By Shanshan Li & Ningxiang Xu Management School, Jinan University, Guangzhou, China ABSTRACT: Up to the present, nearly fo...
By Shanshan Li & Ningxiang Xu
Management
School, Jinan University, Guangzhou, China
ABSTRACT:
Up to the
present, nearly fourteen years have passed since China’s accession to WTO.
Among the various impacts the accession may bring about, the one on State-owned
Enterprises (SOEs) was most widely concerned due to their special
characteristics and particular roles in Chinese economy, politics and society.
This essay will briefly introduce the history of China’s SOE reforms and then
summarize previous research to demonstrate the expected influences of the
accession. Then privatization and removal of protective government policies
will be examined in detail, followed by an evaluation of the effect of
privatization.
Keywords: WTO Accession,
China’s SOEs, Privatization, Protection Policies
1. Introduction
In 2001, China
joined the World Trade Organization (WTO), which is of great significance to
both China’s economic and social developments. According to the WTO accession
protocol, China was required to carry out a number of trade policy reforms,
including tariff reduction, elimination of subsidies and opening up domestic
markets, to conform to the WTO regulations and to promote an open economy.
Among the various impacts the accession to WTO may bring about, the one on
State-owned Enterprises (SOEs) was most widely concerned due to their special
characteristics and particular roles in Chinese economy, politics and society.
On one hand, China’s SOEs were generally perceived as huge, inefficient and
problematic to which drastic measures should be taken. On the other hand, SOEs
played a critical role in leading the domestic market, dominating pivotal
industries and absorbing labor force. Therefore, whether a change in their
state-owned property is inevitable to achieve improvement is controversial and
has received extensive debates.
Up to present,
nearly fourteen years have passed since the accession. Although certain
reforms, such as the Management Buy-Outs (MBO), were implemented during this
period as a response to WTO rules, their effects remained medium. This essay
will first briefly introduce the history of China’s SOE reforms and then
summarize previous research to demonstrate the expected influences of the
accession. In the third part, two types of reforms, namely privatization and
removal of protective government policies, will be examined in detail, followed
by illustration of empirical examples. The third part will also evaluate the
effect of privatization as a dominant approach in SOE reform.
2. China’s SOE
Development and the WTO Accession
Prior to the
1978 economic reform, China had adopted a central-planning economy in which
political propaganda and ranking promotion rather than material rewards were
designed to motivate workers. Moreover, the productions in SOEs were all
decided centrally with costs covered and profits submitted. Since 1978, a
series of market-oriented policies were put forward gradually aimed at
injecting incentives for enhancing productivity and profitability of SOEs. In
spite of some microeconomic managerial adjustments and limited autonomy
introduced, SOEs still lacked essential attributes as a market entity and were
inefficient. Later on, privatization took place in small to medium-sized SOEs.
However, while significant transformation was experienced in the small SOE
sector, the effect on mid to large SOEs remained negligible. Overall, the
number of SOEs, along with their contribution to the total output and
employment, has declined drastically throughout the reform process.
Inconsistent with this phenomenon was the substantial proportion of domestic
investment and savings shared by the SOEs. Moreover, government subsidies were
always available to compensate for the losses incurred by the SOE sector, which
further weakened the incentive for an efficiency growth. Also, due to an
absence of personal stake by managers for inappropriate use of assets, an
increase in management autonomy had exacerbated the problem of
on-job-consumption and embezzlement. Meanwhile, the SOE not only had been
granted an abnormally low price for rent and loans, but also enjoyed monopoly
power in a number of markets which were blocked to the private sector. Worse
still, all these favorable conditions did not prevent SOEs from running
loss-making and generating huge non-performing loans. Therefore, it is argued
that the highly inefficient SOEs were actually adding to the burden of China’s
economy and should be reformed fundamentally [1] .
China’s
accession to WTO was somewhat viewed as a real momentum to the SOE reform
process. According to the Agreement on Subsidies and Countervailing Measures
(SCM) [2] , China was required to terminate preferential government subsidies
and bank supports to the SOE. Furthermore, some previously inaccessible
markets, including the banking industry, had to be opened up to foreign
companies. Therefore, domestic banks would become more profit-based and try to
prevent non-performing loans by the SOE. Given the impending competition and
legislative pressure, the accession to WTO was expected to be a channel both to
regulate government behavior and to accelerate SOE reforms [1] .
Based on Bajona
and Chu’s dynamic general equilibrium model, removals of minimum employment
restriction and subsidies to capital would have significant influence on GDP,
welfare and SOE output shares. Assuming a closed economy with fixed tariff to
isolate the effects of SOE reforms, this model tested the data from 1978 to
2001 to infer a foresight of the tendency under WTO regulations. As a result,
there tended to be strong negative correlation between the reduction of the
minimum employment level and the SOE market shares. That is, as the labor
restriction being released gradually, the SOE decreased in its contribution to
the total output. In terms of the subsidies’ effect, a reduction in subsidy
would weaken the role of the SOE in traded sector while a small reduction
tended to boost SOE shares in non-traded sector at first until the reduction
became sufficiently large. The effect is represented in Figure 1.
This might be
explained as the SOE were traditionally heavily subsidized and less productive
than the private sector, especially in the traded sector. Therefore, a
withdrawal of subsidy first drove a reallocation of resources from inefficient
SOEs in traded sector to SOEs in non-traded sector. Yet the factor of
efficiency and productivity tended to dominate in the long run so that the SOE
declined relative to the private sector with further subsidy reduction. Also,
there would be gains in both welfare and real GDP with the industry
deregulation. Hence, it is most likely to experience a downsizing SOE sector
after the WTO accession. In addition, numerous literatures also predicted an
efficiency growth induced by the WTO accession in existing SOEs [3] .
3. Reforms and
Related Arguments
3.1.
Privatization
Although the
process of privatization was first introduced in China at the beginning of
1990s, it was expected to
Figure 1. The
correlation between the reduction of the minimum employment level and the SOE
market shares.
be further
accelerated by the accession to the WTO [4] . In China, privatization was
implemented mainly through three approaches, namely management buy-outs (MBO),
share issue privatization (SIP), Joint Venture and reduction of state-owned
shares. This section will focus on the impacts of MBO and briefly summarize the
influences of other approaches.
To begin with,
MBO can be defined as a form of acquisition of a firm by its existing managers,
thus transfers the ownership of the firm from state-owned to private. As is
widely noticed, the agency problem in SOEs is prevailing. Aimed at alleviating
this problem, the MBO process combined the property ownership with the
operation rights to exploit the potential in efficiency improvement. Based on
organizational theories, motivation to managers is necessary in order to
activate their initiatives. However, many short-term motivations, such as
salary, bonus and welfare, only have a one-off effect and are considered
unsustainable and expensive. Moreover, when a company enters into a stable
phase with minor fluctuations in sales revenue, cash flow and stock price,
using stock shares or options as an incentive to managerial commitment seems to
have feeble effect. Also, due to a stable stock price, the value of the stock
as debenture investment declines. Thus, those stocks are more likely to be sold
by stock investors. It is under such a dilemma that MBO comes about as a
solution to stimulate managers’ involvement in reducing the cost because the
potentially resulted profits would far exceed their annual salaries [5] .
In terms of
China’s MBO course, the first case took place in the Stone Corporation in 1998.
Previously, this company had a private collective ownership. Nevertheless,
since 1990s, the vague property ownership had become a serious constraint to
future development and had led to 3 major splits among the top hierarchy in the
company. Furthermore, the absence of a clear ownership structure resulted in
numerous problems, including an unclear business direction, an over-heated
expansion, an inert organizational mechanism, a loss of human capital and a
high operation cost. Ultimately, the Stone Corporation initiated an Employee
Stock Ownership Plan (ESOP), ended up with more than 60% shares in the hand of
the 16 core executives. Also, through several issues of new shares, the
existing unclearly defined assets were gradually diluted and distributed among
share holders [6] .
Afterwards, in
2001, GD Midea announced that its 724.303 billion shares were transferred from
Shunde Midea Co., Ltd., a company mainly funded by the local government, to
Shunde Meituo Investment Co., Ltd., a company established collectively by the
Midea Group’ management and the labor union. Hence, the GD Midea Company had
accomplished the MBO process with the management being the largest shareholder
and possessing 22.19% of its total shares. Although most of the funds needed
for the acquisition were gathered via a mortgage on the company’s equity, the
restructuring was quite successful and possibly contributed to the later
exceptional performance of the company [7] .
Since then, the
MBO process was triggered in China. For example, China Comfort Travel (CCT),
Shenzhen Fangda Group, Yutong Bus and GD Macro all had undergone MBOs in a
typical way [5] . According to Gan et al, MBOs accounted for nearly half of the
total privatization programs in China and had achieved most prominent progress
in terms of business performance compared to other privatization approaches. However,
the outcomes of those MBOs still varied from case to case. For instance, the
Midea Company has implemented a number of internal reforms after its MBO
process, including changing the top management and optimizing the organization
structure. In 2002, the company divided its electrical household appliance
division into four individual units, enlarging its original six divisions to
nine. Moreover, the company has experienced a steady growth in its sales and
profitability with an evident direction of developing its primary business.
Whereas Shenzhen Fangda incurred a 0.58 Yuan loss per share in 2002 and a 0.031
Yuan loss per share in 2003 instead of an expected profit gain after its MBO
procedure. On the other hand, some companies encountered intractable difficulties
and interest conflicts in their attempts to implement the MBO. One unfortunate
example would be the Jianlibao Company, whose development was even hindered by
its miserable MBO experience [7] . Consequently, the conflict between its
manager and the local government was not resolved and the company was acquired
by the Uni-President Enterprises some time ago.
Meanwhile,
problems and disputes towards China’s MBO process were also prevailing.
Firstly, due to the relatively undeveloped financial market in China, the
financing channels for gathering the essential funds were narrow and highly
restricted. Obviously, while China tried to connect its economy to the
international market particularly through the WTO accession, its legislative
and financial sectors lagged behind to fit for the changing situation. Various
ways of typical international fund-raising, such as credit loans, supplier
credit finance and convertible subordinate note, were not available in China’s
financial market [8] . The imbalance between the demand and the supply of
capital induced managers to use bank loans as an alternative approach. Indeed,
this method involved substantial legal and financial risk. To illustrate,
according to the 43th provision of Law on Commercial Banks, commercial banks
were prohibited from investing in non-banking financial institutions or
enterprises. Also, based on Lending General Provisions, debtors were not
allowed to use the loans to engage in equity interest investment. Yet in
reality, managers, such as the ones of the Midea, sometimes used the equities
of the targeted company as collateral to get bank loans. Furthermore, while it
was the managers who were expected to assume the risk of the buyout, the risk
was often transferred to other shareholders and creditors as the average amount
of shares acquired by managers was only 25% in China [8] .
Secondly, the
price of the shares acquired by managers were not set by the market mechanism,
but rather decided internally through agreements. Hence, the price was usually
unfairly low, which was somewhat considered plundering of state-owned assets by
management. For example, in Shenzhen Fangda Group’s MBO, the equity transfer
price was 3.28 Yuan per share in the first buyout, 3.08 Yuan per share in the
second one, both lower than the net asset value per share of 3.45 Yuan. And
Mingxiong Jian, chairman of the board, had experienced a dramatic expansion in
terms of his private property up to 1.6 billion RMB via these MBOs [7] .
Moreover, this factor was also strongly cited by Lang Xianping to argue against
the extensive implementation of MBO. Instead, Lang claimed that SOEs could
achieve efficiency if employ market managers while MBO might indeed contribute
to considerable hidden social cost [9] . Worse still, the prevalence of MBOs
might result in a prospect among managers of the remaining firms that they were
also going to take over the company through MBO. Consequently, managers might
behave in their own interests to deliberately lower the value of their
companies through certain maneuver. The cheaper the enterprise, the more likely
the managers could afford it. Undoubtedly, the interests of small other
shareholders were seriously prejudiced under such a circumstance [10] .
In addition,
partially due to an undeveloped information disclosure system, transparency of
the buyout process was quite low. Specifically, since sources of required funds
were usually kept from outsiders, along with related party transactions and
internal transactions, supervision over state-owned assets became rather
difficult and infeasible. More importantly, to earn a short-term profit, some
managers even sold their shares at the market price after MBO at the expense of
a loss of state-owned assets [5] . Besides, excessive government interventions
sometimes distorted the function of market in guiding companies to adopt MBO.
As a result, some enterprises faced enormous difficulties in obtaining funds
whereas others did not. This impeded the healthy development of a fair
financing market [8] .
On the other
hand, it was argued that cross regional privatization in China had been
completed with varied degrees. Privatization was accomplished more thoroughly
and control rights had been transferred from government to enterprises more
completely in cities than in rural areas [5] .Figure 2 provides an overview of
the distribution of privatization.
Figure 2. An
overview of the distribution of privatization.
This finding was
probably associated with the fact that the influence of the WTO accession was
more profound in cities than in countries as the former was exposed to the open
economy earlier and on a broader scale. However, studies by Chan and Unger
suggested that privatization in fact had only mild influence on the internal
governance, labor relations and employee benefits in small scale SOEs [11] .
Many of them had largely retained attributes of a state enterprise after being
privatized. Based on a long-term survey on a local distillery, except for a
reduction in the size of employment and a change in wage system, the firm
inherited the majority aspects from the previous practices. Detailed speaking,
the distillery continued to adopt an organization-oriented model by promoting
relatively egalitarian payment with minimized gaps among members. Gifts,
subsidies and other benefits to employees and retirees were still provided.
Besides, the staff and workers representative congress continued to exist and
the manager intended to maintain an “enterprise family” culture within the
firm. This finding can be explained that managers had successfully taken some
strategies to get through the transition period and accommodate employees to a
new environment. In spite of the positive cases, privatization had contributed
to a capitalism model that managers tended to exploit the benefits of employees
and behaved towards self-enrich- ment [12] .
3.2. Evaluation
of the Privatization Result
Generally,
privatization of the SOEs is viewed as a crucial part in the economic
transition from a central-plan- ning economy to a market economy. Compared with
Central-Eastern economies and Russia, the privatization process in China had
been delayed too long due to a reluctant government inclination [13] . It
started almost 20 years after the beginning of China’s economic reform. Thus,
it might be interpreted as an outcome under the pressure of the WTO accession.
In terms of the post-privatization performance, the survey conducted by Gan et
al. on a nationwide scale of 3065 firms with above 5 million RMB sales has
presented a relative comprehensive picture. The findings have revealed strong
evidence that private ownership was concentrated and corporate governance was
improved after privatization. Also, less involvement by government in firms’
operations and decision-making was observed. Furthermore, firms’ budget
constraints have become much more tightened. Also, the findings suggest non-SIP
approaches, especially MBO, as most effective in introducing efficiency gains
as well as transparency measures to firms’ business practices.
Based on this
research, there was a prominent enhancement regarding firm performance.
Specifically, the profits over assets ratio and the profits over number of
employees ratio had increased by 10% and 5% respectively when comparing the pre
and post stages of privatization. Nevertheless, whereas privatization was
examined to have positive effect on performance, 2 primary factors could
probably exaggerate the magnitude of the real impact of privatization. One is
that governments were more likely to privatize firms with greater potential in
profit-making. The other is that managers might deliberately drive down the
stock price by manipulation prior to the privatization. Thus, the seemingly
profit growth afterwards could be a simply returning-to-normal effect.
Furthermore, Tong reported that it was the reinforcing competition, the
increasingly concentrated FDI and the hardening SOEs’ budget constraints that
play an instrumental role in leading to the emergence of privatization [14] .
All these factors were considered results of the WTO accession. When viewing
from a worldwide perspective, privatization was a core tool accepted by more
than 100 countries for economic transformation from state to market. Also,
numerous studies had tested its influence over companies’ performance employing
different methodologies. And almost all of them had recognized superior
performances in privatized firms relative to un-privatized ones [15] .
3.3. Elimination
of Protection Policies
As mentioned
above, the WTO accession would induce a reduction in both direct and capital
subsidies as well as a soft budget constraint to SOEs, which created an
opportunity for SOEs to become more efficient. In the early stage of the
accession, Chinese government had place a priority on removing excessive SOE
subsidies to standardize the market [16] . Yet in reality, government subsidies
were still available to a number of large SOEs and large listed companies at
present. Many of those listed companies were transformed from SOEs. Besides,
they were still allowed to enjoy preferential land rental as well as cheap
loans. Unfortunately, business performances of those companies were usually
inferior. Some of them even use subsidies to camouflage huge losses and to
avoid being an ST company. For example, the China Eastern Airlines made a huge
loss in 2008 mainly due to some speculative actions in hedging oil. Yet relied
on government subsidies, the company managed to turn this loss into profit in
2009 with insignificant growth regarding business revenues [3] . Despite these
loss-making companies, many profitable businesses also seek every opportunity
to get a government subsidy. For instance, China National Petroleum Corporation
(CNPC) and China Petroleum Chemical Corporation (CPCC), two of the most
profitable Chinese SOEs, applied for subsidies to compensate for the loss
incurred in oil refining sectors this year. Indeed, CNPC and CPCC had made
impressive profits of over 160 billion RMB during the first three quarters.
However, both companies had received substantial subsidies in the past several
years [17] . In 2005, it was estimated that SOEs’ total outputs only accounted
for around 1/2 of those of private sector while their total profits well
surpassed those of private companies. In contrast with the rapidly declining
total number of SOEs over the past decade, their total assets have experienced
a sharp increase during the same period of time.
Furthermore,
SOEs still gain a monopoly power in a number of key sectors currently, such as
telecommunication industry, coal mining industry and oil industry. Although
both the old 36-article stipulation and the new 36 had encouraged private
entries to various previously inaccessible markets, their broad guidelines
resulted in a feasibility problem and the practical enforcement was poor.
4. Conclusion
To sum up,
China’s WTO accession did bring a noticeable impact on the SOE sector. Given
the numerous strict WTO provisions, a series of reforms on China’s SOEs and
essential changes in relevant legislations and government policies were
impending. As a consequence, privatization of SOEs as a major reform approach
was implemented on a national scale. Among the various methods of
privatization, MBO was considered most popular and had most desirable results.
Moreover, the privatization process in China has led to a significant
development of the private enterprises as well as a reduction in the number of
SOEs. However, problems with both the MBO and the privatization process as a
whole were also evident. When referring to the legislative and policy-related
aspect, the existing law deficiencies and residual subsidies somewhat hindered
the reform of SOEs. Therefore, to achieve further development, a more improved
legislative system has to be established and a fair environment of competition
should be ensured. In addition, it was concerned that whether all these
transformations were actually the result induced by the WTO accession, or would
also have taken place even without the accession. Yet overall, the role of
China’s WTO accession was undeniably important in stimulating the SOE reform.
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Publication Details:
ISSN Print: 2329-3284 , ISSN Online: 2329-3292
Vol.03 No.02(2015), Article ID:55786
DOI: 10.4236/ojbm.2015.32019
This work is licensed under the Creative Commons Attribution International License (CC BY) by the Original Publisher.
