The Australian National University’s annual free China Update book is bigger and more interesting than usual this year, in honor of the 40th anniversary of the start of reform and opening up in 1978. It’s got contributions from lots of prominent China economists that I have only begun to work my way through.
Naturally, I immediately checked out the chapter on private sector development by Nick Lardy. It’s quite a useful update to his work on the economic weight and role of the private and state sectors, and includes a careful, data-driven assessment of the resurgence of state enterprises under Xi Jinping. Here is a section where he identifies the symptoms of the crowding-out of private investment by SOEs:
The most plausible explanation of the waning of private investment is crowding out—an explanation supported by several pieces of evidence.
First, the share of bank loans to nonfinancial corporations that went to private firms fell from 57 per cent in 2013 to only 19 per cent by 2015, while the share that went to SOEs almost doubled over the same period—from 35 per cent to 69 per cent.
Second, financing of private firms through microfinance companies stalled after 2015. Lending by these companies grew rapidly from 2008, when the People’s Bank of China and the China Securities Regulatory Commission first issued formal guidelines on microfinance companies. The volume of such lending levelled off at just less than RMB1 trillion in 2014, but has not grown since.
Third, between 2011 and 2015, SOEs’ profits rose by only RMB30 billion, or 1 percentage point, while the investment of these firms rose by almost RMB2 trillion, or more than 20 per cent. Much of the differential between the growth of investment and the growth of profits must have come from increased borrowing from banks.
Fourth, indirect evidence suggests that SOEs have borrowed increasing amounts of funds to cover their financial losses. In 2005, 50 per cent of all SOEs were lossmaking. By 2016, the share of lossmaking SOEs had declined slightly, to 45 per cent. Thus, roughly half of China’s SOEs for more than a decade have been unable to fully cover their cost of capital. Moreover, the magnitude of losses generated by lossmaking firms increased sevenfold, from RMB243 billion in 2005 to RMB1.95 trillion in 2016. As a share of GDP, these losses doubled, from 1.3 per cent in 2006 to 2.6 per cent in 2016.
The interesting question at the moment is how this crowding-out of the private sector evolves in response to the government’s campaign to rein in financial risks. Surprisingly, one of the big casualties has been investment by state entities: there’s been a sharp slowdown in infrastructure investment as the central government has tightened controls over local government fundraising. Mostly as a result, the non-state share of fixed-asset investment rose to 65% in the first half of 2018 from 63% in 2017.
But it would be unusual for tighter financial conditions to really benefit private-sector firms, which tend to be smaller and riskier borrowers than state firms. And there is indeed a great deal of official concern at the moment over small businesses losing access to credit.
(Also see this previous post for other references on the crowding-out of private-sector investment.)
The Tangled Woof 
Could it be that, rather than being caused by crowding-out, the reduced loans to private enterprises are simply the result of a PBOC directive to banks?
Given the general lack of profitability of SOE’s, it seems unlikely that they would be better credit risks than private non-financial enterprises. So they wouldn’t be able to “crowd-out” lending to private enterprises by being more competitive. A bank would always choose to lend to the better credit risk, absent a directive to do otherwise.
Do private enterprises and SOE’s compete head-to-head in China? If not, then “crowding-out” is unlikely. Banks seek to diversify their loan books across industries. If SOE’s and private businesses are not in the same industries, they would not be competing for the same load dollars and crowding-out could not occur. There would have to be another cause of the change in the banks’ loan books.