China's Private Firms Continue to Struggle: Part II
Private firms in China are continuing to grow at a slower pace than state-owned or state-controlled firms, in part because the Chinese government continues to favor state firms with access to credit, according to the latest economic data. Despite statements by President Xi Jinping and officials in the financial sector that the flow of credit to private firms would increase, little appears to have changed. Thus, the risk is that China's growth will itself slow further.
For nearly four decades after the start of economic reforms in China in 1978, the country's private firms were the dominant source of growth of output, employment, and exports. But starting about five years ago, President Xi Jinping has persistently sought to favor state companies at the expense of private firms. The resulting misallocation of credit, away from far more efficient private firms, has contributed significantly to the slower pace of China's growth in recent years.
In response to President Xi's admonition that state firms must be bigger, state banks reversed the earlier allocation of bank credit to favor state over private firms. Private firms were able to partially compensate for this shift by borrowing from nonbank financial institutions (shadow banks). But in 2017 the state became concerned about mounting debt and began a program of deleveraging that focused initially on reducing credit extended by shadow banks.
These developments restricted the viability of private firms. As shadow banks lost access to funding they had to call in their loans, pushing some listed private firms close to bankruptcy. Some firms that had pledged shares to secure their loans were forced to sell them to better financed firms, invariably state-owned companies. In the first three quarters of 2018, 26 listed private companies seeking to repay their loans sold so many shares to state companies, or to provincial-level units of the State Asset Supervision and Administration Commission, that the state became the dominant owner of previously private firms.
Second, after 2015 the formation of new private limited liability companies (LLCs) halted. Typically, an entrepreneur starts a business as a registered private company, most often a sole proprietorship or a partnership. But, if successful, entrepreneurs convert their businesses to LLCs in order to shield their personal wealth from creditors. These LLCs account for a little more than a tenth of the number of private companies in China but on average are larger and thus account for a larger share of output and profits.
Figure 1 shows that the number of privately controlled LLCs rose steadily through 2015. The increase in 2013 was especially large when the government eliminated the minimum capital required to form an LLC. In 2016 the creation of new private LLCs came to a standstill and in 2017 200,000 of these firms, 10 percent of the total, disappeared. The fate of these companies is not known. Some, unable to immediately repay loans to nonbank financial institutions, may have gone bankrupt. Others may have been taken over by better funded state firms. Perhaps in the majority of cases owners closed their businesses without going through a formal bankruptcy proceeding.
Finally, the squeezing out of private firms from access to credit slowed their growth relative to that of state firms. As reflected in figure 2, from 2005 through 2015 private firms on average grew twice as fast as state firms. This was not rapid growth from a small base. Private firms had outperformed state firms from almost the beginning of reform in the late 1970s, and by 2005, the first year shown in figure 2, the share of output of state industrial companies was only about one-third of the total, down from four-fifths in 1978.
After 2015, however, the pattern of relative growth changed dramatically. While the growth of private firms continued to moderate, the pace of expansion of output of state companies began to pick up, and on average in 2017–18 state industrial companies grew slightly more rapidly than private industrial firms.