Thayer Watkins
Silicon Valley
& Tornado Alley

The State-Owned Enterprises of China

The problem of the state-owned enterprises is like a big, broken-down truck that is blocking the road to development in China. Some traffic can find its way around the wreck but the difficulty that it creates grows with time. People are reluctant to destroy the truck because of the thought of how useful it would be if only it worked.

There are about 300,000 state-owned enterprises (SOEs) in China but the real problem lies with the very large enterprises that need ongoing subsidies to survive. These large SOEs employ over 75 million people and provide essential goods and services in the economy so it is not economically or politically feasible to simply shut them down. For example, Sinopec (China Petrochemical Corporation) has a workforce estimated by Fortune magazine to be over one million. Another Chinese petroleum-based SOE, China National Petroleum Corporation, has a workforce estimated by Gordon Chang to be about one and a half million. There is already a serious unemployment problem particularly in rural areas and this is destined to become worse with the impact of China's entry into the World Trade Organization (WTO).

The dilemma is that the Party cannot stop propping up the SOE's because of the role of the SOE's as employers and providers of essential goods and services but as long as the Party keeps propping them up the SOE's have little incentive to change. Even when an SOE is nominally privatized the subsequent treatment of that enterprise by the Party indicates that it is still an SOE. Gordon Chang cites the case of a cement manufacturer in Sichuan province. The SOE was corporatized in 1988 and given the name Golden Summit. Shares of Golden Summit were listed on the Shanghai Stock Exchange in 1993 and private investors own about four percent of the stock. The board of directors of Golden Summit consists entirely of government/party officials. When another SOE, Dadu River Steel, could not pay its workers the local government/party forced Golden Summit to takeover Dadu River Steel and its obligations. When other cement making SOE's, even in areas distant from Sichuan, were in financial difficulties the national government/party officials forced Golden Summit to accept them and their liabilities. So when a nominally privatized SOE had some chance of success the government/party saddled it with debilitizing burdens and demonstrated that it was in reality still an SOE.

The purpose of the reform program enunciated by Deng Xiaoping in 1978, The Four Modernizations Program, was not per se to create an efficient economy. Its purpose was to modernize in order stave off catastrophic collapse and thus preserve the power of the Party. Some reforms have been real and some sham, but none have seriously lessened the control of the Party. One of the supposed reforms that look like a move toward a market economy but is in fact a sham is the shift from government grants to cover SOE's deficits to requiring the SOE's to depend upon loans from the state commercial banks. The state banks must make the loans but the SOE's do not have repay the loans. Thus the state banks takes the saving deposits of the Chinese public and gives those funds to SOE's which will never repay. The loans to the SOE's show up on the books of the State banks as assets but they are entirely worthless. It is estimated by Standard & Poor that at the end of 1999 the proportion of non-performing loans in the state commercial banks of China was in the range of 50 to 70 percent. The Central Bank of China admits that proportion was at least 25 percent. In 2000 the government organized a recapitalization of the state commercial banks in which non-performing loans with a nominal value equivalent to $157 billion were transferred to a state agencies, called asset management companies, in exchange for government securities. The asset management companies are not likely to obtain any substantial return from those bad loans. What the asset management companies are likely to end of with is worthless equity in the SOE's. In effect, the government instead of giving grants to cover the deficits of the SOE's year-by-year accepted responsibility for the accumulated deficits all in one big block. Interesting the Central Bank put the proportion of non-performing loans in the state commercial banks at 25 percent after the recapitalization, the same figure it gave for the proportion before the recapitalization. This indicates that the true proportion before recapitalization was at least 50 percent, consistent with the Standard & Poor's estimate.

The bankrupt state of the state commercial banks is not the only problem with financial institutions in China. The credit cooperatives which function as banks in the rural areas of China are in far worse condition. Illegal financial organizations which are formed to circumvent the government restrictions on interest rates are also financially unsound and a risk to the financial stability of China.

The official Chinese government position is that the state banks are sound and that the SOE's are earning a profit. The government-reported profit of the SOE's in 1998 was about the equivalent of $6 billion. Gordon Chang notes that this is a profit of $6 billion after a subsidy of $18 billion which means that really the SOE's had a loss of $12 billion. The government also reported that increased by almost 80 percent in 1999 and 140 percent in 2000. Clearly the figures are meaningless because they could have arisen simply by an increase in the government subsidies in 1999 and 2000.

Official Employment Figures

Employment in China
by Type of Enterprise, 1952-1996
YearState-Owned CollectivesPrivate
a--individual and family proprietorships with fewer than 8 employees
Source: State Statistical Bureau of China, 1997


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