Tackling The SOEs

Business, China, Company Strategy, Economics, Europe, US
By John Richardson on 06-Nov-2012

“The state advances as the private sector retreats…” The table below shows the size of China state-owned enterprises versus some other corporate giants.


Source of table: The Economist. ICBC is the Industrial and Commercial Bank of China. 


By John Richardson

In the second of our series of blog posts ahead of this week’s 18th Party Congress, when China’s leadership handover will begin, we focus on the scale of the challenge for the new leaders in reducing the role of the state-owned enterprises (SOEs).

BARACK Obama or Mitt Romney will have limited ability to shape US economic policy as a result of the separation of powers.

Not so their Chinese counterparts, who, thanks to the overarching role of the Communist Party in both government and business, enjoy almost unrivalled influence over the country’s direction.

This influence isn’t always to the good. A case in point is the increased role of the SOEs, say a growing number of economists.

During the last eight years, “the institutional, regulatory and interpersonal links between the CCP (the Chinese Communist Party) and SOEs were strengthened,”writes Sydney University associate professor, Dr John Lee.

“Senior management positions within SOEs increasingly became a path to political power and a reward for political officials. The list of sectors designated as ‘strategic’ or ‘important’ by Beijing also expanded, meaning SOEs (or, in rare cases, private companies with extensive CCP links) are well positioned to dominate every major domestic sector in the economy: banking and finance; property; infrastructure; energy and mining; newer fields such as renewables; informational technology; and bio and nanotechnology.

“The Hu-Wen team was extraordinarily successful in rebuilding a CCP-dominated corporate state. At least two of the top three executives in almost all SOEs are CCP members. More than 1900 of the 2047 listed firms in the country’s two stock exchanges are majority-owned by the government.”

This has been to the detriment of sustainable economic development, he argues.

“While China’s emergence as the world’s factory is impressive, there is a more important domestic story. From 1979 to 1989, domestic consumption was the dominant driver of growth,” he adds

“From 1993 until earlier this century, net exports took the mantle. Since the early days of the Hu-Wen period, fixed investment has become dominant. This is significant. From 2004, Hu has overseen a huge increase in fixed investment. Credible Chinese economists have come to the conclusion this is not just unsustainable but dangerous.

“Fixed investment as a proportion of gross domestic product is well over 55%. Such activity is fuelling more than half of China’s growth each year. When you consider that one-third to one-half of these projects offer zero or negative return on investment, a future banking crisis is not just possible but probable.

“If non-performing loans were properly classified as such under internationally credible accounting rules, at least two of the four dominant state-owned banks would be technically insolvent.”

SOE officials routinely carry several business cards, a sales and marketing executive with a global polyolefin producer told the blog on its recent visit to Singapore.

“One card is for their official jobs and the others are for businesses they have set up on the side, using their connections to easy financing. These are often trading companies, run by relatives, which have helped drive-up the price of property.”

The 150,000 SOEs receive more than three-quarters of all formal bank loans, with the 4.5 million domestic firms receiving less than 10%, adds Lee.

In 2009, the three largest Chinese SOEs earned more revenue than the largest 500 domestic private sector firms combined.

During the last decade, the revenues of the SOEs have increased 15% to 25% each year, while household incomes have risen at a paltry 2-4%% per year, he continues.

“There are still an estimated 500m Chinese living on $2 a day or less,” he says.

Eighty percent of poverty reduction since 1979 took place in the first decade of reforms, when the private business and household sectors, rather than the state, were given the biggest share of opportunities, he adds.

The SOE share of investment, which had been in decline, has risen in property, communications and finance, according to the economic consultancy, GK Dragonomics.

In 2004 the average industrial output of SOEs was six times that of the average private firm; by 2010 it had shot up to 11 times as much, it estimates.

“The government showers a range of tax breaks and subsidies on state firms, and favours them in procurement contracts,” writes The Economist.

“Unirule, a Chinese think-tank, reckons not having to pay for the land SOEs sit on was a subsidy worth some 4 trillion yuan ($640 billion) in 2001-09.”

And if Mitt Romney does win the race to the White House, he might use of the role of the SOEs as further ammunition for an assault on China’s trade practices.

“One of the biggest complaints lodged by the multinationals is that they are largely frozen out of (Chinese) government procurement–a market estimated to be $1.3 trillion in size,” continues The Economist.

“China promises to join WTO accession protocols that would bring its rules in this area in line with global norms, but has been dragging its feet for years.

“Strikingly, the EU Chamber of Commerice has issued a thinly veiled threat on reciprocity: if China does not open up soon, the relatively free access its firms enjoy to the EU’s market may become ‘untenable’.”