Chapter 1 Analytical Framework

Firm Size

Mainstream accounts of the developmental state’s phenomenal economic success center on the essential role of large firms in innovation activities (Johnson 1982; Woo-Cumings 1999). The state–big business relations formed the backbone of technological upgrading that was essential to development, and the lead companies were also crucial providers of high-quality, permanent employment that generated social stability. Historically, in China, Japan, and Korea, catch-up technology capabilities were often expected to come from the lead companies because small firms were less productive and less technologically savvy (Kim 2012; Vogel 2018). In Japan, large firms comprised conglomerates—the horizontally integrated keiretsu or the vertically linked pre–World War II zaibatsu (think Mitsubishi and Sumitomo). Astute readers will think of the consortia that the Ministry of International Trade and Industry (MITI) organized to advance semiconductor, then supercomputer and machine-learning capacity from the mid-1970s. These R&D consortia consisted of major electronics firms such as Fujitsu, NEC, and others (Callon 1995). In a similar way, in Korea, the chaebol were construed as central to technological upgrading and employment and were afforded government assistance accordingly (Amsden 1989; Kalinowski 2008).

This big business–centric developmental state model, which best corresponds to Japan and Korea, is akin to Schumpeter’s Mark II. This mode emphasizes oligopolistic firms as essential innovators and focuses on “the industrial R&D laboratory for technological innovation and the key role of large firms” (Malerba and Orsenigo 1995, 47). Monopoly power, which enables access to finance and human capital, endows incumbents with superior innovation prowess (Nelson and Winter 1982; Malerba and Orsenigo 1996).

Analysis of the developmental state in the twenty-first century continues to emphasize the centrality of big businesses. Henry Yeung (2014) maintains that East Asian governments seek to work more closely with their respective country’s most internationalized firms. In the case of China, Richard Appelbaum and coauthors (2011), Erik Baark (2016), and EunYoung Cho (2021) concur that the state seeks to work with established firms to foster cutting-edge innovation, especially in critical technologies such as semiconductors. Meanwhile, Joe Wong (2011) suggests that the alleged failure of East Asian developmental states in fostering a world-leading biotech sector—despite decades of investment—can at least partially be attributed to a limited focus on big companies.

In international business and strategy research, however, scholars contend that structural shifts in the global economy have changed the way large firms innovate. Big businesses, under the guise of open innovation, increasingly draw on external resources such as startups, R&D support, universities, and public institutes (Heurgo and Moreno 2017; Dahlander et al. 2021). Open innovation, as a concept, was established in a Harvard Business Review book by Henry Chesbrough (2003). In Open Innovation, Chesbrough refers to the dynamics whereby firms increasingly rely on external resources and logics to innovate. Changes in the techno-industrial paradigm in the second half of the twentieth century have meant that firms need to engage external resources rather than rely on in-house R&D. Incumbents can harness ideas from startups through partnerships with them, by promoting startup ecosystems, and through investment and acquisition (Chesbrough et al. 2014). The means of engagement with external organizations range from acquiring and sourcing (inbound innovation) to selling and revealing (outbound innovation) (Dahlander and Gann 2010, 700).

Given this proliferation of open innovation, we conceptualize contemporary Mark II as emphasizing big businesses whose capabilities benefit from interactions with startups. In this respect, startup capitalism sees startups infused into incumbent-led innovation systems.⁴ State championing of open innovation strives for the deepening of established firms’ capabilities. For this reason, the Mark II variation is given a score of 1 in figure 1.1. Open innovation, like conventional Mark II understandings, perceives of large firms as the key drivers of transformative advances. However, their prowess now depends on the involvement of startups to boost their innovation capacity.

The other ideal type of startup capitalism, a variety of Mark I, focuses on new entrants. New entrants—what we today call startups—offer strong innovation potential and create opportunities through creative destruction (Schumpeter 1934) by challenging incumbent firms and technologies. This creative destruction dynamic is an essential driver of economic growth and innovation (Fontana et al. 2021; Akcigit and Van Reenen 2023). Creative destruction is said to set “the stage for a permanent conflict between the old and the new,” necessarily involving established firms to “perpetually attempt to block or delay the entry of new competitors in their sectors” (Aghion et al. 2021, 5). Startups pose an existential threat to incumbents; this threat, according to Schumpeter, is the mechanism by which new entrants bring systemic value.

The startup capitalism version of Mark I is given a 4 for the size of firms central to innovation in figure 1.1. This is because policies encourage new entrants rather than the entrenchment of big businesses, but policies do not explicitly aim to disrupt big firms. Taiwan is the salient example here, given its long-standing emphasis on small firms (then called SMEs) as essential innovators and disruptors to world technology markets.⁵ The thrust of these policies is on new and different entrepreneurial pools. Conflict between incumbents and new firms—the central tenet of creative destruction—is absent.

We analyze the size of targeted firms by assessing the nature of how both big businesses and startups are included in policies. Efforts that focus on startups as beneficiaries and strive to boost their high-growth potential align with the variety of Mark I. Initiatives that involve big businesses as partners, judges, and investors may augur for a Mark II pattern, because the initiative may seek mutual benefit. Startup policies may implicitly—and even sometimes explicitly—say that oligopolistic firms are core engines of innovation and economic growth and should thus benefit from the ideas, talent, and technologies that startups can offer. For instance, in 2020, Japan’s Cabinet Office worked with regional governments to establish the Startup Ecosystem Consortium, bringing startups and keiretsu together in a bid to boost each city’s existing innovation capacity (Osaka Innovation Hub 2020).

Initiatives include coordinating an open innovation system with startups as a crucial resource to drive incumbent-led innovation. In addition, big businesses are enlisted by governments to provide mentoring, funding, exit options, and more to startups. In exchange, the incumbent firms seek to benefit from the infusion of startup mindsets, practices, and technologies. For instance, similar to the CCEI quote we opened the book with, in a fieldwork interview, a science and technology (S&T) policy adviser to the Presidential Office in Korea explained that startups are essential to “bring new blood to chaebol DNA” (Klingler-Vidra and Pacheco Pardo 2020: 346). Thus, we study the size of firms central to innovation by exploring the extent to which startup policies ultimately aim to boost startups in their bid to deliver creative destruction (Mark I) or the capabilities of big businesses (Mark II).

Employment

We examine employment in innovative sectors as a continuum from rigid to fluid labor markets. Employment contracts affect the extent to which labor is funneled toward permanent employment at established firms fosters an environment in which it is typical to make career movements across firms and thus encourage entrepreneurship. In the classic developmental era, large firms provided society with high-quality, lifetime employment. The state, then, did not need to provide a direct social welfare system because its backing of big businesses fostered a workfare system. Across the region, the social safety net comprised the provision of jobs from big internationally competitive exporting firms supported by the state (Choe 1998; Vogel 2018). In fact, unemployment insurance was only introduced in Korea in 1996.

In many ways, this developmental state depiction is akin to Mark II labor markets, which involve incentives for talent to join and then remain at incumbent firms. Employment policy prioritizes job retention and protection in times of crisis. Pension-fund regulations in the form of nonportable pensions encourage permanent employment and, relatedly, discourage midcareer movement (Dore 1986). Nonportable pensions refer to regulations in which a worker who leaves a firm forfeits their accumulated pension fund savings (Calder 1990, 2017). Nonportable pensions reinforced the lifelong employment nature of the Japanese and Korean systems (Zeitlin and Herrigel 2000; Jackson 2003; Schoppa 2006). These policies align with a conventional understanding of the Mark II mode of innovation because employee retention contributes to an “accumulated stock of knowledge in specific technological areas” among the large firms’ “researchers, technicians, and engineers” (Malerba and Orsenigo 1995, 47). Mark II employment institutions, in the context of twenty-first-century open innovation, can offer mechanisms for longtime employees to gain experience in other settings. Notably, secondments—when employees spend a period working for an external firm, including a startup or research lab—can help established firms’ employees gain access to ideas without the risk of leaving their job. In figure 1.1, the labor market character for the Mark II mode is scored with a 1, reflecting this orientation toward lifetime employment.

In contrast, the Mark I mode leans toward fluid labor markets in which employees can make career moves and pursue business ventures. As such, the Mark I ideal type is represented with a score of 4 in figure 1.1. Employment in the Mark I type consists of policies that encourage the widening of entrepreneurial pools, resulting in the creation of new firms and jobs. This includes efforts to encourage antecedent conditions for startups, including “mitigating the obstacles faced by entrepreneurs when starting new firms” (Audretsch et al. 2020, 1). Policies that reverse pension-fund portability boost fluidity. Entrepreneurship tax incentives are another instrument that can help widen the pool of would-be founders (Rigby and Ramlogan 2013). Tax incentives for startups can impact the size of the entrepreneurial pool, because the establishment and growth of new businesses depend “strongly on the fiscal environment that a country provides” (European Venture Capital Association 2013, 10).⁶

Another means of employment-themed intervention is the provision of entrepreneurship training and incentives to attract startup talent. Entrepreneurship skills training includes idea generation, business plan writing, product development, and fundraising competencies. Entrepreneurship education can be offered directly through a variety of government agencies and can also be delivered via partnerships with intermediaries.⁷ Accelerators and incubators can provide for direct management of the programs by civil servants or teams assembled by government or through the procurement of a private company, such as 500 Startups, Plug and Play, Techstars, or Y Combinator, to manage the program. Entrepreneurs, armed with skills to establish and scale their business, are more likely to start up. Similarly, bankruptcy reforms can allow business owners to close failing ventures, which can aid labor market flexibility as would-be founders are both more likely to take an entrepreneurial risk in the first place (because they know they can wind it down without damaging their personal finances) and more able to walk away from unproductive activities (e.g., zombie firms).

Relatedly, Mark I policies, from a fluid employment perspective, can strive to encourage the immigration of talented professionals and entrepreneurs as another mechanism for widening the pool of startups. Japan’s X-Hub inbound program, run by JETRO and the Tokyo Metropolitan Government, hosts cohorts of international startups in Tokyo to do just this. In a similar way, the Start-Up Chile program, created in 2010 by the Commerce Ministry, offers a well-known model of programs designed to attract foreign entrepreneurial talent (Gonzalez-Uribe and Leatherbee 2018). Changes to immigrant regulations can also make it easier for foreign talent to change jobs—increasing flexibility in the labor market and helping to de-risk their entrepreneurial venture. Japan, for instance, now allows foreign trainees on a technical program to change jobs within the same sector after one year of immigrating (Yuasa 2023).

Finance

We analyze whether funding for innovation prioritizes equity or debt instruments. This debt/equity binary is consistent with developmental state research, which portrays the state as providing credit to fuel growth and R&D (Amsden 1989). In comparative capitalism scholarship, CMEs are depicted as debt-centric financing systems that offer patient capital, enabling incremental innovation.⁸ LMEs, in contrast, rely on equity-based capital markets to finance high-risk, high-reward, innovations. The equity-based financial system is construed as boosting the creation and scaling up of startups. Comparative capitalism scholarship conceptualizes this relationship between high-functioning stock market–based capitalist systems and the advance of radical innovation, as the equity markets provide both finance and pressure to outperform. Equity-based financing does not require regular repayments, which is an attractive attribute given the (often negative) cash flow realities of fledgling firms.

The intuition of the debt-based CME and equity-focused LME is that the financial systems are complementary to the other institutional arenas (e.g., employment) and thus enable their distinct advantages in incremental (CME) and radical (LME) innovation. We conceive that these financial systems broadly, although not perfectly, align with our startup capitalism understanding of the Mark I and II types. In figure 1.1, Mark I is represented with a score of 4, reflecting its equity focus, while Mark II is scored at 1 to illustrate the centrality of debt.

In the Mark II variety, the expectation is that preferential access to credit is essential to large firms’ innovation activities. Intense pressure to perform, at least on a quarterly (equity) earnings basis, augurs for radical innovation, whereas long-term access to credit suggests innovation on a more incremental basis. In the classic developmental state model, state credit was the staple means of financing big businesses’ activities. Such credit could take the form of loans for product development as well as working capital lines. In the archetypal Japanese case, the state would coordinate consortia and work with main banks to offer the keiretsu steady credit lines (Johnson 1982; Pempel 1998). This aligns with depictions of CME contexts in which patient capital is provided by main banks for firms’ R&D and product or geographic expansion. The result is that established firms excel in incremental innovation.

In contrast, the role of the state in encouraging Mark I–styled finance approaches involve shaping equity markets in which investors buy shares in high-growth companies. By enabling a range of stock markets, the state provides critical exit venues for high-growth innovative startups (Gilson and Black 1998). The launching of a Nasdaq-like technology stock market that is friendly to startups in terms of the number of years in which operating profits are required before the company can list and the assurance that paperwork requirements for listed firms are simple would indicate a stock market–focused effort to bolster startups’ growth. Allowing a second-tier listing scheme helps avail startups’ access to a major exit opportunity.⁹

Private equity, in the form of venture capital (VC), is central to the availing of equity financing for startup-centric settings. VC comprises investments in young, high-growth, and often high-technology firms in exchange for equity stakes in the company. Colin Crouch (2005) asserts that VCs maintain close relationships to monitor firm performance, which is distinct from the traditionally arm’s-length nature of stock market investing in LMEs. In a similar way, John Zysman (1983, 64) asserts that VCs are akin to German universal banks in their closeness and patience. The thrust of VCs’ hybrid features emanates from their serving as smart money (Lerner and Nanda 2020; Mallaby 2022), meaning the financiers bring operational expertise, professional networks, and technical insights that help founders navigate the multitude of product and operational uncertainties encountered when building their businesses. VCs work closely with the startups in which they invest, as they (can) receive board seats and various voting rights (e.g., veto rights) (Alemany and Andreoli 2018).

It is interesting to note that as VC markets have developed in different countries, they have taken on varied characteristics. In some settings, they have manifested as equity-based investments in very early-stage, high-risk technology businesses, which gives them more of a LME flavor, whereas in others, they have sometimes been disseminated as a combination of credit and equity offered for more mature businesses (see Ahlstrom and Bruton 2006). For these reasons, comparative capitalism scholarship conceives of VC as a hybrid form of financing. For us, its provision sits squarely within Mark I, given that the investment target is a startup—not a big company—and because of the emphasis on large-scale growth.

Another Mark I–oriented approach is the use of limited partnership (LP) legal structures. LP fund structures incentivize risk-taking, since the investors’ personal assets are not held as collateral. With the LP structure, investors in VC funds are only liable to lose the capital they have invested, not their personal assets. Regulations around the issuance of preferred stock is also a helpful feature in enabling VCs to have economic and control rights, such as veto and voting rights, that allow them to mitigate risk while maximizing their potential return (Feld and Mendelson 2013).

In a related way, startup capitalism’s Mark I–styled approaches involve boosting cohorts of early-stage equity-based investors, such as angels and VCs, through direct investments in high-potential entrepreneurs. Government efforts to grow VC markets range from funding a set of professional investors to more surgically striving to grow the volume of VC in a specific investment stage (Da Rin et al. 2005; Alperovych et al. 2020; Bai et al. 2022). To fund a domestic VC market, the state forms funds of VC funds, whose investment mandate is to invest in several privately managed VC funds (Klingler-Vidra 2018). These VC funds then each go on to invest in portfolios of startups. There are many examples of funds of VC funds across the globe, with the touchstone version being Israel’s Yozma fund, which was created in 1993 by the Office of the Chief Scientist to foster a professional domestic cohort of Israeli VCs (Avnimelech and Teubal 2006). Through the Yozma fund, Israel created a bench of local VCs that startups could raise early-stage equity financing from before trying to raise funding from US venture capitalists and, ultimately, list on Nasdaq.

The relative mix of debt and equity becomes essential to assessing how this institutional logic contributes to the nature of innovation. As such, we examine the ways in which policy engages with debt and equity financing for startups and big businesses.

Innovation

In Schumpeterian industry life-cycle terms, radical innovation occurs in the Mark I variety.¹⁰ “When technology is changing very rapidly, uncertainty is very high and barriers to entry very low, new firms are the major innovators” (Malerba and Orsenigo 1995, 48). In contrast, the Mark II context is characterized as a time when an industry has developed, there are “well-defined trajectories, economies of scale,” and “financial resources become important in the competitive process and large firms with monopolistic power come to the forefront” (Malerba and Orsenigo 1995, 48).

Bringing developmental state trajectories, comparative capitalism, and Schumpeterian economics together, we posit that the classic developmental state period best aligns with the conventionally understood Mark II mode, as big businesses were leading incremental advances, especially in manufacturing and established technologies. Reflecting this emphasis on incremental innovation, Mark II is scored with a 1 in figure 1.1. In contrast, Mark I is aligned with radical innovation and is thus illustrated as a 4 on the continuum. It is in these radical innovation settings that startups are essential to innovation, as they challenge the existing technological paradigm and threaten to disrupt the position of incumbents.

The developmental state model centered on incremental innovation, as it centered on adopting foreign technologies and subsequently producing them locally at a lower cost. It started with labor-intensive light industries, such as textiles, garments, and footwear; continued with capital-intensive industries, including steel, petrochemical, shipbuilding, or car making; then followed with higher-value-added, technologically more complex industries such as electronics or semiconductors. As capabilities advanced, governments across East Asia were unafraid to invest in new sectors, attempt to pick winning sectors (Aoki et al. 1998), and boost domestic capacity in critical technologies. This was already seen in the 1970s, with Japan’s MITI supercomputer consortium (Callon 1995). MITI’s boost of semiconductor prowess for Japanese firms in the 1970s was motivated by a desire to match what Japanese businessmen had seen at IBM and Bell Telephone Laboratories (now known as Bell Labs) while visiting the United States (Anchordoguy 1989).

By the 1990s in Japan, subsequently in Korea and Taiwan, and then later in China, the catch-up ambitions of innovation policy shifted toward competing at the technological frontier (Lee 2019). In comparative capitalism terminology, this shift can be understood as moving from incremental innovation, in which process advances were the primary value added, toward radical innovation, in which the aim is to develop new, disruptive technologies (Taylor 2004). The policies used to boost prowess in the context of the incremental innovation phase emphasized securing access to foreign technologies and then championing local firms capable of producing along those lines. Innovation policy making at the technological frontier instead emphasized the development of novel products and services that had not previously existed. This required new ways of thinking; more creativity and greater risk-taking were needed than they were for process-based advances.

The four countries analyzed in this book—Japan, Korea, Taiwan, and China—now compete at the frontier across several critical technologies. Firms from these countries are at the cutting edge of sectors such as electric batteries, electric vehicles, green shipping, renewable energies, robots, and famously, semiconductors. Therefore, their innovation approach has had to move away from the catch-up mentality of previous decades. As a result, radical innovation is not a policy option anymore; it is a necessity. Without radical innovation, these four East Asian countries cannot compete against themselves or against other innovation powerhouses such as Germany, Israel, Sweden, Switzerland, or the United States. Perhaps the best known of these world-leading technology ambitions is the Made in China 2025 initiative, which explicitly named being the best in the world in specific technologies as its objective. As of 2024, evidence suggests success in some of these verticals, with China being the world’s largest electric vehicle exporter (Economist 2024b).

Social Purpose

The last institutional arena we examine is social purpose in terms of a continuum of domestic and external aims. We define social purpose as “the social aim of policy efforts, which is rooted in substantive (input) and performance (output) legitimacy” (Klingler-Vidra and Pacheco Pardo 2020, 337).¹¹ East Asian policy making has been predicated on variants of a clear social purpose in which the government propels economic prowess as a means of providing economic growth, shared prosperity and stability, and national security. At the highest level, social purpose involves the state providing stewardship over the economy and security and, in return, the corporate sector providing well-paid, stable jobs. The dual purpose of domestic and external aims has been documented. For example, Elizabeth Thurbon and Linda Weiss (2006, 2) assert that the Korean government’s primary goal in the postwar era was to “promote rapid industrialization for national security and domestic legitimacy purposes.”

Domestically, the developmental state social purposes comprised economic and technological advances that enabled various improvements in terms of the quality of work, housing, and infrastructure. Even though the goal of the state was not to create jobs directly, its social purpose included creating the conditions for (high-quality) job opportunities to grow. For example, Chisung Park and co-authors (2015, 320) argue that historically—especially prior to democratization—the Korean regime “tried to secure its legitimacy by ensuring output-oriented effectiveness . . . [Strong] economic development was essential for output-oriented legitimacy.” In a similar way, Richard Whitley (1992, 112) explains that the Korean ruling elite’s legitimacy claims were symbolic, as “the general identification of leadership [was] with moral authority”; the source of legitimacy changed from 1961 onward, as “state legitimacy rests significantly upon rapid economic development.”

External concerns focus on the ways in which economic competitiveness and capabilities in critical technologies foster security against external threats. A country’s ability to compete in key technologies in international markets is a long-recognized social purpose for innovation policy (Stubbs 2009; Weiss 2014; Taylor 2016). Tai Ming Cheung (2022), for instance, conceives of China’s innovation policies as being fundamentally motivated by “techno-security.” Gerard Roland (2023, 521) gives the example of the launch of the Sputnik satellite in 1957, which saw the “more than tripling of the National Science Foundation budget” in the US bid to overcome the Soviet system in the space race. Capabilities in critical technologies include semiconductors, which are identified as essential to national security and thus a basis for contemporary policy making (Samuels 2008, 2019; Klingler-Vidra and Kuo 2021; Huang 2023).

This link between technological competition and national security—called economic statecraft (Aggarwal and Reddie 2021; Thurbon and Weiss 2021)—is increasingly ubiquitous in motivating startup efforts in the twenty-first century. Particularly salient to the nexus between economic and national security, the United States and the European Union both adopted chips acts—the United States in 2022 and the European Union in 2023—indicating their dedication to advancing domestic semiconductor chip capabilities. The EU Chips Act states that dependency on a small number of international actors poses an important challenge in the critical technology of semiconductors; accordingly, the act aims to strengthen European design and manufacturing capabilities through several levers, including largesse for startups and scale-ups. These interventions are presented in terms of enabling economic growth, job creation, and national security.

Given this expectation that startup policies are motivated by a convergence of domestic and external purposes, we examine degrees of continuity and change in the stated objectives articulated when startup policies are launched. To do so, we analyze objectives as laid out in statements by senior policy makers and politicians as well as in official government outlets. We assess how the policies are motivated—whether they are intended to affect domestic (employment, economic growth, and social inclusion) or external (national competitiveness and, by extension, national security) aims. Our expectation, in terms of this mapping onto the Mark I and II startup capitalism types, is that both varieties comprise a combination of domestic and external social purposes. This expectation is reflected in the fact that both types are scored as 3 in figure 1.1. Our point is that the prioritization of technological capabilities for national security purposes does not fundamentally align with only startups fueling creative destruction (Mark I) or enabling big business (Mark II). The dual purpose of domestic and national security imperatives can instigate either or both modes of innovation.

Plan for the Case Studies

This book adopts an institutionalist approach to analyze startup capitalism, questioning whether governments view startups as disruptive innovators or essential resources for big companies. We explore policies in Japan, Korea, Taiwan, and China, drawing on VoC and developmental state literature to identify how key economic policy-making paradigms change over time. This chapter develops our analytical framework for studying the continuity and change underpinning East Asian states’ startup capitalism, in accordance with Schumpeter’s Mark I and II typologies. In it, we conceive of five institutional arenas to study: (1) firm size; (2) employment; (3) finance; (4) innovation; and (5) social purpose. We explore each of these institutional areas across the startup capitalism varieties of Mark I and II. This helps us understand how startup policies strive to deliver entrepreneurial pool-widening aims (Mark I) or large firm–led advances (Mark II).

The application of the institutional framework helps us to identify degrees of continuity and change, particularly with respect to the ways in which each state’s developmental state model persists. Ultimately, we examine the extent to which institutional change augurs for disruptive startups or the fostering of established firms’ capabilities. This approach offers an updated understanding of the big business–centered developmental state and a challenge to the presumption that the entrepreneurial state is distinct. We evaluate the boundaries between industrial policy and economic statecraft in the lens of startup capitalism by exploring external (e.g., national security) and internal (e.g., economic growth and job creation) social purposes underpinning startup capitalism.