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How China renationalized its economy

Liberal observers may be reluctant to admit it, but the sad reality is that China's state sector is much more dominant today than at any time in the past 15 years. According to official Chinese data, of the 3,000 or so companies listed on the stock markets, the state sector was responsible for well over two-thirds of the total net profits generated in the past five years. Not surprisingly, the most profitable companies are state-controlled banks, insurers, telecoms and oil majors.

     In the unlisted universe, the state either dominates or even monopolizes many important sectors, such as alcohol, tobacco, railways, transport systems, medical care, power generation and distribution, mining, and the defense industries. Even in competitive sectors such as automobiles, shipyards and real estate development, the state still commands significant or even dominant market shares.

     For all its flaws, the official data on fiscal revenues also bears this out. In 1978, when China embarked on its open-door policies, its fiscal revenues as a ratio of gross domestic product stood at 30%. That ratio dropped to 12% in 1999, and then steadily climbed to 23% in 2014, all but reversing the reforms of the first two decades. It is true that the nonstate sector is responsible for a bigger portion of employment and is the driving force for the economy, but it is concentrated in fiercely competitive, labor-intensive and low-margin sectors.

     Some may point to the private sector's dominance in e-commerce, but even here, the infrastructure is in the hands of the state. The private sector is at the mercy of the state telecom operators and electricity suppliers.

     How did the state sector regain all its lost ground in the last 15 years?

     In my view, it has been the result of several seemingly accidental factors. But underlying these factors are the country's fear of, and cultural resistance to, private capitalism. Whatever liberals may say about state capitalism, the dominant view among the Chinese public is that it has served the country reasonably well, particularly in the context of global emerging markets.

     After decades of brain-washing, the Chinese public has a fear of market-based capitalism, particularly given the dismal failure of the experiment of capitalism between 1911 and 1949, which resulted in shocking inequality and civil wars. In the end, the Kuomintang, or the leading Nationalist Party, was kicked out of mainland China and settled in Taiwan.

     Cultural undercurrents aside, several technical factors have contributed to the concentration of economic power to the state.

     The first technical factor is the change of tax codes in the late 1980s and early 1990s. As value-added tax replaced the industrial and commercial tax, the effective tax burden on business has risen, and evasion has become much harder. The information technology revolution has also aided tax collection and plugged loopholes. In a country where the underground economy was, and is, responsible for a large portion of the economy, the change of tax codes has proven powerful in increasing the state's power.

     Second, with persistent inflation in the past decades, the tax burden has also naturally increased. As income tax is progressive, continued inflation means that each tax bracket is being pushed downward. The tax-free threshold of, say, 800 yuan ($128) a month was meaningful 15 years ago, but is meaningless today. With inflation, a flat rate for VAT and capital gains also translates into an ever bigger slice of the pie for the state.

     Third, the state sector's privileged access to credit and much lower cost of funding results in very different financial performance. By my estimates, a state-controlled entity, on average, has a 5 percentage-point advantage in funding costs on a like-for-like basis. The funding costs for the vast majority of small businesses in the private sector are at least 10 percentage points higher than the average state-sector entities. When business cycles turn, a huge number of private sector operators go bust, as seen in the past three years.

     Liberal observers often boast of the ideological superiority and greater efficiency of the private sector over the state sector. But in China, the harsh reality shows that the contrary is true.

Joe Zhang is the chairman of China Smartpay Group, and the author of "Party Man, Company Man: Is China's State Capitalism Doomed?."

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