Local government has become a chokehold for Chinese business

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The writer is professor of law at the University of Southern California and author of ‘High Wire: How China Regulates Big Tech and Governs Its Economy’

The cosy relationship between China’s local governments and its private businesses used to be described as the “mayor economy”: officials clear regulatory barriers, provide cheap land, tax breaks and even subsidies, all to drive regional economic growth.

In recent years, however, struggling local authorities have increasingly targeted private businesses with a wide range of punitive legal actions, from fines to criminal prosecutions for offences such as tax evasion, bribery, fraud and product safety violations. Their need to raise funds means the helping hand of local government has turned into a chokehold.

Beijing is promising change from such interference. As part of a massive stimulus package to revitalise the sluggish economy, the government unveiled a draft law in October that promised to improve conditions for private business. It pledged a more friendly investment environment, increased support for technological innovation and greater protection for the private sector.

But this promise may come with an unsettling price. In an authoritarian regime, the helping and grabbing hands are often two sides of the same coin.

Over the past three decades, China has developed a sophisticated legal regime governing private business, granting local agencies extensive sanctioning power and broad legal discretion. Meanwhile businesses, previously bolstered by close relations with local government, have often operated in a legal grey zone, skirting regulations to boost profits.

Chinese business was thus vulnerable to regulatory crackdowns, prompting some to enter into profit-sharing arrangements with local bureaucrats in exchange for legal protection. This dynamic — part legal manoeuvring, part implicit bribery — entrenched a system of crony capitalism.

But China’s sweeping anti-corruption campaign over the past decade has triggered widespread bureaucratic inertia. Local officials — once eager to spur economic growth — are now hesitant to taken action.

Compounding this is the aggressive deleveraging campaign aimed at cooling the debt-fuelled property boom. This has had a devastating ripple effect on the broader economy. Bankruptcies among property developers have surged. The property market, once the backbone of local government revenue, has collapsed, leaving authorities scrambling to fill the fiscal gaps.

As such, they are relying on fines from legal actions against businesses to offset lost revenue. What was once a system where the law served as a helping hand to support private enterprise has now become a tool for financial extortion.

To reverse this disturbing trend, Beijing’s focus must be on alleviating the financial distress of local governments. The recent stimulus package, which includes a debt swap aimed at freeing up cash for local governments, offers a glimmer of hope. By stabilising municipal finances, China may be able to stem predatory law enforcement.

Yet these stimulus measures can only offer temporary relief. The deeper challenge remains unresolved: how to find new sources of productivity to sustain long-term economic growth.

For China’s private sector to once again expand and drive innovation, the country must rekindle the entrepreneurial “animal spirits” that fuelled its rise. But to reignite this kind of progress, the country may be tempted to retrace its old path of reckless growth intertwined with corruption and cronyism.

The dilemma brings to mind a Chinese adage: tighten the reins, and there will be death; loosen them, and there will be chaos. The question is whether China can break free from this cycle, as the country navigates the twin perils of economic stagnation and market chaos.

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