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Private Sector Battles March of Chinese State

Simon Rabinovitch in Hangzhou, China
Sunday, 11 Nov 2012 | 11:49 PM ET

It was just before dawn when the demolition crew arrived at the Wanqiang silk dye factory, and staff were still asleep in the dormitory. A scuffle broke out, but the drowsy workers were no match for the hundred-strong crew armed with heavy machinery and sledge hammers.

The boss of the factory called the police but was told they could do nothing – the demolition crew had been sent by an investment company owned by the municipal government.

It was eager to get its hands on the land occupied by the factory in Hangzhou, a wealthy city in Zhejiang province, eastern China.

"Our relationship with the investment company is like that between a sailboat and an aircraft carrier," said Xu Zhongwei, Wanqiang's vice-general manager.

This battle between state-owned juggernauts and smaller private companies has played out across China with increasing frequency over the past decade. The state has more often than not been the winner.

A debate is raging inside and outside government about whether to halt this trend, known in Chinese as guojin mintui, meaning "the state advances and the private sector retreats". With the country's top leaders gathered in Beijing this week for the Communist party congress, held once every five years, this is the issue that lies at the heart of their discussions about economic policy.

Reformist officials see the growing power of state-owned companies as the biggest risk facing the Chinese economy, threatening to sap it of the entrepreneurial vitality that has driven so much of its spectacular growth since the late 1970s. A conservative establishment has, however, pushed back, arguing that state-owned companies play a steadying role in an unruly marketplace.

Judging from the comments at the congress so far, the debate is far from being settled.

In his opening address on Thursday, Hu Jintao, the outgoing party chief, said: "We should steadily enhance the vitality of the state-owned sector of the economy and its capacity to leverage and influence the economy". In the same breath, however, he also said "we must unswervingly encourage, support and guide the development of the non-public sector".

(Read More: China's New Leaders—the Lineup)

The challenges facing private companies are readily apparent in Zhejiang, the province that has produced many of China's most successful entrepreneurs – from Jack Ma, founder of e-commerce giant Alibaba, to Zong Qinghou, the country's richest man who made his fortune in the beverage industry.

The news out of Zhejiang has been grimmer of late. Scores of smaller manufacturers have gone bankrupt and the province's banks have the highest ratio of bad loans in the country.

There are many explanations for the troubles, including a property bust and rising labor costs, but the domination of the state sector is perhaps the single biggest factor.

A senior banking official in Hangzhou, the provincial capital, said that entrepreneurs who strike it rich had found that there was little they could do with their money. They are blocked from investing in seven sectors, such as oil and shipping, over which the government asserted "absolute control" six years ago, and they have limited access to nine others including autos and construction in which state companies were granted "relatively strong control".

"So private companies have speculated on property. There should not have been a property bubble but they were lured into it," the banker said, speaking on the condition of anonymity.

China's biggest state-owned enterprises, the 100 or so such as Bank of China and China Mobile, which are managed by the central government, have reaped the benefits from their monopolies. Their assets over the past decade quadrupled to Rmb28 trillion ($4.5 trillion), equivalent to 60 per cent of gross domestic product.

In Hangzhou, they have been busily expanding their footprint.

In August, PetroChina, a government-run oil major, acquired the city's largest petrol station from a private company which had operated it for two decades. Just up the street, two state-owned companies had a few months earlier bought a one-third stake, with an option for a majority, in the city's glitziest new commercial complex, the Xizi International Centre, from a private property developer.

In many cases the advance of the state is less obvious. Rather than state-owned behemoths, the protagonists are smaller, often indirectly owned by local governments through financing vehicles.

For the Wanqiang silk dye factory, its nemesis was a local financing vehicle, the Hangzhou City Construction and Investment Company. The Hangzhou city investment company sent demolition crews three times, starting in late 2010, to push Wanqiang off its land, clearing it for a real estate project.

In most other parts of China that would probably have been the end of the story. But Zhejiang's entrepreneurs have been the country's most vocal in criticizing the state's encroachment. Wanqiang decided to test the government's pledge to accord private companies equal treatment under the law.

In early 2011 it filed a lawsuit, seeking nearly Rmb20 million in damages. Last month a local court awarded it Rmb7 million, an extremely rare instance of a private company slowing – though not halting – the march of the state.

Xia Jingjing, a lawyer who represented Wanqiang, said it was only the beginning.

"We can't be too scared to stand just because an opponent has a government background. If the weaker parties give up, their rights will shrink," she said. "For our society and country, this is a very frightening prospect."