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4.2.5 Comparison of Economic Systems

From the perspective of political structure, China is proceeding more smoothly in implementing policies for foreign investment and economic development. However, from the perspective of economic systems, particularly corporate activities and market mechanisms, India is superior. In his book, Tarun Khanna asked the question, “Why can large companies be created in China, with only a handful of them being competitive internationally?” India has companies such as Infosys that is hailed in the book “The World Is Flat,” and Tata Motors, a well-known manufacturer of passenger vehicles. In addition, Mittal, India's steel manufacturer, merged with Europe's Arcelor to become the world's largest steel company.

China's Communist Party created an economic system in which, pursuant to the construction of a socialist state, the state owns all assets and distributes these assets to the citizenry. Formerly, China had privately owned companies similar to the Tata Group, but they escaped to Taiwan, Hong Kong, and other locales when the People's Republic of China was established. With the economic reforms of Deng Xiaoping starting in 1978, the country began integrating competition via market mechanisms into the domestic planned economy. The country did away with the system of wealth distribution through state-owned corporations that followed planned production activities, as well as price controls, implementing a system of free trade of goods in product markets. The reforms for state-owned corporations were put in place and many companies moved to become joint stock entities with limited shareholders or limited liability corporations. Figure 4.3 lists the changes in share of total value added by form of ownership among Chinese manufacturers (20,000–40,000 mediumand large-sized firms). The state-owned corporations commanded over 70 % share in 1995, but decreased to roughly 20 % in 2011. On the other hand, limited liability corporations (or joint stock companies) had the greatest share increase. The greatest change occurred in the period from the latter half of the 1990s to the first half of the 2000s because of the reforms for state-owned companies that were put in place from 1998 to 2000 by then prime minister, Zhu Rongji. The aim of those reforms was to “grab the large and free the small,” i.e., the state would directly control large firms, whereas small firms would be converted to joint stock entities and its corporate activities liberalized. The State-Owned Assets Supervision

Fig. 4.3 Share of value added by type of ownership among Chinese manufacturers (Source: Estimates compiled from China National Bureau of Statistics data)

and Administration Commission (SASAC) was created in 2003 to keep management of all state-owned enterprises in one place. However, companies that had been converted to joint stock firms often had the government or government personnel as major shareholders, so a large portion of the Chinese economy was still essentially under the control of national or local governments.

Until it was revised to allow for individual ownership of assets in 1999, making possible the creation of fully private firms, private companies were forbidden under the Chinese Constitution. It was possible to manage private businesses as entities called “individual companies,” but revisions to laws allowed for purely private management of firms as companies. However, while the number of private companies in China is large, most are small businesses because everything in the business world in China happens with government involvement. For example, when funding from financial institutions becomes necessary for a new venture, banks will prioritize funding to private corporations backed by the government for its perceived low risk. Under competitive circumstances, there should be banks that will take risks and invest in powerful private firms. However, most large banks are state-owned, with once again bringing the overall industry under the strict control of the state. Huawei Technologies is one of the few private Chinese companies that is internationally competitive. Founded in 1988 as a wholesaler of telecommunications equipment manufactured overseas, Huawei has become a truly global vendor with half of its revenues from switches, cell phones, and other telecom equipment sold outside China. However, even Huawei had difficulty raising capital when it was starting out. The importance of government relations is not limited to raising capital. As observed in Fig. 4.3, state-related businesses account for a great share of the Chinese economy. Accordingly, the counterparties to the private companies that operate in China are state-related businesses. In a B2C business model, sales channels are necessary to deliver a company's products to consumers. Because deregulation in the distribution market, whether wholesale or retail, has been delayed, companies are forced to do business with companies having some connection with the government. Thus, the bureaucracy in China—and in its background, the Communist Party—has spread its net wide across economic activities, making it impossible to do business without touching its network.

However, India has an economy primarily driven by private companies. The core companies among these are multifaceted group companies such as the Tata, Reliance, and Birla Group. For example, the Tata Group began as a textile mill in Bombay (today's Mumbai) in 1870, and continued to grow its operations after Indian independence. Among its group companies are Tata Motors, the third largest passenger vehicle maker in India, and Tata Consultancy Service (TCS), India's largest IT services firm. Other group companies span a broad array of industries including power, steel, and wireless services. There are companies like Infosys, which started in 1981 with the equivalent of 30,000 yen in capital, and has grown to become one of the few world-class IT service company today that threatens the dominance of IBM. Unlike China, the Indian government was historically seen as something that got in the way of private business. Since the economic reforms of 1991, government organizations are said to have become more supportive of business activities (Capelli et al. 2011), although the situation is completely different from China, where government organizations are the primary drivers of business.

The greatest structural difference in Chinese and Indian companies is that those in China are built through their various relationships with government, whereas those in India are private companies that compete in the midst of market mechanisms. Of course, the maturity of product and financial markets in India is nowhere near that of developed countries. The remnants from the era under the “License Raj” regulatory scheme, when activities were heavily bound, still exist in the complex systems for establishing and ending companies, taxes, and labor. In wholesale or other distribution industries, India has stricter regulations than even China and its infrastructure lags. Many government regulations mean that opportunities also increase for civil servants to exercise discretion at the local level, which is one reason briberies given to civil servants are rampant. However, the situation is quite different from China, where governmental decision-making at the national and local levels impacts every aspect of business.

The differences between these two countries are evident in the way risk is managed in running the national economy. In India, manufacturers, distributors, banks, and various other companies each assess risk and reward under the mechanism of a market economy, and then engage in business activities. Further, codified rules such as corporate and labor laws as well as financial market regulations are created with the intent to complement market mechanisms. The companies are able to engage in business, assuming that their counterparties and funding partners are going to act in accordance with the weighted risks and rewards. Trust in these market mechanisms exists as a code of conduct in Indian business.

In China, business owners do not take on all the risk themselves, rather the government shoulders a portion of that risk. In return, the state demands that the business act in alignment with bureaucratic objectives. The Communist Party manages the state, and advancement in the party hierarchy is said to be determined in provincial and municipal level “tournament games,” where economic growths at one local government is pitted against another (Xu 2011). This system led to local governments battling over one another to attract foreign firms, and as a result, it enabled China to maintain high economic growth rate to date on the basis of liberal policies. The policies themselves are not decided at the central government level, which simply sets a certain direction and leaves the rest to the discretion of heads of local governments, so that they might compete more effectively. As such, it is imperative for companies to surmise the views of the local government when doing business in China.

Although China is implementing reforms such as state-owned enterprise reforms and the creation of corporate law to move toward a market-based economy utilizing market mechanisms, the behavior of economic entities in the country follows the informal rules of a socialist state. As a result, capital and financial markets continue to be immature, making it difficult for companies that are internationally competitive to be formed. The 11th 5-year plan that began in 2006 has the creation of “indigenous innovation” as its key objective, which aims for new inventions that are internationally competitive to be home-grown, rather than be produced by importing technologies from the West or Japan as was done in the past. Local governments must now implement specific policies based on this vague goal. However, innovation is only a possibility through constant competition and ingenuity of individual companies. Thus, it will be difficult to obtain this goal if corporate managements run their organizations while gauging the local government's mood and reaction as they have done so far. Therefore, there are few companies in China that can compete internationally, even though the country has large state-owned corporations.

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