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Private sector investment in China: Unshackling the engine of growth

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In Brief

On May 13, the Chinese State Council released a new set of guidelines on domestic private investment. Its 36 measures mirror a similar policy review published 5 years' ago on the non-state economic sector which promoted equal treatment of both state and private sectors. Commentators have dubbed the recent guidelines as the ‘New 36 Articles’.

The measures are aimed at lowering the entry barriers for private investors in sectors such as infrastructure, municipal services, financial services, logistics and defense which have all traditionally been dominated by state titans or excluded from private sector participation altogether.

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The policy has been greeted with cautious optimism by China’s entrepreneurs. In an interview with Caixin, the Deputy Chair of the Association of Small and Medium Enterprises in China, Zhou Dewen, observed, ‘The old guidelines were a lot of thunder but with very little rain drops. Government at various levels erected myriad of barriers for private investors to enter and the implementation of the policy has been fraught with problems.’

Despite the fact that the private sector is responsible for 60 per cent of Chinese GDP and generated 56.4 per cent of fixed urban investment between January and November 2009, it is grossly under-represented in many lucrative sectors. Private investment accounts for only 13.6 per cent of electricity and heat generation, 9.6 per cent of financial services and 7.8 per cent of telecommunications. Surprisingly, it fares worse than its foreign counterparts: where foreign investors are allowed to invest in 62 out of 80 plus sectors, private investors have access to just 42.

Senior government officials from the powerful National Development and Reform Commission (NDRC) openly acknowledge that there are ‘glass doors’ in place that hinder private investment in industries dominated by state monopolies. This is true even for the sectors such as aviation, which is both sympathetic and open to private investment. Private operators find it hard to establish new routes or favorable scheduling times. Many investors subsequently exit the industry or fall victim to predatory state takeover bids.

Aviation is symptomatic of a much broader malaise in the Chinese economic landscape. Though there are no overt legal restrictions on private investment, a cumbersome administrative approval process and discriminatory industrial policy impose a straitjacket on expansion into it by the private sector.

Private investors have also been starved of vital credit from a largely state-controlled banking sector. State-owned enterprises became the principal beneficiaries of Beijing’s massive fiscal expansion and stimulus package while the private sector was left to scrape the bottom of the barrel.

While the private sector struggles to maintain a foothold in profitable sectors such as telecommunications and energy, the Chinese government actively encourages and supports SOEs to consolidate their positions. The recent government-led coal industry restructuring in the resource-rich Shanxi province resulted in substantial losses to private investors from Wenzhou, a hotbed of entrepreneurial activity in southern China. State coal companies benefitted to the detriment of private investors, who had been enticed to invest in Shanxi when commodities prices were depressed. The soaring coal price in recent times saw an end to the official welcome mat for private capital, a policy change that has badly shaken investor confidence and damaged the government’s credibility.

The May policy review came at a critical juncture in the development of the Chinese economy. The massive fiscal expansion unleashed by Beijing worked quite effectively as a buffer against the worst excesses of the Global Financial Crisis and the Chinese economy was one of the few bright spots amid the global gloom. Though the government’s decisive action might have saved the day, the largely government-led fixed investment driven growth and credit expansion is no long-term solution for sustaining growth.

For China to further deepen its market-based economic reform, private investment must be freed from the shackle of government restrictions and allowed to compete on a level playing field across all sectors. This would not only unleash a new locomotive for economic growth in China but it would produce important gains in efficiency and productivity.

It is widely acknowledged that the private sector is more effective in using resources than their state counterparts. According to Han Chaohua, of the Chinese Academy of Social Sciences, between 2004 and 2008, private firms were on average 1.6 times more profitable than their SOE counterparts. He extrapolates that if the resources allocated to the state were given to private firms, the government would earn an extra 2 trillion yuan in tax revenue and profit.

Hopefully the new policy will not fall victim to the same fate as its predecessor: a reform plan that was suffocated by bureaucratic red tape and nepotism for state enterprises. It is a litmus test for Beijing’s reform credentials on unshackling China’s private sector engine of growth.

This essay was prepared by the EAF team at the ANU.

2 responses to “Private sector investment in China: Unshackling the engine of growth”

  1. Interesting story. China is now ranked 89 in the world on the World Bank’s Cost of Doing Business database, compared to 86 last year. It ranks very lowly on measures like starting a business, dealing with construction permits,employing workers and payment of taxes. But it ranks very highly on registering property where it takes just 29 days in China to register property compared to 97 days in the average East Asia-Pacific country. It ranks 61 on getting credit which doesn’t seem to bad, though it could be a lot better by having an effective credit Bureau.

  2. It is very strange that the private sector in China even does not have the same access to industries as foreign companies.

    It is sometimes also difficult to understand some Chinese statistics and studies. For example, while the statement in the second last paragraph may have its basis or facts, it is not certain how comparable those facts are.

    Clearly, many complaints have been made to the fact that many SOE’s pay much higher salaries to their employees. At the same time, it is also reported that workers in many companies are not paid enough.

    That is contributing to many social problems, such as income distribution and inequality, workers rights, long working hours and poor working conditions, low or no social securities.

    SO, if relating all main economic issues in China and taking a holistic view, is the statement in that paragraph really meaningful? I am not that sure anymore as those researchers, although they are fairly reputable ones.

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