China acknowledges limitations of state-control, seeks reforms

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In an attempt to turn around its underperforming state-controlled enterprises (SOEs), the Chinese authorities announced guidelines to reform SOEs into ‘independent market entities’. Although a gradual change is pursued, China’s government expects ‘decisive results’ by 2020. Is China finally embracing free market principles? It may be too soon to cheer…

Mixed ownership

China’s SEOs are structurally underperforming. As figures by WSJ show, state companies have a gap with privately held companies of 10-15% in return on equity, 25% is losing money compared to 10% in the market and debts are significantly higher. State news agency Xinhua reported that in the January-July period, SOE’s profits declined with 2.3%, compared to 0.1% in the previous six months. As a group, SOEs earned 1.4 trillion yuan, or USD 221.2bn, so we’re talking about big numbers. The underperformance is the result of times where there was no motivation to compete and/or produce efficiently. The authorities now seek to implement incentives so that companies shake up their governance in the search of better results. One of the instruments is the introduction of “mixed ownership”, where private investors and the state are both investors. Private investors are encouraged to invest the sectors oil and gas, electricity, railways and telecommunications. However, complete privatization is not considered. Beijing is merely seeking that local, provincial and state government give up part of their control in companies.

Competitive advantage

One of the major problems is however that a large number of companies may have no competitive advantage or even reason for existence. For instance, there are a number of companies in Northeast China, which is considered China’s ‘Rustbelt’, which should be closed down if it where for economic reasons. This would result in thousands of lay-offs, which could cause unrest in certain cities and regions. The process to more market orientation is therefore a delicate process, where it is likely that the state will not give up its last word in the control over companies. Investors may be hesitant to acquire stakes. Joint ventures, which are quite successful, prove to be far more interesting for foreign companies and investors.

Sense of urgency

The call for reforms follow recent steps by the Chinese government of making its currency more market oriented. It seems that policy makers are sensing that drastic steps are needed to prevent a hard landing of the Chinese economy. Some say that a GDP growth of 7% could be in danger, but with power usage growing only 1% one may seriously argue that growth figures are much lower. Chinese President Xi realizes this. Fortunately, Mr. Xi has positive experiences with a more market oriented approach and is aware of SOEs pitfalls. As former secretary in the eastern Zhejiang province, he witnessed the power of private sector development. It’s a relief that China’s leader is no pure bureaucrat and is open for a more market oriented China.

Further reforms necessary

The plans for more private ownership in Chinese companies should be welcomed. Not only China could benefit from more market forces in its economy, but it also offers opportunities for the market. If underperforming companies could be restructured successfully, in which the call of the market is respected, this may lead to a win-win situation. However, some companies might be redundant and it is yet to be seen if Chinese authorities are willing to close those down. Furthermore, it has to be seen if China is willing to expose itself to the forces of the market, which are difficult to control. But we can only encourage more private involvement in the Chinese economy.

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