What lies ahead for China’s entrepreneurs?

When China implemented its first economic reforms in 1978, the government accounted for more than 90% of GDP. By 2005, public sector contributions to GDP represented less than 50%. Does this mean entrepreneurs are thriving?

In rural China, there were no recorded private enterprises until 1994. Today, self-employment preference rates are in flux in all regions of the country, as the country welcomes back foreign university graduates and continues to experience massive rural to urban migration. Paradoxes abound though. For example, Internet censorship continues relentlessly, while a handful of Chinese ICT public offerings on U.S. exchanges in 2014 are hailed as job and value creators at home.

The size of China’s manufacturing sector should be the envy of the modern day Maker Movement as it works to inject manufacturing innovation in what we know as “industrialized nations”. The size of its population and economy presents a market which entrepreneurs from everywhere are trying to tap. Yet, various socio-political limitations present high obstacles to an innovative manufacturing sector and more entrepreneurs meeting demands from its growing middle-income population. These hurdles affect not only these sectors but also banking, services, government procurement, and even traditional sectors like construction and agriculture.

Beyond navigating a political environment that still favors state-owned enterprises, entrepreneurs also have lots of regulatory hurdles to tackle. For many, these hurdles lower their appetite for risk, deterring new ventures altogether, or limiting the number of ventures to the ones inspired by copy-cat ideas that have proven succesful elsewhere, like the plethora of Chinese versions of Groupon or car apps. According to data collected by the World Bank’s Doing Business project, China is among the most unfavorable business environments, ranking 158th among 183 economies. While piecemeal policy changes have signaled an acknowledgement of the contribution of a new wave of companies, the World Bank reports no significant reforms to make it easier to start a business during the 2009-2011 period.

Insecure property rights represent another major roadblock, and removing it has been on the policy agenda since a system of private ownership officially began in 2004, but progress has been slow. The most recent changes have been in the realm of opening new asset possibilities for raising capital. In October 2007, the new property law in China expanded the range of assets that can be used as collateral, to include accounts receivables and a changing pool of assets to secure a loan. Still, the Heritage Foundation has reported sharp declines in the overall property rights environment.

Despite a comparatively unfavorable policy environment, Chinese entrepreneurs in organic clusters in tier-one cities like Shanghai, Beijing and Gaungzhou have long shown that innovation can still flourish in a top-down economy. They form a critical mass of entrepreneurs that have raised the importance of entrepreneur-to-entrepreneur, and entrepreneur-to-investor networks, creating lots of economic freedom. For example, such strong entrepreneurial ecosystems are visible at the Touch (TNT) monthly meetup in Chinese tech cities, or for the outside world through the writings of TechNode, the official partner of the TechCrunch news and events platform in mainland China that is written in both in English and Chinese.

There are also plenty of positive indicators to be found by looking at the incubators and accelerators for China-based entrepreneurs that can be spotted outside of the main cities, such as Axlr8r, a 90-day accelerator program based in Dalian. Some target specific demographics, such as the Tianjin Women’s Business Incubator (TWBI). Respondents to the EY Barometer survey were most positive about this development — 52% saying that access to such supported services had improved in the last three years.

Further, in terms of startup or scale up capital, the success of many Chinese startups has demonstrated that if ideas are validated, the team is dynamic, and the entrepreneurs are rightly coached, money will follow. Earlier this year, the online education website TutorGroup raised approximately $100 million in venture capital. At the same time, Alibaba’s recent filing to go public has set the stage for what could be the largest Wall Street debut in history.

The government does seem to recognize the importance of new firms. As reported by the EY G20 Entrepreneurship Barometer 2013, China’s Ministry of Commerce acknowledged that entrepreneurial ventures are responsible for 75% of new jobs each year and 68 percent of exports and has started to focus on improving the regulatory environment. In an attempt to reduce the amount of time spent paying taxes, the criteria and accounting methods for tax deductions were unified through China’s new corporate income tax law. More recently, measures to enforce contracts have been directed at streamlining court proceedings. In 2013, the Chinese government reduced the cost of starting a business by exempting micro and small companies from paying several administrative fees from January 2012 to December 2014. The test will come after this period expires when policymakers will have to decide whether they want to continue to find new ways to remove roadblocks for new venture creation and firm growth.

One other important “feat” has been what the Chinese government, prone to a planned economy, did not do, such as organized innovation clusters that more often than not, fail and become mere physical structures with little entrepreneurial life and energy. Vivek Wadhwa has pointed out that “top-down industry cluster is a modern-day snake oil”. As he explained:

“Governments can build infrastructure and pump money into education and R&D. But they cannot manufacture innovation. Innovation comes from creative people who challenge authority and take risks–who exchange ideas and experiment at the fringe.”

There are also some trends outside of government that might give hope for China’s entrepreneurs. For example, overseas-educated entrepreneurs returning to China are adding to the local mass of entrepreneurs you can see, for example, at the Entrepreneurship Foundation for Graduates (EFG). The returning graduates are injecting cultural capital and demand for entrepreneurial vehicles and support infrastructure such as startup incubators for their patents. EY reported that China is building 150 startup incubators specifically for graduates returning from overseas.

In addition, the rising tide for technology companies raises many other boats. AsTechCrunch reported, beyond a statement about the value of the entrepreneurial path, these success stories are building investor confidence. Moreover, the successful ventures will know how to work with startups as they seek innovation opportunities. More importantly, these rising large companies challenge the mindset of the lifetime employment at state-owned enterprises (known as the ‘iron rice bowl’).

Looking ahead, as in other economies, sustainable growth will depend on meaningful reforms to make the economy less hostile to new entrepreneurs by unshackling this giant nation’s entrepreneurial limb. From my meetings in China with government officials, I doubt Beijing will kill this enthusiasm. The shear size of the economy and strong government will make it hard for China to create a healthier environment where established and young upstart companies can coexist, but despite inherent contradictions within the political and economic infrastructure, the dominant flow will continue toward removing roadblocks that hinder the development of an organic entrepreneurship ecosystem.

They understand the importance of empowering ecosystems where for example, startups have the breathing space to produce agtech solutions that fuel China’s giant food production sector, which the government currently subsidizes to ensure its productivity and competitiveness.

When party leaders sit down and map the future of the economy, I suspect they are already figuring out how to tear down walls in front of China’s younger problem-solvers who are going overseas and tapping into other local, national and global exchanges of innovative ideas. Even in China, the power of the global startup community is incentivizing change for the better at home.