China’s private sector is getting a bad deal

During 2018, private companies in China, the mainstay of the country’s economic resurgence in the last decades, have been hit by a slump in the stock market, the ongoing credit crunch and the trade conflict with the US. Beijing has taken 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.

The “Communist” element of the Chinese Communist Party was abandoned many years ago. After Deng Xiaoping came to power in 1978 and launched the “Reform and Opening up” programme, China shed its obsession with public ownership of the means of production, distribution and exchange. It 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 property.

Fast forward to 2018, and the private sector has been described using the figure “56789”: private activities 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 or so private equity companies in the tech space—known as unicorns—are worth over $630bn and are world leaders in terms of numbers.

Even though it is widely accepted that China’s private sector has been the driving force in the country’s economic eruption, clouds have been gathering over this part of the economy since Xi Jinping came to power. Lately, private enterprise has not only been flagging but it has also been 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 65.8m individually-owned businesses and 27.3m private enterprises, employing some 340m people. Yet the classification of private, especially as regards the latter, remains 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 of China. Some limited liability companies may have mixed private and public owners, and many 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 of the e-commerce giant Alibaba, was a member of the Party. Senior executives know that if the interests of the Party and those of shareholders are not 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. 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 compared to 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 longstanding, these conditions have become more fraught in the last couple of years.

This year, private companies 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 (to which 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, property, and video gaming, for example, which penalise them at the expense of Party interests. They are also subject 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.

Private companies 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 selling controlling stakes, and thus succumbing to reverse privatisation.

In this, the 40th anniversary year of “Reform and Opening Up,” there is 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 five years later, little of this effort has survived. The 40th anniversary exhibition in the National Museum pays scant attention to the main drivers of reform, Deng Xiaoping and Zhu Rongji, and much to Xi. 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 many other walks of life—at the expense of private firms and enterprise.

In January 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 banker 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.

This summer, notable economists such as professors Zhang Weiying and Sheng Hong criticised the direction that China has headed in no uncertain terms. They refute the idea that the country owes its success to the Party/state/industrial policy model, insisting that the real causes of success have been marketisation, entrepreneurship and learning ideas and practices form abroad.

Partly to address this “identity crisis” for private firms, in November President Xi invited top entrepreneurs to dinner in the Great Hall of the People to reassure 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. As we look around the west, and not least in Britain, we can see China isn’t the only country with this agenda.