Doing Business with China

Dr Lu Chunshan, Deputy Division Chief, Economic Restructuring Office of the State Council

Overview

The institutional transformation of the state- owned enterprises and structural readjustment has entered a critical period and the reform efforts need to take new steps

The reform of the state-owned enterprises (SOEs) is an extensive and profound change and revolution. Years of efforts to reform the SOEs have been manifested in the profound changes that have taken place in the SOEs' management system and operating mechanism. As a result, the aggregate strength of the state-owned economy has further improved, and the state-owned sector continues to play a leading role in the national economy and has remained a main source of the country's fiscal revenue. In 2001 the SOEs and state-equity-controlled industrial enterprises achieved, amidst fierce competition, a total profit of 230 billion renminbi, which basically paralleled the total of the previous year. Quite a number of SOEs have grown and developed in competition and their technological capabilities have been significantly improved.

Doubtless the achievements in SOE reform have, by nature, only fulfilled the phase one objectives of the continuing reform efforts. SOE reform still stays in the centre of the overall effort to reform the whole economic regime . Under the circumstances of economic globalization and accelerated technological progress, SOEs face increasingly stiff market competition and some of the built-in contradictions and problems have now been exposed. A considerable number of SOEs are still unable to adapt themselves to the requirements of the market economy, sharing common problems such as rigid operating mechanisms, weak capability in technological innovation, heavy debts and social obligations, redundant workers, difficulties in production and operation, declining profits and the subsistence difficulties of some workers. The large- and medium- sized SOEs have basically realized the goals of reform and the target of 'getting out of difficulties'. However, small- sized state-owned industrial enterprises and other state- owned non-industrial enterprises are still facing accumulating problems. In the distribution area, for example, state-owned enterprises in material supply, grain supply and foreign trade are confronted with heavy tasks of reform. Therefore, pushing forward the SOE reform still remains an urgent and arduous challenge, and the pace of reform will have to be quickened in order to achieve new breakthroughs.

Strategic readjustment in the pattern of the state-owned sector presence in the economy will be made in order to propel the strategic reorganization of the state-owned enterprises

Since the economic reform and opening up, positive changes have taken place in the layout of the state- owned sector in the economy as well as in the SOE organizational structure. There remain irrationalities, however, which mainly include the over-extended presence of the state-owned sector in the economy, serious duplications in construction projects and in rational resource allocation. The overall competence of SOEs is not streamlined and, typically, large or small enterprises are set up as completely independent operations, which have hindered the formation of specialized production, socialized coordination and cooperative system and economies of scale, leading to an overall lack of competitiveness of the state-owned sector. For a period of time, the market supply and demand balances in China have experienced historical changes and competitive industries have been made to face a buyers ' market. The state treasury is unable, and it is no longer necessary for the treasury , to support such an extensive presence of state-owned sectors in industries in such huge numbers . It is therefore imperative to accelerate strategic readjustment and reorganization so as to achieve a relatively rational distribution and structure of the state-owned sector in the national economy.

Strategic readjustment follows the principle of discretionary entry and exit mechanism and prioritizing 'what to do and what not to do', focusing on enhancing dominant control by the state-owned sector. SOEs will only be present in key sectors and critical industrial territories that are of vital importance to the national economy. Dominant positions will be maintained in industries such as those that involve national security, have natural monopolies, provide critical public products and services, and in the back-bone enterprises in pillar industries and hi-tech development. In other sectors and industrial territories , the state-owned sector will gradually withdraw or reduce its presence in order to allow more room for the private economy and foreign invested enterprises (FIEs) to develop.

At different stages of economic development, the proportion of the state-owned economy can vary in different industries and for different regions, but the pattern of presence should be adjusted accordingly . The importance of the state-owned economy does not necessarily depend on its numerical size and proportion. The dominant control of the state-owned economy will not be impeded as long as the pattern of presence can be optimized and quality enhanced. The current status is that there are still too many state-owned and state-equity-controlled enterprises and the development of strategic readjustment in different industries and regions is not balanced, with some industries and regions lagging far behind. Therefore, the tasks of strategic readjustment will still be arduous.

The state-owned sector will mainly take the form of dominant share-holding or equity participation in enterprises. The state-owned sector will be able to attract and organize more social capital to amplify the function of state-owned capital by way of the joint stock or shareholding mechanism, thus increasing its power of control, influence and leadership. Wholly state-owned enterprises can be transformed into shareholding enterprises by flotation on the stock market, joint venturing with foreign investors and mutual equity participation among enterprises. Such effort will help develop an economy of mixed ownership.

The path of advancing strategic readjustment is to 'keep hold of the large enterprises while freeing the small ones'. 'To keep hold of the large enterprises' is an effort to nurture and develop powerful and competitive enterprise giants and groups. The enterprise groups will be formed by way of capitalization and as a function of the market. They should be distinctive in their core businesses and competitive, and they will be the 'national team' in China's participation in international competition. 'To free the small enterprises' is to liberalize and rejuvenate the small- to medium-sized SOEs. Having regard to the practical conditions of the small- to medium-sized enterprises, asset rearrangement and structural readjustment can be carried out in various forms such as reorganization, alliance, merger, leasing, contract operation, joint-stock cooperatives and sell- off. Up until now, the reform has covered 81.4 per cent of the small- to medium-sized SOEs in the country.

For disadvantaged enterprises, the pace of their exit from the market will be accelerated. As a result of the structural problems inherited historically and from the rigid regime that has created enduring SOEs, there have accumulated a large number of enterprises that have neither the ability to survive nor the basic conditions for development. They should secede from the market. Enterprises with unmarketable products, long- term losses, little hope to turn around and exhausted resources should go bankrupt or be shut down. The same fate should be imposed on those small operations that are resource-wasting, technologically backward, inferior in quality and seriously polluting environmentally, such as small-scale coal mines, oil refineries, cement factories, glass factories and coal- fired power plants. In order to help such enterprises exit from the market, the central government took out a total of 208.6 billion renminbi for bad-debt write-offs between 1996 and 2000. In 2001, 50 billion renminbi were made available for that purpose. In 2002, the effort to write-off bad debt is focused on the shutdown, bankruptcy and orderly exit of SOEs in defence, nonferrous metal and coal mining industries.

Separation of government functions from enterprise management will be carried out at full swing, while efforts will be made to explore effective modes of managing state assets in seeking to construct a state asset core operating system

In recent years a great effort has been made to transform the government function. The Party organizations and government agencies at all levels have been successively 'unhooked', in terms of personnel relationships, financial links and material involvement, from the business entities they have established and the enterprises that have been under their direct management. Administrative affiliations of enterprises with the governments and the administrative rankings associated with enterprise management have been eliminated, all of which has greatly facilitated the severance of enterprise links from government. China's accession to the WTO will result in indiscriminate treatment of all enterprises and the government will no longer use its administrative power to intervene in the production and operation of SOEs. At the same time, SOEs will no longer receive special favours from the government. With the reform of the administrative examination and approval system as well as the reform of the investment and financing regime, the operating environment for SOEs will be more relaxed . The efforts aimed at breaking departmental and sectoral monopolies in areas such as civil aviation, power and telecommunications will catalyse the reform of the SOEs in those areas that were originally regarded as sectors of natural monopoly.

While the separation of government functions from enterprise management is being promoted, problems regarding the management of state assets have become increasingly prominent. The absence of an effective management system for the state assets will hinder the smooth execution of the SOE reform. In fact, the problems that have long troubled the SOE reform, such as ambiguity between government functions and enterprise responsibilities, absence of owners , insider control and pending legal-person status of the enterprise assets are all related to this vacuum . As a result, it is essential to establish a state asset management system. So far, a sequence of principles such as state ownership, management by different levels of authorities, authorized operation and supervision with designated division of responsibilities, have been established, aiming at the gradual establishment of a state asset management, supervision and operation system and mechanism. In addition, a complete and rigorous responsibility system has also been established, which will gradually evolve into an institutional framework and a management mechanism that will reinforce the supervision of SOEs. The State Council represents the State in exercising a uniform right of ownership over state assets, while the central and local governments administer the state assets. Large enterprises, enterprise groups and state- equity-controlled corporations will be the authorized operators of state assets. Designated localities are allowed to carry out experiments in their effort to explore concrete modes of state asset management.

The establishment of a modern enterprise system needs to be advanced faster

The mechanism of market competition that determines the success of the efficient enterprises and elimination of the inefficient is the most important driving force for enterprise development. If SOEs are to win under intense competition, they will have to accelerate their convergence with international rules and establish advanced operating and management mechanisms. In view of this requirement, it is imperative for the SOEs to push forward, in line with the principles of clarity of ownership, clear division of power and responsibilities, breakaway of enterprises from government links and scientific management practices, and the establishment of a more complete modern enterprise system with a reinforcing system of decision-making, execution and supervision. This is a natural course of action in the development of socialized mass production and the market economy. It is also the future direction of SOE reform.

At present, a majority of the large- and medium-sized backbone SOEs has undergone incorporation and has established by law shareholder committees , boards of directors, supervisory boards and management teams . Among those enterprises that are undergoing debt-for- equity swaps are some that have set up new corporate entities by law and in accordance with the requirements of a modern enterprise system. Generally speaking, most of the enterprises have built up a modern corporate system framework, but a number of enterprises remain whose practices in shareholding transformation and actual operations are not up to standard. Therefore, there is still quite a distance to go towards a perfect, modern enterprise system.

In pushing further the establishment of a modern enterprise system, the focus will be placed on advancing the reform in the direction of a standardized corporate system. Reform and improvements will be made towards regulating capital contributors, reinforcing corporate surveillance, establishing incentive and disciplinary mechanisms for the selection and appointment of enterprise managers and formulating standardized corporate governance. Problems such as the irrational equity structure of publicly listed companies, single share holder dominance and difficulties in reducing the state- held share will need to be solved with due attention.

Improvement of the enterprise system will have to be based on the transition of an enterprise's operation system, and to achieve such a transition, other reinforcing mechanisms such as survival of the fittest enterprises, the opening of manager positions to competition, unchecked staff mobility and performance-related pay schemes, will need to be gradually established. Those enterprises that have run into extreme difficulties or are on the verge of bankruptcy are allowed by law to resort to job displacement. Factors of production such as capital and technology are allowed and encouraged to participate in the distribution of proceeds. Technical personnel are permitted to take equity positions in their critical technologies or to receive stock options or other forms of reward or incentives for their contributions to the enterprise. Distribution according to work is a principle that should be adhered to within an enterprise in designing the salary scheme, while allowing an appropriate level of disparity between the incomes of workers and management. The board of directors and members of the management team should be remunerated according to their respective responsibilities and contributions to the enterprise, whereas the salary level of the workers can be determined by the enterprise itself, taking into consideration the average local salary level and the economic efficiency of the enterprise. At present more than 7,400 enterprises have implemented annual salary packages for the managers on a trial basis. Another 10,000 plus enterprises are experimenting in collective consultation (or bargaining) for salaries. In addition, the test for post-specific salaries, an alternative reform measure, is steadily progressing.

Strengthening and improving enterprise management

Management is an eternal theme. Strengthening enterprise management and enhancing the level of scientific management is not only an inherent requirement for a modern enterprise system, but also an important avenue for the SOE to increase profitability and competitiveness. Following China's entry into the WTO, SOEs will directly face competition from multinational companies and their weak management will be made more apparent. In this situation the requirement for an overall improvement in enterprise management and enhancement of the level of scientific management has become increasingly pressing. Therefore, efforts will have to be made to remove the fundamental weaknesses in the current status of enterprise management, characterized by widespread random decision-making, loose governance and casual disciplines.

In order to strengthen enterprise management, the SOEs will adopt a series of measures of which the following are the most significant:

[*] This chapter was originally written in Chinese and was translated by Li Yong.

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