The Reform of State Owned Enterprises in China

Like in many major economies, State Owned Enterprises (SOEs) have been the major driver of the Chinese economy. The operation and management of these SEO has all along been in conformity with the socialist ideals adopted by far many Asian communities. However, major reforms in the management of SOEs witnessed at the end of the 1970s can be termed as the vanguard of economic changes in China. [1] Basically, these reforms took the form of decentralization and profit sharing in addressing the autonomy problem that characterized the Chinese SOEs.

The reform of these enterprises has been necessitated by the desire to increase their efficiency in service delivery, improve the economic development and alleviate regional disparity in the Chinese economy. [2] This was a very critical move given that it was aimed at challenging the great regional imbalance in terms of national resource distribution.

In interpretation, it can be argued that this move was timely as there was a great need to transform the SOEs so as to alter ways in which national resources are distributed in the country.

There have been several stages in the path of the SOEs reform process. The genesis of these reforms can be traced back in 1992 when the Chinese policy on reform agenda underwent a major change. This change was characterized by a distinct separation of asserts from management of these SOEs. As expected, these reforms were not very popular with a good number of stakeholders due to their radical nature.

This paper is therefore going to examine China’s government policy on reform, the risks associated with reforming SOEs, the successes that have been realized so far and provide some explanations on how the SOEs used to be the pillar of Mao’s command system and why it was imperative to change the system. To this end, it will be argued that while reforms in China’s SOEs has been long overdue it is evident that the indented reforms will lead to positive impacts to the economy where by efficiency and effectiveness will be part of the daily management of these enterprises.

To begin with, meaningful reforms in the economic policies of China needed to take shape during the Mao Zedong era as they were characterized by retrogressive policies of socialism that were adopted from the Russian communist ideology. The three important areas for the institutional reforms that were vital for the Chinese economy were the enterprise system, the financial system and the legal system. [3] Tellingly, these are key institutions in any economy and thus any meaningful transformations imparted in them can be perceived as vital particularly in the making of an economy more fluid and friendly to international investment activities.

To this end, it can be argued that by instituting these changes, the Chinese economy was targeting to streamline its investment climate so as to make it more vibrant. For instance, the phenomenal financial system reforms adopted by the country in the year 2001 that were orchestrated by the World Trade Organization can be interpreted as a move to align the country’s banking and insurance sector with conventional standards practiced by other international community players. Ideally, these policy reforms required that foreign companies be given equal national treatment in the China’s domestic banking industry, a measure that was not practiced by the Chinese government. [4] Precisely, the reforms have since brought about liberalization in the banking sector and helped to eliminate autonomy. Tellingly, this has been a real ingredient for rapid and positive change and development in the country’s economy.

In addition, Chinese government has up to date constituted several policies on the economic reforms that have been part of the strategy to reform SOEs. These policies have been in line with the avowed vision by the Chinese government to create a strong economic stronghold characterized by strict ownership of major economic sectors and/or institutions by the public as opposed to private ownership. As a matter of fact, a brief history indicates that the effort to build an efficient command economy began at the founding of Peoples Republic of China in 1949. [5] The policy at the time communized the existing institutions as the state owned all the industrial enterprises. However, what followed later can be termed as a great political and economic turmoil which was occasioned by the adopted economic and political policies that were interpreted by many as retrogressive. Tellingly, it is these chaos that set the ground for the institution of fresh policies that would bring about reformation (more freedom and vibrancy) in the China’s economic performance.

What followed was reformation in terms of ownership where by the government decentralized a large number of SOEs and gave the local government greater incentives to manage the activities of these enterprises. The government also allowed the introduction of private enterprises in sectors that were initially barred from private investments. Ultimately, this led to the onset of realization of financial stability through dualism that was experienced in market liberalization system [6] . Though major reforms took diverse paths, it can be argued that the liberalization of SOEs as well as the opening up of new investment opportunities to private investment was a core part of the Chinese government policy reformation process that was aimed at transforming the SOEs.

It should be noted that these reforms were carried out with great care so as to allow for a smooth transition. To this end, the Chinese government indentified sectors and institutions that were in dire need of reformation and those that did not require immediate reforms. For instance, in the year 2001, the government rolled out a five-year economic plan that was aimed at dismantling loss making SOEs and in the process making way for the private firms and foreign investors which in turn welcomed competition from the multinational corporations. [7] The government took this twist with the view of doubling its Gross Domestic Product (GDP) by the year 2010. Though it cannot be argued that this drastic action has fully paid fruits, it is clear that it has proved to be beneficial to the Chinese economy as there have been drastic improvements in the economic performance following this strategic shift in policy.

From a different standpoint, it is important to highlight that despite several efforts put in the reformation process, all has not been smooth. The reform process has always been hit by serious challenges some of which have threatened to derail the preliminary fruits reaped so far. For instance and based on the notion that the transformation of the SOEs into privately owned entities, it is very interesting to note that Non State Enterprises (NSEs) have always struggled to grow in the modern China as they get little help from the transitional institutions. In this respect, it is therefore important for the Chinese government to create a level the playing ground so that NSEs can also benefits equally from the economic environment [8] . It is also relevant that privatization of the SOEs should be encouraged and decentralization of institutions be made in order to bring about equitable distribution of resources across the country to have meaningful economic development.

In addition, it is critical to highlight the fact that SOEs have been the custodians of the social welfare centers that provided housing, health, education and other social amenities to the Chinese people. [9] From a different standpoint, they also employed great numbers of the Chinese people. To this end, it is therefore prudent that any reform policies be crafted in a way that address the pressing concerns of these social amenities in such away that the common citizen should not suffer from the change of policy negatively but the new NSEs should take up the mantle by equally providing the services to the people.

In view of these challenges it can be boldly argued that the process of instituting major reforms among the SOEs is a very risky endeavor that the Chinese government should approach with great care. As earlier mentioned, the main objective of reforming these SOEs was to break away with the traditional control and management style where the central government exercised a core role. To this end, privatization and decentralization were taken as the most practical options. Even so, it is arguable that these two management/ownership alternatives are not policy panacea towards the challenges that were experienced by the SOEs before the reforms were instituted. This is because has this paper explains below, a number of phenomenal risks are inevitable.

For instance, the continued control policies applied by the central government pose a great risk towards the full implementation of the privatization and decentralization moves. The central government continues to issue new policies which in most cases are not favorable to NSEs. For example, in the year 2006, the government of China closed doors to foreign investors from purchasing control shares of the enterprises that play vital roles in the manufacture of technological equipments. [10] No doubt, this policy posed a great risk to the reformation process since foreign investors became worried about the Chinese government commitment to provide a level ground for all players in the economic performance environment.

In addition and basing on the fact that the other intention of the reformation process was to reduce government control of the business entities where by decentralization was seen as the solution to the problem it can be asserted that the extent which this noble goal has been achieved is arguable. To this end, it can be argued that the government still maintains a significant control over NSEs. Needless to say, this was not the case as anticipated since one kingdom (central government) had been effectively transformed into many independent kingdoms (local governments) that directly control the enterprises. [11] In this respect, the anticipated reform did not completely take place as the government still controlled management of both foreign and local ventures through the local government control policies.

Moreover, there has been a major risk in sense that the reform process was concerned with the liberalization of the market where by foreign investors were welcomed to contribute to the economic advancement of China. This prompted a major risk in a way that foreign investment were to concentrate more on their foreign capital rather than concentrating to domestic needs of its consumers. In any capital market, investors are always concerned with the improvement of their revenues which at times compromise some vital needs of the population being served. This runs contrary to the socialism practices of the socialist community of which China is a subscriber.

On a different note, the fact that these SOEs were the main source of revenue to the Chinese government the Chinese government risked inflationary pressures that tend to become more serious during the transitions. [12] This therefore posed a risk to the government as the revenue generated from these enterprises were now ending up in the hands of private companies and the government was only left with tax revenues accrued from such ventures.

Furthermore, reformation process requires full cooperation of the political and economic fraternity. The two groups needed to work together in harmony in order to harness the necessary policies that are required for economic transformation. It was therefore a risk to reformation process as there was no guarantee that policy making institutions on one hand and the macro-economic institutions on the other were to work towards realization of the reforms (Huang 320) [13] . Political polarization was likely to occur at any given time which could hamper the reform process where by foreign investment could be heavily affected.

There was also a potential risk that diversification which was one of the component of the reform policy could lead to poor account performance. It is a common knowledge that diversifiers may have insufficient knowledge and experience in managing the activities of different enterprises which is a recipe for low efficiency. [14] This therefore posed a risk of continued mismanagement of these diversified enterprises which could have led to failure of attainment of the reform plans.

However, despite the risks associated with the reform process of the SOEs, there have been significant benefits accrued from the reform process adopted. Firstly, there has been massive improvement in performance of enterprises such that they are technically capable of competing in the market environment [15] . This is achievement since initially, these enterprises were operating in autonomy environment where competition was not part of their environment thus there was laxity in performance.

Secondly, the reform process has led to positive reforms in key institutes. For example, there has been widespread reform in social security, infrastructural development and in the political landscape. These reforms have been beneficial to the entire economic advancement of China as foreign investors have streamed in because of the major institutional changes. This has led to the rapid increase in Gross Domestic Product being witnessed in the current times.

Thirdly, it is important to note that China’s economy has been diversified over two decades thanks to the reform process of the SOEs. [16] NSEs presently accounts for more than three quarters of the output in the industry which has dominantly contributed to the growth of the economy. This has been a major step in the reformation process since initially, stakeholders’ feared mismanagement and later grumbling of the economy if the private sector were to fail. However, the reform has turned out to be a blessing for the economic performance of China.

Fourthly, following the reformation of the financial institutions that have been previously owned by the state, by the end of 2006, 118 banks and rural financial institutions had been recognized and the financial industry paved the way for foreign banks under liberalization policy. [17] This was healthy for commercial activities as the financial industry was less controlled by the state which led to constructive competition which is good for advancement.

Fifthly, it is important to note that the main purpose of initiating reforms of the SOEs was to bring about efficiency in absorbing capital and new technology. [18] It is therefore positive that the reform process led to increased productivity as there was massive application of technology in the production processes of these entities. This positive change has been a major benefit to the economic process of China.

Lastly, before reformation of SOEs, ownership of the property rights in China was not clearly demarcated. However, with the reform process in place, there was separation of the government from enterprises through a property rights centered reforms. [19] This was beneficial to the economic reform process as recognition of the property rights policy gave incentives to players in the industry to be more creative and innovative in economic related matters is a good recipes for development.

However, it is relevant to remember that the principle of state ownership of enterprise was bone during the Mao Zedong era which lasted for three decades in China. During this period, China suffered a great deal from Mao’s obsession with mass movements and class struggles which led to a mad rush towards socialists industrialization, according to Mao, it was aimed at catching up with, if not surpassing the Capitalists Britain’s and the United States through labor in communes and SOEs. [20] By making all enterprises in China to be state owned, they became pillars for Mao system of command. This made Mao to manipulate them for his own benefit in order to instill himself in power. SOEs therefore helped Mao to have grip of power for three decades during his reign. These enterprises therefore used to be pillars of Mao’s command in several ways which are discussed in great detail below.

SOEs were centrally controlled by the central government of Beijing. This meant that the wish of the central government was the law for these enterprises where by management teams of the entities had no autonomy to make binding decisions for these enterprises. The major concern of the Mao rule was to communalize every enterprise and as long as the SEOs were in conformity to the communist policies, matters of efficiency and effectiveness were not prioritized.

It is also clear that during the Mao reign, there were rampant vices such as nepotism and corrupt dealings taking places in the SOEs and as long as one was able to dance to the tune and policies of Mao, their positions were guaranteed. This was a major set back to integrity issues in management of these SOEs. Although these vices were threats to the positive performance of the Chinese economy, Mao used it as a way of command to instill himself to power.

In addition, Mao employed his close confidants to senior position of management of these SOEs whom could easily be used and manipulated for Mao’s own benefit. Issues of competency were therefore highly disregarded. This brought about adverse mismanagement issues in these enterprises which turned the SEOs as havens of losses. Mao imposed his close allies in these management positions in order to guarantee full support from all enterprises and to retain his grip of power in China.

From this kind of management of the SOEs during the Mao Zedong era, it is evident that China’s enterprises were being grossly mismanaged during the Mao regime and therefore it was necessary to bring revolution in their management by having massive reform process. The call for reformation of these enterprises emanates from their poor mismanagement styles where by they were characterized by inefficiency and ineffectiveness.

In addition, it was important to reform these enterprises as they were characterized by central autonomy from the central government. This made the market to be of statehood monopoly. This locked out other potential player in market since new ideas were not given chance to sprout. Reformation was therefore necessary to ensure liberalization of the market. Market liberalization brings about competition among players which is health for service delivery, effectiveness and efficiency.

In conclusion, it is important to recognize that reforming these enterprises have never been an easy task. However, it is imperative that reform process of the State owned enterprise is the only way of giving these ventures a new life after a long period that have been characterized by mismanagement, inefficiency and ineffectiveness. The central government has to be detached from the main institution of the economy by liberalizing the market for all players. This motivates entry of foreign investors in the economic issues of the country which is a big plus for its advancement.

However, it is relevant to recognize that management practices that are copied from the developed countries such as Britain and United States of America do not necessarily transform to management effectiveness in reforming other countries. To the China’s case, it was inspired with these capital powers in their reform process and at some point imitated some of their policies. Basically, what is required in the reform process is to understand your own operating environment and craft your own homegrown policies that will work effectively for your country. It is a common knowledge that what works for her will not necessarily work for you.

In addition, the reform process needs to focus on the long term strategic goals rather than short term. Although long term plans calls for patience, it is necessary that plans be instituted that will have positive impacts to the country’s economy in the long run. However, there might be set backs in the reform process, but it is worthy that some sacrifices be made for this worthy course as the reformation is designed to bring about revolution in the China’s economy and turn it to be one of the giant economies of the world.

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