The decision of the National People's Congress (NPC) in March to include private property rights in the constitution was a significant reform step forward. It means private property has now the same legal status as state-owned property. But despite the intention to change, the NPC's move is still symbolic, as the current reform pace will not benefit the private sector as expected. The main problem lies in reform inertia due to a Marxist mindset.
Now you see it, now you don'tIt is true the state sector has shrunk, with its shares in the nation's fixed-asset investment and gross industrial output falling from 80% in 1980s to 40% in case of investment and to 16% in case of output in 2002 (the latest data available). But this does not mean a robust private sector. Despite its rapid growth in recent years, it has remained fragile, fragmented and constrained.
The depth of China's structural reform is distorted by data reporting. Beijing reports two sets of industrial output numbers, gross industrial output and industrial value-added, each with a different output breakdown by sources.
The gross industrial output data has breakdowns for the state-owned enterprises (SOEs) and the private enterprises. They show that SOEs' output share had fallen to 16% in 2002, while the private firms' share had risen to 12% from just 5% in 1999. This shows that the private sector growth has not been as significant as many have claimed.
Crucially, the breakdowns also show that 18% of the output came from limited liability companies and 13% came from shareholding firms. But most of these companies are still state-controlled. This means state companies still control 47% (16% + 18% + 13%) of industrial output, but not 16%.
Meanwhile, the industrial value-added data, which enters into GDP calculations, shows that SOEs accounted for 48% of industrial output in 2002. Granted, this share was down from 54% in 1994, but not so dramatically as some have claimed.
This data set also includes "shareholding companies", which accounted for 15% of total industrial value-added in 2002, up from 6% in 1994. It is wrong to assume, as many have done, these are all non-state firms.
In fact, the state remains the majority shareholder of many of these firms. This means the state still controls as much as 63% (15% + 48%) of industrial value-added. Since the industrial value-added data does not have a private sector category, it is impossible to decide from it the share of private sector output in GDP.
That banking dinosaur
Even in the high profile banking reform, progress is much slower than perceived. After two failed efforts in 1998 and 1999, Beijing has started another bailout this year of the Big Four state banks, which control over 60% of all banking assets. The bailout uses some $45 billion of China's huge foreign reserves to boost the banks' capital.
Arguably, the move comes too little too soon. About $300 billion is estimated to be needed for sustaining the banking system. But even the current small capital injection may have come too early, as the banks should have proven their commercial viability before getting further government funds. But they have not.
The former two recapitalization programs have failed to uproot the way state banks do business, which is still politically driven. New lending took off in 2001, as Beijing tried to boost growth in the face of a world economic slowdown. Then, the authorities tried to clamp down on lending in late 2003, especially on property and heavy industries, to avoid overheating. Beijing has directed this recent boom bust lending cycle, which means the Chinese banks are still taking orders instead of lending on commercial basis.
The domestic capital market is dysfunction, which makes China's asset management companies impossible to price bad assets properly and sell them off successfully. The IPO process is politically driven, with all but a handful of the listed companies are SOEs. Add to that an underdeveloped bond market, it is clear that China's capital market is still largely a tool for subsidising Beijing's industrial policy instead of allocating capital to private companies.
Banking and capital market reforms should go hand in hand. But Beijing is still seeing the two disjoint events, which is strategically wrong for reform. The authorities have promised to improve bank management, corporate governance and risk controls by bringing in foreign investors as both managers and strategic investors. The central bank has also taken steps, albeit very slowly, to liberalise interest rates.
Marx still lives in China
However, such changes are slow to filter through the system, which is still dominated by a Marxist mindset even after years of economic reform. Despite the March constitutional amendment to elevate the status of private property, the leadership remains suspicious of the private sector. While the constitution clearly states state property as "sacred and inviolable", the amendment has failed to grant the same "sacred" status to private property.
Further, the amendment stresses that only "lawful" private property is protected, but the constitution protects all (lawful or not) state property. While it is illogical to expect the constitution to protect unlawful property, the amendment's stress on lawful private property reflects the leadership's wariness of private businesses. It is no use to just amend the constitutional status of the private sector without changing the legal system underpinning it.
The point is that although there is undeniable progress in China's structural reform, its depth and speed have been exaggerated. To create a functional private sector that has full legal protection, China still has a long way to go in reforming the underlying legal framework, improving contract and bankruptcy laws, allocating capital more efficiently to the vibrant but yet vulnerable private sector and eliminating bad incentives of local officials that hurt private businesses.
The bottom lines
But these structural changes will inevitably create short-term shocks to the economy. That is why the leadership has stressed social stability through these years. For Beijing, stability is about control and the unofficial RMB peg to the USD is part of the game. Hence, it is unlikely to un-peg the RMB anytime soon, despite rising market speculation that it would.
Arguably, the RMB peg functions like the Great Wall of China. The Wall was built in the third century BC to keep out invaders. The RMB Wall was put up in 1995 to keep out speculators. Removing it will be a major political undertaking rather than economics. It is useful to heed the recent comment by the head of the State Administration of Foreign Exchange, who offered a six-year timetable for allowing full RMB convertibility.
Chi Lo is author of the book "The Misunderstood China - Uncovering the Truth Behind the Bamboo Curtain", Pearson Prentice Hall, 2004.