A long march for China's national champions

Although the Chinese state-owned media outlets have focused on addressing social inequality and environmental concerns during the Third Plenum, the important document is Reform 2.0, which discusses the country’s reform agenda over the next decade. At the heart of Reform 2.0 is Beijing’s view on the dominance of state-owned-enterprises and its relationship with the domestic private sector, which has actually shrunk in absolute size since 2009. While there were acknowledgements of the need to develop the domestic private sector, Beijing also reinforced the importance of the state-owned economy. 

Beijingg is well aware that the crowding out of the private sector not only creates distortions and inefficiencies, but is a major cause of inequality throughout the country. After all, when some 144,000 receive the lion-share of capital and opportunity in most of the major economic sectors at the expense of the tens of millions of private firms, a small number of individuals and firms tend to benefit disproportionately from economic growth. Although supporting the domestic private sector makes eminent economic and social sense, the problem is that China sees no option but to encourage the rise of giant domestic SOEs in order for these to compete domestically (with foreign firms) and globally. This means that there is a long way to go before we will see the dominance of SOEs being genuinely wound back.

First, why so much excitement about the Third Plenum? A Plenum is the annual meeting of the Chinese Communist Party’s Central Committee, from which the all-power Standing Committee is drawn. Third Plenums are seen as significant because the First Plenum introduces the new leadership, the Second Plenum appoints further personnel, and the Third tends to outline economic and social policies for the years ahead. Remember that it was the Third Plenum that Deng Xiaoping outlined his series of reforms that would set China on a radically difference course from 1979 onwards.

Let’s get on to SOE reform. It is hard to exaggerate the size and dominance of SOEs in the Chinese economy. The 144,000 SOEs account for about half of the country’s business and industrial profits and more than 70 per cent of China’s fixed assets. For the past three years, the China’s three largest SOEs (Sinopec, China National Petroleum and State Grid) earned more revenues than the combined revenues of the largest 500 private domestic firms in the country. Receiving around three quarters of the country’s formal finance, SOEs operate in highly protected environments and are often given preferential credit rates and other tax benefits. Of the over 2,000 listed firms on the country’s two stock exchanges, all but around 50 are effectively state-controlled, with the government holding majority or major stakes in those companies.

One problem with reducing the dominance and size of SOEs for China is that of desperation to remain competitive with international rivals. Since the 1970s, there has been an unprecedented degree of industrial concentration among leading firms in almost all sectors.

From 2006-2009 figures, in large commercial aircraft, two firms have an almost 100 per cent market share. In automobiles, 10 firms have 77 per cent global market share. In heavy duty trucks, four firms have 89 per cent global market share. In PCs, four firms have 55 per cent global market share, with three firms having 75 per cent global market share in smart phones. In pharmaceuticals, 10 firms have 69 per cent global market share, with four firms having 44 per cent market share in construction equipment.

The story is the same within global value chains. For large commercial aircraft engines, three firms have an almost 100 per cent global share. Just two firms have a 75 per cent global share in braking systems. Three firms have a 100 per cent share in tyres for commercial aircraft. When it comes to IT, two firms have a 100 per cent share in micro-processors for PCs. One firm has a global 90 per cent share for operating systems, while two firms have a 63 per cent global share in the server markets.

Importantly, almost all of these firms are head-quartered in advanced economies in North America, Europe and industrialised Asian economies such as Japan and South Korea.

When one looks at outward FDI in the world, developed countries are behind about 84 per cent of all outward foreign-direct-investment in the world, indicating that these same advanced firms are the ones relentlessly entrenching their dominance in existing and emerging sectors and technologies. If there were ever fears that China is buying up the world economy, these figures should dispel that notion.

What does this have to do with Chinese SOEs? In 1998, then Vice Premier Wu Bangguo summarised the government’s thinking in this way:

“International economic comparisons show that if a country has several large companies or groups it will be assured of maintaining a certain market share and a position in the international order. America, for example, relies on General Motors, Boeing, Du Pont and a batch of other multinational companies. Japan relies on six large enterprise groups and South Korea relies on ten large commercial groups. In the same way now and in the next century our nation’s position in the international economic order will be to a large extent determined by the position of our nation’s largest enterprises and groups.”        

The fact that China has ensured that its ‘national champions’ are all SOEs (with rare exceptions such as Huawei – and even then credible doubts about its independence from the state remain) is a function of regime politics and priorities – designed to ensure that the CCP remains the dominant dispenser of business, career, economic and professional opportunities in the system. But the desire to develop huge ‘national champions’ is derived from immense vulnerability and desperation to catch up with advanced economic competitors. It is the same reason why Beijing refuses to genuinely open up key sectors of its economy to outside competitors, fearful that more efficient and technologically advanced foreign firms will similarly dominate key sectors like they have done in other developing economies.

The CCP’s hope is that its SOEs can defy the laws of firm-level economics: that coddled, protected SOEs can nevertheless emerge as world-class players able to compete with the best private sector multi-nationals in the own right. So far, only moderate progress has been made on this account, and the increase in industrial espionage by the Chinese government and these firms could well be explained by lack of progress of its SOEs.

The bottom line is that Beijing is determined that its firms join the likes of Boeing, General Motors, Airbus and Exxon Mobile. And doing what it takes to nurture, protect and grow its SOEs is the only way it knows how.

Dr John Lee is the Michael Hintze Fellow and adjunct associate professor at the Centre for International Security Studies, Sydney University. He is also a non-resident senior scholar at the Hudson Institute in Washington DC and a director of the Kokoda Foundation in Canberra.