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The mysterious Mr Wu and the growing threat to China's private companies

To revive the economy and survive the trade war, Beijing must stop favoring state groups

| China

In normal times, a blog post by an obscure individual should not attract much attention in China. But these are not normal times.

China's social media have been abuzz with worried commentaries since Wu Xiaoping, a self-claimed "veteran in China's financial sector," posted a blog on Sept. 11 boldly claiming that China's private sector has "basically fulfilled its task of assisting the state-owned economy in achieving its rapid development."

As a result, Wu went on to say, "China's private sector should not blindly expand. A new form of more concentrated, unified, and scaled-up economy of mixed ownership ... may gain a greater share."

The main reason given by Wu for merging China's private sector into the state-owned sector is that this is the only way to respond to America-led Western containment against China and fight back against U.S. President Donald Trump in the trade war. 

"If we fail to concentrate the power of the state but instead allow the market to dictate and move toward a path of complete economic liberalization, China's economic and social reform and opening would face unimaginable pressure and resistance, and the advantages and results we have gained could be gradually lost."

Never mind that there is no evidence that Wu was speaking for the Chinese government or conveying an official message. Never mind, too, that few had heard of Wu, who quit his position as a mid-level manager in the state-owned China International Capital Corp. to found a peer-to-peer lending platform that later went bust. Yet, his blog post has set off alarms among Chinese entrepreneurs, many of them interpreting it as a dark omen that, in times of economic difficulty, the Chinese state may be tempted to appropriate the wealth of the private sector -- killing the proverbial goose that lays golden eggs.

Chinese entrepreneurs are not being paranoid. After Wu's blog post ignited a firestorm in the Chinese cyberspace, no senior Chinese officials publicly criticized it or said anything to calm shattered nerves. Tellingly, China's much-vaunted cyber censors, who normally purge anything deemed subversive with ruthless efficiency, did nothing to stop the dissemination of Wu's inflammatory post.

Wu's outburst is but the latest incident that undermines the confidence of Chinese private entrepreneurs in Beijing's economic policy. Despite the Chinese Communist Party's pledge to implement market-oriented reforms in late 2013, economic trends have been moving in the opposite direction in the past five years. While state-owned enterprises (SOEs) continue to engorge on privileges and subsidies, private companies have borne the brunt of China's campaign of "supply-side reform" (the official euphemism for reducing excess capacity).

According to a recent study by the chief economist of China Merchants Bank, nearly all of the 11,000 businesses that disappeared as a result of "supply-side reform" between 2016 and the first half of 2018 were privately owned. At the same time, the cost of deleveraging has fallen also mostly on private companies. While SOEs' leverage fell slightly between 2017 and 2018 (from 61.1% to 59.4%, due to higher profitability), the debt-to-asset ratio for private companies rose from 52.2% to 55.6% and their interest expenses rose 11.8% year-on-year in the same period. This suggests that the financing costs of Chinese private businesses have risen significantly as Beijing tightens the flow of credit while the benefits of reduced overcapacity have accrued mainly to SOEs.

As China faces a protracted trade war with the U.S., Beijing's attention has been excessively focused on dealing with the potential fallout of rising tariffs. Its leaders have been assiduously courting Western business leaders. While such efforts to protect export markets are understandable, they are nevertheless misplaced.

The best long-term strategy for China to address the likely fall of external demand resulting from the trade war is to strengthen its domestic economy, mainly by increasing demand and allocating resources more efficiently. Chinese leaders must be aware that what makes Trump feel confident about prevailing in the trade war is the weaknesses of the Chinese economy. While several key factors, such as its decade-long debt binge, overreliance on investment as a source of growth, and inefficient SOEs, make the Chinese economy vulnerable, a major cause of China's current difficulties is the deteriorating conditions for its once-dynamic private businesses. A recent survey of private Chinese firms by the Cheung Kong Graduate School of Business found that business conditions for private firms, measured by costs, sales, and profits, are the worst since 2014.

On the surface, China's foreign trade ($4.28 trillion in 2017) may seem a critical engine of growth, but in reality exports stopped being a net contributor to gross domestic product growth starting in 2009 (with the exception of 2012). Domestic consumption and investment account for all of China's growth, with the private sector contributing most.

The following numbers illustrate the vital importance of China's private sector. The 12.5 million private firms in China employ 308 million workers, five times the number in state-owned entities. The private sector also accounted for 60% of China's fixed-asset investments in 2017. A study by China Minsheng Bank shows that the private sector contributes over 60% of GDP and 50% of the taxes (more than SOEs), employs 80% of workers in urban areas, and creates 90% of new jobs.

It does not take an economic genius to understand that the real pillar of the economy is the private sector, not the capital-guzzling and value-destroying SOEs. It is astonishing that the government has done little to restore the vitality of the private business.

But it is not too late.

For a start, Beijing must emphatically denounce Wu's remarks. Top Chinese leaders, such as President Xi Jinping and Premier Li Keqiang, should meet entrepreneurs representing small and medium-sized private businesses (not well-connected tycoons) to demonstrate their support for the private sector.

These gestures should be followed by concrete policies aimed to improve conditions for private companies. One could, for example, consider removing barriers for private groups to enter SOE-dominated sectors. It makes little sense to open these sectors to Western companies but deny domestic private businesses the same access. One could also treat private companies and SOEs equally in deleveraging and reducing excess capacity so that efficient private groups will survive while inefficient SOEs are restructured out of existence.

These steps can help dispel the fears among private entrepreneurs that China is about to march back, economically, into its Maoist dark ages. An added benefit for Beijing is that a reinvigorated private sector will not only guarantee long-term growth but also strengthen its hand in bargaining with Trump.

Minxin Pei is a professor of government at Claremont McKenna College and a non-resident senior fellow of the German Marshall Fund of the United States.

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