The Success of China's New Capitalists in the Township and
Village Enterprises and Their Impact on the State Sector
By Satya J. Gabriel
How has China's economy grown
at such extraordinary rates in the 1980s and 1990s?
some of the reasons in previous essays, including some of the
ways economic reforms have worked to unleash the creativity and
hard work of the Chinese citizenry. Forget that China is
still described as a communist country. This rhetoric really
doesn't mean much when it comes to the nuts and bolts of everyday
economic life. Or the perception that China's economy is
severely lacking in flexibility and competition. One of
the hallmarks of the reforms has been the rapid growth of new
economic institutions competing with the old and often stodgy
state-owned capitalist enterprises. Forget, too, that the
Chinese financial markets have gone through a meltdown more severe
than the one that hit Brazil after it devalued. The valuation
of Chinese publicly traded firms have discounted something close
to Armageddon. China's capitalist economy is far
more vibrant than is understood by most on Wall Street or even
in the financial district of Hong Kong. The best
way to see why China is a burgeoning capitalist economic power
is to examine the nation's so-called town-village enterprises
(TVEs). These TVEs represent the vanguard in China's new
capitalism. The TVEs are hybrid institutions --- unusual
alliances between TVE entrepreneurs and local government
officials (acting in the capacity of "owners" of TVE
Despite the mixture of private entrepreneurship with public
ownership, the TVEs have achieved rates of success that would
be welcomed in any capitalist economy. The key seems to
have been the ability of China's capitalist system to generate
an adaptation to the standard relationship between managers and
owners in capitalist enterprises.
In China, where the differential rights of managers and owners
remains ambiguous, the TVE has provided an institution within
which this ambiguity can become a source of competitive advantage.
Entrepreneurs/managers negotiate a contract with the relevant
public officials that may contain both implicit and explicit
conditions. Managers can gain a great deal of flexibility
in such contracts, while the relevant public officials secure
for their local government (or for themselves) fixed claims to
a portion of the enterprise cash flow and other agreed upon benefits
in non cash form. Managers may also obtain from public
officials an agreement that such officials will provide special
access to inputs, public resources, tax breaks, or any number
of other "incentives" that contribute to the competitiveness
of the TVE. This is not so unlike the various incentives
provided by local governments in the USA and elsewhere in exchange
for firm management agreeing to locate facilities in the local
area or to not relocate existing facilities elsewhere.
In the Chinese case this sort of arrangement becomes an important
mechanism for institutionalizing the reform process. It
becomes in the interest of local officials to expand capitalism,
since these arrangements with TVEs become increasingly important
to the local economy (and sometimes to meeting the personal needs
of the officials).
In the TVE, public officials have a greater incentive to take
seriously their role as a contracting agent (playing the role
of owners) in negotiating conditions with the top level managers
of TVEs. The separation of ownership and management, in
this context, creates an environment that fosters greater focus
on generating cash flows than is the case in state owned enterprises
(SOEs). The managers have to satisfy residual claims on
the firms' cash flow and are subject to much harder budget constraints
than SOE managers. Thus, unlike the conditions under which
SOE managers operate, the managers of the TVEs have every incentive
to cost minimize, including stricter oversight of firm assets.
Managers, not surprisingly, have a keen interest in expanding
their authority over these TVEs. Ambiguity in the ownership-management
relation may generate some interesting and creative contractual
solutions, but is not the "optimal" arrangement from
the standpoint of managers. One can clearly observe a trend among
the TVEs towards the "individualization of ownership,"
meaning that ownership shares are increasingly being distributed
from the local governments to firm management, providing an additional
incentive for firm managers to focus on creating share owner
value. As one of my Nanjing University graduate students, Zhong
Qizhi, describes it: "The town-village enterprises are still
evolving. They are still mostly public enterprises, but a lot
of local officials would be just as happy if they were private,
as long as the taxes they get keep increasing."
One of the factors contributing to the success of the TVEs
and providing encouragement to those supporting further privatization
is that the TVEs have tended to engage in fairly aggressive self-policing
of the sorts of corrupt business practices that have plagued
most SOEs. While agency costs continue to eat up substantial
portions of the SOE surplus, the TVEs have achieved a level of
efficiency that is more common to highly competitive capitalist
firms in the so-called West.
This should not, however, be taken to mean that the only or
overriding objective of TVE managers is profit maximization.
In many cases, TVE managers are more concerned about expanding
market share. This in no way contradicts the capitalist nature
of the TVE. They remain enterprises run by managers who appropriate
surplus through voluntary contracts with wage laborers. To
the extent enterprise managers focus on other criteria than profit
maximization, they are acting in accordance with the long-term
capitalist objective of maintaining the wage labor system and,
no doubt, the short-term objective of satisfying their own self-interest.
Indeed, it is not so uncommon for capitalist enterprises in the
U.S.A. and other advanced capitalist nations to focus on such
factors as expansion of market share, even at the expense of
Indeed, the aggressiveness of town-village enterprises has
sent shock waves through the SOE sector. TVEs have not been afraid
to engage in price cutting or to employ relatively sophisticated
marketing of their products. They are not afraid to go head to
head with much bigger SOEs. This is ultimately good for the SOEs,
as well the TVEs. SOEs have been forced to concentrate more on
upgrading their facilities, improving product quality, developing
marketing plans, enhancing management skills and cutting prices.
SOEs are more likely, in fact, than TVEs to devote a significant
portion of their cash flow to research and development activities.
All of these factors make it much more likely that some fraction
of the SOEs will emerge as first-rate, competitive enterprises
on the global economic stage. In any event, the end result ---
better products, better services, lower prices --- is beneficial
to Chinese society as a whole.
Throughout Chinese industry there is a rising culture of innovation
and competition. You can see this first hand by visiting the
TVEs or the more successful SOEs. For example, during my recent
two year stay in China I had the opportunity to observe first-hand
the effectiveness of corporate innovation within one of China's
largest SOEs, Shanghai Petrochemicals. The firm's management
is engaged in a wide-ranging strategy to upgrade technology and
marketing. The company, which is publicly traded as ADRs on the
NYSE, is also involved in several joint-ventures that will bring
their managers into direct contact with some of the most sophisticated
contemporary technology and management practices in the petrochemicals
sector. The success of innovation within both the SOE and TVE
sector is evident in China's export sector, which has remained
healthy despite the Asian economic crisis and the wave of devaluations
that put Chinese firms at a relative price disadvantage.
The Chinese capitalist economy is in a relatively early stage
of development. However, there are clear signs that managers
in the TVEs and in the better of the SOEs are fast learners.
Chinese firms are learning what it means to compete and to market.
The advertising firm, Satchi and Satchi, is expanding in China
in anticipation that it will be the world's largest source of
advertising spending. And quietly Chinese firms of all
types are undergoing massive restructuring. Mergers, acquisitions,
plant closings, and rising unemployment in China are all signs
of the commitment on the part of China's so-called communist
leadership to advancing a Western-style capitalist economy.
The current pessimism about China's prospects going forward
are, no doubt, a product of the continuing lack of understanding
of what is actually going on in China and continued confusion
about what capitalism is really all about. China is, after all,
still called a "communist" country simply because the
political system is ruled by a party that calls itself communist.
The fact on the ground is, however, that China's industrial sector
is not only capitalist but increasingly looks like capitalist
sectors in the more advanced nations. Given this, the rather
authoritarian nature of China's political system actually works
to the advantage of Chinese capitalist firms. It reduces the
possibility of disruption from organized labor or political risks,
such as sudden devaluations. The costs of influencing governmental
policy are probably not significantly greater than for many industries
in the U.S.A. and other advanced capitalist nations.
For the foreseeable future, it remains highly probable that
Chinese firms, TVEs and SOEs, will continue the recent wave of
corporate restructurings that are providing significant improvements
in allocative efficiency. In addition, Chinese firms will continue
to engage in innovation on a scale that far exceeds the norm
in developing nations (no doubt with the support of the central
government and its intelligence operatives). China's capitalist
institutions are probably here to stay. It may not herald the
"end of history," but it is clear that China's leadership
has concluded that the most pragmatic solution to the problem
of Chinese economic development and political stability is to
allow the capitalist sector to prosper and grow.