The private sector accounts for an estimated 60% of China’s GDP, 40% of its tax revenues, and 80% of its employment. Allocating high-ability individuals to the entrepreneurial sector can enhance productivity and further boost the private sector’s significant contribution to China’s economic growth. However, China’s economy is also characterized by a strong state sector, known for job security, superior non-wage benefits, and elevated social status. What do China’s most talented people choose to do: build private firms or work for the state? 

The data. This study uses China’s college entrance exam scores as a proxy for individual ability, as these scores are strong predictors of economic outcomes. Researchers compiled over 20 million records on exam scores and student backgrounds from 1999 to 2003 and supplemented this with survey data from 30,000 students collected between 2010 and 2015 on wages, first jobs, and college behavior. The authors then matched these scores with records of all firm owners in China through 2015 to assess entrepreneurial performance, including firm size, expansion, investments, and public listing status. The final sample included 1.57 million individuals who founded 150,473 firms by 2015.

High-ability individuals are less likely to start firms. The researchers categorized students into three major groups: STEM, which includes science, technology, engineering, and mathematics (52% of students), economics, finance, and law (28%), and humanities (20%). They also segmented colleges into three quality tiers: the top 10 institutions, those ranked 11–100, and the rest.

The relationship between exam score and likelihood of founding a firm

In the aggregate, a one standard deviation increase in one’s ability, as proxied by college entrance scores, is associated with a decrease in the likelihood of founding a firm of approximately 7% from the average probability of 7.36%. The findings remain across majors and tiers of college quality. Specifically, a one standard deviation increase in exam scores correlates with a 13% reduction in probability of firm creation for STEM majors, 11% for economics, finance, and law majors, and 14% for humanities majors. The correlation is evident across all college quality categories. Test scores were not significantly correlated with participation in social activities or risk appetite.

Higher-ability individuals achieve greater success when founding firms. Even though individuals with higher ability were less likely to start firms, those who did tended to drive better firm outcomes. A one standard deviation increase in exam scores is linked to a 1.2% increase in a founded firm’s size, a 5.8% higher likelihood of establishing a firm outside the home province, and a 12% increase in the likelihood a founded firm invests in other companies. The probability of a firm becoming publicly listed also showed a substantial increase of about 39% relative to the average startup firm.

High-ability individuals gravitate towards the state sector. According to the survey data of the authors, 43% of graduates found employment in state enterprises, 50% in private entities, and 6.1% launched a firm, while 64% of graduates indicated that state-owned enterprises were their top employment choice.

To assess what drew talented individuals away from founding startups, the researchers sought to quantify the attractions of waged jobs. They found that higher exam scores were also correlated with 2.6% higher wages in the job market after college, and a higher likelihood that a worker’s job conferred local hukou eligibility, an important perk granting access to better local schools and healthcare. This suggests that higher wages and non-wage perks (in both state and non-state sectors) may draw talented people away from launching startups.

To shed further light on the draw of jobs in the state sector, the researchers compared the extent of state employment in local economies and the propensity of individuals to work for the state or launch a startup. They found that an increased presence of state employment in one’s college location correlates with a more pronounced disinclination toward entrepreneurship. To highlight the loss to firm creation, the authors extrapolate that if individuals at the 75th percentile of ability moved from a high state-employment region to a low state-employment region, their likelihood of starting a business would increase by 16.9%. Taken together, these findings suggest that the state sector diverts talented individuals away from entrepreneurship.

State sector plays outsized role in talent allocation. This study underscores the significant role of China’s government in shaping talent allocation. Individuals with higher college entrance exam scores are, perhaps unexpectedly, less likely to create firms. Instead, they often gravitate toward careers outside entrepreneurship, particularly in the state sector. The implications of this are nuanced: on one hand, talent in the state sector is an important source of state capacity; on the other hand, there is a risk that this talent may be diverted to rent-seeking behaviors that generate limited growth potential or social value. The study suggests that the state’s strong presence may draw talent away from more vibrant, innovative sectors, highlighting a tradeoff between building state capacity and fueling private sector dynamism.