Shanghai: China’s Entrepreneurial Center?

To gain a clear picture of China’s economic history and development up to this point, there is no better economist to follow than Yasheng Huang, a professor at MIT.

In his book “Capitalism with Chinese Characteristics” Huang discusses Shanghai’s development at length and uses it to reinforce his argument about the trends of finance and economic development since China opened up to foreign trade and created rules for a demand-side economy.

Dr. Huang argues that China’s development since the 1980s has changed drastically from a domestic entrepreneurial perspective. He makes a strong case that in the 1980s the Chinese banking system was more open than in the 90s or in this most recent decade. Due to China’s desire in the early 80s to bring their rural population out of poverty, Dr. Huang explains how the Chinese Central Party (CCP) encouraged the banking system to promote small business loans and allowed independent, privately and collectively owned financial cooperatives to operate with minimal restrictions.

Dr. Huang also points out that China’s economic rise in the early 80s was unique in that its people took risks that would not otherwise be considered safe by western entrepreneurs. There were no property protections in place when the economy opened up, and no official announcement of its opening in the countryside. There were simply articles like one in the Peoples’ Daily about a farmer who was raising cows for private profit. This was a signal that the market was now privatising to prospective entrepreneurs accustomed to seeing articles about people imprisoned for similar acts.

Dr. Huang points out that when faced with no legal recourse to become an entrepreneur, the simple opening of the market without fear of prosecution provides sufficient impetus to start a business. I agree with Dr. Huang’s point. I also agree with my father, Randy Brown, a much less decorated but highly talented and insightful economist, that in addition to the above theory the rural population’s bleak welfare in 1979 must have played a role. What is the risk in engaging in a private enterprise when there is no money in farming and no alternative future prospect?

The over-arching point, however, is that the CCP instituted a rural entrepreneurship focus in its overall banking strategy that it later reversed after Tiananmen Square. Dr. Huang has three reasons for the reversal:

• The Tiananmen Square incident nearly ushered in a resurgence of supply-side economic policies due to government concerns about loss of control. Financing rural entrepreneurship became a potential threat to government sovereignty.

• Former high-level officials, such as Zhao Ziyang, with rural backgrounds and progressive ideas were replaced by technocrats, like Jiang Zemin, from Shanghai and other urban centers.

• The new technocrats in power concerned themselves with retaining control while bringing in more FDI through joint ventures and open policies. They did this, unfortunately, at the expense of the entrepreneurial policies displayed in the 1980s.

Shanghai, according to Dr. Huang, is a prime example of state-owned enterprises suppressing wage increases for the working class:

“An entrepreneurial economy has a high share of employee compensation (inclusive of proprietors’ income), whereas a statist economy has a low share… Employee compensation comprised 53% of the net regional product in Zhejiang, a full 12 percent higher than in Shanghai. The two provinces have almost identical shares of corporate profits, about 30 percent, which implies that the key difference between the two is the income accruing to the government. For Shanghai, the ratio is 28.9 percent; for Zhejiang, the ratio is 17.4 percent. The upshot of this analysis is that an average resident in Zhejiang captures 10 percent more of each increment in economic output than does her counterpart in Shanghai. She is 10 percent richer but her government is 10 percent poorer.” (Huang, Pg 182.)

Dr. Huang goes on to explain that Shanghai’s SOEs control 39.4 percent of industrial output, compared with a much lower 13.6 percent in Zhejiang, according to the 2003 National Bureau of Statistics in China. This means private income share in Zhejiang is much higher than in Shanghai. He also points out that the Pearson correlation coefficient between Shanghai’s GDP and both its urban and rural incomes is negative; more so for the GDP / rural incomes (-0.62). (Huang, Pg. 185). This suggests that since the 90s, as the ratio between Shanghai’s GDP growth rate and the rest of the country has increased, that of its urban and rural incomes has shrunk.

This makes sense, because one result of reducing financing for entrepreneurial endeavors and increasing it for SOEs was low wages. The rural population that opened businesses in the 80s and expanded into urban areas through them instead migrated there as laborers, which kept labor costs low for manufacturing and assembly operations.

Dr. Huang’s argument, which I agree with, is that China’s overall policy favors SOEs, large firms, and FDI at the expense of small, independent businesses. This lack of financing reduces jobs and incomes in the interior, which leads to migratory laborers. If left unchecked, this could lead to issues down the road. Right now the government is able to pick up the slack in manufacturing jobs with work programs developing the interior infrastructure. But in order to utilize that infrastructure the CCP will need to promote more small business loans. Entrepreneurial finance creates jobs, increases commerce and income, stabilizes local governance through higher tax revenues, and attracts further developmental FDI.

The issue with entrepreneurial finance is that it also tends to increase demands for personal and political freedoms. While I don’t believe this immediately threatens the CCP’s authority, I do believe it is a fear that keeps the party from a change in policy that would bring about true competition and make China a more legitimate threat to the west. With more entrepreneurial freedoms and more small businesses, the ingenuity and competitive spirit displayed in the US and Europe would allow for technological advances across industries by Chinese-owned companies. It would simultaneously allow more western competition. The increase in income would create a huge domestic market for all sorts of products. It would also usher in more stringent IPR protections, as local entrepreneurs would demand them to protect their own R&D initiatives.

Basically, the issues with Shanghai are the issues, modeled on a smaller scale, with the rest of China. Shanghai is a center through which China’s various economic conduits flow. Labor, capital, and investment flow in and out of Shanghai to create a clear anatomy of China’s economic health.

A company hoping to correctly time China’s domestic economy so that it enters the market when consumers can afford its products or services needs to watch how the major Chinese banks disperse loan funds. When they start going out to small businesses, it almost immediately signals an opportunity to move inwards and expand into what will eventually be the largest domestic market, by population, on earth.

Work Cited
Huang, Yasheng. “Capitalism with Chinese Characteristics”. Cambridge University Press. New York. 2008.

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