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Driving Forces of Privatization

When CCP leaders initiated economic reforms in the late 1970s, they never thought that the limited steps that they took would eventually lead to the predominance of private ownership. As noted above, the unfolding of this transformation in the ensuing thirty years followed three convergent paths: the growth of genetically private economic entities, the conversion of public enterprises into private or predominantly private companies, and the expansion and deepening of foreign (private) ownership. The driving forces behind the changes along these paths have attracted considerable analytic attention.

Three prominent explanations stand out in the pertinent literature: the entrepreneurship thesis, the budget constraint thesis, and the foreign direct investment (FDI) thesis.

A central theme in the research on privatization in post-Mao China is that entrepreneurship has played an essential role in the growth of genetically private economic entities (e.g., Bruun 1993; Huang 2008; Kraus 1991; Krug 2004; Nee and Opper 2012; Odgaard 1992; Tsai 2002, 2007; Wank 1999; Young 1995). This not only involves economically innovative and risk-taking behavior, but encompasses various strategies, such as the evasion, neutralization, and engagement of local officials, to cope with the political constraints and channel influence and resources from the state. As private entrepreneurs pressed their way forward from the initially adverse institutional environment, they contributed to the creation and expansion of markets and competition, as well as the development of informal institutions to govern the new economic space. Over time, the CCP has had to reckon with these realities and, in order to influence them, to co-opt private entrepreneurs into a new alliance of political and economic interests (Chen and Dickson 2010; Dickson 2008; Tsai 2007).

The budget constraint thesis offers an explanation for the privatization of public enterprises (e.g., Brandt, Li, and Roberts; Cao, Qian, and Weingast 1999; Li 2003; Park and Shen 2003; Qian and Roland 1998; Whiting 2000). Its basic argument is that public enterprises, especially state-owned enterprises (SOEs), entered market reforms under soft budget constraint—easy credit and fiscal subsidies for inefficiencies and operating losses. The lack of strong financial discipline fostered imprudent decision-making and led to the accumulation of increasing amounts of debt among these latecomers to market-oriented economic activities. In the mid-1990s, banking reforms heightened the profit goals of state-owned banks and drove them to tighten lending practices. In the meantime, comprehensive tax and fiscal reforms drastically changed revenue streams in favor of the central government and thereby weakened the fiscal capacities of local governments that controlled the vast majority of public enterprises. The result of these concurrent developments was a hardening of the budget constraint faced by public enterprises. Coupled with growing competition, this change pushed many of these enterprises into serious financial crisis. In view of the mounting cost of continuing to finance them, the government had no choice but to resort to a massive sell-off around the turn of the century.

The FDI thesis draws attention to a link between the expansion of foreign investment in China and the resurgence of private ownership. While there is a large body of studies on the growing role of foreign investment, especially FDI, in the Chinese economy (e.g., Gallagher 2005; Howell 1993; Lardy 1994; Moore 2002; Pearson 1991; Shirk 1994; Zweig 2002), Huang (2002) was perhaps the first to make an explicit argument about the privatization function of foreign capital. The gist of the argument is that inefficiencies of SOEs and ideologically and politically motivated discrimination against domestic private enterprises left open extraordinary opportunities for FDI to expand up until the turn of the twenty-first century. The influx of capital from abroad represented a growth of the significance of private (albeit foreign) ownership in the Chinese economy. It also facilitated the growth of domestic private enterprises disadvantaged by legal-regulatory constraints and inadequate financial access, mainly through joint ventures that added property rights security and much-needed capital, though this was sometimes achieved at the expense of local partners’ ceding the rights of control. Moreover, for some poorly performing SOEs, FDI provided an exit through the cannibalization of their remaining assets into equity shares in joint ventures dominated by foreign investors.

Each of these theses illuminates an important part of a big and complex puzzle. They also complement one another in that each accounts for a different avenue of privatization. More research, however, is needed to weave their insights into a fuller and more revealing account of the mechanisms at work.

 
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