How can China really boost business confidence? - Essay #1

A real story about dealing with government corruption, with tears, successes and lessons.

This is not a typical weekly review. Instead, I want to recount the story of a friend to shed light on the real reason why business confidence is low in China right now. It is a simple story, but it is a microcosm of struggles small businesses face every day. To protect my friend's identity, I will call him Mr. X.

This Monday, China's central bank and other government agencies announced the so-called "25 Measures" to step up financial support for the country's private sector, including efforts to diversify financial channels for private businesses, in yet another step to boost the private economy amid challenges. But is financing what private businesses actually lack the most right now? Will more funding make private businesses more confident? Mr. X's story will give you some better ideas.

Mr. X is founder of a consumer product company. Backed by several venture capital firms, he founded the company a few years ago during the height of late Premier Li Keqiang's "mass entrepreneurship and innovation" initiative. Like everyone else, he had some challenges since 2 years ago when consumer sentiments weakened due to a combination of negative factors related to real estate and covid. But he is lucky enough to operate in one of the relatively high growth sectors and has even achieved decent profit as of today.

Yet, he is wary of investing more into this business. For now, he only wants to maintain the business running as it is and tries to explore business opportunities abroad. In fact, he spent most of his time outside of China now and only came back home occasionally.

Why?

One big let-down for him is his experience dealing with local government officials. It first started with a marketing campaign. An innocuous technical flaw of the campaign was seized up by some consumers, who reported it to the local market supervision bureau. The bureau came for an inspection. Inexperienced with dealing with this kind of situation and with no desire to get into trouble, Mr. X found a Laoshi in the bureau (老师 or "teacher", is how a low-level civil servant in the government is commonly referred to) paid him several dollar worth of money to fix it. And fixed it was. Mr. X felt quite happy about it.

But he would soon regret it. From that point on, every few months similar incident will happen again and again. Missing certificate? Loopholes in procedures? All kind of government bureaus went down with their own "speeding tickets". The last straw came with the police force. One day, two economic policemen found them, and told Mr. X that he had breached tax laws by missing on income taxes and social security payments. I can instantly understand what the police were referring to. In China, because effective taxation (including social security payments) is so high in China, almost none of the small businesses pay them in full. So everyone is sort of guilty.

They told Mr. X wistfully that their police salary was only half of the average of Mr. X's employees, and they wanted to have some money for the Spring Festival. Otherwise he would be arrested. This was, essentially, extortion.

This time, it finally dawned on Mr. X he was being picked on. There must be some kind of "blacklist" of easy extortion targets shared among some hidden circles of bad government officials. He decided to pause a bit and think about it. The next day, the policemen called his staff and told them the sum was doubled. Now, Mr. X became really scared. He was no longer sure whether even after paying the doubled sum, this wouldn't be the end of it. He decided to communicate to his shareholders and inform them the string of exhortations the company faced in the last couple years. This time, he told his shareholders that he was fed up, and that he would stood ground and faced consequences. This is it.

One of his shareholders had a legal background and told Mr. X that, although never put into written law, in practice the tax infringement in the case of Mr. X was not serious enough to warrant an arrest. The next day, the shareholder went to the police station and filed a complaint. Mr. X ended up paying the unpaid taxes, but there was no arrest and no penalties. The two policemen were also never seen again, nor were the endless stream of extortions from other government bodies. So it seems, being bold for good reasons, even in front of the government, actually works in China.

Another incident has to do with Mr. X's manufacturing plant, which is located in a village in a relatively prosperous part of China. One day, the village head came to him and asked him to register the plant in that village, in order to pay "taxes". The village head does have a point, but Mr. X decides against it, because he has tax obligations to other localities and simply do not have extra taxes to allocate to that village. Then one day, a dozen villagers stormed the plant and locked the door. The workers inside freaked out. This happened despite the fact that a "village" in China is not actually part of the government and thus has no law enforcement powers. This is, essentially, a local gang doing an unauthorized illegal act.

This time Mr. X instantly decided not to become a fool. He arrived at the plant, dismantled the paper lock on the door, shouted to the villagers that their act was illegal and refused to pay a dime. Afraid, the villagers backed down. From this incident, Mr. X said, he learned that at least in Eastern and Southern China, you have to act like a "gangster" before your opponent, which means to become really rude and look very hard to deal with, like a porcupine, to scare them off. Being the CEO, he is the only one in his company who has the guts and willingness to act this “gangster” role. (He also doubts whether the same tactics apply to northern part of the country, where everyone seems like a real gangster.)

The two incidents both ended up as victories for Mr. X. But you can easily gauge the emotional toll this can leave on Mr. X's psychology. Acting as a gangster is just a pain in the a--. Living in fear also leaves little energy to focus on the real business. As far as I know, these incidents are not unusual at all, although I bet the majority of them also end up as "victories". However this is the precisely the problem. In a business environment where such incident is the norm, not the exception, is the fundamentally why business confidence sags.

Policies and Implementation

The 25 Measures this week was announced after the "31 Measures" announced by the Party and State Council to boost private business confidence, announced in July (great guided translation by

Pekingnology

).

Has either 25 Measures or 31 Measures achieved its goal? I am not sure. But Mr. X's story show that having better financing is not the biggest business difficulty for him. What he needs is more fundamental and more simple: a sense of security. To be sure, worsening macro-economic outlook associated with real estate crisis is also a major factor for pulling down confidence. But everyone knows that economic downturn is just part of the cycle and there are always ups and downs. But for something as fundamental as a sense of security, there will be no confidence whatsoever, if it is permanently breached.

In fact, the 31 Measures sought to address this problem. For example, it stated:

Adhere to the principle of balancing education and punishment, implement enforcement methods such as notification, reminders, and persuasion, and do not impose administrative penalties on first-time offenders who have committed minor offenses and have promptly corrected them in accordance with the law.

But this is only a top-level document, but the devil is always in implementation. The key is how to make those two policemen balk at extortion again.

So what can Chinese government do to boost business confidence?

Some of you may think the solution is simple: just turn China into a western-style democracy and let people vote the bad officials out of office and the problems will all be solved.

But I disagree. I think this is only a solution driven by ideology, but ideology never provides good solutions. Ideology is too simplistic and leads people to be oblivious of nitty-gritty limitations of the real world. The idea that elections can solve business problems is just the same as the claim that socialism alone can make people less starving. If elections are this good, then India should have been a much less corrupt and much more prosperous country than China long time ago.

Here are 5 thoughts of from me for the real world. To be sure, the government is already working on many of them, with varying degree of progress:

1. Tough rule to "lock power in a cage". Implementing tough rules and setting up checks and balances within the system to make it super hard for government officials to extort for personal gains. Among the 5 points, this is arguably where the government has made the biggest progress in the last decade. The fact that those two policemen could be simply scared away because of one complaint from Mr. X, is testament to the effect of the decade-long anti-corruption drive and constantly upgraded anti-graft mechanisms. This is a crucial, basic guardrail to stop the Leviathan from becoming an uncontrollable beast.

2. Raise the bar of criminality for businesses to prevent arbitrary, even corrupt law enforcement. The bars for non-compliance are too low for China's businesses, especially the small businesses. The above-mentioned taxation burden is a great example. Almost no small businesses pay taxes in full, and the government knows it. Setting draconian rules, enforcing the rules only selectively and picking on the weakest - this is a time-honored tactic for many of those "vultures" residing in the government. There are just too many loopholes for them to feed on. We need to close down those loopholes. Give more breathing space for small businesses and give fewer room for small business to have to be non-compliant. Only punish the real crimes, both in written rules and in practice. For taxes, consider hard the selfless proposal made by billionaire Mr. Cao Dewang of Fuyao Glass: give tax breaks for small businesses and just tax the bigger ones, leaving small businesses enough breathing space to grow and innovate before contributing to social welfare in return. (Cao is also the main protagonist in the award-winning Netflix documentary American Factory.) I think this is the most difficult piece to fix in all of my 5 suggestions, given the enormous inertia and self-interest of bureaucracy.

3. Go after anti-business rhetoric really hard. Every now and then, there are demagogues stoking anti-business sentiments. This is especially dangerous because as early as ancient times, business people ranked the lowest in terms of social status, lower than officials, farmers, workers, or 士农工商, in that order, so business people (capitalists) tend to be more easily picked upon in public discourses. The Party should make it very clear that all stakeholders of the society are equal, and as a socialist + market economy, China should punish anti-business rhetoric as hard as anti-socialism rhetoric, or even anti-China rhetoric. On this front, the government has already made some progress. For instance, the 31 Measures stated that, as translated by

   Pekingnology
   :

guide the society to have a proper understanding of the significant contributions and important role of the private economy, and have a correct view of the wealth obtained by actors in the private economy through legal and compliant operations. Firmly resist and promptly refute erroneous statements and actions that undermine or weaken the basic socialist economic system, negate, or downplay the private economy. Respond promptly to concerns and dispel doubts.

What is needed now is more public showcases of law enforcement to put those good principles firmly set in people's minds.

4. Higher compensation, for a leaner civil servant force. Simply being tough on corruption is not enough. People are people, and you can't stop people from having desires. In fact, the two policemen had made some good point: their salary is too low. In fact most of the people who work in China's public sector are paid too low in relative terms. Asking low-paid workers to do hard work selflessly without seeking their own interests is simply not sustainable. One big reason for an efficient and clean civil service in Hong Kong and Singapore it they are decently paid. But because China is so large and so complex, it also requires a massive bureaucracy to run. But a huge, and well-paid civil service force will also cripple the economy. So in order to make the civil service more capable, it also has to be leaner. One vector of reform to lean down government is to introduce more digitalization, which is something the government keeps pushing for. For instance, a few weeks ago, to my amazement, I found it would only take a few clicks on my phone to change particulars of one of my companies, instead of the days and weeks and several painful visits to government counters for the same thing a few years ago. So we are moving in a good direction here.

5. Ultimately it’s about per capita GDP. But digitalization alone is not enough. I do believe the very crux of most of problems in China is a development problem. The precondition for a better-paid, more elite, leaner and cleaner bureaucracy is a society where most of the people can reach relatively high-income level. To achieve this, you would need two things at the same time: 1) high level of technology and climbing higher in the global value chain. This has been a major focus of China for the last years, an endeavor so well-known that it also aroused containment from the West. But to be able to solve our own problems, China will have to keep marching in this direction; 2) We will also need entrepreneurs who dare to invest in those new technologies. This comes back to the business confidence question which is the main topic of this post. Yes, what I mean is simple: if we can get things right, we will make business confidence come back, which in turn will boost the economy, which in turn will make it easier to have a cleaner and more capable government, which in turn will even create more confidence - kickstarting a virtuous cycle.

I hope these are not my wishful thinking.