Globalisation, led by China's giant SOEs

The United States, under President Donald Trump, is turning inward and withdrawing from its leadership role in global integration. This is quite visible in America's exit from the Trans-Pacific Partnership (TPP) and in Trump's policies toward the world economy. China seems well-placed to take America's place. It is the world's largest exporter and, by some measures, already the world's largest economy. Both the IMF and the World Bank now rate China as the world's largest economy based on Purchasing Power Parity (PPP). It is time for China to play a bigger role in setting international rules.

With Xi Jinping's rise as its undisputed leader, China appears ready to take on the mantle. It is saying the right things on free trade, explaining its benefits - from consumer gains to economic growth - and calling for stronger international rules. Premier Li Keqiang recently said, "free trade is the foundation of economic globalisation." China plans to enter a new era of openness by signing free trade agreements with several countries, including Mexico.

By reducing transportation costs, China's Belt and Road Initiative (BRI) could be as important as any major trade agreement. As tariffs have fallen, transportation costs have become the binding constraint to international trade. Creating extensive infrastructure across countries and regions could help integrate isolated countries into the world economy and spur a new wave of globalisation.

China, however, now needs to take bold action on domestic reforms to match its global initiatives. To be sure, it has made significant progress towards becoming a market economy since joining the WTO in 2001. It no longer runs an enormous current account surplus: after hitting 10% of GDP in 2007, its current account surplus fell below 2% of GDP in 2016. Private and foreign-invested firms now account for over 80% of exports, up from roughly 50% before China joined the WTO.

In recent years, however, economic reform has slowed down. Reform of behemoth state-owned enterprises (SOEs) in the energy, heavy machinery, coal and steel sectors has taken the form of mega-mergers, which has reduced the number of firms without reducing the share of output coming from the state sector. Of the 1,000 largest firms in the world by revenue, 136 were Chinese in 2014, as compared with only 41 in 2006, and 70% of these giants are state-owned. The strategy of creating supersized state-owned firms is neither good for growth nor good for global business.

The problem is particularly acute in some industries, where Chinese state firms have become export powerhouses and are distorting global markets. Consider steel, where production grew at double-digit rates in the mid-2000s as China industrialised. As recently as 2004, China was a net importer of steel. It is now the world's largest producer and exporter of steel products. The four largest Chinese steel companies are all state-owned.

Leader in construction

Like steel, civil engineering and construction is an industry that grew out of the infrastructure boom in China. The four largest firms in the world in this industry are all Chinese state-owned firms. As construction has slowed in China, these firms have started bidding for global roads, bridges and metro systems, making their foreign competitors anxious. The presence of these large state-owned firms in construction and steel raise concerns that Beijing's real intention behind the Belt and Road Initiative is to export China's excess capacity.

Reforming the state-owned enterprise sector would be good for China and for the stability of the world economy. For China, the state firms crowd out financing to more productive private companies. China would grow faster if the most productive companies also absorbed the most capital. Indeed, as economic studies have shown, private firms accounted for most of China's rapid growth during the 1990s and 2000s.

The large state firms are also straining the global trade system. Private companies facing competition from China's state-owned enterprises are justified in believing that there is no level-playing field. State-owned firms typically are more focused on jobs and revenues than profitability and are not subject to the same hard budget constraints as private firms. Reforming the remaining state-owned firms, through closures and privatisations, would help China maintain strong growth and go a long way toward showing the world that China is serious about being a good global leader.

It could be America's belief that world trade is currently unfair and so it is turning protectionist. There is some truth in the charge that China is competing unfairly in steel and a handful of other sectors.

Trade in principle is a win-win situation, but economic studies have proved that, in practice, it is unfair. It is noteworthy therefore that China, once an inward-looking and protectionist economy, is now not just defending trade, it is investing in better global infrastructure and fast becoming the world's leader on free trade.

(The writer is professor, LBSIM, Delhi)