Going Private in China
By Henry Zhang
September 27, 2012
Over the last three decades, China’s embrace of capitalism has benefited its socialist society. The country’s foundation for capitalism has been based on private ownership, as it has been in other capitalist economies. For China, this privatization occurred in two stages: the first being the privatization of agriculture in rural areas as the government implemented a “household responsibility system” to align the economic interests of farmers directly with the output of their own plots of land. This largely helped resolve the issue of food shortage that plagued the country during the egalitarianism era.
The next stage—which has taken longer and been a bumpier process—has involved the privatization of China’s state-owned enterprises (SOEs) in urban areas. Despite having undergone some (ongoing) hurdles, China’s smaller firms have seen rapid growth as a result of both reform stages. To better understand these market-oriented reforms, one should note that the management styles of China’s SOEs differ vastly from the country’s smaller businesses, referred to as small and medium enterprises (SMEs), due mainly to their differing incentive structures.
Unlike private entrepreneurs who seek to maximize their economic interests, executives of SOEs (many of whom eventually become government officials) must typically adhere to government policies while pursuing profit at the same time. However, maximizing shareholder value sometimes conflicts with state goals. SOE managers rarely have share-based incentives and their firms have at times endured losses for the wider benefit of the nation.
SMEs also tend to be more capital-efficient than SOEs. For example, one cost-control measure implemented by an SME in the consumer goods industry involves having drivers of company cars report their vehicle odometer readings to guards stationed at the gate of their headquarters upon exiting and returning. The company also installed GPS devices in all its trucks to monitor usage. Executives reported that transportation costs showed an immediate and significant decline after these procedures were established. This is the type of stringent cost management not often exhibited by state-owned enterprises.
However, SOEs continue to benefit from preferential government treatment in many cases. For example, certain strategic industries are still protected and mostly unavailable to private enterprises. During the recent economic slowdown, many SMEs have experienced challenges including a squeeze on credit and have been forced to cut back on expansion plans. Meanwhile their SOE counterparts, in many cases, received generous state funding to combat the slowdown. Although SMEs account for about 60% of China's GDP, they receive only about one-fifth of total bank lending.
China’s smaller firms still continue to face challenges in this current climate but privatization and private sector participation continue to be important steps to improving overall productivity in China. When the economy normalizes, I expect that the highly motivated SMEs may once again prosper and help drive China's future growth.
(c) Matthews Asia