Reforming China's SOEs
- By John Ross
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E-mail China.org.cn, May 15, 2015
China's ability to directly control investment through the state sector also creates stronger tools of macro-economic anti-crisis management than in Western economies. As the Wall Street Journal noted: "Most economies can pull two levers to bolster growth: fiscal and monetary. China has a third option. The National Development and Reform Commission can accelerate the flow of investment projects."
This ability to set investment levels via its state sector is a key reason China strongly outperformed the U.S. since the beginning of the international financial crisis. From 2007 to 2014 China's GDP grew by 79.9 percent versus 8.2 percent in the United States – China's economy grew almost ten times as fast as the U.S. economy.
But if SOEs give China huge advantages overall, what problems are the new changes designed to tackle? There are many individual issues but these are best understood in fundamental economic terms.
In China in the past an error was made in seeing SOEs as having not just economic benefits but a social function. SOEs not only provided employment but social security such as housing and health care. This was an error for two reasons. First, providing such services increases costs for SOEs – eroding or eliminating their advantage in terms of lower borrowing costs and not having to pay dividends to private shareholders.
Second, effective management requires specialization and focus. Company managers need to concentrate on their firms functioning efficiently, while those delivering social protection need to concentrate on that. Trying to do both simultaneously inevitably leads to neither being done most efficiently. SOEs should contribute to social protection by tax payments, not social security management. Remnants of this old system need to be eliminated.
Clearly demarcating SOEs purely economic functioning, and enforcing financial discipline, is aided by ensuring larger parts of their assets are in companies listed on share markets. This principle was followed in the recent reorganization of a major SOE, the Shanghai Electric Group, which transferred assets from its unlisted parent company to a listed subsidiary.
Second, competition powerfully stimulates economic efficiency. But it must be understood within a globalized economy not purely domestically. This is another feature of current SOE reform. To take a leading example, China previously had two state owned railway construction companies – CNR and CSR. The theory was their competition would stimulate efficiency.
But in reality, particularly in global competition in high speed trains, Chinese firms' key rivals are international. Even the US$32.3 billion combined turnover of China's two companies is far behind world leader Siemens US$96.5 billion – and China's manufacturers also face competition from Japan's bullet trains and Canada's Bombardier. China's merging of its two companies correctly flows from understanding competition in global not domestic terms.
This further relates to a more general question. Global data clearly shows large companies have higher productivity than small ones. The greater role played by large companies in the United States is a key reason for its superior productivity compared to competitors – 45 percent of U.S. employment is in companies with more than 250 employees, compared to only 33 percent in the EU.
But China has over 100,000 SOEs – requiring consolidation. Taking the largest currently discussed proposals that the 112 centrally-owned SOEs be merged into 30-50 goes in the right direction. This should be part of China's general company consolidation – it is uncompetitive, for example, for China to have over 10 major automobile manufacturers, compared to three in the United States.
Finally, a key question is monopoly. Competition spurs efficiency but in some sectors it cannot operate – normally because investment costs are impossibly high to have competing systems. No country has competing electricity grids or metro systems.
Faced with inherent monopolies, the last thing required is a "market solution." The market operations by monopolies are well understood – they are excessive prices and inferior quality. Inherent monopolies require an "anti-market solution" – keeping them in state ownership and imposing tough management to overcome their market tendencies. This is a key reason for the necessity to create a cadre of highly trained and tough state enterprise managers.
The fight against corruption is one aspect of that. In 2014, 70 executives at SOEs were placed under investigation for corruption and such investigations continued in 2015. But an overall system of highly efficient state managers must be created.
On this, while the author is in general a strong supporter of China's economic policy, he disagrees with one of China's policies. Deng Xiaoping, famously noted that in China's current "primary stage of socialism" payment must be "according to work." He restated Marx. In strict social terms a manager is a very skilled worker. In every country, including the U.S., despite media myths, the overwhelming majority of large companies are run by managers not by "entrepreneurs" – the owners of the companies. The reason these managers are so highly paid is that the work they do is ultra-skilled – decisions which can involve billions of dollars.
Singapore has the system most in accord with "payment according to work." Managers are highly paid but subject to transparency and treated as workers – they can be easily sacked. It is because this is in accord with economic principles that Singapore has one of the most skilled and non-corrupt management systems in the world.
This view of high SOE manager payment is however not China's current system and would be extremely unpopular there.
The writer is a columnist with China.org.cn. For more information please visit: http://www.china.org.cn/opinion/johnross.htm
Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.
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