In one sense, informality has been the private sector’s great strength during a period of uncertainty and rapid change. It has allowed private enterprises to respond flexibly to changing policies and regulations and to new market opportunities, while diversifying risk and avoiding excessive taxation, regulation, and competition. However, informality creates serious obstacles to the further growth and development of the sector, leaving large, mature companies stuck with structures more suited to small, young companies. It also makes companies opaque and unfocused, endows them with limited management capacity, and difficulty in attracting funding and skills they need to grow or survive. This is especially true for the self-employed businesses: since 1999, the number of self-employed began to drop, and by 2001, this number (48 million) has almost shrunk to the 1995 level (46 million).36 In order to survive in this somewhat uncertain political landscape of a transition economy and system, some private enterprises have to disguised themselves by ‘wearing a red hat’ (falsely declaring themselves as ‘collectively owned’).37 This will inevitably hinder their operational efficiency.

In 1997, the private sector was recognized in a constitutional amendment. The amendment provides a basis of a better policy environment for private firms. The next important step would be to officially recognize private property. Although the 1999 Constitutional Amendment guaranteed protection to private property, such property was not placed on exactly the same footing as state property. Lack of security and fear of possible appropriation by the state are still disincentives for Chinese people to fully apply themselves, expand private businesses, and make long-term investments, thus hampering economic growth.

In order to encourage continuing private sector growth, the government should create a level playing field for all enterprises by intervening less, strengthening the legal framework for protecting the private property rights, providing incentives to lend to private businesses, and focusing on improved commercial legislation and more open markets. Financial institutions must develop to serve the private sector, by providing greater access to bank loans and credits. Meanwhile, the private enterprises also need to mature and improve their corporate governance, in order to derive the most benefit from improvements in the business environment.38

# **_III.2 Promoting Small and Medium Enterprises_**

Small and medium enterprises (SMEs) tend to be the most dynamic part of a country’s economy. Due to their entrepreneurship and flexibility, SMEs can be very competitive if matched with a sound business environment, skillful people and good governance. In China, since most SMEs, especially those in the urban areas, are in the tertiary sector, they have become an increasingly important source of job creation and reemployment for laid-off workers. According to Rong, small enterprises have a greater capacity for absorbing labor or generating new employment than large enterprises. Compared on a per

> 36 _China Statistical Yearbook_ , 1999, 2002, China Statistical Press, Beijing.

> 37 Pannell, Clifton W., “China’s Continuing Urban Transition”, _Environment and Planning_ , V34, No. 9, September 2002.

> 38 IFC: _China’s Emerging Private Enterprises: Prospects for the New Century_ , 2000, Washington, DC, USA.

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