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March 9, 2015

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Helping innovative small businesses grow

CHINA’S economy faces two challenges.

First, the production capability of Chinese businesses, acquired over the course of 30 years after the reform and opening up, has been severely buffeted by sluggish demand and drastically leaner profit margins, as a result of the impact of financial crisis on overseas markets.

Second, the Chinese economy is perennially dependent on foreign direct investment and government policy dividends, at the expense of neglecting the efficiency of resource allocation within the financial system. This has led to a steady increase of foreign exchange reserves in the form of massive holdings of US treasury bonds. Meanwhile, domestic money supply has had to rise in tandem with ballooning funds outstanding for foreign exchange.

Be it dollar assets or yuan-denominated debts, the lack of dominance and capacity in terms of wealth management has considerably affected the implementation of China’s sustainable development strategy. Hence, it is imperative to break China’s development model as a world factory that competes on the basis of sheer volume, to supplant “Made in China” with “Made by China” as quickly as possible, as well as to explore a new development model characterized by innovation.

This quality-oriented growth needs to be shored up by a highly efficient financial system. Observations on recent trips to the United States, specifically the Los Angeles and San Francisco areas, reinforced impressions gained on previous sojourns in Germany and Japan.

I have grown ever more convinced that the key factor to the transition of China’s growth model to an innovation-led one is how we can speed up financial reform so as to support growth of innovative micro- and small-sized businesses, because they are the real underpinnings of China’s economic future.

As such, I would like to elucidate a few new ideas and policy recommendations.

To start with, the betterment of an intellectual property (IP) regime and the fairness and rigor with which it is enforced will serve as an incentive in encouraging the healthy growth of micro- and small-sized businesses. Otherwise, a resulting shortage of innovative businesses will dent the performance of institutions that finance start-ups. It will also make it hard for qualified lenders to come along on the capital market. Of course, a worse consequence is that China’s fiscal spending in aid of small businesses might sustain huge losses.

But if the risk of a flawed legal environment is taken into consideration, compelling us to leave the task of technological innovation entirely to big companies, the so-called innovation activities, characterized by lack of market competition and effective demand, will likely lead to low efficiency, or even create no more than some vanity projects.

China needs to establish an over-the-counter market that trades in intellectual property as soon as possible, to complement the role of incubators as a go-between, as well as the equity incentives. Various financial institutions and investors, in particular private capital such as angel funds, should be introduced to the specific type of financial service.

New supervisory model

To this end, a breakthrough in the supervisory model is called for, so as to enable financiers to operate across the boundaries of varied business interests, thereby overcoming the defects of a single service model based on collateral loans. Establishment of such a differentiated financial service model will dissipate the risks of homogenous investments.

Moreover, although access to financing is broadened for micro- and small-sized innovative businesses, limitations must be imposed in the case of certain investors (for example, retail investors). This is a significant guarantee of lowered borrowing costs and consistent capital flows for innovative small firms.

Thirdly, China is in need of creating a tax policy that encourages innovation. Capital gains made through transactions on the IP markets ought to be given tax breaks. And the profits accruing from equity investments by listed, innovative small businesses are either to be exempted from taxation or taxed at reduced rates.

On top of that, those “comeback” entrepreneurs who fail and start anew merit spiritual encouragement, for this kind of government backing will attract more investors to projects initiated by these entrepreneurs. Historical statistics demonstrate that entrepreneurs with prior experience of running a business have better odds of succeeding in innovation than inexperienced start-up entrepreneurs.

Finally, the talent pool of innovators needs to be enlarged through the provision of education.

By means of fiscal expenditures, the authorities can sponsor professional, self-organized lectures as well as conversations between start-up entrepreneurs. The subsequent creation of an informative talent and innovation project database will provide credible information for the government to arrange for third-party evaluation of business performances.

The author is executive dean of the School of Economics at Fudan University. The views are his own. Shanghai Daily staff writer Ni Tao translated his article from Chinese.




 

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