Order Code RL30519
CRS Report for Congress
Received through the CRS Web
The Growth of the Private Sector in China and
Implications For China’s Accession to the World
Trade Organization
Updated March 28, 2001
name redacted
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Congressional Research Service ˜ The Library of Congress
The Growth of the Private Sector in China and
Implications for China’s Accession to the World Trade
Organization
Summary
Over the past 21 years, economic reforms have transformed China from a
relatively inefficient, centrally planned, economy to one that is significantly more
market-oriented. The gains in efficiency resulting from free market policies have
helped make China one of the world’s fastest growing economies in recent years. A
key policy in China’s economic success has been the decentralization of economic
production, which has helped produce a thriving private sector in China.
Prior to 1979, Chinese government policies eliminated most private enterprises.
However, over time, the central government’s policy towards the private sector has
evolved from prohibition, to toleration, to active encouragement. Chinese government
data show that the number of private sector employees (i.e., those working for a
privately-owned Chinese company or self-employed) rose from 4.5 million in 1985 to
an estimated 81.3 million in 1999. The percentage contribution of the private sector
to industrial output rose from 1.9% in 1985 to 17.9% in 1997. These data indicate
that the private sector in China has become a major factor in China’s economic
growth and development.
The growth of the private sector in China has occurred to a large extent from the
government’s efforts to reform China’s money-losing state-owned enterprises (SOEs).
Workers who have been laid off from SOEs have been encouraged to find jobs in the
private sector or to start their own businesses. Yet, private firms in China continue
to face a variety of discriminatory policies that restrict their development, especially
in sectors dominated by the SOEs. However, in preparation for its eventual accession
to the World Trade Organization (WTO), the Chinese government has announced
plans to end most restrictive policies against Chinese private firms.
Some analysts contend that WTO membership for China serves U.S. interests by
expanding capitalism and diminishing the government’s control of the economy,
promoting the rule of law in China, subjecting China’s trade regime to multilateral
trade rules, and creating new markets for U.S. goods and services. Others question
whether China’s membership in the WTO is good for U.S. interests, especially if
China’s economic development threatened U.S. jobs at home, China failed to
faithfully implement its WTO obligations once it became a member, China opposed
U.S. trade liberalization objectives in the next round of WTO multilateral
negotiations, or if economic liberalization failed to produce improvements in human
rights conditions in China. Either way, this report indicates that the private sector is
growing in China and will likely continue to expand in the near future, although it is
unclear whether the Chinese government is prepared to truly give private firms an
even playing field. A key question is whether China’s private sector will be kept as
a complimentary feature of China’s “socialist market economy,” or whether it will it
be allowed to develop into the dominant sector of that economy. This report
examines the changing role of China’s private sector, and the outlook for its future
development.
Contents
Background on China’s Economy Prior to Reforms . . . . . . . . . . . . . . . . . . 1
The Introduction of Economic Reforms . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
China’s Economic Growth Since Reforms: 1979-1999 . . . . . . . . . . . . . . . . 2
Causes of China’s Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Changing Composition of China’s Economy . . . . . . . . . . . . . . . . . . . . 4
China’s Growing “Private Sector” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Background on the Rebirth and Growth of the Private Sector in China 7
China’s New Entrepreneurs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Recent Improvements to the Business Climate for the Private Sector 12
China’s Accession to the WTO: Implications For the Private Sector . . . . 14
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
List of Tables
Table 1. China’s Average Annual Real GDP Growth Rates:
1960-1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Table 2. Percent Share of Gross Industrial Output by Various Sectors:
1978, 1985,1990, and 1995-1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Table 3. Chinese Employment by Type of Ownership: 1978, 1985, 1990, and
1995-1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
The Growth of the Private Sector in China
and Implications For China’s Accession to
the World Trade Organization
Over the past 21 years, the Chinese government has undertaken various
economic reforms that have helped transform China from a centrally planned economy
to one that is considerably more market-oriented. A key aspect of China’s economic
transformation has been the expansion of the non-state sector (economic activity not
directly controlled by the central government) in China, including a growing private
sector.
Prior to the implementation of reforms in 1979, the private sector in China was
nearly non-existent, due to government policies that strongly discouraged capitalist
activities. However, after economic reforms were implemented, the government
began removing restrictions on the private sector. In recent years, the central
government has encouraged Chinese citizens to start their own businesses, especially
workers who have been laid off as a result of government efforts to reform and
restructure unprofitable state-owned enterprises (SOEs).
The changing nature of China’s economy, and the potential effects on Chinese
economic and trade policies resulting from its possible accession to the WTO, could
be a factor in congressional debate during the year 2000 over whether to extend
permanent normal trade relations (PNTR) status to China. (While PNTR status is not
tied to China’s WTO accession, it will determine whether U.S.-China trade relations
are based on WTO rules once China becomes a member). Many analysts argue that
WTO membership would force China to substantially reform its economy, including
the privatization of many of its state-controlled sectors. Such a development, it is
argued, would benefit U.S. firms doing business in China, namely through the
reduction of government interference in the economy, and expanded opportunities for
U.S. firms to develop business partnerships with Chinese entrepreneurs. Conversely,
other analysts question whether China would fully implement its WTO trade
obligations or allow the private sector to play a dominant role in China’s economy,
especially if such reforms undermined the financial viability of its SOEs.
Background on China’s Economy Prior to Reforms
Prior to 1979, China essentially maintained a centrally planned, or command,
economy. A large share of the country’s economic output was directed and
controlled by the state, which set production goals, controlled prices, and allocated
resources throughout most of the economy. During the 1950s, all of China’s
individual household farms were collectivized into large communes. To support rapid
industrialization, the central government during the 1960s and 1970s undertook large-
scale investments in physical and human capital. As a result, by 1978 nearly three-
fourths of industrial production was produced by centrally controlled state owned
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enterprises (SOEs) according to centrally planned output targets. Private enterprises
and foreign-funded enterprises (FFEs) were nearly non-existent. A central goal of the
Chinese government was to make China’s economy relatively self-sufficient. Foreign
trade was generally limited to obtaining only those goods that could not be made or
obtained in China.
China’s real GDP grew at an estimated average annual rate of about 5.3% from
1960-1978. However, government policies kept the Chinese economy relatively
backward and inefficient, mainly because there were few profit incentives for firms
and farmers, competition was virtually nonexistent, foreign trade and investment was
severely restricted, consumer goods were scarce, and price and production controls
caused widespread distortions in the economy. Chinese living standards were
substantially lower than those of many other developing countries.
The Introduction of Economic Reforms
Beginning in 1979, China launched several economic reforms. The central
government initiated price and ownership incentives for farmers, which enabled them
to sell a portion of their crops on the free market. In addition, the government
established four special economic zones for the purpose of attracting foreign
investment, boosting exports, and importing high technology products into China.
Additional reforms followed in stages that sought to decentralize economic
policymaking in several economic sectors, especially trade. Economic control of
various enterprises was given to provincial and local governments, which were
generally allowed to operate and compete on free market principles, rather than under
the direction and guidance or assistance of state planning. Additional coastal regions
and cities were designated as open cities and development zones, which allowed them
to experiment with free market reforms and to offer tax, trade, and other incentives
to attract foreign investment. In addition, state price controls on a wide range of
products were gradually eliminated. The government also attempted to initiate
reforms to improve the financial performance of SOEs, such as removing mandatory
production plans and giving greater autonomy to managers and workers to run their
operations. Over time, the government has given greater emphasis to the
development of the private sector. In 1992, the Chinese government announced that
the goal of economic reform was to create a “socialist market economy” in which
market forces were to become increasingly important in determining production and
prices, but where the state would continue to exercise overall control of the economy
as well as over key economic sectors. Reforms were intended to be gradual and
experimental: “crossing the river by touching the stones.”1
China’s Economic Growth Since Reforms: 1979-1999
Since the introduction of economic reforms, China’s economy has grown
substantially faster than during the pre-reform period (
see Table 1). Chinese statistics
show real GDP from 1979 to 1999 growing at an average annual rate of 9.7%,
making China one the world’s fastest growing economies. According to the World
1 These characterizations are attributed to remarks made by Deng Xiaoping, the Chinese
leader chiefly responsible for launching the reforms.
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Bank, China’s rapid development has raised nearly 200 million people out of extreme
poverty.2 By 1998, China had become the world’s tenth largest trading economy and
the second largest recipient of foreign direct investment (FDI) after the United States..
Table 1. China’s Average Annual Real GDP Growth Rates:
1960-1999
Time Period
Average Annual % Growth
1960-1978 (pre-reform)
5.3
1979-1999
9.7
1990
3.8
1991
9.3
1992
14.2
1993
13.5
1994
12.7
1995
10.5
1996
9.7
1997
8.8
1998
7.8
1999
7.1
Sources: Official Chinese government data reported by the World Bank,
World
Development Report (various issues), and DRI/McGraw-Hill,
World Economic Outlook,
various issues. Note, many analysts suggest that China’s GDP growth data may be
overestimated.
Causes of China’s Economic Growth
Economists have concluded that productivity gains (i.e., increases in efficiency)
were a major factor in China’s rapid economic growth. The improvements to
productivity were largely caused by a reallocation of resources to more productive
uses, especially in sectors that were formerly heavily controlled by the central
government, such as agriculture, trade, and services. For example, agricultural
reforms boosted production, thus freeing workers to pursue employment in more
productive activities in the manufacturing sector. China’s decentralization of the
economy led to the rise of non-state enterprises, which tended to pursue more
productive activities than the centrally controlled SOEs. Additionally, a greater share
of the economy (mainly the export sector) was exposed to competitive forces. Local
and provincial governments were allowed to establish and operate various enterprises
2 The World Bank.
From Plan to Market, World Development Report, 1996, p. 19.
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on market principles, without interference from the central government. In addition,
foreign direct investment (FDI) in China brought with it new technology and
processes that boosted efficiency.
A study by F.C. Perkins found that export-oriented firms in China have
experienced significantly higher productivity growth than non-exporting firms and that
non-state-owned enterprises have experienced higher productivity growth than the
SOEs. Perkins cites autonomy in decision making and exposure to free domestic
markets as the key factors in productivity growth by the non-SOEs.3 A World Bank
study also attributed productivity gains to the expansion of market forces in China,
including the rise of the private sector in China:
The reforms also gave greater room for private ownership of production, and these
privately held businesses created jobs, developed much-wanted consumer products,
earned important hard currency through foreign trade, paid state taxes, and gave
the national economy a flexibility and resiliency that it did not have before.4
The Changing Composition of China’s Economy
A central factor in China’s reform process has been the decentralization of
economic policymaking in China in order to promote greater competition and
efficiency in the economy. A key aspect of this policy has been to gradually expand
the role of the non-state sector in various sectors of the economy (while attempting
to improve the performance of the state-run sector). Prior to 1979, SOEs accounted
for a significant share of the country’s industrial production and employment. Private
firms and foreign-funded enterprises (FFEs) were nearly non-existent, while local
enterprises were subject to state controls and supervision. Since the initiation of
reforms, the role of the SOEs in China’s economy has greatly diminished, while the
role of the non-state sector has substantially increased.
Beginning in the early 1980s, the central government encouraged local and
provincial governments to establish their own firms. Local officials in the cities and
townships, as well as groups of individuals, were allowed to raise funds to establish
and support a wide variety of enterprises (including joint ventures with foreign firms)
relatively free of assistance or control from central authorities. Over the past several
years, town and village enterprises (TVEs) and urban collectives, which are generally
owned by local governments, have been one of the most dynamic sources of Chinese
economic growth.5 The relative success of these ventures has been attributed to the
fact that, though government financed, they are essentially run like private businesses
3 Perkins, F.C.
Export Performance and Enterprise Reform in China’s Coastal Provinces.
Economic Development and Cultural Change, Volume 45, April 1997, p. 502.
4 Hu, Zuliu and Khan, Moshin S.
Why is China Growing So Fast? The International
Monetary Fund, Economic Issues, No. 8, 1997, p.3 (available at www.imf.org).
5 Expanding the authority of local governments to establish their own enterprises has likely
been an important factor in building political support for the central government’s economic
reforms. It enables local officials to become directly involved in such reforms and, in many
cases, to directly benefit from such reforms financially.
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and must compete in domestic and international markets.6 Local governments have
strong incentives to ensure the efficient operation of such enterprises, since money-
making firms are an important source of tax revenues and job creation, while
inefficient firms can drain away local financial resources.
Restrictions on private enterprise in China have eased substantially since 1988,
and the role of these enterprises in the economy has increased markedly (see
discussion below). The role of FFEs in China’s economy have also expanded sharply
due to a gradual removal of geographical and operational restrictions.7 The non-state
sector is most actively involved in the consumer goods and export sectors, while the
state sector dominates heavy and extractive industries such as iron and steel, coal
mining, petroleum extraction and refining, as well as utilities, banking, tobacco
processing, and transportation.8 While non-state enterprises exist throughout China,
the most dramatic growth in the non-state sector has occurred in the coastal regions.9
SOEs accounted for 77.6% of gross industrial output in 1978, but that share fell
to 64.9% in 1985, 54.6% in 1990, and to 25.5% in 1997. The non-state sector
overtook the state sector in industrial output in 1995, accounting for 57.3% of total
industrial output, and that share rose to 74.5% in 1997. Together, TVEs and urban
collectives constituted the largest source of industrial output in 1997, accounting for
38.1% of total output. (
see Table 2). The private sector’s share of industrial output
rose from 5.4% in 1990 to 17.9% in 1997. The share of other types of non-state
enterprises, mainly FFEs, rose from 4.4% in 1990 to 18.4% in 1997.
While the share of SOE industrial output to total industrial output has fallen
sharply, SOEs have remained a major source of jobs in China. Employment by SOEs
rose from 74.5 million in 1978 to 112.6 million in 1995 (a 51% increase). Recent
reform and restructuring of the SOEs, however, have reduced their employment levels
to 112.4 million in 1996 and 110.4 million in 1997.10 Employment in the non-state
sector risen more dramatically; from 1978 to 1996 it rose by 385%. TVEs and
collectives became China’s largest employer in 1990 with 128.1 million employees,
and that level increased to 165.2 million by 1996. The private sector in China in 1978
was nearly non-existent, but after reforms were initiated, the number of individuals
6 Such enterprises existed prior to 1979. However, they were not allowed to sell their
products at market prices.
7 Initially, foreign investment was permitted only in Special Economic Zones (SEZs), mainly
located in China’s coastal regions, and was limited to joint ventures. In 1986 the government
began to allow foreign firms to establish wholly-owned enterprises in certain sectors. In
recent years, the government has removed most geographical restrictions on foreign
investment, although restrictions on the scope of foreign investment are maintained in many
industry and service sectors.
8 Australian Department of Foreign Affairs and Trade,
China Embraces the Market, 1997,
p. 360.
9 Ibid, p. 362.
10 SOEs continue to remain the most significant source of employment in urban areas,
although their importance has gradually declined, from 78.3% in 1978 to 64.9% in 1995.
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employed in the private sector (i.e., private firms or self-employed) rose from 4.5
million in 1985 to 68.0 million in 1997 (
see Table 3).
Table 2. Percent Share of Gross Industrial Output by Various
Sectors: 1978, 1985,1990, and 1995-1997
Other Types
Urban
Private
of Non-state
State
Year
Collectives and
Enterprises and
Ownership
Owned
TVEs
Self-employed
(including
FFEs)
1978
77.6
22.4
0.0
0.0
1985
64.9
32.1
1.9
1.2
1990
54.6
35.6
5.4
4.4
1995
32.6
25.5
14.5
17.3
1996
28.5
39.4
15.5
16.6
1997
25.5
38.1
17.9
18.4
Source: China Statistical Yearbook, 1998.
Table 3. Chinese Employment by Type of Ownership: 1978,
1985, 1990, and 1995-1997
(millions)
Other
Private Firm or Self-employed*
Types of
Urban
Non-state
SOEs
Collective
Ownership
and TVEs
of which,
of which,
(mostly
Total
Private
Self-
FFEs)
Enterprises
employed
1978
74.5
48.8
–
–
–
–
1985
89.9
54.3
4.5
–
4.5
–
1990
103.5
128.1
22.8
1.7
21.1
–
1995
112.6
160.1
55.7
9.6
46.1
8.9
1996
112.4
165.2
61.9
11.7
50.2
9.6
1997
110.4
NA
68.0
12.0
56.0
11.1
Note: prior to 1988, official data on private enterprises not fully available.
Source: China Statistical Yearbook, 1998.
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China’s Growing “Private Sector”
It is difficult to measure accurately the extent of the private sector in China due
to the lack of reliable Chinese statistics on this sector and because of the complicated
mixture of government and private involvement in the economy. For example, it is
difficult to determine whether (or which) TVEs should be classified as private
enterprises. On the one hand, these enterprises are generally run like private
enterprises and must operate according to market principles (e.g., without
government subsidies). On the other hand, such enterprises are owned and controlled
by local governments, which often use their political influence to obtain capital for
investment as well as to impose restrictions against potential competitors (domestic
and foreign).11 Some private companies in China register as TVEs (or even SOEs)
in order to benefit from preferential government policies given to these entities and
to evade discriminatory policies against private firms. FFEs might also fall under the
private sector category, since the parent company usually is a private business. Yet,
while many FEEs in China are wholly-owned ventures, a large number of them are
joint ventures; the partners of these types of ventures are mostly SOEs or locally-
owned collectives.12 Thus, it is likely that the private sector accounts for a much
larger share of China’s economy than is reflected by official Chinese data (such as in
tables 2 and 3).13 Still, even China’s official data on the private sector indicate that
it is becoming an increasing important component of China’s economy. The rise of
the private sector in China has been the result of a gradual change in attitude by the
government towards the compatibility (and usefulness) of the private sector with
Chinese socialism. The government’s attitude toward the private sector appears to
have evolved from one of prohibition, to reluctant toleration, and recently to active
encouragement.
Background on the Rebirth and Growth of the Private Sector in
China. Following the Communist takeover in 1949, most private firms were allowed
to stay in business, although they were subject to state planning and regulations. In
1952, the government began a series of anti-capitalist campaigns that sought to
undermine private entrepreneurs. Businesspeople were routinely condemned as
“counter revolutionaries” and many were assessed heavy fines. It is likely that such
efforts were intended to make it easier for the state to take control of privately-owned
assets. By 1956, the government required private firms to be jointly owned and run
by the state; in practice, the state controlled and ran the businesses. Additionally, the
state sought to exert its control over China’s 29 million full-time handicraft producers
(in effect, self-employed entrepreneurs) by taking over the supply of raw materials and
11 The level of local government control of TVEs may vary considerably. Sometimes, local
governments allow individuals within a community to establish a TVE with little or no direct
interference from the government. The enterprise is run like a private firm, but it is
technically collectively owned by the community. Some analysts describe TVEs as quasi-
government enterprises while others describe them as quasi-private.
12 Chinese investment data for 1998, indicate that about 48% of approved FDI was for
wholly-owned ventures, while about 51% were joint ventures.
13 The Chinese government in January 2000 announced it intended to conduct surveys on the
private sector in China in order to develop more accurate data on its composition and size.
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the marketing of handicrafts, and then by requiring handicraft producers to form
cooperatives (collective ownership).14 China’s industrial policies were essentially
aimed at stamping out capitalist elements in China and establishing state control over
most sectors of the economy.15 As result, entrepreneurship in China was held in low
regard.16
One of the major objectives of China’s paramount leader Deng Xiaoping during
the initial stages of the economic reforms launched in 1979 was to revive individual
businesses in urban areas in order to promote more rapid economic growth. While
private enterprises began to reappear in China during the early 1980s, the highly
negative stigma of capitalism generated in the past discouraged many individuals from
starting their own businesses. As a result, a significant portion of those entering the
private sector initially were ex-convicts, school drop-outs, retirees, and others who
had limited options for employment. Eventually, mainstream members of society
began to start their own businesses (such as bike repair, restaurants, and beauty
parlors).17
Prior to 1988, the private economy did not have a defined legal position in
China. As a result, many private firms were registered as TVEs or collective
enterprises in order to avoid potential interference from the central government and
local governments.18 In April 1988, the National People’s Congress adopted an
amendment to the constitution stating:
The State permits privately owned economic entities to exist and develop within
the limits prescribed by the law. The private economy is a complement to the
socialist public economy. The State protects the legitimate rights and interest of
the private economy while providing the private sector with guidance, supervision
and administrative regulation.
This represented the first time since the Communist government takeover in 1949,
that China’s private sector was officially awarded legal status.19 The growth of the
private sector was further encouraged after Deng Xiaoping’s famous Southern Tour
of China in 1992 where he proclaimed the government’s commitment toward
expanding and deepening economic reforms and opening up to the outside world. In
14 Dreyer, June Teufel.
China’s Political System: Modernization and Tradition, Third
Edition, 2000, pp. 141-142.
15 Similarly, Chinese agricultural policies during the 1950s led to the collectivization
and abolishment of private plots.
16 Dryer, June Teufel.
China’s Political System: Modernization and Tradition, Third
Edition, 2000, p. 144.
17 Some individuals feared potential backlashes against entrepreneurship, while others
preferred working for the SOEs, where pay, benefits, and pension for minimal work were
generally guaranteed.
18 In addition, such firms wanted to take advantage of tax advantages which were afforded to
the TVEs and collective enterprises, but not to private firms.
19 Wang, Zhonghui.
Private Enterprise In China: An Overview. Journal of Communist
Studies, Sept. 1990, p. 85.
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1993, the Chinese constitution was amended again to indicate that the government’s
goal was to establish a “socialist market economy” and that the private sector was a
“complement to the socialist market economy.” This change represented official
government recognition that the market system was not incompatible with socialism.
The constitution was amended again in 1999 to state that the private sector was “an
important component of China’s socialist market economy.”20
China’s New Entrepreneurs. It is difficult to make general characterizations
of China’s new entrepreneurs. Business Week describes them as coming “from a
broad sector of society, from peasants’ sons to managers who cut their teeth in
foreign ventures to academics who are abandoning government institutes and young
engineers who studied and worked in California’s Silicon Valley.”21 Most private
enterprises are small firms involved in production and services that are closely related
to daily livelihood, such as light industry, manual trades, transport, construction, and
to a slightly lesser extent, commerce and food services and repair industries.22
In 1998, about 37.1 % of the country’s retail sales and consumer goods and
19.1% of industrial output were generated by the private sector.23 While some large
private companies exist (there are 40 private firms in China having capital of over $12
million), the average Chinese private enterprise had a registered capital of about
$60,000, employed 14 people, and was involved in simple services or making light
industrial goods.24
The greatest concentration of private firms is along the eastern seaboard,
particularly in the provinces of Guangdong, Shandong, Zhejiang, and Jiangsu, and in
the city of Shanghai.25 Together, these four provinces and one municipality account
for almost half of all private businesses in China; Guangdong alone accounts for about
15% of private firms in China. According to one estimate, in parts of China’s
southern region, private firms produce over 90% of the region’s contributions to
GDP.26 Increasingly, private firms are becoming involved in high technology
ventures, due in part to the relative lack of competition from SOEs and the desire on
the part of the central government to develop high tech industries in China. Examples
of major high tech firms in China that are privately owned include Stone Computer
in Beijing and Fuxing Hi-Tech Group in Shanghai.27
20 Muzi Dailynews, March 19, 1999 (available at www.latelinenews.com.).
21 Businessweek,
China’s New Revolution, September 27, 1999, P. 23.
22 Wang, Zhonghui.
Private Enterprise In China: An Overview. Journal of Communist
Studies, Sept. 1990, p.85.
23 Hong Kong Trade Development Council world wide web site (www.tdc.org.hk).
24
Far East Economic Review, June 11, 1998, p. 49.
25 Private firms in Shanghai total 99,000 and employ over 900,000 people.
26 Fang, Xinghai,
Problems with China’s Development Strategy. The World Bank Group,
August 1998, available at China Online web page (www.chinaonline.com).
27 Wall, David.
State Needs Help From Mom and Pop, The World Today, February 1999,
(continued...)
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The number of individuals employed by the private sector (i.e., privately-owned
enterprises or individually-run businesses) has grown rapidly in recent years, rising
from 61.9 million in 1996 to 81.3 million in 1999 (an increase of 31.3%). Despite the
growing number of private businesses in China, such enterprises face a wide variety
of problems:
! While firms are allowed to lease property for up to 70 years, private
property is not considered sacrosanct and not protected by the
Chinese constitution. As a result, many private entrepreneurs do not
feel safe about their wealth, which may dampen their business
activities.28 In some instances, corrupt Chinese officials have forced
private firms to register as SOEs, then seized their assets. As a
result, many private entrepreneurs invest their profits overseas.29
! Private firms often find it difficult to obtain bank loans. The Chinese
government requires China’s state banks to provide preferential
treatment to SOEs, which, as a result, obtained 87% of China’s bank
loans in 1996. Private enterprises may only get bank loans outside
the official plan, where they face higher interest rates (around 20%)
than are given to SOEs and loan periods of just three to six months.
When private enterprises need more funding, they must often turn to
friends, relatives or neighbors. The interest rates in these
circumstances often reach 25-30%. Until recently, most private firms
have been barred from using the stock and bond markets to raise
funds.30 At the end of 1998, of the 745 firms listed in China’s two
stock exchanges, only one was a genuine private company.31
! Private firms are barred from a variety of industries and services,
partly to avoid their competing directly with SOEs. For example, In
June 1999 the government defined 18 investment and manufacturing
industries that are “forbidden zones for private investment,” such as
production of non-ferrous metals, fertilizer, pesticides, and
cigarettes and tobacco, as well as wholesale sales of goods
exclusively sold and managed by state monopolies, state regulated
commodities, essential consumer goods, “certain other”
27 (...continued)
p. 26.
28 Fang, Xingai,
Problems with China’s Development Strategy. Available at China
Online web site (www.chinaonline.com).
29
Washington Post, January 5, 2000, p. 17.
30 Xu, Dianqing.
China: Contradictory Measures Frustrate Bank Reform, Center For
International Private Enterprise, 1995. Available at U.S. embassy in Sweden web site
(http://www.usemb.se/ERT/e15/CHINA.HTML).
31 Wall, David.
State Needs Help From Mom and Pop, The World Today, February 1999,
p. 26.
CRS-11
commodities, and books and periodicals.32 Also off-limits to private
firms are investments in a number of service industries, such as
banking and telecommunications.
! Some government departments tend to give special treatment to
locally-owned TVEs and urban collectives, and many state
enterprises are unwilling to establish business relations with private
entrepreneurs. While the central government has encouraged the
growth of private firms, it continues to give preferences to SOEs in
the hope of turning them into large conglomerates.
! Corruption has become an enormous problem for many businesses,
due to the incomplete nature of China’s reforms. Property rights,
legitimate business practices, and other basic elements of a market
economy remain poorly defined. The state and its bureaucrats (both
nationally and locally) are powerful players in the economy.
However, there are few legitimate channels of interaction and
negotiation between bureaucrats and entrepreneurs.33 Published laws
and regulations are often not enforced. Firms generally must rely on
gaunxi (connections) with high-ranking government officials, which
routinely involves providing officials with entertainment, presents, or
cash in order to register businesses, and to obtain licenses, bank
loans, and raw materials.34
! Private firms often find it difficult to obtain accurate information on
China’s economy. According to one Chinese businessman: “Although
the Chinese press has improved a great deal from its heyday of
propaganda, it is still unsatisfactory to intellectuals who demand
more information and less party talk.”35 Business executives often
must rely on foreign sources of information on China through the
Internet and other channels. Basic information on China’s economy
is often unreliable. For example, the State Statistical Bureau and the
32
China Online, June 22, 1999 (www.chinaonline.com).
33 Johnson, Michael.
The Vices–and Virtues–of Corruption, Current History, September
1997, p. 270-273.
34 Some observers have concluded that, in the absence of the rule of law and clear property
rights in China, corruption often proves the only effective means for firms to cut through
government red tape to obtain needed resources. According to this view, “a corrupt market
is preferable to no market.” (See Kennedy, Scott.
Comrade’s Dilemma: Corruption and
Growth in Transition Economies, Problems of Post-Communism, March/April 1997). At
the same time, however, some observers believe that corruption has reached such a high level
in China that it has provoked widespread cynicism and anger among China’s citizens and has
undermined political support for the government. Yet, corruption has helped make local
officials rich, so they have little incentive to change the current system. (See U.S. Congress,
Joint Economic Committee.
China’s Economic Future: Challenges to U.S. Policy; Study
Papers. Politics and Economics in China, by Kenneth Lieberthal, 1996, p. 13.).
35 Mautz, Hong.
China’s Millionaires: A Product of Economic Reforms, October 7, 1999,
(available at www.intellectualCapital.com).
CRS-12
Ministry of Labor list the official unemployment rate at 3%, while the
state media often quotes an unofficial rate of 8%; foreign observers
argue that the actual rate is likely to be in the range of 10 to 15%. 36
In addition, many analysts argue that Chinese data on its real GDP
growth is overly optimistic, due in part to fabricated data provided
by local governments. The inability to obtain reliable economic and
financial data affects the ability of firms to make efficient business
decisions.
! China maintains extensive barriers on import trade and foreign
investment. While such barriers insulate many Chinese firms from
foreign competition, they also lessen pressure to perform more
efficiently. Import barriers raise prices for private (as well as non-
private) firms using imported inputs for production. This undermines
their international competitiveness. In addition, the central
government restricts foreign firms from investing in joint ventures
with private firms.
Recent Improvements to the Business Climate for the Private
Sector. Despite the wide variety of barriers faced by private entrepreneurs, it
appears that the political environment for the private sector is rapidly improving.
Private sector growth appears to be increasingly viewed by the central government
as an important factor in maintaining healthy economic growth as well as for
reforming unprofitable SOEs. China’s SOEs put an increasingly heavy strain on
China’s economy. Over half are believed to lose money and must be indirectly
subsidized through the banking system. While the government understands that
support of unprofitable SOEs diverts resources away from potentially more efficient
and profitable enterprises, it has been reluctant to reform SOEs too quickly due to
concerns that such reform would lead to widespread layoffs and possible political
instability.
In September 1997, Chinese President Jiang Zemin stated that China would take
steps which, if implemented, would essentially privatize (although referred to by the
Chinese as “public ownership”) all but 1,000 out of an estimated 308,000 SOEs by
cutting off most government aid and forcing them to compete on their own. The plan
called for the closing down of some unprofitable SOEs, while merging others. The
government anticipated that such reforms would lead to layoffs for a significant
number of workers but expressed confidence that such individuals would be able to
find employment in non-state enterprises, mainly in the private sector. In March
1998, Chinese Premier Zhu Rongji announced that SOE restructuring would be
accomplished within three years. However, the negative effects on China’s economy
resulting from the Asian financial crisis forced the government to slow the pace of
SOE reforms (especially for the large SOEs) during 1998. During 1999, SOE reform
36 U.S. Embassy, Beijing China.
The Reliability of Chinese Statistics, November 25, 1997,
p.5, available on Chinaonline.com). According to the embassy report, “some progress has
been made in specific areas of statistical collection, but in most areas, coverage, methodology,
and accuracy need to be improved.”
CRS-13
was quickened; several small and medium-sized SOEs were allowed to go bankrupt
or were sold off and several larger firms were restructured.37
Promoting the growth of the private sector has become a key element in the
government’s attempt to reform and restructure the SOEs. The government appears
to be hoping that workers laid off from restructured or bankrupt plants will be able
to quickly find employment in the non-state sector, including the private sector.
Chinese media reports indicate that the private sector is becoming increasingly
important in this respect. For example, it was reported that during the first 11 months
of 1999, the private sector absorbed 1.36 million workers laid off by SOEs.38
A number of recent steps have been taken by the central and local governments
to promote the development of the private sector:
! In January 1999, the central government announced that private
firms for the first time would be given trading rights (the right to
import and exports products); by June 1999 142 trading rights
licences had been granted.39
! In June 1999, the State Economic and Trade Commission for the first
time completed guidelines that establish loan guarantees to facilitate
bank borrowing by private firms.40
! In June 1999, the Shanghai government announced that foreign firms
will now be allowed to cooperate with or form joint ventures with
any legally established private firm. (In the past, policy relating to
Sino-foreign ventures was preferential to state-owned firms, while
alliances between foreign firms and private enterprises were
restricted).41
! In August 1999, the Chinese National People’s Congress passed
legislation (effective in January 2000) lowering the minimum capital
needed to start a private business from 100,000 yuan ($12,048) to 1
yuan ($0.12).42
! In September 1999, the Guangdong government announced it would
permit private firms to own a controlling share of provincial SOEs
37 The Chinese government estimated that 11 million workers were laid off from SOEs in 1999
(
China Online, January 26, 2000). The
Washington Post (April 6, 2000, p. A23) reported
that the Chinese government planned to lay off more than 11 million SOE workers in 2000.
38
China Online (www.chinaonline.com), January 6, 2000.
39
Muzi Dailynews, June 30, 1999 (available at www.china.muzi.net/news/).
40
South China Morning Post, September 9, 1999, p. 1.
41
Muzi Dailynews, June 30, 1999 (available at www.china.muzi.net/news/).
42
China Daily, January 7, 2000, p. 3.
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and collectively-owned enterprises in certain industries.43 In January
2000, the Guangdong announced that certain infrastructure projects
would be open to private sector investment.44
! In January 2000, the Chinese government announced that it planned
to scrap all obstacles to the development of the private sector, except
in areas relating to national security and certain state monopolies.45
Such policy changes, if fully implemented, could make it significantly easier for
Chinese entrepreneurs to start and operate their own businesses, borrow money from
state banks, and raise capital through public stock offering on China’s two stock
exchanges.
China’s Accession to the WTO: Implications For the Private
Sector
Over the past several years, China has been negotiating to accede to the World
Trade Organization (WTO), the international agency that administers multilateral
trade rules. Part of the WTO accession process involves negotiating bilateral trade
agreements with major trading partners who are currently WTO members, including
the United States. Until recently, U.S.-China WTO talks had progressed slowly, but
on November 15, 1999, the two sides announced that a bilateral WTO agreement had
been reached. China must reach agreements with a handful of other WTO members
and complete negotiations with the WTO Working Party handling its accession before
the full WTO can vote on its membership. Many observers believe China is close to
wrapping up all of its negotiations and could join the WTO by the end of 2000.
China’s membership in the WTO would require it to adhere to multilateral trade rules
such as the provision of most-favored-nation, or nondiscriminatory, trade treatment;
reliance on tariffs, rather than non-tariff barriers, when it is deemed necessary to
protect domestic producers; adherence to tariff rates at fixed maximum levels;
national treatment of foreign firms and imported products; and protection of
intellectual property rights. The U.S.-China bilateral trade agreement commits China,
upon its accession, to make major cuts in tariffs on agricultural and industry products,
provide full trading and distribution rights for U.S. firms in China, remove quotas and
other quantitative restrictions, eliminate unscientifically based sanitary and
phytosanitary restrictions, end export subsidies on agricultural products, open service
sectors (many of which are currently closed to foreign firms, such as distribution,
value-added telecommunications, insurance, banking, securities, and professional
services), eliminate various import restrictions and requirements, and require SOEs
to make purchases and sales on a commercial basis.
43
China Online, September 14, 1999 (available on [http://www.chinaonline.com]).
44
China Online, February 1, 2000.
45
Washington Post, January 5, 2000, p. 17.
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China’s accession to the WTO could result in significant changes to China’s
economic and trade regimes, many of which are likely to benefit the private sector in
China :
! The removal of trade and investment barriers would expose a greater
share of China’s economy to international competition. While some
Chinese firms could be negatively affected by such competition, many
more stand to gain from the expansion of free market forces. For
example, competition from foreign banks could force China to
substantially reform its banking system and financial practices,
compelling them to cut off loans to unprofitable SOEs and
redirecting them towards more profitable ventures. Additionally,
competition from foreign banks might force China to permit the
growth of privately-owned financial institutions. These measures
could substantially improve the ability of the private sector in China
to obtain low-cost financing. Reducing tariff and non-tariff trade
barriers would lower the cost of imports used as inputs for
production, while lowering barriers on services would likely improve
efficiency and lower costs of services in China. These measure could
help boost the international competitiveness of many Chinese firms.
! WTO rules require its members to maintain transparent, consistent,
and non-discriminatory trade rules. Should China be admitted to the
WTO, it would be required to bring its trade regime in line with
WTO rules. Many analysts contend that China’s WTO membership
would encourage it to enact new laws on business, intellectual
property rights, and property ownership rights, as well as to develop
an independent judicial system to enforce such laws. Advancing the
rule of law in China would create a more stable environment for
Chinese businesses to operate in and could weaken the ability of
corrupt government officials to extort bribes from private businesses
or use their influence to provide special treatment to businesses they
own or control.46
! Upon its accession to the WTO, China would have to give Chinese
private firms the same benefits and rights given to foreign firms (such
as trade and distribution rights and the ability to invest in certain
sectors). Failure to do so, would put Chinese firms at an extreme
disadvantage in competing with foreign firms in China.
! Liberalization of Chinese trade and investment rules would expand
the ability of foreign investors to choose their own Chinese partners
for joint ventures. Foreign firms would no longer be forced to join
up with a government owned company in order to do business in
46 USTR Charlene Barshefsky stated that the strengthening of the rule of law in China was the
most important achievement of the U.S.-China WTO trade Agreement. See USTR Press
Release, November 15, 1999.
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China; instead they could establish partnerships with individuals and
firms deemed to be the most dynamic and efficient.
! Under the U.S.-China WTO agreement, China agreed that its SOEs
would make purchases and sales based on commercial considerations
and give U.S. firms the opportunity to compete for sales on a non-
discriminatory basis. In addition, SOEs would be subject to WTO
rules on subsidies and countervailing measures. These measure
would force the Chinese government to end many preferential
policies it now gives to the SOEs, and hence could help create a
more level playing field for Chinese private firms.
Some analysts believe that China’s willingness to undertake reforms necessary
for WTO membership represents a substantial change in Chinese economic policy.
For example, Edward S. Steinfeld in a September 1999
Current History article
wrote:
Since the late 1970s, Chinese policymakers had attempted to tweak the socialist
system by gradually introducing market forces. The basic idea was to preserve the
economy’s socialist core–state firms and banks–by introducing change along the
margins. These incremental measures over time saw markets established, state
planning effectively eliminated, prices liberalized, and non-state-owned industry
allowed to prosper, but the underlying logic remained constant. Reforms would
be introduced, but always as part of an overriding effort to preserve the traditional
core of the economy. The concessions of 1999 represented a thorough reversal
of course. Instead of reform serving to sustain the core, the core itself would be
destroyed to save reform, along with the growth, prosperity, and stability that
reform has brought to China. In the new view, instead of using market forces to
save state socialism, state socialism itself would have to be sacrificed to preserve
the market economy.47
According to this view, China’s membership in the WTO will require it to
essentially privatize a substantial portion of its economy, not only to be in compliance
with WTO rules, but to be able to compete internationally. Such a development, it is
argued, would likely benefit U.S. firms doing business in China, namely through the
development of the rule of law in China, the reduction of government control over
various sectors of the Chinese economy, and enhanced opportunities to develop
partnerships with Chinese private firms and entrepreneurs. It is further argued that
a vibrant and growing Chinese private sector will enhance economic opportunities,
living standards, and economic freedom for the average Chinese citizen, which could
help promote greater openness and freedom in China.48
Other analysts are not as optimistic over China’s entry into the WTO. They
argue that, based on China’s past record on implementing trade agreements with the
United States (which they view as poor), China cannot be trusted to implement its
47 Steinfeld, Edward S.
Beyond the Transition: China’s Economy at Century’s End, Current
History, September 1999, p. 272.
48 See Remarks by President Clinton to the Paul H. Nitze School of Advanced International
Studies, Washington, D.C., March 8, 2000 (available at www.chinapntr.gov)
CRS-17
WTO commitments once it becomes a member, especially if trade reforms cause
widespread bankruptcies and layoffs as some predict.49 In addition, many analysts
doubt whether China would allow private firms to operate freely in sectors dominated
by SOEs, due to concerns that to do so would force many SOEs out of business.50
Finally, some analysts argue that significant economic reforms in China cannot be
made until political reforms are first implemented. Notes John Seel, vice president at
Morgan Stanley Dean Witter in Hong Kong:
It is becoming clearer that it’s hard to have real economic liberalization without
at least some political liberalization–fixing the banks gets even harder without the
ability to speak out about the mis-allocation of their resources, and fixing the state
sector is harder unless you have a private sector big enough and secure enough to
stand up and criticize the government for pumping so much money into state
dinosaurs.51
Conclusion
China has substantially expanded the role of the private sector over the past
several years. To a large extent, the Chinese government appears to have gotten
around the ideological problems of promoting capitalism, first by describing the
private sector as a complimentary feature of a socialist market economy, then
describing it as an important component. This represents a pragmatic approach to
economic policymaking. The private sector has become an ever increasingly
important source of economic growth and productivity and has proven to be a critical
source of employment in recent years. Without a growing and dynamic private sector
to absorb displaced workers, SOE reform would likely prove politically
destabilizing.52 It is not yet clear, however, whether the Chinese government is ready
(ideologically or as a practical matter) to allow the private sector to operate on a level
playing field with the state sector, let alone to become the dominant force in China’s
economy. For example, will the government tolerate the development of large
privately-owned corporations? What will the government’s response be when private
firms begin to compete more and more with SOEs and possibly drive some of them
49 Mastel, Greg.
Enter China, Washington Post, January 2, 2000, p. A15.
50 Such analysts also justify this position on repeated statements by the Chinese government
that, under a
socialist market economy, the government permits various types of ownership,
but maintains control over key economic sectors and sets overall economic policies. Based on
this ideology, it is argued, China would never allow the private sector to become a dominant
force in China’s economy.
51
The Asian Wall Street Journal, October 25, 1999. P. S14.
52 SOE reform has become a critical centerpiece in the Chinese government’s efforts to reform
the economy in order to ensure long-term economic growth. Nearly half of China’s 300,000
SOEs lose money and must be subsidized through China’s banking system. Without such
assistance, many SOEs would go bankrupt. However, a large portion of state bank loans to
the SOEs are not repaid, which threatens the financial solvency of the banking system. Many
analysts argue that China’s banking system can only be reformed if the banks are allowed to
cut ties to unprofitable SOEs, and this can only be accomplished if the SOEs are first
reformed and restructured. In order to reform the SOEs, the government must ensure that
laid-off workers can find jobs in other sectors of the economy.
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into bankruptcy? Will China privatize its banking system? Will the government allow
private firms to freely sell stock in China’s stock markets? Will the government allow
individuals to buy, own, and sell private property? Finally, will the government
establish a transparent regulatory business environment (e.g., one that is relatively free
of government graft and corruption) that will enable firms to compete fairly and
freely?
Many analysts contend that the growth and development of the private sector is
critical to China’s continued economic growth and ability to compete in international
markets. For example Dr. Xinghai Fang, formerly an economist with the World Bank,
notes that despite 21 years of reform and rapid economic growth, China has produced
few internationally competitive privately-owned firms. Fang states: “I believe that the
biggest difficulty that will confront the Chinese economy in the near future is that
internationally competitive private firms may not emerge in China for a long time to
come. And that it will stunt China’s economic growth.”53 Fang believes that China’s
leaders, while accepting the need for a vibrant private sector, still believe that state-
owned companies should play the major role in China’s development and have locked
out private firms from participating in major sectors of the Chinese economy, thus
preventing them from developing large-scale operations. Fang states that this
strategy is severely flawed:
Some people may believe that China can become an industrialized economy by
properly restructuring and growing its huge number of state-owned companies.
This belief is certainly wrong. Countries may manage a few state-owned
companies well and make them internationally competitive. Such examples
include Singapore and France. But no country can run thousands, and in China’s
case tens of thousands, of state-owned companies well.54
It is difficult to determine what role the private sector will play in the
development of China’s economy in the near and distant future. Premier Zhu Rongji’s
March 5, 2000, economic report to the Third Session of the Ninth National People’s
Congress (NPC) barely mentioned the private sector other than to state: “While
keeping the public sector of the economy in the dominant position, sound
development of the non-public sector, including self-employed and private businesses,
should be encouraged.” Instead, the report’s main focus was on the modernization
of SOEs in preparation for China’s WTO accession.55 However, during the NPC
session, 30 NPC representatives submitted a proposal that would give China’s private
sector access to China’s telecommunication’s market prior to China’s entry into the
WTO. While the measure was not adopted by the NPC, Premier Zhu, during a
March 16, 2000 press conference, stated that “there is no problem and no difficulty
concerning allowing private businesses to take part in the telecom industry. We have
already promised to allow overseas private investment to take part in China’s telecom
53 Fang, Xinghai,
Problems with China’s Development Strategy. The World Bank Group,
August 1998, p.1, available at China Online web page (www.chinaonline.com).
54 Ibid, p. 2.
55 Zhu Rongji’s
Report on The Work of the Government, March 5, 2000, 15 pp.
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industry. Why should we shut the door on our own private business people? This is
not logical.”56
It appears that China’s accession to the WTO will likely create substantial new
opportunities for Chinese firms, especially in sectors that are being liberalized as part
of that accession, and that the Chinese government will continue to promote the
development of the private sector to in order to provide jobs for workers laid off by
SOE restructuring and reform. However, it appears that central government’s current
main economic priority is to make SOEs profitable and internationally competitive,
especially in preparation for China’s WTO membership. Thus, it is likely that the
Chinese government, in the short run, will continue to maintain many policies that
give preferential treatment to SOEs. However, should the SOEs prove unable to
meet foreign competition and are forced into bankruptcy, the Chinese government will
likely have two options: (1) violate its WTO commitments by re-imposing protective
trade and investment barriers, or (2) privatize most or all of the SOEs. The first
option would do little to make SOEs more competitive and would likely result in the
imposition of trade sanctions against Chinese products by other WTO members. The
second option, while likely boosting economic efficiency, might prove a difficult
option to swallow, based on current government ideology on what constitutes a
socialist market economy, unless Chinese leaders were willing to draw upon an old
Chinese saying attributed to Deng Xiaoping: “It doesn’t matter if the cat is black or
white, so long as it catches mice.”
56 Zhu Rongji press conference, March 16, 2000, p. 5.
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