SOE Reform Faces New Challenges


IN 2015, as China’s state-owned enterprises (SOE) cautiously propel reforms, they find themselves in a new predicament – that of a decline in business performance while under the government anti-corruption campaign searchlight. The economic new normal and construction of the anti-corruption system are the latest features of China’s reforms. Balancing the relations between reform, development, and anti-corruption while endeavoring to make substantial progress, therefore, are the challenges that now confront China’s state-owned enterprises.

Deepened SOE Reform Imperative

State-owned enterprises face problems inherent in the new policy and market environments. Under the backdrop of China’s economy having switched to the new normal, of the transformed growth model, and of comprehensively deepened reforms, radical changes in the policy, industry and market environments will inevitably follow. As the role of the market mechanism gathers strength, preferential policies and industry protection by virtue of state ownership will diminish. State-owned enterprises must hence prepare for unprecedented market competition.

Significant adjustments to China’s formerly effective pro-growth policy system are foreseeable in order to fit the changing situation. For example, modification of the state-owned economic distribution and structure means abandoning the convention of state dominance of so-called “key industries.” To create policy and market environments that “promote fair competition and encourage innovation,” state-owned and non-state-owned economies will operate under the principles of equal competition and survival of the fittest. This will obviously generate unheard-of hazards for SOEs. Policy and resource preferences due to the close relationship between the government and SOEs will diminish and eventually cease to exist. The accustomed administrative monopoly and preferences as regards resource allocation to SOEs, meanwhile, will also gradually evaporate.

Certain SOEs will find themselves in a dire predicament. Their asset-heavy, pro-cyclical, adjustment-unfriendly development disadvantages make them liable to even greater distress amid a new round of adjustments. The slowdown in economic growth, particularly apparent in the heavy chemical industry, during the economic readjustment period will once more highlight the perennial SOE problem of low efficiency.

Significant modifications to the global economic pattern, the industrial and technological revolution, and changes in the consumption model have all brought about a huge influx of business model innovations. China’s economic structure thus faces a new round of adjustment. At this critical stage, substantial reforms to the state-owned capital management system and to monopoly industries are crucial. The investment and financing system and administrative system must be recalibrated accordingly. Moreover, SOEs must espouse the modern corporate system, and improve their operational mechanisms and management standards. If these goals are not met, SOEs across a broad swathe of industries, including the financial sector, will become stranded after a certain period of time.

For example, in 2014 SOE profit growth continued to fall. The return on equity (ROE), profit-cost ratio, and inventory turnover were also slower than the previous year. Meanwhile, there was a rise in asset-liability ratio over that of the previous year; wide losses occurred in the non-ferrous industry, and the coal, petrochemical and oil industries all experienced sharp year-on-year profit declines.

The public will find it ever more difficult to tolerate the inhibiting effect of state-owned enterprises on economic growth. The mainstream view in Chinese theoretical circles is that state-owned enterprises are either ineffective or inefficient. Dynamic private enterprises, on the other hand, have the practical advantage of comparative efficiency. A deep-rooted preference for large-scale operations and state ownership constitutes the reasons why the Chinese government has given priority over the past 30-odd years to protecting large state-owned enterprises. Their close relationship with the government has allowed SOEs easier access to resources than their private peers, which are often of smaller size. This state of affairs affects economic efficiency, hinders innovation and entrepreneurship, and produces serious ethical risks, as well as growing dissatisfaction. Now that the Chinese economy has reached a turning point that presages a slowdown in growth, the inhibiting effect on it of state-owned enterprises is more conspicuous than ever before, a fact that the public finds hard to swallow.

Anti-corruption Campaign Conducive to SOE Reforms

The anti-corruption campaign, in winning time for the institutional construction in state-owned enterprises of corruption prevention, also clears impediments to deepened reforms.

The Central Committee of the Communist Party of China has decided to accomplish in 2015 full discipline inspection coverage of all centrally administered, key state-owned enterprises. First-round inspections will target 26 centrally administered SOEs – more than double the 12 of the previous two years. This signifies the degree of importance China places on corporate corruption. The decision has been met with understanding and support from the overwhelming majority of the people, including state-owned enterprise workers. Doubts, however, exist about whether or not the anti-corruption campaign hype will weaken the theme of SOE reforms, and so affect SOE development.

Anti-corruption is a specific way of removing obstacles to SOE development and to reforms in this special period. China’s SOE supervision is rigorous. It comprises a five-in-one supervision system that involves discipline inspection and auditing supervision. The State-owned Assets Supervision and Administration Commission (SASAC) has, among other measures, promulgated large numbers of documents concerning financial supervision, property rights management, supervision of supervisory boards, and discipline inspections. But owing to the nature of SOEs (wherein executives are agents of the government), information asymmetry and insider control, a serious level of corruption and waste still exists in state-owned enterprises.

This seriously impinges on national interests and rocks the foundations of the state-owned economy. It also defiles fairness and justice, so prejudicing social stability and harmony and arousing doubts and worries among the populace about reforms. Corruption greatly hinders the process of SOE reform and healthy SOE development. It is therefore corruption, not anti-corruption, that is the real obstacle to SOE development and reform. Treating the symptoms of a disease has thus won the time needed to cure it, by creating suitable conditions for the institutional construction of anti-corruption and healthy development.

Our focus from now on should be on institutional construction of SOE anti-corruption. We must, of course, be aware of the need for systematic remedies for SOE problems through the institutionalization of anti-corruption deterrence. These include perfecting the state-owned assets supervisory system on the rule of law basis, setting up a system whereby government-commissioned intermediaries conduct general checkups and appraisals of state assets, and an improved corporate governance structure that gives play to the role of internal supervision and of checks and balances. They also entail enhancing SOE transparency, and establishing an accountability system.

We must prevent the loss of state assets, and encourage and protect reformers’ initiative. When fostering an economy of mixed ownership, which is part of SOE reforms, we must guarantee the security of state assets and also sustain the reform dynamic, so helping reformers overcome any apprehensions they may have. Relevant plans for the top-level design of state assets and SOEs have not yet been promulgated. There hence exists amid the practice of deepening reforms to state assets and SOEs the fear of “crossing the red line,” and the resultant tendency to play it safe and wait for policies. Reform progress, therefore, is slow. The central authorities need to draw a red line that separates “no loss of state assets,” from “no reform back-paddling.”

In the meantime they must build and improve fault-tolerant and fault-correction mechanisms. The former can encourage reforms, and the latter lower the costs of trials and mistakes. This will encourage the reform initiative and protect reformers, empowering them to accept responsibilities and encouraging them to tread new ground, so reducing hesitancy born of the fear of making an error.