Challenges Ahead in China’s Reform of State-Owned Enterprises

Abstract

The reform of state-owned enterprises (SOE) is an urgent priority for the Xi Jinping administration. Economically, Beijing aims to decrease the drag on domestic growth and increase the overseas competitiveness of its largest firms known as yangqi, long plagued by declining performance, rising debt, and serious corruption.1 Politically, the Chinese Communist Party wants to reinforce state ownership as a pillar of domestic stability at home and increased influence abroad. To achieve these ends, Beijing released the long-delayed Guiding Opinions of the Communist Party of China Central Committee and the State Council on Deepening the Reform of State-Owned Enterprises in September 2015, to be followed by a series of detailed policy documents.2 This roadmap calls for regrouping state firms by function; further consolidating their assets, while simultaneously developing mixed ownership; and loosening state authority over executive management, especially for those in nonstrategic sectors.3Categorizing SOEs into a public class (gongyilei) and a commercial class (shangyelei) is a transformative move at the heart of the new reforms. Firms will be divided by function into those dedicated to public welfare and those seeking profit. Future reforms will be carried out separately for these two groups in a dual-track approach: distinct strategic objectives will be set for each, and their performance will be evaluated by different metrics. While Beijing seeks to improve all SOEs' operational efficiency, service quality, and ability to innovate, profitability will always be a secondary priority for those charged with public welfare or national security functions. Specifically, the new guidelines stipulate that firms designated as public will be assessed by their ability to control costs, the quality of their goods and services, and the stability and efficiency of their operations.4 Political rather than market logic will therefore remain the paramount driver of changes to state firms in the public class. In contrast, boosting market competitiveness and delivering gains in financial performance will be a top priority for SOEs classified as commercial, to be assessed by indicators such as economic value added.5 However, these firms will still serve political goals, including fostering indigenous innovation, supporting social stability and crisis response in China, and advancing economic initiatives abroad such as Belt, One Road.This essay analyzes three challenges confronting this reform agenda: determining how and when to grant market forces a greater role, especially for state firms designated as commercial; aligning mismatched managerial interests and incentives; and overcoming complicating factors within companies. First, continuing government-directed mergers while restricting competition in protected sectors will boost state firms' market share at the risk of deepening their financial and operational weaknesses in the long term. Second, while the Xi administration is actively exercising personnel control, defined as the authority to appoint and remove top company leaders, shuffling executives cannot eliminate their mismatched incentives.6 Finally, the size, complexity, and cadre culture of SOEs will complicate reform implementation. Whether these difficulties can be surmounted will ultimately determine the success of Xi's reform agenda and China's economic transformation.CENTRAL STATE-OWNED ENTERPRISESChina's state-owned economy remains significant today. State firms' exact contribution to industrial output is debated but has been estimated at between 25% and 30%.7 State firms continue to enjoy advantages in obtaining bank loans and regulatory approvals, even if their privileged capital access has gradually declined. The central government currently owns 106 companies, out of which 47 firms ranked in the 2014 Fortune Global 500.8 These centrally owned firms, or yangqi, controlled more than $5.6 trillion in assets at the end of 2013, including more than $690 billion abroad. …