China’s privatisation efforts deserve more credit than they get. But they still don't solve the problem
The event would be big in any country. But in Japan, a land of corporate conservatism and secrecy, it will make history.
On November 4, the country will privatise Japan Post, the state-owned mail service, in what will be its largest IPO in more than 30 years. The company, which employs 200,000 staff and controls both Japan’s largest bank and insurer, hopes to raise $11.5 billion. The listing has been more than a decade in the making.
Across the pond, in China, privatisation efforts remain a far cry from eliciting such superlatives. Long-awaited guidelines on how the world’s second-largest economy plans to shake up its state-owned enterprises (SOEs), released this weekend, failed to meet the excitement they generated when first announced in August. After posting strong gains last month, stocks in listed SOEs tumbled back down today.
Investors are disappointed on several fronts. Most likely, they find the announced pace of reforms a little leisurely: after a phase during which SOEs will be classified as either playing a commercial or social function – so as to determine whether they’ll be eligible for privatization – the government says it will “actively introduce different investors” in some of them through what it describes as a “gradual process”. It will give the green lights to each firm “only when conditions are mature”, and doesn’t expect to have completed the main bits of the reform before 2020.
Another weakness of the plan is its vagueness: the State Council, China’s cabinet, did not elaborate on how it would seek to “clean up” and “integrate” state firms, what avenues would be prioritised to pursue “mixed ownership” – a euphemism for privatization – and how the “decisive results” it expects by the end of the period would be measured.
But the biggest downfall of the proposed reforms is their overly limited scope and scale. Some sectors deemed of strategic importance, from finance to energy, are shielded from them. And wholesale privatisations have all but been ruled out by the State Council, meaning new shareholders won’t be in a position to control privatised businesses.
Investors are right to be grumpy. China’s SOE sector is bloated and inefficient, and badly needs reform. State-owned businesses produce two-fifths of the country’s GDP and employ nearly a tenth of its workforce, but they don’t do it in a very productive fashion: the average return on assets for SOEs was at about 4.6 percent in 2014, according to Beijing-based consultancy Gavekal Dragonomics, compared with 9.1 percent for private companies.
State-owned businesses also crowd out their private rivals by absorbing a disproportionate amount of resources – most notably credit, which they receive in abundance at cheap prices thanks to their proximity to lenders also owned by Beijing. And they are responsible for some of China’s worst economic misconduct, including bad investment decisions to excessive leverage. The SOE’s average debt-to-equity ratio rose from 1.3 in 2005 to 1.6 in 2014, while the figure for private firms, also at 1.3 in 2005, dropped to 0.8 last year.
The government thinks a bit of private ownership will help make SOEs more efficient. Its preferred path seems to be a transfer of their assets to listed subsidiaries. Such moves would follow the example of CITIC, a state-owned industrial conglomerate that funnelled $37 billion of its unlisted holdings towards its Hong Kong public vehicle last year. The parent companies themselves could also be listed – though the free float in each case is unlikely to go beyond 20 percent.
It’s not clear whether investors will be keen to pay relatively high prices for stakes in firms that remain under government control, especially in a context where Chinese equities are continuing their slide. But it’s worth noting that the country has had several attempts at privatisation before, with some successes in pursuing its eventual goals: SOEs today represent far less than the 75 percent of output they accounted for in the 70s. Earlier sales of local government-owned companies has allowed for some of the failing ones to be restructured or shut, while helping local authorities shave off a sliver of their debt burden.
A recent paper by Chang-Tai Hsieh and Zheng Song even argues that the reform of surviving SOEs accounted for a greater growth boost between 1998 and 2007 (over 13 per cent) than the release of labour and other resources into the more productive private sector (3.2 percent).
The issue is that China’s ruling party maintains a tight grip on the centrally owned, largest SOEs, which despite being largely outnumbered by locally owned ones control 53 percent of overall SOE assets. And clearly the government has no intention to let them go. “The SOE system should make for higher economic vitality, higher control, greater influence and SOEs will be more risk-resistant,” China’s official news agency said yesterday.
That underlines a persisting tension at the heart of Beijing’s broader liberalisation drive: the desire to let market forces play a role while keeping the economy on a leach. It also suggests its leaders haven’t got to the root cause of SOEs’ underperformance: their inability to fail. Removing this safety net would provide their managers with an incentive to do well. It would also free up labour and capital for more productive uses when such firms should indeed die.
But for this to work SOEs need credible competition – which is why measures to modernise them, privatisations or else, must go hand-in-hand with broader efforts to create a level-playing field. Such a wish list would include speeding up financial liberalisation so that credit flows to the most dynamic firms; strengthening the rule of law to put state-owned and private companies on an equal footing; and opening up strategic sectors to competition.
China will never contemplate a big-bang approach to privatisation. It saw what happened in Russia in the 90s, when the disorderly sale of state assets enriched a limited number of pockets and ushered an era of economic chaos. But Beijing must send clearer signals that it is ready to put its stamp of approval on bolder reforms. That would make history, too.