In 2014, 88 Chinese SOEs were included in Fortune Global 500, Fortune magazine’s annual list of the top 500 corporations worldwide by revenue.
SOEs now make up just 4.9 per cent of firms in China’s mining, manufacturing and utilities sectors. But there are still a few long-term problems that must be resolved.
State capital is deployed across too many sectors, including some purely commercialised ones. SOEs show general features of weak competitiveness: they are small, poorly structured and inefficient. For example, 76.6 per cent of all SOEs in China are classified as small or micro firms. There is excessive concentration of shareholding and administrative meddling, which makes it hard for SOEs to set up governance mechanisms that suit a market economy. Even for listed firms, the state ownership share is over 70 per cent in many cases.
These problems spring from some of the policy defects of SOE reform. First, the goals of state ownership are unclear. It is hard for SOEs to formulate and communicate clear objectives at all relevant levels. This makes it difficult to build effective accountability systems, and inhibits the rational re-allocation of state capital. Second, the government has been used to intervene, and there has been lack of supervision of how ownership rights are exercised. As a result, ownership entities have been executing a kind of enterprise management rather than capital management. Third, warped corporate governance has spawned ineffectual boards of directors, one-size-fits-all remuneration policies and a tendency for internal bureaucratisation.
China has several quite unique characteristics. It has a large population (close to 1.4 billion); it is a middle income country with US$3200 per capita disposable income in 2014; and it is a transition economy that is still developing its market mechanisms and institutional systems. With these characteristics, China needs to keep a large toolbox to deal with potential challenges on its development path.
One tool inside the box is the control of ownership of SOEs. SOEs can be assigned objectives that are different from those of developed Western economies. But the weaknesses of SOE corporate governance in all jurisdictions across the globe are very similar. This brings a real challenge for SOE reform in China: how can China use its SOEs as a unique and important developmental tool while addressing the problems of SOE governance that can be concluded in many countries?
China should use state ownership to remedy market failures, stabilise the foundations of the economy and implement the government’s industrial policies. State capital should be deployed to more sectors than in developed countries. It should be used to ensure the provision of public goods, to offset additional regulatory cost for natural monopolies and to carry out specifically designated functions. State capital should also be deployed in sectors with particular strategic significance.
If the state is to exercise ownership over an SOE then it should meets three conditions. First, the rights, responsibilities and benefits of each department or entity of the state that is exercising ownership over the enterprise must be aligned. Second, there must be a system of checks and balances overseeing policymaking, implementation and supervision of ownership. Third, there should also be well-defined channels to reach the objectives of ownership.
Boards of directors should be independent, expert and accountable. They should possess almost complete authority for strategic decision-making in accordance with market principles and the rights and responsibilities of their type of SOE.
In the medium to long term, China needs to improve its state ownership policies and management systems. The state should define the goals of ownership and delineate the boundaries of the state economy. It must streamline the channels through which the state exercises its ownership rights and the relationship between different bodies. The government should distribute more state capital to sectors that need SOEs, such as public services, natural monopolies, imperfect contracts and industries that pursue national strategies. SOEs should be restructured in order to strengthen competitiveness and eliminate inefficiencies.
By establishing state-owned capital investment companies, the government can find opportunities to implement these much-needed reforms.
China should unveil its plans for state capital and the structure of future SOEs. Mixed public and private capital should still be promoted for commercially-oriented SOEs operating in competitive sectors. China needs to reform SOE governance, strengthen the market principles of governance, introduce a new system of governance that would classify SOEs by category, and clearly define the principles by which the state participates in corporate governance. By implementing these reforms, China can realise the goal of ‘capital management’ over ‘enterprise management’.
State capital and SOE reform needs coordinated and coherent policy. The reform designs made at the top should flow down to concrete policy plans. China needs to further clarify the broad goals and specific objectives, as well as the rights and responsibilities of SOEs.
Zhengjun Zhang is the managing partner and CEO of King Parallel, Beijing. Sarah Du is director of State Ownership and SOE Consultancy, King Parallel.
Are the facts in the following paragraph all correct?
“China has several quite unique characteristics. It has a large population (close to 1.4 billion); it is a middle income country with US$3200 per capita disposable income in 2014; and it is a transition economy that is still developing its market mechanisms and institutional systems. With these characteristics, China needs to keep a large toolbox to deal with potential challenges on its development path.”
I just had a look at the China section of the CIA’s World Facebook that states the Chinese economy was $10.36 trillion in 2014. With the population less than 1.4 billion, that would imply a bit over $7,000, more than double of the $3,200 used by the authors in this post.
How can the difference so large? One of the two must be seriously incorrect.
Sorry, I didn’t realise the authors were talking about disposable income as opposed to per capita income. My apology.
But, why they use disposable income in such context? Isn’t it strange? Isn’t it per capita income is better and more in line with most discussions? It certainly caused confusion to me, at least, because many people may naturally think it was per capita income as an indicator of the income level. I really don’t know how helpful it is to use disposable income there.
Thanks for your comments.In terms of this doubt, per capita income may be used more widely internationally and be more understandable. But in China, indeed per capita disposable income is a widely used measure.
In the wake of the previous post titled “Is China a market economy?” by Gary Clyde Hufbauer and Cathleen Cimino-Isaacs, China should probably consider the potential of its SOEs and particularly its governance and public disclosure of relevant information to make the Chinese a market economy, if the argument that it is not a market economy has merits. Only domestic consideration is not enough and any international implications must be taken into account. Otherwise, China may encounter more problems in trade and investment, including anti dumping against its SOEs exports as well as overseas investment by SOEs.
Thanks for your comments. We agree with you. Actually in this post, we do not only consider the situation in China. We think the competition in trade and investment should comply with some rules, such as competitive neutrality.