Where there’s a will there’s a way to reform

There a three areas that need to be addressed if reforms of state-owned enterprises are to be meaningful and comprehensive.

East Asia Forum

The further reform of China’s state-owned enterprises has attracted a lot of attention and triggered debate since it was discussed last year at the third plenary session of the Chinese Communist Party’s 18th Central Committee (the Third Plenum). Three areas need to be addressed if reforms are to be meaningful and comprehensive: reforming the property rights system of SOEs by developing a ‘mixed ownership economy’; shifting from managing state assets to managing state capital; and promoting a modern corporate system.

At this stage the key to reforming the property rights system of SOEs under the ‘mixed ownership’ model lies in continuing the transformation from an old traditional enterprise system to the modern enterprise system. This will require a four-pronged approach.

First, corporatising the remaining wholly state-owned enterprises should be accelerated. According to the Chinese Ministry of Finance, 16 per cent of SOEs—more than 20,000— fall into this category, having not yet transformed into companies under China’s Company Law.

Second, the parent companies of the 113 central SOEs under the State-owned Assets Supervision and Administration Commission (SASAC) should be corporatised. Currently only seven of them have diversified equities, while in most the state is the exclusive investor. By contrast, the majority of these enterprises’ subordinate companies are now incorporated, and some are already publicly listed on the stock market.

Third, the state should reduce the average proportion of shares it holds in enterprises. In 2012, there were 54,000 wholly state-owned companies in China, accounting for 37 per cent of all SOEs. Their total assets reached RMB 36.7 trillion (US$5.9 trillion), or 41 per cent of the total. While a small number of industries related to national security can remain solely state-owned, most SOEs should diversify their equity structure and reduce their average percentage of state shares. This will improve governance structure by balancing the majority shareholder.

Fourth, the investment of state capital in major industries and key areas involved in national security and the economy should be redefined. More and more state capital should be distributed in the fields of public service, emerging and strategic industries, ecological protection, technological innovation and national security—instead of distributing in competitive fields. State-owned monopoly enterprises should also be encouraged to develop into mixed- ownership enterprises.

Another key area of reform is China’s current system for managing state assets, which needs to be transformed into a new system for managing state capital. It is important that policy guidelines for this new management system be developed at the national level and include the fundamental function of state capital and an operating earnings policy. The functions of capital owners and public administrators should be clearly defined. Separating the shareholder and regulatory functions of the State-owned Assets Supervision and Administration Commission will be crucial to avoid conflicts of interests. While the regulatory function can remain with the existing agencies, the investment arm must be assumed by the proposed government capital investment or operating company.

Efforts should be made to further explore the operational model of state capital to promote the idea of ‘capital management’, so as to increase the efficiency and performance of state capital. The next stage of reforms should focus on the authorised operational mechanism for state capital and establishing a number of specialised state investment and operational platforms. These proposed state capital investment and operational companies can take as examples the Temasek model in Singapore and the Central Huijin Investment model in Chinese state financial assets management which has improved corporate governance and reform in the banking sector.

While a number of state-owned capital operating companies needs to be established, some SOEs qualified in special industries could be reorganised into state capital investment companies. These two platforms could act as a firewall between the state capital owner and the enterprises. This would mean that SOEs had more room for development and ultimately improve the efficiency and performance of state capital.

The Third Plenum decision emphasised the importance of ‘promoting a modern corporate system for SOEs’. The question is: how to achieve that under the principle of ‘clearly established ownership, well-defined rights and responsibilities, separation of enterprise from administration, and scientific management’?

China’s existing SOEs can be classified into at least two categories: non-profit enterprises with policy intention and strategic objectives, and those which operate in fully competitive fields. According to the instructions of the third plenary session, China’s next stage of development will witness more input and support for the former. On the other hand, the latter will have to compete with non-SOEs on an equal footing under the principle of full competition for resources, markets and services.

Reform measures will differ across monopoly industries depending on their nature. Administrative monopolies—those that, by the grace of government, have had monopoly status conferred upon them—must be broken up. Reforms of natural monopoly industries will be aimed at separating enterprise from administration, government functions in managing public business, and state-owned capital management. For SOEs in competitive fields, the assessment and evaluation systems should be developed based entirely on market economy standards.

But even with all of this, traditional regulation—with the structure of SASAC—can only produce a traditional corporate system. Establishing a modern corporate system requires a functional, arms-length regulatory system.

Narrowing the focus, the ‘enterprise system’ at the micro level should also be improved. The first step is to reform and improve the current senior manager selection mechanisms, the salary system, and assessment and evaluation mechanisms—all of which are essential to a modern corporate system.

For example, in most cases, when selecting and recruiting senior managers for SOEs, the mechanism of party-cadre administrators is usually combined with the market mechanism. This is a special recruiting system. Unlike the professional managers that headhunting companies seek in the market, the senior managers of SOEs assume a dual identity: enterprise runner and leading cadre at a certain level.

This has both pros and cons. The upside is that these managers, as leading cadres, may have a stronger sense of responsibility and higher professional standards; the downside is the difficulty in efficiently combining these two systems and the effort required to improve them. The selection and recruitment of leading cadres also encounters the ‘revolving door’ problem. This occurs when the role exchange between government officials and enterprise managers introduces enterprise management experience into government departments and brings government management experience into enterprise operation—another pros-and-cons situation. The key problem lies in whether the departments concerned are willing to delegate powers.

The Third Plenum set out new tasks to deepen the reform of SOEs and made clear the key areas where change is needed. Though hardships are inevitable, as long as the reformers march in the right direction, with clear targets and appropriate methods, breakthroughs will be achieved. Where there is a will, there is a way.

Zhao Changwen is the General Director of the Department of Industrial Economy, part of the Development Research Center at the State Council of the People’s Republic of China.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘The state and economic enterprise’. Republished with permission.

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