As accumulated debts became increasingly dangerous, the government introduced deleveraging and de-capacity initiatives packaged in supply-side structural reform at the end of 2015. Although moves have been made on those two fronts since then, the real issue — soft budget constraints on SOEs — remains unaddressed.
SOE efficiency rarely improves. For a few years, reforms implemented in the late 1990s helped SOEs reduce debts. The following decade-long economic boom brought SOEs increased profits, improving their balance sheets. But the root causes of SOE inefficiency have never been seriously discussed or dealt with by policymakers.
To offset the economic slowdown due to decreased exports from the 2008 global financial crisis, SOEs have taken on an increased role in government spending, triggering an even sharper deterioration of SOE accounts. The latest official data show that the total assets and liabilities of Chinese SOEs reached 144.90 trillion RMB (US$22 trillion) and 95.26 trillion RMB (US$14.4 trillion) respectively by the end of July 2017. While accounting for a quarter of national total assets, SOEs only accounted for a seventh of China’s GDP in 2016.
As privatising SOEs is politically impossible, reformers try to bring in private entrepreneurs to tap into their expertise. This is the rationale behind mixed-ownership reform, a key component of the current policy. Private enterprises are encouraged to purchase SOE equities or invest in SOE projects. Posed as an incentive for hard work, core employees are selected to buy company shares.
Even though many SOE subsidiaries have already diversified their ownerships, they are yet to enjoy obvious improvements in performance. Still, the current reforms continue to target parent firms — China Unicom has made headlines — hoping board members from the private sector will influence corporate governance, which will then translate into improved profits.
An important addition to mixed-ownership reform came in the form of reinforcement of the 1994 Company Law recognising SOEs as entities somewhat independent of the government. The Company Law defines SOEs as government investments seeking returns, and is different from the previous Enterprise Law that stated that the government owns SOEs.
In addition to promoting equal rights of the government and other investors, the Company Law also aims to protect private investors by granting them votes in accordance with stocks. The Company Law and its reinforcement reflect reformers’ efforts to give SOEs more independence from the government, which otherwise tends to emphasise the non-economic roles that SOEs can play.
But despite the reformers’ good intentions, introducing private owners faces technical and social barriers. Technically, about two thirds of SOEs were set up and registered following the Enterprise Law rather than the Company Law. After two years of preparation, in June 2017 the government ordered all SOEs to convert into corporations by the end of 2017, which should alleviate at least some of the technical barriers.
Even if the government welcomes private investors, the private sector in general does not trust the government. Private enterprises are uncertain if and to what degree their property rights will be protected. As the government tightens capital controls, private enterprises with few alternatives may find investing in SOEs attractive. But unless SOEs respect the Company Law and private property in a real sense, private investors will find it hard to be heard, let alone change firm operations.
The 2015 deleveraging and de-capacity initiatives were introduced to fix SOE debts quickly. Having spent relentlessly since 2008, SOEs have built up unprecedented debts concentrated in sectors with excess capacity like steel and coal. Weak demand means profits and the debt-servicing capacity of SOEs will both decline, endangering the financial system. While the initiatives are a step in the right direction, they miss the most important target: liquidating ineffective operations.
Without liquidation, debts are still on somebody’s books — be it SOEs or banks — with outdated capacity easily brought back. Instead, mergers and acquisitions are pushed ahead, with profitable SOEs taking over loss-making ones. Banks are pressed to write off bad SOE assets from their books, or accept SOE equities in exchange for assets.
Missing from the picture are hard constraints on SOE budgets. Despite debate in 2016, no changes have been made. Since they enjoy implicit government backing, SOEs can raise funds relentlessly regardless of their finances. Eyeing quick promotions, SOE officials focus on polishing balance sheets in the short term, rather than fixing long-term issues.
It is the position of the government that will eventually decide the direction of SOEs. Calling for SOEs to go ‘bigger, better and stronger’, Xi Jinping has personally championed SOEs. Xi’s call may reflect his belief in the counter-cyclical role of the government and SOEs — an often overused argument to support SOEs.
As China’s economic slowdown continues, the demand for SOEs and local governments to boost growth will only increase. Xi’s trillion-yuan projects, whether the Xiongan New Area at home or Belt and Road abroad, depend on SOEs for success. Unless there are any fundamental changes in the view of the government, the current agenda will only gnaw on the margins.
Xinling Wang is a research manager at China Policy, Beijing.
“As China’s economic slowdown continues”?
Come, come! China’s economy is accelerating, not slowing down. The author is confusing the acceleration rate of China’s GDP with its growth. They are different things.
6.5% is a RATIO expressing the rate of acceleration, not growth.
Growth is a VALUE derived by multiplying the rate of acceleration and the previous year’s GDP and is expressed in RMB or dollars, not as a ratio.
This year, growing at 6.7%, China will grow by $1.3 trillion–more than Australia’s entire GDP.
Ten years ago, growing at 12%, China grew by $761 billion–about South Africa’s entire GDP.
China’s growth has not slowed down. China’s growth has speeded up. Hugely.
Good point. Yes, it is economic expansion slowdown, not economic slowdown. Sorry for this mistake which should not be made at the first place.
Efficiency seems so easy to define in theory yet very hard to really understand.
To illustrate this, consider two extremes in terms of efficiency.
First, the case of China. There have been and still are so many areas in China which are so inefficient, yet its economy has been growing remarkably fast.
Second, the case of the US. Arguably, it has been the leader of free market economies and should generally be very efficient. Yet, it was the source or epicentre of the GFC. Was it efficient in the time leading up to the GFC? One could argue that some parts of the US economy must have been highly problematic in efficiency term in the broadest sense.
It seems, there are still important issues in economic development processes that are still not well understood, notwithstanding that there is mainstream economics and many theories regarding development. There maybe some disconnect between aggregate economy and particular efficiency issues. There does not seem to be a perfectly efficient economy.