China's growth masks weaknesses
By Yasheng Huang
Published: April 23 2004 5:00 | Last Updated: April 23 2004 5:00
The rise of local Chinese companies such as Huawei, Haier and Legend has inspired awe, and even fear. They are indeed impressive entrepreneurial businesses that can hold their own against some of the best multinational companies. But a far more sobering fact is that, even after two decades of impressive growth, China has produced so few of these home-grown corporate giants.
In 2002, Forbes' list of dynamic small companies included 13 from India compared with only four from China - and those four have their headquarters in Hong Kong. Some state-owned enterprises (SOEs) do better but that is only because they have a monopoly on China's most valuable resources. China's stock markets have underperformed in the past 10 years compared with those in the US, Hong Kong and India.
This underscores the fact that over the past 25 years there has been a macroeconomic miracle in China but no microeconomic miracle to match it. For example, Chinese companies should excel in the cement industry on the back of the country's construction boom and the prohibitively high transport costs of imports. But Anhui Conch, the largest cement group in China, generated sales of $680m in 2003, compared with $7bn by Cemex, the largest one in Mexico, a country that is not having a similar boom.
The paucity of home-grown corporate giants is remarkable given the propitious conditions for such companies. The country has a vast pool of savings, a rich tradition of entrepreneurship, and a high-quality labour force. It also has a potentially large internal market.
The root cause of China's corporate woes is the inefficient economic system that allocates vast financial resources, market opportunities, and legal protection to the SOEs - the worst kind of domestic business - at the expense of private enterprises. The SOEs, although resource-rich, are not competitive because they are burdened with internal inefficiencies, including poor operating incentives and interference from political interests. Private concerns, although efficient, cannot grow because of the constraint on resources.
In 2000, China was ranked fourth from the bottom out of 81 countries in a World Bank survey looking at financing constraints facing private companies. Below China came Moldova, Ukraine and Kyrgyzstan - hardly a dynamic trio.
Outside observers often fail to appreciate the depth of China's economic inefficiencies. Some economists, Joseph Stiglitz for example, may be impressed by the high number of new non-state companies entering the economy. But they miss a fundamental fact: while bad economic institutions do not deter the entry of new businesses, they do stunt their growth. This is the story of China, a sizeable economy populated by individually small enterprises.
A look at the rise of the few home-grown giants reveals why there are so few of them. They all depended on political patrons that offered entrepreneurial sanctuary. Huawei, the telecommunications group, is protected by the army and Legend, the computer maker, thrived early on under the Academy of Sciences.
The system has created a sprinkling of corporate successes, but it has forced entrepreneurs to compete on their political connections, not their business acumen. For each success story, there is a handful of failures by equally talented entrepreneurs who lacked political protection.
However, even the survivors have had to overcome huge regulatory barriers. After Legend was founded in 1984, for instance, the Ministry of Electronics refused to issue a production licence, so the group set up an operation in Hong Kong.
The central government has consistently bet on the wrong horses. It supported the traditional SOEs which, despite their entrenched positions, early market leadership and abundant resources, have performed poorly. The resources that could have been used to finance efficient businesses have been wasted on the state-owned enterprises.
People often wonder how China builds strong brands. The more relevant question is how it has managed to destroy so many. The starkest illustration of how SOEs can damage value is the disappearance of valuable brands and businesses in areas that Chinese entrepreneurs had excelled in for centuries. Last August, Wangmazi Scissors in Beijing was declared bankrupt. This company, with only $1.2m in assets, would not attract much attention except for its 350-year-old brand. It survived wars and other calamities, but not state ownership. There are similar tales in other traditional fields, such as herbal medicine and silk weaving.
Sooner or later, China's micro-economic fragility - which has led to low efficiency and huge non-performing bank loans - will dent its growth. Massive investment booms have fuelled economic growth but the booms are not sustainable in the long term. China's leaders recognise this. Now they need to encourage privatisation and support deserving private enterprises in order to realise balanced and sustained growth.
The writer is an associate professor at MIT's Sloan School of Management and author of Selling |
