Satya J. Gabriel

May 1998

Go to China Essay Series


Restructuring State-owned Enterprises in China


One of the most pressing problems faced by the current leadership in China is the enormous burden on the national budget created by an increasingly inefficient state-owned enterprise (SOE) sector. Most of these state-owned enterprises are either operating in deficit or marginally profitable. Ironically, the condition of these enterprises has deteriorated since the beginning of the post-1978 reform process. After 1978, capitalist relations have been created throughout the state-owned enterprise sector, transforming China's industrial sector into a bastion of capitalism.  But, as has been shown by the current economic crisis in much of East Asia, capitalism is no guarantee for sustainable economic success. It partly depends on what form of capitalism exists at a given historical period. In the case of Chinese state capitalism, the continued subsidization of enterprise losses, rigid labor laws, state control over some input and output prices, easy access to bank credit (through relationships that might be described as a Chinese brand of crony capitalism), and monopolistic market practices have contributed to creating strong incentives for SOE management to operate their firms inefficiently.

The SOE sector is a dominant employer in China. It consumes about 70% of the labor and capital employed in Chinese industry. However, the SOE sector only generates about 40% of the output. This is a statistical sign of the inefficiency of SOE management. And, as Chinese factories attempt to adopt more contemporary technology, the problem of relative inefficiency grows worse. There is minimal incentive for SOE management to adopt best available management practices or most appropriate/most efficient technological solutions. As other sectors of Chinese industry "modernize," the SOE sector falls further behind. This problem is exacerbated by the excessive debt already on the books of most SOEs. It would be difficult for SOE managers to do more than refinance existing loans, particularly as the approval of loan requests from SOE managers to state bank managers is becoming less automatic---a shift in policy that is likely to have serious ramifications for many SOEs and their workers.

The new Chinese leadership, under Zhu Rongji, appears quite serious about advancing to the next stage of capitalist development in China. Banks are to be transformed into more autonomous commercial institutions, more bankruptcies of inefficient SOEs will be permitted, and many SOEs will be sold off (to both domestic and foreign buyers). Indeed, I have been approached by the economic committee of Liaoning Province regarding the new rules for selling off over 500 SOEs in that northern province (see rules for selling off SOEs in Liaoyang City).

Some of my former students in China have discussed the impact of lay-offs at SOEs where their parents had enjoyed, until recently, a guarantee of lifetime employment. Lay-offs do not leave workers with many options. China has an inadequate social insurance "safety net" for unemployed workers. Typically, workers lose health care benefits and other social benefits linked to their "danwei" or work unit and suffer a sharp drop in income. My students talk of colleagues who may be unable to continue their education because newly unemployed parents may be unable to continue providing tuition and living expenses.

Rising income inequality is likely to get worse before it gets better. And it is not entirely clear that workers are going to accept the impact of the reforms without a fight. There have been demonstrations in many cities by workers already laid off. It is clear that the current administration, though cautious about the pace of these reforms, is intent on implementing a more "free market" version of capitalism, but they are not unaware of the risks involved. The plan is to improve the social welfare system simultaneously with these enterprise-level reforms. What is unlikely is any significant slow-down in the reform process, despite continued concerns expressed by western observers and investors in the wake of the Asia-wide economic crisis. Indeed, in many ways the Chinese leadership seems more willing to reform than the leaders of other nations in the region with longer histories of capitalist enterprise, such as Indonesia. And the Chinese leadership confronts a relatively more docile, even if not completely cooperative, population than is the case in many of these other nations.

Nevertheless, there are reasons for concern, in addition to those already indicated. The government must be very careful for public finance and macroeconomic reasons. These recently capitalist SOEs are not only the "backbone" of the Chinese economy, but are also the most important source of revenue for the central government. About 60% of central government revenues come from taxing the SOE sector. Of course, the many unprofitable SOEs are also a significant drain on that revenue. What the central government would like to do is to signficantly improve the efficiency (and revenues) of those SOEs which can be "saved" and allow the rest to either go bankrupt or be sold off to domestic or foreign economic agents more capable of efficiently using the remaining assets. The hope is that the dynamic effect of improving the overall efficiency of the industrial capitalist sector will allow China's economy to continue at the extraordinary pace of growth that has become expected since the post-1978 reforms began to bear fruit. Failure to meet these expectations, with the subsequent rise in unemployment and slowdown in material improvement in living conditions, could erode the legitimacy of the current regime, shatter the aforementioned relative docility of the populace and spark increased social unrest.

At this stage it is not clear what the result of the reforms will be. Indeed, it is not completely clear how deep the reform process will be. Will the Chinese leadership try to emulate the keiretsu/chaebol model of development that has been, at least partially, discredited by long-term economic stagnation in Japan and virtual economic collapse in South Korea? Or will the Chinese leadership opt for a more sweeping reform of the state-owned enterprise sector, forcing decentralization, increased competition, increased reliance on the financial markets as a disciplinary mechanism for enterprise management, and a completely liberalized banking system? Will it try for some variant form with elements of both these "extreme" versions of capitalism? The book is still being written. The leadership is still weighing the potential risks and rewards of different configurations of reform measures. And they are continuing to observe carefully the events unfolding in the rest of Asia. Stay tuned.


Copyright © 1998, Satya Gabriel, Economics Department, Mount Holyoke College.