China's private sector still in the shadow of the state
In an essay published eight years ago (Financial Times;October 5, 2005), I said that China's private sector was in theshadow of the state.
I can make the same argument today with one significantdifference: the state sector's dominance in China has grownconsiderably in the last eight years.
The last decade has almost completely undone the reforms of thetwo previous decades.
The consensus in the West is that China's state sector iscorrupt, inefficient and ideologically inferior, so it must belosing ground against private enterprise which is steadily chippingaway at the communist, state-backed old guard.
That is just not the case.
Nicholas Lardy, in a recent Bloomberg Brief piece,compared the financial performance of China's state sector with theprivate sector. Citing the National Statistics Bureau, his numberswere predictable: last year, the state sector return on assets(ROA) was merely 4.6 per cent and well below the private sector's12.4 per cent.
I think those numbers are biased and wrong.
The biggest components of the state sector are the banks, whichaccount for almost half of the domestic stock market valuation, andabout half of the total net profit of all the listed companies.Other big components in the stock market, or in the unlisteduniverse for that matter, are state-controlled big insurancecompanies, big oil corporations and telecommunicationsoperators.
Chinese banks have an average return on equity (ROE) of about 20per cent – twice the level of their global peers. Insurancecompanies do well in general, and telecoms operators enjoyexorbitant privileges. How can the state sector underperform theprivate sector in financial terms?
Of course, you can argue that the banks' profits are entirelydue to the government's control of interest rates. That is a trueand fair assessment, but the fact remains that the state sector hasa much higher ROE than the private sector.
Lardy's use of ROA is meaningless because banks by definitionare highly-geared business and their ROAs are low in nature (around2-3 per cent). The nature of the banking business is such that youcannot usefully compare bank ROA with other sectors. ROE is theappropriate benchmark.
The other problem with Lardy's comparison is that tens ofthousands of private sector companies go bankrupt, or voluntarilyclose each year. Once that happens, they exit from the statistics.So there is a 「survival basis」. But you do not hear any state-ownedenterprise being shut down.
The playing field is unfair and aligned against the privatesector.
Moreover, there are many hybrid joint venture companies in Chinathat blur the distinctions between the two sectors.
Finally, the state sector takes on many social functions, andtheir existence and activities provide a positive spillover effectfor the whole economy and society.
While liberal commentators may disagree with this, the statesector is designed to achieve more than just financial ratios.
Utilities, (power, water, natural gas and public transportation)for example, where the state sector dominates, are not charged atfull price because of affordability and other social reasons. Thatdrags down their financial returns, but the financial ratios do notreflect their efficiency.
It is wrong for liberal economists to say that the dominance ofthe state sector goes against the public's wishes.
In China, the public wants more, not less, involvement by thestate sector. The public wants a bigger state sector to tackle themany challenges China faces, even if many of these challenges areby-products of the state sector (inequality, overpopulation andpollution).
Even the recent third plenum does not mention the privatesector, a point Lardy acknowledges.
The official data shows that the government tax revenue as apercentage of gross domestic product almost doubled from 12 percent a decade ago to 22.3 per cent last year. This is almost awholesale reversal of the economic liberalisation of the previoustwo decades.
But Western economists do not mention this uncomfortablefact.
The state dominates strategically important sectors – essentialinfrastructure and sectors with pricing power – while the privatesector is left to fight it out in fiercely competitive sectors suchas low-end manufacturing, retail, service industries and (some)real estate.
The writing is on the wall: the score of the past decade's matchof the private sector versus the state sector in China is 「privatesector - zero」 and 「state sector - one」.
Joe Zhang is a corporate adviser based in Hong Kong, and theauthor of Inside China's Shadow Banking: The Next SubprimeCrisis?