- Xi sees Common Prosperity as key to the Party’s long-term legitimacy
- But it is not all bad news for investors – new opportunities may emerge in innovative SMEs
- Large private firms in tech and property will continue to suffer
- The goal of Common Prosperity is to massively increase membership of the middle class
- That involves providing opportunities for social mobility and wealth creation
- This includes trying not to treat small private companies like second-class citizens any more
On August 17, the Central Committee for Comprehensively Deepening Reform (CCCPR) – which is chaired by Xi Jinping and is the main body through which Xi sets reform priorities – significantly realigned the Party's priorities by placing "Common Prosperity" at the heart of economic policy.
The statement rattled investors globally. Following on from Beijing's crackdown on big tech and for-profit education providers, Common Prosperity seemed to codify a shift toward squeezing the private sector in the name of income redistribution.
However, while Common Prosperity has populist elements that take aim at "excessive incomes", it is a far more sweeping vision than initial coverage by the English-language press implies.
It envisages expanding China's middles class by increasing incomes, reducing household costs, and – perhaps most radically – providing new opportunities for social mobility and wealth creation.
We will be looking into what Xi’s vision entails in a series of Enodo Weeklies. In this first report we will examine one of the main ways in which the Party intends to achieve the last point: how to encourage entrepreneurship and support small, private businesses.
Helping small and medium sized enterprises (SMEs) – a group made up almost exclusively of private sector firms and accounting for the bulk of employment – has long been a goal of Xi's administration. But what Common Prosperity does is elevate support for SMEs from a policy prescription to an ideological imperative.
This will create new investment opportunities in China's capital markets as paths are opened to help promising small firms fulfil their potential. As we wrote in “How Long-Term Value Investors Should Think About China”, “Tech start-ups in the key areas Beijing wants to develop are one place to look.” That said, it remains to be seen whether Beijing is able to overcome the institutional barriers that stand in the way of small firms becoming more significant players in the economy.
Common Prosperity, then and now
Common Prosperity isn't a new concept. Rather, it's baked into the Chinese Communist Party's vision of its ultimate goal. As Enodo has written before, Deng Xiaoping famously determined that Common Prosperity wasn't attainable while he was leader and that it was first necessary for China to achieve a certain level of development. He decided that it was necessary for some regions and people to prosper first, and for others to follow in their wake.
Xi believes that phase has passed and that it's now time to start tackling the inequality that's been allowed to take root.
Dealing with inequality has been one of the hallmarks of Xi's administration. Thus far the focus of his efforts has been on poverty alleviation and his Rural Revitalisation campaign. Earlier this year the Party announced that that absolute poverty had been eradicated. With that hurdle out of the way it's time to move onto the next challenge – bringing about Common Prosperity.
The initial statement from the CCCPR was thin on detail. Subsequently, Xi fleshed out some of the key ideas in an essay on October 15 in "Seeking Truth", one of the Party's principal publications. But the concept didn't spring fully formed from the head of Zeus in August. Rather, it has been percolating for about a year.
Xi started using the expression at the end of last year, and in November 2020 Liu He published an essay in the People's Daily that outlined many of the chief tenets of Common Prosperity – minus the more populist elements. Moreover, some of China's top economists, like Yang Weimin – who used to be Liu's deputy – have been talking about redistribution issues for the past year. In hindsight, these comments were laying the groundwork for Common Prosperity.
We also have some ideas as to what Common Prosperity will look like when translated into policy. In June, the central government named Zhejiang province as a pilot zone for realising Common Prosperity, and in July the provincial government put together a raft of measures designed to do just that.
Common Prosperity is best understood as an overarching ideological framework that brings together various strains of government policy into a coherent whole.
Some of those policy strains are already in effect; some will be introduced in the coming years. But like Dual Circulation and Supply Side Structural Reform – other big picture economic frameworks – it is a way of giving coherence to policymaking across a range of areas.
But unlike those two other concepts, Common Prosperity is more deeply rooted in ideology, in the Party moving China further along the road to socialism and eventually to communism. Additionally, while those other economic slogans were relevant for relatively short periods of time, Xi has said that Common Prosperity will form the foundation of the Party's long-term governance.
At its heart, Common Prosperity is about wealth redistribution.
According to the readout of the CCCPR meeting, Beijing wants “[income] distribution to be olive-shaped, where the middle is large and the two ends are small”.
Efforts to achieve that will broadly fall into three categories. Beijing will strive to reduce household costs, whether that be housing, healthcare, education, childcare or eldercare. The second is to raise household income. While part of that involves boosting salaries and wages, it also looks as though reallocating wealth by increasing the public's participation in capital markets will also play an important role. And third, Common Prosperity is about giving people a chance to develop their own wealth, through education and entrepreneurship.
Dare to start a business
The CCCPR statement on Common Prosperity says that "key is to encourage people who work hard...and dare to start a business".
Specifically, it says that the Party should:
- “Create space for small and medium-sized enterprises.”
- “Encourage getting rich through hard work and innovation.”
- "Increase the people’s education levels…and give more people the opportunity to create wealth.”
In short, Common Prosperity is nominally pro-private sector.
That may seem a little disingenuous at a time when China's most successful private sector firms are being buffeted from all sides by multi-pronged regulatory crackdowns. Beijing is aware of the seeming contradiction, and a few days after the CCCPR meeting the People's Daily published a front-page column in which the Party reaffirmed that it stood by the private sector:
“The commitment to create a good environment and provide more opportunities for the development of the non-public sector of the economy has not changed.”
So, what accounts for the seeming contradiction?
Beijing is unequivocally committed to helping small, private companies. For years now the central authorities have been trying to ensure that SMEs have better access to credit, with mixed results. Meanwhile, Premier Li Keqiang's signature policy initiative – one that Xi has repeatedly endorsed – has been to reduce fees and cut red tape for entrepreneurs to start businesses.
The pandemic has further highlighted the importance of small firms to the economy. SMEs are responsible for 80% of urban employment, and the revival of the economy is in large part dependent on SMEs regaining their health. Since mid-2020, pandemic recovery efforts have been squarely focused on helping small firms, with the central bank going so far as to use its own balance sheet to increase the amount of credit available to SMEs.
Cursed by greatness
Large private firms, however, present a problem.
One of the defining features of Xi's administration has been rolling back the power and influence of China's most successful private companies.
That started a few years ago when Dalian Wanda, HNA Group, Anbang Insurance and Fosun Group were told to pare back – and in some cases divest entirely – their global acquisitions. More recently, the focus of attempts to rein in the private sector have shifted to China's two most successful groups of large private firms – internet platforms and property developers.
One of the reasons Beijing curbed the global ambitions of China's most acquisitive companies is that their executives were being feted globally like rock stars, meeting with world leaders and giving speeches at international economic forums. In short, they'd become self-appointed ambassadors for China and yet were acting in their own interests. In effect, they were developing their own political influence outside of the Party. Similarly, it's no coincidence that the crackdown on the tech sector started when Jack Ma publicly criticised China's regulators for their heavy-handed treatment of financial innovation.
In the eyes of the Party, the private sector is tolerated as long as it serves the interest of the state, and large private firms too easily stray from that path.
Private sector firms also pose other challenges when they get too large. One of the reasons Beijing is clamping down on the tech giants is because they use their size to reinforce their market dominance. Such anti-competitive behaviour undermines opportunities for smaller firms to develop. Additionally, large private firms are able to readily access bank credit – which the Party regards as a state resource – but then deploy those funds in ways that don't serve the national interest.
That was one of the reasons Beijing cracked down on the private sector's international expansion. Building six-star hotels and buying European soccer clubs were wasteful vanity projects that did nothing to further China's interests. It's also one of the reasons it's coming down hard on the real estate sector: developers' easy access to credit has inflated housing prices, raised the cost of living and worsened inequality.
It's no coincidence that Yang Weimin – Liu He's former lieutenant – said in an interview in December that corporate earnings in the real estate and technology sectors need to decline relative to national income in order to boost household incomes.
In short, Xi sees developing small private firms as a way to distribute wealth more equitably, but large private firms are both a barrier to Common Prosperity and a challenge to Party authority.
Additionally, small firms are vital to developing the sort of innovative technologies that are necessary to help transform China's economy along the lines that Xi envisions.
What's in store for SMEs
For small firms, we expect Common Prosperity will mean the following:
- Greater protection of intellectual property, particularly for firms in industries identified as priorities by Beijing.
- Greater opportunity to build businesses online without the tech giants operating as gatekeepers and rent collectors.
- The Zhejiang blueprint for Common Prosperity calls for identifying "hidden champions" among the province's SMEs. That's likely to mean that local authorities will provide additional support for those companies that align with Beijing's priorities but also have the potential to scale up.
- Better access to credit and capital markets. The launch of the Beijing stock exchange for SMEs is a way for promising small firms to access the funds they need to expand. It's also a way to encourage local venture capital by giving investors a way to exit locally rather than having to go overseas.
Ultimately, Xi might be striving for a private sector that looks similar to that of Germany's Mittelstand – a large stable of small private firms that are innovative, generate high-paying jobs and produce technologically advanced manufactured goods. However, making such a transformation will prove a real challenge.
Despite their importance to China's economy, SMEs are treated as second-class citizens.
State firms and local governments are notorious for pushing their own financial stress onto small, private sector suppliers and contractors by postponing payment. Moreover, local governments routinely make up shortfalls in their own budgets by squeezing the private sector. Additionally, identifying "hidden champions" seems little different from picking winners, and will tie ambitious private firms not just to the interests of the state but to the needs of local officials.
Xi Jinping’s proclamation of the goal of Common Prosperity is a watershed for China. Xi has made it clear that achieving Common Prosperity is critical in the long term to underpin the Party’s legitimacy. Hence from now on reduction of inequalities and support for entrepreneurship will be at the heart of China’s economic policies.
Xi is clamping down on big private sector companies that he regards as a potential threat to the Party’s monopoly on power. But the sharpened focus on SMEs will provide new investment opportunities for global investors that are able to identify firms with local backing and proprietary IP that have aligned themselves with the interests of the Party and its vision of Common Prosperity.