Abstract
This Selected Issues paper examines the decline in the revenue-to-GDP ratio for the People’s Republic of China. In common with most transition countries, China has experienced a sharp decline in fiscal revenues since the initiation of economic reforms, owing mainly to weakness in tax revenues. This paper describes the secular decline in the revenue ratio in China and reviews the factors behind the decline. It also compares China’s experience with that of other transition countries where revenues have tended to decline.
III. Recent Progress in the Reform of State-Owned Enterprises 1/
1. Introduction
The reform of the large and inefficient state owned enterprise (SOE) sector is presently the most important task facing the Chinese authorities. 2/ 3/ Despite the decline in their relative importance, SOEs still play a significant role in the economy, especially in terms of industrial production, urban employment, investment, and bank borrowing. However, despite efforts to reform the SOE sector since the 1980s, SOE performance has continued to be relatively weak. The main contributory factors include: (i) a weak internal governance structure, unclear property rights, lack of accountability, and weak management; (ii) a heavy social burden imposed on SOEs that requires them to provide employment and social services; and (iii) the lack of a hard budget constraint resulting from the provision of direct and indirect subsidies (through the fiscal and banking systems), an insufficiently competitive market environment, and the infrequent enforcement of bankruptcy.
In the last three years, the authorities have focused attention on SOE reform. In 1993-94 a comprehensive plan for such reform began to emerge as part of a much broader strategy to develop a socialist market economy, in which market forces play the fundamental role in resource allocation while public ownership--in the form of corporatized SOEs and collectively owned units--remains the mainstay. In pursuit of this strategy, enterprise reform has followed a two-pronged approach: first, it has sought to alter the external environment for enterprises, mainly by reducing explicit and implicit subsidies and by promoting competition in the economy; and second, it has sought to alter the incentives within firms, by giving management more autonomy, restructuring operations, and diversifying ownership. Although some progress was made in both areas during this period, many of the major problems affecting SOE performance remained to be addressed. Accordingly, giving particular priority to SOE reform since late 1994, the authorities have initiated a number of experimental actions, covering a large sample of enterprises, to address a broad range of issues related to SOE restructuring. Furthermore, the recently-approved Ninth Five Year Plan (1996-2000) has adopted other important initiatives, including steps to allow greater scope for ownership diversification.
This paper summarizes recent developments in the Chinese program for state enterprise reform. Section 2 reviews recent developments in the sector, including pressures for reform. Section 3 presents the main features of the current reform program and the direction of reform in the Ninth Five-Year Plan. The main issues entailed in this program are reviewed in Section 4. Section 5 looks at the relationship of enterprise reform to other aspects of economic restructuring, including developing competitive markets and financial sector reform.
2. Background
a. Main characteristics of SOEs
The following are some of the main characteristics of SOEs in China, which are a large and diverse group:
• SOEs provide 66 percent of employment, and 67 percent of the value of fixed assets in the enterprise sector, but only 34 percent of gross industrial output (Table 1).
China: State-Owned Enterprises (SOEs), 1994
State-owned Industrial enterprises with Independent accounting systems.
China: State-Owned Enterprises (SOEs), 1994
| Value of Output | Fixed Assets | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| Number | Employment | Value | Ratio | Value | Ratio | ||||
| (’000) | (Millions) | (Y bn.) | (Percent) | (Y bn.) | (Percent) | ||||
| Total enterprises | 10,017 | 113.7 | 7,691 | 100.0 | 283.0 | 110.0 | |||
| Nonstate enterprises | 9,915 | 38.3 | 5,071 | 65.9 | 94.0 | 33.2 | |||
| Total of all SOEs | 102 | 75.4 | 2,620 | 34.1 | 189.0 | 66.8 | |||
| Industrial SOEs 1/ | 80 | 51.4 | 2,530 | 100.0 | 189.0 | 100.0 | |||
| Large enterprises | 4 | … | 1,506 | 59.5 | 122.0 | 64.6 | |||
| Medium enterprises | 11 | … | 554 | 21.9 | 35.0 | 18.5 | |||
| Small enterprises | 65 | … | 471 | 18.6 | 32.0 | 16.9 | |||
State-owned Industrial enterprises with Independent accounting systems.
China: State-Owned Enterprises (SOEs), 1994
| Value of Output | Fixed Assets | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| Number | Employment | Value | Ratio | Value | Ratio | ||||
| (’000) | (Millions) | (Y bn.) | (Percent) | (Y bn.) | (Percent) | ||||
| Total enterprises | 10,017 | 113.7 | 7,691 | 100.0 | 283.0 | 110.0 | |||
| Nonstate enterprises | 9,915 | 38.3 | 5,071 | 65.9 | 94.0 | 33.2 | |||
| Total of all SOEs | 102 | 75.4 | 2,620 | 34.1 | 189.0 | 66.8 | |||
| Industrial SOEs 1/ | 80 | 51.4 | 2,530 | 100.0 | 189.0 | 100.0 | |||
| Large enterprises | 4 | … | 1,506 | 59.5 | 122.0 | 64.6 | |||
| Medium enterprises | 11 | … | 554 | 21.9 | 35.0 | 18.5 | |||
| Small enterprises | 65 | … | 471 | 18.6 | 32.0 | 16.9 | |||
State-owned Industrial enterprises with Independent accounting systems.
• The bulk of the SOEs are owned (and controlled) by local governments, and only a few by central governments.
• A modest number of large SOEs dominate the sector. The largest 4,000 of the 80,000 industrial SOEs account for 60 percent of production and 65 percent of fixed assets.
• About 67 percent of exports and 50 percent of imports in 1995 were channeled through SOEs, mainly foreign trading enterprises.
• While providing about 65 percent of the revenue from taxes on incomes and profits in the state budget, SOEs receive budgetary subsidies, mainly to provide working capital and cover operating losses as well as price subsidies for daily living necessities, especially to compensate enterprises for controlled, prices. In recent years, there have been some reductions in budgetary subsidies, given the greater scope for adjustments of SOE (administered) prices.
• SOEs rely heavily on financing from state banks--for supporting fixed investment and working capital, including operating losses--with over three fourths of bank lending going to SOEs. 1/ With much of this debt having been provided at low interest rates and having become overdue, bank lending has implicitly subsidized SOEs.
b. Recent developments in the SOE sector
During the 1990s, as during much of the reform period, the performance of the SOE sector was much weaker than that of the rest of the Chinese economy. In particular, the growth of industrial production of SOEs averaged only 8 percent per year in the period since 1991, well below the average growth (23 percent) of total industrial output. The slower growth of SOEs reflected in part their concentration in heavy industries built up in the pre-reform period, whereas it was in light industries (such as consumer goods) that rapid development was achieved during this period. Reflecting these trends, the share of SOEs in total industrial output declined from 53 percent in 1991 to 34 percent in 1994 when, for the first time, collectively owned enterprises accounted for a larger share of production. The lackluster performance of SOEs has been reflected in a steady decline in employment, by about 1 percent per year since 1993, attributable to some limited labor shedding and slower growth in hiring.
The financial condition of most SOEs weakened in 1994-95, although some large enterprises remained relatively strong. After improving sharply in the boom conditions of 1993, total SOE profits declined in 1994 and 1995, reflecting the deteriorating finances of the medium- and small-sized enterprises (Tables 2 and 3). While a breakdown by enterprise size is not available for SOE losses, available data show sharp overall increases in 1995. Partly given the need to finance their losses, SOEs have remained heavily dependent on bank financing. The debt-to-asset ratio for all SOEs is estimated at about 75 percent in 1995--about 70 percent for large enterprises and over 100 percent for medium and small sized enterprises under local government control. 2/ The tightening of bank credit in 1994 and 1995 and the related slowing in economic growth contributed to a rapid rise in interenterprise debt. Accounts receivable increased by about Y 300 billion in 1994 to Y 630 billion, and to Y 760 billion in September 1995.
China: Profitability of State-Owned Enterprises, 1991-95 1/
(In billions of yuan)
State-owned industrial enterprises with independent accounting systems.
Annualized data based on the change in the first nine months compared with the same period in the previous year.
China: Profitability of State-Owned Enterprises, 1991-95 1/
(In billions of yuan)
| 1991 | 1992 | 1993 | 1994 | 1995 2/ | ||
|---|---|---|---|---|---|---|
| Total losses of loss-making enterprises | 36.7 | 36.9 | 45.3 | 48.3 | 61.8 | |
| (Percent change) | 5.2 | 0.6 | 22.6 | 6.6 | 28.0 | |
| After-tax profits | 40.2 | 53.5 | 81.7 | 82.9 | 62.2 | |
| (Percent change) | 3.6 | 33.1 | 52.7 | 1.4 | -25.0 | |
| Pre-tax profits | 166.1 | 194.4 | 245.5 | 287.6 | … | |
| (Percent change) | 10.5 | 17.0 | 26.3 | 17.2 | … | |
State-owned industrial enterprises with independent accounting systems.
Annualized data based on the change in the first nine months compared with the same period in the previous year.
China: Profitability of State-Owned Enterprises, 1991-95 1/
(In billions of yuan)
| 1991 | 1992 | 1993 | 1994 | 1995 2/ | ||
|---|---|---|---|---|---|---|
| Total losses of loss-making enterprises | 36.7 | 36.9 | 45.3 | 48.3 | 61.8 | |
| (Percent change) | 5.2 | 0.6 | 22.6 | 6.6 | 28.0 | |
| After-tax profits | 40.2 | 53.5 | 81.7 | 82.9 | 62.2 | |
| (Percent change) | 3.6 | 33.1 | 52.7 | 1.4 | -25.0 | |
| Pre-tax profits | 166.1 | 194.4 | 245.5 | 287.6 | … | |
| (Percent change) | 10.5 | 17.0 | 26.3 | 17.2 | … | |
State-owned industrial enterprises with independent accounting systems.
Annualized data based on the change in the first nine months compared with the same period in the previous year.
China: Profitability of State-Owned Enterprises, 1993-94 1/
(by size of enterprise)
Enterprise sizes as used in Table 1.
Current and long-term debt divided by current plus fixed assets. This definition is different form the ratios quoted directly from Chinese sources which use unpublished information.
China: Profitability of State-Owned Enterprises, 1993-94 1/
(by size of enterprise)
| 1993 | 1994 | ||
|---|---|---|---|
| After tax profits (total, billions of yuan) | 81.7 | 82.9 | |
| Large enterprises | 58.7 | 80.1 | |
| Medium | 10.5 | 3.0 | |
| Small | 12.5 | -0.2 | |
| After tax profits/sales (average, percent) | 3.6 | 3.8 | |
| Large enterprises | 4.6 | 6.0 | |
| Medium | 2.0 | 0.6 | |
| Small | 2.8 | -- | |
| Debt/asset ratio (average, percent) 2/ | 81.9 | 88.7 | |
| Large enterprises | 76.8 | 84.2 | |
| Medium | 89.9 | 96.2 | |
| Small | 87.5 | 94.7 | |
Enterprise sizes as used in Table 1.
Current and long-term debt divided by current plus fixed assets. This definition is different form the ratios quoted directly from Chinese sources which use unpublished information.
China: Profitability of State-Owned Enterprises, 1993-94 1/
(by size of enterprise)
| 1993 | 1994 | ||
|---|---|---|---|
| After tax profits (total, billions of yuan) | 81.7 | 82.9 | |
| Large enterprises | 58.7 | 80.1 | |
| Medium | 10.5 | 3.0 | |
| Small | 12.5 | -0.2 | |
| After tax profits/sales (average, percent) | 3.6 | 3.8 | |
| Large enterprises | 4.6 | 6.0 | |
| Medium | 2.0 | 0.6 | |
| Small | 2.8 | -- | |
| Debt/asset ratio (average, percent) 2/ | 81.9 | 88.7 | |
| Large enterprises | 76.8 | 84.2 | |
| Medium | 89.9 | 96.2 | |
| Small | 87.5 | 94.7 | |
Enterprise sizes as used in Table 1.
Current and long-term debt divided by current plus fixed assets. This definition is different form the ratios quoted directly from Chinese sources which use unpublished information.
The ability to shift profitable assets to other entities may have also contributed to the poor performance of SOEs. Many SOEs have reportedly formed subsidiary entities, in the form of collectives or joint ventures, which are subject to lower tax rates and higher depreciation rates and are not required to make profit transfers. Shifting or selling assets of the SOEs at low prices to these subsidiary entities may have resulted in higher returns to the latter (mainly management and workers). On the other hand, the parent SOE has been left with the burden of excessive debt, surplus workers and retirees, with the resulting losses being borne by the government and the banks. 1/ Policies adopted in 1994-95 to strengthen the management of state-owned assets are intended to limit this depletion.
c. Pressures for reform
Despite earlier efforts to reform the SOEs, most remain substantially sheltered from market forces. In the early-1990s, key reform measures included: greater autonomy for SOEs in production, pricing, investment, and employment decisions, by separating them from the government; and the initial implementation of the Bankruptcy Law to enforce financial discipline. However, these measures did little to impose financial discipline on SOEs, as bank credit continued to be easily available to them and funds were often diverted to speculative projects and for investment outside the main line of business. On the contrary, the increased autonomy afforded to SOEs had the perverse effect of permitting larger bank borrowing that further weakened macroeconomic control.
More generally, the experience of the reform period, in particular the serious macroeconomic pressures evident in 1992-93, has highlighted the major role of the SOE sector in perpetuating economic cycles in China and the consequent need for comprehensive SOE reform. These cycles typically began with a boom in SOE investment demand, often associated with a new phase of economic reform, were fueled by expansionary financial policies, and led to acceleration in inflation. The ensuing policy tightening was, however, difficult to sustain in many cases because the weak financial position of these enterprise led to pressures for premature relaxation of credit and investment controls. With the problems of the SOE sector thus constraining the sustained implementation of appropriate financial policies, the authorities recognized the a strategy to strengthen macroeconomic management could not be successfully pursued in the absence of a major reform of the SOE sector. In this vein, the Decision of the Third Plenum in November 1993 identified the development of a modern enterprise system and strengthening of macroeconomic control as twin objectives for establishing a socialist market economy.
3. SOE reforms since 1994
Building on the strategy envisioned in the Third Plenum, the authorities adopted a comprehensive approach to enterprise reform in November 1994, entailing a fundamental reform of the relationships among the government, enterprises, banks, and workers. It was, however, recognized that the reform program would have to proceed gradually, with an eye to its social and political implications.
The ultimate objective of enterprise reform was to develop a “modern” corporatized enterprise sector based on autonomous shareholding companies, within a framework of continued dominant state ownership. This requires measures to: improve valuation and management of state assets; divest enterprises of their heavy social burden; restructure their overdue debts; strengthen internal management; and alleviate the impact of the sizable labor shedding likely to accompany SOE reform (see Table 4).
China: Reform of SOEs—Issues Being Addressed
China: Reform of SOEs—Issues Being Addressed
| Issue | Main Strategy Adopted | |
|---|---|---|
| a. | Separation of government functions | |
| Separation of regulatory and commercial functions | Commercial departments are being corporatized. Regulatory functions are being consolidated in smaller departments or in other ministries. | |
| Separation of social welfare functions | Development of social funds by local governments. Gradual transfers of schools and hospitals to local governments. | |
| b. | Corporate governance | |
| i. Corporate structure | ||
| Corporatization | Corporatize SOEs, mainly as limited liability companies. | |
| State dominant holding in 1,000 large enterprises | Owner could be holding companies based on ministries, local governments, or commercial holding companies, or any combination of these. | |
| Nonstate ownership - 1,000 large enterprises | Dominant state ownership, but other ownership to be considered to improve the operation of the enterprise. | |
| Nonstate ownership - other enterprises | Flexible approach to develop the economy; local governments can decide to retain state ownership or adopt other measures including sale, merging, leasing, and liquidation. | |
| ii. Management strengthening | ||
| Management objectives | Clarify the dominance of commercial objectives for managers by making them responsible to the shareholders. | |
| Reduce price control and other interventions in the market that create losses for enterprises. | ||
| Financial discipline | Access to bank credit by chronic loss-making enterprises is gradually being reduced, mainly for smaller enterprises. | |
| Financial integrity | Adoption of new accounting standards and upgrading the quality of accounting, accountants, and auditing. | |
| Enhance competition | The reduction of domestic barriers to trade and improvements in transportation are increasing domestic competition. | |
| Import competition is significant, further liberalization is planned but many imports enter the market without paying full import taxes. | ||
| c. | Enterprise restructuring | |
| i. Financial strengthening | ||
| Increase of government equity | Return 15 percent of corporate income taxes paid as equity for use as working capital. | |
| Reduce debt service | Overdue interest written off and principal rescheduled for merged loss-making enterprises. | |
| General debt-equity conversion | Will be needed to significantly reduce debt burden. Details are still being formulated. | |
| Mergers and bankruptcies | Many enterprises are loss-making because of changes in market conditions. Readjustment of industrial structure required. | |
| ii. Labor redundancies | ||
| Redeployment with firms | Firms develop sideline businesses. | |
| Retraining for labor service bureaus attached to the firm. | ||
| Redeployment outside firms | Early retirement or extended sick leave. Lump sum payment and retraining to start own business. Transfers to related enterprise, often after a merger. Local government assistance in finding alternative employment, possibly using a labor exchange. | |
China: Reform of SOEs—Issues Being Addressed
| Issue | Main Strategy Adopted | |
|---|---|---|
| a. | Separation of government functions | |
| Separation of regulatory and commercial functions | Commercial departments are being corporatized. Regulatory functions are being consolidated in smaller departments or in other ministries. | |
| Separation of social welfare functions | Development of social funds by local governments. Gradual transfers of schools and hospitals to local governments. | |
| b. | Corporate governance | |
| i. Corporate structure | ||
| Corporatization | Corporatize SOEs, mainly as limited liability companies. | |
| State dominant holding in 1,000 large enterprises | Owner could be holding companies based on ministries, local governments, or commercial holding companies, or any combination of these. | |
| Nonstate ownership - 1,000 large enterprises | Dominant state ownership, but other ownership to be considered to improve the operation of the enterprise. | |
| Nonstate ownership - other enterprises | Flexible approach to develop the economy; local governments can decide to retain state ownership or adopt other measures including sale, merging, leasing, and liquidation. | |
| ii. Management strengthening | ||
| Management objectives | Clarify the dominance of commercial objectives for managers by making them responsible to the shareholders. | |
| Reduce price control and other interventions in the market that create losses for enterprises. | ||
| Financial discipline | Access to bank credit by chronic loss-making enterprises is gradually being reduced, mainly for smaller enterprises. | |
| Financial integrity | Adoption of new accounting standards and upgrading the quality of accounting, accountants, and auditing. | |
| Enhance competition | The reduction of domestic barriers to trade and improvements in transportation are increasing domestic competition. | |
| Import competition is significant, further liberalization is planned but many imports enter the market without paying full import taxes. | ||
| c. | Enterprise restructuring | |
| i. Financial strengthening | ||
| Increase of government equity | Return 15 percent of corporate income taxes paid as equity for use as working capital. | |
| Reduce debt service | Overdue interest written off and principal rescheduled for merged loss-making enterprises. | |
| General debt-equity conversion | Will be needed to significantly reduce debt burden. Details are still being formulated. | |
| Mergers and bankruptcies | Many enterprises are loss-making because of changes in market conditions. Readjustment of industrial structure required. | |
| ii. Labor redundancies | ||
| Redeployment with firms | Firms develop sideline businesses. | |
| Retraining for labor service bureaus attached to the firm. | ||
| Redeployment outside firms | Early retirement or extended sick leave. Lump sum payment and retraining to start own business. Transfers to related enterprise, often after a merger. Local government assistance in finding alternative employment, possibly using a labor exchange. | |
a. The role of experiments
As is characteristic of China’s reforms, experiments are being used in SOE reform to gather experience with alternative approaches that would be appropriate to the widely varying conditions in regions and enterprises. The four main reform experiments encompass: the adoption of new accounting standards by about 10,000 large and medium enterprises, comprehensive reform in 18 cities, reform of 100 large and medium enterprises, and the formation of 56 enterprise groups. 1/ The last three experiments were expected to be implemented over several years with the main design stages planned for 1995 and 1996, after which the lessons would be applied more widely. The main features of these experiments and the progress thus far are outlined below.
The 10,000 enterprises project aims to assess the value of the (state) assets of these enterprises and implement new accounting standards that would bring Chinese enterprise accounting more in line with international norms. By late 1995 the asset evaluation component was substantially completed, while the new accounting standards are gradually being implemented.
The 18 cities experiment consists of city wide policy changes considered necessary for promoting enterprise reform. 2/ In part, this experiment seeks to study possible means to reduce the debt of enterprises, raise the level of equity capital, and use the shareholding system to make transparent the ownership relationship between enterprises and government units. It also aims to develop social security systems, state owned asset management bureaus, holding companies, and city-wide mechanisms for bankruptcy and redeploying redundant labor. Preliminary results for 1995 from these experiments indicate that some headway has been made in increasing the capital of these firms, partly through debt restructuring. Furthermore, more than 1 million workers, representing about 9 percent of the redundant workers in these cities, found new jobs with the assistance of local governments, or received social benefits, including early retirement. Regarding mergers and bankruptcy, a small number (305) of SOEs were merged and, while 160 state firms applied for bankruptcy, only some 90 of them were permitted to declare bankruptcy. 1/
The experiment with 100 large and medium enterprises involves the comprehensive reform of their internal structures. These SOEs will be corporatized (generally as limited liability companies), 2/ their management strengthened, the financial condition improved (mainly by reducing the debt/asset ratio), excess labor reduced, and funds provided for technical renovation. The 100 enterprises will be monitored by central government departments; in addition, about 2,000 other enterprises will be supervised under local governments. 3/ By end 1995 about 75 of the 100 enterprises submitted plans on their initiatives to the central government. It is expected that, by end-1997, the debt asset ratio of these enterprises would be reduced from about 70 percent to 60 percent. 4/
The program of the 56 large enterprise groups entails giving these groups more autonomy 5/ and foreign trading rights, as well as the reform measures envisaged under the 100 enterprises mentioned above. An important aspect of greater autonomy is the right of enterprises in this group to report directly to the State Planning Commission (SPC), rather than to other departments or local governments. This simplifies and accelerates the approval process and gives the enterprise direct access to the decision making of the SPC, which would be involved only in major decisions.
b. SOE reforms under the Ninth Five-Year Plan
Under the Ninth Five-Year Plan, following the principle of “hold on to the big (enterprises), let go of the small,” reform and revitalization efforts will be focused on 1,000 large enterprises and enterprise groups, which will be retained by the state (both local and central governments) and strengthened. 1/ These 1,000 enterprises are the largest from the main sectors and are generally profitable but some are strategic enterprises that have been making losses. In addition to adopting the reform programs undertaken in the experiments, these enterprises will be given: (i) the right to develop their own financing companies; (ii) foreign trading rights; and (iii) priority in issuing shares on stock markets. 2/ The phased implementation of this program will start with the reform of an initial group of 300 enterprises in 1996. By the year 2000, the 1,000 large enterprises are expected to be able to operate on fully commercial terms, including being subject to commercial credit evaluation criteria for bank borrowing.
Regarding SOEs other than the top 1000, local governments will have greater freedom to formulate their own reform plans, including with regard to the sale, management contracts, or mergers. Specific programs for this group have not been formulated but local governments will have the prime responsibility for such reform.
The decision to use more flexible policies for most of the SOEs does not mean widespread privatization. Indeed, the principle of the dominance of public ownership and the leadership of the state is fundamental to the Ninth Five-Year Plan. However, public ownership is defined to include both state and collective ownership, as well as shareholding cooperatives. It is expected that many of the collectives and small SOEs would be converted into shareholding cooperatives. 3/
In the early years of the Plan period, the above-mentioned experiments will be expanded and extended to other parts of the country. In particular, local governments will be expected to utilize their greater freedom to pursue reform options to develop reform measures more suited to the particular characteristics of the SOEs in their jurisdiction. The lessons learned in this early phase will be applied, in the next year or two, to a progressively larger group of enterprises and regions.
4. Elements of reform
The main elements of the reform of the internal structures of SOEs relate to: the separation of government functions from those of the enterprises, improvement of the system of corporate governance, financial strengthening, and reduction of labor redundancies (summarized in Table 1). Generally these policies will be applied to the large 1,000 enterprises, but local governments would also be able to draw on the experience of these enterprises and apply them to the other SOEs.
a. Separation of enterprises from Government
i. The separation of the regulatory function
Reform requires enterprises to be independent from the related administrative departments. Under the planning system, SOEs had to implement policy decisions of the relevant departments that controlled them. For example, grain procurement, distribution, and pricing policies were implemented by grain distribution agencies that were part of the Ministry of Internal Trade. If enterprises are to be autonomous, a clear separation between the enterprise and the policy department is essential to ensure that the latter will not force the enterprise to make decisions on noncommercial considerations in order to achieve policy objectives.
During 1995 some initial progress was made in separating government departments and SOEs, although the degree of such separation has varied. Many local governments under the 18 cities experiment have also started this process. For example, the Shanghai Municipal Government separated its administrative departments from the enterprises controlled by them, by transferring the enterprises to municipal asset management companies. In the case of the central government, the Ministry of Internal Trade has also started to separate the administration of the domestic distribution system from distributive enterprises. In the case of The Ministry of Metallurgy, the production units under its responsibility are likely to be transferred from the ministry to a holding company, with a view to enabling them to rationalize their structure. Further, with the Ministry of Power to be disbanded and its planning functions transferred to the State Planning Commission, the operations of power stations would be corporatized and owned by the National Power Corporation as a holding company. 1/
ii. Separation of welfare functions
Another key element of enterprise reform is the separation of their welfare functions from enterprise operations. Under the planned economy, the work unit provided all the main social services, such as housing, education, medical services, and pensions to the labor force, estimated to comprise just under half of the total labor costs of SOEs. 1/ This system has not only posed a significant burden on SOE finances but also diverted management attention away from production and limited labor mobility because employees cannot leave their work unit without a large loss of entitlement.
Pension expenses have been increasing and now comprise a major cost because SOEs have always funded pensions on a pay as you go basis. Many SOEs were built up in the 1950s and early 1960s with young staff and low pension costs, but by end 1994, for every five active employees of state-owned units there was one retiree. Thus pension costs are significant, even though they are fixed in nominal terms and their real value was severely eroded by inflation in the last three years. Pension obligations are being transferred to local governments to relieve SOEs of the financial burden but funding arrangements for the new social welfare system have not been finalized. Some local governments have created social funds for pensions, health and unemployment benefits, based on contributions from enterprises and employees, as well as by local governments.
Regarding other social benefits, the separation of housing is likely to be difficult but progress is being made gradually. There are plans to commercialize the housing stock but this will have to be phased in because of the required adjustment in wages, as the housing benefit is monetized, and decisions on how to distribute the existing housing stock. 2/ Transfers of medical services and schools to local governments are not expected to pose major difficulties and will also be carried out gradually.
b. Corporate governance
i. System design
Corporatization through the formation of limited liability companies is the main device proposed for giving incentives for the efficient operation of SOEs. Currently over 4,500 enterprises have formed limited liability shareholding companies and the conversion is continuing. The shareholders, government investment companies, state asset management bureaus, or other parties would form a board of directors to formulate the major decisions of the company, both strategic and personnel. China’s Company Law calls for a board of supervisors for all large SOEs, which would supervise the board of directors and monitor in general terms the increase in the value of the state assets and profits and consistency with national policy. Under one proposal, this additional layer could also represent the interests of groups other than the shareholders. Representatives could be from Government administrative and financial departments, workers representatives, and the Communist Party. 1/
The crucial issue is whether the proposed corporate structure and multiple government owners will be sufficient to ensure that SOEs are profit oriented. It is hoped that, with diversified shareholding, all shareholders will be motivated by the desire to increase the returns to their investments. Under this set up, the noncommercial interests of one shareholder should not dominate, although it is to be seen whether this will be the case, as this process evolves.
Corporate governance will also be enhanced by better accounting and more external scrutiny, especially from banks. The lack of clear accounting and auditing standards has made it difficult in the past to control the financial behavior of managers. The implementation and enforcement of appropriate accounting standards is another major task, which should help improve corporate governance and reduce fraudulent dealings. 2/ The current anti-corruption campaign is also intended to address some irregular business practices in enterprises. Financial discipline will also come from bank commercialization. As banks become more accountable for their profits, lending decisions will have to be based on project evaluations and the borrowers’ creditworthiness.
ii. Multiple state owners
Diversifying ownership among the different institutions is expected to improve accountability and to focus management objectives on maximizing returns. Although in the past SOEs were said to be owned by the people as a whole, this was not an operational concept. The lack of a clearly defined owner was one reason why workers and management had no incentive to meet production goals efficiently and could divert SOE assets for their own benefit.
Reforms in 1995 have started to clarify ownership of enterprises among different institutions that could claim ownership. Several such alternative institutions are: the Ministry of Finance or the local finance bureaus; the department that had previously administered the enterprise (as in the cases noted above); or conglomerate holding companies (such as in the vehicle sector). In the “100 enterprise” experiment, the equity is being divided up between the different institutions as each asserts ownership claims. Thus in some cases SOEs would have as shareholders several different government entities, including those from different levels of government.
iii. Nonstate ownership
Under the Ninth Five-Year Plan there is also substantial scope for nonstate ownership of enterprises, even with regard to the 1000 large enterprises, in which the state, at both central and local levels, would have a dominant role. The role of nongovernment ownership would vary depending on the nature of the enterprise and its industry. While many enterprises will remain solely owned by the state, for those few not considered to be strategic and in competitive industries, the share of nonstate equity could exceed 50 percent. Some of this group could issue shares on domestic or foreign stock exchanges. Since almost all of these enterprises already have some foreign investment, typically thorough a joint venture subsidiary, direct foreign investment is also expected to play an important part in the revitalization of many of these enterprises.
The policies for the smaller SOEs envisage greater flexibility for local governments to choose their own reform strategy. This reflects the view that the state does not have the ability to manage many small enterprises, especially at the lower local levels (e.g., county). Many of these enterprises operate in a relatively competitive environment and thus do not require state participation. However, it is expected that the predominant form of nonstate ownership would be through collectives or shareholding cooperatives considered to be part of the public sector.
Heilongjiang province, in China’s industrial north-east, provides an illustration of the transformation options available for the small and medium size enterprises (see table below). These options include conversion into shareholding cooperatives, merging with larger successful companies being declared bankrupt, or leased out. By end 1995 in Heilongjiang of about 18,000 small and medium sized SOEs, about 85 percent of the total number of SOEs in the province, were transformed by the diverse methods to improve their ownership and management structure.
Transformation of Selected Industrial SOEs in Heilongjiang Province End 1995
Transformation of Selected Industrial SOEs in Heilongjiang Province End 1995
| Selected Enterprises | 18,086 | |
| Transformed into: | ||
| Cooperative shareholding firms | 3,927 | |
| Merged with other firms | 489 | |
| Declared bankrupt | 432 | |
| Assets leased out | 6,555 | |
| Management contracted out | 1,643 | |
| Sold outright | 435 | |
| Shareholding corporations | 957 | |
| Entrusted operation | 202 | |
| Joint ventures | 212 | |
| Other conversions | 3,234 | |
Transformation of Selected Industrial SOEs in Heilongjiang Province End 1995
| Selected Enterprises | 18,086 | |
| Transformed into: | ||
| Cooperative shareholding firms | 3,927 | |
| Merged with other firms | 489 | |
| Declared bankrupt | 432 | |
| Assets leased out | 6,555 | |
| Management contracted out | 1,643 | |
| Sold outright | 435 | |
| Shareholding corporations | 957 | |
| Entrusted operation | 202 | |
| Joint ventures | 212 | |
| Other conversions | 3,234 | |
c. Restructuring of enterprises
i. Financial strengthening of enterprises
With total debt outstanding equal to about 75 percent of their assets, many SOEs cannot service their bank debt. To address the debt burden, several policies were formulated in 1995, mainly for the 18 experimental cities and enterprises. Their main aim is to support the enterprises that could be viable, with a more normal debt burden. Partly reflecting the concern to restrict support to potentially viable enterprises, the government has been very cautious in formulating more general debt relief programs.
Four main programs for debt reduction are available for SOEs. First, about 15 percent of the corporate income tax received by the cities is to be returned to the SOEs to increase the state’s equity; the funds received by the enterprises would help them correspondingly reduce bank borrowing. Second, a loss-making enterprise acquired by a profitable enterprise would be granted some debt relief. 1/ Third, a certain category of loans provided by the banks, on behalf of the government, to enterprises for the purpose of capital injection, would be converted into the state’s equity. 1/ Finally, debt owed to other enterprises or to nonbank financial institutions would be converted into equity, and bank claims on enterprises may be swapped with investment companies and then converted into the investment companies’ equity in the enterprises.
ii. Mergers and Bankruptcies
Mergers and acquisitions are seen as the main method of industrial restructuring, with bankruptcies taking a much smaller role. Mergers and acquisitions are an important means to reorganize the productive structure of Chinese industry and address the management problems in many loss making enterprises. In the past two years about 10,000 SOEs have been involved in mergers while bankruptcy, with the loss of employment opportunities, has been a less attractive means of restructuring.
Trading of property rights can also help many small enterprises find new owners who will be better able to manage them. There are about 36 property rights trading centers set up in large cities where small and medium size enterprises can put themselves up for sale and be bought by other parties. Two active ones are in Wuhan, where 300 enterprises are for sale, and Shenzhen, which introduced a system of authorized dealers to match prospective buyers of unlisted companies. 2/
iii. Labor redundancies
The rate at which redundant workers in SOEs can be redeployed is a major constraint on the pace of reform because of the need to maintain social stability. Of the 15-30 percent of the 75 million SOE workers estimated to be redundant, some 10 million are expected to be reallocated during the Ninth Five-Year Plan. In 1995, about 1.3 million SOE workers were redeployed in the 18 cities as part of SOE reform. Except for those receiving early retirement, most of the surplus workers receive assistance in finding a new job, sometimes in a newly created subsidiary or a related business. Workers who are left to find their own employment are generally given lump sum unemployment benefits as severance pay, e.g., for two years, to start their own business. Financing for lump sum cash (severance) payments for retrenched workers, training, and the formation of sideline businesses has generally come from asset sales.
The moderation of growth and the decline in urban employment in 1995 may not have been conducive for laying off redundant workers. Alternative employment opportunities have grown slowly in the central and north eastern areas, which have large concentrations of SOEs. Continued growth in the coastal areas, especially in Tianjin and Shanghai has, however, permitted significant restructuring. An additional factor that has slowed the redeployment of labor has been that, because of the weak property market, recent land right sales have not been sufficient to fund extensive the payments associated with labor shedding.
Nevertheless, even in inland and northern cities an understanding about the inevitability of reform is spreading. For example in Chongqing, which has a heavy concentration of SOEs, the steelworks was restructured and 20,000 workers out of 50,000 were made redundant (see table below). Of these, 13,200 are to be redeployed by the firm and 6,800 workers will be absorbed by other entities over about 5 years. However, as the absorption of workers by other sectors is likely to be slow, a mix of approaches is being used to redeploy workers, mainly on the basis of efforts by the SOEs themselves.
Program for Redeployment of Surplus Workers at Chongqing Steel Corporation
Includes sick leave, absence at reduced pay, and transfers to other agencies.
Phased over the years 1996-2000.
| To be Redeployed | |||||
|---|---|---|---|---|---|
| Total | Up to 1995 | 1996-1998 | |||
| Total original workforce | 50,000 | ||||
| Surplus workers | 20,000 | ||||
| Redeployed by firm | 13,200 | 8,200 | 5,000 | ||
| In tertiary sector | 8,200 | 5,900 | 2,300 | ||
| Retirement and early retirement | 2,500 | 2,000 | 2,500 | ||
| Other methods 1/ | 500 | 300 | 200 | ||
| Redeployed by local government | 6,800 | 400 | 6,400 | 2/ | |
| Redeployed in society | 3,600 | 400 | 3,200 | 2/ | |
| Retrained and redeployed | 3,200 | -- | 3,200 | ||
Includes sick leave, absence at reduced pay, and transfers to other agencies.
Phased over the years 1996-2000.
| To be Redeployed | |||||
|---|---|---|---|---|---|
| Total | Up to 1995 | 1996-1998 | |||
| Total original workforce | 50,000 | ||||
| Surplus workers | 20,000 | ||||
| Redeployed by firm | 13,200 | 8,200 | 5,000 | ||
| In tertiary sector | 8,200 | 5,900 | 2,300 | ||
| Retirement and early retirement | 2,500 | 2,000 | 2,500 | ||
| Other methods 1/ | 500 | 300 | 200 | ||
| Redeployed by local government | 6,800 | 400 | 6,400 | 2/ | |
| Redeployed in society | 3,600 | 400 | 3,200 | 2/ | |
| Retrained and redeployed | 3,200 | -- | 3,200 | ||
Includes sick leave, absence at reduced pay, and transfers to other agencies.
Phased over the years 1996-2000.
5. Linkages to other policies
a. Enterprise reform and industrial policy
As part of the strategy for the revitalization of the industrial sector, the Ninth Five-Year Plan envisages the formation of large enterprise groups in key sectors, mainly to overcome the production inefficiencies resulting from the fragmentation that resulted during the period of the planned economy.
The formation of such enterprise groups gathered strength in 1995. The relatively tight financial conditions of 1995 and debt relief provisions encouraged many small weak SOEs to merge with larger ones. In other cases this consolidation has been on a regional or industry basis. Thus, light industries in Shanghai and Zhejiang (separately) are combining into larger groups, so as to be able to share technology, management, and marketing resources. The metallurgical power, nonferrous, petrochemical, and aviation industries are also forming large holding companies. 1/ The automobile producers are also being encouraged to consolidate production to achieve better economies of scale. Similarly the Ministry of Internal Trade is also forming large commercial conglomerates, 2/ as are some of the foreign trading corporations.
b. Bank commercialization
Bank commercialization, another key element of the authorities’ structural reform agenda, is closely linked with SOE reform because progress with regard to the former is largely constrained by the problems in the SOE sector. In particular, unless SOE budget constraints are tightened, banks cannot be fully commercialized nor can all interest rates be fully liberalized, and nonperforming loans of state banks might continue to mount. One aspect of a program to limit lending to loss making enterprises is to strengthen banking supervision and safeguard the operational autonomy of banks, measures that are important parts of the People’s Bank of China work program in the Ninth Five-Year Plan. 3/
Some progress was made in limiting bank borrowing by loss making enterprises in 1995. As a result of the restrained credit policy in 1995, some loss making enterprises are reported to have experienced difficulty in obtaining credit for their working capital needs. While it is difficult to quantify this problem, reports indicate that many small SOEs, especially in the north-east and central areas, have not had enough funds to pay full wages to workers. In some cases redundant workers were given lower pay and not required to come to work, while weaker enterprises were forced to seek mergers. Notwithstanding this initial progress, much remains to be done to enforce financial discipline on SOEs and permit banks greater autonomy in lending decisions.
6. Conclusions
Enterprise reform is a central element of China’s program to develop a socialist market economy by the year 2000. An efficient industrial sector is essential to meet the challenges of a more open economy and to support the increase in living standards envisaged in the Ninth Five-Year Plan. The comprehensive program of reform started in 1994-95 is clearly complex, both in terms of the deep-seated problems being addressed and the balance of interests necessary to preserve stability while fundamentally transforming economic, political, and social relationships. This complexity, as well as the experimental nature of the process, suggest that SOE reform will necessarily have to be implemented over several years.
Reflecting this medium-term orientation, gradual progress is being made on various experimental initiatives, including the increasing scope for diverse forms of ownership, laying the foundation for a modern enterprise system. Incipient efforts are also under way to reduce subsidized credit and other financial support to SOEs, especially for the weaker enterprises. The gradual reduction in the share of bank credit to loss making enterprises while giving banks more flexibility to lend to profitable enterprises will support both these SOE reform and financial sector reform.
A strength in the Chinese reform program is the multiplicity of strategies being used. Awareness of the cost and complexity of SOE reform has contributed to the decision to concentrate central government reform efforts on 1000 largest enterprises in the Ninth Five-Year Plan, while delegating responsibility for the remaining SOEs mainly to lower levels of government and permitting them more flexibility on reform issues. Such a flexible approach will yield a diversity of practices, experiences, and outcomes across regions, which can be extended to not only the larger enterprises but also to enterprises in the nonstate sector.
Prepared by Mr. Winglee, Deputy Resident Representative. Ms. Gotur (ext. 34615) is available to answer questions related to this paper before the Board discussion.
Premier Li Peng in Report on the Outline of the Ninth Five-Year Plan. March 6, 1996.
The SOE sector comprises all enterprises owned by the state under the control of either the central or local governments. The nonstate sector in China comprises collectives, (including the township and village enterprises), joint urban collectives, joint rural collectives, foreign-funded enterprises, and private enterprises. It should be noted that many collectives are established by local governments; the difference between them and the SOEs is that the collectives are neither managed by, nor report to, industrial ministries/bureaus, operate largely in a market-based environment, and are subject to a relatively hard budget constraint. Foreign-funded enterprises include both joint ventures and wholly foreign-owned enterprises.
Data on the financing of investment suggests that more than half of investment by state-owned units is financed from internal funds. However, this high rate may also reflect the use of unidentified sources of financing, especially the use of working capital loans for investment.
From Xinhua report November 28, 1995. The data from these sources are different from Table 3 which is from published data; however, the orders of magnitude are approximately the same.
See for example, Zhou Xiaochuan, Restructuring Financial Relationships Among Enterprises, Banks, and Capital Market, Paper for Conference on Asian Economies in Transition, March 1996.
The experiments relating to the 18 cities and 100 enterprises are closely linked. The former are about 4 enterprises from each experimental city plus 30 enterprises run by central government departments.
The 18 cities are Shanghai, Tianjin, Shenyang, Changchun, Harbin, Qiqihar, Chongqing, Chengdu, Wuhan, Taiyuan, Qingdao, Tangshan, Bengbu, Changzhou, Zibo, Zhuzhou, Baoji, and Liuzhou.
Xinhua report, December 12, 1995, of State Economic and Trade Commission Minister, Wang Zhongyu, report to working conference.
Limited liability companies limit the liability of the shareholders, including state shareholders, in the event of bankruptcy to the value of the paid in capital. In the past, many SOEs were offshoots of government departments so that the extent of government liability was not defined.
This division was not established on the basis of ownership, i.e., some of the 100 enterprises being reformed by central government departments are owned by provincial governments.
Chen Qingtai ed. Collection of Papers for the National Working Conference on Enterprise Reform Experiments, China Economic Publishing House, December 1995 (Chinese).
Included in this group of enterprises are the First Automobile Works in Changchun, Capital Iron and Steel, Baoshan Steel, and Tangshan Alkali Company.
These 1,000 enterprises include 878 industrial enterprises, which roughly account for 63 percent of industrial SOE assets, 70 percent of both output value and sales volume, and 74 percent of pre-tax profits. From Premier Li Peng’s statement on the 9th Five-Year Plan, reported in China Daily, October 8 1995, and Xinhua release, October 21, 1995
They will also be subject to enhanced monitoring from information collected by banks.
Shareholding cooperatives issue shares to members, typically the employees, and each member has one vote. Outside shareholders should only have a small role.
Statement by Minister of the Power Industry, Shi Dazhen, Xinhua December 28, 1995.
World Bank, 1995 China: Reform of State-Owned Enterprises. Report No. 14924, December 14, 1995.
Plus transitional measures for older workers and retirees, as applied in some experimental cities. See Guo Shuqing in System Transition Needs Solutions to Stock Problems, Economic Daily September 11, 1995 (Chinese).
Jia He ting Corporatization of Enterprises and Reform of Corporate Governance, Paper for Conference on Policy Options for Reform of SOEs June 1995.
Statements by Vice Premier Zhu Rongji to the National Working Conference on Accounting Economic Information Daily, October, 25 1995 (Chinese).
The overdue interest on the loans will be written off by the bank, and the loans will have an interest moratorium for two or three years. The principal will have to be repaid over five years. To prevent this scheme from being used to avoid interest payments, the loss-making enterprise must have had losses for the past three years and overdue debt service for more than two years.
Prior to the early 1980s, capital injections from the government to SOEs were made as budget transfers. Subsequently these transfers were changed to bank loans, which added to the debt burden of the SOEs.
Reported in “Merger Trend Takes Shape”, in China Business Review, January 11, 1996.
Xinhua press release December 14, 1995.
Xinhua press release January 25, 1996.
PBC Governor Dai Xianglong’s Comments on the Continued Moderately Tight Monetary Policy in Financial News January 22, 1996 (Chinese).