Should China want to remain an international economic superpower, it will need to substitute its current growth model – one largely based on abundant, cheap labor – with a different comparative advantage that can lay the foundation for a new, more sustainable growth strategy.

Chinese policymakers are hoping now that an emerging entrepreneurship may fit that bill, with start-ups and family-run enterprises potentially becoming a major driver of sustainable growth and thus replacing the country’s current economic model. In 2014, international conferences on private entrepreneurship and innovation were organized all across China: The China Council for the Promotion of International Trade organized its first annual Global Innovation Economic Congress, while numerous innovation-related conferences were held at well-known Chinese universities such as Tsinghua University, Jilin University andWuhan University.

New Growth Model Needed

Although China still ranks among the fastest growing economies in the world, the country’s growth rates have decreased notably over the past few years. From the 1990s until the 2008 financial crisis, China’s GDP growth was consistently in the double digits with only a brief interruption following the Asian financial crisis of 1997. Despite a relatively quick recovery after the global financial crisis, declining export rates resulting from the economic distress of China’s main trading partners have left their mark on the Chinese economy. Today’s GDP growth of 7.8 percent is just half level recorded immediately before the 2008 crisis, according to the latest data provided by the World Bank.

This recent slowdown in China’s economic growth has naturally been a source of concern for the government. A continuation of the country’s phenomenal economic growth is needed to maintain both social stability and the Communist Party’s legitimacy. Sustainable economic growth has thus been identified as one of China’s key challenges for the coming decade.

That challenge is complicated by demographic trends, which are set to have a strongly negative impact on the Chinese economy within the next decade. Researchers anticipate that as a consequence of the country’s one-child policy, introduced in 1977, China will soon experience a sharp decline of its working-age population, leading to a substantial labor force bottleneck. A labor shortage is likely to mean climbing wages, threatening China’s cheap labor edge. The challenge is well described in a recent article published by the International Monetary Fund.

Replacing the Cheap Labor Strategy

Entrepreneurship is widely recognized as an important engine for economic growth: It contributes positively to economic development by fuelling job markets through the creation of new employment opportunities, by stimulating technological change through increased levels of innovation, and by enhancing the market environment through an intensification of market competition. Entrepreneurship and innovation have the potential to halt the contraction in China’ economic growth and to replace the country’s unsustainable comparative advantage of cheap labor over the long term. As former Chinese President Hu Jintao stressed in 2006, if China can transform its current growth strategy into one based on innovation and entrepreneurship, it could sustain its growth rates and secure a key role in the international world order.

Indeed, increasing levels of entrepreneurship in the Chinese private sector are likely to lead to technological innovation and productivity increases. This could prove particularly useful in offsetting the workforce bottleneck created by demographic trends. Greater innovation would also make China more competitive and less dependent on the knowledge and technology of traditional Western trading partners such as the EU and the U.S.

Transition

In fact, China has long been preparing the ground for entrepreneurial revolution. When Deng Xiaoping became chairman of the CPPCC National Committee in 1978, he ended China’s era of economic isolation. The country de-collectivized its agriculture, opened up its economy to foreign investors, and liberalized its markets. Investment spilled over from Hong Kong and Macau and pushed the Chinese economy into the international system. The establishment of China’s special economic zones (Shenzhen, Zhuhai, Shantou and Xianan) in 1980 attracted foreign direct investment and encourage private business. There was no shortage of Chinese entrepreneurs willing to take advantage of the new opportunities. According to the CEO of a copper refinery in Zhejiang Province, “the Chinese people really exceeded the government’s expectations.”

Starting in the 1980s, the Chinese government actively encouraged entrepreneurship across the country, by introducing the first patent law, allowing state-owned enterprises (SOEs) to go bankrupt, and creating a more investor-friendly environment for private entrepreneurs. Contrary to the popular belief that China’s miraculous economic growth over the past three decades has been exclusively driven by its SOEs, the emerging private sector has played a major role. Examples of China’s most successful entrepreneurs include Jack Ma (Alibaba), Ma Huateng (Tencent), Robin Li (Baidu), and Lei Jun (Xiaomi smartphones).

Although historically subject to the dictates of the central government, China’s entrepreneurs have been grantedincreasing self-determination and independence in recent years. The government has officially recognized the rising importance of entrepreneurship to China’s future economic success. Chinese Premier Li Keqiang, for instance, recently pleaded for entrepreneurship to be encouraged and for start-up businesses to be given support. More specifically, he called for support to be given to entrepreneurial students, a measure which could play a role in fighting youth unemployment in China. In recent years, China has also given higher priority to the development of the R&D and high-tech sector, investing a larger portion of its budget in R&D, increasing its high-tech output, and encouraging Chinese students to pursue engineering degrees.

Obstacles

Still, despite these recent steps, the Financial Times writes that “entrepreneurial education remains a relatively new concept and practice, particularly in China’s university sector.” More “entrepreneurship education is needed” and “the country’s business schools should adopt western tactics and have start-up labs.” The incompatibility of classical Confucian values which laid the foundation of the Chinese culture such as “obedience,” “respect for authority” and “emotional control” with the entrepreneurial spirit constitutes one of the key challenges in entrepreneurial education.

Moreover, there are still a number of obstacles for entrepreneurs that make private investments in China riskier than it is in most Western, high-income countries. Because of the “heavily state-based, government-run legal system” and the relatively high corruption levels in the Chinese court system, private entrepreneurs who lack Communist Party connection are still disadvantaged in many aspects compared to SOEs and politically well-connected private investors. For example, a survey of court proceedings in China reveals that small, private enterprises usually lose against large state firms. Also, starting a business is still relatively bureaucratic and time-consuming. It takes 38 days to complete all the required procedures in China, compared to an average of 5.7 days in OECD countries.

Another major challenge is the funding shortage in the private entrepreneurial sector. While the government has sought to give budding entrepreneurs access to funding in order to support Chinese start-up businesses, financing remains a key bottleneck. As the Beijing correspondent of Time magazine pointed out in a report released in 2009, credit standards are often too high to be met by small business. Moreover, state-owned banks often give preference to SOEs and partially state-backed companies when it comes to issuing commercial loans. There is, however, reason for optimism, with recent promises made by both former premier Wen Jiabao and current president Xi Jinping to facilitate access to credit for private entrepreneurs and to create a more investor-friendly lending environment.

In early 2006, Hu Jintao said that “China will be built into an innovative nation in about fifteen years.” Today, about 8.5 years later, China still has a long way to go before it could be called an innovative nation; its dependence on cheap labor remains critical to its economic success. Given the recent economic slowdown and expected demographic changes, the Chinese government is under pressure to accelerate the country’s transition to an entrepreneurial and innovation powerhouse. With both social stability and the Party’s political legitimacy are at stake, this could prove to be one of the government’s most pressing challenges over the next few years.

by Julia Ebner, a postgraduate student at Peking University and London School of Economics. Julia has previously written for The Diplomat.

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