A Look at Capitalism with Chinese Characteristics: The Evolving Relationship Between Entrepreneurship and the State

Photo of Joseph Chen, the founder and CEO of Renren, a social networking site colloquially known as the "Chinese Facebook" following his companies IPO

“Capitalism with Chinese Characteristics: Entrepreneurship and the State” approaches basic questions about the results of China’s economic reform on private enterprises in China. The author focused on the paper trial of various private companies in China to find a more nuanced and factually sound explanation for the relationship between government and business in China and how the evolution in that relationship has evolved over time. It was important to contextualize this information within different policy periods. These policy periods also saw significant shifts in the reach of the Chinese government while owning less of the country’s businesses, which then affected the treatment of different forms of capitalism within China. A big theme is the urban-rural divide in China regarding the treatment of capitalism through different periods. The most obvious juxtaposition being the emergence and role of TVEs in fostering rural entrepreneurship during the 1980s and the dominance of urban policies favoring large SOEs and foreign invested enterprises through out the 1990s.

The author notes that there are several definitions and classification schemes to determine the size of the Chinese private sector. This is due to several complex legal statuses that private companies operate under in China. The author refers only to indigenous firms and excludes that qualify as foreign invested enterprises or FIEs. This is done to account for the myriad of favorable government policies toward FIEs that afford them both technological and policy induced advantages over their indigenous counterparts. An example of this is the technology giant, Lenovo, which is often touted as an example of the success of China’s policies for fostering a successful private sector. However careful examination reveals that was founded in Beijing, it was owned and controlled by Lenovo Hong Kong. The Hong Kong status is very important because that allowed Lenovo to operate under the much freer regulations of a FIE as well as the institutional benefits of being a legal Hong Kong business entity. It’s the confluence of these factors mitigated the lack of formalized and efficient capital markets in China by allowing sufficient access to them. However this access isn’t applicable to most of the private sector in China due to the need for sufficient foreign-based ownership and involvement necessary to reach those types of resources.

To measure the affect of Chinese government policies on the growth of the indigenous private sector, the author tracks fixed-asset investments of the different classes of firms operating in China. This is because the government heavily controls fixed-asset investments compared with other measures like output, which are subject to trends in the economy not as affected by government policy.  Examination of fixed-asset investments showed that the ratio of private sector’s share of fixed-asset investments was at an all time high during the 1980s at 21.4%, but declined to 14.7% as recently as 2005.[1] This means that the indigenous private sector experienced the most favorable growth conditions during the 1980s and that the surge in growth in China’s private sector must be the result of continued support for FIEs, firms engaging in joint ventures with foreign firms, or direct involvement of foreign multinationals.

The rural origin of a lot of China’s entrepreneurial success stories speaks to the what many scholars and political observers find is a strong capacity for entrepreneurship amongst the residents of the rural providences. When capitalistic reforms were implemented in the provinces in the 1980s, the local residents were able to translate this into large increases in household income and poverty reduction. This was done due to the explosion in entrepreneurial activity as seen in the increase in the numbers of sole-proprietorships operating in China to 10.7 million in the rural areas of provinces as opposed to just 3.8 million in urban areas according to data from the Business Industry and Commerce Administration and Self Employed Business Survey Data at CUHK’s University Data Center. What makes this more remarkable is the large numbers of rural, private businesses in nonagricultural sectors. These same surveys of business and entrepreneur origins show that 64% of businesses in China in 1988 were registered in rural areas, though many of them may have actually operated in cities, were on average larger than firms run by their urban counterparts, had more investors, larger amounts of registered capital, and more fixed assets.[2]

These findings show that the rural entrepreneurs seemed to have a better grasp of running firms in a capitalist system. Generally speaking, the education level of many of these burgeoning businessmen received a boost with the Mao era’s focus on rural education and health reforms, enabling many of them to achieve high rates of schooling compared to the past and on par with urban residents. This along with the myriad of small-scale markets through out much of rural China provided an informal supplementary education to operating businesses in a market economy setting.

This can be seen in the success of various township and village enterprises or TVEs, through out the 1980s and into the 1990s. Many have used the TVE cases to show that they were a publically owned and operated entity that worked well due to the strength of the government planning involved. But a closer examination of the performance and behavior of TVEs as opposed to SOEs show stark differences that suggest that TVEs were actually largely privately owned and operated. One such case the author points to is Kelon, a Rongqi based appliance group. The firm was actually founded by Wang Guoduan, a local entrepreneur. But due to the lack of legal framework for a private enterprise to operate in Rongqi at that time, the local government was given nominal control of the company and appointed an official as general manager, but all operating equity and strategic decisions were undertaken by Mr. Wang and a core group of workers that would go on to be credited as founders and stay on for over 15 years. This is important because SOE tenure averages only 5.5 years, and the Rongqi government’s initial funding for Kelon took the form of a loan and credit line, not an equity stake. The firm grew through out the 1980s, but started to seriously falter when the local government decided to exercise it’s control through appointing a new official as general manager whose strategic decisions thoroughly derailed until it incurred 3.7 Billion Yuan in losses in 2005 amid dozens of law suits.[3]

The Kelon case provides the starting point for the observation that TVEs were actually almost completely private. In fact, the official definition of TVEs implies that many of them would have been classified as a normal private enterprise in a full market economy environment, “TVEs include enterprises sponsored by townships and villages, the alliance enterprises formed by peasants, other alliance enterprises and individual enterprises.”[4] This means that TVEs were to be located in townships and villages, but not necessarily owned and operated by those respective governments. They flourished when their operations were left to the privately based investors and managers and declined in the wake of the politically motivated, post Tiananmen crackdown on private enterprises. This resulted in local governments exerting their nominal control over the operations of the company, leading many of them into decline. The private TVEs greatly outnumbered and outperformed the collective TVEs, especially considering that the private TVEs were from the poorest areas thus their added value to the economy was greater in terms of the impact in had on poverty reduction and increasing household income during the period of the 1980s.

There were other important changes in policy that adversely affected rural based entrepreneurship and more fervently favored system of larger, urban-based SOEs. By cracking down on the informal finance system in a lot of rural areas, the Chinese government sought to eliminate what they saw as a source of competiton but didn't replace it with suitable alternatives of funding for private TVEs.  The reform period known as the “Tiananmen Interlude” saw rural household income grow at the lowest rate since the beginning China’s economic reform, and nonagricultural business income in the rural areas actually a net loss of 5%.[5] The slowdown in business opportunities for peasants led many to begin migrating to the cities as laborers in the 1990s as opposed to the entrepreneurs of rural origin in the 1980s.These changes resulted in increased income inequality in China and decline in business dynamism in rural areas that was to persist through out the 1990s. The political leadership changes are also an important factor as well. In the 1980s, China’s political leadership all had backgrounds in the more entrepreneurial rural areas as opposed to the highly urban experiences of the Jiang Zemin headed leadership. This marked a changing of the guard to a more technocratic and urban focused China. Since strong central planning had long been more of a hallmark of the urban political experience, having the most powerful leaders coming from that type of political background would have policy implications for the direction of Chinese capitalism and effect the growth of small businesses in China.

[1] Capitalism with Chinese Characteristics p. 21

[2] Ibid p. 59

[3] Ibid p. 70

[4] Ibid p. 74

[5] Ibid p. 117