Reforming China's SOEs
- By John Ross
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E-mail China.org.cn, May 15, 2015
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An employee of a subsidiary of China National Petroleum Corporation's oilfield operations in the Xinjiang Uygur autonomous region inspects pumping equipment. [Zhang Yuwei / Xinhua] |
China is currently carrying out major changes in its State Owned Enterprises (SOEs) in a framework set by the Third Plenum of the Chinese Communist Party's current Central Committee. This resolved: "We must unswervingly consolidate and develop the public economy, persist in the dominant position of public ownership, and give full play to the leading role of the state-owned sector."
This fact that China sees SOEs as the core of its economy is the key structural feature distinguishing China's "socialist market economy" from the West's "private market economy."
Given that China's economic system has outgrown capitalist market economies for over thirty years, what is the connection between China's SOEs and its superior rate of economic development? Why has a "dominant position of public ownership" produced higher economic performance, and what are the specific problems leading to SOE reform? The answer to these questions indicates what the changes should be.
SOEs give China clear micro- and macro-economic advantages. The first micro-economic one is that as SOEs do not have private owners they do not pay dividends to private shareholders. Dividends are a significant proportion of Western economies – around 5 percent of U.S. GDP. In China profits which in the West would be dividend payments to private shareholders can instead be invested by SOEs. As a part of Western private shareholders' dividends are used for their consumption, SOEs raise an economy's overall investment level. As investment is a chief driver of economic growth, this enhances China's economic performance.
The second micro-economic advantage of SOEs are that the state, and therefore state-backed companies, pay lower interest rates for borrowing than private companies – due to lower risk.
The macro-economic advantages of SOEs are even greater than the micro-economic ones. In a private economy, no automatic mechanism ensures that company profits, which technically are a form of saving, are transformed into productive investment. Keynes put this in a famous comparison: "Saving means – so to speak – a decision not to have dinner today. But it does not necessitate a decision to have dinner… a week hence."
The theoretical possibility that private company savings will not be invested operates practically. A key mechanism leading to the 2008 international financial crisis was that U.S. companies did not invest all their profits. U.S. company operating surpluses rose substantially, from 20 percent of Gross Domestic Income (GDI) in 1980 to 26 percent in 2013, while simultaneously U.S. private fixed investment fell from 19 percent of GDI in 1979 to 15 percent in 2013. Falling investment, despite rising profits, led to economic slowdown and eventually financial crisis.
This situation has continued with the accumulation of U.S. companies "cash mountains." By mid-2013 U.S. non-financial companies cash holdings reached $1.5 trillion.
U.S. companies, instead of investing, transferred money to shareholders not only in dividends but via share buy-backs. In 2014 U.S. S&P 500 companies spent 95 percent of their operating margins on buying their own shares or on dividends. Failure to invest meant that by 2013 the average age of U.S. fixed assets reached 22 years, the oldest since 1956.
As Larry Fink, the head of BlackRock, the world's largest asset manager noted: "More and more corporate leaders have responded with actions that can deliver immediate returns to shareholders… while underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth." The U.S. government can appeal for greater investment, but no mechanism exists to enforce this on private companies.
In contrast in China state ownership of SOEs means they can, if necessary, be instructed to invest. This is a key reason China's investment level is far higher than the United States – in 2013, the latest internationally comparable figures, China devoted 45.9 percent of GDP to fixed investment compared to the U.S.' 18.9 percent.
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