Editor's note: While stories detailing the unsavoury working conditions of factories (a la Foxconn), shoddy quality control measures, squandered foreign investment and other problems typical to foreign companies in China are all commonly discussed topics, insights into the current business climate in China for Chinese companies are slightly less common. In particular, stories covering the vast range of issues facing China's small and medium enterprises (SMEs) and struggling entrepreneurs are near non-existent. The following article, written by the deputy director of the International Strategies Research Institute at Central Party School – China's highest institution for training new government officials – seeks to shed some light on what the author has deemed "the institutional risks making it hard for China's small businesses to succeed".

Photo: bandao.cn

If you were to take a snap shot of China's business climate today, it would likely be comprised mainly of omnipresent state-owned enterprises (SOEs) such as China Mobile and Sinopec; a handful of large, privately owned Chinese companies such as Baidu and Lenovo and a healthy sprinkling of popular foreign corporate brands like McDonalds, Nike etc. What you will not see is an overabundance of successful SMEs and small businesses, for the simple reason that the "institutional risks" associated with starting and running a small business in China are so overwhelming that most who try, eventually fail.  

The author identified the following four "institutional risks" for SMEs and small businesses in China:

1) High administrative threshold to start-up business
In many countries, it's very easy to register small businesses, but in China, a complicated registration-based system is used which makes it much more difficult for small businesses to get the licence and approval needed to operate. Many countries will issue permits to street vendors, permitting them to operate in designated places at designated times, but in China street vendors are prohibited, and the City Administration forces strictly control these "illegal operations". Unlike in many Western countries, where you can easily register just about any business you like as long as the name is unique, entrepreneurs in China must first go through an application process and get approval for their business registration. These barriers make it more difficult for China's entrepreneurs to access the market than in many other developed and developing countries. In addition, while opening a business inside your residence, like Bill Gates and Steve Jobs did in their families' garages, is legally permitted in other countries, in China it is basically prohibited (it is somewhat allowed in certain areas, entrepreneurs are still faced with quite a few restrictions). The result of these restrictions is that if entrepreneurs want to legally set up a business, they must first front a large sum of money for office space rental.

2) Government's approval process is unnecessarily complicated 
Although China (arguably) has a market economy, the government still maintains a lot of control over it due to its various approval and licensing processes. A business may be subject to a dozen annual inspections per year, and even a single company car may require repeated annual inspections through different government departments. Meanwhile, no other developed country has a similar kind of annual inspection system. In total, Chinese businesses may need to spend several months dealing with these annual inspections for the government and administrative departments, in addition to paying high public relations costs.

3) Taxes, taxes, and more taxes
For some government departments and administrative law enforcement agencies, funding doesn't only come from financial allocation, but rather from the "two lines of revenue and expenditure – surplus collection awards and imposed fines divided bonuses", which in layman's terms means that they'll bend over backwards looking for things for which to fine small businesses. Foreign businesses, foreign-funded businesses and large Chinese businesses are generally better protected, so the City Administration forces and quality inspection departments will generally direct their efforts at "cleaning out" local and small businesses instead. Moreover, SMEs are also burdened with a 17% value-added tax (VAT), a 5.5% (or higher) sales tax, and a personal income tax on year-end bonuses for employees. According to the Forbes "Tax Misery Index" from 2009, China ranked second in a list of countries or regions with the harshest tax regimes in the world, although Forbes' calculations didn't include the various fees and fines collected by the government's administrative agencies. No doubt, if these were included in the calculation, China's "Tax Misery" ranking would far exceed that of France, who is currently ranked first in the world. It's no small wonder that under these heavy taxes and fines, many SMEs find it hard to stay in business.

4) Loans are hard to get; interest rates are high
Because China's banking industry has a monopoly on who gets business loans, it's nearly impossible for micro enterprises to ever secure loans from banks. This is doubly true for small businesses with low operating costs, as banks are unwilling to let them open accounts because they won't turn a profit from their service. Many small businesses are unable to make transactions using public enterprise accounts, which leads to many missed opportunities. Even if a small business is able to secure loans from a bank, the combined interest rate of the various service charges ends up being twice as high as those paid by state-owned enterprises (SOEs). Consequently, small businesses usually have no choice but to find underground channels for funding, such as borrowing from loan sharks. These private loans often carry an interest rate that is as high as 40% — even higher during tense periods such as the loaning crisis last year in Wenzhou when interest rates reached 100%!

How does China compare to the rest of the world?

When compared with other countries, it becomes clear that institutional risks are hampering the development of China's small business entrepreneurs. On average, there are about 45 SMEs or large companies per 1,000 people in developed countries, while there are only about 13 per 1,000 people in China (even many developing countries has 25-35 SMEs per 1,000 people). Another way to look at this problem: in China, less than 2% of college graduates start a business within the first three years after graduation, compared to 20% of college graduates in developed countries.

According to the global average data, 70-80% of a nation's employment should be in SMEs, which are also closely tied to youth employment. Normally, high youth unemployment in other countries is solved by adopting measures to reduce taxes, which encourage entrepreneurs and the development of small businesses. For example, the Obama administration's 2013 budget introduced an 800 billion USD plan to expand employment, of which 300 billion USD was set aside to cut taxes (tax cuts accounted for 7.9% of the overall budget). Meanwhile, China last year introduced a 200 billion RMB plan to support SME financing, which will likely be insufficient. 
 

Source: finance.huanqiu
 

Related links
The Great Gamble: Starting a Business in China
Business Mismanagement: Private Lending Backfires in Wenzhou
Why Americans Worry that Chinese People Won't Save Money

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Keywords: Chinese entrepreneurs risky business in China China small and medium enterprises problems institutional risks for business in China chinese entrepreneur struggles