Rise of China Inc offers mixed bag of pleasure and pain

PUBLISHED : Monday, 19 September, 2005, 12:00am
UPDATED : Monday, 19 September, 2005, 12:00am

Last week, brokerage company CLSA published a research report arguing that the private sector now accounts for 70 per cent of China's economy. Within days, competitor UBS issued a note asserting China's private sector is 'tiny', citing official figures that private enterprise accounts for no more than 30 per cent of China's gross domestic product. Both cannot be right but working out which is nearer the mark is tricky.

The point is of much more than academic interest. Entrepreneurs are the lifeblood of any healthy economy. The small firms they set up grow more rapidly than large, established concerns, create more jobs and stand ultimately to generate more wealth. So assessing the size and strength of China's private sector is essential for understanding just how robust China's economic miracle really is.

The problem is partly one of definition. On the surface, much of China's economy remains in state hands. According to official figures, domestic firms registered as private enterprises contributed only 22 per cent of GDP in 2003.

In 2003, when the State Asset Supervision and Administration Commission was formed to oversee these assets, it counted about 150,000 companies on its books. According to UBS, state enterprises still own nearly 60 per cent of China's fixed assets.

Yet, despite the size and influence of the big state-owned companies, China's economy is deeply fragmented and determining exactly who owns what can be difficult. CLSA's chief China strategist Andy Rothman says many entrepreneurs are 'wearing a red hat' - passing off their firms as publicly owned in order to grease political wheels.

Counting all collectives, joint-stock companies, the entire agricultural sector and foreign owned firms as private, Mr Rothman estimates that fully two-thirds of China's economy is now in private hands. Adding a conservative estimate for the informal sector, he says the true figure is in excess of 70 per cent.

This is quite a discrepancy. Happily, in its first survey of China, published on Friday, the Organisation for Economic Co-operation and Development has taken a stab at solving the puzzle.

To work out how many firms are privately run, it examined not the official categories firms are registered under but the identities of their controlling shareholders. It concluded that 59 per of the economy is now private and 34 per cent state-controlled (the other 7 per cent is collectivised). Outside agriculture, 57 per cent of output comes from private companies.

That figure is only going to grow. The number of registered domestic private companies is rising fast and contrary to common belief, most are not remodelled collectives or former state enterprises taken over by their old management but new companies set up by entrepreneurs .

And despite tough operating conditions, little or no access to credit and obstructive bureaucracy, private companies outperform their state sector rivals. According to the OECD, productivity at private firms is double that at state-controlled companies. Their financial performance is better, too. The vast majority are profitable and few have significant levels of debt.

The strength of China's private sector is good news for job creation. Over the past five years, the number of workers at private industrial companies in China has tripled, balancing the number laid off by the state sector.

But there are potential dangers in the rise of private enterprise. State-run and privately owned companies react differently to changing economic conditions. In a downturn, state-owned companies are more likely to accept losses in order to preserve jobs. Private firms have a greater incentive to cut costs by shedding staff. That will make China's inevitable cyclical downturn more painful when it comes.