In China, this year (2018) marks the 40th anniversary of the reform and opening-up initiative launched under the leadership of Deng Xiaoping. Over the four decades, China has been in the process of transition from a planned economy to a market economy. As private enterprises that started from scratch have ridden the wave of the shift to a market economy, the private sector comprised of those enterprises has outgrown state-owned enterprises (SOEs) in terms of revenue and employment (Figure 1). However, recently, the sluggishness of the business performance of private enterprises has become conspicuous, raising concerns over the trend toward "the advance of the state and retreat of the private sector" (increasing the share of SOEs and decreasing the share of private enterprises) trend, which runs counter to the shift to a market economy that has been promoted by the Chinese government. In response the government has introduced a series of measures to support private enterprises, mainly through financial assistance. However, if private enterprises are to achieve sound development, China must quickly create a market environment that enables them to compete with SOEs on an equal footing.
China in Transition
Development of Private Enterprises in China Entering a Difficult Phase
—Urgent Need to Create a Fair and Competitive Environment
Chi Hung KWAN
Consulting Fellow, RIETI
1. Concerns over the ongoing trend of "the advance of the state and retreat of the private sector"
Private enterprises are at a disadvantage in market competition as they are discriminated against because they operate under a different type of ownership from SOEs. As the recent deterioration in the economic environment has added to this disadvantage, many private enterprises are having a hard time. Concerns are growing that this situation may trigger the decline of private enterprises, accelerating the trend toward "the advance of the state and retreat of the private sector."
1) Private enterprises having a hard time
For many years, private enterprises have suffered discriminatory treatments compared with SOEs on the following points. First, in some sectors, SOEs enjoy a monopoly, with market entry barriers set very high for private enterprises. In addition, while SOEs receive fiscal and financial assistance from the government, such benefits are not available to private enterprises. Furthermore, although SOEs can procure factors of production at low cost, including land and funds, private enterprises cannot. Finally, under the current laws, the protection of property rights is weaker for private enterprises than for SOEs. Furthermore, SOEs and private enterprises are treated unequally under the law.
In addition to suffering from those disadvantages, private enterprises are also confronted with unfavorable changes in the economic environment as described below.
First, in line with a rise in prices of producer goods, such as raw materials, production costs are rising. Since 2016, as a result of structural reforms on the supply side, mainly through the reduction of excess capacity, prices of products in upstream and midstream industries (producer goods), such as coal and steel, have been rising. However, enterprises have been unable to pass the additional cost on to downstream products (consumer goods) amid the weakening of final demand due to the economic slowdown (Figure 2). One notable feature of the industrial structure in China is that the share of SOEs is larger in upstream and midstream industries, and the share of private enterprises is larger in downstream industries. As a result, while revenues and other indicators of SOEs' business performance are improving in response to the rising prices of producer goods, the business performance of private enterprises is deteriorating because of growing production costs.
Next, as a result of the initiative to resolve excess capacity and meet environmental protection regulations, many private enterprises have been forced to scale down production or even to go bankrupt due to their failure to meet new standards.
Meanwhile, in order to prevent a financial crisis and curb the already high level of debt owed by enterprises, the government has adopted a tight monetary policy and is strengthening regulations on shadow banking. Small and medium-size private enterprises with low creditworthiness have been the first to feel the impact of those measures, finding it more and more difficult to raise funds.
Consequently, SOEs have overtaken private enterprises in terms of the growth rate of value added and the share of profits in the industrial sector, aggravating the trend toward "the advance of the state and retreat of the private sector." (Figure 3).
2) Intensifying debate over the retreat of private enterprises
Under these circumstances, comments the situation of private enterprises made by two individuals who happen to have the given name "Xiaoping" have created a buzz.
On September 11, 2018, Wu Xiaoping, who claims to be a financial expert, issued a commentary saying that in China, as the private sector has fulfilled its role of assisting the state-owned economy in achieving development, it should gradually retreat (on the website Toutiao). In the commentary, Mr. Wu insisted that the private sector should not blindly expand and should merge with the state-owned sector to form a huge state-private mixed-ownership sector that will play the leading role socially and economically in the future.
On the same day, Qiu Xiaoping, Vice-Minister at the Ministry of Human Resources and Social Security, speaking at a meeting on the democratic management of private enterprises nationwide hosted by a private company called Transfar Group, emphasized that private enterprises should let employees play a more active role and involve them in corporate management, thereby allowing them to enjoy the benefits of corporate development, and that in order to realize that goal, it is necessary to strengthen the Communist Party's guiding role ("Develop a harmonious labor relationship by promoting deep and comprehensive democratic management at private enterprises," the website of the Ministry of Human Resources and Social Security, September 13, 2019). His comments were taken by some people as a message signaling the government's intention to intervene in the management of private enterprises and revive the state-private joint management initiative that marked the first step toward nationalization of private enterprises in the 1950s.
Now that nurturing large and strong SOEs has become a national policy as the ongoing U.S.-China trade war is putting downward pressure on the Chinese economy, the commentaries by the "two Xiaopings" have attracted intense attention as arguments supporting the trend toward "the advance of the state and retreat of the private sector," which runs counter to the market economy reform that was launched by Deng Xiaoping who is regarded as the mastermind behind China's reform and opening-up initiative.
2. Symposium on private enterprises presided by President Xi to reverse the trend
Government leaders, as well as government-affiliated media organizations, are trying hard to downplay the intensifying arguments erupting over the retreat of private enterprises. The prime example of this effort is a speech made by Secretary General Xi Jinping at a symposium with private enterprises on November 1, 2018 that was presided over by himself. In the speech, Xi paid high compliments to the importance and role of the private-sector economy in China and pointed out difficulties faced by the private-sector economy on the path of development. Having done that, he presented a policy supporting the private-sector economy on six points, including tax cuts, the reduction of financial costs, and obstacles to fundraising.
1) High praise for the private-sector economy
Xi highly praised the private-sector economy, which had previously been small and weak but has grown large and strong over the four decades since the launch of the reform and opening-up initiative, as an indispensable force in promoting China's development, citing the following points. First, he pointed out the private-sector economy's various contributions to the overall economy in quantitative terms: it contributes more than 50% of tax revenue; it accounts for more than 60% of gross domestic product (GDP); it accounts for more than 70% of the technological innovations achieved in China; it supports more than 80% of the employment of urban-area workers; it accounts for more than 90% of the total number of enterprises. Moreover, the private-sector economy plays an important role in the development of the socialist market economy, the transition of the government's systems, the absorption of surplus rural workers and the penetration of international markets, as it has come to perform the main role in business start-ups and employment and to serve as an important player in technological innovation and as an important source of tax revenue.
In reference to the recent debate over the private-sector economy, Xi expressed his opinion as follows. For some time, in certain quarters of society, there have been attempts to write off or cast doubt on the private-sector economy. For example, some people have argued that the private-sector economy should retreat from the stage of history on the ground that it has already fulfilled its mission. Others have misrepresented the ongoing reform toward a state-private mixed-ownership system as a new form of state-private joint management. Still others have argued that the strengthening of Party construction and labor union activity at enterprises is intended to exert control over private enterprises. These arguments are completely wrong and are inconsistent with the Party's broad policy line, according to Xi. He argues that China's private-sector economy should grow larger and stronger, not weaker—and that it should play a role on a wider stage.
Describing private enterprises and entrepreneurs as "our comrades," Xi emphasized the following points: that there has been no change in the position or role of the non-state-owned economy in China's economic and social development; that there has been no change in the government's policy of encouraging, supporting and leading the development of the non-state-owned economy or measures to implement the policy; and that there has been no change in the government's policy of developing a favorable environment and creating more opportunities for the development of the non-state-owned economy or measures to implement the policy.
2）Recognition of factors that obstruct the development of the private-sector economy
President Xi concluded that private enterprises are facing difficulties and problems as a result of the following four factors: (1) changes in the international economic environment, (2) the Chinese economy's transition to a higher-quality stage of development from the stage of fast growth, (3) unruly business management in the case of some private enterprises; and (4) failure to fully implement policy measures.
In particular, in recent years, the Chinese government has implemented many policy measures to support the private-sector economy, but there have not been many notable effects, as many of them have yet to be fully implemented. Some ministries of the central government and local governments are not sufficiently aware of the broad policy line of the Party and state, which is to encourage, support and lead the development of the private-sector economy, and there is still a wide gap between the reality and the goal of ensuring equality in terms of property rights, market participation, and access to factors of production.
For example, in order to prevent or reduce financial risks, some financial institutions show a reluctance or refuse to provide loans to private enterprises, demand premature loan repayment, or suspend loans, thereby causing borrower enterprises to face liquidity problems or to discontinue business operations. In addition, when the business tax was replaced by the value-added tax (the business tax, which was applicable to services, was unified with the value-added tax, which is applicable to goods, as part of the turnover tax reform), relevant rules were not fully enforced, producing the unintended effect of increasing the tax burden on some small and micro businesses.
3）Proposed measures to support private enterprises
President Xi expressed his intention to assist reform and development by creating a better environment for the private-sector economy and supporting the resolution of difficulties through the implementation of the following six measures.
(1) Reduction of the tax and cost burdens on enterprises
The government must effectively reduce the burden on enterprises by fully implementing projects that will lower costs through supply-side structural reforms. It is necessary to increase the level to which company's needs are met by reforms in a simple and clear manner, for example by expanding applicable tax deduction or by promoting effective reduction of the value-added tax. Tax exemption measures should be adopted for small and micro businesses and high-tech start-up enterprises. Furthermore, the burden on enterprises of social security payments should be mitigated.
(2) Resolution of problems such as the difficulty for private enterprises to raise funds and high fundraising costs
It is necessary to resolve the credit squeeze problem by adopting support for the development of the private-sector economy as a business performance assessment item for banks. The government must expand the scope of fund suppliers for private enterprises by increasing financial market entries and must make private-sector banks, small-lot lenders, venture capital companies, and the stock and bond markets fulfill their role as fund suppliers. It is also necessary to avert such problems as the transfer of ownership of private enterprises to state-owned entities by implementing special support measures for private enterprises which have borrowed funds using stocks as collateral and are facing a difficult position due to falling stock prices. Moreover, the government must instruct local governments to provide necessary fiscal support to promising private enterprises that will be able to contribute to the optimization and sophistication of the economic structure.
(3) Creation of a fair and competitive environment
Various obstacles standing in the way of private enterprises should be removed in order to create a fair and competitive environment for them in terms of market entry, review for approval, management and auction. The government must also encourage private enterprises to participate in the reform of SOEs. In addition, it is necessary to shift from discriminatory and optional industrial policies to comprehensive and functional ones, review policies that run counter to market rules that ensure fairness, openness and transparency, and promote the enforcement of antimonopoly and anti-unfair competition laws.
(4) Improvement of policy implementation methods
The government must ensure that private enterprises' needs are increasingly met in terms of policy implementation by strengthening policy coordination, designing and quantifying segmented policy measures and adopting relevant incidental measures and making sure that those measures are actually implemented down to the last detail. Regarding the resolution of excess production capacity and deleveraging, it is essential to apply the same standard to enterprises operating under different types of ownership. When implementing policies in such fields as safety supervision and environmental protection, it is important to take account of the respective circumstances of individual enterprises, rather than applying a one-size-fits-all approach.
(5) Development of a new type of government-company relationship that is clean and friendly
A new type of government-company relationship should be developed that is clean and friendly and support for the development of private enterprises should be promoted as an important task. The government should devote more time and effort to the development of private enterprises and the growth of private-sector entrepreneurs, rather than merely making verbal commitments or promoting slogans. Senior officials of government ministries and agencies concerned and local governments must consistently listen to appeals from private enterprises, and when private enterprises are facing difficulties in particular, they must make active efforts to support the resolution of those problems. It is necessary to include support and guidance for efforts to overcome difficulties faced by SOEs and private enterprises, especially small and micro businesses, and to promote innovation among the assessment criteria of the performance of senior officials.
(6) Strengthening protection of the personal and property rights of entrepreneurs
When seeking cooperation from entrepreneurs to conduct investigations in the course of performing their duties, discipline inspection and oversight agencies must not only make the nature of the problem clear, but also protect the entrepreneurs' legitimate personal and property rights and ensure that they can continue to lawfully conduct business. With respect to private enterprises that have committed illegal acts in the past, it is necessary to treat their cases based on legal principles and the supposition of innocence without proof to the contrary, liberating entrepreneurs from mental burdens and allowing them to move forward without hindrance.
3. Urgent need to carry out institutional reform based on the principle of competitive neutrality
In order to resolve the difficulties faced by private enterprises, the Chinese monetary authorities have already launched a three-pronged initiative featuring (1) support for securing credit, (2) support for fundraising through corporate bonds, and (3) support for fundraising through stocks ("Governor of the People's Bank of China: Expand fund-raising routes for private enterprises based on three arrows," Xinhuanet, November 6, 2018). To be more specific, regarding support for securing credit, the People's Bank of China adopted the expansion of credit for private enterprises as a new assessment item under the Macro-Prudential Assessment system (MPA) that is applied to commercial banks and also expanded its relending and rediscount quotas for financial institutions. On support for fund-raising through corporate bonds, the Standing Committee of the State Council decided at a meeting on October 22, 2018 to introduce a scheme to support fundraising by private enterprises through bonds, such as CDS (credit default swap). In addition, on support for fund-raising through stocks, the People's Bank of China will support the establishment of private placement funds and venture capital funds by securities companies and asset management companies affiliated with banks.
However, these measures are nothing more than quick fixes that address the symptoms, and treating the cause requires creating a fair and competitive environment through institutional reforms. When doing that, the principle of competitive neutrality advocated by the OECD will serve as a useful reference.
If the principle of competitive neutrality is to be followed, the government must maintain neutrality by providing equal treatment to enterprises operating under different types of ownership, including SOEs, private enterprises, and foreign invested enterprises. This is consistent with China's existing policy that the government protects the property rights and legitimate interests of enterprises under different types of ownership, and ensures that they have equal access to factors of production, can participate in market competition publicly, equally and fairly, and receive equal protection under the law ("Decision of the Central Committee of the Communist Party of China on Some Major Issues Concerning Comprehensively Deepening the Reform" adopted at the Third Plenum of the Central Committee of the Communist Party of China, November 12, 2013).
To dispel the concerns of private-sector and foreign-invested enterprises, Governor Yi Gang of the People's Bank of China, speaking at a G30 seminar on international banking on October 14, 2018 sounded a positive note on the possibility of the Chinese government embracing the principle of competitive neutrality, as did State Market Regulatory Administration Director Zhang Mao in a speech on November 6 during the first China International Import Expo in Shanghai.
In international trade negotiations, such as those concerning the Trans-Pacific Partnership (TPP), the principle of competitive neutrality is regarded as important for the development of rules intended to realize fair trade and investment. For China, promoting the principle of competitive neutrality as a key concept in its market economy reform will be helpful not only for developing private enterprises but also for resolving the ongoing trade friction with the United States.
March 13, 2020
Article(s) by this author
Can China Reform State-Owned Enterprises without Privatization?
—Creation of a Fair and Competitive Market Environment as the Second-Best Option
March 13, 2020［China in Transition］
Development of Private Enterprises in China Entering a Difficult Phase
—Urgent Need to Create a Fair and Competitive Environment
March 13, 2020［China in Transition］
January 31, 2020［China in Transition］
October 10, 2019［China in Transition］
September 19, 2019［China in Transition］