How the strengthening of state enterprises threatens China's economy
Is China's economic structure crushing private industry. At the core of the concern is a slogan: “the state advances, the private retreats.”
China Economic Review
In the 80s and early 90s, many government officials and professors went into business to make money. Now, many people don’t have that courage.
Popular opinion, the capital environment, institutions, all are more complementary to the development of big firms than small, entrepreneurial ones,” Wang Jianlin, chairman of real estate conglomerate Dalian Wanda, told journalists at the signing ceremony for his company’s purchase of US cinema chain AMC Entertainment in May.
Wang, a self-made man who now flaunts a 24-metre yacht and a private jet, said he’s seen many successful Chinese entrepreneurs sell their companies and emigrate in recent years. “When most of our entrepreneurs no longer have the motivation to strive, they just sell their businesses to go enjoy themselves... then this country is done for,” he said.
Wang’s comments offer a glimpse into a debate quietly raging in China: whether the country’s economic structure is crushing private industry. As usual in the country, at the core of the concern is a snappy, codified slogan: guojin mintui, meaning “the state advances, the private retreats.”
“We’ve seen the emergence of very powerful industrial groups with strong links to the state,” said Williams. “That trend only intensified in 2008, when the government shifted its focus entirely to securing growth, and did that by channelling funds to the state sector to invest.”
Meanwhile, private firms have been left out in the cold, buffeted by declining demand from the developed world, rising wages and limited access to credit within China. Some Chinese view state-owned enterprises (SOEs) as a cornerstone of the economy while others see their growing dominance as a dangerous departure from the reform legacies of Deng Xiaoping and Zhu Rongji.
“There’s a real kind of clash of perceptions here about the way forward,” said Patrick Chovanec, an associate professor at Tsinghua University’s School of Economics and Management in Beijing.
Many economists agree that China’s era of rapid growth fuelled by exports and investment – a period in which SOEs thrived – is drawing to a close, and that Beijing needs to cultivate other sources of growth, in the form of individual consumers and private enterprise.
In the 80s and early 90s, many government officials and professors went into business to make money. Now, many people don’t have that courage.
Popular opinion, the capital environment, institutions, all are more complementary to the development of big firms than small, entrepreneurial ones,” Wang Jianlin, chairman of real estate conglomerate Dalian Wanda, told journalists at the signing ceremony for his company’s purchase of US cinema chain AMC Entertainment in May.
Wang, a self-made man who now flaunts a 24-metre yacht and a private jet, said he’s seen many successful Chinese entrepreneurs sell their companies and emigrate in recent years. “When most of our entrepreneurs no longer have the motivation to strive, they just sell their businesses to go enjoy themselves... then this country is done for,” he said.
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Wang’s comments offer a glimpse into a debate quietly raging in China: whether the country’s economic structure is crushing private industry. As usual in the country, at the core of the concern is a snappy, codified slogan: guojin mintui, meaning “the state advances, the private retreats.”
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Control over the commanding heights of key industries has always been one of the Communist Party’s defining political philosophies, but China has slowly liberalised, shifting in fits and starts from a stagnant economy dominated by state enterprises in the 1970s to a booming mix of free-market capitalism and state-run businesses today. However, this tide of reform has shifted in the past decade, said Mark Williams, chief Asia economist at Capital Economics in London.“We’ve seen the emergence of very powerful industrial groups with strong links to the state,” said Williams. “That trend only intensified in 2008, when the government shifted its focus entirely to securing growth, and did that by channelling funds to the state sector to invest.”
Meanwhile, private firms have been left out in the cold, buffeted by declining demand from the developed world, rising wages and limited access to credit within China. Some Chinese view state-owned enterprises (SOEs) as a cornerstone of the economy while others see their growing dominance as a dangerous departure from the reform legacies of Deng Xiaoping and Zhu Rongji.
“There’s a real kind of clash of perceptions here about the way forward,” said Patrick Chovanec, an associate professor at Tsinghua University’s School of Economics and Management in Beijing.
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“Is the Chinese model of market socialism or state capitalism not just successful but actually dominant in the world? Does that symbolise the future? Or is there something deeply wrong with it – is it unsustainable, does it desperately need to be changed?” Economic research suggests that the model does need to be changed. Many economists agree that China’s era of rapid growth fuelled by exports and investment – a period in which SOEs thrived – is drawing to a close, and that Beijing needs to cultivate other sources of growth, in the form of individual consumers and private enterprise.
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But curtailing the position of SOEs in the Chinese economy will be politically difficult – perhaps impossible. Not all economists agree with the idea of guojin mintui. Louis Kuijs, project director of the Fung Global Institute, a Hong Kong-based think tank, argues that the advance of the state sector at the expense of the private sector is not borne out by China’s economic data.
“This guojin mintui concept has become very much part of the folklore. However, if you look at any of the data, of the share of SOEs in investment or assets or production, that share has continued its decline,” he said. That may be true, yet the position of SOEs vis-à-vis private enterprise has changed significantly in recent years, in ways that deserve attention, writes Rosealea Yao, an analyst at research firm GaveKal.
This strengthening of the state sector has had many supporters in China, in part because the system has given Beijing more flexibility in the financial crisis. Central and local governments have convinced or coerced SOEs into keeping the economy chugging along by hiring new college graduates, limiting product price increases and investing in new infrastructure.
Lost Efficiency
However, these advantages come at a price, the most obvious being lost efficiency. Fixed investment by SOEs often costs 20-30% more than that of private companies and takes about 50% longer to complete, economist Andy Xie wrote in an editorial in Chinese magazine Caixin in late June. “The leakage through overpriced procurement and outsourcing and underpriced sales is enormous.”
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This “leakage” is essentially financed by ordinary Chinese people who deposit their savings in banks. Account holders (mostly China’s high-saving households) earn only a lowly 3% interest or less on their deposits under a government instituted cap. This reduces their ability to consume, a situation that economists call “financial repression.”
Meanwhile, by fixing the lending rate at 6%, China’s central bank ensures that banks pocket the difference between the two rates in profit, and that borrowers (often SOEs) can obtain plenty of cheap loans. Private enterprises, with higher risk of default than SOEs, are often unable to obtain loans at all. This ready source of cheap capital permits a shocking degree of waste among some SOEs.
Michael Pettis, a finance professor at Peking University’s Guanghua School of Management, points to the Sino Iron mine that state-owned CITIC Pacific is developing in Western Australia as an example. Four times bigger than any domestic iron project, the mine was first projected to cost less than $2.5 billion in 2006. Now the project is three years behind schedule, the cost has already ballooned to $7.1 billion, and some analysts believe the final total will surpass $10 billion.
Monopoly Pricing
SOEs also drive up costs for private companies and households through monopolistic pricing. Higher prices charged by monopolistic SOEs act as a tax on private industries, and companies in turn pass along costs to employees by keeping wages artificially low.
This is one reason that the share of labour income of China’s total GDP has fallen persistently since 1992, even as growing international trade increased the demand for exports. But this model no longer seems sustainable.
External demand from Europe and the US has dropped off, and, as rising wages demonstrate, China’s excess labour is drying up. “If [China] sticks to the current state capitalism model, the private firms will suffer first.
And when the private firms collapse, eventually the SOEs will collapse as well,” Xi Li, a professor at the Hong Kong University of Science and Technology, said. “China is between a hard rock and a total collapse.”
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However, Beijing has launched several initiatives aimed at making SOEs more efficient. Since its creation in 2003, the State-Owned Assets Supervision and Administration Commission (SASAC) – a central company that holds controlling stakes in the largest and most important central SOEs (excluding banks and insurers, which are owned by the relevant ministries) – has worked to incorporate SOEs as proper companies and set up boards of directors. But critics say China’s efforts to bring in directors and shareholders so far constitute no more than window dressing, since the Party has not given up operational control.Reformists also aim to allow more competition to enter non-strategic industries (including perhaps steel and cars), forcing out those SOEs that are too inefficient to compete. But some say that is unlikely to happen, because the playing field for SOEs and private enterprise is so uneven.
Reforms Imperative
With China’s growth set to slow, reforming the SOE sector to allow private enterprise to compete seems increasingly urgent. Economists argue that the simplest solution would be privatising some stateowned enterprises and transferring the revenue from the sales back to the household sector, for example using the funds to pay down banking debts, for which households will ultimately be liable, or building a better welfare system.
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But this solution, however economically elegant, would be difficult to implement politically. In addition, many powerful families in the government have risen to wealth and power on the back of stateowned businesses, and are likely to oppose reforms to this power base.Officials seem reluctant to liberalise interest rates or legalise private banks, and with reason. By allowing the banking system to allocate capital based on return, the Party would essentially be giving up control over the country’s financial resources. Analysts say policymakers are eager to show Chinese people that they are doing something to rein in the dominance of SOEs, but they also want to avoid drastic reforms before the leadership transition later this year.
But at some point Beijing will have to start that momentum of reforming the capital system. With labour costs rising and US and European demand stagnant, more and more private firms could go bankrupt, lead to mounting losses at SOEs.
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