People’s Republic of China: Selected Issues

This Selected Issues paper analyzes state-owned enterprise (SOE) development and reform in China. The paper discusses the role of state ownership in the Chinese economy, providing a “snapshot” of key features of the state sector, and a review of the growth, efficiency, and profitability of SOEs. The paper argues that economic performance in SOEs has declined in the last few years as evidenced by falling profitability, increasing losses, growing industrial inventories, and low rates of capacity utilization in some sectors. The paper also examines banking sector development and policy issues in China.

Abstract

This Selected Issues paper analyzes state-owned enterprise (SOE) development and reform in China. The paper discusses the role of state ownership in the Chinese economy, providing a “snapshot” of key features of the state sector, and a review of the growth, efficiency, and profitability of SOEs. The paper argues that economic performance in SOEs has declined in the last few years as evidenced by falling profitability, increasing losses, growing industrial inventories, and low rates of capacity utilization in some sectors. The paper also examines banking sector development and policy issues in China.

I. State-Owned Enterprise (SOE) Developments and Reform1

A. Introduction

1. The purpose of this chapter is to summarize recent developments in China’s SOEs, as well reform initiatives and issues. Sections B and C, together with Annex I, discuss the role of state ownership in the Chinese economy, providing a “snapshot” of key features of the state sector, and a review of the growth, efficiency and profitability of state-owned enterprises. The remaining sections (D through J) provide a summary of recent progress in SOE reform. Conclusions are provided in section K.

2. The chapter argues that economic performance in SOEs has declined in the last few years; as evidenced by falling profitability, increasing losses, growing industrial inventories and very low rates of capacity utilization in some sectors. One of the primary reasons has been the dynamic growth of the nonstate sector, which has resulted in greater competition with state enterprises in many industries and exposed the inefficient use of resources in parts of the state-owned economy.

3. Reflecting these developments, there has been an acceleration in SOE reforms during the past two years, particularly in the areas of small enterprise ownership reform and the de facto closing of many loss-making enterprises and release of redundant workers. On the other hand, progress in more difficult areas, such as formal bankruptcies and liquidation, reducing the outstanding stock of state enterprise debt, and changing the ownership structure of medium and large SOEs, has been slower.

B. Role of SOEs in the Chinese Economy

4. Summary figures for state ownership in China are given in Table I.1.2 The broadest aggregate covering state-owned entities is “state-owned units” (SOUs), which includes government agencies as well as SOEs and state administrative organizations in all sectors. The latest available data show that SOUs numbered around 1.4 million at end-1993. Within SOUs, SOEs refer to production centers in agriculture, industry and construction, as well as service sectors such as transportation, communications, trade and financial services. State entities in other services sectors (social services, health care, education and culture, scientific research as well as government agencies) are considered “state administrative institutions.”3

Table I.1.

China: State-Owned Enterprises: Basic Indicators

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Source: State Statistics Bureau, State Asset Management Bureau and IMF staff estimates

Staff estimates

Excluding government employment as well as employment in social, cultural, medical and scientific activity

5. At end-1995, there were over 300,000 state-owned enterprises in the Chinese economy. Total employment in SOEs was 80 million at end–1995, or 13 percent of the economically active population. In the aggregate, SOEs accounted for an estimated one-third of China’s gross domestic product.4 The state enterprise sector also plays a key role in fiscal operations, contributing around 70 percent of general government budget revenue in 1995.

6. In addition to their core products or services, most medium and large state enterprises—as well as many small SOEs—provide an extensive range of social services, such as housing, education and medical facilities, which have posed a significant burden on enterprise finances.5 While exact figures are not available, the cost of providing such services has been estimated to comprise almost half of the total wage bill for many enterprises (with housing alone costing as much as 40 percent). At end-1995, industrial SOEs with independent accounting systems employed nearly 1.5 million workers, or 4 percent of their total workforce, in such “non-productive” activities; the share of total SOE assets used in “nonproductive” uses may be as high as 15–20 percent. Another social “service” provided by SOEs is the retention of excess labor; of total SOE employment of 80 million, estimates of “redundant” labor (including labor which has in fact been laid off) run as high as 20 million, or one-fourth of the workforce. This not only lowers production efficiency and raises costs, but also saddles SOEs with relatively high unfunded pension liabilities.6

The following is an overview of state ownership by sector:

Agriculture

7. The role of state-owned production units is relative minor in agriculture, being confined primarily to state-run farms. At end-1995, these numbered around 2,000, employed roughly 5 million workers and produced gross output of some Y 58 billion, or 2.8 percent of total agricultural output. Including another 1 million state workers outside of state farms, in 1995 state employment in agriculture was only 1.9 percent of the total agricultural workforce.

Industry and construction

8. Table I.2 provides indicators on state ownership in the industrial sector. At end-1995, the 118,000 industrial SOEs, included about 4,700 “large” enterprises and 11,000 “medium” enterprises with independent accounting systems.7 Of the total, 7,300 are administered by the central government, with the remaining 110,000 administered by provincial and local governments. Industrial SOEs account for an estimated one-half of total value added of stateowned enterprises, and fixed assets of industrial SOEs make up nearly two-thirds of total SOE assets.8

Table I.2.

China: State-Owned Industrial Enterprises: Key Indicators, 1985-96

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Sources: State Statistical Bureau; and staff estimates.

Figures for state-owned enterprises compiled by the State Statistical Bureau reflect different aggretation methodology than that used by the State Asset Management Bureau (Table I.1).

For enterprises at the township level and above with independent accounting systems.

Gross output figures for 1995 and 1996 are adjusted upward for consistency with previous years’ data.

Staff estimates.

Figures for value added are reported in constant-price terms; the nominal figures shown here are adjusted by the industrial GDP deflator

9. On average, industrial SOEs are larger than their nonstate counterparts. While making up only 1.6 percent of the total number of industrial enterprises, they accounted for one-third of industrial employment, gross industrial output and industrial value added (Table I.2). Among independent industrial enterprises at the township level and above, SOEs accounted for roughly half of employment, gross output and value added, and two-thirds of fixed assets.9

10. As the above figures indicate, industrial SOEs are more capital-intensive than enterprises in the nonstate sector. An examination of the sectoral breakdown of state ownership within industry (Table I.3) shows that SOEs are relatively concentrated in heavy industrial and industrial inputs sectors, while nonstate ownership predominates in light industry and finished goods manufacturing. For example, at end-1995, SOEs accounted for over three-fourths of the value of gross output in petroleum and natural gas extraction and processing, coal mining and processing, and electric power production, and over half of the value of gross output in metals mining and smelting, raw chemical processing and transportation equipment. Meanwhile, the lowest shares of SOE output were recorded in sectors such as finished garments, furniture, electronics and plastics products.10 Overall, SOEs accounted for 56 percent of heavy industrial production, compared to 35 percent of light industrial production.11

Table I.3.

China: State-Owned Industrial Enterprises by Sector 1/2/

(In billions of yuan)

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Source: State Statistical Bureau.

Data for enterprises at the township level and above with independent accounting system for 1995.

Gross output figures in the table differ form those in Table I.2 due to the fact that sectoral gross ouptut is reported net of VAT for 1995.

11. The regional distribution of state-owned industrial enterprises is shown in Table I.4. The highest concentration of SOEs (according to shares in gross output) is in the relatively poor inland provinces, as well as the northern “big three” industrial provinces (Liaoning, Jilin and Heilongjiang). Meanwhile, the four most developed coastal provinces (Jiangsu, Guangdong, Zhejiang and Fujian) have SOE shares of less than 30 percent of total industrial output.

Table I.4.

China: SOE Industrial Concentration by Region, 1995

(In billions of yuan) 1/

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Source: State Statistical Bureau

Data for enterprises at the township level and above with independent accounting systems.

12. In the construction sector, state-owned construction enterprises numbered approximately 7,500 at end-1995, or 8 percent of the total number of construction units. These enterprises employed one-third of the total construction workforce and accounted for one-fourth of total value added. Among formal construction enterprises, construction SOEs accounted for half the work force, two-thirds of gross output and value added, and three-fourths of recorded fixed assets.

Services

13. At end-1993, there were 189,300 SOEs in the services sector, comprising some 30 percent of total SOE assets, and accounting for an estimated 40–50 percent of value added in services (including value added from state-owned administrative institutions). State enterprise employment in services was 22 million at end-1995, or 32 percent of total employment in “productive” services sectors; SOEs accounted for 35 percent of employment in transport and communications, 25 percent in wholesale and retail trade, and 74 percent in financial services and real estate activities.

14. While data on total output and assets in services sectors are not available, these shares are likely to be higher than the corresponding employment figures. For example, SOEs account for 80 percent of total assets of highway, waterway and ports enterprises, and a similar share of assets in railways, aviation and telecommunications. In wholesale trade, SOEs accounted for over half the total sales value in 1995.

C. Economic Performance of State Enterprises

15. The economic performance of the state-owned sector in China has been the focus of much attention. Since the beginning of China’s economic reforms in the late 1970s, output growth in nonstate enterprises has been much more rapid than SOEs. While the relative dynamism of the nonstate sector has reflected greater efficiency in production, it is not clear whether SOEs have served as positive contributors to the economy or a net drag on resources and growth. Closely tied to this issue is the question of whether SOE inefficiency is the result of state ownership and the planning process per se or other factors such as the current sectoral structure of state production or inherited debt and social welfare burdens.

16. Entering into 1997, these issues have been given increased urgency by what is considered to be a very poor performance in the last two years. Reported net profits of industrial SOEs fell in 1995 and again in 1996, while nominal losses (together with the number of enterprises reporting losses) also increased in both years. Capacity utilization in certain industrial sectors has fallen to extremely low levels, and industrial inventories are estimated to have risen sharply. Meanwhile, there have been large increases in reported layoffs, as well as accumulating wage arrears.

Efficiency and growth

17. Time-series data on the share of the state-owned sector in the Chinese economy are given in Table I.5. The data imply rapid growth in nonstate production, and much more moderate rates of increase in SOEs; between 1985 and 1995, the share of total value added generated by SOEs (excluding state administrative institutions) decreased by about 13 percentage points, from 43 percent in 1985 to close to 30 percent in 1995. At the same time, SOEs accounted for rather higher shares of total input accumulation, as the changes in relative shares of capital and labor inputs were not as marked; the state enterprise share of fixed assets decreased by only 8 percentage points over the same period, and the share in total employment did not change very much.

Table I.5.

China: State Enterprises: Growth Indicators, 1985-95

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Sources: State Statistical Bureau; and staff estimates.

Staff estimates.

Data for enterprises at the township level and above with independent accounting systems; in billions of yuan.

Real growth rates of fixed assets were calculated using the implicit GDP deflator.

18. More detailed data are available for the industrial sector. The annual real growth of industrial output for state and nonstate enterprises is also shown in Table I.5. The table confirms that growth rates in the state-owned industrial sector have been consistently lower than other ownership forms. Between 1990 and 1995, real SOE industrial output grew at an average annual rate of 7 percent, while output in nonstate enterprises grew at over 30 percent in real terms (similar rates were recorded for the growth of value-added). Reflecting these trends, the share of SOEs in total industrial output declined from over 65 percent in 1985 to under 35 percent in 1995—while the share in industrial employment fell only from 44 percent to 37 percent.

19. For industrial enterprises with independent accounting systems, the state-owned sector also grew on average by 7 percent in real terms between 1990 and 1995, while nonstate output increased by nearly 30 percent per year. As regards input growth, SOE employment did not increase by very much, while state-owned fixed assets grew by around 9 percent in real terms; at the same time, nonstate firms increased employment by 4 percent per year and their real capital stock by 24 percent.

20. In sum, the data suggest that the nonstate sector has outperformed SOEs in terms of both growth and efficiency. There are two caveats with regard to the evidence on growth, however: first, there are a number of difficulties with the data which tend to understate the growth of inputs in the nonstate industrial sector and overstate input growth in industrial SOEs. For example, agricultural employment figures are thought to include a growing proportion of persons actually engaged in (primarily nonstate) industrial and services activities. Moreover, the reportedly widespread practice of “asset stripping”, or informally transferring state assets to nonstate enterprises, is not adequately reflected in the statistics. There have also been significant informal labor flows out of SOEs, as enterprises which have stopped production, but not yet undergone bankruptcy, may keep workers on their books despite the fact that they have left for nonstate employment. In addition, it is not clear whether fixed-asset investment in smaller nonstate enterprises is adequately captured in official aggregate investment data.

21. Second, the relatively strong performance of nonstate enterprises does not necessarily mean that state enterprises performed poorly or “inefficiently” in an absolute sense. In particular, given that the real growth rate of industrial SOEs’ output lies between that of their (official) labor and capital inputs, it is difficult to determine a priori whether SOEs have experienced negative rates of total factor productivity growth.12

Profitability

22. Comprehensive data on enterprise profits by sector are not available on a time-series basis. However, end-1993 data compiled by the State Asset Management Bureau suggests that SOEs were profitable on the whole, were with net after-tax profits in all sectors totaling almost Y 200 billion, or 6 percent of GDP. At the same time, however, roughly 40 percent of the 280,000 SOEs then extant were loss-making, with gross losses reaching some Y 90 billion. Most of the loss-making enterprises were located in services sectors; however, while only one-fourth of industrial SOEs recorded losses, gross losses of industrial SOEs accounted for one-half of the total.

23. More detailed data on profits and losses over time are available for industrial enterprises with independent accounting systems (Table I.6). There has been a steady decline in both net pre- and after-tax profitability of industrial SOEs as a percentage of gross output since 1993; the decline in net profitability has primarily reflected decreasing gross after-tax profits, as there has only been minimal upward movement in reported losses as a percentage of output.

Table I.6.

China: Indicators of Industrial Profitability, 1985-1996 1/

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Sources: State Statistical Bureau; and staff estimates.

Data for enterprises at the township level and above with independent accounting systems.

24. An examination of Table I.6 yields a number of important additional findings. First, and most notably, nonstate enterprises have also performed poorly in recent years, with both state and nonstate enterprises recording declines of over two percentage points in after-tax profits between 1993 and 1996.

25. Second, recorded declines in both SOE and nonstate pre-tax profitability have been rather larger than those in after-tax profits; the slower decline in net after-tax profits reflects a falling relative tax burden.

26. Third, declining pre-tax profitability contrasts strongly with the stable trend in the gross margin between output and production costs, which suggests the influence of indirect taxes and charges against earnings rather than a worsening of “underlying” economic fundamentals (factors which affect this gap are discussed in Annex I).

27. Fourth, the tax burden of state-owned enterprises is twice as high as that of non-state enterprises; thus, while SOE pre-tax profits were more than 8 percent of output compared to 6 percent for the nonstate sector, after-tax profits of SOEs were only 1 percent compared to over 2 percent for nonstate enterprises.

28. Finally, regardless of ownership type, the figures for after-tax profits and gross losses represent a very small percentage of gross output, so that small changes in the economic environment can give rise to very large fluctuations in reported profitability.

29. At the time, there have been significant differences in performance in individual sectors and enterprises, as can be seen from Tables I.7 and I.8, which provide data for pre- and after-tax profits of individual industrial sectors in 1990 and 1995. The tables show that SOE losses in 1995 were concentrated in small and medium-size enterprises; large SOEs were the only group to maintain after-tax profits roughly in line with their share of gross output.

Table I.7.

China: SOE Industrial Enterprise Profits by Sector, 1990 1/

(In millions of yuan)

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Source: State Statistical Bureau.

Data for enterprises and the township and above level with independent accounting systems.

Ratio of SOE after-tax profits to gross output.

Table I.8.

China: SOE Industrial Enterprise Profits by Sector, 1995 1/

(In millions of yuan)

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Source: State Statistical Bureau.

Data for enterprises and the township and above level with independent accounting systems.

Ratio of SOE after-tax profits to gross output; these figures differ from those in Table I.6 due to the act that sector gross output is reported net of VAT.