Introduction

The People's Republic of China (PRC) is a relative latecomer to modern industry and is|by most standards|a highly successful one. Evidently, the PRC's market-oriented reforms have, thus far, produced remarkable results. The PRC's manufacturing sector has enjoyed high and sustained rates of growth, with shares of gross national product (GNP) and exports rising sharply. The emergence of dynamic small and medium enterprises (SMEs) is, above all, one of the most important outcomes of the entire reform process. SMEs are the major growing force behind the PRC's prominent success in terms of their contribution toward the national gross domestic product (GDP) (accounting for 40%), scale of assets, diversification of products, and the creation of employment|in spite of offical Party policy that favors state-owned enterprises (SOEs). Despite their significant contribution to the PRC economy, SMEs have largely been neglected in official thinking about technological issues, although they now do rate a mention in the current long-term plan.

This paper examines the role of SMEs in technological issues such as innovation, research and development (R&D), and strategic clustering. It focuses on the questions that need to be addressed in any further attempts to reshape the PRC's industrial policy, in the context of what is generally regarded as the national innovation system (NIS): What challenges and constraints do the internal economic environment pose for SMEs seeking to grow? How does the external environment, especially the PRC's entry into the World Trade Organization (WTO), affect the ability of SMEs to operate and compete? What opportunities are available to the PRC's authorities seeking to reform its NIS in a SME-friendly fashion?

Although there exists a relatively large literature on SMEs in general, most authors have focused on country-level studies that are focused on idiosyncratic aspects of the SME contribution to growth outcomes. The limited empirical evidence is, at best, mixed. Some authors find that small firms have an advantage in highly innovative, high-skill industries (Acs & Audretsch 1987), while others find that larger firms are better able to take advantage of increasing returns associated with R&D (Pagano & Schivardi 2003). Similarly, while entrepreneurship may be more prevalent in smaller firms (Acs, Audretsch & Feldman 1994), such activity may (Little, Mazumdar & Page 1999) or may not (Little, Mazumdar & Page 1994) translate into productivity outcomes. Recent cross-country evidence, however, casts doubt on the notion that the promotion of SMEs, per se, yield systematic growth benefits (Beck, Demirguc-Kunt & Levine 2005). However, the same paper also finds that the overall business environment influences economic growth.

Given this context, the paper develops an analytical framework that is premised on enhancing the business environment in which SMEs operate. This framework is informed by four distinct theoretical perspectives: resource-based development in late industrialization (Barney 1991), institutionally based technological learning (Nelson 1993), network-based competitive strategies (Porter 1990), and the monopolistic competition model of trade (Krugman 1979). Our argument is that, as a late-industrializing open economy, the PRC can enhance the competitiveness of its industries by limiting its shortcomings as a late entrant, while tapping its unique strategic resources and its integration in the world economy.

The primary contribution of this paper is that it sheds light on these issues by proposing a strategy that is oriented toward small- and medium-sized firms. In particular, we make the case for a network cluster strategy that enhances the linkages between existing actors, while building on the PRC's existing NIS. We consider this strategy as particularly suited to the PRC at this stage in its development and transition, since the collective nature of the cluster may help resolve the problem of the "missing middle."¹

The rest of the paper is structured as follows. The next section presents a basic analytical framework for rapid industrial and technological catch-up based on the SME sector. Section 3 analyzes the PRC in terms of its internal strengths and weaknesses, within the framework of its national innovation system. It also includes a background discussion on the current status of SMEs in the PRC, as well as its industrial policies as they pertain to the SME sector. Section 4 then looks into several general global trends. These trends and economic imperatives are viewed as potential external threats to SMEs in the PRC. In response to these threats, it is necessary that the PRC actively harness national policies as a strategic tool for continued progress. These policies are the focus of the next section (Section 5), which is a discussion of the opportunities for future development, especially with regard to strengthening the PRC's NIS (drawing heavily on the analytical framework of Section 2). Concluding remarks will be made in the final section.

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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