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The Advance of China’s State Sector: Some Implications for the China’s Economy
By Jialin Zhang
August 1, 2010


Since the introduction of market-oriented economic reforms in the early 1980s, China’s government has encouraged private sector growth of the national economy, and downgraded the role of state-owned enterprises (SOEs). But in the last few years, the pendulum has begun to swing the other way. Given the changing domestic and external economic conditions, the SOEs are making a comeback at the expense of the private sector. There is concern that Beijing will shift away from the market and return to the command economy. A heated debate is now going on in China’s business and intellectual circles, which regards this new phenomenon as “Guojin Mintui” (The state advances as the private sector retreats). This change has new implications for China and the world economy.

The Resurgence of the SOEs

When China officially announced economic reforms and an open-door policy in 1984, the SOEs were urged to initiate a “responsibility management system”. But it failed to reverse the money-losing behavior of the SOEs. Then in the early 1990s, Beijing started structural reforms of the SOEs by “grasping the big, letting go of the small.” This meant the government retained some large, vital SOEs, while allowing most of the country’s medium and small businesses to become private. The central authorities in 1999 further redefined the SOEs’ status as follows.

They can remain only in three economic domains: (1) industries related to national security; (2) natural resources which the state monopolizes; (3) industries that produce public goods and social welfare. Many SOEs had to leave the competitive industries in order to make place for the private sector. Subsequently, the SOEs almost disappeared in food and beverage, textile and apparel, home appliance and other consumer good industries. Legally, non-state-owned enterprises were even allowed to enter such industries formerly monopolized by the state as finance, electricity, telecommunications, railroads, civil aviation, petroleum, etc.

As a result, the share of SOEs in China’s industrial production has fallen from approximately 80 percent at the outset of the reforms, to about 30 percent in 2008.

The fate of SOEs, however, has experienced a favorable turnaround since 2003 when the State Council set up a new organ---the State-owned Assets Supervision and Administration Committee (SASAC). This agency was tasked to revitalize the SOEs and to reorganize them from money-losing into profitable firms, through restructuring and consolidation. Li Rongrong, the Chairman of SASAC declared that the country’s seven major industries, including electricity and grid, petroleum and petrochemical, telecommunications, coal, civil aviation, and maritime, should be exclusively owned by the state, while excluding any domestic private entities.

In the meantime, Beijing was welcoming and attracting foreign investments to the SOEs. Indeed, these new policies have benefited the SOEs’ performance. They began to make money by reaping annual profits of $147 billion in 2006. Among 149 centrally controlled SOEs under the direct supervision of the SASAC, 19 were on the Fortune 500 list. The SOEs had started to resurface again.

The 2008 global financial crisis also gave the SOEs a new impetus. Most of the government’s 4 trillion yuan, or US$586 billion, stimulus package, already designated for rebuilding infrastructure such as railroads, highways, airports, and construction, were contracted to centrally controlled SOEs. In addition, these enterprises also enjoyed privileges by borrowing from state banks. In 2009, around 80 percent of bank loans, 9 trillion yuan, or US$1.4 trillion, went to SOEs.

Conglomerates and Monopolies

As the global financial crisis weighed on China’s economy, China’s exports declined, bankruptcies and the unemployment rate rose. Beijing issued its “Plan on Revitalization of Ten Industries” in early 2009, to encourage large SOEs in steel, automobile, shipbuilding, equipment and other industries to merge with medium and small private enterprises, thus transforming them into giants that could compete in the world market.

 

The SOEs, supported by financing from central and local governments, made an impressive comeback after 2008. The following examples cite some major mergers and acquisitions in 2009:

 

----In the steel industry, the Shangdong Iron and Steel Group Co. Ltd., long a money-losing SOE, acquired the private Rizhao Iron and Steel Co. Ltd. It, in turn, created the second largest steel company in China. The Baoshan Steel Group, a famous SOE, acquired the private Ninbo Steel Company.

 

----In the oil industry, the China Petroleum (CNPC) acquired most of the non-state oil companies in Heilongjiang Province.

 

----The China National Cereals Group invested in and purchased private Mengniu Dairy Company, the largest-ever deal in the Chinese food industry. Its business goes far beyond food and beverages, to include residential and commercial real estate.

 

----In Sangxi, the provincial government ordered a reorganization of the coal industry. The share of private capital in that industry is not supposed to exceed 30 percent.

 

Such SOE acquisitions and merges took place in almost every industry such as in automobiles, shipbuilding, civil aviation and finance. The consolidation process has also formed the behemoth SOEs that typically squeezed private sector development and stifled market competition. Currently, the SOEs enjoy a monopoly over almost all of China’s resource industries: petroleum, telecommunications, electricity, tobacco, coal, civil aviation, finance, insurance, etc. As a consequence, private enterprises had to exit from these industries.

 

Furthermore, these SOEs now enjoy a priority status in going public and having access to financing. Most centrally controlled SOEs are listed in the Shanghai and Shenzhen Composite Indexes. Their capitalization has risen rapidly. With abundant financial resources and backed by political power, these special interest groups can easily merge with and acquire other companies and exercise monopolistic behavior in many markets. In addition, the growing liquidity they possess has flowed to property and stock markets, thus propelling a bubble economy.

 

Recently, 80 percent of the profits earned by centrally-controlled SOEs come from less than 10 huge conglomerates--CNPC, China Ocean Oil (CNOOC), China Telecom, China Mobile, China Telecommunications, etc. Most other SOEs either have overcapacity or are just mismanaged. They have to rely on government subsidies and credit to survive. Many private enterprises in coastal areas have also closed down in 2008. Thus, the advance of SOEs not only has promoted a price bubble, but also increased structural imbalances in China’s economy.

 

A New Enclosure Movement

 

One of the most adverse effects of the advance of the state-owned sector has been the increasing real estate market bubble.

 

According to China’s laws, all urban land belongs to the state. But local governments can transfer the land use right (for no more than 70 years) of certain sizes of land to private or public bidders. The winning bidders then become landlords, and can resell their land use right of a certain plot of land to developers for residential and commercial development.

 

Since the Beijing government liberalized the real estate market in 1992, the non-state sector has been the major player in this market. But gradually, the share of SOEs increased to 60 percent from an initial 8 percent. Many central and local SOEs that never were involved in real estate have competed for a share of this now booming market. According to official data, over 70 percent of the 136 centrally controlled SOEs, like China Chemical, China Railroad and China Metallurgy have entered the new real estate market.

 

Among the country’s top ten most expensive plots of land for building, around 60 percent are connected with the SOEs. In the light of the global economic slowdown, most Chinese manufacturing companies have experienced overcapacity. Their executives saw the real estate market as the easiest way to make a profit. Relying on low-cost loans from state-owned commercial banks and a high credit rating, they always succeeded to win land auctions in “golden districts” of Beijing, Shanghai and other metropolitan areas, which smashed price records and created one or more “land kings”. This generated a public outcry. More people now call this excessive acquisition of land by the SOEs as the Chinese-type of “enclosure movement”.

 

But these new landlords are not rushing to resell their land to developers for residential construction. Due to the limited supply of land, these “land kings” usually hoard land in their stock holdings and corner that market, because they expect an appreciation of that land. As a result, land in many urban areas remains idle, while residential housing is still in short supply. According to recent news reports, the vacancy rate of new condos in many major cities reached over 50 percent, while 85 percent of residents cannot afford to buy even a single unit. This drives housing prices to sky-high levels. Over the past 4-5 years, China’s land and resources prices has quadrupled or worse. These centrally controlled and local SOE landlords therefore have reaped windfall profits. Currently, housing is becoming a source for social turmoil and one of the very unstable factors in Chinese society.

 

Implications for the SOEs Expansion in China’s Economy

 

A heated debate has been going on in China whether the state sector is making a comeback, and if so, what implications that would have on China’s economy.

 

The spokespeople for Beijing’s authorities have officially denied any trend of the state sector expanding at the expense of the private sector. They have asserted that over the past 30 years both state and private sectors were “flying wing to wing”. According to official data in 2009, they said, the share of private assets such as their production value, profit, employment, and growth rate, still exceeded that of the state sector. They reiterated that the government’s policy of promoting the non-state sector has not changed. Hybrid and interlocking asset ownership by state, non-state and foreign capital is still encouraged.

 

But most academics and the media contend that these cited figures are unreliable and selective. Due to the overall poor performance of the SOEs, it is unconvincing to deny their “advance” only because their output, revenue, employment and profit have declined. The advance of state assets and the retreat of private assets should be judged from the following variables: First, the state still denies private companies access to many key industries, especially those monopolized by the SOEs; second, the state intervenes more vigorously into the economy; third, the state allocates more resources to the SOEs rather than to private companies; fourth, the SOEs expand to the competitive industries and their concentration increases. Many scholars also argue that in a market economy, the government should merely act as a regulator instead of a stakeholder.

 

Some negative effects of the above processes have already been seen.

 

n        SOE monopolies have combined assets and power in many industries to limit market competition. This action causes market failure and widespread corruption.

 

n        Because the SOEs’ revenues depend more on government spending and less on market demand, their behavior may not boost consumer spending and help the country to achieve a more balanced economy. It would certainly change the transaction costs for transforming China’s economic growth models. 

 

n        Relying on government loans and subsidies instead of depending on innovation and technology progress could enable SOEs to have lower efficiency compared to that of private companies.

 

n        The SOEs also reap benefits by giving high salaries and bonuses to their executives and employees. That means paying little to the government and shareholders.

 

n        Further, because many SOEs have invested in risky projects, bad loans will increase if the bubble bursts in the future and triggers a bank crisis.

 

If the above negative signals are not taken seriously, many Chinese elite worry deeply that there will be a trend of de-marketization and a return to the command economy.

 

New Attempts to Revitalize the Private Sector

 

Many economists point out that one miracle of the Chinese 30-year economic reforms has been the surge of private enterprise, becoming the main driving force of the economy. According to official statistics, private enterprise now account for 65 percent of the nation’s GDP, 80 percent of newly added jobs, and 65 percent of government tax revenue. In 2009, the year-on-year industrial production of private enterprise grew by 18.7 percent, compared to SOEs’ 6.9 percent; the revenue of private enterprise rose by 18.7 percent, compared to SOEs’ –0.2 percent; the gross profits of private enterprise grew by 17.4 percent, compared to SOEs’ –4.5 percent; the employment by private enterprise increased by 5.3 percent, compared to SOEs’ 0.8 percent. Based on these current trends, intellectual circles have called for the government to loosen its grip and return legitimate rights to the private sector so as to revitalize private enterprises that previous party and government decisions once specified but were not enacted through proper regulations.

 

It seems that the Beijing government has begun to pay attention to the critical housing problem. As a first step, the SASAC ordered 76 large central SOEs whose core business were not real estate to retreat from the property market in February 2010. This action is now regarded as part of a broader government plan for SOEs to divest and rein in fast-rising housing and land prices.

 

Apparently, the authorities also have realized the grave ramifications of the advance of the state sector and the retreat of the private sector. In late 2009, the government agreed at its Central Economic Conference to promote private enterprise to create jobs, to increase market access for private investment, and to protect the legitimate rights and interests of private investors. In March 2010, Premier Wen Jiabao announced an important new policy-- “Wen’s Four Guidelines” as nicknamed by the media.

 

With the global financial crisis easing, Beijing has started to ponder an exit strategy from its previous stimulus program in order to diminish the state role and step up efforts to encourage private and foreign investments. These guidelines include the following new developments:

 

·        Encourage and guide private investment in sectors currently controlled by the state, such as infrastructure for transportation, telecommunications, energy, public utilities, scientific and technological programs for national defense, and affordable residential construction.

 

·        Promote private enterprise innovation and upgrading through research and development.

 

·        Encourage and guide private enterprises to participate in restructuring and reorganization of SOEs through buyout, shareholding or joint shareholding actions.

 

·        Set up a sound administrative system to serve and guide private investment and amend unfavorable laws and regulations.

 

At the same time, Li Rongrong, head of the SASAC pledged that SOEs would gradually retreat from those competitive sectors to make way for private enterprises to expand.

 

Some analysts have commented that if all these new policies were implemented, it would certainly reverse the trend of “advance of the state sector and retreat of the private sector.” Approximately $6.7 trillion of private capital would replace the government stimulus plan and become the new engine for China’s post-crisis economic growth.

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Jialin Zhang, a visiting fellow at the Hoover Institution, Stanford University, specializes in international economics, China's economic reforms, and U.S.-China relations. He received his degree at the Moscow Institute of International Relations in 1960 and served as a senior fellow of the Shanghai Institute for International Studies. He is the author of numerous articles, essays and books. His recent books are U.S.-China Trade Issues After the WTO and the PNTR Deal----A Chinese Perspective, Hoover Institution Press, 2000; The Debate on China's Exchange Rate----Should or Will it be Revalued? Hoover Institution Press, 2004.
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