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Xi should accelerate drive to help private business

To revive slowing economy, cut the burdens of bureaucracy and bribery

| China
Beijing should cut payroll taxes.   © Reuters

These are bittersweet times for Chinese private entrepreneurs. A double whammy of debt deleveraging and the U.S.-China trade war has hit Chinese private entrepreneurs especially hard.

The number of Chinese companies filing for bankruptcy, nearly all privately owned, rose 60% in 2018 and is expected to jump by another 20% this year. A Purchasing Managers' Index tracking private manufacturing companies' activities in China showed that they contracted in December last year -- the first time since May 2017. A survey of 224 Chinese citizens with an average net worth of $4.5 million conducted by the Hurun Research Institute in China last June found that a third were considering emigration.

Yet there is good news despite these bleak numbers. Alarmed that the private sector -- China's growth engine -- is losing confidence in his economic management, President Xi Jinping held a highly-publicized forum with more than 50 private entrepreneurs on November 1 last year and pledged support.

Since then Beijing has rolled out several measures to make financing more accessible to private companies, which have consistently suffered discrimination by state-owned banks. Less than a week after Xi's meeting with private businessmen, the chairman of the China Banking Regulatory Commission announced an ambitious program that would direct one third of all the new loans from large banks, and two thirds of the new loans issued by medium and small banks, to private businesses. Within three years, according to Chairman Guo Shuqing, at least half of all the new loans would go to the private sector. The State Council has also ordered financial institutions to design instruments to make it easier for private companies to borrow in the corporate bond market.

While easing access to capital for private companies is a step forward, it is hardly enough to rekindle the animal spirit of Chinese private entrepreneurs. For starters, administrative fiats, such as the new lending policy announced by Chinese banking authorities, are prone to abuse and rent-seeking. Instead of channeling capital to the private sector, this policy is likely to benefit state-owned enterprises (SOEs) rather than small private businesses. A common practice today is for private businesses to collude with SOEs to take advantage of the new policy. For instance, an SOE in need of credit but has hit its borrowing limit would guarantee a bank loan to a private company, which acts as the nominal borrower. After the private company obtains the loan, it simply lends it to the SOE for a fee.

What this example illustrates is that China needs more comprehensive action to address the private sector's real ailments. Administrative and market-distorting measures hastily implemented to please top leaders are likely to do more harm than good.

As rising costs are hurting Chinese companies, Beijing's top priority should be cutting costs. While the government can do little about growing labor costs due to demographics, one thing Beijing should definitely pursue is cutting payroll taxes. Currently various payroll levies, such as pension contributions, health and unemployment insurance, amount to 40% of the wage bill (the median payroll tax rate is 20% in OECD countries). Employers pay 30%, with employees contributing 10%. China maintains such high payroll taxes because its defunct socialist economic system saved nothing for such expenditures and current benefits for a rapidly-growing population of retirees must be funded by a shrinking workforce.

To make China's social safety net more sustainable and alleviate the burden on private companies, Beijing must embrace the option it has so far resisted: privatizing state-owned assets to generate cash. Selling state-held shares in giant SOEs, such as ChinaMobile and PetroChina, would finance a reduction in payroll taxes and help private business owners.

A second line of attack should target a level playing field for private companies. Like Western companies, Chinese private companies face unfair competition from SOEs that receive generous state subsidies (chief among them cheap capital, underpriced land, monopoly protection, and research and development support). Monopoly protection may make inefficient SOEs look profitable on paper, but private companies foot the bill because they are in competitive downstream industries and must pay the prices set by SOEs that dominate sectors such as banking, telecoms and utilities.

That is why some Chinese private entrepreneurs are rooting for U.S. President Donald Trump's administration's tough trade tactics despite the pain of tariffs. They hope that Washington's battering ram will open the door to a level domestic playing field.

In addition to tax relief and removal of subsidies for SOEs, Beijing must strengthen the legal protection of the private sector, in particular the personal safety of private businessmen. In the last few years, President Xi's anti-corruption drive may have ensnared tens of thousands of government officials, but a large, albeit unknown, number of businessmen have also fallen into the dragnet. To be sure, some of them might have committed crimes such as bribes and fraud, but many of them were arrested or simply "disappeared" without due process. Chinese courts must review these cases and restore freedom to wrongly convicted private entrepreneurs. This should surely boost private entrepreneurs' sense of security.

Any improvement in China's legal system must enable private entrepreneurs to better resist the predation of local officials. Despite President Xi's recent claim that his anti-corruption campaign has achieved an "overwhelming victory," private businesses continue to suffer routine regulatory harassment by bribe-hungry local officials. As revealed by a recent widely-circulated social media post by a private entrepreneur who has emigrated to Malta, China's tax burden, however onerous, is not what keeps entrepreneurs awake at night because they know what the tax rates are. What they cannot cope with is the everyday harassment by local officials who wield enormous discretion in enforcing environmental regulations, building, zoning, and safety codes, and determining whether migrant workers can get housing or send their children to public schools. To use the private entrepreneur's colorful language, these officials are "like flies you cannot keep away." They not only force private companies to pay petty bribes but also waste time and energy in fending off such harassment.

So while we should all applaud Beijing's recent show of support for the private sector, we must also be realistic about the limits of its current policy and urge more substantive reforms.

Minxin Pei is a professor of government at Claremont McKenna College and currently holds the Chair in U.S.-China Relations at the Kluge Center of the Library of Congress

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