Will China’s new leaders walk the talk on economic reforms?

china-private

As China braces for a new wave of economic reforms, the debate has centered on whether the new leadership will walk the talk and deliver on its promise of reducing the state’s role in the Chinese economy. This will inevitably involve a fine balance between the plan for privatization and reform of the state-owned enterprises which currently dominate the Chinese economy.

Privatisation vs Reform of SOEs

A conventional state-owned enterprise (SOE) in pre-reform China resembled a “mini-society” through which the production unit followed the plan, but had to attend to all the non-production related matters. The “iron rice bowl” means that once a worker was assigned to a SOE, employment would be life-time and the SOE would look after the daily needs of the worker. The economy would not have any unemployment, and because all the welfare needs of the workers were provided, the wage was basically a net payment for the purpose of daily transactions. Many would have thought that wage in China was low.

Following the Soviet Union style since the 1950s, the structure of SOEs was largely geared towards heavy industries. There were huge mismatches of supply and demand for household consumer items at the time of economic reform in 1978. In the mid-1980s, the then Premier Zhao Ziyang attempted to carry out industrial reform by encouraging production of consumer products and suggested a delineation between management and party influence in order to speed up marketisation and industrial restructuring. There were severe industrial bottlenecks for consumer goods, and imports were reflected in parallel trade via Hong Kong in various household electrical appliances. The demand for traditional output from SOEs was low and many SOEs had cumulated the so-called “triangular debt” as debts were interlinked among a number of SOEs. State banks had been generous to loans given to SOEs.

For much of the 1980s and early 1990s, output from SOEs did not play a major role in economic reform, and excess demand for consumer products was conducted through imports and parallel trade. The Renminbi was overvalued then, while much of external trade was conducted using the “foreign exchange certificates”, which effectively was the external currency. Foreign investments from Hong Kong and other overseas Chinese were geared to production of light manufacturing products for exports. Privatisation of SOEs, or corporatisation as the preferred term, was slow, as much of export was produced by foreign direct investment.

Industrial output was conducted on a dual basis with foreign direct investment serving the export market, while output from local SOEs remained unpopular and served only the state sector. Despite the reconfirmation of economic reform after the late Deng Xiaoping visited southern China in early 1992, the turning point came in 1994 when the then Premier Zhu Rongji declared an austerity plan that involved a devaluation of the Renminbi by 30% and eliminated the “foreign exchange certificates”, restricted bank loans, encouraged investment to go “west” to the interior provinces, and a number of banking steps were introduced, leading to the bank reform in 1995.

Reforming the SOEs

The reform of SOEs was formally introduced in 1997 that included the principle of “keep the large, release the small.” Around 1,000 or so enterprises in strategic industries were kept as SOEs, all other SOEs would have to be dismantled, either through joint ventures with Hong Kong companies, sold entirely or partially to foreign enterprises, formed share-holding corporations by the workers themselves, bought up by provincial or local governments, or they were closed down entirely. The government injected a “one-time” massive amount to rescue the SOEs’ debts. There were various consequences that flowed from this step. Many government officials or key managers of the SOEs profited through under-reporting the actual value of the SOEs when purchased from the state but sold handsomely to a new owner. The reform created large unemployment at least in the short term, as numerous workers were laid off. Over the years, many of these SOE workers began their businesses using their own skill or acquiring capital elsewhere, resulting in a growing number of small-and medium-sized enterprises (SMEs) since 1997. With the smashing of the “iron rice bowl”, many workers had lost their welfare support, and the state did not increase their social infrastructure in the form of medical supply, elderly care and child education. The overall level of social welfare is inadequate.

Rise of state-controlled enterprises

Today, the number of SOEs has declined, but instead, the number of state-controlled enterprises (SCEs) has formed the bulk of industrial enterprises in China. These SCEs are mainly large corporations, using state or provincial capital, have a strong link to the party, influenced or managed by the princeling, and may even get listed in the stock market with the ability to raise large funds from Hong Kong and other overseas financial markets.

Business Ethics

Entrepreneurship is strong in China, though it has often been misled by the profit motive. The lack of business or commercial ethics has dented the development of industrial growth in China. Beginning from the violation of copyrights and the production of fake products, poor ethics has spread to bad businesses. Toxic milk and baby formulae, fake soya source and eggs and numerous cases of industrial misconduct have continuously been found, and yet there is no sign of improvement. Parallel trade, in baby formulae, for example, has expanded as domestic consumers showed no confidence in local production.

Privatisation has not been developed in a truly market manner in China as the decline of SOEs is replaced by the growth in SCEs, and the profit motive has overshadowed the need to have strong business ethics. Although there may be laws, rules and guidelines on industrial production, the execution by appropriate authorities is definitely lacking, resulting in a low consumer confidence in domestic production. This is worrying as the call to increase domestic consumption would have ended up in an increase in imports, while domestic output in the end remains as an inferior product. There is no easy, short-term answer, but improvements have to begin with a reliable and qualitative market system where openness, fairness and transparency in commercial conduct are upheld.

Hardware versus software

In China, it is not the availability of “hardware” that counts, but the importance of the “software” is missing. Marketisation and privatisation should next be focused more on the business culture and ethics, than on profitability in order to promote a healthy business environment that could nurture sustainable economic and industrial development.

Rome was not built in a day. Indeed, one would not expect perfection in China’s economic reforms. China’s new leadership of Chairman Xi Jinping and Premier Li Keqiang should see the improvement in business conduct becoming a source of strength in the Chinese economy. Xi reiterated the importance of clean government and it is hoped that his anti-corruption drive would produce positive results. Being an economist, Li would have the knowledge and understanding of developing the China economy.

The Hong Kong model

The Hong Kong economy has been serving as a reference point or a “showcase” to economic development in post-reform China. Hong Kong has established an effective business system that should provide lessons to business development in China, including management issues, ethical standards, required law and order and institution development. In short, both the “hardware” and “software” can be considered from Hong Kong experiences.

(Dr. Kui-Wai Li is Associate Professor, Department of Economics and Finance, City University of Hong Kong. This article has been written exclusively for India Writes, www.indiawrites.org. It is part of the ‘China Connect’ initiative of India Writes and The Global Insights India (TGII), that seeks to provide insights into key developments impacting the world’s second largest economy.)