Reforming State-Owned Enterprises in China: Two Decades of Struggles

Zhengxu Wang

Of all the problems China is facing in its transforming from a command economy to a market economy, no one is more formidable than the reform of SOEs, or State-Owned Enterprises. This legacy of the old command economy system, designed and established with both technical and financial help from the Soviet in the early 50s, became the main target of Chinese reform policy makers as early as early 80s, shortly after the reform began. After two decades of experiments, while other former socialist countries have technically privatized all their previous SOEs, China is still struggling to find a way to reinvent and reengineer these economic establishments. And the future success of this reforming effort is still uncertain.

In the command economy era, the SOEs served as production organs where raw materials are turned into industrial products. The planning commissions in national or local governments decide for each SOE what needs to be produced and how much. In such a system, the government agencies plan what to produce, supply resources, and distribute the products. This is known as the centralized command economy. As there is no free market per se, there are no free enterprises either. In this sense, a SOE is basically a production place. It has no marketing department, no R & D function, or whatsoever. Accordingly, SOEs in China are called factories (工厂, or just 厂, for short), instead of companies or firms in the west business management language.

What is unique besides the production side of these enterprises is that they, as any of the other social organs in China, are called units (单位). A unit is a basic urban organization in Maoist China. Someone has called it a village in the city, because a city both physically and administratively comprises of a great number of units, each of which has its physical establishment generally known as a compound (大院). A SOE is a social unit in that, besides providing life long employment to its employees, it also provides all the necessary social services to its employees and their family: housing, healthcare, child care, education, grocery, to name a few. In some sense, a unit takes care of its employees “from the cradle to the grave”. At a certain point of time, SOEs in China provide such services for more than 112 million workers and their families[1]. This social service function became a huge difficulty when it comes for the policy makers to change SOEs into market competition oriented firms.

Chinese reformers started to work on SOEs as early as in the early 1980s. By that time, it had become evident that SOEs would not survive in an economy system that was becoming more and more market-oriented. Chinese leaders refer to the problem of the SOEs as lack of vitality or energy (活力). The policies used to make SOEs more viable included a series of decentralization efforts. Firms were allowed to produce more than the plan quota, and sale the extra to the market. Part of the profit resulted from the extra products were kept by the firms. In addition, the firms were allowed to divide their profit with the state. In general, the firms were given more freedom regarding to making management decisions (production, marketing, investment, and profit distribution). This resulted in the increase of productivity and efficiency of the firms. Later firms were allowed to get involved in international business, and built joint-ventures with foreign companies, especially those in the coastal cities that were identified by the state to be cities “open to the outside”. These experimental efforts were later institutionalized as the so-called contract-system, or Contract Responsibility System. Under this system, the manager of a firm signed a contract with a state agency. The manager had the right to run the firm in its day-to-day operation, while the firm remained to be the state’s assert.

The contract system proved to be a fairly successful strategy in increasing the productivity and efficiency of SOEs. However, new problems emerged. The managers in negotiating their contracts with the state agencies always tried to hide the real base figures of production, revenue, and profits, in order to gain benefits. Together with other efforts the firms took in order to gain benefits for themselves, the result was the drain of state assert. The firms increased their productivities and efficiencies but also came into debts[2].

A new reform plan known as corporatization was publicized in 1993, when the National People’s Congress legislated Enterprise Law. The aim was to reorganize SOEs into “modern enterprises.” A typical “modern enterprise” is defined using sixteen Chinese characters, which mean “clear property right, clarified rights and responsibilities, separation between the government and the firm, and scientific management[3]”. Despite a strong stance of the government, this strategy was implement slowly[4]. The slowness of moving this reform is due to lack of a macro environment that is conducive of needed changes. For example, the financial system in China had not finished its transition either. And there was lack of a social security network, so the restructuring of firms could not take place because worker layoff was impossible.

In general, by mid 90s, it became apparent that the reform of SOEs had resulted in several major political economy problems. The first is corruption of firm managers and state officials who have rights over the firms they govern. Managers became rich while the firms went into debts. State officials also request funds from the firms, either for their own benefits or for their governmental agenda. For example, a mayor may request a firm to provide two million RMB Yuan for the construction of a road. This is also known as rent seeking of the government. The second is drainage of state asserts, as mentioned early. The contractual system also resulted in the managers short-term behavior, when they try to make as much profit as possible during their contract term, neglecting the maintaining of the asserts. And the third is that firms became more and more in debt to the banks. The banks are controlled by the government. In order to keep the firms running, the government often orders the banks to give loan to the firms, even though the firms are unable to return even the interest of the loans. Also, firms became in debts with each other, a phenomenon known as “Triangle Debts”.

How did this happen? What’s the problem? Theoretical debates become intensive as pessimism grows. Many pointed out that the state-owned economy is doomed to fail, so the only way out is to privatize[5]. Others, including some of the most important advisors to the policy makers, believe that the difficulties that SOEs are facing are the problems resulted from the old command economy. The transition of the economic system comes with price, but will succeed in the long run. They gradually realize the key problems for the SOEs both in the environment in which the SOEs function and the inner management and operation systems of the SOEs[6]. In their mind, the goal outlined by the sixteen-word slogan is right to the point. The problem lies in how to move from here to there. Steinfeld conducted three case studies on the SOE reform in China in the 1995-1996 period[7]. He outlined the problems of the SOEs as: (1) Lack of hard budget constraints. A firm can keep running even though it is losing money. This is mostly due to political reasons. The government cannot afford to close them, as the unemployment of the work force will cause social instability. (2) Lack of legally clear and enforceable property rights. In other words, Whose firm is this? In theory, the firm is owned by all the people, and the state owns it on behalf of the people. But in practice, various government agencies will be able to intervene the firm, claiming themselves as being the state. (3) Lack of incentive (and discipline) structures that induce firm managers to act in the interests of firm owners. Since the managers are politically appointed, their career is less linked to the performance of the firm than their political loyalty and competence. Lack of management accountability also resulted in the wealthy managers in money-losing firms.

Thus, policy makers understand that new and radical efforts become necessarily. On the Ninth National People’s Congress, the newly appointed (elected) Premier Zhu Rongji announced that his government would turn the SOEs into profit-making in a period of three years starts from 1998. Now, two years later, many of his plans have been implemented. And as the party recently also released its policy outline for the country’s next, also the tenth, five-year plan, it is possible to understand the whole SOEs reform package. It appears that this package, even though the reformers themselves might not realize at the beginning, includes two clusters of strategies: a cluster of short-term ones and a cluster of long-term ones.

The short-term strategies, which were debuted soon after Zhu took his position, turned out to be some efforts that would hopefully remedy some most imminent problems. The first is known as “grasp the big, let go the small[8].”The state will keep only 2000 in number, which are recognized as most critical to national economy. Other SOEs will be sold, merged, turned into collectively owned firms, or just closed. Related to this, SOEs will go through a huge wave of downsizing, or, rather, right-sizing, since many of them had been overstaffed[9]. To avoid big social percussion, the state also started to build social security networks to cope the unemployment. A brand new social security industry started to take its shape.

Some other efforts targeted the finance/investment system. One is a debt-share swap. As noted earlier, Chinese banks have accumulated a huge amount of so called non-performing debt. The state supplies money through Ministry of Finance, and forms assert management companies. The assert management companies provide money to the firms. The firms pay their loan back to the banks. After this, the firms’ debts are turned into the shares held by the assert management companies on behalf of the state. And banks retain a healthier condition by getting rid of the bad loans. Another effort is that some firms go public by listing on the stock market.

Even though the unemployment in China keeps growing, and some small- and medium-sized SOEs are facing difficulties as they are being “let go”, these short-term efforts on the “grasped” large- and medium-sized SOEs are declared to be successful[10]. At this time, the long-term strategies of SOEs begin to unfold. First, efforts are being made to build a new environment for SOEs (as well as for all the firms in China). This is a market economy framework in which firms will run, including finance system, stock market, taxation, personnel, social security, and others. Second, on the macro level, industrial restructuring will resulted in the concentration of SOEs in several key industries that are critical to national economy, such as steel and iron and steel, energy, and national defense. Third, at the micro level, change plans have been released to realize the earlier-mentioned sixteen-character configuration of SOEs.

To apply enforceable property right over SOEs, state assert management companies will be formed. These companies will be the investors and shareholders of SOEs, and will send board members or board directors to SOEs. The firms will become independent legal persons. This will also hopefully result in (finally!) the separation between government and firms. To achieve “clarified rights and responsibilities”, incentives and disciplines on managers will be introduced. Managers will be holding shares, and the introduction of board system will bring overseeing over managers. This is also part of the “scientific management” project. In addition to the introduction of the board system, the selection of managers will become open to the society, rather than putting political criteria at the first place[11].

The state by now also realizes that as the change agent, by its effort along, SOEs cannot be turned into strong competitors in the world market. The state can only work to change the environment for the firms, while improving firm competence is a job for the firms themselves. Chen Qingtai, one of the foremost economic advisors to the policy makers, points out the importance of “the core competence” and other areas for firms to work on, such as financial portfolio management[12]. This appears to be an awkward area for the policy makers. The state is not the president or CEO of the firms. But it, at least for right now, has to worry about some issues a president or CEO of a firm needs to worry about.

It is probably too ambitious for such a short essay to tack this issue. To make a conclusion, although the effect of many policy initiatives remains to be seen, after two decades of struggle, Chinese reformers seem to have achieved a consensus of where the reform of SOEs should be going. And they seem to have a strong belief that the SOEs, after the reforming plans are materialized, will thrive in the market economy[13]. A free market economy modeled after western industrialized systems with a group of substantial state-owned players in many key industries, such as manufacturing, electricity, transportation, communication, petroleum, and finance and banking, seems to be the goal in their mind as they are working to build a “socialist market economy”, or “socialism with Chinese characters.” The picture looks good. But whether it will be materialized remains a big question.

Bibliography

Chen, Qingtai. “What Can Chinese Big Enterprises Do?” Chinese Economic Daily, 27 January 2000.

Hanson, Jon. “Gradual Path to Economic Liberalization: state-Owned Enterprise Reform in China.” Unpublished Paper. 26 April 2000.

Lin Yifu: “Projecting Chinese Economy in the New Millennium.” Twenty-First Century (2), 1999, (Chinese).

Lin, Yifu. The China Miracle. Hong Kong: Hong Kong Chinese University Press, 1996

Nanfang Daily (Nanfang Ribao) (Guangzhou), 8 October 1999 (Chinese).

Steinfeld, Edward S. Forging Reform in China: The Fate of State-Owned Industry. Cambridge: Cambridge University Press, 1998.

Xinhua (Beijing), 27 November 2000 (Chinese).

Xinhua (Beijing), 18 October 2000 (Chinese).

Yang Shujin, “Economic Reform and Development of China: A Retrospect and Look-Afar at the Turn of the Century.” University of Princeton: Research of Modern China (2), 2000, (Chinese).

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[1] Nicholas R. Lardy, 1998, as cited in Jon Hanson, “The Gradual Path to Economic Liberalization: State-Owned Enterprise Reform in China”, unpublished paper, 2000, p.5.

[2] e.g. Yifu Lin, The China Miracle. (Hong Kong Chinese University Press, 1996), p. 211-213.

[3] In Chinese: 产权明晰，权责分明，政企分开，管理科学。These sixteen characters have been the slogan of SOE reform since then.

[4] As cited in Hanson, 2000, p.7, as of 1997, only 200 companies had accomplished cooperatization and had their shares listed.

[5] See, e. g. Yang Shujin, “Economic Reform and Development of China: A Retrospect and Look-Afar at the Turn of the Century”. University of Princeton: Research of Modern China (2), 2000, (Chinese).

[6] See, e. g. Lin Yifu, 1996, p. 211-219. Also, Lin Yifu: “Projecting Chinese Economy in the New Millennium”, Guangzhou: Twenty-First Century (2), 1999, (Chinese).

[7] Steinfeld, Edward S. Forging Reform in China: The Fate of State-Owned Industry. Cambridge: Cambridge University Press, 1998.

[8] In Chinese: 抓大放小。

[9] As cited in Hanson, 2000, the textile industry was going to layoff 1.2 million workers, railway, 1.1million, and chemical industry, 400,000.

[10] As cited in Hanson (2000, p. 14), by 2000, Chinese reformers announced that profits of medium- and large-sized SOEs increased by 77 percent. Also, Zhu Rongjin in his annual report to the National People’s Congress, announced on March 3^rd, 2000, that textile industry had used only one year to achieve profit-making, other than the planned three-year period, while other industries are making progress in this direction. On November 27, 2000, the State Statistic Bureau released the figure that from January to October, 2000, the SOEs made a profit of 183.9 billion RMB Yuan, a increase of 160 percent over the same period of 1999 (See, Xinhua, 27 November 2000). On November 30, 2000, the CCP Economic Meeting declared that the three-year goal of turning SOEs into profit-making had been achieved.

[11] These policy initiatives have been discussed widely in the theoretical arena. Recently (September, 1999, Published on 8 October 1999, Nanfang Daily), the provincial government of Guangdong published its plan to reform SOEs, which including these initiatives. Other provinces, such as Hunan, are also carrying out similar efforts. It can be argued that the central government is using these provinces as experiments, and the experiments will soon expand to the whole system.

[12] Chen, “What Can Chinese Big Enterprises Do?” Chinese Economic Times, 27 January 2000. (Chinese).

[13][13] For a good illustration of this, see the Party’s newly released “Suggestion to the Writing of the Tenth Five-Year Plan”, published by Xinhua, 18 October 2000.

Zhengxu Wang is a Ph. D student in the Department of Political Science, Center for China Studies and the School of Education at the University of Michigan in Ann Arbor.