As China transitions towards innovation-led growth amidst global economic pressures, its small and medium-sized enterprises (SMEs) find themselves at a crossroads. While China’s private sector boasts globally leading enterprises that dominate international markets with innovative products, the vast majority of its private companies are less prominent SMEs facing significant challenges.
Accounting for 90 percent of China’s private sector, these SMEs often lack the substantial resources necessary for large-scale research and development. With limited access to investment and striving to stay afloat, they must navigate a rapidly changing landscape both domestically and internationally.
To explore what the future holds for these SMEs, we spoke with Christoph Loch, former director of the University of Cambridge Judge Business School. Loch emphasizes that while innovation is crucial, it should be viewed beyond the narrow scope of cutting-edge high-tech advancements.
“High-tech is often seen as a magic wand to solve all economic problems,” says Loch. “While essential, especially in areas like AI, quantum computing, and nanotechnology, it’s a misconception to believe that these alone will create all the solutions.”
Loch argues that innovation must become pervasive across all levels of enterprise, especially within SMEs. “Innovation in this discussion is viewed just too narrowly. Every advanced economy relies not only on a few big companies conducting fundamental research but also on the multitude of SMEs that adopt proven technologies to enhance their operations,” he explains. “These companies use innovation to improve processes, develop new products, and find new ways of engaging with customers. That’s where the huge lever lies.”
According to the World Bank, firms play a crucial role in adopting sophisticated technologies for producing goods and services, which in turn leads to higher productivity jobs and greater prosperity. Loch underscores that SMEs can achieve significant productivity improvements by continuously innovating in small ways. “Total quality management and everyday process improvements can lead to a 10 to 15 percent productivity boost annually,” he notes. “This means halving your cost per unit every seven years—a huge impact on economic growth.”
Despite recent increases in activity, as indicated by China’s Small and Medium Enterprises Development Index, which rose from 88.4 in 2022 to 89.2 in 2023, SMEs still face considerable challenges amid a global economic downturn. The World Bank projects sluggish global GDP growth of just 2.4 percent by the end of 2024—the slowest in 30 years. In this context, what can SMEs do to thrive?
Loch suggests that SMEs need to be frugal, customer-oriented, and entrepreneurial. “They need to do a little bit better every day,” he advises. “Some of this requires investment, and the fact that capital is not easily available for smaller companies is a significant impediment that needs to be acknowledged.”
He also points out that China’s vast domestic market offers substantial opportunities. “One of the advantages of Chinese companies is you have a huge home market,” says Loch. “Some SMEs, having reached critical size, possess the energy and knowledge to explore international markets.”
However, expanding abroad is fraught with new challenges, including rising protectionism and geopolitical tensions that make international trade less predictable. Despite these hurdles, Loch remains optimistic about global opportunities. “Chinese companies are still exporting to places like the U.S.,” he says. “Moreover, the current global polarization opens doors in regions looking eastward. Opportunities are not only in the West but also in other parts of the world where doors are opening.”
In the first two months of 2023, China’s trade with its largest trading partner, ASEAN, rose 8.1 percent year on year, accounting for 15 percent of China’s total trade value. This indicates growing opportunities in regions outside the traditional Western markets.
“The richest economies tend to be in what people normally call the West, but that’s changing,” observes Loch. “There are vast opportunities in economies like India, Southeast Asia, South America, and Africa. While these markets may have less purchasing power individually, their growth potential is significant. Companies need to adapt to local conditions in every market.”
Loch concludes with a note of cautious optimism. “I’m seeing companies that are impressively looking for the upside in the currently difficult situation,” he says. “Not all of them will be successful—that’s the nature of such challenges—but the ones that adapt and innovate effectively will find a path forward.”
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Inside, outside and the future: What should China's private sector do?
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