A Stimulus Package with Chinese Characteristics: “the state advances as the private sector recedes”

A special report in the Financial Times, entitled “Rule of the Iron Rooster,” discussed the unintended consequences of China’s massive 4 trillion RMB stimulus plan: while this enormous fiscal expansion together with an overtly loose monetary policy has produced a boom in the equity and real estate markets, this “easy money” has also encouraged poor lending practices and produced waste that many – including Zhou Xiaochuan, the governor of the People’s Bank of China —  fear will result in a significant rise in non-performing loans.

Yet the stimulus plan may be producing an even more noteworthy negative consequence, although one that is very much by design. As core beneficiaries of the state’s numerous large-scale investment projects and enormous financial aid, the stimulus plan is significantly strengthening the dominance of state-owned enterprises and, in particular, reinforcing the influence of the colossal “Central Enterprises” — the 136 large-scale SOEs directly controlled by the State Council, whose management positions usually serve as rewards for the well-connected.

Guojinmintui

In fact, the widely read Southern Weekly estimates that a whopping 90% of the stimulus plan’s investment projects have been directed towards state-owned enterprises — especially the Central Enterprises — to the dismay of China’s private businesses which, after all, have been responsible for 70% of the country’s explosive economic growth. While favoritism towards state-owned enterprises is certainly not a new phenomenon, the stimulus plan appears to be producing a powerful new wave of guojinmintui — translated roughly as “the state advances as the private sector recedes.” Supporting this assertion, over 70% of the mid- and upper-level managers surveyed by China Economic Magazine in April 2009 state that the stimulus plan is repressing the private sector.

Indeed, despite playing a crucial role in China’s economic development — including through successful advocacy of pro-market reforms — private enterprise continues to play on an unequal footing against their state-owned counterparts, with China’s Central Enterprises in particular enjoying enormous advantages in access to financing, share listings, and contracts, thereby severely crowding out the private sector. This explains, for instance, why the privately owned Spring Airline, China’s answer to Ryan Air, has failed to receive adequate credit from banks despite its strong credit history and the enormous growth in lending that has accompanied the stimulus plan.

Further threatening the private sector, state-owned enterprises are using stimulus funds to progressively expel private businesses from a growing number of industries through vertical integration that crowds out private sector alternatives. China Economic Magazine, for instance, describes how two of the behemoths of China’s energy sector — China Huaneng Group and China Datang Corporations — have begun to develop their own wind turbine manufacturing technology so that they can bring in-house capabilities they currently rely on from the private sector. With control rather than cost as the primary consideration, private entrepreneurs are quickly being pushed out of this promising industry. Most recently, SOEs have taken this process of vertical integration a step further by outright acquiring successful private enterprises as part of a trend of “creeping renationalization” of parts of the economy (for more information, see this Financial Times article), reversing China’s supposed policy of progressive privatization.

“Capitalism” with Chinese Characteristics

Contrary to common wisdom, China is moving backwards on the path towards a genuine market economy. True, China underwent a big wave of privatization in the 1990s that resulted in the layoffs of over 30 million workers. But many have ignored the fact that this privatization effort involved mostly the smaller, loss-making SOEs and was complemented by massive state investments in larger SOEs following a policy of “grasping the large and letting go of the small,” as documented by Dr. Huang in his book, Capitalism with Chinese Characteristics. This policy is in direct opposition to economic wisdom, which dictates that profitable enterprises be sold off first so as to finance the social costs resulting from the dissolution or restructuring of loss-making SOEs. China’s leaders, however, were not so much interested in improving the competitiveness of its economy and reducing the social pains associated with economic transformation as with strengthening its core state-owned enterprises.

China, in fact, never intended to fully embrace a competitive market economy and has vowed to hold on to the commanding heights of the economy by maintaining control over pillar industries, from automobiles and telecommunications to petrochemicals and steel. Today, the government seems to be using the stimulus package as an opportunity to squeeze out the private sector and tighten its control over additional industries. This raises strong concerns about the future of Chinese capitalism: a “capitalist” system that imposes social costs on the public to maximize the state’s profits falls well short of the genuine, virtuous capitalism that is at the heart of the world’s prospering societies.

Published Date: September 09, 2009