Contact Us FAQ Index Search

Beyond Transition 
THE NEWSLETTER ABOUT REFORMING ECONOMIES

About
Recent
Issues
Archives
Russian
Version
Submissions
Subscribe
Related
Web Sites
Search
Home Page

 

Reform of China's State-owned Enterprises A Progress Report of Oxford Analytica

Under its Ninth Five-Year Plan, which begins in January, Beijing has committed itself to concentrating on a core 1,000 state-owned enterprises. The others are to become candidates for bankruptcy, merger, divestiture, and management buyout. Almost 50 percent of China's state-owned enterprises (SOEs) made losses in the first half of 1995, according to official figures. Since SOEs receive preferential treatment, including large financial subsidies, their poor performance has a negative impact on many aspects of economic activity. The Chinese leadership has accepted the need for fundamental state sector reform.

China's phenomenal economic growth since 1979 was fuelled initially by agricultural advance and more recently by the development of thriving private and "township and village" enterprise sectors. In contrast, the state sector, because of its sluggish economic performance and heavy indebtedness, is widely perceived as an impediment to development:

  • In the first eight months of 1995, SOE industrial output expanded by only 8.3 percent compared with a 13.7 percent increase for all industry. According to estimates, non-SOEs, on average, required less than a third as much investment as SOEs to achieve equivalent industrial output.
  • Although SOEs account for less than 50 percent of gross industrial value output, they mounted up almost two-thirds of the 65.5 billion renminbi ($7.89 billion) official losses made by Chinese firms in the first nine months of 1995. This represented an 18.8 percent increase in state sector losses over the same period last year. SOE profits were also down, by more than 20 percent. Moreover, nonofficial statistics suggest total losses by SOEs may exceed 100 billion renminbi in 1995.

Problem Child: the State-owned Enterprise

The poor performance of SOEs has hurt economic development in four main ways: Direct macroeconomic implications: Channeling of resources into loss-making SOEs for political purposes means inefficient allocation. It constrains the economy's ability to generate balanced growth. Many SOEs still receive privileged access to key resources, especially oil and electricity.

The use of subsidized credit and government transfers to support SOEs is inflationary. It hampers Beijing's attempts to control inflation and prevent another boom-bust economic scenario.

State revenues: China expects its budget deficit in 1995 to be a mere 1.5 percent of GDP. If policy lending by centrally controlled banks—most of which is, effectively, transfers to SOEs—is taken into account, the central government's true financial deficit is 6 percent of GDP, and possibly higher. SOEs thus impede the government's ability to fund education, social security, and infrastructure.

Effect on banks/financial sector reform: The government is seeking to convert its four giant specialized banks into commercial operations. These banks, wholly state-owned and under the direct supervision of the State Council, control the bulk of banking assets that are critical to China's financial stability. Their transition is jeopardized by the large amounts of policy loans. Last month, Dai declared that "problem loans"—where repayment is at least one year in arrears—constitute 20 percent of all advances made by the four banks.

Interenterprise debt: Many troubled SOEs are unable to pay their debts to other firms. According to official figures, debt owed among enterprises stood at 400 billion renminbi in the first eight months of 1995. This figure would probably more than double if unpayable bank loans were included.

The Bright Side

SOEs still play a critical role in the economy:

  • SOEs account for 46 percent of industrial output, albeit down from 70 percent in 1990. Moreover, they are responsible for around half of all exports and most urban employment and wages.
  • SOEs are responsible for most large-scale activities, which are the areas that most interest foreign investors. All Chinese firms with overseas share listings are majority state-owned. Likewise, most joint ventures with foreign investors involve state companies. (The private sector is dominated by small-scale concerns.)
  • Although 46 percent of SOEs reported losses at the end of the first half-year, others reported healthy profits. Deposits by enterprises have been rising: 30 percent of the increase in individual savings deposits last year is believed to have come from enterprise deposits in nominee accounts to take advantage of higher interest rates.
  • With the right capital investment, many SOEs will be able to compete in a more open market-oriented economy. These companies will remain dominant in key sectors and are set to play a significant role in the economy for many years to come.

Impressive advances have been made in increasing management autonomy and in providing incentive structures for workers:

  • Top managers now sign contracts specifying performance targets, and their pay is frequently linked to sales and profits.
  • Management turnover has increased to almost 20 percent a year, reflecting the fact that managers can be sacked or demoted for poor performance.
  • Uniform wage increases have been abandoned, leaving enterprises free to set relative wages.

As long as subsidized credit continues, however, managers of loss-making firms have only limited incentive to improve performance. Furthermore, in some cases managers effectively collude with workers to use state subsidies to pay bonuses all around, regardless of economic performance.

Of the 1,000 SOEs targeted for special assistance under the Ninth Five-Year Plan, 800 are in the industrial sector. These account for about two-thirds of state industrial assets and more than 70 percent of sales revenue, profits, and tax remittances generated by all SOEs. The implication is that the other 13,000 large and medium-size SOEs and 86,000 small SOEs—which are not considered vital to the economy—will be left to fend for themselves. They will presumably become candidates for bankruptcy, merger, divestiture, and management buyout.

Bankruptcy and Mergers

The hardest task facing the government is the closure of the worst-performing SOEs. A bankruptcy law has been in place since 1986, but has been little used owing to its inadequate nature and to state concern over the social implications of mass closures. A pilot project in eighteen "pioneer" cities is currently under way. Some 474 SOEs have been identified as suitable candidates for bankruptcy or merger. Bankruptcy procedures have begun for 161 of them, but only 58 have actually been declared bankrupt. The bankrupt companies had combined debts of 3.2 billion renminbi ($385 million) and assets of just 1.87 billion.

A much-delayed new draft of the bankruptcy law should be presented to parliament next month. This could improve the situation, as it recognizes a creditor's claims on a defaulter's assets. Current law effectively allows only for the protection of workers. Consequently, many creditors, especially banks, prefer to keep debts "sleeping" rather than obtain only part or none of a liquidation settlement.

An alternative to outright closure is the absorption of ailing SOEs by more profitable ones. The government has indicated that it is prepared to consider special loan terms for companies that merge. For the core 1,000 companies, a more comprehensive program of interest payment exemptions, debt-equity swaps, and debt forgiveness is being considered. In theory, such a program of rationalization could bring considerable efficiency savings. However, these will only be realized if the new owners are given a free hand to close plants and lay off workers.

Keiretsu Yes, Privatization No

Although Beijing has accepted the need for ownership reform in order to encourage market-oriented behavior among SOEs, it has repeatedly stated its opposition to privatization. Last month Prime Minister Le Peng ruled out privatization as a way of improving Beijing's prospects of joining the World Trade Organization. An East European-style mass sell-off of state industry is not considered compatible with the development of a socialist market economy.

Instead of privatization, Beijing has embraced the concept of corporatization. Many surviving large and medium-size enterprises are earmarked for transformation into joint-stock companies with public ownership spread across a variety of state institutions and enterprises. In this way, majority "state" ownership is maintained, even though the central government has little or no direct role in running the company.

Corporatization fits well with Beijing's vision of a more dynamic state sector that dominates key sectors of the economy. It provides a mechanism for the formation of state sector conglomerates and possibly also the development of cross-ownership in the style of the Japanese keiretsu. However, this strategy can only succeed in raising efficiency if subsidies are progressively withdrawn. Furthermore, conflicts of interest between shareholders and enterprises are likely as the former will frequently include the administrative and regulatory bodies of the former central planning apparatus.

For smaller companies and noncore subsidiaries of larger ones, Beijing is likely to allow management buyouts and divestiture. The decisions on individual cases will be left largely to local authorities, as they control most small SOEs.

Although full privatization is politically unacceptable, partial privatization is taking place. A number of SOEs have been listed on foreign and domestic stock exchanges and others are keen to be listed because of the benefits of injections of nonstate capital. The development of corporatization and the expansion of domestic stock exchanges should create a wealth of opportunities for private investors. Private and foreign participation is likely to be mainly restricted to minority shareholding in the "subsidiaries" of state-owned holding companies.

Hainan Airlines provides a good example of how ownership structures in major industries are likely to develop over the long term. The authorities approved the sale of a 25 percent stake to American Aviation Investment with the proviso that it would help the airline "study" foreign management and technology. The rest of the shareholders are state institutions (56 percent), the government (4 percent), and other individuals (15 percent).

Obstacles to Reform

Apart from ideological reservations, there are some major interlinked obstacles to reform and the reshaping of the state sector:

  • Unemployment. Fear of high levels of unemployment is the main factor holding back rapid reform. Urban unemployment is officially 4.8 million (2.8 percent of the urban population). However, an estimated 30 million out of 100 million SOE workers are redundant. Official statistics show a 66 percent increase in labor disputes in 1994, mainly caused by labor-shedding. Officials claim to have found new work for 99 percent of the workers laid off in the fifty-four pilot bankruptcies. A promising scheme has been pioneered by Dongfeng Motor Co., China's third largest automobile company, which in 1995 shed 15 percent of its workforce by offering enhanced pension packages to workers who retire early. (Dongfeng is preparing for an overseas share issue.)
  • Inadequate social security. In addition to layoffs, the divestiture by SOEs of social functions, such as housing, health care, education, and pensions, will lead to hardship for many previously privileged workers. The expansion of state welfare activities and the development of a social security system have not kept pace with reform, officials admit. The labor ministry is drafting laws on social insurance and labor contracts, and is considering laws on employment promotion, training, and dispute settlement.
  • Regional impact. It is common for a town or towns, or even regions, to be dependent on a few industries and state firms. For example, Maanshan Iron and Steel, which is listed in Hong Kong and Shanghai, has plans to lay off an unspecified number of its 53,000 workforce, which accounts for 13 percent of the city's population. However, the firms' actions are constrained because the city cannot absorb its surplus labor.

Excerpted from recent Asia Pacific Daily Briefs of Oxford Analytica, the Oxford (U.K.)-based research group.

The World Bank Group
Contact Us | Help/FAQ | Index | Search
© 2001 The World Bank Group, All Rights Reserved. Terms and Conditions. Privacy Policy