SOEs
spur congress to grind old axe for China's Xi
Jinping By Benjamin A Shobert
In the midst of Chinese Vice President Xi
Jinping's tour of the United States, the American
Congress' US-China National Security and Review
Commission turned its attention on Wednesday to
one of the ongoing points of tension between the
two countries: the ongoing role of state-owned
enterprises (SOEs) in China's economy.
Xi's tour is designed both to introduce
China's likely next leader to America's political
leadership while also using his reformist
credentials as a reminder to Washington's
policy-makers of how far China has come. In this
light, Wednesday's congressional hearing on
"China's State Owned and State Controlled
Enterprises" suggested that it would take more
than traditional
diplomacy to answer many
of the questions that remain about the role of
China's government in the nation's economy.
SOEs represent a point of contention in
US-China economic policy in large part because
their very existence as a protected space by
Beijing signifies two things: first, that a part
of China's domestic economy remains walled off
from foreign competition, and second, a protected
SOE sector signals to Washington that China's
process of economic reforms still comes up short
of the ideal.
Cynics are eager to point
towards SOEs as signs that China's process of
reforms has stalled out, while more-balanced
commentators believe SOEs play a necessary
stabilizing role as the country moves towards
increasingly market-based policies. For the latter
group, the role of SOEs is destined to rise and
fall as Beijing's leaders try to use SOEs to
provide employment or price stability. To the
extent rigid lines of demarcation about how far
SOEs should be allowed to reach into the Chinese
economy exist in the minds of those suspicious as
to China's reform process, congressional attitudes
towards this part of the country's economy are
important to understand.
Andrew
Szamosszegi, principal at Capital Trade, testified
on Wednesday that, as any China watcher knows,
"SOEs are ubiquitous". He was quick to also share
that while SOEs are present in almost every area
of the Chinese economy, "The direct role of SOEs
has been diluted in manufacturing."
Whatever dilution SOEs may have
experienced in China, today the country's economy
remains reliant on the state. Szamosszegi
estimates that "the share of GDP owned and
controlled by the state is approximately 50%."
Even if in relative terms the SOE sector is
diminishing, once the role of foreign and
privately owned companies in China is divorced
from the country's total gross domestic product
(GDP), the primary actor remains the state.
In response to the USCC's question about
how the relative size and scope of SOEs in China
has changed since 2001, Szamosszegi stated that
China's SOE sector has continued to shrink.
According to him,
By most measures, the size of the
state sector has expanded in absolute terms
since 2001. However, the state sector has shrunk
in importance due to the growth of the non-state
sector. The one indicator where the state sector
has declined in both absolute and relative terms
is employment. The absolute number of SOEs has
also declined.
These results are
important to note given the ease with which
Beijing could have used SOEs even more than they
did in order to stabilize the domestic economy in
the difficult days post the 2008 financial crisis.
That they did so without entirely reversing the
economic reforms of the last decade is worth
noting.
David Gordon, head of research and
director of Eurasia Group's Global Macro Analysis,
testified that SOEs should not be understood as
purely state-driven actors. As he said,
"their relationship with the state
(or, for that matter, the market) is not always
clear or uniform - and neither is the ability of
the central government to influence their
behavior. Indeed, even the largest and most
powerful SOEs have in some cases flatly
contradicted Beijing's broader policy goals.
Assuming unanimity among the SOEs and their
manipulability by Beijing is a mistake that
obscures their true nature.
However,
Gordon believes that China's response to the 2008
financial crisis shows that Beijing still needs,
and intends to maintain, a strong SOE sector.
According to Gordon, two trends indicate
that SOEs will retain their privileged status in
the Chinese economy: first, what he called the
"heavy-handed and interventionist response to the
2008 financial crisis", and second, what he refers
to as a growing "economic nationalism" in China
that drives a need by Beijing to foster national
champions in the form of SOEs. The events of 2008
loom large for more than just questions about the
direction of China's SOEs; similar questions
remain about the direction of the American economy
given Washington's willingness to step in and take
over troubled automakers and financial
institutions.
In the midst of the most
recent financial crisis, it is true that both
Beijing and Washington took the path of least
resistance. Beijing went backwards on certain
economic reforms, using SOEs as a vehicle to
ensure some modicum of stability while Washington
did something that in many ways was even more at
odds with its free-market foundations: it doled
out state money to stabilize private entities,
essentially turning them into Washington's own
version of SOEs.
Against the backdrop of
Wednesday's USCC hearing, whether this was the
right step to take is perhaps less important to
consider than whether it was the necessary step
for both Beijing and Washington. If so, the
question needs to be asked as to whether China
should be similarly able to use the state to
slowly work its way forward given its relative
poverty and history of economic instability, and
in moments of intense crisis, use these same
assets to stabilize the nation's economy in
moments of distress.
Derek Scissors,
research fellow in Asian economics at The Heritage
Foundation, believes that the retrenched role of
SOEs in China's economy goes back to 2002, well
before the 2008 financial crisis. Pointing towards
the 2002 transition of political power that
brought Hu Jintao into office, Scissors noted that
the new leadership "engineered a powerful economic
stimulus starting with lending expansion by state
banks (which utterly dominate banking). State
banks loan overwhelmingly to state firms and, as
early as September 2003, it was clear that the
trend of shrinking the state had been altered."
Scissors' testimony suggested that he not
only disagrees with those who believe SOEs are
shrinking in relative importance, but also that
SOEs represent a major conceptual problem to which
American policy makers and business do not have an
adequate response. Because China's SOEs act as the
tip of the spear for the country's "Go Out"
strategy, Beijing's favorable policies and
incentives for SOEs create the potential for
unfair competition within international markets,
in particular those of other emerging economies.
Gordon echoed this concern in his
testimony when he said that Beijing remains
"determined to transform many of them into
globally competitive 'national champions". " As
Gordon sees it, "This goal lies at the heart of
Beijing's favored lending rates and encourages
consolidation in targeted industries. Beijing now
allows these firms to borrow from the state's
massive foreign exchange reserve holdings to
conduct outbound purchases."
Whether the
US and other developed economies can evolve a
strategy for countering the success China is
having with its SOEs in emerging economies,
Wednesday's testimony suggested that many policy
makers believe Washington needs to focus first on
what it can most easily control: its own domestic
markets.
According to Scissors, "The
indirect link is that SOE control of the home
market forces other firms, foreign and domestic,
to seek customers overseas. As China gets richer,
the internal market has become more attractive,
but it has also become inaccessible for many firms
and they continue to export as a result."
What does Scissors believe should be done
in response to this? "The best American response
to SOE's in exports is, thus, the same as in
China: rolling them back in their home markets to
the extent possible."
For many in
congress, SOEs are problematic for another reason:
at their disposal are a number of
government-provided incentives and investment
schemes that would not be available to them from
the free market. Together these allow China's SOEs
to compete in ways that market-based competitors
would not be able to.
As Szamosszegi said,
"subsidies and preferences afforded to SOEs are
significant. According to the Chinese think tank
Unirule, these subsidies and preferences account
for the entire profits of the state-owned sector
from 2001 to 2009. Absent subsidies the real
return on equity of SOEs would have been minus
1.5%. Similarly, a study by the Hong Kong
Institute for Monetary Research, cited in The
Economist, found that SOE profits would disappear
if they had to pay a market interest rate."
In his testimony, Scissors made note of an
interesting possible alliance between American
business and that of China's own private
enterprises: "The comatose Chinese market reform
effort might be revived by sustained American
demands, years overdue, for both immediate
transparency and the smallest possible role for
SOE's across industries over time. These translate
to the largest possible market shares for American
goods and services and better conditions for
profitable operation in those markets. Not
coincidentally, they translate into the same
things for Chinese private companies."
China's SOEs are likely to remain big and
powerful players in the country's economy. The
question appears to be less and less whether
Washington can encourage Beijing to roll back its
emphasis on SOEs and more on whether developed
nations can build strategies to counter the
incentives SOEs have at their disposal when they
export to developed economies and when they build
partnerships in emerging economies.
America's market-basis criticisms of
China's SOE sector may well prove to be accurate;
but the lack of a coherent articulation of how
America will beat SOEs in either of these areas
suggests that at the end of the day old-fashioned
protectionism may be the only usable tool at
Washington's disposal.
For all of its
faith in the inherent superiority of market-based
reforms, its own response to the 2008 financial
crisis and today's inability to compete
internationally with China's SOEs may well lead to
the ugliest and most conventional of responses:
protectionist measures which attempt to achieve in
different fashion what China's SOEs currently
enjoy.
Benjamin A Shobert is the
Managing Director of Rubicon Strategy Group, a
consulting firm specialized in strategy analysis
for companies looking to enter emerging economies.
He is the author of the upcoming book Blame
China and can be followed at www.CrossTheRubiconBlog.com.
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