Though Australia maintains an open foreign investment regime for foreign private capital, it remains wary of investment from government-controlled entities. The general perception is that ‘Chinalco is a state-owned enterprise’, and hence ‘the Australian economy is in danger of being taken over by Communist China’. This is a simplistic view to take. People who hold such opinions must not have a great deal of knowledge about China’s SOEs, and are unaware of the implications of investment from China’s SOEs in Australia.
China’s SOEs have been undergoing restructuring. The reasons for this are twofold: the first one is the profitability problem – enormous and unprofitable SOEs and laid-off workers were a heavy drain on the state coffers before the late 1990s. The second reason is the need to build a market economic system in China. Due to possible government bias towards SOEs at the expense of their private sector competitors, a market economy based on fair play cannot be achieved with the presence of so many SOEs.
After massive privatisation and bankruptcies in the late 1990s, only 138 SOEs remain in central government ownership, and the numbers will be further reduced to between 80 and 100 by 2010. These SOEs are dominant in some of the most lucrative and strategically important sectors of the economy, such as telecommunications, banking, resources, oil, aviation, infrastructure, public service sectors, and so on.
The SOEs’ profitability problem has largely been resolved. The 138 SOEs that remain are among some of the most profitable firms in the world, thanks partly to improvement in their corporate governance, but more importantly because of their monopolistic position in the market and extensive support from the state. Private sector competitors experience difficulties in accessing these protected sectors due to a host of visible and invisible barriers, even though their access is nominally allowed by Chinese law.
The opportunity costs for shoring up the bottom line of SOEs are considerable. China’s economy could have been more efficient if stronger competition was introduced through the liberalisation of monopolistic sectors dominated by SOEs. Many problems, such as economic and structural imbalances, inefficient growth, and an underdeveloped service sector could be solved through reform in SOE-monopolised sectors.
China’s national interest therefore lies in the opening up of monopolistic sectors and through SOE reform. According to ‘China’s Guideline for Reforms in 2009’, recently released by the State Council, China is now engaged on the work ‘to deepen the reforms in monopolistic sectors, and broaden the sectors and channels for private investors’ on the top of its reform agenda.
The reform of China’s SOEs, however, has different implications for Australia. Would it be better for Australia if Chinalco was a private company, or and SOE in the process of being privatised? The answer is that it would not, since in that case Chinalco could no longer hold a monopolistic position and be eligible for special support from the government. To make money in the Chinese market, it is easier for an Australian company to engage with an influential monopolistic Chinese SOE than to work with a private Chinese company.
The so-called ‘threat’ from China’s SOE investment is an illusion. The motivation of China’s SOEs is actually quite simple: to secure a supply of resources, rather than to control a market or the economy. Actually, subject to the laws and policies in Australia, China’s investment could never be ‘out of control’. China has a low share in Australia’s FDI and Chinalco’s would have had a minor stake in Rio. In contrast, some Chinese scholars doubt whether SOE-driven overseas investments are really helpful for China to secure its global resource supply, and suggest that some SOEs are merely cash cows in some overseas M & A cases.
The further reform of SOEs is critical for China to establish an effective market economic system. But now China’s reforms confront strong opposition from vested interests. SOEs are supposed to serve the interests of all Chinese people, but in reality they have somehow been manipulated by an elite group pursuing its own interest in the name of national interest. This makes reform in monopolistic sectors hard to achieve. It might also be familiar to Australians.
A real worry for China’s institutional reform is that the vested interests from both China and the West will work together to make China’s reforms even harder. Multi-national companies usually play a positive role in pushing forward China’s reforms. But once they are married with China’s SOEs and enter into China’s monopolistic sectors and benefit from the monopoly they naturally oppose moves, similar to the SOEs, to open up those sectors. Like the SOEs quoting national interest as an excuse to defend their own interests, foreign companies would hold the Chinese state stake as hostage to seek extra benefit from the Chinese government.
Throughout history, many mistakes have been made in the name of national interest. Some people may treat the rejection of the Chinalco deal as a success in defending Australia’s national interest (even though the decision was not made by the Australian Government). But if national interest means economic benefit, then they have made a mistake. Rio may benefit from its ‘smart’ tactics in the short run. But its opportunistic behaviour will definitely harm mutual trust and its long term interest in China. As Peter Drysdale has suggested, ‘Australian policymakers… will have to work hard to restore confidence in the Australian investment environment’.
It is hard to say whether the outcome of the Rio-Chinalco deal is actually good for Australia. The frustration of some Chinese SOEs’ overseas investments in recent years suggests that economic success is not sufficient for China to be recognized by the world. The interaction between China and the world through overseas investment could exert a positive influence on China’s institutional reforms at home. As for the supply of resources, this is determined predominantly by market forces.
I am a bit confused after reading the article. It is unclear whether the so called monopolistic positions of some Chinese SOEs would benefit Rio or not. Chinalco is not a monopoly in the Steel industry. It is not a firm in the steel industry. Further, Zhang has argued that further reforms may further reduce their monopolistic powers.
I thought the potential advantages to Rio if that deal had gone through would be it would have a closer strategic partner in China to work in its interest, since Chinalco would benefit more if Rio benefit from increased share of the Chinese market. That would be very important. The Rio board had pointed out this point when it supported the deal.
That aside, I find some other arguments in this article confusing.
First, I don’t believe that all SOEs are monopolies, like firms in the steel industry where I had some experience, and in the non-ferrous metal industry which Chinalco belongs, if my understanding is correct (if there are any SOEs in the steel industry). Yes, in some sectors, SOEs are monopolies, possibly in the post and communications sectors.
Second, I don’t think the performances of SOEs were as bad as Zhang described. Government subsidies are only one of the financial relations between SOEs and the government. One also needs to look at many other things, such as whether they were taxed more heavily, whether they have other burdens such as many social responsibilities, like housing for employees, providing schools and hospitals, and even urban infrastructures, etc.
Another point that struck me as surprising is the argument that “the motivation of China’s SOEs is actually quite simple: to secure a supply of resources”. I am not sure that is always the case. It somehow implies that the SOEs act like one China Inc. That itself is an illusion. The SOEs are separate entities and each of them has its own interest, and that interest differs from one to another. They don’t act like a China Inc. Quite the opposite, they act for their own interest.
In the Chinalco – Rio case, for example, Chinalco was unlikely to act to secure the supply of resources. It was acting in its own interest. It is an aluminium firm. Rio’s most valued assets in Australia are iron ore. Iron ore is not a resource for Chinalco per se. It was motivated by perceived values of the assets and expected returns from investment. It had the funding capacity and Rio had the need to raise capital and reduce debt at the time the proposal was made. Chinalco was a shareholder of Rio, so it understood the situation. It appeared that it wanted to increase its interest in Rio to maximise its own profit, possibly to 19%. I am not sure 19% holding can secure the supply of resources from Rio.
Thank Lincoln Fung very much for your valuable comments! I would like to make some clarifications.
The focus of the small piece is to investigate the different implications of China’s institutional reforms and SOEs reforms for China and Australia, not just focus at the corporate level. Since the SOEs have visible and invisible privileges in China, it might be a smarter choice for an Australian company to engage in business with a Chinese SOE rather than with a private company for the purpose of making money in the Chinese market.
As for whether it is monopolistic, it depends on how you define it. It would be more accurate to say that Chinalco, as a SOE, has some privileges that its private competitors could never have.
For the other comments of yours:
‘First, I don’t believe that all SOEs are monopolistic.’
—-Yes, you are correct, but…it seems I didn’t say ‘all SOEs are monopolistic’. I suggested that ‘SOEs are dominant in some of the most lucrative sectors and strategically important sectors’, and ‘private sectors competitors experience difficulties…… due to a host of visible and invisible barriers’. Most monopolistic sectors are related to SOEs. So ‘China’s national interest therefore lies in the opening up of monopolistic sectors and through SOE reform’.
‘Second, I don’t think the performance of SOEs were as bad as Zhang described’.
—- You are correct regarding the SOEs’ performance. But it seems you misunderstood my point. As I suggested, SOEs’ profitability problem (or performance) was a problem ‘before the late 1990’, and now no longer a problem. ‘Some SOEs are among the most profitable firms in the world’. Now, the important reason why the SOEs should be restructured is not because the SOEs are not profitable, but probably too profitable: China needs to establish a fair play market economic system without the bias against the private economy. The opportunity cost of the SOEs’ profitability is high.
“Another point that struck me ….is the argument that ‘the motivation of China’s SOEs is actually quite simple —-to secure a supply of resources’”.
—-You are absolutely correct, and I completely agree with you that China’s SOEs have different motivations for overseas investments. But in the context of this article, I meant the investments in resource sectors, especially the cases conducted by the central companies.
Once again, thank you very much! This small piece is not a strict academic paper, so some expressions may be not that accurate. I wish my explanations are helpful for clarifying my position.
Best regards!
YS