February 6, 2015, by editor
The Second Surge of Private Business in China
Written by Xiaohong He.
The re-emergence at the grass-root level of entrepreneurial development in villages and towns across China has been the driving force for the state’s economic miracle. As of March 2013, there are over 13 million domestic firms in China, 11 million of which were private business, amounting to 80% of total economic output. Alongside these numbers are over 40 million individual household businesses (getihu) and 700 thousand farmers’ co-operatives.
Contrary to popular opinion, the majority of small and medium size businesses (SMEs) in China are private-owned and contribute to 50% of Beijing’s tax revenue, 60% of GDP, 68% of exports, 80% of employment, 65% of patents, 75+% of technological innovations, and 80+% of new product development.
Given this impressive contribution, there are both opportunities and yet also challenges. The two major challenges are the regional development gap and lack of financing for private businesses. When we compare 14 provinces/cities on China’s eastern seaboard with 17 provinces/cities within China’s interior, the differences are notable. In the Eastern region there are 205,000 SMEs generating RMB 31 trillion in revenue. However in the Western region there exist only 42,400 SMEs, that by contrast produce for Beijing only RMB 18 trillion in revenue, as of 2012.
For the past 30 years, the majority of these start-ups, especially at village and town level, obtained their financing through an underground banking system with extremely high interest rates. The financing cost is twice that for larger business firms thus inhibited the growth of SMEs in China. However, the large scale of contribution and entrepreneurial energy brought by this private sector has attracted a lot of attention from government policy makers. Given its increased economic importance, this private sector is too big to ignore and there exists enormous economic potential in the underdeveloped, western region of China.
China is at a crossroads. At the Third Plenum in 2013 President Xi’s administration produced a series of policies and plans as China’s economic reform deepens and initial development premium disappears. As noted by key economic observers of China, the lowest hanging fruits are now gone.
Internationally, China faces a declining global export market due to a deteriorating economic recovery in Eurozone and other developed economies since the 2008 financial crisis, and continued economic stagnation in Japan. Domestically, China’s developmental model of high exports, low domestic consumption and manufacturing has proved environmentally unsustainable. The government’s role in the economy has induced rent seeking and corruptions at all levels of governments. The result has contributed to greater income inequality and social instability. This can impact on the legitimacy of the Chinese Communist Party.
In this context, as part of Chinese government strategy to rejuvenate domestic economy and overhaul its development model, the government has implemented registration reform for start-up companies. The State Council has also come up with a series of policies in its memorandum to support micro-businesses.
China’s company registration reform includes following:
- Reduce entry barriers by eliminating registration capital limits, initial investment requirement and its verification process.
- Decentralize the procedure for a company’s headquarter residence requirement.
- Streamline start-ups registration process.
- Eliminate annual examination process at the local government office and move it to an online annual reporting system to reduce time, office trips, and to increase transparency.
The State Council’s micro-business supporting memorandum includes following:
- Make current SMEs funding pool accessible to microbusinesses, reduce tax burden of microbusinesses.
- Expand current funding pool for large and medium firms accessible to microbusinesses which are suppliers of these firms.
- Social security subsidies for these start-ups that hire disable and handicapped employees in the first three year of registration.
- Encourage to create seed-money funding pool at each level of the local government.
- Improve microbusinesses funding guarantee policy.
- Encourage big banks to increase their services to support microbusinesses and regional development.
- Establish medium or small size local community banks with private and community funds.
- Establish information data bank, microbusinesses registration list, and reporting system to promote information sharing and track credit records (this would be helpful for service support such as research, analysis, and monitoring.
- Build microbusiness service platform for education, training, marketing, industry standard consulting, accreditation, notarization etc.
All the above policies seem to serve the following purposes:
- Lower entry barriers for start-ups. In the past, this process is rigorous to enter but weak in mentoring and monitoring. The new policy aims to reverse this process, i.e. easy to enter and follow-up/monitoring closely afterwards.
- Bring firms back to the society and use market guided reward, incentives and punishment. The objectives are to involve the entire society to monitor firms’ social responsibilities; to shape public awareness and encourage public participation in corporate governance system; and to move away from a system that solely relies on government regulation and administrative means. Transparency is the entre piece to make this system work. By building firms information data base, information can be shared among governments, firms, and general public. It is supported by website for public disclosure, reporting and monitoring.
Government policy frequently lags behind the market. For China, once it comes, it can be very powerful and effective due to the one party system’s commanding line. In 2014, there were about 1.6 million new companies registered. This represents a 64% increase from 2013 according to Xinhua News Agency. This increase is not only a result of the recent micro-business friendly policy. There are other factors as well. One is the recent e-commerce boom in China. It opens up an untapped free virtual market, for instance 10 million Getihu businesses were created using the Alibaba platform. This allows many small start-ups to open e-business online cheaply and faster. Many of these online businesses are tax free either due to policy overlook of this virtual market or intentionally.
Secondly, it is due to a career shift as many government cadres quit their jobs and join entrepreneurial ventures. This is caused by recent and widely spread anti-corruption campaign and transformation of governmental role from managing/monitoring to service. Once secure and lucrative governmental jobs have turned out to be very risky and rent seeking opportunities are disappearing. This has led many former government employees to leave their positions and become entrepreneurs.
Thirdly, the weaker global economy and domestic economic structural transition, plus the lower employment opportunities in traditional industries have pushed these domestic graduates and return overseas graduates to become self-made bosses in emerging industries. As China expands from manufacturing to service oriented economy, it also has attracted many young entrepreneurs to innovate and to test their new business models, products, and services.
The next 10 years will be critical for China’s next stage of development, with 1.6 million new businesses being just be the tip of the iceberg. China may be at the dawn of a second private business boom not witnessed since the 1980s.