How real is China's private sector?

Does one really exist or are foreign firms acting as a proxy?

The Chinese private sector has attracted a huge amount of attention since the International Finance Corporation (IFC) started its pioneering work with it in 2000. For outside observers, this is hardly surprising given that individual ownership, protected by laws within a democratic framework, is the hallmark of Western capitalism.

In the context of a disappearing Communist structure, the transition to a private economy seems to be the litmus test of modernization for westerners. But China has confounded expectations partly because it is not always easy to define what is public and what is private sector.

Some 2500 years ago, Confucius pointed out that the mainstay of a stable society was definitions. Words had to mean what they were meant to, and people to act according to their station in life.

He certainly knew his countrymen.

Although many Western scholars have lauded the emergence of an entrepreneurial class it is not easy to separate the private sector from the public sector. There is a welter of inter-grown business activity, from SOE managers setting up parallel operations to private companies posing as SOEs to access finance.

Inaccurate definitions also prevent accurate categorizations, according to Arthur Kroeber, MD of the China Economic Quarterly and author of a recent report.

For example, contrary to many reports, he argues that limited liability companies and shareholding companies that contributed 48% of retail sales and 30% of gross industrial output in 2002, should be added to the state sector, despite being structured differently to traditional SOEs.

More broadly, many argue that it is almost meaningless to speak of pure private companies because there is little acceptance of the private sector as an ideology, complete with the all the necessary add-ons, such as an independent legal system, respect for property, the property owner as a contributor to the political process through freely-articulated opinions and the ballot box, etc.

And are recognizably 'private' companies any more efficient?

"If you take access to financing as an example, private entrepreneurs often need to pay kickbacks to bank loans officers," notes one US diplomat based in Beijing. "That corrupts their relationships to the banks, just as officials exploit state-owned banks as their piggy banks. In neither case is lending based on commercial principles."

"And when it comes to resisting pressure from politicians not to fire workers in order to ensure social stability, private companies may actually be more vulnerable to government pressure, she adds.

Other observers note the weak identity of the firm compared to the individuals that run them.

"You often tend to find yourself negotiating with individuals rather than with the firms, notes Tim Clissold, author of a recent book on China 'Mr China'.

In many cases, the firm becomes a vehicle for the ambitions of its staff, leading to asset stripping from the tea boy all the way up the CEO.

Kroeber adds that despite its high profile, the private sector contributes far less to China's economy than most realize.

"It's not a matter of the Communist Party believing in public ownership," he says. "It's far more a matter of an elite wanting to keep its hands on the levers of power."

Lever is the key word here.

"The government has realized it can leverage its ownership of state assets. It does not need to own 100% when it can sell of 25% to foreign investors and raise quite a lot of money. So-called privatization via overseas and domestic markets is actually more of a capital-raising operation, he points out.

The rapid growth of the private sector in China should be viewed with caution for a number of other reasons.

New privately-owned companies tend to be small, just 25% on average of SOEs by registered capital.

Another important point is that far from becoming weaker, the public sector is actually becoming stronger thanks to the new policy of focusing on the top 196 largest firms. These firms, although few in number, have a whopping Rmb 7 trillion ($846 billion) in corporate assets, compared to Rmb 18 trillion in assets overall. Of the top 500 enterprises, 74% are state controlled, accounting for 96% of the assets and 85% of the profits.

In total, there were still 159,000 SOEs at the end of 2002, according to the China Economic Quarterly. Of the total number of SOEs, only around 5% to 10% have been privatized, with 10% in the process of being privatized and another 10% likely to be privatized. Of value added industrial output, just one third come from the private sector.

In addition, SASAC, overseeing the country's top public firms, is beginning to muscle its way into local government as a regulator. SASAC has opened up branches at all levels of government and is ensuring that local governments apply to it for approval, even if SASAC has no stake in these smaller, provincial firms.

That could lead to a slow down in privatization, since as Kroeber notes, "while the local authorities are only too keen to get ride of SOEs, especially loss-making ones, the closer you get to the central government, the more cautious people get."

In contrast to the mixed message of the domestic private sector, the foreign private sector is extraordinarily strong.

Capital and technology rich, the foreign private sector is being prevented from hoovering up great swathes of the economy by the restrictions imposed on them by the Chinese government - and by the occasional arrogance/blindness exhibited by numerous newcomers to the market.

These problems are brilliantly captured in Tim Clissold's book, which narrates how he and his US partner ran through $420 million dollars in other people's money, as they sought to impose their views on how businesses should be run in China.

Despite this, Foreign Invested Enterprises have put their stamp on the economic landscape.

FIEs contribute 52% of China's total export value, compared to 4.2% for the private sector in 2002 and 54.3% of imports compared to 3.2% for the private sector. FIEs contributed to 29% of total industrial output in 2002, compared to just 12% by privately-owned enterprises. In terms of gross output of industry, the private sector contributed 11.7% compared to 17% by FIEs.

The one area where private firms do outperform is the catering trade. But as any visitor to the mainland knows, it is not these Mom & Pop stores that will make Western capitalists feel the country is moving powerfully in a familiar direction.

Observers speculate the government may be afraid of a powerful domestic sector, despite recent assurances that private property rights will be respected and the private sector embraced as new force in society.

In contrast, FIEs are docile tax cows. They do not get involved in politics and do not clamour for representation.

As a result, they are doing good job of providing the many advantages of a dynamic and fast moving private sector with none of the problems.

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