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Over the recent decades, the planned economy of China underwent rapid transformation, and the role of the state-owned enterprises (SOEs) has diminished. This trend toward deregulation is one of those factors that contributed to the economic and financial growth of this country. However, the percentage of SOEs still remains very large, and it is believed that these organization have ceased to be cost-effective. This paper will discuss the argument made the representatives of the World Bank: according to them, China’s state-owned industrial enterprises are a drag on the system.
The key argument that we can advance at this point is that modern Chinese SOEs should not be evaluated by traditional Western economic standards because their key objective is to maintain employment (Garnaut et al, 2006). In the case of China, liberalization should be regarded as a means of improving organizational and financial performance of the company, but not the ultimate goal. One should bear in mind that privatization and liberalization of economy are usually accompanied by numerous redundancies and very high unemployment. The Chinese government does not support rapid liberalization of economy or “shock therapy” because similar reforms were carried out in the former Soviet Union, and they did not yield expected results (Lo, 1999, p 693).
The privatisation did not generate sufficient returns since many SEOs were purchased at virtually no cost, and many of its employees were dismissed indiscriminately. These are the reasons why modern economists should not criticize the Chinese government for its lenient attitude to SOE. To some extent, the policies of the government can be called as an attempt to mitigate the effects of deregulation and make this process as smooth as possible. The next sections of this paper will dwell on these issues in more detail.
The purpose of the economic reforms in China
At first, it is necessary to explain the essence of the liberal reforms, conducted in China. Overall, this is a complex of reforms, which are known as gaizhi. Modern scholars define as “restructuring on firms’ financial discipline and economic performance” in the decade or so since its inception (Garnaut et al, 2006: p. 36). In general, the findings of many authors do not support the critical view of the World Bank. Modern scholars admit that the gaizhi process had stimulated growth and engendered a constructive effect on the profitability of state owned industrial enterprises.
The key essence of these changes lies in the structure and management of these organizations. They have become much more independent of the state, for example, they estimate the production products according to the market demand, and not according to some guidelines of the state officials. However, these reforms did not revolutionized the form of ownership. Many of them are still completely or partially owned by the state, though in the near future the share of the private investors will increase, though we do not for sure, when it will happen.
In their research article Ross Garnaut, Ligang Song and Yang Yao (2006) analyzed China’s state owned industrial enterprises using three main variables: debt, budget constraint, and social security. The authors hypothesize that the local government deliberately delays the privatization of many SOEs because of them are not performing as well as they should, and their privatization will not yield sufficient profits to the state (Garnaut et al, 2006: p. 61).
This is one of those reasons why these companies should not assessed according to the Western economic standards, such return on investment, liquidity, operational costs, and so forth. Such evaluation will be possible only when the economy of the China becomes fully deregulated. Contemporary state-owned enterprises have to fulfil both economic and social functions. On the one hand, they need to maximize the profit, while retaining jobs for the employees (Garnaut et al, 2006). American or European companies do not have to cope with these tasks. Thus, the approach, taken by the World Bank is not quite acceptable.
As far as debt is concerned, a lesser quantity of gaizhi firms as opposed to non-gaizhi firms possessed outstanding bank debts (Garnaut et al, 2006: p. 58). Compared to non-gaizhi firms, the average size of debts attributed to state owned industrial enterprises was significantly less, however, scholars believe that gaizhi can turn into a good pretext for many organizations to evade debt (Garnaut et al, 2006: p. 58). Thus, we can argue that rapid privatization of economy can give rise to fraud and tax evasion. Those people, who continuous appeals to privatize Chinese economy as quickly as possible, overlook the potential risks, entailed by this process, for instance, low returns, high unemployment rates, and even fraud.
While criticizing the policies of the Chinese government, the representatives of the World Bank often state-driven companies are less efficient in terms of organizational performance, and that they are more likely to lose assets (Garnaut et al, 2006: p. 62). However, these critics overlook some very important points, and one of them is the purpose of these reforms, and it is to maintain relatively low unemployment rates in the country, while allowing the companies to become more independent of the state.
Overall, the so-called gaizhi organizations have managed to cope with this task, especially in comparison with those enterprises are under total control of the state (Garnaut et al, 2006: p. 62). Judging from this information, we may argue that while assessing the efficiency of economic reforms, one has to consider the local context. Furthermore, Western economic standards are not always applicable, especially if we are speaking about the country that has been a planned economy for more than half a century. Therefore, the World Bank has to make allowances for the fact that the deregulation and privatization of the planned economy is in itself a very time-consuming process that may require several decades in order to be completed.
Competition in China
Another aspect of these problems that we need to discuss is the peculiarities of the competition in China. It is quite possible to assume that in the country, where the majority of enterprises are controlled by the state, the role of competition will diminish.
Such authors as Yuk-shing Cheng and Dic Lo (2002) highlight another essential difference between traditional Western economic ideals of competition and the situation in Chine. These scholars believe that neo-classical model of perfect competition is based on the premise that inefficient are eventually driven out of the market by those companies which manage to reduce production costs or excel in customer service (Cheng and Lo, 2002, p 434). In other words, market exit is very easy, while it is very difficult to drive the company out of the market because the government is particularly concerned about creation or at least preservation of employment opportunities for people.
The state views the country’s citizens not as customers of a certain enterprise but as workers, who need to sustain their families. Yuk-shing Cheng and Dic Lo believe that in the years to come the competition in this country is most likely to become oligopolistic which means that the industry will be dominated by few manufacturers, however, they will not be able to dictate prices to the buyers, since pricing policies will be under the supervision of the government (2002). This is why one should not suppose that the purchasing power of Chinese people would diminish.
Again, one has to remember that gaizhi reforms are not profit-centered. They aim to change the structure of the Chinese society. In particular, we need to speak about urbanization and industrialization of the country in which the majority of population leaves in rural areas with very high unemployment levels. In his article, such scholar as Dic Lo (1999) reiterates the position that China’s state owned industrial enterprises cannot be adequately judged or understood in the context of traditional Western economic thought, since the Chinese government’s goals run counter to the profit- centred Western economic mindset (Lo, 1999: p. 702).
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Simply put, the Chinese government’s main goal for restructuring remains social in nature: it centres on employment (Lo, 1999: p. 702). As Lo (1999) points out, in China there exists an “implicit contract between the state and the urban population (and thus the historical development of China’s political economy), whereby the former has undertaken to provide certain levels of welfare to the latter” (Lo, 1999: p. 702). This idea of contract is crucial in this case, the government of this country is concerned mostly about the needs of middle class and low-income population, rather than entrepreneurs and employees. Thus, if we look at this problem from this perspective, we may argue that the preservation of SOEs is crucial for the government at least at this point.
Another reason, why gaizhi reform comes under criticism is the alleged preferential treatment of the government. In other words, many Western economists believe that the state restricts the expansion of private companies, while allowing the unprofitable SOEs to remain in the market. Nonetheless, one should not assume that the government of this country pursues the policy of protectionism.
In his paper, Junyeop Lee (2009) points to the changing situation in China, especially in those industries. Lee (2009) asserts that the reforms that the Chinese government implemented in the late 1990s have led to a diminishing presence of state owned industrial enterprises in China overall (p. 6). In 2004, according to Lee (2009), state owned industrial enterprises now account for roughly one third of the production in China’s economy, compared to over 75 per cent in the late 1970s (p. 6).
These data proves that the economic reforms, implemented by the Chinese government did contributed to the deregulation of the domestic economy. The only problem is that these changes are not as quick as one would expect. Furthermore, we need to mention that over recent years the efficiency of many SOEs has dramatically improved. In his article, Junyeop Lee (2009) presents statistical data which shows that the ROI (Return of Investment) in modern state-owned enterprises has risen to a higher level.
China’s state owed industrial enterprises have not been nearly as inefficient and unprofitable as much of the literature over the last decade, including the World Bank’s 1996 Development report, has suggested. However, some large scale reforms, many of which could be construed as more Western influenced – namely – large scale lay offs as a means of stimulating performance, were adopted by the Chinese government in the early part of the twenty-first century (2009).
These data indicates that the Chinese government attempts to maintain equilibrium between economic performance and profitability, on the one hand, and employment, on the other. Most importantly, the overall presence of state owned industrial enterprises and their contribution to the Chinese economy have diminished considerably in the years covered by this paper. However, their overall performance and efficiently has improved vastly as a result (Lee, 2009: p. 12). Thus, one should regard Chinese SOE as some cumbersome bureaucratic organizations that are completely indifferent of the customer’s needs. Such perception is not quite evidence based.
Overall, the findings show that modern Chinese SOEs are going to be privatized. However, this process will be very gradual and probably time-consuming. The reforms, which the government of this country attempts to carry out in the course of recent decades, aim to improve the overall quality of living in the country and at improve the overall efficiency of SOEs. State-owned enterprises should not be assessed according to the standards, established in the United States, Australia, or the European Union because their major priority is to provide employment opportunities, rather than to maximize profits.
Cheng, Y., and Lo, D. (2002) Explaining the financial performance of China’s industrial enterprises: beyond the competition-ownership controversy. The China Quarterly [online], 170. Web.
Garnaut, R., Song, L., and Yang, Y. (2006) Impact and significance of state-owned enterprise restructuring in China. The China Journal [online], 55. Web.
Lee, J. (2009) State owned enterprises in china: reviewing the evidence. OECD Working Group on Privatisation and Corporate Governance of State Owned Assets [online]. Web.
Lo, D. (1999) Reappraising the performance of China’s state-owned industrial enterprises, 1980-96. Cambridge Journal of Economics [online], 23. Web.
McNally, C. (2002) China’s state-owned enterprises: Thriving or crumbling? Asia Pacific Issues [online], 59. Web.
World Bank (1996), World Development Report 1996. New York, Oxford University Press.