Self-made in China
China’s economic growth has been achieved through the rapid emergence of a dynamic private sector. What lessons can we learn from the generation of entrepreneurs who have driven this transformation?
The development of the non-state sector – private firms led by an emerging class of entrepreneurs – has been crucial in China’s move away from a centrally planned economy. In 1978, the first year of reform in China, state-owned enterprises (SOEs) accounted for more than 90% of the country’s GDP; this has since fallen to about a third.
From the mid-1990s, China saw a dramatic growth in the share of self-employed people in its workforce. By the 2000s, more than one in eight people had started their own business in market-driven provinces such as Jiangsu.
Not all of China’s growth achievements can be attributed to entrepreneurs, of course. Although rural industries – the township and village enterprises – contributed up to a third of GDP in the mid-1990s, foreign investors also played a role from then onwards. Nevertheless, China’s entrepreneurs have been a key driver of growth. They are the creators of the de novo firms that are forming a dynamic and innovative private sector and are an essential force in any developing country.
The rise of China’s entrepreneurs has not been without obstacles. By guaranteeing employment and providing social security in the absence of a national safety net, the lifetime employment system in the state-owned enterprises (known as the ‘iron rice bowl’) strongly discouraged urban workers from becoming self-employed. Not until the dismantling of the employment system and the massive layoffs that accompanied the restructuring of state-owned enterprises in the mid-1990s did private Chinese firms begin to flourish. By providing an alternative source of employment and revenue, the emerging non-state sector has given the government leeway in its efforts to downsize and reform state-owned enterprises.
Another institutional challenge that entrepreneurs face has been limited access to credit. A recent estimate by the chief economist of the World Bank suggests that, in 2006, fewer than 0.5% of the 40 million small and medium-sized enterprises in China could obtain loans from banks. Aspiring entrepreneurs have also faced a shortage of key assets, such as land or property (the property market did not develop until the late 1990s), and insecure property rights in a system that did not protect private ownership officially until 2004.
Amid these constraints, which characteristics distinguish entrepreneurs from non-entrepreneurs in China? The findings from a national household survey undertaken in 2000 show that they share some similarities. The average age of both sample groups is 35; the groups have been educated for the same number of years; and almost 85% of both groups are married.
There are, though, a number of differences. The first is that nearly 18% of non-entrepreneurs are members of the Chinese Communist Party, compared with 6% of entrepreneurs. It may be that Party membership protects against retrenchment, reducing the chance of someone stepping out into the private sector.
Second, almost a third of entrepreneurs have experienced unemployment, compared with fewer than a fifth of non-entrepreneurs. Despite this, the average entrepreneur earns at least 35% more than the average person in paid employment. This difference in income is remarkable given that, in most countries, individuals who have experienced unemployment suffer from ‘scarring’, which results in a lower wage when they are in work again. In China, the opposite is the case; in fact, with the loss of the ‘iron rice bowl’, involuntary unemployment has prompted the pursuit of self-employment. A willingness to embrace risk appears to increase the likelihood of an individual becoming an entrepreneur.
Third, entrepreneurs have larger social networks. In the context of a weak legal system and opaque regulations, perhaps it is not surprising that starting a business requires contacts to secure supplies and distribution, as well as operating licences. Some features of an individual’s socioeconomic background affect his or her potential for entrepreneurship. Women and people who have been in employment for a number of years are less likely to be entrepreneurs. Having a well-educated mother or one who was in a professional job increases the likelihood of entrepreneurship, while having a father who is a Communist Party member decreases it. Mothers who are more accomplished seem to encourage their children to start their own businesses, while fathers with connections to the Party seem to reduce the job insecurity of their children.
When considering a job opportunity, both entrepreneurs and non-entrepreneurs value wages, social security provision, good working conditions and the ability to learn skills on the job. They differ in that entrepreneurs do not worry as much about job stability or job dignity, and the drive to earn money is a significant motivating factor. Curiously, despite their higher earnings, they are less inclined than others to hope that their children will become entrepreneurs.
Entrepreneurs around the world share many of these characteristics. Women and older people are less likely to start their own business in most developed countries. Strong social networks, a healthy attitude to risk and an inclination towards hard work are traits that are common to entrepreneurs the world over. Developing countries, in particular, will be seeking to foster these very traits in order to replicate China’s dynamic private sector in their economies.
Tricks of the trade
There is much to be learnt from the ability of China’s entrepreneurs to thrive in challenging conditions. Not only does the country have an underdeveloped legal environment, it is also unique in terms of how big a role state-owned enterprises play and how large a proportion of bank financing they take, meaning that private enterprises are credit-constrained. Chinese entrepreneurs overcome these challenges by using their social networks to find financing, drawing on the incomes of migrated family members. They join with family members to start businesses and thereby rely on so-called relational contracting, where business is conducted on the basis of trust in order to cope with the imperfect enforcement of contracts.
The Chinese experience may, however, be difficult to replicate. Because of its history of central planning from 1949 to 1978, China was industrialised under difficult conditions. This meant that there was a foundation for businesses to start up, as credit cooperatives were available throughout rural and urban areas to channel savings into investment. The ability to channel savings into investment funds is important, even if the credit system remained distorted towards state-owned enterprises.
China has benefited from having a fairly well-educated labour force. Enrolment in tertiary education has increased from 7% to 23% of the population since 1999, helping to imbue prospective entrepreneurs with the skills needed to start new firms. As China has become increasingly open to the world economy, entrepreneurs have faced new competitive forces, as well as gaining access to global practices through educational exchanges. These factors, together with the hunger from decades of central planning, have all added to the strong culture of entrepreneurship that exists among the Chinese and is particularly visible among the diaspora in southeast Asia.
The ability of China’s entrepreneurs to overcome the ‘scarring’ that can reduce incomes upon re-employment is closely tied to social and political developments. The dismantling of the lifetime employment system and the decline of state-owned enterprises meant that there was little expectation of finding work in the state sector. This encouraged people to start their own business as the private sector took off and generated higher incomes. It helped that there was not generally a pejorative perception of people who had been made redundant, since the future was seen to be driven by entrepreneurs, even in the eyes of the Chinese Communist Party.
Indeed, the Chinese state did not ban the rise of entrepreneurs. It practised what has been described as a ‘no encouragement, no ban’ policy. The policymakers allowed experimentation to happen so long as it did not disturb stability. In this way, entrepreneurs could fill niches in the markets neglected by SOEs and eventually compete with them, thus allowing market forces to operate within the institutional structure of China’s gradual economic transition. The easing of the state’s control over the economy has allowed the emergence of a generation of entrepreneurs who have helped to make competition, innovation and productivity the drivers of national growth. Their resourcefulness, despite less than ideal conditions, makes them formidable competitors to the west and elsewhere.
Until recently, little was known about these entrepreneurs, but the emerging picture is one of a group of individuals that is able to navigate China’s uncertain institutional terrain and find opportunities in what is potentially the world’s most significant market. Their foray into overseas markets is as inevitable as their rise within China.
Linda Yueh FRSA is a Fellow in economics at Oxford University and economics correspondent for Bloomberg TV. Her latest book, Enterprising China: Business, Economic and Legal Developments since 1979, was published by Oxford University Press in May.
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