Ahead of a trip next week to Beijing to learn more about the lending business of China Minsheng Bank, I’m encouraged to see that the private sector is already flourishing in China.
In December 2013, President Xi Jinping made clear the scope of his refom ambition at the third plenum of the Chinese Communist Party’s 18th Central Committee. He announced a shift in policy towards expanding the role of the private sector, among many other reforms such as ending the one child policy. Many commentators were surprised at the scale of the planned changes and impressed by the announcement that the market would play a “decisive function in resource allocation”.
Not that much has actually happened since, leaving some people to wonder whether the reforms are on track. The prevailing view I heard on a recent trip to southern China is that the anti-corruption programme currently in force is in part a means of clearing obstacles to greater reforms, which will then start in earnest in 2016. But there is actually quite a lot of good news about the private sector
Small business creation rising fast
The number of new small businesses launched in the first half of 2014 was 1.68 million, up nearly 60% on a year before, and creating some 10 million jobs. The rules on setting up businesses have gradually been relaxed in the last decade, with the minimum share capital cut from 300,000 (about $40,000) yuan to 30,000 yuan in 2006. Further reforms on limited liability and tax have made it easier and cheaper to set up small businesses and the growth in 2014 is largely independent of the reforms promised at the third plenum.
SME lending not as bad as thought
One major constraint on small and medium enterprises (SMEs) around the world is access to finance. It is the conventional wisdom that Chinese SMEs in particular lack access to credit but this is no longer true, as Nicholas Borst of the Peterson Institute of International Economics tells us in a recent article. It’s hard to do accurate analysis because the definition of SME varies not only across countries but even across different sectors of the Chinese economy. Borst makes some adjustments to estimate the lending to SMEs in China with 300 employees or fewer, which is roughly in line with the definition used in a recent OECD report on SME lending. He concludes that about 30% of total bank lending goes to these SMEs, above average across the world and better than Russia, Turkey, Thailand and Mexico.
What is true is that the big state owned banks are under pressure to lend more to the private sector and SMEs in particular. In July the Prime Minister Li Keqiang criticised the big banks for lending only to large companies, though of course they have been instructed to do so for the last thirty years. The heads of the big five are also reported to be first in line for the new pay cuts announced for the public sector.
Stock exchange reforms favouring high tech start ups
There has been a sharp increase in companies listing on China’s New Third Board, an electronic stock market for smaller, early stage companies, mainly from the technology sector, which started in January 2013, with the full support of the China Securities Regulatory Commission. It is intended to complement the larger markets of Shanghai and Shenzhen. Like most such markets round the world, the Third Board is not very liquid and has depended on electronic order matching of buyers and sellers. That means sometimes no trading at all in some of the stocks.
Last week the Third Board changed to a market making system, meaning that financial intermediaries pledge to buy and sell shares using their own capital, thereby allowing investors to buy at any time the market is open, even if there is no seller at that moment. Improved liquidity should attract more investors, expanding the appeal of the Third Market to both companies and investors. Brokers in China hope that the Third Board could act as a stepping stone for companies to then list on Shenzhen’s ChiNext electronic market, which is intended to copy the US NASDAQ high tech market, but for earlier stage companies.
The companies acting as market makers on the Third Board in many cases have little or no experience, so we shall see how well the system operates. But it’s a useful step towards improving access by the private sector to equity funding, something that China’s widely distrusted stockmarkets have so far failed to achieve.
The private sector is already very important
China’s state capitalist system has been driven by state owned firms in the key strategic sectors of the economy, including the major banks. But the share of total employment that is in the private sector is now 82%. The reason for pushing the private sector further is that the state owned enterprise sector is still inefficient. Nicholas Lardy, also of the Peterson Institute, argued recently in the financial and business magazine Caixin that the private sector has made great strides in the last decade, mainly because some of the biggest obstacles were removed in the 1990s. The next set of reforms are about removing the remaining protections that SOEs enjoy in several sectors and in reforming those SOEs, including through privatisation.
The need for reform is reinforced by the underlying slowdown in the Chinese economy. Growth has been disproportionately driven by high levels of investment, much of it through the public sector. Some, possibly a lot, of that investment is likely to be of poor value, generating low returns. The economy needs to rebalance towards a lower share of investment and higher share of consumption. It also needs a higher quality of investment, which means a rising private sector share and higher returns on the remaining SOE investment.
Nicholas Lardy’s new book Markets Over Mao, which I have downloaded but not yet read, has been published and there is an accompanying presentation which shows how far China has moved from the state dominance of the economy in the 1970s. For example:
- the state share of industrial output was 26% in 2011, down from nearly 80% in 1979 (though it’s much higher in sectors such as tobacco, oil and gas and coal mining)
- the state share if investment in manufacturing was only 11% in 201
- the state share of exports is only 11% in 2014
He also points out that the return on assets in the state sectors was 4.9% in 2012 compared with 13.2% in the private sector. As some state sectors are utilities such as electricity and water, in which the return would be expected to be lower than the average for the private sector, this is not a like-for-like comparison. But most remaining state dominated sectors could be moved to the private sector and the low returns reflect over-investment and poor cost control. Privatisation, which is the government’s policy, is needed to raise returns and overall economic efficiency.