Private Economy’s Original Sin

Whether measured in terms of gross domestic product, tax contributions or job creation, statistics prove that the private economy plays a crucial role in China.

In some well-developed parts of the country the private sector, when factoring in contributions to employment and tax receipts, accounts for more than 90 percent of local GDP.

However, although private business output has risen substantially as a percentage of GDP in recent years, it’s still not on an equal footing with the state-owned economy. Hidden and overt forms of discrimination against the private economy can be found almost everywhere.

Such discrimination is reflected by the government’s attitude and in its regulations. State-owned companies are heralded as “the leading force for the national economy” that deserve to be “consolidated and developed.” Private companies in official jargon are distinguished as “the non-public economy, encompassing the individual economy and private-owned businesses that make up an important part of the socialist market economy.”

While state-owned companies are promoted by authorities, private businesses in many areas are not even legally allowed to exist. The gap between public and private companies in some cases seems too wide to close.

What’s the reasoning behind this discrimination against private businesses? It lies mainly in three concepts: original sin, moral hazard, and a lack of macroeconomic perspective.

Source of Sin

Today, private companies are metaphorically forced to wear dunce caps. The charges against them do not make much sense.

In the early developmental stages for China’s private economy, many businesses did not comply with laws and regulations. There were two types of violations: Illegal activity simply because the law at the time didn’t allow an existence for anyone in the private economy; and activities involving tax evasion and speculative investment.

The fact that private businesses existed illegally was not the fault of the private sector, but rather a problem built into the system at that time. China’s failed attempts at building a planned economy at the end of Cultural Revolution forced farmers to change their means of production to survive. So if there is an original sin, it’s all about the system rather than the private economy.

If a business was punished in the past for the errors of the past, that’s well and good. If it escaped punishment, also consider that to be in the past. If they were punished in the past, though, they should have the right to start again.

In a society with the rule of law, most crimes have a statute of limitations. We can’t say that a company that committed some minor fault twenty years ago still bears original sin.

Moral Hazard

A second strike against the sector is the supposed moral hazard that a private business carries. This refers to the possibility that in economic activities people will try to win advantages over others.

The moral hazard supposedly lies in private company dealings with governmental agencies, as well as other state-owned commercial institutions that take extra precautions when working with them.

For instance, in agreeing to grant a loan to a state-owned company, relevant agents at a state-owned commercial bank don’t have to be responsible for additional risks as long as the process goes through normal risk controls—even if the loan is never repaid.

However, loans to private companies require extra procedures. This has prompted banks to be reluctant toward granting loans to small and medium-sized businesses. This significantly restricts their development.

This extra level of caution also raises private business operational costs and undoubtedly reduces our society’s economic efficiency. Many of China’s economic problems today can be attributed to the existence of this perception of moral hazard.

Missing the Big Picture

Third is the perspective taken toward the overall situation. Many officials regard private companies as a mercenary bunch unconcerned about the nation’s broader needs. They welcome the private economy from the perspective of GDP and employment, but deep in their hearts they still as always resist the private economy.

Moreover, in their view, many of these private businesses are not as obedient as state-owned companies. This probably explains why the latest efforts to privatize public utilities have largely dissipated.

It should be understood that companies pursue profits, and that beyond paying taxes, they also bear some extra social responsibilities. Unfortunately, such simple reasoning is taken by many public officials as evidence that private companies lack any view of the bigger picture.

This may be due to the fact that during the process of public utility privatization, many unfinished details remained unresolved in contracts. After all, the privatization of public utilities is a relatively new phenomenon in China. However, this imperfection has become a major excuse for inhibiting the privatization of public utilities. It is a rather sad consequence.

Past examples have shown us that the country’s central macro-economic control policymakers have preferred to sacrifice private entrepreneurs and their businesses. If it violates the same regulations, though, a state-owned company would receive a much lighter punishment than a private firm.

The law clearly defines relationships between a private company’s legal representative, its shareholders, and the corporate structure. But in practice, many people, in particular law enforcement agencies, often confuse them.

For example, when the culprits are shareholders of a company, the company is held to bear the civil liability. And when companies have committed offenses they also involve the shareholders. Were they leaders of state-owned companies committing the same offenses, such punishment would have not have been imposed. This is selective enforcement of the law.

The market itself bears risks. There’s no free lunch not perfect system for business ownership. But we can seek out the lesser evil.

The market economy has been established as the basic method for allocating resources in China. And since fair market competition will continue to pay a role as one of several ownership structures, it’s time to end the discrimination.

Fu Weigang is a researcher at Shanghai Institute of Finance & Law.