Asia Times: China's private dilemma


	April 20, 2002	atimes.com

China

China's private dilemma
By Francesco Sisci

BEIJING - The economic reforms of Deng Xiaoping inspired a boom in private enterprise in China. In fact, the reforms were designed to bring the vitality of private enterprise to the service of China's development. However, private companies remained on a second tier until the last Communist Party Congress in 1997 when the wording of the constitution was modified, and the private sector was no longer just a "complement to the state-owned economy" but ascended a position of being "an important constituting part" of the socialist market economy.

Yet now, on the eve of a new Party Congress, that constitutional amendment has yet to be transformed into a law, or a set of laws, fully guaranteeing the rights of private enterprise in China that many see as crucial for the healthy development of the national economy.

Debate on a private-enterprise law has been fierce over the years. Opponents of such a law claim that in some cases private capital was acquired through shady deals, and that a law securing private property would in effect cement and legalize these deals, hampering possible future confiscation or reprisals by the state. This is a very political concern, as the government wants to keep a leash on private entrepreneurs.

However, the insecurity of private entrepreneurs also forces them to side with corrupt officials who, in return for favors and bribes, protect the "rights" of private business. This creates a very unhealthy economic environment: entrepreneurs are without rights and are at the mercy of officials who can do whatever they want to small and medium enterprises. Almost any official has the power to temporarily close down any business on the basis of almost any kind of suspicion, tax evasion or anything. Such a temporary closure deals a heavy, sometime fatal blow to the company. As a result, enterpreneurs are put into the position of having to corrupt officials to stay out of a possible investigation that can stop their businesses.

So Beijing, by leaving open the possibility of solving in the future a past crime, creates an environment in which crimes must be committed every day, and where corruption thrives. The danger is that minor crimes such as tax evasion and minor corruption can lead to a larger system of illegality in which more serious offenses are committed and organized crime can thrive. Unprotected by the state and dependent on corrupt officials to keep them in business, private entrepreneurs naturally turn a blind eye to, if not openly siding with, bona fide criminals. This opens the door to protection rackets that strengthen criminal organizations and finance expansion of their activities.

Opponents of a private-property law argue also that statistics show a discrepancy between the relative tax payments of the state and private sectors. Tax payments from the private sector, which produces a larger chunk of the gross domestic product (GDP), are disproportionately smaller than those from the state sector. This is due to tax evasion, which is a common practice among private enterprises. If private property is legalized, critics argue, the tax bureaus will have to clamp down on the private sector, which will result in difficulties for its development with ensuing negative effects for the Chinese economy. But legalization and tax exaction do not necessarily go hand in hand.

China's leaders, as good Marxists, know that "primitive accumulation" is not a clean process. History is full of examples; in the United States there were the notorious robber barons and in England pirates gained knighthood. The passage from one economic system to another is no smooth process and China's experience is no exception. But the real point is not to prosecute possible past misdeeds but to prevent future wrongs and the expansion of organized crime and corruption.

On the tax issue first. An estimated 37 percent of China's GDP stems from the state sector, compared with 33 percent from the private sector. The rest is from the non-state sector, which often disguises de facto private enterprises that find it convenient for many practical reasons not to register as private companies. According to statistics, by 2000 China had 1.76 million registered private enterprises with a total registered capital of 1.33 trillion yuan (US$160.7 billion). But in that year private businesses paid only 54 billion yuan in direct taxes while vastly contributing to the treasury through the payment of all kinds of indirect taxation.

On the other hand the state sector, while contributing to about a third of GDP, is the recipient of some 60 percent of the total of all outstanding loans, thus collective and private enterprises are left out in the cold. For many reasons, banks are unwilling to lend to the private sector. Therefore, tax evasion becomes an instrument for private enterprises to finance themselves and expand.

This system is not unlike the experience of Italy, where small and medium enterprises make up 90 percent of GDP but do not enjoy the same support from the financial system large corporations do. For decades, smaller Italian enterprises managed to finance themselves through tax evasion, with the tacit approval of the government.

Basically, the state needs tax income to finance three main functions: infrastructure, social welfare and the military. The infrastructure has been largely financed in past years through bonds issues. Cities such as Wenzhou have successfully applied the experience of Hong Kong in involving private capital in the development of local infrastructures; the same example could be used nationwide.

On the issue of social welfare, it is very important for the Chinese government to ensure that the growing number of unemployed from the countryside and the failing state sector are absorbed. The best way to suck up unemployment is to create new businesses, which are mostly small private enterprises. These entities receive no financial support from the banks or the state and can survive only through tax evasion. The government winks at this as it helps to solve unemployment without spending a penny. Indeed, during the recent National People's Congress there were calls from delegates to give full play to the role of the private sector in creating jobs.

As for the Chinese military, top officials forecast a peaceful environment for China in the next decades and, despite a larger injection of money into the People's Liberation Army coffers, demands from the military are unlikely to tilt the balance of the state budget. Therefore there is no need for a larger money transfusion into the army taken from the tax pool.

The legalization of private property, even without greater fiscal pressure, is in fact likely to boost tax returns, as more of their business will be brought to the open, they would expand, and thus returns from value-added tax or other indirect taxes would grow.

Of course, from the administration's point of view, the issue of private property is also an issue of control. Not legalizing private property allows the government to check on everybody's accounts and use past economic misbehaviors as a form of political pressure on those entrepreneurs who might want to gain political representation. In reality, however, by not legalizing private property the government helps criminal organizations to find accomplices. President Jiang Zemin proposed a way out of this conundrum when he said entrepreneurs should be allowed to join the Communist Party. Entrepreneurs could have their business legalized and could represent their needs within the party.

There is also an issue of social inequality. Ordinary people may resent the flaunting of money by new businessmen, but they resent even more corruption and oppression from criminal gangs.

If action in this direction is not taken, the government will end up pumping in the water in which the fish of criminal organizations can swim more freely. The goal of the government should be to dry up the water in order to have the fish exposed. This can be done by legalizing as much as possible of the economy, and this can happen only if private property is legalized. Otherwise, even greater pieces of the economy will go from gray to black, and even if the government might thinks it is hanging on to the tools it needs to control everybody, in fact it will lose control of large parts of the state.

The government has to concentrate on the fight against grossly illegal behavior, such as trafficking of drugs and protection rackets, and find alliances in the civil society for this fight. If it doesn't, it faces the risk of being overwhelmed, not by private entrepreneurs, but by Mafia bosses.

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