China's small businesses have been forgotten in the rush to economic growth

China's 60 million micro and small-sized enterprises are the lifeblood of the economy, but many are struggling to survive.

MSEs make up 98 percent of China's businesses, contribute 60 percent of GDP, and provide 80 percent of urban jobs and 90 percent of other jobs. Less obviously, they are innovators, producing the bulk of new business models, which is crucial to China's economic transformation, its growth and its ability to compete internationally.

What's more, by alleviating employment problems in the low-skilled labor force, MSEs contribute greatly to balanced economic growth and long-term social stability.

China's MSEs have been growing ever since the nation reformed its state-owned enterprises, cut government departments and joined the World Trade Organization around the turn of the century.

But in recent years, with low domestic and overseas demand, high production costs and shortage of funds, they have found themselves in increasingly perilous situations. It is estimated that 20 percent of MSEs have been forced to stop operating or are in a state of semi-shutdown. Most of the others are struggling to survive on very low profit margins.

Learning from established international practice, the Chinese government has begun to help its MSEs by cutting taxes and encouraging banks to provide loans and special funds. However, it seems that these policies are ineffective and the problems MSEs face stem from deeper difficulties.

For the past 10 years, on the one hand government has grown, and its taxes and rent-searching behavior have become more and more unbearable for MSEs. On the other hand, state-owned enterprises have imposed tighter controls on important industries, with the result that MSEs do not have access to promising industries.

Many MSEs started in low-end manufacturing, which produces low profits. This left them no extra money to invest in sales channels, brand building, research and development or staff development. So it is no surprise that they are vulnerable to fluctuations in demand or production costs, and that banks are therefore reluctant to lend to them.

In the short run, the government should take steps to solve the urgent problems facing MSEs. The primary issue is that the tax burden is so heavy that many MSEs cannot survive unless they cook their books to avoid some of the duties.

Although the government is cutting some taxes, this policy will not alleviate much of the pain. In the short term, the government should exempt micro-sized enterprises from all taxes and cut most of the taxes imposed on small-sized enterprises to give them have a chance to take a breath.

Another important issue is that most MSEs struggle to obtain loans. The government should increase the size of special funds for MSEs while continuing to encourage large banks to provide loans to struggling small businesses. The government should urgently set up a deposit insurance system and reduce the threshold for establishing small banks. After all, small local banks should be the source of loans to MSEs. In the United States, there are almost 10,000 banks, but there are only hundreds in China.

In addition, the government should set up a high-level department to provide MSEs with professional services in credit guarantees, training, information sharing, technical assistance and government procurement.

In the long run, the government should improve the general business environment for MSEs.

First, state-owned enterprises should withdraw from all competitive industries and the government should strictly protect patents, prohibit unfair competition and, especially, limit administrative monopolies.

Second, the government should ease financial restrictions by developing multilevel capital markets, including all kinds of private equity and over-the-counter trading. It should also open financial markets to more private capital.

Third, the government should reduce its size and increase its efficiency, changing from a control-oriented government to a service-oriented government. If it reduces its spending, it will be able to spend the savings on improving social welfare. In this way, ordinary people will be released from worries about housing, pensions, education and healthcare, and will be able to spend more on consumption and taking some entrepreneurial risks.

Finally, education should be broadened to be more market-oriented instead of the status quo where it rarely meets the needs of industry.

The author is a lecturer at the Management School of Shanghai University and a research fellow at the China Europe International Business School Lujiazui International Finance Research Center.

(China Daily European Weekly 06/28/2013 page9)