China’s State Enterprises – a success story with many lessons

Virodhi’s post on China is revealing and a direct challenge to the orthodoxies of growth, development and liberal agendas..

China is the center of the debate. With the brilliant show of Olympics at Beijing, the debate regarding the character of the Chinese state and society has also resurfaced. What is China? Socialist? People’s Democracy moving towards capitalism or socialism? Degenerated workers’ state? Capitalist? Imperialist? I argue that China was never a socialist state. Since its birth in 1949 in a very backward terrain, China continues to be a People’s Democracy moving towards socialism. With the advent of the period of Deng Xioping, revisionism took hold of Chinese ecnomics and society and the movement towards socialism was reversed. However, lately new information has been emerging from China which provides an interesting perspective, i.e., the reversal of the process of reversal. I am posting here an interesting article (I am not in agreement with the analysis, but the facts are interesting) that appeared in The Australian regarding the role played by the State Owned Enterprises in China:

China’s state enterprises aren’t dinosaurs

THE Olympic Games comprise China’s most prominent state-owned enterprise.

In some other countries, including Australia, the Olympics, and sport in general, are chiefly the realm of volunteers, of corporations, of a discrete professional world.

But there is no disguising that these Olympics are inseparable from China Inc.

This is a good time, then, to take a look at the realm of state-owned enterprises (SOEs), mostly set up under Mao Zedong, which a few years back some portrayed as dinosaurs about to pass into extinction.

Instead, as Barry Naughton, professor of Chinese economy at the University of California, San Diego, says in the latest edition of the influential China Economic Quarterly: “Since their low point in the mid-1990s, China’s SOEs have made a stunning return to profitability.”

In 1997 the entire state-owned industrial sector returned a net profit of just below 0.6 per cent of China’s gross domestic product.

Ten years later, the sector’s profits constituted 4.2 per cent of a much, much larger GDP, while the non-industrial SOEs scored a further 2 per cent of GDP in profits.

One of the reasons, Naughton points out, is that “the Government has been willing to subordinate other agendas such as privatisation to the quest for a robust state enterprise sector that was financially self-sufficient and able to contribute to the government revenue base as well”.

This quest began with the closure of thousands of loss-making SOEs, described by economists in the mid-1990s as “zombie firms”, the living dead, kept alive mainly because no one else could think what to do with the millions of workers they employed.

Crucially, the Government removed from SOEs the responsibility for providing social welfare for their workers, the old “iron rice bowl”. The process of reinstating adequate provision of such services outside the workplace remains an arduous one, barely begun, but that’s another story.

The number of industrial SOEs dived from 80,000 to 26,000 in 10 years.

This enabled the Government to concentrate on a number of strategic sectors, in which it intends to retain a firm — even monopolistic, but more commonly, oligopolistic — grip. They include energy, power, industrial raw materials, defence, large-scale machinery, transport and telecommunications. Financial services are state dominated.

In some areas, non-government competitors are banned. In others, says Naughton, “high capital requirements combine with discriminatory regulatory treatment to discourage non-state entrants even when they are theoretically allowed”.

The core 153 enterprises answer to their Chinese shareholders via the state-owned assets Supervision and Administration Commission (SASAC), which reports to the State Council led by Premier Wen Jiabao.

There are now three national oil companies, four telcos, and three airlines that carry 82 per cent of domestic passengers.

China’s 31 provinces, regions and municipalities also each operate a large number of local SOEs, though their numbers have been pruned and their efficiency raised in a parallel drive to that at the national level.

Overall, in 1995 China had 7.6 million SOEs, more than 80 per cent of all businesses, of which two-thirds were collective enterprises, the others traditional SOEs.

In 2006, PetroChina, Sinopec, China National Offshore Oil, China Mobile, China Telecom, Baosteel, Chinalco, Shenhua Energy and the state Electricity Grid produced 69 per cent of the profits of all 153 centrally owned SOEs.

In Australia, a misleading perception has emerged, that we have been the winners out of the commodity boom and China has been the chief victim, having to cough up for the inputs of its insatiable industrial machine.

But Naughton points out the situation on the ground in China is very different.

“Control of resource extraction and processing sectors by central SOEs has meant that they have profited handsomely from the global resource boom, which in turn is largely a result of the Chinese investment boom that SOE restructuring helped to create, and changed global relative prices massively in favour of raw materials.”

Chinese SOE resource companies are also expanding production overseas, as Australians know.

Treasurer Wayne Swan says that every nine days he has approved a Chinese bid to invest, with China’s investment here as a result tripling from $3.5 billion in 2006 to $10 billion last year and being set to triple again, to $30 billion, by the end of 2008.

It is China’s retail manufacturers that pay, in squeezed margins, for the commodities boom and they are being forced to pass their higher costs on to global consumers.

As long as this does not cause massive job losses or inflation driven by food and oil prices, China’s Government is prepared to stand back and watch the trend continue.

Because manufacturing in China, unlike the resource industry, is increasingly privately owned, and the export sector involves substantial foreign ownership, about 60 per cent of China’s exports come from sources fully or substantially foreign owned.

All SOEs have been corporatised to a large degree, with boards that include an outsider or two. Managers mostly operate under three-year contracts with a performance component. In 12 years, the debt-to-assets ratio of industrial SOEs has been reduced from 68 per cent to 57 per cent.

This year — the icing on the cake for the Government — Premier Wen has succeeded in forcing almost all sectors to pay the state dividends, rather than retain their profits to boost management and board perks, and to reinvest them, sometimes before the equities collapse this year in the share market, sometimes resulting in overcapitalised assets. Most are now paying 5 per cent of post-tax profits back to the Government.

But although SOEs mostly lack accountability to the holders of the minority stakes sold on share markets, pressure to perform continues, from the Government itself.

Only the top three businesses in each sector will survive, SASAC has warned.

Thus in some paddocks of China’s Animal Farm, it’s dog eat dog.

Naughton says that SASAC “encourages firm strategies organised around commercial, service or investment markets, not just traditional industrial production”.

Under dynamic chairman Huang Tianwen, Sinosteel, principally a provider of logistic and technological services to China’s steel industry, propelled its revenues to $US15 billion in 2007, placing it fairly firmly on high ground if and when SASAC starts its next cull. Every one of the 22 Chinese corporations on the Fortune 500 list is state owned, 16 by SASAC, five financial institutions and just one — Shanghai Automobile — by a local government. Arthur Kroeber, managing director of research firm Dragonomics, and Rosealea Yao, research manager, say: “Chinese policy makers have succeeded in the task they set themselves in 1995 to zhuada fangxiao (keep the big, lose the small)”.

It is the fast-growing private sector, flourishing in areas like retail and manufacturing, that has sucked up many of the jobs shed by downsizing SOEs.

From 1995-2006, the state sector of employment fell from 77 per cent to 35 per cent. The private share soared from 20 per cent to 60 per cent. But, Krober and Yao stress that “economic power remains firmly concentrated in the hands of the state”.

In 2006, the top 10 SOEs were eight times bigger than the top 10 private firms.

They point out that the state share of revenues in banking is 94 per cent and in insurance 97 per cent.

Jonathan Woetzel writes in the latest McKinsey Quarterly: “The line between SOEs and private companies has blurred. Over the next five years their ownership structure will matter much less than their degree of openness, their transparency and receptiveness to new ideas.”

This is true to a degree.

The Chinese central Government has proved itself an adaptable and subtle manager of its own assets. But ownership and control continue to count a great deal.

Is there a real prospect for change?

Chen Zhiwu, finance professor at Yale school of management, says privatising China’s assets would “unleash a wealth effect and boost domestic consumption”, transforming the growth model from the present drivers of investment and exports.

Unlike eastern Europe and Russia when they embarked on their convulsive privatisations, he believes “China is operationally ready” for a change of ownership. That makes sense. But don’t hold your breath.

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Filed under China, governance, Growth, Southeast Asia

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