Financial Times, 13 August, 2014, by Joe Zhang,

    Warren Buffett would have picked the lucrative markets the government has chosen

In the past year and a half, China has arrested thousands of public officials, to much applause at home and abroad. The highest-profile cases concern high-ranking Communist party officials such as Zhou Yongkang, the former security chief. But when business executives have been the target, the anti-corruption campaign takes on a more insidious tinge. While private-sector wrongdoing has been energetically exposed, investigators often prefer to let sleeping dogs lie when state-backed businesses are involved.

Widespread corruption is usually blamed on the cronies of officials rather than the flawed governance that opens up the opportunity for the crime. These people, not themselves on the government payroll, have stolen huge sums from the state with the connivance of its employees. This serves only to reinforce the stereotype, a commonplace in China, that all merchants are crooks.  There is no doubt that some private business people have committed serious crimes. But that is not the end of the story. A deeper malaise is at work.

In the two and a half decades after Deng Xiaoping became Communist party’s de facto chief in 1978, much of the state sector was privatised. That trend has been almost totally reversed in the past decade. Each year since 2005, for example, state-controlled oil and financial institutions (mainly the banks) have accounted for between three-fifths and four-fifths of all the profits made by companies listed on the Chinese stock market. Government tax revenue has increased from about 12 per cent of gross domestic product 1996 to 23 per cent in 2013, reversing steep earlier declines.

Even Xu Shanda, a retired vice-minister at the tax bureau, argued: “China’s government revenue as a percentage of GDP, at 44 per cent in the first half of 2014, was too high.” This figure is based on a wider definition that includes state fund incomes, social security proceeds and capital gains from state enterprises, as well as tax revenue. It has risen sharply, from 31 per cent three years ago, according to Mr Xu.

Many state-controlled businesses are quoted in the stock markets, leaving the government with a residual stake as small as 30 per cent or 40 per cent. But there is no doubt who is boss or where the companies’ allegiance lies. Most young Chinese people entering the labour market choose to work for the state-owned enterprises. The queues at recruitment events are long and depressing.

What is wrong with China’s private sector? Most privately held businesses are still too small, too inexperienced and too fragile to succeed. Many are opportunistic concerns that trade for a few months or years and then shut down. They must contend with public hostility and a legal system that offers scant assurance that they will be able to enforce their rights. Driven by greed as well as discrimination, many private business people are forced to find illegal shortcuts, even if this jeopardises the future of their business – or their lives.

There is still systematic discrimination against the private sector by the government and the public. City officials fear, for example, that awarding a public contract to a private concern over a state-owned competitor might damage their careers. The same happens at the lending banks, where executives who make bad loans face the sack – unless the borrower has political connections. When private-sector businesses go bust, they do not go quietly. Hapless entrepreneurs are showered with opprobrium on social media and in state-owned outlets – a reputational hazard which the public sector is immune.

Companies owned by the state dominate every market where there are profits to be made: from telecoms to tobacco, from insurance to infrastructure. The state has liberalised some sectors – retail, services, agriculture and low-end manufacturing – but these are fiercely competitive sectors with tight margins. If Warren Buffett had been allowed to invest freely in China, the billionaire American investor would have bought into the lucrative markets that the government has chosen.

What limited evidence there is suggests the financial performance of companies in the private sector is inferior even to those in the inefficient state sector. The picture is still worse when you take into account the thousands of private-sector companies that go bankrupt or close voluntarily each year. This hostility towards private enterprise has insidious effects.

Many investors perceive state-controlled companies as less risky propositions. That is understandable: during the past two decades, instances of fraud and operational risk have hurt private-sector businesses badly.

The inevitable consequence will be a bigger state sector. That may be what the Chinese public wants. But, if China is to stamp out corruption in business, it is not the place to start.  

 The writer is author of ‘Party Man, Company Man: Is China’s State Capitalism Doomed?’