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A world apart

17 October 2014 By Edward Chancellor

Edward Chancellor is a financial historian, journalist and investment strategist. He is the author of ”Devil Take the Hindmost: A History of Financial Speculation”.

Has the impetus for economic reform in China ground to a halt? Many China-watchers think so, citing state banks’ favouritism of state-owned enterprises (SOEs), the continuing monopoly power of state-owned “national champions,” and the effects of the massive fiscal and credit stimulus launched after the 2008 collapse of Lehman Brothers. Nicholas Lardy will have none of this.

In his new book, ”Markets over Mao: The Rise of Private Business in China”, Lardy, a veteran China economist at the Peterson Institute, argues that the private sector in China continues to grow at the expense of the state-controlled parts of the economy. The data supports his claims. The trouble is that since Chinese national statistics are generally vague and sometimes downright unreliable, they can be used to justify wildly contrasting views of China’s economy.

There is no disagreement that the private sector in China has grown marvellously since economic reforms were initiated in the late 1970s. The markets for labour and the vast majority of inputs have been liberalised. There has been a huge influx of foreign investment. Private firms now account for around two-thirds of China’s economic output and an even greater share of industrial and manufacturing production.

Lardy doesn’t believe that China’s state-owned sector poses much of a threat to this free market paradise. He points out that the SOEs were severely culled in the late 1990s. Many of the sectors which remain under Chinese state control – such as energy, telecoms and utilities – have traditionally been under national ownership in most Western countries. Although the largest banks remain in state hands, their share of financial assets has steadily declined.

Besides, as Lardy observes, private Chinese companies with poor access to bank credit have used retained profits to fund their growth. Most contentiously, he says that state-owned enterprises haven’t crowded private firms out of the credit markets. In recent years, the supply of credit to the private sector has actually outpaced the growth in lending to SOEs.

According to Lardy, the evidence suggests that private firms “grow faster, employ capital more efficiently, create more jobs, and increasingly generate more exports than state firms”. Just how robust is this “evidence”?

MIT economist Yasheng Huang has claimed that the size of China’s private sector is overstated in the national statistics. Many “shareholding” and “limited liability” firms, generally viewed as private, are in fact state-controlled. This makes a huge difference. Adjusting for that, the private sector’s share of fixed asset investment in 2012 was not 64 percent but just 29 percent.

Chinese economic statistics can drive just about anyone crazy. But Lardy misses a far more important point. In modern China, the line between “private” and “public” has always been fuzzy and has often shifted. The fast-growing Township and Village Enterprises were generally deemed public in the 1980s. They later morphed into private enterprises, when their bosses no longer felt that they had to escape the opprobrium that was attached to “capitalist roaders.”

Today, it’s still not clear whether even well-known Chinese companies are truly private or public. Lardy cites Lenovo as a private concern. Yet the computer maker came out of the Chinese Academy of Sciences and is categorised in OECD documents as “state-owned.” Lenovo was incorporated in Hong Kong, and thus also qualifies as a “foreign invested enterprise”. The ownership status of Huawei, the Chinese telecoms equipment firm, which has been dogged by claims of association with China’s military, is even more contentious.

The confusion is a consequence of China remaining an authoritarian single-party state which suffers from endemic corruption. This is crony capitalism, where everything is up for grabs and there is no clear-cut distinction between public and private. Connections with leading Communist Party members and their families appear to be vital to business success. Even Alibaba, the internet giant often praised as a private sector success story, is not exempt. As The New York Times recently pointed out, four companies invested in Alibaba prior to its IPO have had executives who were scions of former Politburo members. But reliance on protection that comes from distributing shares to princelings is hardly a triumph of the market.

China’s institutions have not advanced in line with the country’s economic development. There is still no rule of law, no judicial independence, no absolute protection of property rights and no impartial enforcement of contracts by the state. Regulation is often arbitrary and fosters rent-seeking. Successful entrepreneurs are vulnerable to expropriation by Party cadres and their cronies.

Even when the private sector is gaining ground, the state’s influence is huge. Lardy notes that private outfits are doing well in steel, mining and construction sectors, at the expense of state-owned companies. Private firms have also taken a greater share of credit supplied by the burgeoning shadow banking sector.

Yet all these developments are linked to China’s epic property boom. Given that all land in China is ultimately owned by the state, that the government has expropriated land from tens of millions of people for development, that the real estate boom has fostered graft on a legendary scale, and that China’s property bubble is in large part a product of artificially low interest rates delivered by the central bank and propelled by the government’s post-crisis stimulus, this recent expansion of the private sector is not the product of laissez-faire policies.

Nor is it sustainable. China’s economy today resembles not so much Lardy’s “markets over Mao” as the worst of both worlds.


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