There's more to China's rise than state capitalism

China's economic miracle has been made possible not because of the visible hand of Beijing but by unshackling the country's innate entrepreneurial energy.

Our understanding of the Chinese economy is coloured by many conventional wisdoms --  one of the most enduring of which is state capitalism. There are many critics and commentators who believe that the state sector dominates the country’s economy and attribute China’s growth to the visible hand of Beijing.

This couldn’t be further from the truth. It's a view that gives too much credit to the ruling Communist Party. China’s economic miracle has been made possible by unshackling the country’s innate entrepreneurial energy.

Liu Yonghao, chairman of New Hope group and one of China’s most prominent businessmen, says that although private business employers only account 10 per cent of the labour force in China, they produce 40 to 50 per cent of all goods in China, account for 50 to 60 per cent of tax revenue and are responsible for creating 70 to 80 per cent of all jobs.

For those sceptical of Liu, Nickolas Lardy, a senior fellow at Washington think-tank the Petersen Institute for International Economics, makes similar claims.

He estimates private enterprises in China account for two-thirds of total output in China, up from zero three decades ago, when private business was outlawed in the country. The much criticised state-owned sector only accounts for between one third and one quarter of GDP, according to his latest book, ‘Markets over Mao’. In manufacturing, which represents about 41 per cent of GDP, state-owned enterprises only account for 20 per cent of output.

Our perception of the supposedly dominant state sector is coloured by its concentration at the top of China’s corporate league table. The country’s largest companies are inevitably state-owned and the leading private company, Huawei Technologies, is only ranked 37th in terms of revenue. But most small and medium sized companies are privately controlled, and they form the backbone of the economy.

The fact is the role of the state in China has diminished significantly since 1978. “When you look at the number of people employed by the state, it is less than France as a percentage of the labour force. China is not a pure market economy, but it is very hard to find pure market economies these days, especially given the recent history of the financial crisis and the degree of government ownership,” Lardy told the Wall Street Journal.

Despite the much diminished role of the state sector, it is still a huge drag on the economy because state-owned companies receive a large share of resources. Though they only account for between one third and one quarter of total output, state-owned companies receive nearly half of the total credit from the banking system.

That is a serious misallocation of resources. Analysts estimate that if state-owned enterprises can bring efficiency and productivity to the level of their private sector competitors. China’s GDP could add another two percentage points. That means an additional RMB11 trillion or A$1.9 trillion, more than Australia’s GDP.

One of the major reform initiatives on the horizon is the liberalisation of interest rates on deposits. Central bank governor Zhou Xiaochuan said repeatedly that the government was committed to lifting the official cap on deposit rates within two years.

When and if that happens, lending rates will tend to go up. It is good news for private companies, because of their higher productivity and profitability; they can afford to pay higher rates. Lardy says the ability of private companies to repay loans is more than twice as great as state-owned companies on average.

This means Chinese banks are more likely to direct their resources to underserved private companies.

Another area ripe for change is the services sector, which accounts for nearly 50 per cent of the economy. Unlike in the manufacturing sector, state-owned companies dominate many parts of the booming services economy, including in telecommunication, business and leasing services and transportation.

However, productivity differentials favour private sector challengers; you only need to look at Alibaba to see how disruptive a private company can be to established players. As China become a more service-oriented economy, there is an enormous opportunity for productivity growth.

“If China enacts economic reforms announced last year, particularly eliminating all but natural monopolies such as power distribution, and making the market the decisive factor in the allocation of resources, private businesses will displace state enterprises in services,” Lardy wrote in an op-ed for the Financial Times this month.

That would allow China to continue to grow for decades to come. He warns those making policies and predictions based on a fundamental misunderstanding of China’s ascent are likely to lose out. It would be wise to pay attention to advice from one of the most formidable minds on the Chinese economy. 

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