HONG KONG – China has lately been facing harsh criticism for the direction of its
reforms of state-owned enterprises, particularly its strengthening of the role of
Communist Party committees in SOE management. But while this might seem like a
step backward for China’s market-oriented reforms, there are good reasons to boost
oversight, at least for now. With China undergoing a fundamental transformation into
an innovation-driven, knowledge-based, and services-led economy, its leaders must
think carefully about how to reform the SOEs so that they can contribute to the new
economy.
In the past, the role of the SOEs was clear. Over the last three decades, they
underpinned China’s emergence as a global manufacturing powerhouse, by
spearheading China’s infrastructure-construction boom. In the process, they became
dominant, especially in sectors prone to natural monopolies (such as
telecommunications and power) and key strategic sectors (such as steel, coal, and
banking).
But the traditional single-sided markets where SOEs lead are now being disrupted by
new technology firms like Alibaba and Tencent, which straddle multi-sided markets of
production, logistics, and distribution by using unified platforms that benefit from
economies of scale. By creating platforms for consumers and small-scale producers –
what is essentially public infrastructure – these firms have directly challenged the
SOE business model.
New digital platforms respond quickly and efficiently to public needs. These
businesses are more collaborative or sharing than the traditional business of
manufacturing, allowing consumers and smaller start-ups to shape products and
services, from design to distribution. Given China’s population of 1.3 billion – a major
competitive advantage in terms of innovation and purchasing power – these platforms
can disrupt the incumbent one-sided market producers by offering superior scale,
speed, and convenience, including access to global markets.
Meanwhile, the SOEs’ obsolete business model – not to mention strong inertia –
makes it difficult to identify and respond to new opportunities in providing public
goods in a changing economy. China’s state-owned telecommunication companies
and banks, for example, have failed to respond to new technological challenges.
Even traditional private companies like Huawei and Midea have done much better,
adjusting to shifting consumer demand and changing factor costs by retooling as
quickly as possible, acquiring, for example, robot technology and product designs
from the West.
Such responsiveness is particularly critical today, when the inexorable logic of
technological progress is demanding a transformation of China’s growth model. With
demand for consumer hardware and durables falling, China must begin to develop its
own higher-tech products, while building a strong services sector. And with world
exports of goods declining – both cyclically and as a result of the growth slowdown in
the advanced economies – China must activate its domestic consumer base.
But the inability to update the roles and business models of SOEs is holding China
back in this regard. SOEs may enjoy privileged access to bank credit, natural
resources, and land, but they also suffer from rigid governance and high staff
turnover, spurred by President Xi Jinping’s anti-corruption campaign. When it comes
to key personnel, the Communist Party establishment calls the shots. So, for SOEs to
make changes, there must be consensus among internal and external officials in
charge of business, industrial policy, and politics.
In the late 1990s, public listings of SOEs had the twin benefits of securing new
resources for tackling legacy losses and propelling governance and productivity
gains. Today, however, privately owned technology platforms, many of which are
listed abroad, have captured much of the valuation gains of the new economy. As a
result, policymakers are struggling to find a way to finance the creative destruction of
outdated SOEs burdened by debt, excess capacity, and obsolete equipment.
It is this uncertainty that seems to have spurred the authorities to rethink their
original, more aggressive reform plan. They recognize that, when economic and
financial systems comprise intricate networks of a variety of interlocking and
interdependent elements, changes to one component – especially one as dominant
as China’s state sector – can have far-reaching consequences. With the recent
adjustments to the reform strategy, China’s leaders have bought themselves some
time to figure out where the SOEs can fit into the new economy.
The answer probably lies in new public infrastructure challenges – the kind that the
advanced economies are already facing – including issues related to information
security and competition. If SOEs shift their business models to provide platform and
regulatory services at low cost, taking advantage of economies of scale, they can
help, for example, to manage the use of information by the large private platforms. Or
they might help to guide the entry of foreign tech giants like Facebook and Google
into the Chinese market, to ensure that those companies do not become too
dominant.
State-owned banks, for their part, might be able to provide multi-tiered financing for
the millions of small and medium-size enterprises that are eager to shape and enrich
the new economy. Finally, SOEs can enter into public-private partnerships with local
businesses to handle the construction and management of transport and traffic
systems, urban drainage, and bodies responsible for food safety, pollution control,
and public security.
The good news is that the Chinese government, at both the national and local levels,
has plenty of assets with real value, amounting to more than 140% of GDP. Those
assets can help to smooth the transition to this new SOE business model, such as by
plugging the holes in the social security system and addressing legacy liabilities,
including those arising from past corruption, non-performing loans, and inadequate
provision of public goods and services.
China’s SOEs are at a crossroads. Given the high stakes of reform, the country’s
leaders are right to take some time to assess their options. Whichever route they take
is sure to be challenging. But those challenges pale in comparison to the problems
that would arise from sticking to the old SOE model.
This article first appeared in Project Syndicate, 28 June 2016
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