Lessons from China's support for local startups — a path to innovation for India

India, despite its own startup momentum, has failed to replicate this success at the local government level.

Quite counterintuitively, China's local governments are playing an important role in the country's startup ecosystem. The form of economic federalism in practice there differs substantially from India’s approach, which provides them with unique economic incentives to help propel China's innovation economy. This has resulted in the creation of regional innovation hubs beyond just Beijing and Shanghai. India, despite its own startup momentum, has failed to replicate this success at the local government level. There are some structural challenges that prevent this.

Economic Incentives

The incentives provided by Chinese local governments for startups are much more than just simple subsidies. Consider the Government Guidance Funds, for instance. These funds are public-private partnerships which are aimed at supporting industries and startups in strategic sectors. Interestingly, between 2015 and 2018, there was a significant increase in these guidance funds, especially at local and provincial levels.

In innovation hubs like Shenzhen, local governments offer various subsidies for qualifying technology startups. Tax incentives are equally substantial - high-tech enterprises can receive substantial corporate income tax reductions, while R&D expenses enjoy significant deduction benefits for tax purposes.

Hangzhou's local government, home to Alibaba, provides subsidised housing specifically for startup employees, high-level talent and entrepreneurs, addressing a major operational cost. For instance, high-level talents can receive subsidies ranging from 1 million to 8 million yuan for housing purchases, depending on their classification (A to D levels). This package of coordinated incentives addresses multiple pain points in a startup's early lifecycle.

China's Economic Federalism Model

It is pertinent to understand what makes local governments capable enough to do all this.

China practices what economists term "fiscal federalism with Chinese characteristics," where local governments retain significant tax revenue (approximately 50% of fiscal revenue remains at the local level, compared to only 3% in India). This enables Chinese local governments to directly invest in infrastructure, startups, and innovation. Local officials' career advancement depends a lot on economic performance metrics of their regions. Their career incentives are tied to regional growth. This, in turn, encourages competition between various local jurisdictions, further driving local business development. This is a virtuous cycle. This also dictates the delegation of necessary authority to local levels of government to experiment with economic policies. It is this experimentation that helps competition to thrive at the municipal level.

Studies show that Chinese mayors play a crucial role in economic development. Mayors in China are indeed empowered and accountable. They focus on various economic activities at the local level, including urban planning, public goods provision, and local economic policies, since they are empowered enough, and, therefore, held accountable too. The concept of the "mayor economy" is an important analytical lens to look at this, as it highlights the active role of mayors in supporting promising businesses and fostering innovation.

Chengdu is a wonderful example of this approach. Chengdu has committed significant resources to growing its artificial intelligence (AI) industry. This includes a broader plan to invest over 100 billion yuan ($15.2 billion) in more than 170 AI-related projects. It has taken steps to support autonomous vehicle development while simultaneously adapting local regulations to allow autonomous vehicle testing and creating specialised industrial parks. For example, Baidu partnered with the Chengdu Hi-tech Industrial Development Zone to promote its Apollo Go Robotaxi service, which supports the city's autonomous driving sector.

Key Differentiating Factors from India 

India's approach to local economic development differs along three axes. Indian state governments receive approximately 42% of central tax revenues through Finance Commission transfers, but municipalities have minimal independent revenue-raising authority. Most Indian cities depend on state transfers for a major portion of their budgets, severely limiting their ability to offer competitive incentives. Indian local governments have limited ability to raise their own revenues, with tax revenues constituting only about 30% of their income.

Along with these economic constraints, Indian local governments face significant constraints in policy experimentation. Local bodies often require state government approval for most of their economic initiatives since their purses are tightly controlled by the state or union governments, and they don’t have enough own revenue-raising avenues. This leads to significant implementation delays for new programs.

Moreover, career advancement for Indian municipal officials isn't as directly tied to local economic growth metrics as in China.

India's Path Forward: Three Critical Reforms

Based on China's success model, India should consider three concrete steps to empower local governments in supporting startups.

1. Enhance Fiscal Autonomy for Urban Local Bodies
India must significantly enhance the fiscal autonomy of urban local bodies. This requires constitutional amendments to guarantee a specific percentage of state taxes to municipalities, authority for cities to issue municipal bonds specifically for innovation infrastructure, and direct startup grant authority with allocated annual budgets based on city size. This reform would enable cities like Pune or Hyderabad to independently fund startup infrastructure without waiting for state approvals, accelerating their responsiveness to market opportunities.

2. Establish Special Municipal Innovation Zones
India should establish special Municipal Innovation Zones with simplified regulatory frameworks managed at the city level, fast-track approval systems for startups, authority to modify local regulations to accommodate emerging technologies, and dedicated economic development officers focused exclusively on startup attraction. Consider these zones as controlled policy experiments, allowing Indian cities to compete more effectively for investment while maintaining appropriate oversight.

3. Reform Municipal Leadership Evaluation and Reward Systems
India should reform how municipal leadership performance is evaluated and rewarded by establishing startup growth metrics as key performance indicators for municipal commissioners. It wouldn’t be too radical an idea to create specialised career tracks for officials focusing on innovation economy development, implementing performance-based compensation that includes startup growth measurements, and designing inter-city competitions with significant fiscal rewards for successful startup attraction. The professional interests of local government officials have to be aligned with local development and competition. This realignment could begin with startup ecosystem development, similar to China's approach.

China's decentralisation structures demonstrate the potential of empowered local governments with aligned incentives to drive local development, competition, and innovation. The principles of fiscal autonomy, administrative authority, and aligned incentives are something that India can learn from.

The path to a more distributed innovation economy runs through empowered local governments with both the resources and motivation to support tomorrow's startups.