Given the red tape, small firms in China are minor miracles

PUBLISHED : Wednesday, 14 September, 2005, 12:00am
UPDATED : Wednesday, 14 September, 2005, 12:00am

Despite years of reform, China's business and regulatory environments are still biased heavily against small entrepreneurs. Today, small private companies contribute more than ever before to China's economic health.

According to a research report published this week by brokerage CLSA, private enterprises now account for roughly 70 per cent of China's gross domestic product, compared with just 17 per cent in 1990. The private sector employs 75 per cent of all workers and creates 80 to 85 per cent of all new jobs.

But life is tough for small entrepreneurs. A survey published yesterday by the World Bank ranked China just 91st out of 155 countries for ease of doing business. That puts China one place behind Yemen and only just ahead of African basket-cases such as Nigeria and Lesotho. (Hong Kong ranked seventh, behind Singapore at number two and Australia at six.)

The World Bank survey examined 10 different factors, including how easy it is to start a business, enforce contracts and trade across borders. Although it found that China had made great strides over recent years in some areas such as processing imports and exports, in others the mainland remains relatively backward.

For example, the study assessed how long it took to obtain all the necessary licences for a new warehouse to store books and stationery. In Korea it takes 60 days to complete the 14 required procedures, in Hong Kong 230 days to get the 22 permissions needed and in China it takes 363 days, or very nearly a whole year, to comply with the 32 necessary regulatory processes (see bar chart).

Such labyrinthine bureaucracy is a big obstacle for small businesses. While state-owned companies or foreign-backed enterprises often have the contacts and resources to smooth over problems, small companies do not. Compliance makes disproportionate demands on their resources while delays soon eat into their limited working capital. For many small businesses, the answer is simply to ignore the regulations or to bribe officials to speed up approvals.

Tax regulations are another problem. Domestic private companies in China must make 34 separate payments each year which take 24 days to prepare and process and eat up 47 per cent of gross profits. That contrasts with Hong Kong where companies make a single annual payment which takes an average of three days' work and swallows just 14 per cent of profits. Not surprisingly, tax abuse in China is rampant.

But the biggest obstacle facing small companies is the difficulty they have getting bank loans to finance either operating expenses or investment. With credit analysis in its infancy and regulations governing the use of collateral and foreclosure deeply inadequate, China's banks prefer to lend to large companies, especially in the state sector.

Private companies have to finance their business through their own funds or by informal private loans (see pie chart), which CLSA estimates to be worth some US$34 billion annually.

So far, lack of bank credit has not stopped millions of private enterprises from springing up in China but over time it will restrict the scale of their growth and limit their ability to create new jobs. If not addressed soon, that will become a drag on overall economic development.