Endnotes

¹By the "missing middle" we mean the presence of some large enterprises at the top and many small enterprises at the bottom that are unable to graduate into the medium-sized category.

²The economics of transition literature is varied in its policy suggestions concerning the best strategy for how such a transition should take place. We will not review the vast literature here, but merely point the interested reader to the excellent books by Blanchard (1997) and Roland (2000). Our approach here draws on the work of Porter (2004).

³There is some parallel to the more classical factor proportions model of trade, where a country tends to produce and export the good which uses intensively the input with which it is relatively abundantly endowed. The distinction here is that, unlike the Heckscher-Ohlin model, production technologies differ between countries. Moreover, the underlying technological capability of a nation is conceived as endogenous|with resource allocation affecting the rate of technological development|not unlike models of endogenous growth (Romer 1986, 1990).

⁴At its best, then, this mode seeks to combine an upstream, externally available technology with internal, often proprietary knowledge of a downstream application domain.

⁵The primary insight of the model of international trade is the role that Dixit-Stiglitz-style monopolistic competition plays in the determination of international trade patterns. With economies of scale in production and the ability to costlessly differentiate their products, trade allows for increasing returns that produce gains from trade even in economies with identical tastes, technology, and factor endowments. The model has served as the basis for understanding the phenomenon of intra-industry trade.

⁶In equilibrium, however, the number of firms in the economy is likely to fall as inefficient firms exit the industry in the presence of free trade. Overall welfare, however, remains higher with trade than in autarky (Melitz 2003).

⁷Naturally, such a sweeping statement does not preclude the possibility that certain industries|notably high- productivity exporters such as the textile/clothing and toy sectors|also exist. However, while such export powerhouses easily capture news headlines, they do not represent the majority of the nation's SMEs.

⁸This is a theme that is repeated in the New Economic Geography literature. See Fujita, Krugman & Venables (1999) for a detailed exposition of models in this class.

⁹Note that such organized clusters involve non-equity-based linkages among firms. Collaboration occurs as a result of either firms possessing similar degrees of market power but holding complementary assets, or a dominant firm acting as a coordinator by setting standards for other firms within the cluster.

¹⁰For a fuller discussion of the PRC's classification of SMEs, we refer the reader to Appendix A.1.

¹¹Note that if self-employed businesses|such as leasehold farm households and individual partnerships|are also classified as SMEs, this number is far larger, with estimates of as high as 40 million.

¹²However, the counterargument is that latecomers enjoy the possibility of leapfrogging due to the ability to pass over obsolete technology and not having to deal with an excess of legacy infrastructure. On balance, it appears that the costs of the PRC's relatively late entry into the world economy probably dominate the benefits of this late entry. The issue of legacy infrastructure is also discussed below.

¹³In more mature financial markets, venture capital financing may be available to make up for credit rationing problems associated with more traditional bank loans. We discuss the development of the venture capital industry in the PRC in Appendix A.2. For a fuller discussion of the development of the financial market in the PRC over the period 1990{2000, see Shi (2001).

¹⁴These are discussed more fully in Appendix A.3. See also Wang (2004) for a detailed discussion.

¹⁵Except, perhaps, for supplier-driven innovation, such as through improved inputs and the introduction of new machinery.

¹⁶New growth theory, or endogenous growth theory, was pioneered by Romer (1986). This subsequently enjoyed important contributions by himself (Romer 1990) and others (Aghion & Howitt 1997; Grossman 1991; Lucas 1990). The literature has attempted to deal with how increasing returns allow long-term growth to be self-sustaining, an issue that the neoclassical growth literature (Solow 1956) had treated as exogenous.

¹⁷It is important to keep in mind that SME policy in the PRC is largely guided by the "Act on the Promotion of SMEs," which came into effect in 2003, and is the only such act dealing with SMEs. The Act includes policy measures such as financial support, support for start-up businesses, and support for technological innovation and market expansion. The Act also states that the PRC's government will be involved in information provision and training services for SMEs. However, the wording in the Act is very brief and ambiguous, and does not provide any specificity in terms of proposed measures. As such, one could argue that there currently remains no comprehensive SME policy in the PRC; perhaps the best characterization of the current SME policy direction is that remains mostly ambiguous.

¹⁸Moreover, a joint benchmarking exercise may have a catalytic effect in terms of encouraging more intens exchanges between firms on technical issues, such as when employees from different firms are jointly trained i benchmarking techniques.

¹⁹However, it is important to note that the specific mechanisms that should underlie a functioning system of intellectual property rights, as currently understood, remains highly debated (Boldrin & Levine 2002; Romer 2002).

²⁰A comparative analysis of the development of Japan vis-a-vis the PRC's SME sector is beyond the scope of this article. However, we provide a parallel analysis of the evolution of Japan's SME sector and its experience with the industrial cluster strategy in Appendix A.4.

The views expressed in this paper are the views of the authors and do not necessarily reflect the views or policies of the Asian Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms..

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