The modern economic story of China is well known. In just over three decades, the country has experienced phenomenal economic growth and much improved standards of living by tearing at the seams of its formerly tightly planned economy.

The country has made substantial progress on two essential components of a market economy – letting the market determine prices, and introducing incentives to allow private ownership and wealth acquisition. It is now trying to tackle the third and most challenging component: that of creating the right macro-environment for property protection rights and contract enforcement.

Professor Tao Zhigang of the Faculty of Business and Economics said the country had started to address some of the macro-environment issues when it created Special Economic Zones, but the work had been complicated by two unique features of the Chinese economy.

“The first is the continuing dominance of state-owned enterprises [SOEs]. China has not gone for outright privatisation like Russia did, and that has important implications. The government is both the regulator, and the owner of these enterprises. So SOEs may lobby for cheaper credit or preferential treatment in government procurement, and even for discriminatory policies against private enterprises.

“The second feature is the significant role of the state versus the market in the economy. In China people tend to turn to the government to resolve contractual disputes, instead of using litigation through courts or private settlements. That tends to make personal connections with government officials more important. You need to cultivate relations with senior level officials who control resources and who can help you to resolve a dispute. These officials won’t do this for nothing. So bribery and corruption could become a by-product – a way for you to get business done. This is how I look at the phenomenon of corruption in China.”

Striking a balance

The central government is fully aware of the problem and is starting to take action, he said. When it created the Shanghai Free Trade Zone in 2013, it introduced a new reform that limits the discretionary power of the government through a ‘negative list’. Foreign investors cannot invest in sectors named in the list but are free to do so in sectors not listed. “That concept is very powerful. It is saying the discretional power of government officials is going to be kept to a certain minimum,” Professor Tao said. And at the recent Fourth Plenum of the 18th Party Congress, reforms were unveiled to promote the use of the law to resolve disputes, rather than the government.

But all of this does not mean SOEs are being phased out, he said.

“The Communist Party believes that while private enterprises give you growth, SOEs help maintain social stability because they do things privately-owned enterprises don’t do, such as hiring a lot of people in a downturn. You need a balance of the two. If too much of the economy is state-owned, growth slows down. If too much is privately-owned, you have growth but no stability.”

Local government officials are part of that mix, too. In the early days they were given incentives to kick-start economic growth, such as permission to keep some of the revenues they generated and to build large government buildings and guesthouses. The recent crackdown on government corruption adversely affects the incentives for local government officials. However, these incentives are no longer needed if the private sector has taken off and become the dominant part of the economy.

Macro-environment for private sector growth

President Xi has announced that 80 to 90 per cent of the economy will be privately-owned within the next decade. Currently, SOEs account for about 30 per cent of output and 40 per cent of employment.

“The central government wants to be a helping hand, not a grabbing hand. It wants to see local economies grow and it will continue to look at local economic growth when it is promoting local officials. Those officials have to maintain the quality of their macro-environment and not just take money away from enterprises. If they are expropriation-oriented and they violate property rights, their economic growth won’t be spectacular.

“The Party’s loosening of its control of the economy, both at the central and local government levels, also has an impact on the allocation of talent. Young people don’t want to work in government when there are crackdowns on corruption, and the salaries of CEOs in state-owned enterprises are being capped. The signal President Xi is sending is very clear: the state sector will sink and the private sector will grow.”■