The Precarious Leap: A skeptic's view of entrepreneurship in China

The 2012 State of the Union's viewership approached 38 million people. To one extent or another, most of those watching have stakes in the policy announcements of the speech—investors, businessmen, and consumers. Inevitably, they will react to the speech, in either a big or small way. One can track market reactions to State of the Unions throughout the years (http://articles.marketwatch.com/2011-01-24/markets/30701524_1_stock-mark...). As Congress debates the upcoming fiscal cliff, journalists and investors wait with bated breath for each announcement of progress and compromises in the proceedings. When the day comes for the decision of whether to extend the Bush Tax Cuts, compromise on extending cuts for the middle class, or let them expire in whole, the markets will react to the announcement. This is self evident: the government announces policy decisions, the investors respond whether they like or dislike the new policies. However this reaction is all based upon one important assumption: what the government says actually reflects what it will do. 

In the United States when tax cuts are announced, economists ask “What will be the results and effects of this tax cut?” Contrasted with the reform era central government announced tax cuts or reforms, when economists should first be asking the question “did these reforms really happen?” According to Yashen Huang, Professor at MIT's Sloan School and author of Capitalism with Chinese Characteristics,Rhetoric and action are not always synonymous in the Middle Kingdom.

Professor Huang emphasizes his research methods—combing through “thousands of pages of memoranda, directives, operating manuals, and rules of personnel evaluations issued by the presidents of China’s central bank, all the major commercial banks, rural credit cooperatives, and so on.” (I was excited to note that his primary research was done using the Chinese University of Hong Kong library, which houses one of the most extensive collections regarding the Chinese economy.) He sees much of the current economic statistics, even those compiled by western academics, as inherently flawed through their misunderstanding of the ownership structure of most Chinese businesses.

Professor Huang casts convincing doubt on what he sees as the misguided narrative that Western economists have written for China, a narrative based on efficient state ownership, and effective centralized economic policy. He looks specifically at the TVE, Township and Village Enterprises, and that Western economists have long misunderstood the fundamental ownership structure of these important developmental instruments. TVE's were developed during Deng's reform era as a conduit for creating entrepreneurial growth in the countryside. TVE's represented small industrial projects within a town which produced goods for export. This served the double purpose of attracting capital and investment into rural areas, as well as industrializing the countryside. The TVE project is seen as fundamental to China's growth since the 1970s, one of the most important results of this experiment being the narrowing of the urban rural gap. However, where western economists assumed that these enterprises were owned and operated by local governments, Huang argues that 10 million of the 12 million TVE's were 100% privately owned by the villagers themselves. This was an example of rural entrepreneurship, not centrally planned industrialization.

The important factor here was just that Deng declared that rural industrialization was now a priority of the government. Deng, having been purged three times by Mao and his son crippled during the cultural revolution, heralded change and carried a gravitas few Chinese politicians held. At the beginning of his term in office, Deng officially “proposed a system governed by rules, clear lines of authority, and collective decision-making institutions to replace the over-concentration of power and patriarchal rule that had characterized China under Mao.” However, many quantitative indicators signal that Deng's actual policies were not too dissimilar to Mao's, especially in terms of private property ownership. Merely his presence at the helm as a reformer lead to expansion of private ownership and capitalism in the rural sector.

What Huang argues for China's current economy however, is starkly different than his idealistic entrepreneurial rural boom of the 1980s. Much of that progress was rolled back in the 1990s due to urban biased central planning and the birth of the giant SOEs. Here the narrative Western economists project onto Chinese companies—that centrally planned allocation of resources has combined with vicious capitalistic competition to create a super-engine of growth—doesn't take into account the real ownership structure of Chinese company. Furthermore, he argues, much of the growth in China's economic centers, especially Shanghai, is a facade. 

The stories told in the Western media about the successful Chinese entrepreneurs creating world-class companies by competing with SOE's are in fact just that, stories. Huang says that the way private ownership laws, finance, and the industrial landscape of China are currently set up makes entrepreneurship nearly impossible. Dig a little deeper beneath the surface of the seeming miracle growth of Shanghai, there are some shocking realities. According to Huang's research, asset investment by the private sector peaked in 1985, and has drifted lower or stayed stagnant ever since. Indigenous private sector business in Shanghai are some of the smallest in the country, comparable to some poor, western provinces. New patents have also dwindled in Shanghai, especially compared to other parts of the country, and even the quality of those patents is highly questionable. In spite of all the unclear laws and shifting regulations, Shanghai's GDP is one of the largest in East Asia. Where has this growth come from?

According to Huang, the true catalyst of Shanghai's growth—and of business in China as a whole—lies just off China's southeast coast—Hong Kong. Hong Kong is the free market entrepot through which investment and innovation flow. China's laws are set up to discourage private, domestic entrepreneurs from succeeding. However, foreign investment is regulated by a much looser set of laws, in order to spur FDI. Chinese entrepreneurs are incentivized to set up their corporate headquarters in the tax and regulation haven of Hong Kong, and merely outsource business to Shanghai. Huang goes through examples of China's most successful private companies. All of them, he says, can trace their corporate leadership to Hong Kong or Taiwan.

Although this foreign loophole has been an effective go-around of the state-run system, it is dubious how long it can work for. Eventually there will have to be reform or China will run into stunted growth due to lack of domestic entrepreneurship. With the once-in-a-decade leadership change happening now in Beijing, the CCP is trying to institute reform of the state-run, protectionist system from the top-down. Whether they'll be able to challenge the status quo internally is a looming question for the new government. Eventually, China's institution's will have to become dynamic if they want their economy to be so. When and how they will hit that ceiling, however, is hard to foresee.