While conventional wisdom considers research investment and human capital the wellsprings of innovation, a more subtle catalyst has perhaps been overlooked: the quality of institutions, especially at the regional and local level. This column exploits the staggered implementation of government agency reforms in China to examine the impact of institutions on innovation. It finds that the regions which pioneered these reforms have reaped the rewards of reduced bureaucratic friction and enhanced regulatory efficiency, manifesting in marked gains in innovation performance. The dividends of institutional reform are most pronounced in city-regions already endowed with robust innovation infrastructure and intellectual capital.
Innovation has emerged as the lodestone of economic development and competitiveness in our time (Kogan et al. 2017). Yet while the usual suspects – investment in research and development, human capital, and infrastructure – have commanded attention, the catalytic role of institutional quality, particularly at the subnational level, remains curiously underexplored. This oversight persists despite mounting evidence that robust local institutions can profoundly shape the destiny of innovation ecosystems.
In China, where constant economic changes continue to transform cities and regions with remarkable speed, local institutional reforms offer an unprecedented laboratory for examining this gap in our understanding and assessing how governmental efficacy might nurture innovation and reduce the risk of economic stagnation. Our recent research (Zhang and Rodríguez-Pose 2024) delves into this relationship, focusing on the transformative potential of government agency reforms in galvanising innovation across Chinese city-regions.
The institutional landscape of innovation
Institutions are the cornerstone of economic systems, with their influence reaching from property rights to the rule of law. They can serve as either midwife or mortician to innovation, often determining whether regions can attract investment, nurture business growth, and retain talent. Institutional scholars have demonstrated that high-quality governance can effectively dissolve administrative barriers and reduce transaction costs for firms, thereby providing a fertile soil for innovation (Rodríguez-Pose and Zhang 2019, D’Ingiullo and Evangelista 2020). Tebaldi and Elmslie (2013), for instance, revealed significant cross-country variations in patent production attributable to institutional structures, while research by Donges et al. (2023) showed how improved governance in French-occupied German regions drove long-term innovation.
Moreover, theoretical frameworks abound, with social filter and innovation ecosystems theories suggesting that institutional weakness – manifested in inefficient governance, lack of transparency and accountability, or outright corruption – can suffocate innovation by fostering a hostile environment for economic actors (Rodríguez-Pose 1999, Morgan 2007). However, most scrutiny of how institutional constructs shape innovation has been confined to national-level institutions. Yet the efficacy of institutions often varies dramatically across regions within a single country, particularly in behemoths like China. Regional disparities in institutional quality shape the extent to which local governments can implement policies conducive to innovation, suggesting an urgent need to assess how subnational reforms influence local innovation performance (Rodríguez-Pose and Di Cataldo 2015).
A natural experiment in institutional reform
From 2009 to 2016, China embarked upon a remarkable odyssey of institutional reform targeting local government agencies. Historically centralised and encumbered by inefficiencies, China’s Administration for Industry and Commerce (AIC) agencies underwent a gradual transformation into Market Supervisory Authorities (MSAs) in a decentralised reform effort aimed at raising regulatory efficiency and market oversight. The reforms bestowed greater autonomy upon local agencies, streamlined procedures, and eliminated redundancies. Unlike top-down, one-size-fits-all initiatives, the AIC-to-MSA reforms were voluntary, triggering considerable variation in implementation timing across city-regions. Early adopters of these reforms, with Shenzhen leading the vanguard, implemented changes that dramatically compressed business licensing times and simplified administrative requirements, fashioning a more hospitable environment for innovative firms. Shenzhen’s example soon inspired emulation across China. Yet not all cities embraced the reform, some remaining – whether through inertia or convenience – anchored in the old system (Figure 1).
Figure 1 Government agency reform
Note: “Early adopters” denote city-regions that finalised the government agency reform by 2014, “Late adopters” those that executed the government agency reform between 2015 and 2016, and “Non-adopters” encompass city-regions that had not yet initiated the reform by 2016.
Institutional reform as a boost to innovation
We leverage this staggered rollout as a natural experiment to examine how these reforms influenced regional innovation outcomes. We find that city-regions that adopted the MSA model early witnessed more robust growth in innovation. Early adopters of the reform saw marked increases in innovation, particularly in regions with medium to high baseline innovation levels (Figure 2). For example, Shenzhen, the trailblazer in AIC reforms, streamlined business licensing and consolidated regulatory functions, reducing the average time to obtain operational licences from nearly 23 days to 8.5 days. This reduction in bureaucratic drag not only enhanced business efficiency but also attracted high-quality talent and investment, contributing to Shenzhen’s ascendancy as a national and global innovation hub.
Figure 2 Evolution of patenting per capita by the timing of the reform
Further analysis reveals that the reform’s impact was not uniform: it proved most pronounced in city-regions already possessed of some measure of innovation infrastructure and human capital. These findings align with other studies showing that institutional reforms prove particularly effective in places where economic actors can respond to enhanced governance by intensifying innovation activities (Rodríguez-Pose and Zhang 2019). For less innovative regions, however, institutional reforms alone may prove insufficient to spark innovation without concurrent investments in education, skills, and infrastructure.
The broader implications of China’s local reforms for innovation policy
The implications of these findings are twofold. First, they underscore the paramount importance of localised institutional quality in fostering innovation. While China’s central government has choregraphed economic reform efforts, often linked to reforms in corporate taxation (Chen et al. 2018) or to limit corruption (Zhao et al. 2017), the experience of local agency reforms suggests that decentralised institutional adjustments can yield remarkable economic benefits. Indeed, reforms tailored to the needs and capacities of specific regions may prove more effective than one-size-fits-all policies. In Europe, for instance, Rodríguez-Pose and Ketterer (2020) argue that improving government quality in lagging regions demands targeted interventions rather than universal solutions.
Second, this study brings to the fore the potential of institutional reform to act as a powerful development driver in emerging economies. The experience of Shenzhen and other early reform adopters in China demonstrates that institutional enhancements can facilitate not merely incremental improvements but transformative economic shifts. The success of Shenzhen’s MSA model has inspired other cities to follow suit, suggesting that effective local governance can amplify the broader goals of national development policy.
Lessons for policymakers: Towards tailored institutional interventions
China’s government agency reform illustrates that institutional quality at the local level serves as a critical lever for innovation-driven growth. For policymakers, the key insight is that enhancing regional institutions can yield substantial returns, particularly in city-regions poised for innovation. Effective institutions reduce transaction costs, safeguard property rights, and diminish corruption, creating fertile ground for investment in high-risk, high-reward activities like R&D. However, as demonstrated in both China and Europe, the success of institutional reforms depends profoundly on context. City-regions with higher innovation capacity tend to derive greater benefit from these changes, suggesting that reforms ought to be tailored to regional characteristics. In our case study, in already highly innovative region, the immediate gains from MSA reform are manifest, while in regions with lower initial levels of human capital or economic complexity, additional reforms in education and infrastructure might prove necessary to amplify the benefits of institutional improvements. A phased approach to institutional reform, coupled with continuous evaluation and adaptation, is likely the most adequate pathway for countries marked by high levels of regional inequalities in wealth and innovation, ensuring that reforms remain aligned with local economic conditions and capacities.
The Chinese experience also underscores the virtue of policy experimentation and evaluation. The staggered rollout of AIC reforms created natural laboratories for assessing the efficacy of different approaches. Nations facing similar challenges, particularly those marked by stark regional disparities, might profit from a measured approach to institutional reform, gauging outcomes at each stage and calibrating strategies accordingly.
Conclusion
In an age where innovation determines the fault lines between economic resilience and fragility, our research has put in evidence the imperative of calibrating institutional reforms to regional contexts, suggesting that improvements in local governance can serve as the decisive lever for promoting innovation in areas of latent potential. For China, this reform-driven boost to innovation not only aligns with national economic imperatives but also strengthens regional resilience and inclusivity, addressing the challenge of uneven development. For the rest of the world, the Chinese experience offers a compelling blueprint for policymakers worldwide seeking to harness local institutions for balanced and sustainable innovation and growth.
Source : VOXeu
