China’s growing private sector

A new book by Nicholas Lardy, a prominent American student of the Chinese economy, called Markets over Mao and published by the Peterson Institute in Washington, takes a look at what has actually happened in the Chinese economy over the period of reform, and especially during the past decade, based in large part on a close study of official Chinese data. He carefully examines the changes in Chinese output and employment, paying particular attention to the role of state-owned enterprises (SOEs) and enterprises that are effectively privately owned. Despite the apparent slowdown in Chinese reforms, Lardy finds that the country has evolved toward ever greater private economic activity, with a sharp diminution in the overall role of SOEs.

Concretely, by 2012 the share of industrial output of SOEs was down to 24 percent. The share of urban employment by SOEs was down to 18 percent in 2012, from 99 percent in 1978; privately owned firms accounted for virtually all of the large growth in urban employment since 1978. (The government accounted for the remainder.) Rural employment was essentially all private by 2012, as the communes of 1978 had been disbanded, and most town-and-village enterprises had become private during the past decade. SOEs accounted for only 11 percent of exports in 2013, compared with 47 percent by (private) foreign-owned firms and 39 percent by domestic private firms. SOEs, including those owned by provincial and municipal governments, still accounted for 34 percent of total fixed investment, compared with 48 percent by private firms (the remainder by governments at all levels), but the corresponding figures were 11 percent and 73 percent in manufacturing.

The overall picture is one of rising private enterprise and declining state enterprise over the entire period, including the past decade. Of course, in certain sectors SOEs maintained their dominant positions: financial institutions, power generation and distribution, tobacco, much transportation, publishing, basic telecommunications, and oil and gas exploration and development. Even here, though, some private activities have emerged, in trucking, oil refining and distribution, and mobile phone production and applications. Profits in most of the near monopoly SOEs have been exceptionally high.

In general, though, profits have been significantly higher on average in private enterprises than in SOEs, 13.2 percent in 2012 versus 4.9 percent. Since most new investment and expansion are financed by retained earnings, this suggests that private enterprises will continue to expand relative to SOEs unless the government directly or indirectly subsidizes the latter. It is true that SOEs have easier access to (state-owned) bank credit than do private enterprises, but even here bank loans to private enterprises have been growing more rapidly, reaching 25 percent of the total by 2012.

Of course, government can influence economic activity in many other ways than through SOEs. It can control prices, as in interest rates on bank deposits and retail prices of petroleum products in China; use competition policy to shape industries and even firms; and impose regulations and taxes. But the government is not exceptionally large relative to the population and production. The government, including the Communist Party, employed just over 42 million people in 2011, a large number it is true, but only 31 per thousand of population, compared to 95 in France, 75 in the United States, and 38 in Mexico and Turkey. China raised 22 percent of GDP in taxes at all levels of government, much lower than the levels in rich countries and even lower than the 28 percent average for emerging markets and developing countries. Regulatory powers are much more difficult to compare across countries, but an Organization for Economic Cooperation and Development study of 2008 found China’s regulations weaker than those in India, Belgium, Brazil, Indonesia, Russia and Turkey. All the other BRIC members have more intrusive government in the economy than does China. (This comparison probably does not allow for indirect control through Communist Party channels.)

The ability of the central government to control activities at the local level is notoriously weak, of which probably the most egregious example is air and water pollution, which have figured heavily in the 11th and 12th five-year plans, but still worsen.

Nonetheless, Lardy foresees the continued relative growth of the private sector in China. This would reflect the thrust of the decisions at the third plenum, which called for “a reduction in the direct role of the government in the allocation of resources” and the promotion of resource allocation on the basis of “market principles, market prices and market competition.” But it would also reflect the fact that most SOEs are not earning their cost of capital, so they must gradually atrophy unless provided significant subsidies. Whereas in contrast private firms are earning substantially above their cost of capital and thus are able to expand as China’s economy grows.

*Richard N. Cooper is Maurits C. Boas Professor of International Economics at Harvard University

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