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SPEAKING
FREELY
Bringing China closer to the
market
By Dag Detter and Sue
Anne Tay
Speaking Freely is an Asia
Times Online feature that allows guest writers to
have their say. Please click here
if you are interested in
contributing.
The recent uproar
over CNOOC's attempt to take over Unocal gives us
the chance to delve into a far deeper - and, for
the future of the Chinese economy and US-China
relations - much more important question: what is
the real nature of large, reforming state-owned
companies in China? Will they be more and more
driven by the forces of capitalism? How does one
reduce the role of the "state" in state-owned
enterprises, and open them to greater market
orientation, good corporate governance, and less
political interference?
China has pressed
on with unprecedented economic reforms, leaving
traditional communist orthodoxy far behind. For
the past decade, it has been selling off,
privatizing and advocating corporate governance
within its state-owned enterprises (SOEs). Through
administrative actions such as privatization,
policy-driven bankruptcies, and mergers and
acquisitions, the policy of "grasp the large and
let go the small" became official in 1999.
The state-owned sector will remain
dominant for the near- to medium-term. It is
estimated that SOEs supervised by the state-owned
Assets Supervisory and Administration Commission
(SASAC), a state ownership vehicle, accounted for
40.7% of GDP at the end of 2004. However, while
sources have indicated that these SOEs have grown
more profitable since 2000, others have also
pointed out that only 20% of China's top 200 SOEs
are cash flow positive. In a World Bank report
from 2001, sectors such as chemicals, forestry,
food processing, textiles, machinery, urban
utilities, construction, transportation/storage
and commerce showed province-wide losses in more
than half of China's provinces. Returns on equity
for a third of them were actually negative: almost
-20%.
Clearly China's SOEs face massive
problems, and are in critical need of reform. The
success of that reform will depend very much on
progress in establishing the three fundamental
pillars put forward by the Organization for
Economic Cooperation and Development's (OECD)
Corporate Governance Policy for SOEs: clear
objectives, transparency, and political
insulation. The OECD approach was influenced by
the successful Swedish experience of restructuring
SOEs from 1998 to 2001, which subsequently saw its
SOEs outperform the local stock market for six
consecutive quarters.
First, "clear
objectives" mean a clear mandate from a political
agency, clear performance benchmarks and clear
guidance on trade-offs. Chinese SOEs are often
burdened with multiple, sometimes conflicting
objectives in the form of social and political
obligations while simultaneously having to
maximize the financial return on state capital.
Harmonization of such goals rarely works. Breaking
millions of "iron rice bowls", and dealing with
the resultant social unrest, is a cost local
officials are usually unwilling to bear.
Furthermore, with debt financing coming largely
from state commercial banks with little or no
requirements for commercial returns, it has been
easy for SOEs to worry less about the cost of
state capital, leaving them more open to indulge
in cultivating political favors such as
sanctioning bank lending to friendly directors of
failing firms. Traditionally, directors of local
SOEs are appointed by the party not for their
management skills but for their networks in
townships and provinces. Unsurprisingly, these
local networks are so deeply-entrenched that even
Beijing has a hard time penetrating them. To align
so many interests, Beijing must effectively
communicate a single and clear objective. In
Sweden, the government used the slogan, "Valuable
companies create valuable jobs", clearly
recognizing the need to meet the challenges of a
globally competitive marketplace.
The
Swedish experience has also demonstrated that the
second pillar, "transparency", is absolutely
critical and cannot be underestimated. The Swedish
government produces a Consolidated Annual Report,
as well as quarterly reports, for its entire
portfolio of SOEs. These reports, which detail the
goals, actions and results of the SOEs and are
made easily available to the public, instill
valuable public confidence in the economy. In
contrast, the existing legal foundation for
corporate governance in China remains
fundamentally weak. For example, the corporate law
introduced in 1993 is often cited as shrouded in
ambiguity, hence rarely invoked. The law entirely
lacks codes on how SOE boards and executives
should make information available to shareholders,
as well as disclosure requirements on issues like
corporate registration and taxation information.
As the third important pillar, "political
insulation" is often the most difficult to
achieve. This requires a clear, consolidated
ownership structure, with close monitoring of the
corporation by a professional board which is
distanced from the political structure. In China,
SASAC, an organ of the State Council, was
established in March 2003 to promote "strategic
adjustment" of the state sector, exercising
ownership rights on behalf of the state and tasked
with improving the corporate governance of SOEs.
Upon its inception, concerns arose about SASAC's
broad mandate. Some saw SASAC operating almost
like a "superministry", which would contradict the
objective of political insulation. Critics have
argued that SASAC should function as a corporate
vehicle operating on a commercial basis, rather
than maintaining such expansive political power.
This would also enable the government to distance
itself from the commercial world and the
inevitable troubles involved in the
restructurings. Another major criticism of SASAC
is its overwhelming power compared to the other
ownership vehicle, the Huijin Investment Company,
another state-owned vehicle responsible for
managing China's four state commercial banks.
Currently, Huijin lacks the political authority,
much less the ministerial powers SASAC wields. The
imbalance of political power between SASAC and
Huijin is skewing the relationship between
industrial restructuring and lending, at a time
when the government is trying to introduce an
equity culture.
By corporatizing and
retaining strong SOEs, the government might ensure
that they will be a significant contributor to the
economy, while also retaining ownership over
strategic industries such as energy and
commodities. In a time of growing demand for
scarce resources and pressing domestic social
challenges, the option of privatization in
strategic sectors is not always desirable for the
Chinese government. Thus, the SOEs must strike a
balance between state-ownership on the one hand,
and competitiveness and efficiency on the other.
To do this and still achieve the "three pillars",
the government needs to support the necessary
agencies by providing a strong legal foundation
and a business-oriented environment.
China's progress in SOE reform has
enormous implications for the United States and
the world. Instead of the deep-seated suspicion on
display in much of the debate about the CNOOC bid
(which is especially ironic given that even US
experts consider CNOOC to be more independent and
professionally managed than the typical Chinese
SOE), the US Congress and administration should be
encouraging Beijing to move even faster and more
boldly to improve the corporate governance
structure of SOEs, including through their
operation in the harsh conditions of the
international marketplace. The next major Chinese
sector we will see testing the international
waters will be state-owned commercial banks;
indeed, this process is already under way, as
shown by the recent investment in the state-owned
China Construction Bank by the Bank of America. It
is in the interest of the US to speed up this
process.
If China can successfully
implement greater SOE reform, transparency, and
corporate governance, Chinese companies will
experience less suspicion of being state-dominated
corporatist giants implementing a nationalist
agenda without commercial foundations. The US and
the rest of the world have a stake in avoiding the
latter outcome. By bringing Chinese SOEs into a
rules-based market system, Americans will soon be
able to invest in better performing Chinese firms,
and US banks will gain full access to Chinese
financial markets and Chinese customers, who are
already accumulating capital at a prodigious rate.
Moreover, a prevailing culture of good corporate
governance in China will be nothing but beneficial
for the country's domestic business and political
environment.
Dag Detter is the
founder and director of Detter & Co, an
independent and privately owned corporate finance
advisory firm. He was previously the Director and
Head of the Division for State Owned Companies
within the Ministry of Industry in Sweden. Sue
Anne Tay is a research assistant with the
Freeman Chair in China Studies at the Center for
Strategic and International Studies.
This article originally appeared in The Freeman Report, a
publication of the Center for Strategic and
International Studies in Washington, DC. Reused by
permission. Copyright (c) 2005 The Freeman Report.
Speaking Freely is an Asia Times
Online feature that allows guest writers to have
their say. Please click here
if you are interested in
contributing. |
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