studies showing a positive correlation between general economic growth and entrepreneurial entry. Yasheng Huang is a professor of political economy and international management at the Sloan School of Management, Massachusetts Institute of Technology. Yi Qian is an assistant professor of Marketing and Kraft Research Professor at the Kellogg School of Management, Northwestern University, and a faculty research fellow of the National Bureau of Economic Research. We thank Randall Morck and the participants at the NBER conference on international differences in entrepreneurship for their comments. We are grateful to S. P. Kothari, Joshua Lerner, and Antoinette Schoar for their detailed comments on an early draft of this chapter. We also thank Harrison Shih for RA work. The usual caveats apply. 322 Yasheng Huang and Yi Qian In this respect, it is particularly interesting and—as we would argue, ana- lytically important—to note that a city widely regarded as a huge economic success in China, Shanghai, has an unexpectedly low level of entrepreneur- ship, defi ned here as de novo private businesses. China as a whole is not short of entrepreneurship. It is well- known that township and village enter- prises (TVEs) powered the Chinese economic growth in the 1980s and the early 1990s. (What is less well- known, however, is that the vast majority of the TVEs were completely private from the very beginning of the reforms.1) Relative to the rest of the country, the level of entrepreneurship in Shanghai is conspicuously low. This fi nding is robust to a variety of specifi cations— to detailed industry and fi rm- level controls and to alternative defi nitions of private fi rms. This phenomenon of missing entrepreneurship in Shanghai raises a num- ber of questions. During the period of our data set (1998 to 2001), Shanghai grew rapidly. Its real gross domestic product (GDP) growth was in excess of 10 percent annually. During this period, Shanghai also attracted an enor- mous amount of foreign direct investment (FDI). (In 2004, FDI infl ows amounted to six billion dollars, equivalent to the entire FDI infl ows to India during the same period.) That entrepreneurship was lagging at a time when GDP growth was fast in the richest region of China calls into question the mechanism of growth in Shanghai, as well as why the benefi ts of this growth did not accrue to the indigenous entrepreneurs in Shanghai. We offer some conjectures in the concluding section. There is also an analytical issue. There are not many prima facie reasons why entrepreneurship should be missing in Shanghai. We will elaborate on this point more fully in section 10.1 of the chapter. Suffice it to say here that the phenomenon of a low level of entrepreneurship in Shanghai is particu- larly intriguing given our primary measure of entrepreneurship. Here, we measure entrepreneurship primarily by the density of private businesses— the number of private businesses per population—and we supplement the measurement with an alternative proxy—the average number of employees per entrepreneurial business. Our priors are that Shanghai should have per- formed very well by these measures of entrepreneurship. In the 1990s Shanghai experienced a massive restructuring of SOEs. Total employment in the city declined. In 1995, the broadest measure of employ- ment stood at 7.9 million; in 2000 it was 6.7 million, a reduction of 15 per- cent (mainly due to the restructuring of the state sector). At the same time, Shanghai had one of the highest unemployment rates in the country. This 1. Based on detailed archival research of Chinese documents going back to the early 1980s, Huang (2008) fi nds that the Chinese defi nition of TVEs refers to their geographic location—that is, their rural location. However, Western academics assume that TVEs refer to their owner- ship—that is, by townships and villages. In 1985, of the 12 million TVEs in China, 10 million were straightforward private. Is Entrepreneurship Missing in Shanghai? 323 is the important macro context against which our regression results should be understood. Shanghai should have performed very well by our measures of entrepre- neurship absent any policy barriers. Because of the high and rising unem- ployment, there should have been ample incentives to go into entrepreneur- ship (e.g., self- employment). Studies of entrepreneurship examine whether self- employment is really a disguised form of unemployment. The trade- offs between self- employment and other employment in Shanghai were not sub- stantial during the period in question. Also, to the extent that policy played a role, it is interesting to note that Shanghai had a low density of private business even at a time when the SOEs were shedding jobs on a large scale. Much of the economics literature on how government affects entrepre- neurship focuses on the role of regulation. This focus has led to a prolifera- tion of studies on and development of measures of “ease of doing business.” In this chapter, we propose that government affects entrepreneurship not only by regulations but also by economic policies. Governments in develop- ing countries seldom stand aside and let market determine resource fl ows among the various economic sectors. Rather, industrial policy intervenes to privilege certain industries to the detriment of others. Among local governments in China, Shanghai is known as having a par- ticularly strong industrial policy. Our hypothesis about the phenomenon of missing entrepreneurship in Shanghai suggests that it was the industrial policy in Shanghai that suppressed its entrepreneurship. We provide narra- tive and descriptive evidence of this industrial policy in Shanghai (although, due to data limitations, we are still unable to explicitly link industrial policy with the entrepreneurial measure in our main data set). An industrial policy model may be anti- entrepreneurial in several ways. One is that it may favor incumbent businesses because incumbent busi- nesses are large. This is the familiar national championship rationale. A second anti- entrepreneurial bias embodied in industrial policy is a techno- cratic mechanism. An emphasis on technology may prompt government to privilege one type of investment—foreign direct investment (FDI), often associated with high- tech—at the expense of indigenous small, low- tech entrepreneurs. A third prominent characteristic associated with industrial policy is entry restrictions and government targeting of fi rms. Would- be entrepreneurial businesses are often viewed as competitors in terms of taking precious resources such as bank credits and, critically in the case of Shanghai, land. Although economists have studied the effects of industrial policy on com- petition and corruption (Ades and Di Tella 1997), our study probes the potentially detrimental effects of industrial policy on entrepreneurship. Our main empirical fi ndings are generated by our unique data set. This is the Chinese Industry Census (CIC) compiled by the National Bureau of 324 Yasheng Huang and Yi Qian Statistics (NBS). (We will provide additional details about this data set in section 10.1 of the chapter.) Our data set is the most detailed data set on fi rm activities in China. It is an annual census covering 1998, 1999, 2000, and 2001, including all industrial fi rms—regardless of ownership type— with sales value above fi ve million yuan in these four years. The advantage, compared with other survey data supplied to Western researchers that does not disclose details about sampling procedures (or with sampling procedures that may contain known or unknown biases), is that our data set is compre- hensive. Another advantage is that because our data set contains informa- tion on fi rms of all ownership types, we can benchmark entrepreneurial fi rms against incumbent fi rms (such as SOEs). In contrast, very few surveys cover fi rms of all ownership types. To be sure, there are also some disadvantages with our data set. One is that the CIC covers fi rms, rather than entrepreneurs. Due to this limitation, we cannot go into detail about why or how the entrepreneurs in our data set became entrepreneurs. We leave this question to other scholars who have looked into this issue (see, for example, Djankov et al. [2006]). We hope that factors such as motivation, education, and gender—personal attributes deemed relevant to entrepreneurial activity in the academic literature—do not systematically vary between Shanghai and other regions of China. The second limitation of the CIC is that it only covers industrial fi rms. This raises the issue of whether Shanghai, as the most urban economy in China, may have larger service- sector entrepreneurial fi rms. This bias is not too severe, however, for two reasons. One is that we are benchmarking Shanghai against other cities. The vast majority of fi rms in excess of fi ve mil- lion yuan in sales are urban fi rms and, to the extent we can, we try to control for factors such as rural migration. Second, unlike metropolitan economies in the developed countries, Shanghai has not entered the postindustrial age. As of 2001, in terms of employment, industry still accounted for 55 percent of the total, so it was still larger than the service sector. The results reported in this chapter do not differ qualitatively from the results reported in a pre- vious version of this chapter, which used a private- sector survey conducted in 2002 that did include service- sector fi rms.2 The other disadvantage of the CIC is that it has a cutoff threshold of fi ve million yuan in annual sales. This means that the CIC is biased toward larger industrial establishments. The issue here is whether these larger industrial establishments can still be considered “entrepreneurial.” We answer in the affirmative. One reason is the recent vintage of these fi rms—almost all the private fi rms in the CIC were created in the 1990s. The other reason is that an important criterion of the quality of a business environment is whether it facilitates the growth of entrepreneurial businesses. It is thus meaningful 2. The 2002 private- sector survey shows that, after controlling for a variety of industry and fi rm characteristics, Shanghai has among the smallest entrepreneurial fi rms in the country. Is Entrepreneurship Missing in Shanghai? 325 to ascertain if the entrepreneurial businesses located in the richest and the fastest- growing regional economy in China, céteris paribus, can grow. In our empirical tests, we benchmark the size of entrepreneurial businesses against the size of incumbent businesses such as SOEs. This is to illustrate the relative size differentials between entrepreneurial businesses and non- entrepreneurial businesses in Shanghai and other regions of China. The chapter is organized as follows. Section 10.1 is a detailed empiri- cal illustration of the missing- entrepreneurship phenomenon in Shanghai. Section 10.2 offers a hypothesis as to why entrepreneurship is missing in Shanghai. The hypothesis focuses on the suppressive role of industrial pol- icy. Section 10.3 concludes with some remarks on the broader implications of our fi ndings. 10.1 The Missing Entrepreneurship in Shanghai: An Empirical Investigation One reason why the phenomenon of missing entrepreneurship in Shang- hai is interesting is that it contrasts sharply with the conventional wisdom in the West—that Shanghai is a dynamic economy. Another is that Shanghai has a number of locational and other advantages that should be propitious to the development of entrepreneurship. In this section we illustrate some of these factors. We then explain our data and our measures. 10.1.1 Some Basic Facts about Shanghai Shanghai is located in the southeastern region of China.3 It is a coastal city, with a total area of 6,300 square kilometers. According to the 2000 population census, it had a population of around 16.7 million. Shanghai is an economic center of China. With a population of only 1.3 percent and a land area of 0.1 percent of the national totals, its GDP is about 5.4 percent of the national total and 6.9 percent of the total national industrial output value. It is the richest region in China. To underscore an earlier point, industry continues to power Shanghai’s economy. Shanghai is the country’s biggest producer of a number of prod- ucts, such as chemical fi bers, ethylene, cars, program- controlled exchanges, power- generating equipment, and personal computers. From 2000 to 2004, Shanghai’s heavy industry grew at an annual rate of 24.9 percent and its light industry grew at 10.4 percent. Our data set thus offers valuable insights about the city even though it is limited to industrial fi rms. Our priors are that Shanghai should have been abundantly endowed with entrepreneurship if the policy environment had been accommodating. For one thing, history is on its side. Shanghai has a long history of entrepre- 3. Some of these fi gures are taken from the website of the Shanghai government, at http:/ / www/ / shanghai.gov.cn. 326 Yasheng Huang and Yi Qian neurship. In the fi rst three decades of the twentieth century, Shanghai was a major business and fi nancial hub of Asia. It was the home of the country’s largest textile fi rms and banks. It was also the founding venue of a number of fi rms that are still major multinational corporations (MNCs) in the world today, such as Hong Kong Shanghai Banking Corporation (HSBC) and American Insurance Group (AIG). A very powerful illustration of Shanghai’s rich entrepreneurial heritage is the near- absolute dominance of the Hong Kong economy by industrial- ists who left Shanghai in 1949.4 During Hong Kong’s take- off period, its most important industry was textiles. As recently as 1977, the textile indus- try produced 47 percent of Hong Kong’s export value and employed 45 percent of its workforce. In the late 1970s, Shanghai industrialists owned twenty- fi ve—out of a total of thirty—of the cotton- spinning mills in Hong Kong. Shanghai industrialists also created twenty out of the twenty- one cotton- spinning mills established between 1947 and 1959. It is not an exag- geration to say that the Hong Kong miracle was a Shanghai miracle in dis- guise. Thus, it is surprising that contemporary Shanghai should be so short of entrepreneurship. Entrepreneurial businesses in Shanghai also have some substantial loca- tional advantages. Because it is one of the most important economic centers of China, agglomeration economics should favor its entrepreneurs. There are substantial business opportunities. Measured in terms of per capita GDP, Shanghai is the richest economy in China. It has the highest GDP per capita in the country; in 2005, its GDP per capita was about fi ve times the national average. In the 1990s, annual GDP growth averaged above 11 percent in real terms. Some scholars have argued that entrepreneurship is rooted and embedded in culture. According to Kirzner (1979), entrepreneurs are those who are particularly alert to business opportunities that often elude others. Saxenian (1994) attributes the difference between Route 128 and Silicon Valley to the latter’s more freewheeling culture. Although this is highly anecdotal, the “folk wisdom” in China is that people in Shanghai satisfy one particular defi nition of entrepreneurs very well; that is, Shanghainese are reputed to be well- endowed with business acumen. Shanghai also has other advantages. It has a rich endowment of human capital, as the home to a number of the best educational institutions in the country (such as Fudan and Jiaotong). The economics literature stresses the importance of institutions in ex- plaining economic growth. In particular, institutions protecting private prop- erty rights and enforcing contracts are of fi rst- order importance (North 1991; Acemoglu, Johnson, and Robinson 2005). New fi rm growth in transi- tional economies is shown to be highly sensitive to the security of property 4. For a good account of the role of Shanghai industrialists in Hong Kong, see Wong (1988). Is Entrepreneurship Missing in Shanghai? 327 rights (Johnson, McMillan, and Woodruff 2000). Economists also stress fi nancing constraints as important to the investment decisions of private fi rms (Levine 1997). However, these theories may not readily apply to Shanghai, at least not in their original formulations. China does not have well- developed legal and fi nancial institutions but it is not clear why Shanghai is substantially underdeveloped as compared with other regions of China. The conventional wisdom is just the opposite. China scholars believe that Shanghai has the most developed legal system in China and many Western legal academics have used Shanghai as a case study to illustrate the progress China has made in terms of rule of law (Guthrie 1999). Transitional economists have also shown that there are a variety of “self- help” coping mechanisms that entrepreneurs have devised to ameliorate the shortcomings of formal institu- tions. For example, entrepreneurs only do businesses with people whom they know and they rely on supplier or customer credit to obviate a dependency on banks (McMillan and Woodruff 1999a, 1999b). Thus, even if formal institutions in Shanghai are found to be lacking, a deeper and more relevant question is why these informal self- help coping mechanisms have also failed to work in Shanghai. 10.1.2 Data: Chinese Industry Census (CIC) Our empirical investigation is based on the CIC compiled by the NBS in China. The CIC is, to our knowledge, the most detailed database on Chinese industrial fi rms. It covers the entire population of Chinese companies with sales above fi ve million yuan for