Ambiguous Capital:
The Success of China's New Capitalists in the Township and
Village Enterprises and Their Impact on the State Sector
By Satya J. Gabriel
How has China's economy grown
at such extraordinary rates in the 1980s and 1990s, with real
GDP per capita quadrupling in two decades? We've seen
some of the reasons in previous essays, including some of the
ways economic reforms have worked to unleash the creativity and
hard work of the Chinese citizenry. Forget that China is
still described (in polemical terms) as a communist country. This rhetoric really
doesn't mean much when it comes to the nuts and bolts of everyday
economic life. Or the perception that China's economy is
severely lacking in flexibility and competition. One of
the hallmarks of the reforms has been the rapid growth of new
economic institutions competing with the old and often stodgy
state-owned capitalist enterprises. Forget, too, that the
Chinese financial markets have gone through a meltdown more severe
than the one that hit Brazil after it devalued. The valuation
of Chinese publicly traded firms have discounted something close
to Armageddon. China's
capitalist economy is far
more vibrant than is understood by most on Wall Street or even
in the financial district of Hong Kong. The best
way to see why China is a burgeoning capitalist economic power
is to examine the nation's township-village (because they are owned by townships and villages) enterprises
(TVEs).[1] These
former commune and brigade enterprises represent the vanguard in China's new
capitalism. The TVEs are hybrid institutions --- unusual
alliances between TVE entrepreneurs and local government
officials (acting in the capacity of "owners" of TVE
enterprises).
Despite the mixture of private entrepreneurship with public
ownership[2], the
TVEs have achieved rates of success that would
be welcomed in any capitalist economy. The key seems to
have been the ability of China's capitalist system to generate
an adaptation to the standard relationship between managers and
owners in capitalist enterprises. This adaptation has
taken the form of the creation of a local market for management
control as
a solution to the principal-agent problem, where the principal
is, in this case, local government.[3]
In China, where the differential rights of managers and owners
remains ambiguous, the TVE has provided an institution within
which this ambiguity can become a source of competitive advantage.
Entrepreneurs/managers negotiate a contract with the relevant
public officials that may contain both implicit and explicit
conditions. Managers can gain a great deal of flexibility
in such contracts, while the relevant public officials secure
for their local government (or for themselves) fixed claims to
a portion of the enterprise cash flow and other agreed upon benefits
in non cash form. Managers may also obtain from public
officials an agreement that such officials will provide special
access to inputs (including new, upgraded machines and other
forms of technology), public resources (including training for
laborers), tax breaks, exemptions
from legal restrictions (including restrictions designed to
protect the rights, health, and safety of workers employed by
the TVE)[4] , protection from rival state-owned
enterprises and their supporters within the central
government, or any number
of other "incentives" that contribute to the competitiveness
of the TVE. This is not so unlike the various incentives
provided by local governments in the USA and elsewhere in exchange
for firm management agreeing to locate facilities in the local
area or to not relocate existing facilities elsewhere or the
sort of client-patron relationship created by corporate sponsorship of
politicians (in the form of campaign contributions and related support,
lobbying, and so on).
In the Chinese case this sort of arrangement becomes an important
mechanism for institutionalizing the reform process. It
becomes in the interest of local officials to expand capitalism,
since arrangements with TVEs become increasingly important
to the local economy (and sometimes to meeting the personal
needs, whether in cash or in kind, of the officials).
In the TVE, public officials have a greater incentive to take
seriously their role as a contracting agent (playing the role
of owners) in negotiating conditions with the top level managers
of TVEs, as well as in structuring rules and
regulations to meet the cash flow needs of the TVEs, such as
allowing more lay-offs (rationalization) of TVE workers.
The separation of ownership and management, in
this context, creates an environment that fosters greater focus
on generating cash flows than is the case in state owned enterprises
(SOEs). The managers have to satisfy residual claims on
the firms' cash flow and are subject to much harder budget constraints
than SOE managers. Thus, unlike the conditions under which
SOE managers operate, the managers of the TVEs have every incentive
to cost minimize, including stricter oversight of the firm's
existing assets, and to maximize the net present value
of assets acquired during the management's tenure. [5]
Managers, not surprisingly, have a keen interest in expanding
their authority over these TVEs. Ambiguity in the ownership-management
relation may generate some interesting and creative contractual
solutions, but is not the "optimal" arrangement from
the standpoint of managers. One can clearly observe a trend among
the TVEs towards the "individualization of ownership,"
meaning that ownership shares are increasingly being distributed
from the local governments to firm management, providing an additional
incentive for firm managers to focus on creating share owner
value. As one of my Nanjing University graduate students, Zhong
Qizhi, describes it: "The town-village enterprises are still
evolving. They are still mostly public enterprises, but a lot
of local officials would be just as happy if they were private,
as long as the taxes they get keep increasing."
An ironic consequence of transfering ownership to
management might be a reduction in the willingness of TVE
managers to take certain risks. When managers sign contracts
granting them the right to receive and distribute the net
cash flow, while ownership continues to be vested in the local
government, then such managers may seek out opportunities that
may have large payouts if successful, even if there is
substantial risk that these payouts might not materialize. At
the extreme, a failure to achieve desired results could lead
to the failure of the managed firm. If managers are also the
owners of the firm, the possibility of failure may represent
a much more serious risk because the managers would suffer a
significant reduction in their personal net worth. In
addition, social prestige for managers has become increasingly
linked to their ability to create and maintain positive cash
flow and to avoid insolvency (as opposed to the political path
to social prestige and material rewards of the old system).
Managers might, under such conditions, seek to implement less risky
business strategies that produce positive net cash flows but
with a lower probability of extraordinary rates of cash flow
growth (as has been common among TVEs). The result could be a
sharp drop in the rate of growth generated within the TVE
sector and therefore a slowdown in overall economic
growth.
Another benefit of local government contracting TVEs to
private management is that this arrangement offers significant
strategic options to both parties. Depending upon the details
and duration of the contract, local governments can retain the
right to reacquire operational control of the firm and/or to
dictate conditions for altering certain critical operational
aspects, such as the level of employment or location of new
facilities. To the extent this is the case, it limits the
options for the private managers. On the other hand, it is
also possible that the special relationship with local
government will provide firm management with unique options
for accessing favorable facilities, building sites, local area
resources, skilled labor, and information (possessed by local
authorities but not made public) which may be of strategic
value. And it is also possible that local government
authorities enter into the contract to create certain options
that might not be politically feasible if they were to remain
in direct control of the firm. For example, the contract may
grant (explicitly or implicitly) the private managers the
right to eliminate redundant workers or unprofitable
facilities. Every contract involves the creation of a complex
array of options, some of which represent trade-offs, but
overall the benefits for both parties are likely to be
significant and tangible.
Despite this very cozy working relationship between public
authorities and firm management, one of the factors contributing to the success of the TVEs
and providing encouragement to those supporting further privatization
is that the TVEs have tended to engage in fairly aggressive self-policing
of the sorts of corrupt business practices that have plagued
most SOEs. This is in sharp contrast to privatization in
Russia which resulted in an escalation in corrupt business practices and
outright thuggery.[6]
While management inefficiency, misfeasance and
malfesance continue to eat up substantial
portions of the SOE surplus in China, the TVEs have achieved a
level of
efficiency that is more common to highly competitive capitalist
firms in the so-called West.
This should not, however, be taken to mean that the only or
overriding objective of TVE managers is profit maximization.
In many cases, TVE managers are more concerned about expanding
market share. This in no way contradicts the capitalist nature
of the TVE. They remain enterprises run by managers who appropriate
surplus through voluntary contracts with wage laborers. To
the extent enterprise managers focus on other criteria than profit
maximization, they are acting in accordance with the long-term
capitalist objective of maintaining the wage labor system and,
no doubt, the short-term objective of satisfying their own self-interest.
Indeed, it is not so uncommon for capitalist enterprises in the
U.S.A. and other advanced capitalist nations to focus on such
factors as expansion of market share, even at the expense of
short-run profitability.
Indeed, the aggressiveness of town-village enterprises has
sent shock waves through the SOE sector. TVEs have not been afraid
to engage in price cutting or to employ relatively sophisticated
marketing of their products. They are not afraid to go head to
head with much bigger SOEs. This is ultimately good for the SOEs,
as well the TVEs. SOEs have been forced to concentrate more on
upgrading their facilities, improving product quality, developing
marketing plans, enhancing management skills and cutting prices.
SOEs are more likely, in fact, than TVEs to devote a significant
portion of their cash flow to research and development activities.
And the SOEs have a good deal of slack that could be tightened
to improve their overall performance: SOEs pay almost 10%
more in wages than TVEs and SOE workers tend to have much
lower productivity than the TVEs. Typically, the bigger and
more powerful the SOE, the lower labor productivity. Any
improvement in productivity or convergence of SOE and TVE pay
scales would benefit the SOEs in this competitive battle. It
is already the case that SOEs in more competitive markets have
higher productivity and stronger cash flow than comparable
SOEs in more protected market segments. And because i) the
SOEs
are generally located in urban areas, where the pool of talent
available to fill managerial and direct producer slots is
richer than for most rural TVEs and ii) there are greater
opportunities for joint venture arrangements and other forms
of cooperation with both foreign and domestic firms on
technological innovation there is reason for optimism that the
productivity gap might not only be closed but that it might
eventually move in favor of the SOEs.
All of these factors make it much more likely that some fraction
of the SOEs will emerge as first-rate, competitive enterprises
on the global economic stage. In any event, the end result ---
better products, better services, lower prices --- is beneficial
to Chinese society as a whole.
As the TVE sector has become more corporatized, many of
these enterprises have chosen a joint stock company
designation within which shares are kept in the local
community, in many cases owned primarily by employees
(including management), with restrictions on the sale of such
ownership shares. To keep shares in the family, so to speak,
employees who seek to leave the firm may be required to sell
to existing shareowners.
Some of these joint stock companies have even
required that new employees become shareowners, creating a
corporate structures similar to that of the Mondragon
corporate conglomerate in the Basque region of Spain
(considered by some the largest "communal" corporation in the
world). In this form of corporation, capital is substituted
with a communal endowment of financial resources and skills,
all owned and controlled by the workers themselves (including
management). As in the case of the much larger Mondragon
conglomerate, these firms have proven quite effective in
generating surplus value (even if the form of this surplus
value may be communal, rather than capitalist).
Throughout Chinese industry there is a rising culture of innovation
and competition. You can see this first hand by visiting the
TVEs or the more successful SOEs. For example, during my recent
two year stay in China I had the opportunity to observe first-hand
the effectiveness of corporate innovation within one of China's
largest SOEs, Shanghai Petrochemicals. The firm's management
is engaged in a wide-ranging strategy to upgrade technology and
marketing. The company, which is publicly traded as ADRs on the
NYSE, is also involved in several joint-ventures that will bring
their managers into direct contact with some of the most sophisticated
contemporary technology and management practices in the petrochemicals
sector. The success of innovation within both the SOE and TVE
sector is evident in China's export sector, which has remained
healthy despite the Asian economic crisis and the wave of devaluations
that put Chinese firms at a relative price disadvantage.
The Chinese capitalist economy is in a relatively early stage
of development. However, there are clear signs that managers
in the TVEs and in the better of the SOEs are fast learners.
Chinese firms are learning what it means to compete and to market.
The advertising firm, Satchi and Satchi, is expanding in China
in anticipation that it will be the world's largest source of
advertising spending. And quietly Chinese firms of all
types are undergoing massive restructuring. Mergers, acquisitions,
plant closings, and rising unemployment in China are all signs
of the commitment on the part of China's so-called communist
leadership to advancing a Western-style capitalist economy.
The current pessimism about China's prospects going forward
are, no doubt, a product of the continuing lack of understanding
of what is actually going on in China and continued confusion
about what capitalism is really all about. [7] China is, after all,
still called a "communist" country simply because the
political system is ruled by a party that calls itself communist.
The fact on the ground is, however, that China's industrial sector
is not only capitalist but increasingly looks like capitalist
sectors in the more advanced nations. Given this, the rather
authoritarian nature of China's political system actually works
to the advantage of Chinese capitalist firms.[8]
It reduces the
possibility of disruption from organized labor or political risks,
such as sudden devaluations. The costs of influencing governmental
policy are probably not significantly greater than for many industries
in the U.S.A. and other advanced capitalist nations. In
addition, Chinese firms have the
advantage of a large and rapidly growing domestic market
coupled with a government that continues to fund large-scale
infrastructural development (even as social service
expenditures have been pared down due to SOE reorganization
and, before that, the elimination of the communes).
For the foreseeable future, it remains highly probable that
Chinese firms, TVEs and SOEs, will continue the recent wave of
corporate restructurings that are providing significant improvements
in allocative efficiency. In addition, Chinese firms will continue
to engage in innovation on a scale that far exceeds the norm
in developing nations (no doubt with the support of the central
government and its intelligence operatives). China's capitalist
institutions are probably here to stay. It may not herald the
"end of history," but it is clear that China's leadership
has concluded that the most pragmatic solution to the problem
of Chinese economic development and political stability is to
allow the capitalist sector to prosper and grow.
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NOTES
[1] Township and village enterprises comprise about 60%
of enterprises not classified as state-owned (meaning central or
provincial government owned). There are approximately 500,000 such
non-state-owned enterprises recognized for tax collecting purposes in
China. TVEs are increasingly important sources of income and employment
(generating almost a third of Chinese gross domestic product and employing
approximately 131 million workers). TVEs are particularly important in
the production of clothing (sweatshop manufacturing), including contract
manufacturing of clothing for export. Given the importance of generating
hard currency reserves via exports, one should also note that the TVEs are
responsible for more than a third of export earnings. Thus, TVE sales
play a critical role in the "Four Modernizations" (which must be financed
with such hard currency earnings).
Return to Essay
[2] Most town-village enterprises are owned, in whole or in
part, by local governments. A significant portion of the sector
represents what's left of industrial enterprises started during the
commune era. The output generated within these enterprises was
depressed
by the late 1950s famine, which was partly the result of the chaotic
conditions
created by the Great Leap Forward. The pro-ancient (promoting
self-employment in agriculture and handicrafts)
reforms adopted in the
late 1970s generated a sharp rise in rural incomes. This sharp rise in
rural
incomes created a market for the output of rural industrial
enterprises. These rural industrial enterprises within the communes were
organized along feudal lines (as discussed in earlier essays) and would
later morph into state capitalist firms.
Thus, the first stage of the rapid economic growth was generated within
the ancient (self-employment) sector of the Chinese economy, not the
capitalist sector, but then had knock-on effects in the nascent
state-capitalist
TVEs. It is ironic that the early growth in self-employment would have
been so critical to TVE growth because the TVEs now represent a
significant
threat to the survival of ancient farmers and artisans, as TVEs expand
and encroach upon markets that had been captured or created by
self-employed
farmers and artisans and the government takes a more pro-capitalist
stance, promoting the growth in surplus labor (by making millions of
workers in state-owned enterprises redundant). Return
to Essay
[3] This local market for management control, created
by the commoditization of management, can be differentiated from the
typical market for corporate control in which ownership is both commodified and
traded in highly liquid markets. In the latter case, it is the struggle
over control of ownership, by vying for controlling percentages of equity
shares, that determines control over management. These struggles are
shaped by the specific nature of liquid financial markets within which
ownership shares are traded and the political processes governing both the
transfer of ownership control and the specific rights of owners to replace
management. The local market for management control,
created in the town-village case, is epitomized both by a high degree of
illiquidity and the fact that ownership is not for sale. The private
transactions that determine management
contracts leaves a great deal of latitude in the hands of the owners, in
this case local governments, about whether, when, and under what
conditions to alter management. Ownership itself remains uncontested.
Return to Essay
[4] The role of public authorities as owners of enterprises dependent
upon distributed shares of surplus value and as the protectors of
citizens' rights to health and safety are in basic conflict in the Chinese
system. This is epitomized by the failure of public authorities to carry
out the latter function, opting instead to take actions in support of
higher rates of exploitation in the township-village enterprises by the
contracted management. Studies of the TVEs have shown that cost
minimization in the context of supportive public policies has resulted in
longer work days, poor safety conditions, and physical and emotional abuse
of workers in those enterprises. TVEs account for more work-related
deaths than the SOEs, despite the fact that SOEs employ far more
workers. TVE managers have been found to violate rules on overtime,
often forcing workers to perform unpaid labor. Both TVEs, private firms,
and foreign firms have been found to engage in beatings and other forms of
abuse of workers. See for example Xiaojun Xu's 1995 paper
"You Xianqin Lingli dao Gongye Guanxi --- Xianzhen Qiye Laodong Guanxi de
Zhuangkuang yu Tedian (From the Neighbor Next Door to Industrial Relations
--- the Conditions and Characteristics of Labor Relations in Township and
Village Enterprises), in Chang and Zhao (eds.), Laodong Guanxi,
Laodongzhe, Laoquan --- Dangdai Zhongguo de Laodong Wenti (Labor
Relations, Laborers, and Labor Rights --- the Labor Conditions in
Contemporary China), published in Beijing by Zhongguo Laodong
Chubanshe (China Labor Press). Thanks to Natalya Marusich and Zhong Qizhi.
Return to Essay
[5] These contracts represent a more efficient solution to the problem
of agency costs than the bureaucratic solution attempted in the larger
state-owned enterprises (soes): in the soes the owner-agent, the central
or provincial government, attempts to control the behavior of management
by appointing a majority of the policy-making board members (previously
the bureaucracy directly appointed the top-level management) who, in turn,
appoint and monitor management. As has been pointed out by others, the
political objectives of government bureaucrats may generate suboptimal
management strategies in firms where these bureaucrats weild power
directly: government bureaucrats appointed to boards of directors are
likely to place political objectives above maximizing the net present
value of corporate assets. This problem is solved within the TVEs where
private parties, who are more likely to be focused on maximizing the net
present value of corporate assets, set and implement corporate
strategy.
It is worth noting that the problem of agency costs is not unique
to Chinese capitalist firms, whether publicly or privately owned.
Return to Essay
[6] Jeffrey Sachs, the former advisor to the Russian state, described
the privatization process as "corrupt asset grabs, managerial plunder of
enterprises and paralysis of firms." The Russian version of capitalism
had a lot in common with the late 19th century USA era of robber barons and organized
crime, giving renewed emphasis to Marx's writings on primitive
accumulation.
Return to Essay
[7] Government has always played an
active role in shaping market exchange processes, especially under
capitalism and slavery (the two most market dependent economic systems): at the most
basic level, complex exchange relationships presume the existence of contracts and contracts presume the
existence of government. Perhaps more to the point, under capitalism, as
Armen Alchian and Harold Demsetz have pointed out, an organization (in
capitalism the wage labor dependent firm) is understood as a nexus of
contracts and agreements --- by nature dependent upon political and
cultural processes. Although the Alchian-Demsetz approach to
institutional analysis assumes voluntary agreements (and the wage labor
contract under capitalism is certainly more voluntary than the conditions
of labor of slaves or feudal serfs), in reality most
agreements are the product of a combination of coercion, concord, and
conflict. In particular, the wage labor market exists because of
historical processes within which income inequality and the creation of
severe limitations of access to land, other natural resources, and technologies forced large numbers of
individuals into labor markets. Thus, the wage labor contract is voluntary
only in a relative sense. Nevertheless, governments have played important roles in
creating and reproducing these voluntary wage labor markets: the most
fundamental contractual relationship in capitalism is that between wage laborer and capitalist firm.
The misspecification
of the role of government in the behavior of individual capitalist firms comes, in part, from the notion of "market
externalities" which takes factors, such as political rule-making and
rule
enforcement and cultural processes by which economic agents come to
particular understandings of economic relationships, as separable from and
outside of market exchange relationships. This is an ontological problem
in neoclassical economic theory. In reality, the government is either a
visible or invisible partner in every market transaction, every contract
that is agreed to, and every aspect of the social relationships that
result in the creation of new value in the firm and the greater society.
Return to Essay
[8] A number of social scientists have noted the
important role of the Chinese government in the economic growth of the
reform era. C. Bramall, In Praise of Maoist Economic Planning, 1993; and
G. White, The Chinese State in the Era of Economic Reform, 1993 are
two excellent examples of the developmental state approach as
applied to China. Developmental states, whether in Japan, South
Korea, or even the 19th century United States of America, have played
important roles in advancing capitalist relationships. It is
unlikely, perhaps impossible, that China could have generated the dramatic
growth of the past two-plus decades without the hyper-active role of the
Chinese state. It is likely that the Chinese state will continue to play
an important part in the growth of Chinese capitalism, albeit a very
different one from the past. This is the challenge of China's pragmatic
modernists, to remain flexible enough to adjust the role of the state
to fit the needs of not only China's changing economy but a changing
global economic environment, as well.
Return to Essay
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