The Chinese entrepreneur charges ahead

Alysha Webb argues that the recent investigations into private businessmen in Shanghai are unlikely to quell the entrepreneurial spirit in China although funding is still difficult to obtain

Anyone reading local headlines lately in China might be confused about the status of the private sector there. The fraud trial of Chinese-Dutch tycoon, Yang Bin, and the fraud investigation of Shanghai property magnate, Zhou Zhengyi, are just two of the most visible cases of private businessmen in trouble. Several other Shanghai property bigwigs are reportedly also under investigation. Editorials in the official People's Daily rail against millionaires and their 'avarice for primitive capital accumulation'.

At the same time, Beijing looks to be seeking to codify the private sector's place in China's economic and political makeup. In 1999, a constitutional amendment upgraded the non-State-owned portion of China's economy from a 'complement to the State-owned economy' to 'an important part' of a socialist market economy. In 2000, capitalists were granted the right to become members of the Chinese Communist Party.

If that seems like a contradiction, to use a popular Maoist term, think again. Rather, it's a recognition that no matter what the Government's attitude towards private businesses, the sector is simply too important a part of China's economy to ignore.

Bowing to inevitability - and keen for the jobs a vibrant private sector will produce - areas previously closed to private investment, like aviation and banking, are slowly being opened to private capital. Banks are being encouraged to lend more to private companies. Politically, growing numbers of entrepreneurs are serving on political advisory bodies. And, press reports aside, small and medium-sized companies - who make up the bulk of China's private sector - are charging ahead.

But China's private sector still faces growing pains. Difficulty finding financing for expansion and continued close government scrutiny will continue to dog China's private sector. 'The private sector has been doing well despite obstacles,' says Hong Kong-based CSFB senior regional economist, Dong Tao. 'Beijing is trying to adapt.'

The numbers tell the story. The non-state sector - which includes collectively-owned enterprises and partly government-owned listed companies like China Telecom - accounted for more than 75% of China's RMB10.2 trillion (US$1.23 trillion) GDP in 2002, up from less than 10% in 1980, says Tao. Exports from private companies grew 163% in the first four months of 2003, and their total share of exports grew to 8.4%, up from 6.6% in 2002. China has more than 1.7m private businesses representing RMB1.1 trillion in total investment and employing 27m people, the official China Daily reported in February.

Much of that investment comes from small and medium-sized companies like Profex, a specialist pharmaceutical goods company in Shanghai that markets products for other companies and distributes its own branded products. Started in 2000 with less than US$1m in private capital, Profex now employs 70 people and is looking to expand by buying another company.

Financing that expansion won't be easy, though. 'We looked into getting a bank loan,' says CEO Philip Xiao, 'but decided it was probably not worth the trouble.' Profex talked to several local banks, including the Bank of Shanghai, whose mandate is to fund small and medium-sized businesses. To get a loan, a company needed assets to use as collateral, or a guarantor. For a small company like Profex whose main assets are intellectual property, taking out a loan 'appeared very difficult,' says Xiao.

Part of the problem is China's poorly-developed credit rating system. Only a few cities - Shanghai is one - even have data on personal and business credit histories. And Chinese banks have little experience in evaluating a potential borrower's credit worthiness. Big private companies exploit this weakness by getting cross guarantees from companies with overlapping ownership. And though the Government has called on banks to investigate more closely the background of guarantors, slipping through loopholes is still easy. Once companies have some cash they can use it to buy assets - which can then be used as collateral for more loans. 'If you don't need money it is easier to get money,' Xiao says with resignation. Profex is now looking at using private equity to fund expansion.

Listing on China's domestic stock exchange is another financing option, but until China opens its long awaited 'second board' for listing of smaller firms, that door is closed to many private companies. To get listing approval from the China Securities Regulatory Commission, a company must have RMB50m in assets and three continuous years of profitability. At least private companies don't have to wait in line behind state-owned enterprises for listing approval anymore. Until three years ago, such approval was based on subjective judgements. Now, ownership doesn't matter. 'As long as you are a good company, we like you,' says an executive of the Shanghai Stock Exchange.

Financing is at the root of many of the private company scandals, believes Jin Saibo, a partner at Beijing's Yiwen Law Firm. 'Actually, these cases against private companies, at the end of the day, are because private companies don't have equal economic status,' he says. 'The important problems are getting loans and unequal access to all sectors of the economy. Because their status isn't equal, private companies can't get bank loans to expand, so they must use illegal methods.' The character of the private businessman also enters the equation, Jin admits. 'Of course, personal traits can also be part of the problem,' he says. 'For example, a disregard for the law.'

Chinese entrepreneurs tend to come in two types, theorises Yu Lei, managing editor of the Shanghai Tatler, a lifestyle magazine that focuses on nouveau riche. Entrepreneurs figured prominently in the Tatler's list of 'most desirable party guests'. There is the 'use connections to get rich quick type', personified by Zhou Zhengyi. Zhou's business empire started with a small restaurant in Shanghai in 1994; by 2002 he was ranked 11th on Forbes list of China's richest people. Or Yang Bin, who was a peasant entrepreneur in 1989, and ascended to second place on the Forbes list by 2001. 'They need connections, they need bank loans to grow so quickly,' surmises Yu.

Then there is the 'get rich through adding value type', personified by another 'most desirable party guest', Guo Guangchang. The 36-year-old head of Shanghai-based Forsun High-Tech Group, a conglomerate with interests in pharmaceuticals, medical equipment, real estate and software, comes from a peasant family but has an MBA from prestigious Fudan University. Ranked ninth on the 2002 Forbes list, Guo started his company with four friends and $4,500 in 1992 to market a Hepatitis A drug they had developed. An avid golfer, Guo 'is pretty open-minded', says Yu.

The corporate culture in China may also play a role in encouraging people to push the legal envelope, says Simon Keeley, director of Greater China for human resources consultancy, Hewitt. Keeley, who has worked with private companies in China, says executives in entrepreneurial Chinese companies get lots of room to operate and are expected to produce results, but are given few guidelines about how to do that. 'There is a massive amount of delegation, but expectations you won't screw up,' he says. While this tends to make middle-level managers more cautious, for ambitious high-level executives in competitive environments, 'the temptation to cut corners is very strong', says Keeley.

And what about the seeming link between appearing on the Forbes list and getting thrown in the slammer? 'Zhou Zhengyi is not representative of China's private sector,' replies Russell Flannery, Forbes' Shanghai bureau chief. 'Most people on the list have good ties with their community and with the local government.'

Stronger government ties

The private sector's ties with the national Government are getting stronger. More than 100 entrepreneurs - including Forsun Group's Guo - are members of the National People's Political Consultative Conference (NPPCC), an advisory body to the Government. And, according to Cao Hongbing, director of the economic bureau of the United Front Work Department, a central government body, 133 will attend the 2003 National People's Congress, up from just 48 for both bodies a few years ago.

Indeed, the Communist Party has drawn up a five-year plan to bring more business people into politics, Cao said.

Good relations with the Government certainly won't hurt China's private sector, but it will take legal and financial reforms to help private businesses truly grow in China, says Profex's Xiao. Still, expect to see the private sector assume an increasingly prominent role. 'The private sector is crucial for China's long-term development,' says CSFB's Tao. 'It's going to boom with or without banking loans.'

Alysha Webb is a business journalist based in Shanghai.