Demystifying China: Understanding China’s State-Owned Enterprises

Authored by Daniel T. Murphy

China’s Cultural Revolution was a social, political and economic experiment intended to restore Maoist orthodoxy to the country.  Like the Great Leap Forward, it was a failure.  Thus, after two inward-focused attempts to transform China, the PRC leadership, under Deng Xiaoping in 1978 began to look outward.  Economic transformation would be centered on the idea of “socialism with Chinese characteristics,” or socialism with elements of capitalism.

Through the late 1970s and early 1980s, the People’s Republic of China (PRC) focused on privatization of agriculture (redistributing land from communes to private ownership), opening up the country to foreign investment, and some small private business start-ups.  Through the late 1980s and 1990s, the PRC began privatization and partial privatization of large state-owned enterprises.  The country also began eliminating price controls and protectionist policies and regulations to continue to make the country’s economy attractive to foreign investment.  Private enterprise now accounts for seventy-five percent of China’s GDP.

A significant component of the economic policy is based on a “grasp the big, let go of the small” state-owned enterprises.  Since 1999, while the number of China’s state-owned enterprises has steadily decreased, and while the state’s share of GDP has steadily decreased, the average size of a state-owned enterprise has significantly increased.  In addition, the PRC has identified strategic industries and pillar industries.  Strategic industries are critical to economic and national security.  The state will maintain at least a fifty percent ownership stake in each enterprise in the strategic enterprise group.  These industries include: Energy; Aerospace; Power Sector; Petrochemical; Shipping and Telecommunications.  Not surprisingly these industries have undergone the most significant growth.  China’s largest companies today are not agricultural concerns.  The top five today are: China National Nuclear Corp (CNNC); China Nuclear Engineering Group Corp (CNEC); China Aerospace Science & Technology Corp (CASC); China Aerospace Science & Industry Corp (CASIC); and Aviation Industry Corp of China (AVIC).

In pillar industries, the state will seek to maintain a controlling stake.  The PRC may take a minority share or no share at all, in individual companies in the pillar industries.  The automotive industry is an example of a pillar industry.  In addition, the government has also developed a “national champion” strategy for certain emerging industries that require large investments of capital, and will have longer-term returns-on-investment – For example, high speed rail and aviation industries.

There are four ownership types of state-owned enterprises: (a) Some enterprises are fully owned by the state through the State-owned Assets and Supervision and Administration Commission (SASAC) of the State Council and by SASACs of provincial, municipal, and county governments.  (b) Some enterprises are majority owners of enterprises not officially considered SOEs but effectively controlled by their SOE owners.  (c) Some entities are owned and controlled indirectly through SOE subsidiaries based inside and outside of China (The actual size of this group is unknown).  (d) And finally, there are urban collective enterprises and government-owned township and village enterprises (TVEs) that also belong to the state sector but are not considered SOEs.

A recent major step in reforming the economy came in 2003, when the PRC created the SASACs (mentioned above).  SASACs are holding companies that hold the shares of state-owned enterprises that were previously held directly by the state.  SASACs have the “legal liabilities and rights of investors holding shares on behalf of the state.”  There are approximately 300 SASACs in China administering 100,000+ state-owned enterprises.  One central government SASAC oversees 30 provincial SASACs, and more than 200 municipal SASACs.  The SASACs helped create “distance” between government and business that has given company executives greater autonomy.  The SASAC model has also helped the PRC present itself as “majority shareholder” rather than the big brother government overseer.

Ironically, one of the key enablers of China’s economic evolution over the past quarter of a century has been the “non-westernization” of its financial services sector.  Chinese companies continue to benefit from a PRC financial sector that is heavily tilted in their favor.  China’s state-owned banks and state-owned commercial banks give Chinese companies preferential loans in the form of low interest rates.  They write-off bad loans or continuously roll over the principal for state-owned enterprises unable to pay their debts.  And they write loans to non-credit-worthy enterprises.

Copyright Daniel T. Murphy 2012