The Business(es) of the Chinese State

Abstract

The State industrial sector is the Achilles heel of China's otherwise remarkable economic performance over the past two decades. Most other countries in transition from socialism have transformed SOEs into commercial entities through systematic, market-driven restructuring and privatization to become more efficient and competitive. In China, a series of innovative, if often administrative, institutional reforms since 1978 have begun to achieve the Chinese authorities' goal of separating government from businesses. But the Chinese State still maintains ownership of key enterprises, and government agencies carry out shareholder functions typically performed by private owners in a market economy. Although privatization and restructuring of SOEs is occurring, it mostly pertains to small and medium sized firms. For the principal businesses, by contrast, the creation of large enterprise groups and holding companies (and experiments in other forms of state asset management) have become the main form of restructuring. Today, China's SOEs still account for more than one-quarter of national production, two-thirds of total assets, more than half of urban employment and almost three-quarters of investment. While direct budgetary subsidies have declined, explicit and implicit subsidies are still making their way to prop up loss-making SOEs through the financial system and other routes. At the same time, SOEs are still producing non-marketable products, resulting in a sizeable inventory overhang. These inefficiencies and distortions represent a drain on the country's resources and thus present a challenge to the Chinese leadership for reform. This paper sheds light on these challenges by analyzing the incentives and constraints on China's SOE reform program. Four critical aspects of the reforms are highlighted and evaluated against the backdrop of international experience: clarification of property rights; establishment of large group/holding companies and other new organizational structures; improved corporate governance incentives; and implementation of international financial accounting and auditing practices. The paper concludes with policy recommendations.