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Tuesday, July 29, 2014         

NEW YORK TIMES


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Huge state enterprises pose test in China's transition

By Keith Bradsher

New York Times

POSTED:



BEIJING » Wealthy Chinese carry up to three smartphones, one for each of the state-owned service providers, in the hope that at least one will have enough network capacity to provide reliable email service. Most Chinese factories have heavily polluting diesel generators to cope with blackouts of up to three days a week, because state-owned electricity companies have not added capacity fast enough to meet demand.

Meanwhile, Chinese investors have poured more than $1 trillion in the last several years into loosely regulated trusts to bypass ultralow deposit rates offered by state-owned banks. The banks cannot readily afford to pay more because they need fat margins to cover losses on loans to politically connected borrowers.

For all the talk in recent years about the extent to which China has embraced capitalism, huge sectors of the economy still have not fully done so: those dominated by the country's 145,000 state-owned enterprises.

With China's top officials in Beijing for the 18th Party Congress, which is intended to put a seal of approval on the country's next generation of leaders, one of the toughest issues on the agenda is how to overhaul this sprawling empire.

Many Chinese economists argue that the biggest conglomerates, especially banks and the leading oil and telecommunications companies, have grown so large that they swallow a large part of bank lending, crowd out more creative small companies and line the pockets of the politically well connected. The state sector ultimately threatens to choke the country's economic growth and even damage its political stability, they say.

Almost no one has much good to say about state-owned enterprises these days — not even the people who run them. Wang Yong, the director of the State-Owned Assets Supervision and Administration Commission, which manages the enterprises belonging to the central government, chastised them publicly in a report to China's legislature on Oct. 24.

"More efforts will be made to reform the power, telecommunications, oil and petrochemical industries," Wang said. "Market entry into these sectors will be expanded based on the development of these industries."

But whether those efforts will amount to more than window dressing depends on the willingness of the next Chinese leadership team to challenge the politically connected families that run many state-owned enterprises. And given the lavish opportunities these enterprises provide for insider corruption and self-dealing, that remains an open question.

On Thursday, at the opening of the party congress, the departing president, Hu Jintao, who has presided over an enormous increase in the wealth and influence of state-owned enterprises during his 10 years in power, seemed to suggest placing some limits on the sector and creating a more level playing field for private companies that try to compete against them.

But two political advisers to the incoming leadership, who have a deep knowledge of the factional rivalries in the Communist Party, expressed strong skepticism that most state-owned enterprises have much to fear.

The national, provincial and local governments are financially dependent on the profits of such enterprises and are reluctant to give them up, the advisers said. At the same time, the state enterprises provide political patronage for factions of the Communist Party and lower-level cadres, whose support is crucial to the government.

State-owned enterprises are also very important as providers of blue-collar jobs and as the operators of about 8,000 schools, hospitals and community centers for their current and former employees and their families.

Companies in which the state owns a majority represent 35 percent of all business activity in China, according to official figures. Yet they earned 43 percent of profits last year. Their hammerlock on a long list of strategic industries has allowed them to charge relatively high prices for their goods and services, even as they borrow at artificially low interest rates from state-owned banks.

To be sure, the pressure for change is building. Factional struggles before the party congress opened the way for a national debate over state-owned enterprises. A wide range of economists say further liberalization of the parts of the economy still dominated by the state is essential to long-term growth.

"Without fundamental reforms, the country's economic prospect will dim, with a diminished chance to leap into the ranks of developed economies," said Fred Hu, a former economist at the International Monetary Fund and Goldman Sachs who is the founder and chairman of Primavera Capital, a large private equity fund based in Beijing. "Only bold reforms could fully unleash the country's enormous potential and entrepreneurial energy and propel China into the first world."

Public support for economic reform makes it impossible for the incoming team simply to do nothing, said one of the two political advisers, both of whom insisted on anonymity because of the sensitivity of the issue in China. But the new team may limit its actions to the privatization of some state-owned manufacturers, like steel mills, which do not have monopolies and are plagued by problems like overcapacity, ferocious competition and heavy financial losses.

A few top executives in the auto industry have begun calling for a limit on further investments in that sector, which also faces severe overcapacity. The government has also been doing considerably more detailed audits of state-owned enterprises this year, seeking signs of fraud or corruption.

But the broader network of state-owned enterprises in the service sector, like telecommunications, banking, health care and electricity distribution, is likely to remain "virtually unchanged" for the next few years, the political adviser said.

"It's going to be very difficult to do," said Roderick MacFarquhar, a Harvard professor who is one of the best-known experts on contemporary China from outside the country. "They've kept a very low profile for so long, they don't know how to do anything else."

The new leadership has just as many ties to state-owned enterprises as the old. The brother of Li Keqiang, who is expected to become the prime minister, is one of four deputy directors of the State Tobacco Monopoly Administration. With 98 percent of the Chinese market for cigarettes, the state-owned tobacco administration generates taxes and profits that total 7 percent to 10 percent of the entire revenue of the central government, according to a report in late October from the Brookings Institution in Washington.

China has a growing anti-smoking movement, but it has little support from the government. The Brookings report said that a "change in mindset on the part of the leadership, especially the highly misleading and one-sided perception of tobacco as a ‘cash cow' and major contributor to the Chinese economy, is a prerequisite for policy change."

Officials at the tobacco administration declined to comment, and declined to make Li's brother, Li Keming, available for an interview.

For all the pessimism about far-reaching reform, there is still considerable discussion of ways that state-owned enterprises might be changed if the new leadership decides to tackle the thorny political issues involved.

One of the most influential proposals within the Chinese leadership in the past few months was from Chen Qingtai, the deputy director of the Chinese cabinet's Development Research Center. Chen's paper calls for the government to become essentially an investor in state-owned enterprises, instead of actively managing them and selecting the management teams for each enterprise.

While useful in the past in advancing big projects like the Three Gorges Dam, Chen suggested in his paper, the government should now move more aggressively to sell off its ownership in sectors like steel that face overcapacity, redeploying that capital to emerging industries. He called for the state to hire more professional financial administrators to manage this process.

Hu seemed to endorse this stance on Thursday, saying that "we should separate government administration from the management of enterprises, state assets, public institutions and social organizations."

But there is little sign of a consensus yet.

"I think there are definitely different schools of thought" inside the government, said a manager at a company looking closely at acquiring stakes in state-owned enterprises if they are privatized. "What they actually choose to do will also depend on the courage of the new leadership."






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