3 What is special about SOEs? A comparison between the EU and China
Theoretically, the most convincing justification for the existence of SOEs is achieving social objectives and/or correcting market failures. As such, most SOEs do not need to pursue a profit maximisation objective, and are often strictly regulated and assessed by government.
In China, SOEs have a much wider scope as they originate from the planned economy era when they dominated all sectors (either SOEs or collectively-owned companies). Most Chinese SOEs, even now, are not established on the basis of correcting market failure, but more to carry out government objectives.
Chinese SOEs: bigger, more pervasive and more dominant than their EU counterparts
Although China started on its path of market reform and openness in the 1980s, it was only in the 1990s that reform started to have an impact on SOEs – a movement that happened under the slogan ‘Grasping the large, letting go of the small’. The aim of that wave of reform was to limit the influence of the government over small-scale SOEs by transforming them into private firms or merging them with large state-owned enterprises. As a result, the number of SOEs declined more rapidly than SOEs’ share of employees (Figure 3). In other words, SOEs became larger on average. Another important consequence was that a good part of the private firms existing in China today were SOEs until the late 1990s, meaning their current owners still have connections, directly or indirectly, with the Chinese government.
Figure 3: Chinese SOEs, shares of employees and profits
Source: Bruegel based on China Statistics Yearbook. Note: Data for number of SOEs is missing from 2003-05, so the plots are smoothed over the three year period.
Since the late-1990s reforms, the Chinese government has pursued a number of initiatives to reform SOEs, but the logic has switched away from privatisation to improving efficiency while maintaining the role of the state in the production of goods and services. The ultimate objective of the ongoing reform has shifted to creating corporate giants that can compete globally. Those giants remain state-controlled, especially in strategic sectors. Nearly 70 percent of the Chinese firms in the Forbes Global 2000 list of the world’s largest public companies are SOEs. However, in terms of the share of SOEs in the market value of its largest companies, China ranks third globally after Qatar and the United Arab Emirates (OECD, 2016).
State-owned enterprises in the EU are of a very different nature. They are generally smaller than Chinese SOEs. They are typically found in sectors affected by potential market failure and externalities, such as utilities. Figure 4 shows SOEs’ share of total employment in 21 EU countries. Together, the EU’s SOEs have an employment share below 10 percent, which is much lower than that of the SOEs in China in 2015.
Figure 4: Employment in SOEs, % of total employment
Source: Bruegel based on European Commission (2016), OECD, World Bank and Eurostat.
Though relatively large, Chinese SOEs tend to perform worse than their private peers. We calculated the assets and profit distribution of Chinese listed companies – SOEs and private firms. On average, SOEs own more assets than private firms but their profitability is lower (Figure 5). Our results are in line with those of Hsieh and Song (2015).
Figure 5: State-owned enterprises (SOEs) versus private-owned enterprises (POEs) in asset and profit performance
Source: Bruegel. Note: we calculated the probability distribution of the listed companies’ assets (left) and profits (right) for Chinese SOEs andPOEs separately. To make sure our results are not sensitive to extreme values, data is truncated with firms above and below 5 percentiles for both variables.
Another important characteristic of Chinese SOEs is their industry coverage. Chinese SOEs seem to be much more engaged in manufacturing than European SOEs. More than 30 percent of Chinese SOEs are in the manufacturing sector and 55 percent of SOE employees work for manufacturing firms. The equivalent EU figures are 2.8 percent and 4.8 percent (Table 3). This is not so surprising if we consider that the manufacturing sector is larger in China, but this is not the whole story. The figures also highlight the Chinese government’s industrial policy to develop what has long been a key strategic sector.
Table 3: Sectoral distribution of SOEs in China and the EU: number of firms and employment
|
Agriculture, forest, fishing
|
2.21%
|
0.70%
|
1.69%
|
2.48%
|
|
Manufacturing
|
31.32%
|
2.81%
|
55.48%
|
4.81%
|
|
Services
|
66.47%
|
96.49%
|
42.83%
|
92.71%
|
Source: Bruegel based on Source: (1) Chinese National Bureau of Statistics; (2) Author’s calculation based on BvD Amadeus/Orbis data set. Kalemli-Ozcan et al. (2015) presents a comprehensive introduction of the dataset.
To further highlight the extensive presence of SOEs in China, even among large firms, Table 4 shows the sectoral breakdown of the revenues of Chinese firms for state-owned, private-owned and foreign-owned firms. Chinese SOEs lead in many strategically important sectors beyond manufacturing, while foreign ownership is very limited even in sectors that are officially open to foreign competition.
Table 4: Sectorial sales distribution of SOEs, POEs and FOEs in China in 2008
|
Health
|
58.92%
|
41.06%
|
0.02%
|
|
Wholesale and Retail
|
2.20%
|
97.73%
|
0.08%
|
|
Construction
|
24.43%
|
75.26%
|
0.30%
|
|
Culture
|
54.71%
|
44.36%
|
0.94%
|
|
Education
|
34.06%
|
64.85%
|
1.09%
|
|
Finance
|
21.74%
|
76.78%
|
1.48%
|
|
Accommodation
|
25.96%
|
71.60%
|
2.44%
|
|
Real Estate
|
7.32%
|
90.11%
|
2.57%
|
|
Environment
|
43.65%
|
53.51%
|
2.83%
|
|
Research
|
33.94%
|
62.28%
|
3.78%
|
|
Lease and Business
|
26.94%
|
64.65%
|
8.41%
|
|
Restaurant
|
4.00%
|
86.96%
|
9.04%
|
|
Manufacturing
|
15.11%
|
75.26%
|
9.63%
|
Source: Bruegel based on China’s Economic Census Data. Note: FOE = foreign-owned enterprise
The special environment for Chinese SOEs
The fact that Chinese SOEs are generally larger and more pervasive than their global peers, but are also less profitable than private companies has its roots in the special corporate governance of SOEs. The appointment of SOEs’ managers is still political, at least to some extent. Before 1992, SOEs’ managers were government officials. After China’s deepening market economy reform, the method of selecting SOE leaders was changed to a combination of official recommendation and market recruitment. Nevertheless, given that most SOE executives still retain an administrative rank, prospects for promotion in SOEs are significantly influenced by political decisions. A second reason for the relatively lower profitability of Chinese SOEs is their compliance with non-economic administrative orders. This is very hard to quantify but can be illustrated by a number of examples. A well-known issue is the treatment of overcapacity in SOEs. Bankruptcy is not an option for fear of its social impact through increased unemployment. Therefore, many steel companies have had no choice but to turn into unprofitable ‘zombie enterprises’. Such non-economic orders can come from local, as well as central, government. A recent example is the Beijing government’s political objective to reduce the population density in Beijing. To do this, the Beijing government requires some SOEs in Beijing’s urban region to move to suburban areas, regardless of the potentially negative impacts on profits and employees.
However, it is also because of SOEs’ connections to the political hierarchy that they have access to benefits from the government, such as cheaper and easier access to financing than is available to private enterprises. Other sources of preferential treatment for SOEs seem to raise even greater levels of concern, according to an OECD survey (Table 5).
Table 5: Types of preferential treatment for SOE investments
|
Preferential financing
|
15%
|
62%
|
23%
|
|
Explicit/implicit guarantee
|
15%
|
31%
|
54%
|
|
Outright subsidies
|
38%
|
23%
|
39%
|
|
Regulatory exemptions
|
25%
|
33%
|
42%
|
|
Position in domestic marketplace
|
38%
|
39%
|
23%
|
|
Access to state information
|
46%
|
36%
|
18%
|
Source: OECD (2016).
Will global consumers benefit from Chinese SOEs? Not necessarily
One could make a case that Chinese SOEs might not foster competition but could still be good for global consumers because they drive prices down even in tradable sectors, such as manufacturing. More specifically, given the intrinsic advantages SOEs have, coupled with their relatively lower profitability and managerial efficiency, the key question is whether such undue advantages can enable SOEs to set lower-than-equilibrium prices, which could possibly undercut competitors. Even if Chinese SOEs are capable of setting prices lower than their marginal costs because of subsidies (ie conduct dumping policies), and could thus weaken the EU’s competitive environment, the final impact on welfare for the EU is ambiguous, because the consumer can benefit from lower prices and increased product variety. In that regard, market access seems to be the key factor for tilting the balance from a positive to a negative impact, according to Brander and Krugman (1983). In other words, market access helps maintain consumer welfare when dumping happens. The problem is that market access is indeed an issue in China, not only for foreign companies but even for private Chinese companies. This is why it is hard to argue that consumer welfare might be increased as a consequence of lower prices being set by Chinese SOEs.
Should the focus be on SOEs when looking at market dominance and its consequences?
Chinese private firms, including many in the manufacturing sector, were partially privatised in the late 1990s and early 2000s but still retain strong connections to the Chinese government. More specifically, five percent of Chinese private firms are under the direct control of Communist Party of China (CPC) members (Milhaupt and Zheng, 2015), and even non-party entrepreneurs are also likely to pursue political resources and sometimes recruit CPC members or those people with relationships with government, in order to improve their chances of accessing scarce resources. A striking example is that more than 150 Chinese billionaires belong to a group of lawmakers in the National People’s Congress, China’s top legislature, or to the Chinese People’s Political Consultative Conference, the leading political advisory board. More generally, Milhaupt and Zheng (2015) show striking similarities between SOEs and some special private companies, leading them to argue that “drawing a stark distinction between SOEs and privately owned firms (POEs) misperceives the reality of China’s institutional environment.” In the same vein, a number of surveys conducted by Chinese officials show that private firms directly owned by Party members and those related to political elites obtained significantly more bank loans than others. This result is also verified by Kung and Ma (2014), who find that China’s poor environment in terms of property rights has not affected private enterprises much because, in such an environment, many private business owners devote time and money to developing political connections with the government in exchange for looser regulation and easier access to finance, which is similar to the general environment for SOEs.
