Paper Tigers, Hidden Dragons

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China presents a conundrum: how has a developing nation with an inefficient financial system and struggling state-owned firms managed to foster vibrant high-tech companies? The domestic financial system largely neglects private firms, hindering their technological upgrades, while state-favored firms receive excessive support. In contrast, multinational corporations, buoyed by foreign financing, face neither funding shortages nor soft budget constraints, but lack commitment to China's development. The hidden drivers of China's technological advancement are hybrid firms that blend ethnic Chinese management with foreign financing. These firms navigate the pitfalls of the domestic financial system while actively enhancing China's technological capabilities. Unfortunately, domestic firms remain technological paper tigers, as state initiatives to create innovation clusters and national champions have failed to transform them into engines of development. This challenges conventional debates about China's political economy, revealing that it has cultivated state capitalism while allowing for the importation of foreign market institutions. The findings suggest that both state and domestic market institutions are ineffective, yet hybrid firms offer a potential pathway to escape the middle-income trap. By examining how variations in China's institutional landscape influence technological growth, the text adds nuance to the debate over wh