China's incoming leaders face reforms challenge

Overhauling the state-owned enterprises is not easy as top leaders have links with them

Wealthy Chinese carry as many as three smartphones, one for each of the three state-owned providers of mobile phone service, in the hope that at least one will have enough network capacity to provide reliable e-mail service. Most Chinese factories have heavily polluting diesel generators to cope with blackouts of as many as three days a week, because state-owned electricity companies have not added capacity fast enough to meet demand.

 Outgoing president Hu Jintao (left), and incoming president Xi Jinping attend the first meeting of the presidium of the 18th National Congress of the Communist Party of China (CPC) at the Great Hall of the People in Beijing, China on Wednesday. APMeanwhile, Chinese investors have poured more than $1 trillion in the past several years into loosely regulated trusts to bypass the ultralow deposit rates offered by state-owned banks. The banks cannot readily afford to pay more because they need fat margins to cover losses on loans to politically connected borrowers.

For all the talk in recent years about the extent to which China has embraced capitalism, huge sectors of the economy still have not fully done so: those dominated by the country’s 145,000 state-owned enterprises.

With China's top officials all in Beijing for a Communist Party congress intended to put its seal of approval on the country’s next generation of leaders, one of the toughest issues on the agenda is how to overhaul this sprawling empire.

President Hu Jintao offered encouragement for reform at the opening of the congress, in his valedictory remarks as general secretary of the Communist Party. He called for a greater proportion of government investment in state-owned enterprises to be concentrated in a few industries “that comprise the lifeline of the economy and are vital to national security.” It was one of the strongest hints yet that the government was considering whether it should play less of a role in managing enterprises in many other industries.

Almost no one has much good to say about state-owned enterprises these days — not even the people who run them. Wang Yong, the director of the State-Owned Assets Supervision and Administration Commission, which manages those enterprises belonging to the central government, chastised them publicly in a report to the Chinese legislature on Oct. 24.

“More efforts will be made to reform the power, telecommunications, oil and petrochemical industries,”  Wang said. “Market entry into these sectors will be expanded based on the development of these industries.”

But whether those efforts will amount to more than window dressing depends on the willingness of the next Chinese leadership team to challenge the politically connected families who often run state-owned enterprises. And given the lavish opportunities these enterprises provide for insider corruption and self-dealing, that remains very much an open question.

Two political advisers to the incoming leadership, neither with a background in economics but with a deep knowledge of the factional rivalries in the Communist Party, expressed strong scepticism that state-owned enterprises have much to fear.

National, provincial and local governments depend financially on the profits of such enterprises and are reluctant to give them up, they said. At the same time, the state enterprises provide political patronage for factions of the Communist Party and lower-level cadres, whose continuing support is crucial to the government. State-owned enterprises are also very important as providers of blue-collar jobs and as the operators of 8,000 schools, hospitals and community centers for their current and former employees and their families.

Companies in which the state owns at least a majority represent 35 per cent of all business activity in China, according to official figures. Yet they earned 43 per cent of profits last year in the country. Their hammerlock on a long list of strategic industries has allowed them to charge relatively high prices for their goods and services, even as they have borrowed at artificially low interest rates from state-owned banks.

Building pressure

To be sure, the pressure for change is building. Factional struggles that occurred before the party congress met this year have opened the way for a national debate about state-owned enterprises. A wide range of economists say further liberalisation of the portions of the economy still dominated by the state is essential to long-term growth.

“Without fundamental reforms the country’s economic prospect will dim with a diminished chance to leap into the ranks of developed economies,” said Fred Hu, a former economist at the International Monetary Fund and Goldman Sachs who is now the founder and chairman of Primavera Capital, a large private equity fund based in Beijing. “Only bold reforms could fully unleash the country’s enormous potential and entrepreneurial energy and propel China into the first world.”

Public support for economic overhauls makes it impossible for the incoming team simply to do nothing, said one of the two political advisers, both of whom insisted on anonymity because of the sensitivity of the issue within China. But the new team may limit its actions to the privatisation of some state-owned manufacturers, like steel mills, which do not have monopolies and are frequently in sectors with overcapacity, ferocious competition and heavy financial losses.

A few top executives in the automobile industry have also begun calling for a limit on further investments in that sector, which also faces severe overcapacity. The government has also been doing considerably more detailed audits of state-owned enterprises this year, seeking signs of fraud or corruption.

But the broader network of state-owned enterprises in the service sector, like banking, electricity distribution, health care and telecommunications, is likely to remain ‘virtually unchanged’ for the next few years, the political adviser said.

The new leadership has just as many ties to state-owned enterprises as the old one. The brother of Li Keqiang, who is expected to become the next prime minister, is one of four deputy directors of the State Tobacco Monopoly Administration. With 98 per cent of the Chinese market for cigarettes, the administration generates taxes and profits that total 7 per cent to 10 per cent of the entire revenues of the central government, according to a report in late October from the Brookings Institution in Washington.

China has a growing anti-smoking movement, but it has little support from the government. The Brookings report said that a “change in mind-set on the part of the leadership, especially the highly misleading and one-sided perception of tobacco as a ‘cash cow’ and major contributor to the Chinese economy, is a prerequisite for policy change.” The tobacco administration declined to comment.

For all the pessimism, there is still considerable discussion of possible ways that state-owned enterprises might be changed if the new leadership decided to tackle the thorny political issues involved.

One of the most influential and most widely circulated proposals within the Chinese leadership in the past few months is from Chen Qingtai, the deputy director of the cabinet’s Development Research Centre. Chen’s paper calls for the government to become essentially an investor in state-owned enterprises, instead of actively managing them, and selecting the management teams for each enterprise.

While such enterprises were useful in the past in advancing big projects like the Three Gorges Dam, Chen suggested in his paper, the government should now move more aggressively to sell off its ownership in sectors like steel that face overcapacity, redeploying that capital to emerging industries. He called for the state to hire more professional financial administrators to manage this process.

International Herald Tribune

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