China’s entrepreneurship problem

SUNDAY, 18 DECEMBER 2011 17:20 DOUGLAS HERVEY

DURING the 2008 Summer Olympics, China dazzled the world with Beijing’s posh athletic venues and revamped urban landscapes. And as the US and Europe have struggled with economic crises in the years since, China’s prodigious economic growth rates convinced many that it was only a matter of time before it became the globe’s economic leader.

But there are many reasons to be skeptical. Critics have cited China’s income inequality, poor urban migrants and political corruption as reasons to doubt China’s ability to maintain its rapid growth. Often lost in the discussion, however, is the fact that the cards are stacked against the Chinese entrepreneur.

The potential market for Chinese entrepreneurs is huge. Millions of Chinese have foregone certain purchases due to cost, accessibility and convenience. And millions of Chinese innovators would love to flood the market with smaller, cheaper more convenient products that don’t appeal to the mainstream market’s performance expectations.

But before that can happen, China must conquer several obstacles. The first is the value of the yuan. China could allow its currency to rise in order to lessen its dependence on the dollar, but this would harm exports and likely lead to widespread layoffs and social unrest.

An additional challenge is lending. Despite China’s recent announcement to cut the reserve-requirement ratio for its banks by 0.5 percentage points, it is still historically high. China’s inflation fighting policies have decreased bank lending to entrepreneurs. While inflation fears are easing, a limited stimulus will do little to discourage more lending to large, state-subsidized companies.

Those large, state-backed companies are themselves another obstacle. The government has provided many of them with capped interest rates and other favorable lending terms. Formed to create employment, not to maximize profit, they aren’t incentivized to disrupt themselves.

China’s growth will soon slow as the ‘’easy’’ phase of economic development ends. Fostering an environment that favors disruption is the prescription for continued growth. Instead, China has opted for a myopic approach at the expense of individual entrepreneurs.

In the United States, disruptive innovation has harmed a few but benefited many. In China, top-down capitalism has benefited a few but harmed many. An absence of disruptive innovation is suffocating China’s future growth potential. The future of that growth potential will depend in large part on whether China suppresses or unleashes its would-be entrepreneurs.

Douglas Hervey is a research associate for Harvard Business School professor Clayton Christensen, with whom he is coauthoring a book on aligning incentives in health care.