China recently adopted new guidelines to strengthen protection of property rights. The guidelines are an important step toward ensuring long-term economic growth. But there is more to be done.
The guidelines aim to advance three key objectives. First, they limit the government’s discretionary ability to take private property from entrepreneurs and private citizens. In the past, the law defined the state-owned sector as the “foundation” of a “socialist market economy,” and the private sector as its “supplement.” The new guidelines stress the “equal status” of state-owned enterprises (SOEs) and private firms, and the “equal protection” of their property rights. Now, private property will no longer be inferior to state property — at least officially.
China has lately been facing a new wave of capital flight, driven partly by concerns among entrepreneurs that President Xi Jinping’s anti-corruption campaign — so far focused on corrupt government officials — could one day be re-directed at them and their assets. After all, given that the laws and regulations governing business in China are highly complex and, at times, even contradictory, it has been difficult for Chinese entrepreneurs not to violate some rule or another.
The new guidelines address this by calling for forgiveness of “original sins” — irregular or illegal activities or tax evasion by private entrepreneurs in their firms’ early days. This amnesty program – together with a broader shift toward equality between SOEs and private firms – could remove a thick cloud of uncertainty for Chinese businesspeople, encouraging them to keep their wealth and talent in the country.
The second objective of the new guidelines is to eliminate the expropriation of state-owned assets by private parties, including by self-dealing managers of SOEs. Such self-dealing takes many forms, including selling state-owned assets at below-market value to connected private parties and insider trading in the stock market.
One positive effect of the anti-corruption campaign has been the suppression of such behavior. Even so, to be responsive to Xi’s call to strengthen and expand existing SOEs, it makes sense for the guidelines’ drafters to propose more measures to minimize risks stemming from poor corporate governance.
The third objective of the new guidelines is to encourage innovation, by protecting the fruits of creative efforts. The engines that have propelled China’s growth over the last few decades – a huge supply of cheap labor, imported technology, and massive physical investment — are petering out. Now, productivity increases and local innovation must pick up the slack. And that requires adequate protection of intellectual property.
My own research, carried out with Zhuan Xie and Xiaobo Zhang, shows that Chinese firms — especially in the private sector — have lately accelerated innovation, and are being awarded an increasing number of patents at home and abroad. Unsurprisingly, they have joined multinational firms and foreign trade negotiators in demanding better intellectual-property protections. As intellectual property rights become more secure, China’s new growth engines can gain substantial steam.
But the new guidelines are not sufficient to guarantee such an outcome.
For one thing, the amnesty program for entrepreneurs’ “original sins” still lacks sufficient detail. If it allows the officials implementing the program to define which sins are eligible, and what timing makes them “original,” it could create new rent-seeking opportunities, augmenting the burden on entrepreneurs, rather than removing uncertainty.
Moreover, the guidelines will not eliminate the state-owned sector’s advantages. Despite the new, more equal terms established in the guidelines, a financial system that is dominated by state-owned banks will give an edge to SOEs in terms of access to funding and the cost of capital.
Similarly, local governments, which own a majority of the SOEs, may struggle to adjudicate fairly disputes that arise between their own firms and private companies. To ensure genuinely equal status for SOEs and private firms will require reforming the financial system, as well as government divestment from those SOEs lacking a strong national-security dimension — that is, the majority of them.
China’s new legal framework for protecting property rights holds a lot of promise. But its success will depend heavily on how it is implemented, as well as on the extent to which the government pursues complementary reforms. For the sake of the entire global economy, one hopes that China gets it right.
Copyright: Project Syndicate, 2016. Read more of Shang-Jin Wei’s commentaries for Project Syndicate.