Privatization with Chinese Characters

Christopher Lingle

Gavle, SWEDEN

SINOPEC

Since China’s economic reforms began in the late 1970s, there has been considerable focus on transforming and restructuring state-owned enterprises (SOEs). Several encouraging signs indicate that steps are being taken in the right direction.

In the first instance, there has been a dramatic shift in the dominance of state enterprises. China’s non-state sector now produces about 70 percent of GDP. This sector has about 30 million enterprises employing over 70 million workers. Non-state enterprises produce nearly 40 percent of all traded goods, up from 1990 when they only accounted for 19 percent.

To date, more than 6,000 SOEs have been transformed to shareholding companies, even if not fully privatized. Communist orthodoxy has encouraged obfuscating language whereby equity diversification is applied in place of privatization.

Although PetroChina, China Unicom and Huaneng Power were partially privatized by selling shares on overseas stock markets, the largest and most valuable SOEs are controlled by Beijing. But all trading on the Chinese stock markets involves enterprises where the government holds at least 51 percent of outstanding shares, even though this is a reduction from government control of 75 percent of traded companies.

Now the bureaucracy that supervised most SOEs will control fewer than 200 of the largest ones. The smaller ones will be given to local authorities that can dispose of them after a new set of rules grants them full shareholder’s rights.

This round of “privatization” will be decidedly different from the first wave of sell offs in the late 1990s. In this current wave, local government bodies will be selling off their share of around 174,000 state-owned enterprises with combined asset valuation of about $500 billion.

Since most of these SOEs are relatively small, their sale may only have interest for domestic investors. Even so, potential foreign buyers would face considerable risks since China’s SOEs do operate differently from their counterparts in industrialized economies, making it is difficult to gauge their true condition.

Altering accounts and providing false impressions about the profitability of enterprises is commonplace in China. And with declining domestic spending and falling export growth, overall economic losses for state enterprises will expand and will have distorting knock-on effects for other sectors in its economy.

While bankrupt SOEs divert scarce resources from other enterprises that might be more productive; their most damaging effect is the weakening of the financial sector. When funds are provided to insolvent enterprises, the day of reckoning when inefficiencies have to be resolved by massive shutdowns is merely delayed. State banks have over a trillion yuan in non-performing loans making a mass default in the banking sector very likely.

Meanwhile, much of the hard-earned savings of the peasantry and workers has been squandered and the credibility of government banks as prudent managers has been shredded. Official estimates admit that at least one-quarter of total savings that the Chinese people have entrusted to state banks has been wasted, although the true figure almost certainly much higher.

At the same time, much of the capital initially raised on the domestic stock markets and abroad to finance the renovation of state-owned enterprises was paid out in salaries and for purchase of raw materials rather than invested. Shares issued to the public were for partial ownership in SOE factories that continued to be managed by many of the same people with many of the same bad habits. Unable to earn profits, they do not pay dividends to shareholders.

In keeping with the intent to lessen state control over its economy, China’s constitution has been amended to validate private enterprises through assigning them a legal status. However, it is one thing to declare the sanctity of private ownership and another thing to establish an independent judiciary to defend it and a competent legal system to enforce it. Claims about property rights are extremely complex and become more so when individual rights come into conflict with public interest.

Resolving contract disputes requires attorneys and judges that can refer to established case or common law guided by a constitutional framework. Like other former communist countries, China must build such institutions from scratch. It is not enough merely to change the incentives for people who have lived within a system that does not encourage initiative or penalize idleness.

While much of the non-state sector is owned or controlled by local or provincial governments, these enterprises do not operate under the same competitive conditions as private firms. And managers in local government enterprises have less accountability and shoulder less of the burden for failures.

China’s domestic private sector suffers from a myriad of problems. These include vague property rights, uncertain ownership structures and limited access rights to stock markets. At the same time, many of these also have weak corporate governance mechanisms and their financial records are shoddy, at best.

The economy suffered from a bias that favored state-owned enterprises by providing them preferential access to markets and financing. A real market economy requires that there be a shift away from a discretionary regulation and taxation towards a nondiscriminatory policies based upon general rules. This includes strengthening private property rights with an independent judicial system capable of enforcing them.

There must also be greater access to investment funds. As it is, a very small portion of bank credit goes to private firms that must rely heavily upon self-financing for expansion. And but a small fraction of the listings on the Shanghai and Shenzhen exchanges are truly private enterprises.

Unfortunately, socialist bureaucracies are exceedingly reluctant to relinquish ownership of government property to private investors or corporations, (unless to themselves or their cronies). In the first round of de-nationalization, the transition process resembled that of the former Soviet economies whereby “spontaneous privatization” meant that the most valuable assets were stripped by current managers and transferred to themselves or to friends or family.

Despite these risks, steps towards complete privatization of the Chinese economy must be undertaken, and the sooner the better. Unless there are gains in productivity from shifting more assets to more efficient and competitive private enterprises, China’s economy will not generate high enough growth rates to keep unemployment from rising or standards of living from falling.

Under the direction of Zhu Rongzhi, Beijing began to privatize smaller state-owned enterprises and shedding workers to improve operating efficiency. Up to 27 million state sector jobs were shed in the five years from 1998 while the number of SOEs was slashed. Even so, as indicated by a World Bank report, about 51 percent of SOEs were loss makers as of the end of 2000.

A new strategy for the reform of state-owned enterprise involves reconfiguring the relationship between the government and the enterprises it owns. As a first step, ownership of state companies will be transferred from the current ministries and commissions to a State Assets Supervision and Administration Commission (Sasac).

So far, the ownership and supervision of 196 enterprises with assets worth Rmb6,900bn ($834bn) had been transferred to Sasac. It remains unclear as to how many of China’s 174,000 state enterprises would be transferred to Sasac.

The state sector’s contribution to GDP fell from about 100 percent in the early 1980s to roughly 30 percent in 2000. China’s remaining 180,000 state-owned enterprises account for about one-quarter of industrial production. Officially, the state sector still employs about 70 million people and the valuation of Beijing’s assets is around 12.1 trillion yuan ($1.5 trillion). In the past five years, 27 million workers were laid off from SOEs.

Christopher Lingle is Professor of Economics at Universidad Francisco Marroquín in Guatemala and Global Strategist for eConoLytics.com. His E-mail address is: CLingle@ufm.edu. Shalom institute publishes this article written in 2011 by his authorization.

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