The role of innovation-led profits in the development of an international financial centre

Michael, Bryane Article The role of innovation-led profits in the development of an international financial centre Journal of Innovation and Entrepreneurship Provided in Cooperation with: Springer Nature Suggested Citation: Michael, Bryane (2024) : The role of innovation-led profits in the development of an international financial centre, Journal of Innovation and Entrepreneurship, ISSN 2192-5372, Springer, Heidelberg, Vol. 13, Iss. 1, pp. 1-22, https://doi.org/10.1186/s13731-023-00338-4 This Version is available at: https://hdl.handle.net/10419/290326 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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RESEARCH Michael Journal of Innovation and Entrepreneurship (2024) 13:14 https://doi.org/10.1186/s13731-023-00338-4 Journal of Innovation and Entrepreneurship The role ofinnovation-led profits inthedevelopment ofaninternational financial centre Bryane Michael1,2* Abstract Qianhai—an innovation park in Shenzhen—has the possibility of boosting innovation in Hong Kong, Shenzhen and in the wider region. This paper reviews the existing evidence about which policies have promoted profitable innovation in the Qianhai region (Hong Kong and Shenzhen) in the past. We also point to the importance of profitable innovation—rather than just innovation for its own sake. Profits attract and keep firms in an international financial centre. Yet, until we know exactly how much profitability these innovative firms require and how to promote such profitability, the advice given in the literature to Qianhai’s and other policymakers will remain woefully inadequate. Keywords: Qianhai, Cross-border economic zones, Innovation, Special economic zones JEL Classification: P48, R12, R58 Introduction Qianhai represents the first of its kind—the attempt by two special economic zones to create another (common) economic zone. Behind the public declarations stand a vision to use the project to support R&D, innovative new companies in selected sectors, such as high-tech and logistics, and to attract capital as a way to bolster both cities’ position as national/international financial centres.1 How Qianhai affects the development of innovative firms in the region will determine the success of—what is effectively—a free trade/economic zone. Yet, What role can regulatory reform play in maximising Qianhai’s impact on innovation-led profits in the ‘Qianhai region’ (covering principally Hong Kong and Shenzhen)?2 We argue that the literature fails to discuss the profitability of innovation—making these studies unsuitable for determining the likely future of firms in places, such as *Correspondence: [email protected] 1 Asian Institute of International Financial Law, Faculty of Law University of Hong Kong, Cheng Yu Tower Pokfulam Road, Hong Kong, Hong Kong 2 Department of Geograph, University of Oxford, Oxford OX1 3QY, UK 1 Qianhai also represents an attempt to liberalise Mainland capital markets, integrate them with Hong Kong’s and encourage the repatriation of RMB. We do not discuss the capital market aspects of Qianhai, in order to focus on our main topic of supporting product/service market innovation. 2 Ambitiously, the government of Hong Kong, as of 2020, might not only include Zhuhai and Macao (the obvious nearby areas), but far away areas such as Foshan, Zhaoqing, and Huizhou! See Greater Bay Area, The Cities, available at https:// www. bayar ea. gov. hk/ en/ home/ index. html. Page 2 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 Qianhai. We address this lacuna in four branches of the finance-of-innovation and international financial centre literature. In the first section, we look at the special economic zone studies—noting how authors hope that increased proximity will miraculously lead to innovation (putting the cart before the horse). The second section looks at the innovation system literature. Again, these authors assume that with the right ‘institutional configuration’, innovation will just appear—again without looking at the profitability of such innovation. The third section looks at the way these international financial centres finance innovation. Authors writing in this vein stress attracting investment. They rarely (if ever) discuss the subsequent return on that investment that draws in this investment in the first place. The fourth section looks at the way investment in innovation ‘flows’ over international financial centres—like some wave that these centres try to attract with a range of policies. Increasing the profitability of innovation–investment never features as one of these policies. The final section concludes, by setting up the stage for future studies looking explicitly at the profitability of innovation in international financial centres. We do not argue or touch/upon a number of things. First, our ‘Qianhai region’ only covers Hong Kong and Shenzhen, conspicuously omitting Guangzhou (and to a lesser extent) Zhuhai. We do so given the physical proximity of Qianhai to the two megacities, as well as their complementarity (which we discuss in the article). Second, we do not compare Hong Kong and Shenzhen with other jurisdictions. This will disappoint readers who want to know how the optimal design could draw on “lessons” from other jurisdictions. We try to reference some of this comparative literature for interested readers in our literature review.3 Second, we do not review the profitability of innovation in general. As we focus on Qianhai’s promise, we want to assess the way an international financial centre’s policies (and its explicit, intentional creation) affects such profitability. We do not deny that—and thus have no need to review—once innovation becomes profitable, innovation-focused companies in an international financial centre will engage in investing in such profitable innovation. Third, we treat profitability as an all-of-nothing proposition. Either firms in an international financial centre are profitable—or not. Naturally, a range of outcomes, for different firms and at different times, may exist. What dowe know aboutfinance andinnovation intheQianhai region? Many of the so-called studies from the private sector paint Qianhai in glowing colours. Figure1 shows a way of thinking about the value of innovation in Qianhai, while Table1 provides the main conclusions reached by a number of example studies which looked at the likely effects of Qianhai on Hong Kong and Shenzhen. Most studies note that the successful development of Qianhai would ease Hong Kong’s real estate constraints, help attract funds (particularly in the form of off-shore RMB that Chinese seek to repatriate) and attract a critical mass of finance, IT, and logistics companies needed to create a self-sustaining business system. Most also raise the moot question of whether Qianhai will serve to accentuate complementarities between Shenzhen and Hong Kong or 3 A vast literature—exists showing readers how to supposedly import lessons from other jurisdictions. Block and Keller (2011) show how government agencies in the US helped foster technological innovation. Klerkx and Leeuwis (2009) describe the challenges for government agencies to encourage private agricultural enterprises to adopt innovative practices in the Netherlands. Page 3 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 exacerbate competition?4 These self-interested publications draw on the same implicit formula. Expanding the number and size of companies working in the Hong Kong and Shenzhen region (which we call the “Qianhai region” for reasons of convenience) will automatically increase innovation and profits. Without any reference to previous studies or any convincing story, these studies just assume that expanding the availability of real estate, providing incentives for information technology (IT) companies and money (both publicly and privately given), innovation and profits will inevitably arise. None of the existing studies talk about the core role of profits. The data falsely appear to confirm the common sense intuition that Shenzhen would supply the property rights (the brains) and Hong Kong would supply funding (or the financial brawn) to a joint Qianhai undertaking. Figure2 shows the scores from the What advantages would the creation of Qianhai generate for Hong Kong and Shenzhen? Would profitled innovation exceed the destructive influence of financial market and industrial competition? Most of the analyses boil down to the simple formula shown below. Qianhai could serve as nothing more than a glorified real estate development. Yet, with full participation by the Hong Kong and Shenzhen governments, Qianhai could represent the first special economic zone created by/from two special economic zones – with real twin cities’ benefits. Yet, these studies do not talk about Qianhai’s real raison d’etre – how the region will promote profitable innovation. Value of financial easing + tech company attraction + access to big market Qianhai innovation - costs from financial market and industrial competition Fig. 1 Implicit framework of Qianhai’s promoters. Source: Authors Table 1 Self-interested parties writing about a glorious Qianhai and their formulae for success Source: See individual sources for more information Author (and link) Major theses Colliers (http:// www. colli ers. com)Qianhai will promote innovation by relaxing space (real estate) constraints and easing the flow of money (RMB) to companies Credit Suisse (https:// resea rchandanaly tics. csfb. com/ docVi ew? docid= Yx09eI) Qianhai represents a platform for internationalising the RMB and Hong Hong’s high-tech service offerings into the Mainland Daiwa (http:// asiar esear ch. daiwa cm. com/ eg/ cgibin/ files/ Speci al_ Repor t__ Qianh ai_ Devel opmen t-_ 130422. pdf) Logistics plus finance and incentives to bring financial, technological, logistics and telecoms make for a unique geographical place of profit Cushman Wakefield (http:// www. cushm anwak efield. com/ ~/ media/ repor ts/ china/ Shenz hen% 20Qia nhai% 20Zone% 20Cus hman% 20Wak efield% 20EN. pdf) Qianhai represents a land extension for Hong Kong (as little geographical room to grow) 4 While the non-academic community continues to use the rhetorical device of Hong Kong versus Shenzhen as a way of attracting attention to their publications, academics have already shown that financial and other services in the region tend to specialise—like any sector in a freely traded economy. Aener etal. (2014) provide the data and academic references for such specialisation. Page 4 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 Global Innovation Index for 2015 for Shenzhen (which we calculated using regression analysis by using national China-level scores) and for Hong Kong.5 As shown in Fig.3, Shenzhen scores much higher in most of the “knowledge and technology outputs” (part 6) components of the dataset (Reynoso & Litner, 2015). Hong Kong appears to diffuse— rather than create—knowledge as well as provide a vector for collecting licensing and royalty fees and for sending money out of the China region. Given Hong Kong’s rank—of 29th place ranking out of 56 countries on the recent Global Innovation Index—Hong New business Docs H-Index Comm, IT, logistics Knowledge diffusion FDI outflows High tech exports High/medium tech output GDP growth Knowledge impact New businesses Software spending Royalties/licence fees Knowledge creation ISO9001 Publications Docs H-Index Hong Kong side of the figure Shenzhen side of the figure -60-40 -20 020406080100 120 Innovation Index Score (100 means Shenzhen best and -100 means Hong Kong is best) Fig. 2 Showing that Shenzhen provides the brains and Hong Kong the Financial Brawn. The figure shows the Global Innovation Index for Shenzhen and Hong Kong in 2015. We use China’s data as a base for calculating Shenzhen’s Innovation sub-indices. We adjust Mainland innovation scores, as the dependent variable, from a regression which regresses Shenzhen’s GDP per capita and its proportion of GDP in industry with the innovation scores held by other countries with similar levels of these GDP per capitals and industrialisation. In practice, we only needed to modify two variables (knowledge creation and know ledge impact) Source: Escalona and Litner (2015) 0102030405060708090100 Business sophistication Human capital and research Infrastructure Creative outputs Market sophistication Institutions Innovation Index Scores (higher are better) Hong Kong (in red) Shenzhen (in black) Fig. 3 Yet Hong Kong beats Shenzhen in the factors that make for profitable commerce’. The figure shows the Global Innovation Scores for China (as a proxy for Shenzhen) and Hong Kong. We do not adjust China’s scores to take into account Shenzhen’s particularities—as don’t want to confuse the reader by presenting data which have been highly modified. We also might argue that national policy determines most of these factors—thus Shenzhen might show little meaningful difference with the broader Mainland. Hong Kong can clearly provide the market oriented institutions, market sophistication, infrastructure, human capital and business sophistication needed to make Qianhai a success Source: based on data from Escalona and Litner (2015) 5 As explained in the figure, we treated Shenzhen as a separate jurisdiction, looking at correlations between similar jurisdictions and Shenzhen. With these differences in mind, we could adjust the China-level national scores up or down to reflect our regression outcomes. In practice, such a complicated technique turned out useless—as Shenzhen’s scores differed in only a few areas. Page 5 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 Kong needs to cooperate with Shenzhen on Qianhai to compete with other jurisdictions like the US or Finland.6 Yet, behind the self-serving analysis of companies looking to cash in on Qianhai, what do we already know from the academic literature about the way a Qianhai-style development might promote innovation-led profits?7 Table2 shows the clusters of research which directly or indirectly answer the question—what effect would Qianhai have on Hong Kong’s innovation-led profits? The first group of studies looks at the Closer Economic Partnership Agreement (CEPA) and other related agreements covering the region—ignoring recent initiatives like the Greater Bay Area initiative (given their number and seeming unimportance).8 Unsurprisingly, academics consider the largest positive benefits stemming from the usual gains from trade. Scholars have not specifically addressed the extent to which relaxing capital constraints and industrial policies (specifically choosing sectors rather than having market forces decide them) has contributed to this growth.9 In addition, they certainly have not considered the role of profitability on growth in the region. The special/border economic zone literature Several studies from this first group of studies claim to show how closer union between Hong Kong, Shenzhen (and the Guangdong region in general) helps promote at least growth—if not innovation. Figure4 shows that the Closer Economic Partnership Agreement (CEPA) supposedly has helped keep Hong Kong’s GDP up during—what would otherwise be—major slowdowns in GDP growth. According to this study, the CEPA contributed around 3–4% in GDP growth over the period the authors looked at. The figure also shows the purported effect of regional integration on generalized productivity (what economists call “total factor productivity”). The CEPA supposedly has increased such productivity. Naturally, increases in productivity necessarily frequently imply change in industrial innovation—as innovation makes production better, cheaper and so forth. Thus, the authors’ results for productivity might serve as a proxy for CEPA’s effect on innovation.10 Figure5, for its part, shows similar results—with the authors hypothesizing that Hong Kong could benefit from a “Guangdong effect”—which helps promote trade, innovation and productivity (Zhang etal., 2009). As Hong Kong’s manufacturing sector shrinks, Hong Kong’s manufacturers reduce duplication/ competition with Shenzhen 6 The Index uses the usual quantitative indicators of innovation policy—like patents, journal citations, spending per capita on R&D and so forth. Ezell (2016) provides more on these indicators. 7 We refer to the phrase “innovation-led profits” frequently in the text—to refer to profits that more and bigger companies could make from innovations which would not occur without agglomerating Hong Kong and Shenzhen. Any economic approach to innovation must accept to measure innovation as the probability-adjusted (weighted) long-term expected profit from companies engaged in creating new tech-related goods and services. 8 For example, the Greater Bay Area Framework Agreement represents another example of agreements to lower tariffs and increase trade/investment. A litany of agreements, such as those underpinning the Guangdong Pilot Free Trade Zone exist already. See Framework Agreement on Deepening Guangdong-Hong Kong-Macao Cooperation in the Development of the Greater Bay Area, available at https:// www. bayar ea. gov. hk/ en/ about/ agree ment. html. 9 Chen and Unteroberdoerster (2008) provide one of the most relevant studies for our purposes. They have mapped the economic clusters developing in and around the Hong Kong/Shenzen area. Shen (2014) looks imperfect flow of goods and information across the border, while Shen and Luo (2013) look at the way Hong Kong has opened up to regional integration in the Pearl Delta Region. 10 Xu and Yu (2012) find, using a completely different methodology that Shenzhen’s total factor productivity grew by around 5% per year. Page 6 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 and Guangzhou. Such shrinkage also helps resources move to more productive sectors. Yet, most studies of regional integration are so badly done that they provide a flimsy base from which to draw conclusions about Qianhai. We really do not know what effect regional integration had on innovation in the Qianhai region (Hong Kong and Shenzhen).11 The Hsiao etal. study created a model based on numerous other economies, to simulate what benefits might have accrued to the region. Based on these findings, they ran simulations—known as Monte Carlo simulations— to see what the benefits might have been, if we compared our reality with hundreds of other realities. The Zhang etal. (2009) study makes firm predictions about integration in the Pearl River Delta region by taking the results of a simple regression of GDP growth and total factor productivity on levels of integration (trade). Their specification suffers from problems with what economists know as “endogeneity bias”, “omitted variable bias” Table 2 Literature of relevance for the Qianhai Design Question Source: See cited authors for more information on these sources a Of course, talking about “Qianhai law” makes little sense (as the region has little if any administrative autonomy). We use this phrase as short-hand to talk about the relevant legal provisions affecting Qianhai’s operation Summary and major authors Description and Results CEPA (and special/border economic zone literature more generally) Chen and Unterober-doerster (2008), Shen (2014), Shen and Luo (2013), Hsiao (2012) Question: Based on previous experience with economic integration in the Guangdong region, would Qianhai actually generate benefits above/beyond the status quo? Result: Several poorly done studies show that regional integration has generated benefits so far. Yet, Hong Kong’s institutions and rule of law explain any profitgenerating innovation better than simple economic integration. Thus, if Qianhai can share some of Hong Kong’s institutions, the project would be much more successful Innovation Systems literature Baark and Sharif (2006), Xu et al. (2010), Fu (2011), Fu and Li (2011), Li et al. (2006) Question: What does it take to make an innovative area (cluster)? What parts of a Qianhai-law would lead to innovation-led profits (and thus demand for Hong Kong’s financial services)?a Result: Institutions represent a key constituent for growth. Given the tension between Hong Kong’s Anglo-Saxon “variety of capitalism” and Shenzhen’s “Continental variety of capitalism,” any Qianhai-law holds little promise of working in the medium-term. Moreover, forced growth (rather than organic growth) makes firms locating in Qianhai less likely to survive/thrive Finance of Innovation literature Cheung et al. (2015), Sharif and Huang (2010), Baark et al. (2011) Question: Will more govt-led finance in Hong Kong and Shenzhen actually result in innovation-led profits far in excess of the status quo? Result: Scholars can not agree. But complementarities between the two jurisdictions likely lead to conflict rather than cooperation Investment flow literature Girma et al. (2009), Wang and Wang (2011), Zhang (2010) Question: How to encourage investors in the Qianhai region and outside to invest in Qianhai-based companies? Result: Such a push probably mis-guided. Capital needs to go to highest productive use. Encouraging capital to go to Qianhai without existing great ideas distorts capital, labour and goods/services markets 11 The internet and journals are flooded with badly done quantitative studies looking at the effect of innovation on Chinese firm profitability. We do not have room to provide a full list, but refer the reader to authors like Zhu and Huang (2012). Page 7 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 and other misspecification error.12 As a more substantive critique, authors like Shen and Luo (2013) have found that political gains, more than economic gains, drove much of Hong Kong’s increased co-operation on integration with Shenzhen. The establishment of special economic zones in the Qianhai region might account for these results far more than any gains from regional integration. Figure6 shows the estimated effect of creating a high-tech industrial zone—like the proposed Qianhai zone—based on past experience (Alder etal., 2015). Accordingly, the establishment of Shenzhen-region high tech zones (more than economic and trade integration with Hong Kong) explain growth in the region. Other authors such as Jin etal. (2013) have shown how such zones—and especially the transport links that tie these zones together—result in productivity growth. These zones benefitted, because they were already industrialized areas.13 If Jin and co-authors’ findings reflect Qianhai’s future, creating a special economic zone ex nihilo will have very limited impacts on innovation. Yet, authors such as Sawyer etal. (2015) might argue that these gains came mostly from the resource accumulation due to the central government’s orders—and not from the natural attraction of resources according to Shenzhen’s comparative advantage. Because we cannot separate the innovation–creation effects from the innovation–diversion effects in these Fig. 4 A Casino study says that Hong Kong’s regional integration might have added an extra 4% to GDP growth -8 -6 -4 -2 0 2 4 6 Mainland Factor Trade with Guangdong Manufacturing Share Percent of variance the model explains change in GDP per \capita and overall economic productivity for a 10% change in... 73%72% GDP per capita Productivity (TFP) growth Fig. 5 A very misspecified econometric study finds evidence of a “Guangdong effect”. The figure shows the coefficients for regressions trying to explain Hong Kong’s GDP per capita growth rate and general productivity (what economists call "total factor productivity" or TFP). The figure show s trade with the Mainland, trade with Guangdong, and manufacturing’s share of Hong Kong’s GDP as explanatory variables. We also show the misleading percent of variation the model explains (know n to economists as the model’s R-squared). The model’s results are useless, as the authors failed to control for other factors which affect GDP growth (like labour used), they don’t take into account that GDP growth affects trade as much as trade affects GDP growth (called "endogeneity bias") and other problems Source: Zhang et al. (2009) 12 We do not have space to explain what these terms mean. For non-technical readers, they/you only need to know that the problems with the study mean that the results tell us nothing about integration in the region. 13 Barbieri and Pollio (2015) find—in an analysis of Guangdong special economic “enclaves”—that highly industrialised areas benefit the most from these zones. Page 8 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 studies, we can know the extent to which Qianhai would create innovation unavailable otherwise.14 As in other parts of economics, numerous authors such as Yang etal. (2011) are finding that institutions play a larger role in innovation than simple trade creation/expansion. A recent Asian Development Bank study focused on cross-border economic zones (like the proposed Qianhai scheme). The authors found that these cross-borders zones need their own special, unique policies to attract companies and related investment in the zone. Using relative simple statistical methods, these authors find that—contrary to the case in Shenzhen–Hong Kong region—these cross-border zones raison d’etre revolves around importing resources and lowering production costs.15 Qianhai would thus neither help import resources nor lower production costs significantly. Thus, governments on both sides of Qianhai’s cross-border economic zone should harmonize infrastructure, labour policies, and other market institutions so as not to create a divided city/region. Innovation systems literature The second branch of the literature (which we summarised above in Table2) focuses on the way that “innovation systems” have developed in the Qianhai region—and how they might interact. Such innovation system studies look at the way cooperation and competition between manufacturing/IT and service firms leads to profitable innovation.16Figure7 shows the constellation of innovation relationships around the Shenzhen region.17 Accordingly, Shenzhen’s innovation system revolves around university–company collaboration—with a wide range of one-to-one (called dyadic) connections. Thus, we do not know about the profitability of innovation. However, we do know that universities should serve as central actors in promoting innovation in the Qianhai region. What affects the rate at which these network relationships generate innovations? Fig.8 represents one example of a study seeking to answer that question. Innovative Fig. 6 Creating a Chinese new high-tech development zone has questionable impacts on GDP 15 One might view innovative ideas or even errant RMB as a type of resource. Yet, the study most specifically focused on materials and raw materials. 16 Several scholars like Baark and Sharif (2006) have studied Hong Kong’s innovation system—and such systems in the region overall. Baark and Sharif provide the historical background of Hong Kong’s innovation system. Boeing and Sandner (2011) describe the innovation system from the China side. 17 We focus on these relationships in Shenzhen as the Qianhai project physically sits in Shenzhen. 14 Zheng etal. (2015) use geographical data for the location of various industrial parks to look at which factors contribute to productivity growth in these parks. For the general sample—we can not separate out Shenzhen’s effects—they find that from productivity growth (or total factor productivity) comes denser output and input linkages, skill spillovers, and access to rail travel. Yet, broader industry change also plays a role. Page 15 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 innovation does indeed lead to growth. Yet, they also find that such innovation fragilizes the banking sector—making crisis more likely. Chang (2010) shows that financial innovation leads to firm innovation. The data—as shown in Fig.16—seem to suggest that foreign capital and foreign markets seem to encourage Chinese innovation. Local investment, according to this study, does little to foster profit-oriented innovation. Figure17, in contrast, shows that state-owned enterprises (SOEs) would have strong incentives to locate in Qianhai—despite the fact that such a location does not increase profits or necessarily lower costs. To the extent that Qianhai might be considered as an ‘overseas listing’—these SOEs which list there would do worse than private firms. Qianhai is thus likely to attract the least desirable companies for creating and sustaining new innovation—namely, state-owned enterprises (SOEs). However, for political reasons and loophole jumping reasons, rather than for profits. More evidence seems to point toward the futility of the present Qianhai design. The two figures below undermine Qianhai’s claims to promote innovation. Figure18 shows the effects of Chinese R&D, training, foreign capital, financial position, and subsidies on innovation levels. Figure19 shows access to finance for Chinese innovators as a result of the same variables. As shown, internal financial position (retained earnings), foreign capital and subsidies play an extremely marginal role in both fomenting innovation and attracting money. Interestingly, as Hanley etal. (2011) show, even though finance does not help individual firms innovate, the overall level of finance (credit) does correspond with higher rates of innovation outside of the Qianhai region! Zhao (2016), for his part, finds that deeper credit markets (for central and western regions) and equity markets (for coastal provinces) incentivize innovation at the provincial level. Hu etal. (2005) also find that foreign investment fails to promote the adoption of foreign innovations. Thus, the preponderance of the evidence suggests that finance only promotes innovation indirectly—through a still undiscovered causal mechanism. Wu etal. (2012)—as mentioned previously) further finds that companies with Hong Kong-based investors have less innovation than other types of investors. If true, Qianhai’s tax incentives and RMB repatriation mechanisms will have marginal, indirect effects on promoting innovation in the Hong Kong/Shenzhen region—and probably no effect at all. Fig. 16 In SOEs at least, foreign investment good and domestic investment bad (unless the SOEs engages in foreign-oriented activity) The figure shows the effect of the variables above on Chinese innovation. As shown, foreign direct investment, export orientation and R&D play pivotal roles in promoting innovation. See original study (Table 4) for variable definitions and econometric methods used. Source: Girma (2009) Page 16 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 What about private equity and venture capital? One might imagine that the rules of venture capital differ from other types of capital. Qianhai’s focus on IT, finance, and logistics suggests that competencies can develop in these specialist areas. Yet, Liu etal. (2010) find that venture capitalists in the Qianhai area do not specialise by industry or in any other way. Using econometric analysis, they find no evidence that venture capital-funded firms under-price their IPO share offering nor do they only choose the best -10 -5 0 5 10 regression/logit coefficients change in sales media exposurepolitical promotion change return on assets change marketadjusted returns political promotion Fig. 17 Politically Connected Would Choose Qianhai—even if companies do worse. The figure shows the regression coefficients for each of the variables shown (above and below each bar) as the dependent variable. These coefficients refer to the effect that political connections play in deciding to list overseas. Overseas listing (if Qianhai would be considered like Hong Kong as "overseas") would help promotion prospects even if the foreign listing correlates with worse financial performance (lower sales, return on assets and cumulative adjusted returns of the company’s shares). The toip coefficients refer to logit coefficients and the bottom to instrumental variables estimates. See econometrics textbook for more on these procedures. Source: Hung et al. (2012) 0 0.5 1 1.5 2 2.5 3 R&DTrainingExport intensityForeign KFinance Subsidies regression coefficient SOEs Pr ivate Fig. 18 Is Access to Chinese Domestic Capital and Subsidies Useless for Innovation? The figure shows the results of econometric analysis looking at the determinants of INNOVATION in Chinese companies. To the extent that Shenzhen’s companies reflect the wider Chinese situation, then Qianhai would not help promote innovation by putting more finance and subsidies on offer. See source for empirical methods and variable definitions 0 0.5 1 1.5 2 2.5 3 3.5 R&DTrainingExport intensityForeign capitalFinancial position Subsidies regression coefficient SOEprivate Fig. 19 Access to Chinese Capital Doesn’t Depend on Foreign Investment or Subsidies? The figure shows the results of econometric analysis looking at the determinants of FINANCE (specifically bank loans) for Chinese companies. To the extent that Shenzhen’s companies reflect the wider Chinese situation, then Qianhai would not help promote innovation by making putting more finance and subsidies on offer. See source for empirical methods and variable definitions. Source Girma et al. (2008) Page 17 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 (most potentially profitable) companies to work with.26 Wang and Wang (2011) find that senior management (CEO) experience in the industry in which the venture capital firm is investing remains critical to the investment’s profitability. Figure20 shows the way various factors affect the probability that a VC investment goes IPO. As shown, for companies with a former industry insider CEO-turned-venture-capitalist, the investee has about a 60% greater likelihood of going IPO. In a more recent paper, they also find larger post-IPO share price increases for firms with foreign venture capitalists (He etal., 2015). In the Qianhai context, one might interpret these findings in such as a way as to argue -300% -200% -100%0%100% 200% 300% R2 Syndicate size IPO Conditions M&A conditions VC affiliatijon* Founder Stays VC Industry Development Founder Leaves Founder Leaves Special CEO Experience VC Industry Developmen t VC Affiliation* M&A Conditions Syndicate Siz e Portfolio Company Qualit y IPO Conditions Foreign VC Human Capit a Founder Stays Domestic CEO Experience R2 statistically significant factors insignificant factors Fig. 20 Chinese Industrial Magnates, Rather than VC Specialists Make for the Best. The figure shows the extent to which the factors shown affect a Chinese company’s prospects of going IPO. We have changed the scale for this logit regression—to make more clear that an effect of 100% or more means that the probability of going IPO changes by one standard deviation or more. Source: Wang and Wang (2011) These people claimthatHong Kong’s innovation ranks poorly. Yet, forthe development of the source → sink ↓ Beijing Shanghai Shenzhen Hong Kong Overseas Beijing 3595 49029240 749 Shanghai 3923248 123205973 Shenzhen72 159229 30185 Hong Kong 26 16 060 0 Other8501323334 327226 Fig. 21 Would Qianhai simply divert money going to and coming from China? The figure shows the paths of co-investment funding among China’s and foreign venture capitalists and the amount of venture capital funding in 2008. Source: Zhang (2010) 26 These results do not necessarily hold for the entire Chinese equity market. Wu etal. (2012), for example, find evidence of venture capitalist under-pricing during their investee companies’ IPO—and delimit five conditions which affect the extent of such under-pricing. Page 18 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 that Hong Kong venture capital can help add value to Shenzhen-based companies planning on listing (and others). Yet, profits remain conspicuously absent in all these stories. Will Qianhai add to the stock of innovation or simply displace innovation from other parts of China? Fig.21 shows the flows of venture capital funds destined for China. Authors like Fan and Wan (2006) argue that Shenzhen (and Hong Kong) can produce innovation without government support of high-tech parks—and such support results in unnecessary “inequality in innovation capacity.” In other words, government policy shifts R&D geographically, rather than increasing innovation in the China region. Shenzhen has access to money and ideas—many of which may serve Shenzhen-based firms with locations outside of Guangdong.27 Even if Shenzhen does manage to fill out (with high tech firms), several authors like Zhao and Arvanitis (2010) have questioned whether non state-owned enterprises could innovate in a policy environment hostile to them. Strong centrifugal forces tend to push finance (and thus potentially innovation) to Beijing and Shanghai.28 If we knew the rates of profitability in these areas, we would not have to talk about centrifugal forces. These people claim that Hong Kong’s innovation ranks poorly. Yet, for the development of the financial centre, Hong Kong does not need to rank highly. Instead, the companies it funds should rank highly. As such, looking at Hong Kong is erroneous. Thus, the literature points to three robust conclusions. First, money spent on innovation by local governments will likely be wasted. Any design for Qianhai should encourage foreign investment—preferably using Hong Kong and a conduit for foreign investment rather than as a source of investment itself. Second, joint research projects, platforms, and university joint ventures will determine the way of promoting innovation in the region. Third, the current structure of Qianhai will likely have no effects on innovation in the region. Policymakers must pursue another design—focused on harmonizing institutions—rather than investment regimes—across the Shenzhen/Hong Kong border. Yet, we can not trust any of these conclusions without knowing the effect of policy on profits. No amount of local government support or university incubation will keep unprofitable firms in Qianhai. Qianhai firms must not only earn profits, but earn profits higher than those available in Hong Kong, Shenzhen—as well as in all the other financial centres (as per opportunity cost). Until we know how profits attract innovative firms to a financial centre—we will not be able to say if Qianhai will succeed or fail. Never has a future research agenda been so clear. Conclusions Does Qianhai—a glamorized real estate development project so far—hold the potential to radically reshape innovation policy and finance in Hong Kong and Shenzhen? To date, policymakers and analysts alike misguidedly focused on investment and innovation— ignoring the vital role of profit. Companies will move to Qianhai—just as Qianhai will ‘move’ into Hong Kong and Shenzhen—in search of higher profits. Governments and companies will participate in the Qianhai project if they can make more profits doing so 27 See Bichler and Schmidkonz (2012) for more on the Chinese Innovation System, and Shenzhen’s place in it. 28 Even though the Zhao etal. (2004) study appeared in the early 2000s. Page 19 of 22 Michael Journal of Innovation and Entrepreneurship (2024) 13:14 than they do now. Yet, the literature completely ignores the profit motive in describing/ predicting likely investment in innovative Qianhai-based firms. Our paper unabashedly sets the stage for future econometric work looking innovative firms’ profitability in determining whether an international financial centre, like Qianhai, succeeds or fails. We show the results of previous econometric studies finding serious fault with innovation policies in the Hong Kong—Shenzhen area (an area we optimistically refer to as the Qianhai region in this paper). Yet, these misguided studies assume that innovative firms will come and stay for every reason except the one that matters most—profitability. Will Qianhai’s regulations and other design features (like location, access to capital and so forth) allow for the sufficiently high profits needed to improve Hong Kong’s and Shenzhen’s competitiveness as international financial centres? Will Qianhai even develop as an international financial centre in its own right? Further econometric study will tell. Abbreviations CEO Chief Executive Officer CEPA Closer Economic Partnership Agreement GDP Gross domestic product IPO Initial Public Offering IT Information technology R&D Research and development RMB Renminbi (Chinese currency) SOEs State-Owned Enterprises VC Venture capital Acknowledgements Hong Kong Research Grants Council RGC Theme-based Research Scheme (TRS) Financial Technology, Stability, and Inclusion T35-710/20-R. Author contributions I contributed everything to this paper. Funding We would like to thank the Research Impact Fund Balancing the Opportunities and Risks of Financial Technology: FinTech Regulation and Policy (Grant number R7054-18) for their financial contributions. All errors remain our own. Availability of data and materials All data come from easily obtainable public sources. 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He completed his graduate level economics education at Harvard and Oxford, and his legal degree at King’s College London.