Written by Andrew Atherton.

China has seen a leap in registrations of private businesses since it streamlined procedures to register businesses in May 2014. Is this a sign of a jump in entrepreneurs starting their own businesses, and if so what challenges and opportunities do they face? This short piece looks at the emergence of entrepreneurship in China, and considers future trends in the development of the private sector. Private enterprises have driven economic growth in recent years, and now account for most economic activity in China. Their future prospects will determine how fast China continues to grow.

Urban China was already a private sector economy

Before the recent upsurge in registrations of new private businesses, China had already become a private sector economy. In 1998, there were only 140,000 enterprises registered as private businesses, accounting for less than 1% of economic activity. By early 2014, the State Administration for Industry and Commerce, which registers new businesses across China, reported that there were more than 40 million active registered businesses. The majority of these are private, and most are small. According to a wide range of estimates, the private sector now accounts for between two-thirds and three-quarters of the economy. As the private sector has grown, the state sector has shrunk. In China’s cities, where most people now live, jobs in state-owned enterprises have dropped from over 70% of total employment in 1990 to 25% in 2012.

What is striking about this transformation is that it has been relatively recent. Although China’s current reform period started in the late 1970s, collective and state-owned enterprises dominated until the mid-1990s, and the private sector only really took off just over a decade ago in the early 2000s. Put it another way, it’s only people in their teens and twenties who have experienced a job market where most employment lay in the private sector. In contrast, anybody over 30, and certainly those in their 40s and 50s, would have worked in a state-owned enterprise, a collective, or a rural township-village enterprise and would have learned how to work and develop their careers in the state sector.

Is the increase in registrations a real rise in private enterprises?

If the growth of the private sector had already occurred before the changes to registration in May 2014, has the recent increase in new registrations actually been the result of more businesses starting up? Although this is difficult to establish, several possibilities present themselves. Let me look at three.

Firstly, it is possible that the new registrations are by existing businesses operating in the informal or semi-formal sectors. The smallest category of private enterprise – the household enterprise, or getihu – has tended to operate in a semi-formal way, active in markets where costs and barriers to entry are low. In practice, local Industry and Commerce Bureaus (gongshangbu) have not been aggressive in monitoring these businesses, or always requiring their registration. By simplifying procedures, it may be that existing unregistered enterprises are registering.

A second possibility is that some, or all, of this increase is real. There are indirect signs that suggest this could be the case. Let me give two examples. Firstly, a Property Law was finally introduced in 2007, which recognised private ownership of enterprises and assets. Before this, there was no clear legal framework that recognised private ownership. Although implementation has been patchy, over time there has been a growing recognition of legal protection of private enterprises. This is likely to have been reinforced by the current climate, where government officials have been subject to a strong campaign against corruption. Secondly, there have been ongoing attempts to create an environment that is friendlier to private enterprises. Take finance as an example. Policy has sought to open up credit from state banks and other public financiers to the private sector.  There is still a long way to go before private enterprises are actively supported by state banks, but there has been progress towards this goal. As funding is made available to private enterprises, entrepreneurs have more resources to start and grow their own businesses.

And the third possibility is that falling economic growth combined with fewer job opportunities in the state and in state-owned enterprises have ‘pushed’ people into starting their own businesses. In most OECD countries, a downturn in economic conditions stimulates greater levels of business start-up, and in particular self-employment – as employment opportunities dry up. In China, rises in registration of household enterprises, many of which are sole traders who are self-employed, would indicate such a trend.

The likelihood of course is that all three explanations have contributed to recent increases in registrations of businesses. Regardless, not all new registrations will be of new ventures with strong prospects of growth and survival over time. Instead, and as has been found consistently since Birch’s studies of job generation by small private businesses in the US in the late 1970s, most new jobs are created by a very small sub-set of high growth new ventures. The increase in registrations will most likely be followed by a rise in de-registrations, and so greater levels of ‘churn’ of businesses coming in and out of existence.

How much bigger could China’s private sector become?

So, there has been growth in China’s private sector. But, has China reached its entrepreneurial limit or will this growth continue? Although there are no clear benchmarks, some rough calculations suggest that China’s private business population is still under-developed. By counting private smaller businesses per population, China has 1 private small and medium enterprise (SME) for every 33 people. In contrast, in Taiwan it is one SME per 18, and in the UK and US respectively one per 13 and one per 11. The UK and US are highly entrepreneurial economies with well-established and dynamic private sectors, and so it is unlikely – in the short-term at least – for China to reach the population intensities of these two countries. However, Taiwan is a closer economic model and so indicates a possible benchmark. If China were to reach the same SME intensities as Taiwan, the Chinese private sector would almost double. If China were to move closer to the UK and US, then the private SME sector would treble. By either count, there is significant further growth potential for China’s private smaller business population.

But will the private sector continue to grow?

This then raises a question around whether this growth will happen. On the one hand, there are some positive developments that suggest that public policy and the institutional environment are becoming friendlier towards private entrepreneurs. The private property law is a case in point. In addition, there is a positive culture around entrepreneurship, especially amongst younger people interested in forging their own careers. On the other hand, however, the legislative environment remains concerned with promoting large state-owned and – controlled enterprises than creating a financing, regulatory and institutional environment that actively and positively encourages new businesses to start and grow. Until a clearer and unequivocal framework for private sector development is established, and sustained, the likelihood is that there will be continued private sector growth, but the full potential of entrepreneurship will not be realised. This most likely means that increases in entrepreneurship will stimulate continued GDP rises, but that private sector would be higher with the right environment and framework in place.

Andrew Atherton is a Professor of Enterprise and Deputy Vice-Chancellor at Lancaster University and an expert in SME policy and China. Image credit: CC by Cory M. Grenier/Flickr.