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The Growing Role of Private Sector

3.1 Concept of the Private Sector

What is the definition of private enterprises in the PRC? It seems first that there is no clear definition, and second that it is fairly complex. There are many concepts relating to "private," including individual business, private enterprise, private sector, private economy (Ming ying jing ji) and the privately operated economy. However, it seems that none of these concepts have a clear definition, and there has been a heated debate among economists on what comprises "private enterprises." (See Appendix 1.)

Some experts see private enterprises as equivalent to either the private sector or the private economy. Some experts classify enterprises into state-owned and private enterprises, using ownership as a criteria. Some with a broader perspective insist that foreign-invested enterprises and non-public shareholding companies not controlled by the government should be included within the private sector. However, many Chinese private enterprises have mixed ownership, making it difficult to determine to whom they belong. For example, a foreign-funded company may be a joint venture, with 25% ownership by foreign companies and 75% ownership by Chinese private companies. Though Chinese hold the largest share in such enterprises, in accordance with the enterprise registration regulations, the status of these companies is foreign funded rather than private. In our study, the private sector mainly represents individual and private enterprise as stipulated in the Provisional Act on Private Enterprises. In some cases, due to limited data, the concepts of non-state owned sector or non-public sector are used.

The concept of private enterprise is very narrowly defined in the official document According to the "Provisional Act on Private Enterprises of the PRC", and taking effect on July 1, 1988, a private enterprise is defined as a profit-making unit invested in and established by natural persons or controlled by natural persons using employed labor. This definition includes private limited liability corporations, private shareholding corporations, private partnership enterprises and sole private-funded enterprise registered in accordance with the corporation law, partnership enterprise law and interim regulation on enterprises. Private enterprises are firms whose assets belong to individuals and that employ more than eight workers. At one time (see Chapter 1), individual enterprises were not allowed to employ more than seven workers. Therefore only profit-making units employing more than eight workers are officially called private enterprises. In PRC official statistics, only domestic Chinese enterprises are included in "private enterprise," and individual business, foreign-invested enterprise and collective enterprise are excluded from this category. However apart from the difference of the number of the employees, there is no significant difference between private enterprise and individual enterprise in the aspect of private ownership. Accordingly when discussing private sector development, at least individual enterprise should also be included.

The "private sector" seems to be a broader concept, but it is also not clearly defined. The "private economy" is a concept based on economic components. In accordance with the classification of economic components issued by the National Statistical Bureau, it is defined as the portion of the economy that belongs to individuals. In addition to individual and private enterprises, many foreign funded enterprises and shareholding enterprises also contain private economic components. However, most official statistics are not based on this economic component classification, but rather on the classification of the registered status.

There is some evidence that private sector development may be undervalued. Some private enterprise, in order to receive preferential tax treatment, may be registered as foreign funded enterprise. Some, in order to obtain support from local governments and avoid political shocks, may be registered as collective enterprises. These nominally private enterprises are usually called "false collectives" or "red hats" (hong maozi). Considering these factors, the number of private enterprises is likely much larger than official statistics show. Since 1995, the private sector in the PRC has been growing at a surprising pace. Private enterprises have grown not only through their own efforts but also through restructuring and mergers of SOEs and collective enterprises. Since the registered status of these restructured enterprises may not be changed immediately after the restructuring, official statistics based on registered status may underestimate the real development of the private sector.

3.2 Rapid Growth of the Number of Private Enterprise

Since 1978, along with the rise of its political position, the private sector has played an increasingly important role and contributed to employment, tax revenue, economic growth and the cultivation of the market system. The number of private enterprises increased from 90,000 in 1989 to 3 million in 2003, an increase of more than 30 times. The number of individual business during the same period almost doubled from 12.47 million to 23.53 million. The number of foreign funded enterprises rose from about 16,000 in 1989 to 226,000 in 2003, an increase of nearly 14 times. In comparison with the rapid increase in the number of these enterprises, the number of SOEs and collective enterprises fell from 1.55 million in 1992 to 1.05 million in 2003 and from 4.16 million to 1.63 million, respectively. In recent years, the number of all types of enterprises except private enterprise has been declining. (Table 3.1 [PDF 63KB | 1 page] and 3.2 [PDF 97KB | 1 page])

It should be noted that Deng Xiaoping’s famous South China tour of 1992 led to high investment, and the number of private enterprises and registered capital registered a sharp increase in 1994 and 1995. However, this resulted in high inflation, and after 1994 the central government adopted tight monetary and fiscal policy in order to curb excessive investment and economic overheating. As a result, investment growth slowed. Because of this, growth in the number of private enterprises slowed somewhat, although it still continued to be high relative to those of SOEs and collective firms. (Chart 3.1 [PDF 109KB | 1 page] and 3.2 [PDF 188KB | 1 page])

Seel also Table 3.3 [PDF 174KB | 1 page] and Chart 3.3 [PDF 209KB | 1 page]

3.3 Contribution of Private Enterprises to Employment

The reform of SOEs has been accompanied by increasing unemployment. This has brought with it social and economic instability. In the face of this problem, the government must find a way to address the unemployment issue. In fact, the private sector has become an important substitute for SOEs and has made a great contribution to solving the problems of unemployment and layoffs.

According to recent PRC statistics, in 2003 the number of employees working for SOEs was 68.8 million, a sharp decline compared with 112.6 million in 1995. By contrast, workers in individual and private enterprises in 2003 reached 89.5 million, exceeding SOE employees by about 20 million, and registering a big increase over 55.7 million in 1995.

Looking at the breakdown, the number of employees of individual business rose steeply from just 2.3 million in 1981 to 46.5 million in 2003, an increase of about 20 times. The number of employees rose even faster in private enterprises than in individual business, from 1.6 million in 1989 to 43 million in 2003, meaning an increase of 27 times within only 14 years. Foreign funded enterprises also employ many workers, even though their share of total employees is still lower than individual and private enterprises (Table 3.4 [PDF 81KB | 1 page]) Employees in private enterprises now make up 19.2% of total national employees. (Table 3.56 [PDF 983KB | 1 page])

Though private enterprises have played a very important role in alleviating unemployment pressure, they have not been able to completely solve the unemployment problem. While in some provinces where the private sector plays a vital role in the economy, private enterprises have recruited more than the number of workers laid off by SOEs (for example, in Jiangsu Province 127,000 employees were laid off by SOEs, but private enterprises absorbed 503,000 workers, reducing the unemployment ratio by 0.1% in 2003, according to China Economic News April 26, 2004 [7]). SOEs usually employ more workers than private enterprises due to their strong motivation to expand production scale, on one hand, and their inefficient use of labor on the other. In the industrial sector for example, from 1996 to 2000, the number of workers in SOEs has fallen from 42.8 million to 20.9 million, and workers in collective-owned enterprises have decreased from 14.3 million to 5.6 million. However, workers in other enterprises increased from just 7.4 million to 14.4 million. It is obvious that the development of the non-public industrial sector has not been sufficient to offset the decline in the employment in the public sector. To absorb all the laid off workers from SOEs, more policy efforts will be necessary, and there is still a long way to go. (Table 3.6)[PDF 84KB | 1 page]

3.4 The Growing Share of Private Enterprises in Output and Investment

In 1991, SOEs held a 68% and 66% share of industrial output and investment in fixed assets, respectively. With the development of the private sector, including foreign-invested enterprise, these shares fell to 41% and 43% in 2002. (Table 3.7) [PDF 81KB | 1 page]

Taking into account that these are designated enterprises, which are relatively large and mostly private, and that other non-SOEs are excluded from the statistics, the output ratio and investment ratio of SOEs would likely have been smaller if these non-designated enterprises had been included. The size of each private enterprise is still relatively small, and we do not yet see a tendency for them to grow. It seems that the increase in employees in the private sector in the 1990s was primarily driven by an increase in the number of enterprise and not by an increase in the number of employees per enterprise. (17.3 employees per enterprise in 1990 versus 14.3 in 2003 from Table 3.1 [PDF 63KB | 1 page] and Table 3.4 [PDF 81KB | 1 page]) It can be concluded that the private sector in the PRC is not yet mature and may be sensitive to outside shocks, but at the same time its growing share in terms of industrial output and investment seems to indicate that it possesses strong energy and flexibility.

3.5 Regional Distribution

The regional distribution of private enterprise is severely unbalanced. They are generally concentrated in the coastal area, and in particular in the five biggest coastal provinces of Guangdong, Shandong, Shanghai, Jiangsu and Zhejiang, all relatively developed areas. These five largest provinces account for 60.7% and 47% of total private income and private capital in the country. The eastern coastal area as a whole accounts for more than 70 % of total private income and capital. (Table 3.8 [PDF 94KB | 1 page]) The background for this seems to be first that in the coastal areas, innovative entrepreneurship has developed along with economic reform and the open policy. Second, these are advanced agricultural areas with agro-industry developed originally in the form of township village enterprise, which were transformed into private enterprise later. Third, thanks to the high economic growth, huge consumer markets have emerged in these areas.

There are two famous models of private sector development in the provinces, namely the "Guangdong Model" and the "Wenzhou Model". The characteristics of the "Guangdong model" are that private enterprises were developed as equipment suppliers for foreign-invested enterprises, and are trying to reduce costs as much as much as possible. The most common industries are electric appliances, IT-related high-tech equipment and automobiles. Jiangsu province is characterized by the development of the agro industry, while Zhejiang province is famous for its spirit of entrepreneurship, which gave birth to the "Wenzhou model." Wenzhou consists of about 30 industrial clusters (kuai zhuang jingji), with each including several hundred private enterprises. Most enterprises are in light industries. Private enterprises in Wenzhou are quite close to Western-style enterprisse. It should also to be noted that both provinces are in the backyard of Shanghai.

Box 2: The case of Zhejiang Province

The China Statistical Information Network (CSIN), released by the China National Statistical Bureau in April 7, 2004. provides some interesting hints about why private enterprises developed rapidly in Zhejiang Province in comparison to other provinces. According to this report, the industrial output of private enterprise in Zhejiang Province in 2002 was 366.7 billion RMB or 47.1% of total provincial output, a much higher figure than in other provinces, such as Jiangsu with 65.8 billion (18.8%), Shandong with 59.8 billion (18%), and Shanghai with 318.1 billion (38.1%). Although the share of the non-state sector in Guangdong Province in 2002 was 54.3%, slightly higher than in Zhejiang, the non-state sector in Guangdong includes foreign invested companies, and investment in Hong Kong, China and Macau. If this factor is taken into account, even the private sector in Guangdong may be smaller than that of Zhejiang. In Zhejiang, the number of private enterprise grew very rapidly. In 2003, 71,434 private enterprises were newly registered, meaning that on average about 230 private enterprises completed registrations every day. As of the end of 2003, there are a total of 1.89 million private enterprises, exceeding the number in Guangdong and registering the second largest figure nationwide.

It seems that there are several reasons why private enterprises have developed so rapidly in Zhejiang. These factors primarily relate to the innovative market environment and its development model

Innovative market environment: Zhejiang is located on the seacoast front line, and before the economic reform started, it was considered to be a very important strategic place from the standpoint of national security. Accordingly, SOEs in key heavy industries were not located in this region, and national investment here was alsorelatively small compared to other regions. Some places such as Wenzhou were called "kongbai xian" (empty counties) of SOEs. In addition, the province has only scarce natural resources. As a result the region's economy lagged, and the people’s standard of living remained low. However, it can be said that the very these circumstances put pressure on the people of Zhejiang and nurtured their innovative "capitalistic" spirit and culture.

Generous policy of the government: It is pointed out that during the early stage of economic reform, the local government, taking account of the difficult situation of this region, took a very flexible and generous policy, which accelerated private sector development. The CSIN report introduces one interesting anecdote. In the 1980s, 85% of Wenzhou's total fiscal revenue came from private enterprises. During the 1980s, the committee of Zhejiang province reshuffled the leaders of Wenzhou three times, and every new leader, after taking the position, tried to develop SOEs and collective firms in order to meet the requirements of the upper bureaucracy. However, they all quickly realized that private enterprises would need to play a vital role in the Wenzhou economy and started to support them, respect their spirit of innovation, and build economic democracy.

Demand-supply situation: At the early stage of private enterprise development in Zhejiang, from the macro economic point of view, aggregate demand exceeded aggregate supply, and all commodities were immediately sold out after being produced. In this sense, the risks of going to the market to compete with others were not very high for private enterprises, and an increasing number actively produced commodities and sold them on the market. Consequently the private sector developed very rapidly.

Concentration on light industries: In 2002, the output of private enterprises accounted for almost 100% of total industrial output in Zhejiang; among this the shares of textile and fabrics, machineries, electric equipments and metals were about 30%, 7.7%, 7.3% and 6.1%, respectively. The success of these industries primarily relied on the following factors. First, they do not necessarily require high technology, and it is easy for newly developed private enterprises to go to the market (in other words, barriers to entry are low). Secondly, high quality labor is also not necessarily required; it is good enough to simply absorb excessive labor force. Thirdly, private enterprises normally face serious difficulties with financial resources, and can only rely on their own funds or friends. However, starting up such light industries does not require a tremendous amount of money and the cash flow turnover is relatively fast. Fourth, since the rate of return in these industries is not very high, local governments tend to neglect these industries, and do not protect them, As a result, it is very easy for private enterprise to go to the market and make profits. Last, the size of these industries is small and most of their commodities are daily consumption goods, so that they are not much affected by various policies of the government.

Cluster development model: The size of private enterprise in Zhejiang is usually very small, but it is common for many small enterprises to work together, producing similar or complementary goods, and thus to develop one big economic zone ("kuai zhuang jinji" or cluster economy). Thanks to the division of labor in the cluster, economic efficiency is enhanced and sound market competition is enhanced. That is the so called "small dog economy." The CSIN report discusses one case, of the motorcycle industry in Taizhou. There are more than 1,000 enterprises producing motorcycle equipment. They are all very small enterprises but they have achieved a division of labor and work as if they were one big manufacturing enterprise.

Sector-wise, although there are no detailed statistics, it is widely reported that industrial manufacturing for a wide range of wholesale and retailing businesses accounts for almost 80%, and that in particular most retailing businesses, such as small shops and restaurants, are managed under private ownership. In fact, it is quite impressive that unlike many socialist countries in the past, the quality of service provided by retailers is relatively high in the PRC. It should also be noted that in recent years, many high-tech knowledge-intensive enterprises in areas such as information, communication and technology (ICT), or joint ventures between industry and universities, have emerged. It is widely expected that the private sector will further develop, particularly in those new areas. One example is a venture company set up by a professor of the People’s University of China to provide innovative financial service information.

In the case of the Beijing Municipality area, it is reported that the development of non-public sector has promoted the optimization and upgrading of the industrial structure. With the development of the non-public sector, the share of primary and secondary industries declined from 5.2% and 42.3% in 1996 to 3% and 34.8% in 2002 respectively, while the share of tertiary industry increased from 52.6% to 62.2% during the same period.

See Table 3.9 [PDF 94KB | 1 page]


3.6 Contribution of Individual and Private Enterprises to Tax

The development of the private sector creates a great deal of tax income for the government. Government tax income from individual and private enterprises has grown rapidly. From 1992 to 2002, the average growth rate of private and individual taxes was over 30%, and its contribution to the total national tax has reached over 10%. (Table 3.10 [PDF 94KB | 1 page]) In urban areas, the contribution of the private sector to the tax revenue must to be much more significant. In Beijing Municipality, for example, the non-public sector contributed more than 65% of total tax revenues in 2002 (China Economic News April 19, 2004 [7]).

It appears from official statistics that the tax contributions of the private sector to total national tax are still not very high. However, if we take account of the fact that there are many private enterprises that are registered as collective enterprises (false collective enterprises or "Jia Ji Ti" in Chinese), the contribution of individual and private enterprises may be severely undervalued.

The views expressed in this book are the views of the authors and do not necessarily reflect the views or policies of the Asian Development Bank Institute nor the Asian Development Bank. Names of countries or economies mentioned are chosen by the authors, in the exercise of his/her/their academic freedom, and the Institute is in no way responsible for such usage.

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