The 70th anniversary of the People’s Republic of China (PRC) provides an opportune moment to reflect the policy choices China has made vis-a-vis the reform of its State-Owned Enterprises (SOEs). As SOEs remain the cornerstone of economic reform in China, the efficient working of these enterprises largely determine where the Chinese economy is heading.
The story of China’s State-Owned enterprises (SOEs) can be divided into two broad periods spanning the seventy years of China’s Communist Party Rule. The first period covering three decades mainly witnessed the establishment of SOEs through the “Three Great Socialist Reforms”, Elimination of Private Property Rights” and the subsequent “National Industrialisation”.In the pre-liberalisation years, these SOEs existed in the forms of the branches or affiliates of governmental departments under highly centralised and planned management. It was only after 1978 that economic experiments began to be gradually carried out in the SOEs.
A majority of these initiatives were directed to expand SOEs autonomy. The first of such initiatives that began in 1978 in Sichuan Province was a success, following which it was adopted across the country.One of the major achievements of this initiative was that enterprises were allowed to retain a few profits after fulfilling the state targets. The profit retention system as popularly known however underwent some reformulations, faced with a financial crisis and the Economic Responsibility System (ERS) was subsequently adopted in 1981. 
While the profit-retention remained at the core of this system, it also created a direct relationship between employee income and SOE performance. But this failed to improve the efficiency of the SOEs. There were no fixed profit quotas and retention rates were subject to negotiations between enterprises and supervisory authorities. Owing to this distorted price system, the profitable firms failed to reap the benefits of extra-profits. They became victims of higher quota targets imposed by the government, whereas the losses faced by the weak enterprises were covered by the government. 
As a result, profitable SOEs slowed their production, resulting in major state revenue drops between 1981 and 1983. To further enlarge the autonomy of the SOEs, the dual-track price system was introduced that granted new rights to SOEs and enabled many SOEs first in light industry and then increasingly across all sectors of China’s industrial economy, to sell a portion of their output at market prices, after meeting the state targets. Although this system yielded some favourable results, such as an increase in SOE profits, yet it suffered due to the lack of a proper price reform in China during that period. Hence the government tightened monetary control and the dual track price system was replaced by the contract responsibility system in 1986. 
The 15th Party Congress in 1997, however, proved to be the major turning point for SOE reform when the policy of “Grasp the large and let go the small” (zhua da fang xiao) was announced. By grasping, the central committee meant that large SOEs were to be merged into industrial conglomerates and the control over these conglomerates would be with the central or local governments. For example, in China’s steel sector, large industrial groups like the BaoSteel Group, the WuSteel Group, and the AnSteel Group came under the central government whereas the Hebei Steel Group and the Shandong Steel Groupwere placed under the provincial governments.“Letting go small” indicated that small SOEs would be privatised or closed. By the end of 1998, more than 80percent of state and collective firms at the provincial level or below had undergone restructuring.
Whilst the policy was relatively successful in terms of reforming SOEs, a number of problems remained unresolved. First, the policy of “grasping the big and letting go the small” was carried out hastily without proper planning. Second, the implementation of “grasping the big” was taken too seriously by all levels of the Chinese government, who tried to use political and administrative means to merge enterprises in order to create giant monopolies. All they were concerned was with the word “big”, regardless of any other economic and social considerations. On the other hand, both “letting go of the small” as well as “grasp the big” created “reform with losers”. They resulted in dramatic layoffs and decline in the size of the SOE workforce. Between 1995 and 2001, the number of jobs in the urban state sector fell by 36 million, from 59 percent to 32 percent of total urban employment.
After failed attempts to streamline various ministries dealing with reorganisation of SOEs, the Chinese government created State-Owned Assets Supervision and Administration Commission (SASAC) as the key supervisory body in 2003. Signalling the fourth stage in the SOE reform process, SASAC, therefore,marked a shift from fragmented to concentrated regulatory power. The primary responsibilities of SASAC were to consolidate state assets management of SOEs, except the assets of the financial enterprises and the state banking sector.
Although SASAC is empowered to appoint SOE officials at the central and local government levels, however, in reality, it is the Chinese party-state which makes the key appointments to retain its supreme control over strategic SOEs. For example, the top manager and chairman of the Board in a central SOE are appointed by the Communist Central Committee Organisation Bureau.Also SASAC’s efforts to corporatize SOEs by providing various incentive mechanisms are often jeopardised by the excessive state protection that reduces competitiveness and efficiency of the SOEs.
Let us take the example of the banking sector. China’s banking system remains an indispensable part of the SOEs reform. It is the bank loans and the interest rates that redefine the relationship between the Chinese state and the SOEs. The State Owned Banks (SOBs) not only form a key pillar of Chinese state capitalism, but itself acts as a conglomeration of enterprises that are highly regulated. They are often used to serve the party objective of steering money into its favourable projects and in the process cultivate political support and legitimacy for the Chinese state.Empirical evidence from the large SOBs suggests that the regulatory structure and lending decisions, hardly motivated by profits, hamper their efficiency and effectiveness.Although there is no clear picture of the real amount of China’s non-performing loans (NPLs), it has, however, become one of the bottlenecks for China’s further reforms in the banking sector.
Rising debts in China (Source: worldfinance.com, 2017)
The 18th Party Congress at the end of 2012 marks the beginning of a new and fifth phase of SOE reform in China. The Third Plenary Session of the 18th Central Committee adopted a comprehensive reform program that has a section dedicated to SOE reform.The momentum continued through the 19th National Congress when President Xi pledged to make SOEs “stronger, better, and bigger”. But the nature of reforms has now increasingly come under question.
Attempts at re-centralisation of the SOEs are stronger than ever before, turning them increasingly into extensions of the Chinese state. For example, appointments to key positions in the SOEs through nomenklatura system (gan bu ren ming zhi du) and cross-appointments are on the rise, which has enabled the Xi government to maintain tight control on the enterprise management system. This has rendered the corporatisation process as well as the process of separation of the enterprises from the government incomplete. One of the major issues in the ongoing US-China trade dispute has been the Chinese government’s policies towards the SOEs which not only discriminates against the domestic private and foreign companies but also breaches the spirit of the World Trade Organisation (WTO).
Currently, mixed ownership is the buzzword in China’s SOE reform sector. Unlike the process of ownership re-structuring of the early 1990s that allowed only flow of private capital into the SOEs, the current reform involves both private companies to hold stakes into the SOEs as well as the investments by the SOEs into the private firms.What is worrisome is the SOE investment into the private sector which paves the way for state intervention into the functioning and financing of the private firms (guojin mintui). 
The 70th anniversary of the PRC thus offers a moment to reflect on the policy choices China has made vis-à-vis its SOEs reform. The timing is significant given the period of consternation that China’s economy is currently facing. Evidence suggests that China’s SOEs reform have essentially followed a path which is characterised by varying degrees of decentralisation and centralized control. As the US-China trade war escalates and the returns on the larger SOE assets marks a rapid decline, it therefore remains to be seen the extent to which President Xi will encourage the development of private sector, cut down subsidies to the SOEs and allow market driven policies to guide the management of the state enterprises. It is time that the Chinese government stops acting as the owner and the keeper of the state firms.
* Dr. Priyanka Pandit, Research Fellow, Indian Council of World Affairs.
Disclaimer: The views expressed are that of the Researcher and not of the Council.
Nomenklatura system involves two essential elements: a hierarchical list of leadership positions to be filled by the Communist Party and a list of persons (party cadres) suitable for these positions.
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