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2009-09-10 | Beijing, Shanghai, Southwest China, Nanjing, Shenyang, Tianjin, South China

China's struggling smaller firms
Small fish in a big pond
Economist (print edition), 10th September 2009

CHINA’S massive, state-backed firms are becoming ever more visible on the world stage, but the country can trace a great deal of its recent economic success to countless small and medium enterprises. Today, as China continues to grapple with the effects of the global slowdown, these smaller firms are enduring a large share of the economic pain.

Virtually non-existent in 1979 when China took its first steps away from central-planning orthodoxy, its smaller companies numbered around 1m by 1990 and 8m by 2001. Today they total around 60m. The smallest have just a handful of workers, and the largest of the medium-sized ones, according to the government’s definitions, employ no more than 2,000 people. Yet together they account for 60% of China’s GDP and half its tax revenues. More than 95% are privately owned and, since they are largely free of the political and bureaucratic friction that plagues larger enterprises, they are among the most creative and nimble of China’s economic actors. They are responsible for 66% of the country’s patent applications and more than 80% of its new products.

They are also responsible for 68% of China’s exports, and it is this last figure that has made the current hard times especially difficult for them, as foreign demand has sagged. China has long sought to rebalance its export-driven economy toward a greater role in supplying domestic consumption, and if declining demand in America and other big export markets helps prod it along that path, that will represent a silver lining to the current gloom.

In the short term, however, smaller firms’ fortunes are lagging. An alarming set of official figures showed that the consumption of power by China’s smallest industrial enterprises declined by half in the first half of this year. Only after recovery will it be clear whether this reflects widespread devastation among small industrial firms, or simply a prudent tendency to slow production temporarily in the hope of surviving the crisis.

But it is China’s labour-intensive smaller firms rather than its energy-intensive ones that most depend on exports, and there is no ambiguity about the difficulty they face. Chinese exports began declining last November and the government reckons that poor export performance knocked 2.9 percentage points off the growth rate in the first half of this year. The government also cites the decline in exports as an important factor in the loss of 20m jobs held by rural workers who had migrated to urban and industrial centres.

According to Connie Zheng of Australia’s Royal Melbourne Institute of Technology, hard knocks are nothing new for the smaller firms, which often bear the brunt of negative trends in China. In the decade since China began paying more attention to environmental regulation, for example, smaller firms have been far more likely than larger ones to face costly enforcement measures or closure. They have likewise drawn the short straw in the government’s response to the economic crisis. One part of that response was the 4 trillion yuan ($586 billion) stimulus package launched last November, but much of this has been directed toward the sort of infrastructure projects that are dominated by large state-owned enterprises.

According to Joerg Wuttke, president of the European Union Chamber of Commerce in China, state firms have been the “big winners of this crisis”. Monopolies, he says, are only getting more entrenched and big state firms are crowding out the smaller players China will ultimately need to sustain growth.

Another longstanding challenge for smaller firms has been poor access to credit, and although another part of the government’s crisis response has been a massive boost in bank lending, they have again been shut out. Of more than 7 trillion yuan loaned out in the first half of this year by Chinese banks, only an estimated 10% has gone to smaller firms.

Much of China’s bank lending remains politically driven, putting state enterprises at a great advantage. Smaller firms have fared little better with lending decisions made on commercial terms. It is not without justification that banks often view smaller businesses as bigger credit risks, and China’s credit-rating system remains too poorly developed to benefit even the more solvent ones. This, according to Ms Zheng, has forced them to rely either on informal financing from friends and family, or on black-market lending schemes for which interest rates can be far higher than official bank rates.

There are fresh signs that officials recognise the need to level the field. State news media this month reported plans for new measures aimed at improving access to capital for smaller businesses, including the establishment of two dedicated investment funds totalling 4 billion yuan. That, alas, is a mere pittance in the context of this year’s broader lending spree. It is not easy being small.

Source: http://www.economist.com/businessfinance/displaystory.cfm?story_id=14409584