China in Transition

Growing Criticism over Advancing State-owned Sector and Retreating Private Sector - China should be aiming for the reverse -

Chi Hung KWAN
Consulting Fellow, RIETI

Since launching its reform and open-door policies in 1978, China has been moving forward with market-oriented economic reforms. As part of this, it has been encouraging the development of non-state-owned enterprises, including private companies, and the privatization of state-owned enterprises. As a result, the percentage of state-owned enterprises in industrial production has fallen from approximately 80% at the outset of the reforms, to about 30% in 2008. However, following the Lehman shock in September 2008 and the subsequent economic stimulus measures adopted in response by the government, there has been a noticeable advance in the state-owned sector and a retreat in the private sector in some quarters, contrary to the trend of a rising share of private companies at the expense of state-owned enterprises in the earlier period.

State-owned enterprises monopolizing the benefits of the stimulus measures

Behind the trend in the advancing state-owned sector and the retrogressing private sector, there have been four changes in the environment facing Chinese enterprises.

First, the global financial meltdown has had a greater impact on private companies, which are highly dependent on exports, than on state-owned enterprises that focus on the domestic market. In addition, the latter are eligible for support, including financial aid, from the government should they encounter difficulties, while the former do not qualify for such support.

Also, the stimulus plans for ten key industries, announced in succession in early 2009, encouraged mergers and acquisitions (M&As) led by large state-owned enterprises with the aim of fostering large and strong companies.

Moreover, the domestic demand expansion policy of 4 trillion yuan announced in November 2008 focuses on investment in infrastructure such as railways, roads and airports, which are areas almost entirely monopolized by state-owned enterprises. In fact, growth in investment in fixed assets undertaken by state-owned enterprises had stayed below that of "other enterprises," but positions of the two have reversed since the fourth quarter of 2008 ( figure 1 ).

Finally, in step with government policies, bank loans are flowing into state-owned enterprises rather than into private companies.

Areas where state-owned enterprises are gaining ground

The advance of the state-owned sector and retreat of the private sector is particularly noticeable in the areas of land purchase and M&As.

First, with respect to land purchases, the fact that China Overseas Land & Investment Ltd., a state-owned enterprise, won a bid for a housing site in Shanghai with the highest unit price in China in September 2009 has attracted public attention (the accepted price was 7 billion yuan). State-owned real estate enterprises are purchasing prime land not only in Shanghai, but in other large cities, including Beijing, Chongqing, and Shenyang.

Figure1: Fixed Asset Investment of State-Owned Enterprises Growing Faster than that of Non-State-Owned Enterprises

Figure 1: Comparison of High-Growth Periods of China and Japan

(Note) In urban areas only

(Source) National Bureau of Statistics of China

Meanwhile, in M&A activity, China National Cereals, Oils and Foodstuffs Import & Export Corporation and Hope Investments Management Co., Ltd., both of which are state-owned enterprises, invested 6.1 billion Hong Kong dollars in China Mengniu Dairy Company Limited (listed in Hong Kong) under the umbrella of the Inner Mongolia Mengniu Dairy Industry (Group) Co., Ltd, a private company, to acquire a 20% stake in July 2009. This investment is the largest-ever in the Chinese food industry.

Subsequently in September 2009, Rizhao Iron and Steel Co., Ltd., a private company, and Shandong Iron and Steel Group Co. Ltd., a state-owned enterprise, agreed to merge, with the latter absorbing the former. This has created the second largest steel company in China after Baosteel Group Corporation. While Shandong Iron and Steel Group posted an enormous loss before the merger, Rizhao Iron and Steel has steadily maintained healthy profits in recent years. It is generally believed that the reason why a loss-making enterprise was able to acquire a profitable company is that the purchaser was able to receive government support, as it is a state-owned enterprise.

M&As by state-owned enterprises have been burgeoning not only in China but also overseas. Overseas investments like this are concentrated in the field of resources development such as energy.

Concerns about a setback to economic reforms, especially market-oriented reforms

As a country that has been promoting market-oriented economic reforms while maintaining the principle of socialism, the issue of how China should treat state-owned enterprises has always been controversial. In 2004, new leftists, who emphasized equality, gained public support by criticizing the privatization of state-owned enterprises (which were carried out primarily through management buyouts) as "stripping of state-owned assets." On the other hand, neoliberalists who supported the privatization from the standpoint of efficiency were forced on the defensive. This time around, however, public opinion is more critical of the advance of the state-owned sector and retreat of the private sector, and the offensive and defensive stands of both camps have reversed for the following reasons.

First, despite making vast profits by taking advantage of their monopoly positions, state-owned enterprises pay relatively little in the way of dividends to the government, their shareholder. Ultimately, it is not the general public, but only executives and employees of these enterprises who reap the benefits by receiving high salaries and bonuses.

Also, the purchase of large tracts of land by state-owned enterprises is driving up real estate prices. As a result, the dreams of ordinary citizens of buying their own home are becoming increasingly unrealistic.

In addition, as certain bank loans to state-owned enterprises go to risky projects, bad debt will increase if the bubble bursts in the future.

Finally, although the shift of the economic center from inefficient state-owned enterprises to productive non-state-owned enterprises has been driving China's impressive economic growth, a series of recent moves symbolized by the trend of the advancing state-owned sector and the retreating private sector take it in the opposite direction.

An advancing state-owned sector and retreating private sector could depress economic growth

The advance of the state-owned sector and retreat of the private sector could limit the growth of the overall economy for the following reasons.

First, through lobbying activities, large state-owned enterprises seek to raise barriers to market entry to maintain their monopoly profits. This hinders the introduction of the principle of competition and further market opening.

In addition, as monopoly enterprises can generate profits readily, they have no incentive to improve efficiency, and so cannot achieve competitiveness in international markets. In fact, even though China is called the workshop of the world, this is largely attributable to foreign-affiliated companies. Those Chinese state-owned enterprises that are ranked in the Fortune Global 500 announced each year by Fortune magazine in the United States contribute little to exports.

Moreover, while most retained earnings generated by state-owned enterprises are reinvested, they are not necessarily used effectively to increase corporate value. Overseas M&As by Chinese state-owned enterprises, which have been increasing recently, are no exception.

To correct these harmful effects, China should aim to roll back the state-owned sector and promote the private sector, instead of the reverse.

February 3, 2010