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Meaningful reform in China? Don’t hold your breath

During 2018, private companies in China, the mainstay of the country’s economic resurgence in the last decades, were hit by a slump in the stock market, the on-going credit crunch and the trade conflict between China and the US. The government took measures to help them, but entrepreneurs have concerns that run much deeper, namely that the government’s industrial and economic focus on the state sector is at their expense.

It is widely understood that the  ‘Communist’ bit of the Chinese Communist Party was abandoned many years ago. After Deng Xiaoping came to power at the end of the 1970 and under the ‘reform and opening up’ slogan, China shed its obsession with public ownership of the means of production, distribution and exchange, and gradually allowed some market mechanisms and private ownership and enterprise to take root in the economy, albeit under close state and Party control. In the 1990s, a huge wave of privatisation of state enterprises occurred, along with the development of a thriving private market in real estate. 

Fast forward to now, and the private sector has evolved into a ‘56789’ phenomenon. This has been used to describe private activities that account for 50 per cent of fiscal revenues, 60 per cent of GDP and investment, 70 per cent of industrial upgrades and innovation, 80 per cent of jobs, and 90 per cent of enterprises. China’s 164 our so private equity companies in the tech space, or unicorns, as they’re known, are worth over $630 billion, and world leaders in terms of numbers. 

Even though it has become accepted widely that China’s private sector has been the driving force in the country’s economic eruption, clouds have been gathering over this dynamic part of the economy since Xi Jinping came to power.  Lately,  private enterprise has not only been flagging but it has also the focus of great controversy and uncertainty.

What is private in China anyway?

Official data testify to the overwhelming numerical predominance of private firms. At the end of 2017, there were 65.8 million individually-owned businesses and 27.3 million private enterprises, employing some 340 million people. Yet, the classification of private, especially as regards the latter, remains rather opaque. Companies that register as private can, in practice, still be state-controlled, or file as collectively-owned or co-operative companies, according to the National Bureau of Statistics. Some limited liability companies may have mixed private and public owners, and many may have layers of holding companies behind which is a state owned enterprise. Many private firms are increasingly being co-opted by the state in various ways.

Even well known private companies such as Alibaba, Tencent and Huawei operate in a murky political space. It was recently revealed that Jack Ma, China’s richest man and founder and force behind e-commerce giant, Alibaba, was a member of the Party. This case is far from unique. Senior executives know that if the interests of the Party and those of shareholders are not always well aligned, those of the former always prevail. The Party offers protection, pressure and reward in a system in which the rules and regulations are often random, or ignored. Party cells are now mandatory in the operational management of all companies in which there are more than 3 Party members. Numerous sectors are still out of bounds to private firms, including banking, healthcare, energy and TV and broadcasting.

Under pressure

Since 2017, the private sector in China has been under growing pressure from both the slowing economy and the trade conflict with the US. The roots of the problem are deep and go back to a long history of unequal treatment vis-a-vis the state sector. This spans things such as liquidity, subsidies, access to and cost of credit, tax benefits, market access, legal protection, regulatory treatment, and more recently, bail-outs and help with defaults. While long-standing, these conditions have become more fraught in the last 1-2 years.

They have borne the brunt of capacity cutbacks in coal and steel, and faced severe liquidity stress as the financial crackdown weighed especially on the shadow finance sector where private companies had to turn because of the preference of state banks for state enterprises. They have been adversely affected by new regulations affecting e-commerce, real estate, and video gaming, for example, which penalise them at the expense of Party interests, and had to succumb to new regulations which provide for the Party to be represented in operational management in all firms where there are three or more Party members. 

They have also been experiencing rising levels of default on their bond financing, and become ensnared in the equity market slump this year. Forced to pledge their shares as collateral for loans, they have been stung by the fall in equity markets. According to stock exchange filings, about 46 private firms have had to sell large stakes back to state enterprises, with about half of them succumbing to reverse privatisation, in which they have sold controlling stakes back.

For 40th anniversary year of the launch of Reform and Opening Up later last year, there was inevitably a lot of focus on how much of the previously pragmatic approach to the economy and government is still in situ. At the end of 2013 at the Third Plenum of the 18th Party Congress, a year after Xi Jinping became President, a major reform initiative was announced covering over 300 measures across over 60 sectors. Yet 5 years later, little of this reform effort had survived. The 40th anniversary exhibition in the National Museum paid scant attention to the main drivers of reform, Deng Xiaoping and Zhu Rongji, and much to Xi, himself. All the emphasis,. especially since the 19th Party Congress in October 2017, has been on the primacy and increased intervention of the Party in the economy and commerce and many other walks of life, at the expense of private firms and enterprise.

In January of 2018, Zhou Xincheng, a Professor of Marxism at Renmin University in Beijing, wrote a paper in which he argued for the abolition of the private sector. In August a relatively obscure investment bankers turned internet entrepreneur, Wu Xiaoping, wrote a paper arguing that the private sector had played its historical role and should now be phased out, and merged back into the state sector. The paper went viral and was eventually deleted, but no one senior in the Party disowned it, and it caused widespread consternation among China’s entrepreneurs.

Within the last few months, notable Chinese intellectuals such as Professors Zhang Weiying and Sheng Hong criticised the direction that China was headed in no uncertain terms, and refuted the idea that China owed its success to the Party/State/industrial policy model, instead insisting that the real causes of success had been marketisation, entrepreneurship and learning ideas and practices form abroad. 

Partly to address this ‘identity crisis’ for private firms, President Xi  invited top entrepreneurs to dinner in the Great Hall of the People in November to assure them that the private sector was valued and had a critical role to play in China’s development. Yet, verbal assurances alone are not going to cut the mustard, especially when the President and his senior comrades also offer regularly a  full-throated defence of state owned enterprises and the dominant roles they have been earmarked to play in the development of China’s economy and technological prowess.

China’s economic and perhaps political outlook in years to come will be framed in large measure by how it addresses the tension between the politics of state control against the economics of a reform-oriented economy. You don’t have to take my word for it.

In mid-December, Professor Xiang Songzuo of Renmin University wrote a trenchant essay in which he bemoaned the loss of private sector confidence and dynamism, and the rampant violation of laws and regulations by those in positions of influence and authority. For him, the key issue in China’s ubiquitous economic slowdown is not whether the government adopts counter-cyclical policies, which may have a temporary but wasting impact, but how or if the government restores the vitality of private enterprise and trust in government, and bites firmly on tax structure, political and state governance reform.

No one is holding their breath.