Commentary | 25 July 2019

How the state runs business in China

Originally published in The Guardian.

Originally published in The Guardian.

When Xi Jinping took power in 2012, he extolled the importance of the state economy at every turn, while all around him watched as China’s high-speed economy was driven by private entrepreneurs. Since then, Xi has engineered an unmistakable shift in policy. At the time he took office, private firms were responsible for about 50% of all investment in China and about 75% of economic output. But as Nicholas Lardy, a US economist who has long studied the Chinese economy, concluded in a recent study, “Since 2012, private, market-driven growth has given way to a resurgence of the role of the state.”

From the Mao era onwards, Chinese state firms have always had a predominant role in the economy, and the Communist party has always maintained direct control over state firms. For more than a decade, the party has also tried to ensure it played a role inside private businesses. But in his first term in office, Xi has overseen a sea change in how the party approaches the economy, dramatically strengthening the party’s role in both government and private businesses.

International governments have noted Xi’s interventionist instincts with alarm. When US officials were pressed in early 2019 to provide evidence that Huawei, the Chinese telecommunications giant, had facilitated spying on the US and its allies, they pointed out that Beijing had already made their case for them: first with the party’s systematic infiltration of private companies, and second with the introduction of a new national intelligence law in 2017. The law states that “any organisation and citizen” shall “support and cooperate in national intelligence work”. The director of the US National Counterintelligence and Security Center, when asked about China’s entrepreneurs, cited these two policies in asserting that “Chinese company relationships with the Chinese government aren’t like private sector company relationships with governments in the west”.

Such shifts, under Xi, have gifted the US and EU an excuse to limit Chinese access to their markets, technology and companies. Australia has cited the same intelligence law to keep Huawei’s 5G technology out of its future mobile networks. Gordon Sondland, Donald Trump’s envoy to the European Union, gave such sentiment a hyperbolic spin to argue that Europe should do the same. “We want to keep critical infrastructure in the western world out of Chinese malign influence,” Sondland said. “Someone from the politburo in Beijingpicks up the phone and says, ‘I wanna listen in on the following conversation, I wanna run a certain car off the road that’s on the 5G network and kill the person that’s in it’ – there’s nothing that company legally can do today in China to prevent the Chinese government from making that request successfully.”

Until recently, such a statement would have been laughed out of court. No longer. Nor would Washington have contemplated the policy of “decoupling” the US and Chinese economies – shorthand for the administration’s commitment, through taxes, tariffs and other punitive measures, to disentangle its companies and their technologies from China’s supply chains.

The relationship between the party and private sector companies is, up to a point, flexible – certainly more so than with state companies. The party doesn’t habitually micromanage their day-to-day operations. The firms are largely still in charge of their basic business decisions. But pressure from party committees to have a seat at the table when executives are making big calls on investment and the like means the “lines have been dangerously blurred”, in the words of one analyst. “Chinese domestic laws and administrative guidelines, as well as unspoken regulations and internal party committees, make it quite difficult to distinguish between what is private and what is state-owned.”

The answer to the question “does the party control a company?” is that it is impossible to tell. In the current environment, fewer foreign governments want to give Beijing the benefit of the doubt. If there was any question as to who was in charge of the economy and business, Xi’s local and overseas critics alike only have to take the Chinese leader at his word, that in private enterprises, as with state-owned firms and every institution in China, the party is the ultimate authority.

In the early optimistic glow of Xi’s ascension to the leadership, a number of western commentators talked up his appreciation of markets. After all, from 1985 to 2007, Xi had served in two provinces, Fujian and Zhejiang, which were thriving bastions of private enterprise. Starting in the 1980s, Fujian was an important gateway for investors from nearby Taiwan, while Zhejiang was home to a number of China’s most famous private companies, such as Jack Ma’s Alibaba. The arc of Xi’s father’s career, from revolutionary to reformer, reinforced this optimism about China’s new leader. Lu Guanqiu, a businessman who owned and ran Wanxiang, a private car parts group, told Bloomberg: “When Xi becomes general secretary, he’ll be even more open and will pay even more attention to private enterprise and the people’s livelihood. It is because he was in Zhejiang for five years.”

Yet a deeper dig into Xi’s past statements and writings on the economy reveals an official who has been a dogged supporter of party orthodoxy on the economy at every turn. Xi might have taken big risks in domestic and foreign policy, but on the economy he was not one for ideological experimentation. In the politburo, as vice-president from 2008 to 2013 and as the leader of the party school for most of the same period, there is little evidence of him straying from his core beliefs about the need to strengthen party control inside businesses.

When Xi arrived in Zhejiang in 2002, the province was already well on the way up the economic ladder. Xi headed a group of officials, known as the “New Zhijiang Army”, who embraced the use of private investment to spread the risk in funding the province’s signature infrastructure projects. In 2007, in a conversation with Washington’s then ambassador to Beijing, Clark Randt Jr, recorded in US diplomatic cables and later released by WikiLeaks, Xi delivered a sophisticated, self-aware exposition on Zhejiang. He didn’t pretend that there was any secret to the province’s wealth other than local entrepreneurs, although he avoided using the language of the market in describing them. Xi did what every other official with responsibility for the economy did at the time: he simplified registration for private companies and helped them to access finance. When the party debated a law to protect private property, he supported it. “With property protection in place, Chinese can gain even more wealth,” Xi told Randt.

But Xi’s support for mixing private and public ownership structures was purely pragmatic. It had value, he said in another forum, because it would “improve the socialist market economic structure”. Xi’s assessment is echoed by Michael Collins, one of the CIA’s most senior officials for Asia. “The fundamental end of the Communist party of China under Xi Jinping is all the more to control that society politically and economically,” Collins argued earlier this year. “The economy is being viewed, affected and controlled to achieve a political end.”

By 2012, when Xi came to power, the landscape had changed substantially. China was initially knocked sideways by the global financial crisis in 2008, before swiftly navigating its way back to fast growth through a giant fiscal stimulus orchestrated by the government and delivered by the big state banks. The economy was also changing shape. From around 2010, after the fiscal splurge of the financial crisis, Chinese technocrats began to focus more intently on cutting debt and lifting consumption. That meant less focus on investment and exports and, if you listened to the entrepreneurs, a greater reliance on private business to generate growth.

“Chinese consumption is not driven by the government but by entrepreneurship, and the market,” Jack Ma of Alibaba said in September 2015. “In the past 20 years, the government was so strong. Now, they are getting weak. It’s our opportunity; it’s our show time, to see how the market economy, entrepreneurship, can develop real consumption.”

Ma may have thought that the times suited him, and to a degree, they did. His business continued to soar. But Xi was all the time making sure that the party grew in tandem with the economy, in both the state and private sectors. In retrospect, Ma’s comments look dangerously cocky.

Xi spent much of his first term in power reining in the big state firms. Under his predecessor, Hu Jintao, many of the large state enterprises, big enough to be in the top 20 of the global Fortune 500, had grown into powerful empires and breeding grounds for serious corruption. In the words of analyst Wendy Leutert, Xi “faced the aftermath of a decade of rapid expansion and weak internal discipline in the state sector”.

In 2016, Xi chaired a national meeting that cleared the way for a more expansive role for the party in enterprise. In 2017, the measures were further extended, with the body overseeing big state companies directing them to write the party into their articles of association. In 2018, the securities regulator followed up by issuing a new corporate governance code requiring listed firms, at home and abroad, to include in their internal guidelines an expansive role for the party. Many Chinese companies listed in Hong Kong also wrote the party’s role into their articles of association.

In some ways, codifying in public documents the party’s role in managing companies was both an instance of rare transparency and part of an increasing trend of the party openly displaying its power. In the past, Chinese state-owned listed companies had customarily filed misleading prospectuses ahead of their stock exchange listings, omitting the party’s pivotal role in the hiring and firing of senior executives. Similarly, company boards had long been legally and theoretically independent of the party, but not in practice. “The same individual who is chairing a party committee meeting on a Monday might well be chairing a board meeting later in the week,” notes a 2018 report on Chinese corporate governance.

There has always been an awkward fit between western notions of corporate governance and the party state’s insistence on having a role in companies. “It is rather like drawing a tiger with a cat as a model,” said one Chinese commentator. But the direction of policy under Xi has been clear: the power that the party had over business decisions and personnel in state firms, once wielded behind the scenes, would not only be strengthened. The party’s power would also be exercised explicitly.

Xi’s shadow now looms increasingly large over private firms as well. In March 2012, a few months before taking over as general secretary, Xi delivered a speech in which he stressed the need to increase the number of party bodies inside private business. Around the same time, new details for “party building” in enterprises were released, calling “for the party secretary to participate in and attend important executive-level meetings”.

The party’s efforts to place itself inside private companies have been, according to its own figures, very successful. One recent survey by the Central Organisation Department, the party’s personnel body, found that 68% of China’s private companies had party bodies by 2016, and 70% of foreign enterprises. Although these figures sound high, they don’t match the targets the party has set for itself. In Xi’s old stamping ground of Zhejiang, for example, officials set a target in August 2018 to have cells inside 95% of private businesses. There was a need, the survey said, to retain the revolutionary spirit inside the companies as their ownership was handed on to the next generation.

Although the party is becoming more involved in private firms than ever, it wants to be part of business successes, not failures. It wants to sit alongside local and foreign entrepreneurs and share their wealth, not run their companies into the ground. Increasingly, it also wants to do more than supervise companies. It wants to be at the table when commercial decisions are made, not just manage staff. “We should make money together,” Lu Wei, then head of China’s party office for internet security, told Paul Jacobs, CEO of Qualcomm, a US chip maker, in 2014. Lu’s comments to some extent reflected Beijing’s desire to acquire Qualcomm’s technology, a sector in which China was weak. But the message was clear: the fat of the land should be shared with the state.

The party’s overarching aim, though, has remained consistent: to ensure that the private sector, and individual entrepreneurs, do not become rival players in the political system. The party wants economic growth, but not at the expense of tolerating any organised alternative centres of power. During the 1990s, Chinese leaders watched in horror as the Soviet Union disintegrated and its assets were privatised. Having seen business threaten to take over the state in Russia, Beijing has been determined to make sure that the same disaster does not befall China.

For a reliable benchmark about the power of the party in China, you only need to listen to wealthy entrepreneurs hold forth on politics. These otherwise all-powerful CEOs go to abject lengths to praise the party. To take a few companies listed in a single article in the South China Morning Post, Richard Liu of e-commerce group JD.com predicted communism would be realised in his generation and all commercial entities would be nationalised. Xu Jiayin of Evergrande Group, one of China’s largest property developers, said that everything the company possessed was given by the party and he was proud to be the party secretary of his company. Liang Wengen of Sany Heavy Industry, which builds earthmovers, went even further, saying his life belonged to the party. “They act as if they are being chased by a bear,” wrote Zhang Lin, a Beijing political commentator, in response to these comments. “They are powerless to control the bear, so they are competing to outrun each other to escape the animal.”

Jack Ma of Alibaba, the global face of Chinese entrepreneurship, has always managed to strike a quirkier and more independent stance than his fellow billionaires. “Be in love with the government. But don’t marry them,” he memorably said at the World Economic Forum in Davos in 2015. Ma’s pithy aphorisms at home and abroad were mostly a plus for his business, but they had a downside. Ma’s high profile made him vulnerable. Last year, one of Ma’s former business partners told me, only half-joking, that if there was a presidential election in China tomorrow, Ma might win. That, he added, was a dangerous position to be in.

In September 2018, Ma unexpectedly announced that he would step downfrom a day-to-day role in the company the following year. Ma said he wanted to focus on education and philanthropy. An equally plausible reason for his resignation, the former business partner said, was Ma’s fear that his power and popularity had made him a target of the party. Ma has been in the party since the 1980s, although his membership was not declared until late 2018, after his retirement announcement, in an article in which the People’s Daily newspaper complimented him for his contributions to reform.

Whether or not some entrepreneurs were intent on taking him on, Xi pre-emptively took the fight to them. In 2017, his administration began a campaign to rein in swashbuckling business leaders, starting with some of the corporate chieftains who had become the standard-bearers for aggressive Chinese dealmaking overseas. Some business leaders were forced out of overheated commercial sectors such as real estate. Others were told to pull back from offshore forays, either because their high profile was an embarrassment for Beijing or because the government was trying to stop capital flight. Some, such as Wu Xiaohui, the chairman of Anbang Insurance Group, went the way that communist members who fall foul of the system often do, vanishing without explanation into the party’s detention system. Only months earlier, Wu had been leading negotiations to spend $14bn on hotels in the US, but the deal collapsed. In May 2018, the authorities announced Wu had been sentenced to 18 years in jail for fraud and embezzlement.

Meanwhile, China’s three dominant internet companies, Baidu (a search engine), Alibaba (e-commerce) and Tencent (messaging and gaming), known collectively as the BAT, have all felt the government’s wrath. In 2018, Tencent lost $200bn in its market capitalisation after regulators stopped approving new online games, pushing the company out of the world’s top 10 companies ranked by their share market valuation. The rapid growth of the BAT companies and their dominance of the internet in China has given them an outsized economic status. But their political value is just as important, as they have become indispensable to China’s surveillance state. With the mountain of data they generate, the BAT trinity are in effect turning into a real-time, efficient and privately run intelligence platform. In that respect, they are seen as ideal private companies. They both drive economic growth and also buttress the political system.

Foreign CEOs, too, have come under pressure to give the party a larger role in their firms. Again, this is a trend that began before Xi. Walmart, which famously won’t allow unions in its US stores, has had party cells in its companies in China since at least 2006, and party-controlled unions even earlier. Under Xi, however, emboldened officials have pushed foreign firms harder to accommodate the party and give its representatives a role in business decisions.

Now a wide range of foreign companies in China, from the cosmetics giant L’Oréal to Walt Disney and Dow Chemicals, all have party committees and display the hammer and sickle on their premises. In 2017, Reuters published an article that quoted executives from one European company saying that party representatives had demanded to be brought into the executive committee and have the business pay their expenses. Like Chinese entrepreneurs, foreign businessmen and women are trying to outrun “the bear”, not always with success.

But the party’s persistent efforts to colonise the private sector have stoked a backlash of their own. In late 2017, the EU business chamber in China formally complained about party organisations trying to extend their influence in their member companies, something they said would undermine the authority of their boards.

Yet the chamber’s argument was met with indifference in China, at least in public utterances. “When you are in Rome, do as the Romans do,” said Chen Fengying, an expert at the China Institutes of Contemporary International Relations, a foreign policy thinktank. “Foreign investors should respect local rules and regulations in China.”

On one level, Xi has been untroubled by the backlash over his treatment of entrepreneurs. From his point of view, the idea that the private sector is being overly politicised is upside-down. Business leaders should “strengthen self-study, self-education and self-improvement,” he said in 2016. “They should not feel uncomfortable with this requirement. The Communist party has similar and stricter requirements on its leaders.”

Later, in 2018, when the economy started to slow and the trade war was ramping up, Xi was much more pragmatic and solicitous. In November, he invited a select group of entrepreneurs, including Tencent’s Ma Huateng (also known as Pony Ma), for a meeting in the Great Hall of the People. He wanted to reassure them that they were “all part of our family”. At the same time, a surfeit of stories appeared in the official media urging banks to lend private firms more money.

But not all entrepreneurs were buying the new line. One businessman, Chen Tianyong, posted a lengthy rant on social media, which he titled “An Entrepreneur’s Farewell Admonition”, explaining why he had left China. “China’s economy is like a giant ship heading to the precipice,” he wrote in a post that was later taken down. “Without fundamental changes, it’s inevitable that the ship will be wrecked and the passengers will die.”

Adapted from Xi Jinping: The Backlash by Richard McGregor, published by Penguin Books.