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China's Richest 2019: Private Sector Dynamism Blunts Impact Of Trump's Trade War

A customer looks at souvenirs on display at a store in the Yuyuan Bazaar district of Shanghai, China

This story is part of Forbes’ coverage of China’s Richest 2019. See the full list here.

The private sector has been indispensable to China’s economic success over the past 45 years. As Nicholas Lardy at the Peterson Institute for International Economics documented in his 2014 book Markets Over Mao: The Rise of Private Business in China, the private sector has been the primary source of growth in both productivity and employment, and powered China’s transformation into a manufacturing powerhouse. Today, private businesses are blazing new trails in the service sector, and most significantly in China’s world-leading digital economy. Intriguingly, the trade war is also giving China’s private business sector a powerful boost.

The dynamism and competitiveness of China’s private sector are key reasons the trade war has not led to the widely expected collapse of China’s exports. In the nine months ending in March—a period that saw a major escalation in the trade war between China and the U.S.—exports by China’s private sector grew by an average of 15% a year, even as exports by China’s state-owned enterprises (SOEs) shrank, according to an August analysis by Aletheia Capital. The tough market conditions created by the trade war are equivalent to a stress test, and China’s private businesses, with their more efficient operations and strong bottom-line focus, have outperformed their state-owned counterparts in an increasingly stormy global market.

China’s SOEs are pampered with preferential treatment, including easy access to credit, subsidies, licenses and implicit loan guarantees. From this perspective, the playing field is still decidedly tilted in favor of SOEs. However, new conditions have emerged in China’s rapidly evolving domestic economy that are advantageous to private businesses as well. China’s domestic consumption has achieved critical mass in the decade since the global financial crisis, enabling private businesses to rapidly grow. The benefits of China’s massive consumer market are magnified by the speed and scope of the country’s urbanization. Megalopolises made up of dozens of cities with tens of millions of residents are emerging, underpinned by efficient transportation and communications infrastructure and connectivity.

Each of these massive urban markets is made up of Chinese consumers with rising discretionary spending power, who are digitally mobile, eager to embrace new technology and willing to try new products and services. They make perfect partners to the entrepreneurial startups populating China’s service economy with innovations customized for the urban middle class.

More on Forbes: China’s Richest 2019: Growing Consumer Appetite Boosts Fortunes Of Nation’s Wealthiest

China’s private businesses have a powerful advantage over SOEs in sectors where SOEs have traditionally dominated, including banking, healthcare and telecommunications—agility. Consumer demand in these sectors is evolving faster than SOEs can effectively react. Despite their privileged position—indeed because of the shelter they’ve enjoyed—SOEs are less efficient and much slower in adapting to customers’ new needs and preferences.

The success of China’s private businesses at home is a key factor in their success in export markets. They are able to leverage the scale and efficiency of their domestic operations to compete overseas with low prices and rapid innovations. The fact that it is harder for them to access credit than for SOEs makes private businesses more efficient in deploying investment capital.

This export resilience has been noticed in Beijing, which is helping the private sector. In July, Premier Li Keqiang announced that the government would lift ownership caps on foreign ventures in China and further open the market. These new policies mean Beijing must work harder to promote China’s own private businesses. SOEs will have a tough time competing against foreign entrants, but Beijing is counting on China’s private businesses to hold their own.

The first step is leveling the financial playing field. Last December, the People’s Bank of China, the central bank, introduced lending facilities that offer lower rates for private companies, and small and midsized enterprises. This step complements the formalization of the so-called “shadow” lending to private businesses and SMEs that banks have been making off-balance-sheet to skirt lending limits or disguise their true exposure to borrowers. The government’s intent is clear: banks are not to neglect private businesses.

More private sector support does not mean Beijing will leave SOEs entirely at the mercy of market competition. SOEs will continue to dominate industrial production, as reflected in President Xi Jinping’s “Make in China 2025” program, which identifies ten industrial and technology sectors that China aims to become world leader by 2025.

But private businesses increasingly dominate services, a sector that is fast becoming the most important driver of the economy. Accordingly, China’s capital intensity is steadily declining because services require less capital than manufacturing. In turn, this means a higher proportion of economic output goes into workers’ pockets, increasing household spending power. The government has also been raising minimum wages in recent years, particularly in second- and third-tier cities. All of this is helping to supercharge consumer demand, making the service sector an even more promising and profitable arena for China’s private businesses.

Could China’s slowing economic growth dampen the rise of its private businesses? Not at all. The media is filled with alarmist headlines about China’s growth being the lowest in decades. This takes things completely out of context. With a $10,000 per capita GDP, China is now a solidly middle-income country. The historical growth pattern of countries at a similar per capita GDP level is 3-4% annual growth in real GDP. Between 2005 and 2017, China’s real GDP grew at an annualized rate of 9.1%, according to the IMF. Even as its growth rate drops to 6%, China remains a high-growth outlier among middle-income countries. The private business sector in China is taking off, and with it, a whole new chapter of wealth creation will unfold.

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