assessments

China's State-Owned Firms: Problems Deep and Wide

6 MINS READMay 11, 2005 | 02:34 GMT
Summary
Several Chinese state firms are launching an effort to get a grip on their financial details, possibly as a prelude to radical reform. Although Beijing's commitment to real reform is — as ever — in doubt, the real question is not: Can China reform? It is: Can it reform in time?
China's state-owned Assets Supervision and Administration Commission (SASAC) leaked to the Chinese press May 9 that some of the country's largest state-owned enterprises (SOEs) are seeking to fill top positions with candidates from the private sector. Many of the firms are going so far as to seek foreigners for positions normally reserved not just for Chinese nationals, but for people handpicked by local governments. China's SOEs were never designed to operate at a profit, but to maximize employment. Such a system is all well and good in a largely closed, command-style economy, but in a rapidly evolving system becoming more involved in international trade with every passing month it is a social and economic explosion waiting to happen. Beijing is equally aware of both that contradiction and the extremely hard wall standing at the end of the tunnel should the SOEs not begin operating on a more sustainable premise. As such, SASAC has been charged with transitioning the SOEs to less statist and more capitalist underpinnings. SASAC's efforts have been moderate so far, as only a handful — by some reports, only three — of SOEs are now truly profitable by non-Chinese definitions. The complication is that the SOEs employ about 60 percent of China's urban labor pool and as such are a critical — perhaps the critical — element in the government's efforts to maintain power. Long-since stripped of any ideological justification to rule, Beijing's sole source of credibility is now fully based on its ability to protect and provide a suitable standard of living for its citizens. That requires maintaining maximum employment at the SOEs to prevent the type of citizen uprisings that have resigned previous Chinese governments to the dustbin of history. And because China remains a single-party system, a fall of the government would look less like a Western government change and more like the societal collapse of the Soviet dissolution. Local party bosses are part and parcel of the SOE network. Not only are they able to enrich themselves based on their role as middlemen between the SOEs and the state banks that subsidize the industrial sloths, they also benefit from their ability to appoint most of the key positions within the SOEs to ensure a steady supply of political power and kickbacks. The government's decision to bring outsiders into some SOE leadership posts aims precisely to weaken the links to the local party officials. But this is not an all-out effort to clean house. Although the new plan affects some of the largest SOEs, it involves only 25 out of a roster of thousands. Furthermore, full general managers are only being sought for two: China Worldbest Group and the China Academy of Building Research. Most of the firms are simply seeking outsiders to serve as chief accountants. Such seemingly tentative efforts are the chosen route because of the local party bosses' intimate involvement with the SOE network. The endemic corruption helps explain why Beijing has been so piecemeal in its efforts to reform the SOEs. The Politburo may give orders, but local and regional officials have their own interests and often disregard broad government dictates. Any no-holds-barred, nationwide approach would stir up internal party tensions between conservatives and reformers, or the center and the periphery. The government's "solution," therefore, to bring outsiders into some SOE leadership posts aims precisely to weaken the links to the local party officials, circumventing the entire corrupt drama of the local leadership. For now this is mostly a government attempt to engage in damage assessment — not an aggressive effort to implement reforms. This is not to belittle the effort. Getting a grip on the SOEs real financial pictures is a logical — and absolutely essential — first step toward any type of reform or house-cleaning effort to make the SOEs stand on their own. South Korea engaged in similar activities when it forced the reformation of its megafirms — the chaebol — in 1999-2001. Based on the information gleaned from forced transparency, Seoul was able to enact a series of varied, dynamic policies — which were more akin to open-heart surgery without anesthesia than China's apparent choice of homeopathic medicine. In the storm that followed, several Korean giants crashed and burned. Daewoo, for example, eventually ceased to be an independent player. Hyundai Motor Co., on the other hand, rose from the ashes as a powerful global megafirm able to compete with anyone, anytime, anywhere. But SASAC — or more to the point, Beijing — lacks Seoul's policy flexibility. As a whole, the Korean people are far more unified and far more willing to accept short-term adversity in exchange for long-term growth than are their Chinese counterparts. At worst, then-President Kim Dae-jung could have become a lame duck president or perhaps been impeached. The worst that could happen to the Chinese Communist Party is annihilation. As such, Beijing has yet to make the fateful decision as to whether it can stomach the level of reform necessary to ensure the 25 selected companies — much less the untold thousands of SOEs in the broader economy — find more profitable footing. For now it is seeking better information on the size of the problem, and little more. Yet the clock is ticking. The December 2006 end of China's World Trade Organization (WTO) phase-in period will bring with it a deluge of foreign competition in the banking sector that will directly undermine the government's ability to subsidize the SOEs. If they are not restructured by that time, then mass bankruptcies, mass unemployment — and mass chaos — will result. Ultimately, STRATFOR expects Beijing to be too afraid of the consequences to bite the bullet. Instead of launching mass reforms, we expect the government to use its better information to order mass purges and prosecutions of the worst offenders. Cracking some heads might give the central government a bit of street credit with citizens regularly abused by local bureaucrats, but until China forces a fundamental break between the dud firms and the subsidized loans that support them — the critical action that led to Korean success — the rest is merely talk. Come the end of 2006, Beijing's decision will not be so much whether it should implement reforms, but how specifically to abrogate its WTO commitment so it can keep its system — and its government — intact. Meanwhile, STRATFOR expects little more than discussion of the various problems. Even in Korea, where change is part of life, ripping apart the chaebol to make them stronger in the long run took years and was often done in stages. Only now is China beginning serious efforts to gather information — a mere 19 months before its do-or-die date. It will not be a deep enough effort, a wide enough application or a serious enough reform to succeed. But most of all, Beijing lacks the luxury of time.

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