The following OECD assessment and recommendations summarise Chapter 2 of the Economic Survey of China 2005 published on 16 September 2005.
The private sector has become the basis of economic expansion.
Indeed, the changes in government polices have created a largely market-oriented economy in which the private sector plays a key role. Precise measurement of the size of the private sector is difficult, but a definition which considers as private all companies that are controlled neither by state nor collective shareholders suggests that the private sector was responsible for as much as 57% of the value-added produced by the non-farm business sector in 2003. Even amongst larger companies in the industrial sector, the private sector produced over half of value-added in 2003 and that share appears to have risen even further in the following two years. Overall, between 1998 and 2003, the progressive evolution in government policies allowed a fivefold rise in the output of domestically-owned private companies and a threefold rise in the output of non-mainland controlled companies; by contrast, the output of the state sector rose by just over 70% in this period.
The growth in private output has also been the result of the higher productivity of most companies in the sector. The sharper incentives facing the private sector companies have resulted in them using less capital and labour to produce output than state companies. Overall, the aggregate productivity of private companies in the industrial sector is estimated to be almost twice that of enterprises controlled directly by the state. The profitability of private companies has also risen considerably and, by 2003, they were earning a 15% rate of return on their physical assets. Such a high level of competitiveness has resulted in the private sector accounting for three-quarters of all exports in 2003. While the bulk of these exports are made by foreign-controlled companies, the domestically-owned private sector managed to quintuple its exports in the five years to 2003, as more small and medium sized enterprises were granted export licences. Overall, the growth in private sector ownership has had a very favourable impact on real incomes and macro-economic activity, boosting the level of multifactor productivity in the industrial sector by close to 10% in five years. With the decision in 2005 to allow private enterprises to establish businesses in many previously restricted areas, further improvement in multifactor productivity may be possible.
Prospects could be enhanced by further modernisation of the business framework,
The growing importance of the private sector in supporting the economy makes it all the more important to further modernise the legal framework for business. The government is preparing legislation in three important areas: bankruptcy law, company law and the implementation of the constitutional amendment on property rights. The second draft of the bankruptcy law has now passed the legislature and is generally acknowledged to follow international best practice. The law should clearly establish the precise claims that employees have on assets, limiting payments to wages owed to employees and leaving other costs, such as redundancy and resettlement expenses, to social funds. Secured creditors would be more likely to lend to private companies under such circumstances. A new company law is under consideration. A reduction in the barriers to the formation of both limited and joint stock companies should be a priority. The upper limits on the number of shareholders in a limited company should be abolished, while at the lower end companies with one shareholder should be allowed. For both sorts of companies the minimum capital requirements needed for incorporation should be lowered. Such changes would facilitate the expansion of privately-owned companies. The revised company law should aim to improve corporate governance, notably offering better protection to minority shareholders in both quoted and unquoted public companies and defining the role of corporate bodies such as the supervisory board and the duties of directors. In addition, the proposed anti-monopoly law should cover a much wider range of anti-competitive activities than do current laws. Finally, rapid introduction of the laws to implement the constitutional amendment on private property rights should be envisaged.
with better enforcement of laws in the economic sphere
Beyond the content of the law, though, there is a more substantial problem of giving force to economic laws. A relatively complete set of laws and regulations covering intellectual property rights is in force, having been updated in 2001. The focus of government policy in this area has now switched to the enforcement of these laws. Adequate protection of intellectual property is also of increasing importance to Chinese entrepreneurs. Weaknesses here may hold back the degree of innovation and product development of local companies. At present, in this and other areas, it can be very difficult to obtain judgements in court and even more difficult to obtain enforcement of the judgement. Such difficulties are not just felt by foreign enterprises. Chinese entrepreneurs feel that expansion across provincial borders is made difficult by the lack of objectivity of local judiciaries when it comes to trying cases involving the infringement of trade secrets, intellectual property rights and contract enforcement more generally. The solution would appear to require a series of steps. One might be to transfer some of the financing of courts to the central government; another would be increase the extent of specialisation of the courts (notably in the area of bankruptcy and intellectual property).
and a continued reduction in the number of loss-making state enterprises.
Reforms in the way that state-controlled firms are managed have improved performance but there remains significant scope for further improvement. In the industrial sector, the rate of return earned by state-controlled companies rose from 5% to 10% in the five years to 2003. Most of the increase in returns has, however, come from a minority of companies. Over 35% of all state-owned companies are not earning a positive rate of return and one in six has negative equity. For loss-making enterprises, the government has announced a four-year programme that will involve substantial additional restructuring. In some cases, asset sales may be possible in which case it is important to follow the regulations, issued in the spring of 2005, that ensure transparency in management buyouts. Within this framework, assets need to be valued on a forward-looking basis, supplementing valuations based on the acquisition cost of assets. Greater use could be made of the new property exchanges to ensure competitive prices are achieved for state assets. The government could also consider further sales of packages of distressed assets to companies with experience of restructuring, in order to supplement the efforts of the asset management companies. For quoted state-controlled companies, which earn returns on assets comparable with those of listed companies worldwide, the government has announced that there will be a progressive lifting of the non-transferability of state and local government owned shares, an initiative that could ease mergers and acquisitions.
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For further information please contact the China Desk at the OECD Economics Department at email@example.com. The OECD Secretariat's report was prepared by Richard Herd, Sean Dougherty and Margit Molnar, under the supervision of Silvana Malle. Consultancy support was provided by Charles Pigott, Ping He and Xin Zhang.