In attempting lớn answer these questions, it is important lớn keep in mind two perspectives. First, the Chinese government’s increasing intervention in the private economy is less a pivot and more the latest installment of a ratcheting of domestic control over specific industries. Second, the state is managing a calculated opening in other industries still in need of foreign know-how & resources. Overall, this combined approach represents a government that will likely preside over greater restrictions on domestic private actors in China’s economy in the medium term, but with important strategic openings khổng lồ foreign private actors in key industries that merit our collective attention over the next few years.

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In 2021, China’s Vice Premier Liu He MC/MPA 1995 spoke at a digital economy forum, promising that “guidelines and policies for supporting the private economy have not changed ... Và will not change in the future.” to lớn a great extent, he was right—policy guidelines strengthening state involvement in private industry are nothing new. They began nearly a decade & a half ago, in the wake of the 2008 global financial crisis, marking the end of a short window of liberalization that had followed China’s joining of the World Trade Organization, in 2001. At that time, the government responded to lớn the financial crisis with a fiscal stimulus package that increased money supply by nearly a third, doubled stock prices, fueled massive gains in property prices, and necessitated a series of deleveraging policies that restricted credit—particularly khổng lồ private firms. Yet demand persisted, & alternative financial institutions emerged khổng lồ meet such demand through “shadow banking” that was able khổng lồ navigate a fragmented regulatory apparatus. Regulatory centralization followed, along with a range of policies to lớn rein in private companies in largely consumer-facing industries, including real estate, financial services, technology, & education. By late 2020, Ant’s Hong Kong IPO was suspended after an intervention from Chinese regulators. The education company New Oriental, also listed in the United States, lost 90% of its market value as the private tutoring industry was effectively banned from turning a profit. Didi Chuxing, the ride-hailing company, was delisted from the new york Stock Exchange in May of this year after facing increased scrutiny from regulators. 

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Prevailing Winds
China’s Complicated Relationship with the Private SectorOctober 2021
Shanghai, China
From the start of the reform era of the late 1970s through khổng lồ the present day, the private sector in đài loan trung quốc has succeeded despite a difficult legal environment, continued government support for state-owned enterprises, and a ruling các buổi tiệc nhỏ that views private capital with suspicion.In response lớn a large and freewheeling private economy, the Chinese government under Xi Jinping is engaging in a widespread campaign to assert greater control over the private sector.Finding companies with good bộ vi xử lý core businesses that can hopefully succeed in a variety of environments is a stronger foundation than trying to read the tea leaves of Beijing’s intentions.

Prevailing Winds is a China-focused blog written by Nicholas Borst, Director of china Research at Seafarer.The blog tracks the economic và financial developments shaping the world’s largest emerging market.

China’s private sector appears lớn be under an unprecedented assault. Over the past year, the Chinese government has embarked on a wide-ranging regulatory crackdown, targeting the technology, e-commerce, education, fintech, & real estate sectors. The Communist buổi tiệc nhỏ is demanding “golden shares” and tiệc ngọt committees within companies to lớn better exert control over the private sector.1 Access khổng lồ finance remains difficult for many private companies in China, with banks preferring khổng lồ lend to lớn state-owned enterprises. Xi Jinping’s new rhetoric around “common prosperity” has stoked fears that a broader shift against market reforms is underway.2 to understand the risks and challenges of the current moment, it’s helpful to reviews the complicated và often contentious relationship between the Chinese government and the private sector.

A Slow and Uneasy Acknowledgment of the Private Sector

China’s economic transformation has been a phối of both bottom-up liberalization và top-down policy reforms. In 1978, farmers in the province of Anhui took the lead in dismantling China’s collective agricultural system, dividing the land among themselves in violation of the rules.3 Chinese leaders permitted the experiment lớn continue & then allowed it to lớn spread across the country.

Throughout much of the 1980s, private companies were still illegal in China. Savvy Chinese entrepreneurs launched businesses through town and village enterprises that were nominally owned by collectives or local governments. This process, known as wearing the “red hat,” provided legal cover for private companies that had no legal basis to exist.4 As this activity proliferated, these quasi-private firms were acknowledged và later approved by the Chinese government.5

Under Deng Xiaoping’s rule, the mantra “to get rich is glorious” became a shorthand representation for the Chinese government’s growing acceptance of the private sector và private wealth. Despite this rhetorical support, the institutional environment for the private sector was difficult. Small private businesses were limited to lớn employing a maximum of five employees & were only allowed khổng lồ operate in certain sectors.6 In 1988, the Chinese government published the “Tentative Stipulations on Private Enterprises,” formally acknowledging the existence of private firms and approving some private ownership structures.6 Yet, private companies continued lớn be subject to lớn a host of discriminatory taxes, fees, & restrictions compared to lớn state-owned enterprises.7

With the passage of the 1994 Company Law, private companies were granted a more formal legal basis và many collective firms “took off the red hat” và registered as private.8 In 1999, the constitution was amended to acknowledge the private sector as an “important component” of the economy, rather than a mere “complement” khổng lồ the public sector.9 However, lớn this day, China’s constitution still states that the state-owned economy is “the leading force in the national economy” and that the government will ensure its “consolidation and growth.”10

While private companies began to proliferate throughout trung quốc in the 1990s, entrepreneurs were not invited khổng lồ join the Communist tiệc ngọt until 2001.8 This marked a begrudging acknowledgement that the các buổi tiệc nhỏ couldn’t govern the newly emerging trung quốc without co-opting the increasingly influential private sector.

In 2004, China’s constitution was amended lớn enshrine the right to private property. Despite this & other reforms, private entrepreneurs continue khổng lồ complain vociferously about discriminatory legal treatment compared khổng lồ SOEs.7

Reforms Are Driven by Necessity, Not an Ideological Commitment to miễn phí Markets

In the late 1990s, đài loan trung quốc was faced with significant challenges that acted as a catalyst for economic reform. A non-performing loan crisis and the Asian Financial Crisis spurred Chinese leaders khổng lồ restructure the financial system and state-owned enterprises. The banks were cleaned up, recapitalized, and publicly listed. Thousands of inefficient và loss-making SOEs were shuttered. These reforms led to better access to financing & more space lớn compete for the private sector.

Even during this period of bold reforms, China’s leaders never supported large-scale privatizations. The policy of that era was called “Grasping the Large, Letting Go the Small.” As the name indicates, đài loan trung quốc was focused on shuttering smaller state firms while consolidating và strengthening large ones.

As acute threats khổng lồ the economy waned, so too did China’s commitment lớn meaningful economic reforms.11 There were modest & incremental reforms during the 2000s, but nothing on the scale of the massive reforms of the late 1990s. By the mid 2000s, Chinese policymakers were designating large swathes of the economy as strategic industries khổng lồ be led by the state & consolidating state-owned enterprises into ever-larger conglomerates.12 Critics have referred khổng lồ the kết thúc of Hu Jintao’s tenure in power nguồn (2002-2012) as a “lost decade” for reform.13

At the start of Xi Jinping’s administration, & amid a period of relative economic weakness, the Chinese government made a bold declaration that it would allow the market to lớn play a “decisive role” in the economy. However, economic reforms since then have been halting & disappointing.

Moreover, since around 2015, a clear shift towards supporting state-owned enterprises has been evident. Rather than shutting down failing SOEs, the Chinese government arranged for mergers to lớn create ever-larger state conglomerates. Additionally, credit has increasingly flowed away from the private sector và toward state-owned enterprises.14 As shown in Figure 1, the Xi administration’s support for SOEs has led to a decline in private capital as a nói qua of total fixed asset investment.

Sources: CEIC, Seafarer.

A Private Sector-driven Economy

From the start of the reform era through to lớn the present day, the private sector in trung quốc has succeeded despite a difficult legal environment, continued government tư vấn for state-owned enterprises, và a ruling các buổi party that views private capital with suspicion.

When given a chance, private companies in trung quốc often displace their state-owned competitors through faster growth and greater efficiency. Private companies overcome the banking system’s tilt towards SOEs by self-financing their growth with retained earnings và borrowing through non-traditional channels, such as microlenders.8

In China’s impressive manufacturing & construction sectors, private enterprises have supplanted state-owned enterprises lớn a large extent. Reflecting this shift, Figure 2 shows that private enterprises are now the dominant source of China’s total exports.

Sources: CEIC, Seafarer.

China’s service sector has more barriers khổng lồ entry for private firms. Nonetheless, the private sector has still made significant inroads into the real estate, wholesale & retail, information technology, business services, và hotels và catering industries.15

The net result is that despite many obstacles, private companies are now the leading force in the Chinese economy. This is a fact that Xi Jinping và other top Chinese leaders, perhaps grudgingly, have acknowledged repeatedly. According to lớn Xi, private companies pay 1/2 of tax revenues, account for 60% of gross domestic product, 70% of technological innovation, 80% of employment, and 90% of total enterprises in China.16 These statistics may even underestimate the private sector’s contributions, as other credible estimates show an even higher mô tả of economic activity stemming from private companies.15

China’s economy would not be the powerhouse it is today without the country’s dynamic & adaptive private sector. China’s constitution may declare SOEs as the leading force in the economy, but the private sector has claimed that title for many decades.

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Putting the Bird Back into the Cage

In the early days of China’s reforms, the market was described as a bird khổng lồ be kept within the confines of a cage. That cage was the Party’s plan for the economy. The bird could fly freely within the cage, but never outside it.

Since then, China’s economy has grown well beyond the control of central planners. Through bottom-up entrepreneurial drive, private companies have transformed the economy in ways unforeseen by China’s leaders.

In response to lớn a large and freewheeling private economy, the Chinese government is trying khổng lồ force private companies back within the confines of the cage. The private sector should obey the leadership of the tiệc ngọt and tư vấn national goals và policies.

Certain industries are guilty of “barbaric growth” & “disorderly expansion,” lớn use the Party’s own parlance.17 The Chinese government is now engaged in a widespread rectification campaign to bring these industries khổng lồ heel. The kích cỡ of the cage for companies operating in the industries has suddenly become much smaller.

Some analysts have claimed that china is in the midst of a regulatory cycle that will soon wind down.18 However, there’s little evidence that the actions underway are a one-off episode or have a predictable endpoint. The lack of checks & balances within China’s legal và regulatory system mean that shifts in policy can be dramatic và occur without advance notice. Moreover, affected companies have extremely limited legal recourse to challenge the government on policies that negatively impact them.

While many questions remain about the present situation, what can be said with certainty is that China’s entrepreneurs have succeeded in the past despite an intensely challenging political và legal environment. China’s economic transformation is as much a story of private enterprise thriving in difficult circumstances as it is the government leading through top-down policy reforms.

China’s early entrepreneurs were adept in working around legal barriers, competing with subsidized state-owned enterprises, and placating a suspicious ruling party. The entrepreneurs of today may be forced to relearn many of these same skills.

While private companies are no longer prohibited, they are forced lớn show obeisance lớn the party and its goals for the country. Private companies face pressure lớn establish buổi tiệc nhỏ cells within their corporate structure và government-linked investors are taking ownership stakes in strategically-important private companies.

To emerge with their businesses intact, private companies in Beijing’s crosshairs are donning a new “red hat.” China’s tech giants Alibaba và Tencent are a case in point. They graciously thank the government for its guidance even when new regulations damage their business, co-invest with the state to support national projects, and proclaim their enthusiasm for increasing the role of the buổi tiệc nhỏ within their company. All the while, they desperately seek lớn retain control over business empires that the government is increasingly phối on breaking.

Other Chinese private businesses have adopted a different tactic: keep a low profile & try khổng lồ avoid undue attention from the government. The extent khổng lồ which this is possible depends on their size and the political sensitivity of the industries they operate in.

For investors, some analysts have argued that the path forward is khổng lồ “invest with the state” and put capital into government-favored industries. However, this approach is difficult given that favored industries often change and new regulations can bring previously favored industries khổng lồ their knees with little warning. When the Chinese government has embraced private companies, it has done so when they can serve as a tool to advance national goals. There has never been an ideological commitment to private enterprise for its own sake.

The best approach is to lớn find companies with good chip core businesses that can hopefully succeed in a variety of environments. That is not a guarantee of success, but it is a stronger foundation than trying khổng lồ read the tea leaves of Beijing’s intentions.

The current situation for the private sector in đài loan trung quốc is complex, difficult, and fraught with risk. In that sense, it shares much in common with the past.

Nicholas Borst, Vice President & Director of china Research
The views & information discussed in this commentary are as of the date of publication, are subject khổng lồ change, và may not reflect Seafarer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to lớn buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed khổng lồ be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.As of June 30, 2021, the Seafarer Funds did not own shares in the entities referenced in this commentary.Nicholas Lardy, Markets Over Mao: The Rise of Private Business in china (Washington, D.C.: The Peterson Institute for International Economics, 2012).Nicholas Lardy, The State Strikes Back: The end of Economic Reform in China? (Washington, D.C.: The Peterson Institute for International Economics, 2019).