Tuesday, August 31, 2010

China Fortifies State Businesses to Fuel Growth

August 29, 2010

China Fortifies State Businesses to Fuel Growth

New York Times

BEIJING — During its decades of rapid growth, China thrived by
allowing once-suppressed private entrepreneurs to prosper, often at
the expense of the old, inefficient state sector of the economy.

Now, whether in the coal-rich regions of Shanxi Province, the steel
mills of the northern industrial heartland, or the airlines flying
overhead, it is often China’s state-run companies that are on the

As the Chinese government has grown richer — and more worried about sustaining its high-octane growth — it has pumped public money into companies that it expects to upgrade the industrial base and employ more people. The beneficiaries are state-owned interests that many analysts had assumed would gradually wither away in the face of private-sector competition.

New data from the World Bank show that the proportion of industrial
production by companies controlled by the Chinese state edged up last
year, checking a slow but seemingly inevitable eclipse. Moreover,
investment by state-controlled companies skyrocketed, driven by
hundreds of billions of dollars of government spending and state bank
lending to combat the global financial crisis.

They join a string of other signals that are fueling discussion among
analysts about whether China, which calls itself socialist but is
often thought of in the West as brutally capitalist, is in fact
seeking to enhance government control over some parts of the economy.

The distinction may matter more today than it once did. China
surpassed Japan to become the world’s second-largest economy this
year, and its state-directed development model is enormously appealing to poor countries. Even in the West, many admire China’s ability to build a first-world infrastructure and transform its cities into

Once eager to learn from the United States, China’s leaders during the
financial crisis have reaffirmed their faith in their own more statist
approach to economic management, in which private capitalism plays
only a supporting role.

“The socialist system’s advantages,” Prime Minister Wen Jiabao said in a March address, “enable us to make decisions efficiently, organize
effectively and concentrate resources to accomplish large undertakings.”

State vs. Private

The issue of state versus private control is a slippery one in China.
After decades of economic reform, many big state-owned companies face real competition and are expected to operate profitably. The biggest private companies often get their financing from state banks,
coordinate their investments with the government and seat their chief
executives on government advisory panels.

Chinese leaders also no longer publicly emphasize sharp ideological
distinctions about ownership. But they never relaxed state control
over some sectors considered strategically vital, including finance,
defense, energy, telecommunications, railways and ports.

Mr. Wen and President Hu Jintao are also seen as less attuned to the
interests of foreign investors and China’s own private sector than the
earlier generation of leaders who pioneered economic reforms. They
prefer to enhance the clout and economic reach of state-backed
companies at the top of the pecking order.

“China’s always had a major industrial policy. But for a space of a
few years, it looked like China was turning away from an active and
interventionist industrial policy in favor of a more hands-off
approach,” Victor Shih, a Northwestern University political scientist,
said in a recent telephone interview.

Mr. Shih, among others, now believes that the 1980s reforms that
unleashed China’s private sector and the 1990s reforms that dismantled great sections of the state-run sector are being partly undone.

“The problem is that the reforms of the first 20 years, from 1978 to
the end of the ’90s, actually did not touch on the power of the
government,” said Yao Yang, a Peking University professor who heads
the China Center for Economic Research. “So after the other reforms
were finished, you actually find the government is expanding, because
there is no check and balance on its power.”

Divining Government’s Role

There are no comprehensive statistics to catalog the government’s
influence over the economy. So the shift is partly inferred from
coarse measures like the share of financing in the economy provided by state banks, which rose sharply during the financial crisis, or the
list of the 100 largest publicly listed Chinese companies, all but one
of which are majority state owned.

The statistic showing an uptick in the share of industrial production
attributable to the state sector is regarded by some analysts as a
blip rather than the start of a trend. The World Bank’s senior
economist in Beijing, Louis Kuijs, said the state sector’s unusually
rapid growth will most likely moderate with the ending of the
government’s stimulus spending.

“As the growth process normalizes again, the traditional trend toward
a declining SOE share will take over again,” he wrote in an e-mail
message, using the shorthand for state-owned enterprise. “I don’t
think that the senior leaders had a strategy of reversing this trend.”

But others argue that officials had always intended to create a
vibrant state sector that would tower above the private sector in
important industries, even as they sold off or shut down money-losing
state enterprises that drained capital from the government budget and
banking system.

Recent alarm over the expanding role of the state, said Arthur Kroeber
of Dragonomics, an economic forecasting firm based in Beijing, is
mostly “perception catching up with reality.”

In some ways, the differences in this debate are small. Everyone
agrees that China runs a bifurcated economy: at one level, a robust
and competitive private sector dominates industries like
factory-assembled exports, clothing and food. And at higher levels
like finance, communications, transportation, mining and metals — the
so-called commanding heights — the central government claims majority ownership and a measure of management control.

Yet the two camps’ view of China’s future are markedly different.
Those who see little evidence of an expanding state sector generally
believe that China has a decade or more of robust growth awaiting it
before its economy matures. Theirs is a Goldilocks view of state
intervention — not too much or too little, but just enough to push a
developing economy toward prosperity.

The skeptics have a darker view: they believe distortions and waste,
in no small part due to government meddling, have resulted in gross
misallocation of capital and will end up pushing growth rates down
well before 2020. What drives their pessimism, the skeptics say, is
that China, like Japan a generation ago, has too much confidence in a
top-down economic strategy that defies conventional Western theory.

The skeptics also point to what they say is the growing political and
financial influence of China’s state-owned giants — 129 huge
conglomerates that answer directly to the central government, and
thousands of smaller ones run by the provinces and cities.

While no public breakdown exists, most experts say the vast bulk of
the 4 trillion renminbi ($588 billion) stimulus package that China
pumped out for new highways, railroads and other big projects went to
state-owned companies. Some of the largest companies used the flood of money to strengthen their dominance in their current markets or to enter new ones.

In the last year or so, many of the 129 central government companies
have moved forcefully into China’s real-estate industry, with hundreds
of billions of dollars in construction projects and land deals.
State-owned steel giants have cut deals to buy out more profitable and
often more efficient private competitors. A host of government
conglomerates have snapped up coal mining companies in Shanxi

“In 2009, there was a huge expansion of the government role in the
corporate sector,” Huang Yasheng, a leading analyst of China-style
capitalism at the Massachusetts Institute of Technology, said in a
telephone interview. “They’re producing yogurt. They’re into real
estate. Some of the upstream state-owned enterprises are now expanding downstream, organizing themselves as vertical units. They’re just operating on a much larger scale.”

Local Interests

At the local level, governments set up 8,000 state-owned investment
companies in 2009 alone to channel government dollars into business
and industrial ventures, Mr. Huang said. One example suffices: a
private Chinese automaker, Zhejiang Geely Holding Group, made
worldwide headlines in March when it agreed to buy Sweden’s Volvo
marque from Ford. Much of the $1.5 billion purchase price came not
from Geely’s relatively modest profits, but from local governments in
northeast China and the Shanghai area.

Geely reciprocated this month, announcing that it will build its Volvo
headquarters and an assembly plant in a Shanghai industrial district.

The reasons for the state’s push for greater involvement in business
vary. State control of energy supplies is crucial to China’s growth,
and the Shanxi coal takeovers will increase production, guarantee fuel
to some state-owned utilities and give Beijing new power to control
coal prices. State mining companies also argue that they have a
superior safety record to their accident-prone private competitors.

But in other areas the state looks more mercenary.

Take telecommunications. Upon joining the World Trade Organization,
China committed itself to opening its communications market to foreign
joint ventures for local and international phone service, e-mail,
paging and other businesses. But after eight years, no licenses have
been granted — largely, the United States says, because capital
requirements, regulatory hurdles and other barriers have made such
ventures impractical. Today, basic telecommunications in China are
booming, and are virtually 100 percent state-controlled.

Take the passenger airline industry. Six years ago, the central
government invited private investors to enter the business. By 2006,
eight private carriers had sprung up to challenge the three
state-controlled majors, Air China, China Southern and China Eastern.

The state airlines immediately began a price war. The state-owned
monopoly that provided jet fuel refused to service private carriers on
the same generous terms given the big three. China’s only computerized reservation system — currently one-third owned by the three state airlines — refused to book flights for private competitors. And when mismanagement and the 2008 economic crisis drove the three majors into financial straits, the central government bought stock to bail them out: about $1 billion for China Eastern; $430 million for China Southern; $220 million for Air China.

One private passenger carrier that remains is Spring Airlines, a
tenacious startup run by a founder so frugal that he shares a
100-square-foot office with his chief executive and takes the subway
to business meetings.

That founder, Wang Zhenghua, survived in part by building his own
computer reservation system. He canceled a planned interview. But in
Chinese news reports, he was caustic about the state subsidies given
his competitors. “Now with the injection of 10 billion yuan” for China
Eastern and China Southern, “everything is in chaos,” he told Biz
Review, a Chinese magazine.

China’s private entrepreneurs have a catchphrase for such maneuvers:
“guo jin, min tui,” or “the state advances, the private sector

State-owned enterprises in China have taken the best of the economy
for themselves, “leaving the private sector drinking the soup while
the state enterprises are eating the meat,” Cai Hua, the vice director
of a chamber-of-commerce-style organization in Zhejiang Province, said in an interview.

First in Line

Mr. Cai says he believes that China needs government-run industries to compete globally and manage the country’s domestic development. But locally, he said, their advantages — being first in line for financing
by state banks, first in line for state bailouts when they get in
trouble, first in line for the stimulus gusher — have created a
“profound inequality” with private competitors.

Some analysts argue that the state-owned conglomerates, built with
state money and favors into global competitors, have now become
political power centers in their own right, able to fend off even
Beijing’s efforts to rein them in.

Of the 129 major state enterprises, more than half the chairmen and
chairwomen and more than one-third of the chief executive officers
were appointed by the central organization department of the Communist Party. A score or more serve on the party’s Central Committee, which elects the ruling Politburo. They control not just the lifeblood of China’s economy, but a corporate patronage system that dispenses top-paying executive jobs to relatives of the party’s leading lights.

China’s leaders have sought occasionally in the past year to curb
speculative excesses by state-controlled businesses in real estate,
lending and other areas. In May the State Council, a top-level policy
body sometimes likened to the cabinet in the United States, issued
orders to give private companies a better shot at government contracts
— for roads and bridges, finance and even military work — that now go
almost exclusively to state-owned companies. Virtually the same rules
were issued five years ago, to little effect.

Yet it is hard to argue with success, other economists say, and
China’s success speaks well of its top-down strategy. Asian
powerhouses like South Korea and Japan built their modern economies with strong state help. Many economists agree that shrewd state management can be better than market forces in getting a developing nation on its feet.

Experts on both sides of the debate have but two questions. One is how much longer state control of vast areas of the economy will generate that growth.

The other is whether, should that strategy stop working, China will be
able to change it.

Li Bibo contributed research.

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