What Is Wrong With Shanghai? (Part I)

In 1992, a book with the title Shanghai: Her Character Is Her Destiny became a best-seller in China. The Shanghai government sponsored the book project — its preface was written by Mayor Wang Daohan — to research the identity of the city.

Its principal theme was Shanghai’s distinct culture, which is characterized by "its great tolerance, diversity, individuality and entrepreneurship." The book goes on to assert that the renaissance of Shanghai owed much to this distinct cultural heritage.

The claim that Shanghai is historically entrepreneurial is accurate. In the first three decades of the 20th century, Shanghai was the major business and financial hub of Asia — similar to or even more significant than the role of Hong Kong today.

It was the home of the country's largest textile firms and banks, as well as the founding venue of a number of firms that are still major multinational corporations in the world today. These include Hong Kong Shanghai Banking Corporation (HSBC) and the now much-tarnished American International Group (AIG).

A powerful illustration of Shanghai's rich entrepreneurial heritage is the near-absolute dominance of the Hong Kong economy by industrialists who left Shanghai in 1949.

During the take-off period of Hong Kong, Hong Kong’s most important industry was textiles. As recently as 1977, that one industry produced 47% of the value of its exports and employed 45% of its workers.

In the late 1970s, Shanghai industrialists owned 25 cotton-spinning mills in Hong Kong out of a total of 30. Between 1947 and 1959, Shanghai industrialists created 20 out of the 21 cotton-spinning mills established that decade. It is not an exaggeration to say that the Hong Kong miracle was a Shanghai miracle in disguise.

Today, Shanghai cannot claim any large-scale, well-known private-sector businesses. In addition, the city is at the bottom of the country in terms of entrepreneurial measures.

These two phenomena are closely linked with each other — and they are a self-fulfilling prophecy created by Shanghai’s industrial policy approach toward economic development.

Industrial policy always favors big, incumbent firms — and in Shanghai, not only are large firms subsidized, but small entrepreneurial businesses are restricted in terms of their access to market opportunities.

Because Shanghai systematically discriminates against small firms, Shanghai's private sector never had the time, opportunities or resources to grow from small to big. The only exceptions are a few cases where private businesses got big very quickly through corruption.

Despite a rich history of creating some of the largest businesses in China and in Asia in the first part of the 20th century, the average size of Shanghai private-sector firms is among the smallest in China by employment — and is on the small side in terms of sales.

Despite the image of the city as a high-tech hub, the private-sector firms in Shanghai, on average, are less likely to hold patents and/or hold fewer patents than private-sector firms based in the heavily agricultural and poor interior province of Yunnan.

Fixed-asset investments by self-employed household businesses, after reaching a peak in 1985, collapsed in the second half of the 1990s. The missing-entrepreneurship phenomenon is completely an artifact of policy, as Yu Zhensheng, the current Party secretary of Shanghai, pointed out.

Yu recounted how the poor business environment of Shanghai drove out Alibaba — one of the most successful Internet entrepreneurial businesses in China — to Zhejiang province in the late 1990s.

Shanghai should have thrived in entrepreneurship. It has history on its side, but it also has other huge advantages.

It has a rich endowment of human capital. Its economic growth has been rapid, and it has attracted a large influx of FDI. It also has the kind of agglomeration economics that economists believe to be important for economic and business development.

The anecdotal "folk wisdom" in China is that people in Shanghai satisfy one particular definitional feature of entrepreneurs very well. The reputation of Shanghainese is that they are well-endowed with business acumen.

Editor’s Note: This feature is adapted from “Capitalism with Chinese Characteristics: Entrepreneurship and the State,” by Yasheng Huang. Reprinted with the permission of Cambridge University Press. Copyright Yasheng Huang 2008. All rights reserved.