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A Systems View Across Time and Space

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


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 innovationrather 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.


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.Footnote 1 How Qianhai affects the development of innovative firms in the region will determine the success ofwhat 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)?Footnote 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 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 studiesnoting 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 appearagain 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.Footnote 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 exacerbate competition?Footnote 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.

Fig. 1
figure 1

Source: Authors

Implicit framework of Qianhai’s promoters.

Table 1 Self-interested parties writing about a glorious Qianhai and their formulae for success

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 Global Innovation Index for 2015 for Shenzhen (which we calculated using regression analysis by using national China-level scores) and for Hong Kong.Footnote 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 IndexHong Kong needs to cooperate with Shenzhen on Qianhai to compete with other jurisdictions like the US or Finland.Footnote 6

Fig. 2
figure 2

Source: Escalona and Litner (2015)

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)

Fig. 3
figure 3

Source: based on data from Escalona and Litner (2015)

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

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?Footnote 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 regionignoring recent initiatives like the Greater Bay Area initiative (given their number and seeming unimportance).Footnote 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.Footnote 9 In addition, they certainly have not considered the role of profitability on growth in the region.

Table 2 Literature of relevance for the Qianhai Design Question

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.Footnote 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 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.

Fig. 4
figure 4

A Casino study says that Hong Kong’s regional integration might have added an extra 4% to GDP growth

Fig. 5
figure 5

Source: Zhang et al. (2009)

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

We really do not know what effect regional integration had on innovation in the Qianhai region (Hong Kong and Shenzhen).Footnote 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” and other misspecification error.Footnote 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.Footnote 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 studies, we can know the extent to which Qianhai would create innovation unavailable otherwise.Footnote 14

Fig. 6
figure 6

Creating a Chinese new high-tech development zone has questionable impacts on GDP

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.Footnote 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.Footnote 16 Figure 7 shows the constellation of innovation relationships around the Shenzhen region.Footnote 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.

Fig. 7
figure 7

Source: Xu et al. (2010)

The Shenzhen University-industrial innovation network highly fragmented. The figure shows the number of groups (clusters) formed when a Shenzhen-based university applies for patents with local companies. The roughly 240 institutions form highly fragmented relationships with each other (as shown by the large number of “sticks” and few “spider webs”). The bottom part of the figure shows the frequency of each type of group—from most sparse to most lush

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 interaction and firms’ own innovation count much more for innovation than training, education, firm experience and other factors. The authors importantly find that ownership structure and even innovation supposedly “imported” from abroad have no positive effects on the “innovative performance” of Shenzhen-based firms.Footnote 18 Yet, not all innovation (or R&D resulting in that innovation) is the same. Gau et al. (2015) find that when innovative firms list on an exchange, they engage in “exploitative” rather than “exploratory” R&D. To the extent that Chinese firms engage in R&D, new product development accounts for roughly 13% of such R&D expenditure (Jefferson et al. 2006). Lau et al. (2010) found that Hong Kong based manufacturers innovate more with supplier–customer integration, when they co-develop new innovative products, and when they share information with others in the business system (suppliers, customers, etc.).

Fig. 8
figure 8

Source: Fu (2011)

Shenzhen innovation system centres around university-company partnership and own R&D. The figure shows the results of surveys, of 167 Shenzhen electronics firms, asking about the importance of various methods for producing electronics-related innovations. These results represent the b-value coefficients for a logit regression. In other words, a ten unit increase in a Shenzhen electronics firms ow n innovation results in 8 units of "innovative performance" (whatever that is). Intergroup training and training from the customer result in harms rather than been its. In Shenzhen, unlike in other Chinese cities, the ownership structure, firm size, extent of foreign led innovation, training from a multinational’s headquarters and training done via Guanxi relations have no statistically significant effect on innovative performance

Yet, simply enlarging the scale of such cooperation does not ensure the broader development of profit-generating innovation. Ben and Wang (2011) find that industrial parks which are too large also result in just as inefficient production (and thus have the same lower productivity) as parks which are too small. Qianhai represents one of the largest industrial parks proposed to date. Even if local officials could grow a very large industrial park area, they have no guarantee that firms based there could profitably absorb and use innovative ideas (as Boeing et al. (2010) show). Authors like Yasar (2013) find a strong positive statistical relationship for Chinese firms in general between outside investment and firms’ “absorptive capacity.”Footnote 19 As shown in Fig. 9, collaboration with universities represents one way of developing such absorptive capacity. Chinese firms that made alliances with Hong Kong-based (and other) universities innovated more.Footnote 20 Alliances with local Mainland universities brought no such significant innovation. These data suggest that Qianhai companies would benefit more from their access to Hong Kong’s universities than from the zone per se. These results thus imply that a Qianhai, without significant Hong Kong participation, would just remain another property development project.

Fig. 9
figure 9

Source: Fu and Li (2011)

Qianhai’s destiny likely tied to cooperation with Hong Kong’s universities. The figure show s the parameter estimates for Tobit regressions on the extent of novel innovation (as sales of newly conceived products) and diffusion innovation (sales of improved versions of products already on the market). Cooperation with Newly Industrial Economies (NIEs)—which we take in this context as Hong Kong, Taiwan, Singapore and Korea (due to similar use in other papers in this literature)—varies strongly and closely with such innovation

Numerous studies support the finding that the overall policy environment—rather than targeted sectoral innovation policies—unsurprisingly explains much of the performance of innovation systems in these special economic zones. Bhattacharya et al. (2015), for example, find that stability in the policy environment is more important than the type of innovation policy pursued. Du et al. (2008) find that institutions providing for contract enforcement and IP protection explain why foreign investors choose one province or city over others. Yueh (2006), for her part, shows how the protection of property rights (through patent law) explains much of the variation in output-generating innovation across Chinese regions. Eberhardt et al. (2011) find that a limited number of companies account for most of China’s patents. As shown in Fig. 10, we see that large industrial giants file for most Chinese patents. The authors don’t explicit say it—but Chinese companies seemed to take out US patents when trying to protect a more commercially profitable product or process invention.Footnote 21 Cumming et al. (2006), for their part, show that legality affects IPO or private exits much more than factors like stock market capitalization, market conditions, the skill of the VC fund manager, fund characteristics, as well as firm and transaction attributes. Li et al. (2006) find, in their own statistical study of Shenzhen, that poorly defended IP rights in Shenzhen stifles industrial innovation. Studies like these tend to show that the institutional environment in Qianhai will matter far more than any tax rebates or even capital account liberalisation rules Qianhai adopts. The profitability of innovation appears in none of these stories.

Fig. 10
figure 10

Source: Eberhardt et al. (2011)

Innovation in China relies more on membership in Financial industrial group and applicable law more important than geographic proximity. The figure shows the proportion of total Chinese patents received by the companies shown. For example, Hongfujin filed for roughly 25% of all US patents during the time period covered by the authors. The high proportion of patents going to China’s industrial giants casts doubts on the ability of a Qianhai to grow a mass of entrepreneurial companies which will dominate patent filings in the future

Finance of innovation literature

The third branch of the literature deals with the effect of finance on innovation. More spending in the Qianhai region—either by government or industry—as this argument goes, can help generate the innovation needed to boost profitability, and thus investment in Hong Kong and Shenzhen. Writers such as Cheung et al. (2015) and Naubahar and Baark (2005), for example, erroneously argue that Hong Kong’s R&D spending needs to rise to facilitate the development of innovative companies. Hong Kong’s Commission on Strategic Development’s (2015) analysis comes to much the same conclusion.Footnote 22 Zhang (2009) represents another “dim sum” style analysis—offering a wide range of potential policies—with scant empirical support. Yet, these studies imply thatgiven Shenzhen’s vast lead over Hong Kong in many areas of innovation policy, any policy aimed at looking at Hong Kong (or Shenzhen) in isolation is misguided.

The evidence on government support for innovation in Hong Kong and Shenzhen provides no clear cut answers. From international studies, authors, such as Brander et al. (2015), show that government funded venture capital augments—rather than replaces—private finance. When government and private start-up investors participate together, the resulting firms are more successful and more likely to list on publicly-traded equities markets. In the Hong Kong context, Sharif and Huang (2010) show that ventures on the Mainland tend to survive longer and do better when Hong Kong companies invest in their R&D more heavily. As further shown by these two researchers, shown in Figs. 11 and 12, Huang and Sharif (2009) show that R&D investment represents a far more useful vector of innovation than money from Hong Kong (or abroad). These results cast doubts over the “division of labour” between Shenzhen (strong in production and innovation) and Hong Kong (strong on finance). Worse still, these results would suggest that the Qianhai project represents a zero-sum game—where Shenzhen’s gain could be Hong Kong’s loss.Footnote 23

Fig. 11
figure 11

Source: Huang and Sharif (2009)

R&D intensity far more important than Hong Kong Sourced Investment as Source of Industrial Growth. The figure shows the regression coefficients for innovation growth (with industrial value added as the dependent variable). The original paper looked at capital from Hong Kong, Taiwan and Macau—which we cannot disaggregate into Hong Kong only. We thus label the effect of this capital as from Hong Kong and Other (with Macau and Taiwan representing the other). We show only one model’s results out of many (the most relevant model in our opinion). See the original for more details.

Fig. 12
figure 12

Source: Sharif and Huang (2010)

Does Hong Kong and Shenzhen Government Financial Aid for Innovation Actually Hurt Innovation? The figure shows the extent to which various factors explain a firm’s share of a new products market and R&D/innovation on the Mainland. For example, firms with support from the central government in Beijing tend to capture a greater share of it’s new products market-niche. The effect of financial support from local governments in the Guangzhou region (Hong Kong and Shenzhen) remains much less clear. The authors show one model where the effect of such support hurts innovation—and one which helps innovation.

Several authors have highlighted the futility of government spending as a way of promoting innovation in the Qianhai region. Guo et al. (2014) find that only government funding from the central government would have a positive effect on firms in the Qianhai region. Financing for innovation from Hong Kong actually correlates with the loss of market share (albeit with increased R&D spending).Footnote 24 Yet, as shown in Fig. 13, work by Guo et al. raise doubts about even the central government’s ability to spend their way into innovation. They find that government support only microscopically helps regional firms improve profits and patent production. More worrying, Baark et al. (2011) find that such product market shares do not even depend on the typical factors often associated with innovation policy—like more machines, R&D capacity or cooperation with universities in the Qianhai region and abroad. As shown in Fig. 14, internal departments’ activity seems far more important for product market share than these other factors. If true, these kind of results cast doubt both on Hong Kong’s ability to use finance to promote innovation at home and in the overall Qianhai region. They will need these firms’ own profitability to provide the impetus for further investment.

Fig. 13
figure 13

Source: Guo et al. (2014)

Maybe Effect of Sales and Government Support Is Too Small to Measure? The figure shows the regression coefficients for the amount of Chinese innovation fund support given to firms and these firms’ total sales on dependent variables like obtaining new patents, new product sales, increasing export volumes, increasing prof its to sales and exports to sales. We multiplied these regression coefficients by 1000, as the effects were to small to show in a graphic. For new patents, new product sales, and export volumes, we show the true regression coefficients about the bar (namely 341, 314 and 422 out of one thousand). None of the authors’ many models explained more than 5% of the variance in the original dataset.

Fig. 14
figure 14

Source: Baark et al. (2011)

Product Competitiveness Depends on Stakeholders More than Other Factors? The figure shows the effect of a one standard deviation change in each of the variables shown on Hong Kong and Pearl River Delta companies’ "product competitiveness."

Similarly, mixed evidence appears on the use of tax and other incentives to stimulate innovation-led growth. In their 20 year old paper, Tung and Cho (2000) find that tax incentives encourage investment. Alix-Garcia et al. (2014) show that Shenzhen (and Hong Kong), as a well-studied export zone, would likely benefit far less from a Qianhai scheme than less developed urban areas. Yet, if Shenzhen reacts to tax incentives the same way that Shanghai did, Zhu et al. (2006) data predict that tax incentives will distort investment away from profit-increasing innovation in Qianhai.

Scholars and policymakers agree that any innovation policy must hinge on funding from private sector companies themselves. Figure 15 shows Hong Kong’s R&D funding compared with other jurisdictions. As shown and oft-mentioned, Hong Kong spends less on R&D than other jurisdictions. Yet, as a proportion of total spending, the private sector supplies more money for R&D than the government. As the data from these other jurisdiction imply—Qianhai’s innovative companies must rely more on private sector funding than government funding. Thus, market profits—rather than government support or other measureswill likely draw investment into Qianhai’s innovation system.

Fig. 15
figure 15

Source: Cheung et al. (2015) based on OECD and Hong Kong Government data

Does the Qianhai-Model of Innovation-System Development Serve Hong Kong Better than a Scandinavian One? The figure shows spending on R&D as a percent of GDP. The red part shows government R&D spending (as a percent of GDP) while the entire bar shows total spending. Such a dichotomization highlights the role of government versus private sector in funding R&D.

What about the Hong Kong’s role as a financial centre? Will Qianhai encourage funds to flow from Hong Kong’s financial institutions to Shenzhen-based financiers and innovative companies? Li (2007) finds that changes in Hong Kong’s stock market index “causes” changes in Shenzhen’s—suggesting that funds do flow from Hong Kong north. At least, he finds integration in a study looking at how share price variance in one market translates to other markets. Qiao et al. (2008) and others like Johansson and Ljungwall (2009) also find integration between markets—and show that the further deregulation of equity markets in Qianhai would lead to far more shareholding (depth). Zhang presciently finds that Hong Kong direct investment in the Mainland should decrease as China’s low labour costs evaporate.Footnote 25 Lee (2009) finds that Mainland exchanges provide more liquidity for issuers—casting further doubts on any advantages Hong Kong can provide in channelling money to innovative firms.

Despite the linkages between Hong Kong and Shenzhen financial markets, share price changes do not provide enough information about changes in profitability inside the companies to prove useful for our purposes. Gul et al. (2010), for example, show low levels of “synchronicity” (or the extent to which changes in share prices reflect firm-specific rather than market-specific factors) for Chinese equity markets. Even if share prices reflect company specific information in the short-run, they reflect economic fundamentals of China in the longer run (Liu & Sinclair, 2008). Listing through some form of Qianhai scheme—where firms list in Hong Kong, Shenzhen, both, or through some kind of “stock connect” programme—affects levels of cash at primary offering (Karreman & van der Knaap, 2012). However, changes in share prices would have a much weaker link when trading on secondary markets. Despite correlations between Hong Kong share prices and Shenzhen share prices, share prices in both jurisdictions do not contain enough firm-specific information to shed light on the relationship between innovative firm profitability and innovation.

Investment flow literature

What about the other claim for Qianhai—that financial innovation (in the form of easier repatriation of RMB) could promote innovation? Beck et al. (2012) find that financial 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. 16seem 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 loop-hole jumping reasons, rather than for profits.

Fig. 16
figure 16

Source: Girma (2009)

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.

Fig. 17
figure 17

Source: Hung et al. (2012)

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.

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. 18
figure 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

Fig. 19
figure 19

Source Girma et al. (2008)

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.

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 (most potentially profitable) companies to work with.Footnote 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 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.

Fig. 20
figure 20

Source: Wang and Wang (2011)

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.

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.Footnote 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.Footnote 28 If we knew the rates of profitability in these areas, we would not have to talk about centrifugal forces.

Fig. 21
figure 21

Source: Zhang (2010)

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.

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, Shenzhenas 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.


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 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 mostprofitability.

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.

Availability of data and materials

All data come from easily obtainable public sources.


  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

  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.

  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.

  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.

  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

  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.

  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).

  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.

  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.

  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.

  18. See original study for definitions of “innovative performance” and the other factors in the study.

  19. Yasar (2013) uses the employment of knowledge workers like engineers, technicians and managers—as well as firm size – as a gauge of these firms’ absorptive capacity.

  20. Huang and company (2013) find similar results with techno-parks in and around Beijing. Local government support proved un-useful—but links with Hong Kong helped foment innovation.

  21. This argument relies on the interpretation of the authors’ results concerning SIPO (Chinese) and USPTO (USA) patents. They show how Chinese IT companies which had been particularly worried about their intellectual property, would take out a USPTO patent rather than—or in addition to—a SIPO patent.

  22. Their analysis represents a hodgepodge of ad hoc solutions covering a wide range of policy areas. Presumably the approach they adopt consists of trying everything and see what works.

  23. Such an outcome depends on income and substitution effects of R&D spending. A zero-sum game ensues if R&D funders must choose between Hong Kong and Shenzhen. If R&D spending expands profits in the longer run, then total R&D spending could rise in both places. We know of no study looking at the effect of R&D spending to generate further R&D spending.

  24. Our interpretation of this study contradicts the authors’ own interpretation of their results. They argue that their finding support the view that Innofund finance improved innovation-related outcomes. We argue not always (as highlighted in the main text). We leave it to the reader with a doctoral background in economics to decide which interpretation is right, given the results reported in the paper’s many figures.

  25. Indeed, Qianhai will have the effect of helping to equity returns to labour and capital in both markets. In this way, If Zhang’s findings still hold, Qianhai-related integration should remove the advantages that cause(d) Hong Kong investors to invest on the Mainland in the first place.

  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.

  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.



Chief Executive Officer


Closer Economic Partnership Agreement


Gross domestic product


Initial Public Offering


Information technology


Research and development


Renminbi (Chinese currency)


State-Owned Enterprises


Venture capital


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Hong Kong Research Grants Council RGC Theme-based Research Scheme (TRS) Financial Technology, Stability, and Inclusion T35-710/20-R.


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.

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Michael, B. The role of innovation-led profits in the development of an international financial centre. J Innov Entrep 13, 14 (2024).

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