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Opportunities and Strategies Behind the Reform of Chinese SOEs

Mar 20 , 2014
  • Ding Yifan

    Deputy Director, China Development Research Center

At the two Conferences (National People’s Congress and Chinese Political Consultative Conference) of 2014, the reform of State-Owned Enterprises (SOE) became a hot topic of discussion among the representatives. Since the start of reform and opening up, the reform of state-owned enterprises has been on the agenda several times. Why has the same issue again become a focus of opinion now? 

In general, there are several reasons behind the fact that SOE reform has become a focus of the government: 

Ding Yifan

I. With the international financial crisis going on, the external market environment has not shown any obvious improvement, so China’s economic growth has to shift from a reliance on external markets to a reliance on internal market development. To this end, economic restructuring is a necessary condition to keep economic growth going. State-owned enterprises exist as a force that the government can rely on and find easy to mobilize. As a Chinese saying goes, implementing the reform of SOEs to promote economic restructuring is  “to skillfully achieve strong effect with little input.” 

II.The key point in economic restructuring is to strengthen technological innovation and make technological breakthroughs, so as to guarantee the growth of return on investment. China has a typical “catch-up” economic structure, with very few original innovations and even fewer financing channels for innovation. In other words, lacking a venture investment mechanism restricts China’s ability to introduce new technologies in large numbers. However, in a “catch-up” economy, state investment often works as a substitution mechanism for venture investment. Targeting some industrial areas, the government can offer special preferential policies to encourage investment in these areas, while SOEs are usually the carriers of this type of investment. The reform of SOEs also involves finding methods to stimulate these enterprises for more technological innovation. 

III.Several years ago, the Chinese government launched an economic stimulus of RMB¥4 trillion. State-owned enterprises undertook many infrastructure investment projects, outshining others in the plan. Although the SOEs have made great contributions to China’s economic growth at a time of global economic recession, they are often given a bad name for “getting profits by taking advantage of their monopoly position.” According to the 18th session of the 3rd plenary session of the Party Central Committee held at the end of 2013, the future economic reform would make the market play a decisive role in resource allocation. Therefore, the reform of SOEs is aimed at a partial withdrawal from the market, thus creating more growing space for non-state-owned enterprises. 

VI. With the growth of the economy, people have started to demand an improvement in public service quality. However, there is a little or even no profit in  public service, so it is undertaken by state-owned enterprises in most countries. Yet, how can public services be improved and provide better public services so that ordinary people can enjoy the fruits of economic development? This is a question to be considered by state-owned enterprises responsible for public service. It is only through the reform of these enterprises and even through the reform of government management of such SOEs that people can better enjoy public services. 

People are still questioning what direction the reform for SOEs will take. In fact, the reform plan for SOEs announced in Shanghai shortly after the 3rd plenary session of the Central Committee did give some clues to the future direction of SOE reform: 

I. The tendency will be to classify the management of state-owned enterprises. There are all sorts of SOEs, so government is unable to give them a unanimous evaluation. According to the Shanghai reform plan, SOEs can be classified into at least three types: enterprises in the public service area, leading enterprises in technological innovation, and enterprises in competitive areas. Obviously, it is unfeasible to manage these three types of enterprises by applying unified standards, and there must be different standards to evaluate their performances. Public service enterprises should be mainly evaluated in terms of service quality, innovative enterprises in terms of the ability for technology innovations and competitive enterprises in terms of profits. 

II. Government should control enterprises in accordance with their nature. For instance, some non-profit public service SOEs will still be under government control, since they are not for profit.  Innovation-driven enterprises run a high risk and non-public enterprises are usually unwilling to get involved, and they are often part of the country’s competitiveness, hence the great possibility that the government will take full responsibility. As for enterprises of a competitive nature, it is most likely that the government will no longer exert full control.

III. State-owned enterprises in competitive areas will gradually be transformed into mixed ownership. In fact, from the perspective of law, some large-sized SOEs are no longer totally controlled by the government, because they are already listed companies with a very complicated capital structure and have become “mixed ownership” enterprises to a great extent. However, small investors are the shareholders of such enterprises, but they do not have much say in management and operations. Therefore, in the future it will be necessary for these investors to have more say on the board of directors.

IV. State shareholding will gradually reduce and withdraw from mixed ownership. After enterprises in competitive arenas turn into mixed ownership, the government can gradually reduce its shareholding and let them return to the market. Government does business not for the purpose of just making money. It is not necessary for the government to hold most of the shares in an enterprise. According to the experience of some European countries, government can also have the right to veto key decisions in reformed SOEs by means of holding a “Golden Share”, i.e. holding a small amount of shares.

Now, what opportunities can the reform of SOEs provide for the non-public sector? Several possibilities can be seen as follows:

I. Hold shares and get dividends. State-owned enterprises should open up their

capital to allow for investments from non-public and private enterprises. Some monopolistic SOEs have enjoyed high profits, and will be extremely profitable.

II. Enter into some special markets. Chinese markets are gradually opening up, which can be seen from the fact that areas like government procurements have not yet totally opened to the outside. Joining some state-owned enterprises by way of investment can be a shortcut to having access to these markets.

III. Participate and improve business management. One purpose of turning some SOEs into mixed ownership is to improve their management level. Participation of private investors in SOEs’ management will bring new management concepts and methods, thus improving the performance of these enterprises.

IV. In the process of participating in SOE reform, private enterprises can play their role and improve their management, with the result that they will surely gain the further right to participate and gain bigger profits.

Ding Yifan, Deputy Director, Research Institute of World Development, China Development Research Center (DRC).

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