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China’s Ownership Transformation: Process, Outcomes, Prospects

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International Finance Corporation Australian National University
China Center for Economic Research Peking University
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The findings, interpretations, and conclusions expressed herein are those of the authors and do not necessarily reflect the views of the Executive Directors of the International Finance Corporation or of the Bank for Reconstruction and Development/the World Bank or the governments they represent.
The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the International Finance Corporation or the World Bank concerning the legal status of any ter- ritory or the endorsement or acceptance of such boundaries.
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ISBNs: 0-8213-6237-2 978-0-0-8213-6237-2 DOI:10.1596/978-0-8213-6237-2
Tenev ... [et al.]. p. cm.
Includes bibliographical references. ISBN 0-8213-6237-2 1. China—Economic policy—1976–2000. 2. China—Economic policy—
2000– 3. Industrial policy—China. 4. Privatization—China. 5. Free enterprise—China. 6. Government ownership—China. 7. Government business enterprises—China. 8. Unemployment—China. 9. Corporate governance— China. 10. China—Economic conditions—1976–2000. 11. China—Economic conditions—2000– I. Garnaut, Ross. II. World Bank.
HC427.92.C42874 2005 330.951–dc22
Overview of SOE Reform in China 2 Focus and Empirical Approach of the Study 11 The Structure of the Study 24
How Far Has Gaizhi Progressed? 25 The Key Participants 31 Theories on Incentives for Gaizhi 38 Empirical Tests 42 Conclusion 45
Forms of Gaizhi 46 Sample Distribution of Forms of Gaizhi 50 Trends and Geographic Variations 54 What Determines the Form of Gaizhi Chosen? 59 The Process and Main Issues Surrounding the Transfer
of State Assets 62 Asset Valuation 67 Dealing with Enterprise Debts and Other Obligations in
the Gaizhi Process 76 Land-Use Rights and Gaizhi 81 Conclusion 86
China’s Emerging Social Security System 87 Government Policy toward Unemployment
in the Gaizhi Process 89 The Impact of Gaizhi on Employment
and Labor Force Structure 95 Gaizhi and Obligations of Firms to Workers 103 Gaizhi and Changes in Compensation Schemes 108 Conclusion 111
Changes in Ownership Structure 114 Ownership and Control 121 Gaizhi and Traditional Stakeholders 127 Gaizhi, Managerial Autonomy,
and Managerial Incentives 133 Gaizhi and Changes in the Relative Influence
of Stakeholders 138 The Role of Outside Investors in Corporate Governance 139 Conclusion 143
Gaizhi, Internal Restructuring, and Financial Discipline 145 Gaizhi and Firm Performance 158 Gaizhi and Time Trends in Performance 170 The Impact of Other Factors on Performance 172 Conclusion 174
The Public Debate about Privatization in China 175 Regulating Gaizhi 181 Strengthening Enforcement 185 Reducing Transaction Costs for Outside Investors 191 Enhancing the Role of the de Novo Private Sector
in China’s Transformation 197 Conclusion 201
China’s emergence as a global economic player has been accompanied by a major internal transformation. Over the past decade or so, the economy has made the transition from complete reliance on state- owned and collective enterprises to a mixed economy where private enterprise plays a leading role. This remarkable transformation has been accomplished through the dynamic growth of the de novo private sector and more recently through privatization.
IFC has been an active participant in this transformation process through investments and technical assistance for private companies and pioneering research on private sector development and enterprise reforms. In 2000, IFC published one of the first studies on the emerg- ing domestic private sector in China. The study analyzed the structure of private enterprise, the enabling environment for its development, and access to financing. It outlined an agenda for entrepreneurs, the government, and the financial sector for addressing constraints to pri- vate sector development. In 2002, IFC jointly with the World Bank published a study on the status and evolution of corporate governance and enterprise reforms in China. The study explored the main corpo- rate governance issues that China has encountered during the course of corporatization and ownership transformation of its enterprise sector.
While China has been implementing reforms in its state enterprise sector over the past two decades or so, reforms have accelerated and have acquired new features since the start of the present century. First, the scale of change has expanded to affect almost every kind of state- owned enterprise—small, medium, large, and very large—under both central and local control. Second, ownership diversification has been so extensive that the role of the wholly state-owned nonfinancial com- pany has declined substantially in many areas. Third, the range of re- structuring mechanisms being used has expanded dramatically to include bankruptcies, liquidations, listings and de-listings, debt-for-
equity swaps, sales to private parties (domestic and foreign), and auc- tioning of state firms, their assets, or liabilities. Finally, large layoffs, something unheard of just five or six years ago, have become a regu- lar phenomenon in corporate restructurings and privatizations.
There has been no systematic study of the magnitude, forms, and consequences of this stage of enterprise restructuring. This book aims to fill this gap by looking at the process, the main players involved, and the outcomes. The empirical analysis is based on a survey of close to 700 enterprises in 11 Chinese cities. The study is a joint venture among the Australian National University, Beijing University, and the International Finance Corporation of the World Bank Group. The former State Economic and Trade Commission of the Chinese gov- ernment facilitated the study for its successful implementation. Funding was provided by AusAid and IFC.
The study sheds new light on the progress that China has made in enterprise restructuring and privatization and on the challenges that en- terprises, investors, and governments are facing in the process. An im- portant finding of the study is that among the various forms of enter- prise restructuring, privatizations involving outside investors have had the strongest positive impact on firm performance. Furthermore, the analysis finds that outside investors deliver improvements in perfor- mance more quickly than other forms of restructuring. The study shows that the private sector is emerging as an important player in the re- structuring of SOEs but argues that its role could be enhanced further.
The International Finance Corporation has been playing an active role in supporting the growth of the private sector in China. Our cu- mulative investments in China since 1985 are approaching $2 billion in over 80 companies. The size and the breadth of IFC’s program in China are in many ways a function of the level of development of the private sector in the economy. When the private sector was mostly small and informal, and the industrial and financial sectors were dom- inated by SOEs and joint ventures with foreign private investors, IFC’s China program consisted largely of industrial projects sponsored by foreign investors. A number of these projects were in effect restruc- turings of state-owned enterprises through the injection of funds and modern technologies from foreign investors. IFC had an important role to play as a provider of long-term project financing that was not otherwise available for private projects.
The emergence of the domestic private sector has given us new op- portunities to broaden our program to include support for local fi-
nancial institutions, indigenous industrial and infrastructure enter- prises, and small and medium businesses. The dynamic growth of the domestic private sector is creating the jobs needed to absorb laid-off workers from restructuring state enterprises. It is therefore a major positive force in the restructuring process.
Today we see the biggest investment opportunities in China with domestic private companies. These businesses are driving the rapid growth of the economy as they strive to expand and become more so- phisticated. Increasingly, domestic private companies in China are looking at acquisitions of SOEs as their main growth strategy. A num- ber of our projects demonstrate how a privately managed company can transform an ailing state enterprise into a profitable business that contributes to the local economy.
The study has benefited from the knowledge accumulated through our investment and technical assistance experience in China. Its find- ings also provide us with new ideas on how to continue to support the process of enterprise restructuring. I hope that investors, policy mak- ers, opinion leaders, journalists, and all those interested in the status of China’s enterprise reform can also learn from the study. And I hope that this study contributes to the further progress of enterprise re- structuring in China.
Javed Hamid DIRECTOR
Gaizhi, a Chinese term meaning “transforming the system,” has be- come a major phenomenon in most parts of China. The restructuring of state enterprises has accelerated in recent years to include bank- ruptcies, liquidations, listings and delistings, debt-for-equity swaps, sales to private parties (domestic and foreign), and auctioning of state firms and their assets or liabilities. In many cases gaizhi has involved full privatization. Gaizhi programs in China have been gradual and low profile, but in many ways as far reaching as, and generally eco- nomically more productive than, privatization measures in Eastern Europe and the former Soviet Union.
Reforms have been most dramatic in the industrial sector where the number of state-owned enterprises has declined from 114,000 in 1996 to 34,000 in 2003. According to our estimates, about half of the decline is due to privatizations. Privatization in China has not been limited to small enterprises only: the average size of privatized SOEs is about 600 employees. The process has been socially painful: around 30 million SOE workers have been laid off since 1998. A dynamic de novo private sector has been able to absorb most of the laid off work- ers, thus alleviating the social cost of restructuring.
Gaizhi and the growth of the de novo private sector have trans- formed the structure of the Chinese economy. Over the past decade or so, the economy has made the transition from complete reliance on state-owned and collective enterprises to a mixed economy where pri- vate enterprise plays a leading role. We estimate that the private sec- tor, narrowly defined, has become the largest sector of the Chinese economy, accounting for about 37 percent of gross domestic product in 2003. Overall, the nonstate sector accounted for two-thirds of China’s GDP in 2003.
Gaizhi is not a one-off event but a continual process of reforms and restructuring. As of October 2004, about 40 percent of SOEs were
making losses, compared with 18 percent for the nonstate sector. Enterprise reforms in China still have a long way to go.
There has been no systematic study of the magnitude, forms, and consequences of gaizhi. This book aims to fill this gap by looking at the process, the main players involved, and the outcomes of gaizhi. The empirical analysis is based on a survey of close to 700 enterprises in 11 Chinese cities.
Because gaizhi involves a comprehensive transformation of the state sector, which had been the foundation of the Chinese economy, a number of players have stakes in the process. Our analysis shows that local governments and enterprise managers have been the most active proponents of reforms with managers assuming a leading role in later rounds of restructuring. The government considers preserving social stability and protecting the welfare of state employees a top pri- ority in SOE restructuring. Therefore, concerns about the social and fiscal implications of redundancies tend to constrain the pace of pri- vatization. Consistent with this finding, firms with greater net assets are easier to privatize because they can compensate workers. Similarly, cities with stronger financial capacity tend to privatize more aggres- sively because they can absorb a greater portion of the social costs of restructuring. As a result, better-performing SOEs are likely to be pri- vatized first, and there are significant regional variations in the pace and scope of enterprise reforms. A dynamic de novo private sector makes it easier to absorb redundant workers and therefore reduces the cost of restructuring. We find that the level of development of the de novo private sector has been the most important macroeconomic fac- tor leading local governments to release SOEs into private hands.
While gaizhi can be held back by fear of labor redundancies, it is often the only way to check job losses in the state enterprise sector. An important result of our analysis is that gaizhi and privatized firms have maintained a lower rate of employment reduction and a higher rate of wage growth than non-gaizhi and fully state-owned firms. Consistent with the conventional belief, gaizhi firms discharged more workers in the year when gaizhi was implemented, but in subsequent years and overall they were able to retain more workers than non-gaizhi firms.
Gaizhi firms were able to limit job losses because restructuring has brought efficiency gains. We find that gaizhi has a positive impact on firm profitability, although a weak or insignificant impact on unit cost and labor productivity. Privatizations involving outside investors have the strongest positive impact on firm performance. Furthermore, out-
side investors deliver improvements in performance more quickly than other forms of gaizhi: their positive impact tends to appear early in the reform process.
Interestingly, we find that SOEs as outside investors also tend to have a strong positive impact on firm performance. China’s experience shows that SOEs with a relatively high degree of autonomy in the mar- ket process may have difficulty in putting reforms into effect in their own enterprises but can be effective agents of change in other state en- terprises.
Gazhi has brought efficiency gains by aligning incentives and re- allocating decision-making powers within the firm. We find that gaizhi firms are more likely than non-gaizhi firms to provide managers with shares and bonuses. Shareholder representation on the board of direc- tors of gaizhi firms has improved, and power sharing among the share- holders’ conference, the board of directors, and the management has begun to occur. The influence of the Communist Party over the firm tends to decline after gaizhi, but the role of the labor union in collective wage bargaining is more clearly defined and enhanced. We find that the government is retreating from the privatizing firms by reducing its own- ership share, while the share of insiders has been increasing rapidly.
The dominance of managers appears to be the main corporate gov- ernance issue of gaizhi firms. Managers tend to be overrepresented at the boards of directors and maintain decisive influence on key issues. What players and institutions are emerging to control the agency costs of managerial autonomy? Survey results indicate that outside investors are more likely to use and rely on the new mechanisms of corporate control, to provide effective checks and balances on managerial discre- tion, and to offer high-powered incentives to senior managers. In gen- eral, the presence of outside investors is associated with a reduced role for traditional stakeholders such as the government, the Party, and the labor union. These traditional stakeholders have less significant roles in outsider-controlled firms than in insider-controlled firms.
Thus one important result of our analysis is that privatizations in- volving outside investors are generally more productive than other forms of privatization and gaizhi. Yet, privatization in China does not exhibit a clear trend in the direction of a greater role for outside in- vestors. While on average the ownership share of insiders has grown rapidly in recent years, outsiders’ share has remained largely stagnant. In our sample of firms, insiders held 5 percent of privatizing firms’ shares in 1995. In 2002, their share had risen to 32 percent. Over the
same period, the combined share held by domestic and foreign private companies has remained at about 20 percent.
Insider privatization could be subject to greater conflicts of inter- ests than other forms of gaizhi, especially given the major role that en- terprise managers play in initiating and implementing restructuring programs. Media reports on irregularities in insider privatizations and particularly management buyouts (MBOs) have raised public concerns about lack of fairness and transparency of the privatization process in China. In response, the government has promulgated a host of regula- tions aimed at establishing an orderly process of ownership transfor- mation, and at expanding the role of outside investors. A policy pri- ority is to enhance the involvement of the private sector, both domestic and foreign, in the restructuring and privatization of SOEs.
We already observe a change in the role that the domestic private sector is playing in China’s state enterprise reform. Historically, the private sector has been supporting restructuring largely indirectly by creating the jobs needed to absorb laid-off workers. While this indi- rect role will continue to be important, domestic private enterprises are emerging as significant players in the privatization process. A growing number of de novo private firms have begun to look at acquisitions of SOEs as their main growth strategy. These private companies have been injecting capital and dynamism in moribund state enterprises thus helping to preserve jobs. While private enterprises are becoming more active in acquiring and restructuring state-owned enterprises, they still account for a small share in all gaizhi cases.
China’s approach to state enterprise reform has been extremely pragmatic. Ownership change is not seen as an end in itself nor is it seen as the automatic solution to inefficiency problems in the state en- terprise sector. Local governments are primarily interested in aspects such as tax revenues, growth and employment. Looking for ways to obtain these results, they have been experimenting with institutional reforms. In the process, local governments have found that the way to deliver tax revenues, growth and employment to their constituencies is by opening more room for private enterprise. Enhancing the role of private companies in SOE reform will require, however, sustained ef- forts from both the government and the private sector to improve the business environment for entrepreneurship and move private enter- prises toward global best practice.
The State Economic and Trade Commission (SETC, now part of the National Development and Reform Commission) facilitated this study. Wang Hailin, director, and other SETC staff provided valuable guid- ance and support throughout. Extensive assistance was provided by Karin Finkelston, IFC’s associate director for China in Beijing. IFC staff Jianguo Cui and Wenqin Zhu played a key role in organizing and co- ordinating the contributions of the various parties involved. Rana Ganguly managed the project from the Australian National University side. The study was funded by AusAid and IFC’s Trust Funds.
Xiaolu Wang (Australian National University and the National Economic Research Institute), Yu Sheng (Australian National University), and graduate students from the China Center for Economic Research at Beijing University contributed to the technical report on the field work.
Survey findings were presented and discussed at a workshop orga- nized by the International Finance Corporation in March 2003 in Beijing. Wang Hailin and Tian Chuan (SETC), Chunlin Zhang and William P. Mako (World Bank), Omar Chaudry (IFC), and Robin Scott-Charlton and Michael Willcock (Australian Embassy in Beijing) provided valuable comments at the workshop.
A draft of the study was presented and discussed at a workshop in Beijing organized by the International Finance Corporation in March 2004. At the workshop, An Chongli (Asian Development Bank), Liu Xiaoxuan (Chinese Academy for Social Sciences), Davin Mackenzie (iVentures L.L.C.), Ping Xingqiao (China Center for Economic Research), Tian Chuan (National Development and Reform Commission), Richard Yu (AusAid), Strahan Spencer (Department for International Development), Wang Liming (National Development and Reform Commission), Wang Xiaolu (National Economic Research Institute), Wang Zhongjing (Ministry of Finance), Yang
Yiyong (Central Party Academy), Zhang Chunlin (World Bank Group), Zhang Shuguang (Chinese Academy of Social Sciences), and Zhang Weiying (Guanghua School of Management, Peking University) made useful comments and suggestions. Andy Rothman of CLSA pro- vided valuable comments that enriched the final study.
The study also benefited from comments and insights from IFC and World Bank staff, including Bernard Sheahan, Sanjay Grewal, Sunita Kikeri, and Peter Taylor. Udayan Wagle, Mwaghazi Mwachofi, Mariko Higashi, Maria Cussianovich, Aminata Mbodj, Michael O’Neill, Bayo Oyewole, Amber Turner, Wai-Keen Wong, and Frederick Wright supported the study through funding from IFC Trust Funds. Lixing Li from the University of Maryland provided valuable re- search assistance. Robyn Flemming edited the text, and Garry Cousins prepared the index. Special thanks to Dana Lane for her excellent man- agement of the publication process.
Abbreviations and Acronyms
ABC Agricultural Bank of China AMC assets management companies BOC Bank of China CCB China Construction Bank CCP Chinese Communist Party CEO chief executive officer CSRC China Securities Regulatory Commission DCD discounted dividends DCF discounted cash flow DRC Development Research Center ETC economic and trade commissions FDI foreign direct investment FIE foreign-invested enterprise GDP gross domestic product ICBC Industrial and Commercial Bank of China IPO initial public offering M&A mergers and acquisitions MBO management buy-out MOF Ministry of Finance NPC National People’s Congress NPL nonperforming loan PAYE Pay As You Earn PER price-earnings R&D research and development ROA return on assets SARS Severe Acute Respiratory Syndrome SASAC State-owned Assets Supervision and Administration Commission SASMC State Asset Supervision and Management Commission SETC State Economic and Trade Commission SME small and medium enterprises SOE state-owned enterprise SPC Supreme People’s Court TVE township and village enterprise
1 Introduction
The recent emergence of China as a global manufacturing powerhouse and the world’s top destination for foreign direct investments (FDI) is attracting considerable attention from policy-makers and the media. In fact, China’s rise to economic prominence is viewed as the economic event of our age (Wolf 2003). Chinese companies are expanding their presence abroad, building internationally known brand names and trans- forming global production networks.
China’s emergence as a global economic player has been accom- panied by a major internal transformation. Over the past decade, the economy has made the transition from complete reliance on state- owned and collective enterprise to a mixed economy where private en- terprise plays a leading role. This is an ongoing process, during which the economy will remain structurally a very diverse one. While some Chinese companies are in the vanguard of globalization, many are struggling with old legacies of planning. And to use a military metaphor, it is dangerous for the vanguard of the army to get too far ahead of the rear-guard. Thus, in these times of optimism and dynamism, increased attention must be given to solving the problems of the state-owned sector.
Gaizhi, a Chinese term meaning “transforming the system,” has become a major phenomenon in most parts of the country; in many cases it has involved full privatization. Unlike the mass privatization programs that have occurred in Eastern Europe and the former Soviet Union since the late 1980s, gaizhi programs in China have been grad- ual and low profile. The significance of the Chinese reforms should not be underestimated, however. In many ways they have been as far- reaching as, and generally more economically productive than, those in Eastern Europe and the former Soviet Union.
Overview of SOE Reform in China
Reform of China’s state-owned enterprises (SOEs) has been a major aim since urban reforms began in 1984. Although there were calls to privatize the SOEs, the government’s initial emphasis was on boosting performance by changing the internal governance of SOEs and im- proving the market environment in which they operated.
Inspired by the success of the rural household responsibility system, the government introduced a contracting system into the state sector that required SOE managers to meet various performance targets— including targets for sales, profitability, and capital accumulation—in return for a share of the profits. The success of the enterprise thus depended on the efforts that managers were prepared to make. The main problem with this system was that managers were rewarded for their successes but not credibly penalized for their failures.
By the late 1980s the government had decided that the best way to reform small SOEs was to lease them out, with the manager paying the state a fixed proportion of the firm’s profit. The first significant lease contract was to the Wuhan Motor Engine Factory in 1986, when three people put up RMB34,000 as collateral to lease the factory. In May 1988 the State Council issued a regulation on the leasing of small SOEs.1 A direct consequence was that managers could be recruited from outside the enterprise. In many cases, leasing led to the de facto privatization of township and village enterprises (TVEs). After several years the accumulated and contributed capital of the manager would outweigh that of the local government, and the firm would be effectively owned by the manager.
Incorporation was another significant measure that led to priva- tization. At first the government restricted incorporation to the exchange of shares among the SOEs; soon, however, private shareholding was allowed. The first cases of private shareholding were in three Guangzhou SOEs in 1986, when the employees bought 30 percent of the shares of their firms. The first large SOE to be incorporated was the Shenyang Motor Corporation, which became Shenyang Jinbei Motors when it issued shares to the public in August 1988.
1. The Tentative Regulations on the Lease of Small State-Owned Industrial Enterprises, State Council, May 20, 1988.
The opening of the Shenzhen Stock Exchange in 1990 and the Shanghai Stock Exchange in 1991 enabled SOEs to issue shares to the public. The Chinese government ensured that it would not lose con- trol of listed SOEs, however, by requiring that a proportion of the state’s shares in the firm could not be sold.
Privatization started in earnest after a visit by Deng Xiaoping to southern China in 1992. As with many other reform initiatives, priva- tization started at the local level and was later sanctioned by the central government. The most important impetus for privatization in the lo- calities was the large amount of debt built up by the state sector. The level of debt was a more pressing problem in small cities. For example, in Zhucheng city, Shandong province, 103 of the 150 SOEs were in the red at the end of 1992, with losses amounting to RMB147 million— equivalent to the revenue of the city government over 18 months (Zhao 1999). The Shunde government, in Guangdong province, also encoun- tered a debt problem when it first started privatizing its SOEs in 1992. Most local governments decided that it would be possible to privatize only small firms, but Shunde and Zhucheng went further by privatiz- ing almost all of their state and collective firms (Huang and Wei 2001; Yao 2003).
In 1995, after extensive discussion, the central government de- cided on the policy of zhuada fangxiao, or “keep the large and let the small go.” The state decided to keep between 500 and 1,000 large state firms and to allow smaller firms to be leased or sold.2 There were good reasons for this decision. In 1997 the 500 largest state firms, most of them controlled by the central government, held 37 percent of the state’s industrial assets, contributed 46 percent of the taxes collected from state firms, and earned 63 percent of the profits of the state sec- tor. Small firms owned by local governments had been performing poorly. In 1995, 72.5 percent of local firms, but only 24.3 percent of central government firms, were unprofitable (Zhao 1999). As Vice Premier Wu Bangguo said in a speech in December 1997, “Control of
2. In 1994 the ministry in charge of government economic affairs, the State Economic and Trade Commission (SETC), sent a report entitled “Suggestions on Revitalizing Small State-owned Enterprises” to Vice Premier Wu Bangguo, who was in charge of enterprise reforms. In September 1995 the policy was formally announced by the Central Committee of the Chinese Communist Party (CCP) in one of its plenaries and went forward as a suggestion for the ninth five-year plan.
the [500] largest firms means we have a control of the largest chunk of the state economy” (Zhao 1999).
From the “let the small go” part of the policy came the term “gaizhi,” meaning “transforming the system.” An important part of gaizhi was the order issued in March 1998 for “red hat” firms—that is, firms registered as collectives but in reality privately run3—to “take off their red hats” by the following November.
Privatization first commenced in rural areas. Many localities— including those renowned for the success of their collective enterprises, such as Shunde and southern Jiangsu—implemented privatization on a massive scale. Early in the reform era, the impressive growth of the TVEs had been hailed as proof that, contrary to conventional eco- nomic theory, clearly defined property rights were not essential for de- velopment (for example, Weitzman and Xu 1994). As the growth of the TVEs slowed, the disadvantages of their vaguely defined property rights became clearer. Like their urban counterparts, the TVEs faced soft budgets, and the resulting build-up of nonperforming loans (NPLs) placed a considerable burden on local governments (Zhang 1998).
By the end of 1998, more than 80 percent of state and collective firms at the level of the county or below had gone through gaizhi, which involved direct privatization in most cases (Zhao 1999). Most of these firms were TVEs. The pace of reform has accelerated in recent years, and it is likely that TVEs will soon disappear, proving to have been an important but transitional institution in China’s march to market.
In the cities, gaizhi has occurred in two waves. Reform started in the mid-1990s and followed the model of employee shareholding adopted by Zhucheng. When Zhucheng abandoned this model and moved toward concentrated ownership through management buy-outs (MBOs), other cities followed suit. The trend reflected the belief that, for an enterprise to be truly transformed, it is necessary for manage- ment to own the majority of shares. Forms of MBO have been the most common model in the second wave of gaizhi and have spread to very large firms, such as the SOEs listed on the stock market. Privatization has been accepted as the key for urban reform, and the slogan “the state retreats and the private sector moves forward” has become com- mon in many cities.
3. On the “red hat” phenomenon, see Gregory, Tenev, and Wagle (2000).
Since the start of the present century the reform of China’s state enterprise sector has accelerated and acquired some qualitatively new features. First, the scale of change has expanded to affect almost every kind of SOE—small, medium, large, and very big; under both central and local control. Second, ownership diversification has been so ex- tensive that the wholly state-owned nonfinancial company has become an endangered species in China’s business ecology. Third, the range of restructuring mechanisms being used has expanded dramatically to in- clude bankruptcies, liquidations, listings and de-listings, debt-for-equity swaps, sales to private parties (domestic and foreign), auctioning of state firms and their assets or liabilities, standard corporate governance techniques, and so on. Finally, mass layoffs—unheard off just four or five years ago—have become a widespread phenomenon.
At the grassroots level, local governments have been particularly active in implementing corporatization and ownership diversification in SOEs—the most decisive actions for grappling with the financial burdens and unemployment pressures resulting from loss-making SOEs. A national survey in 1998 showed that a quarter of China’s 87,000 industrial SOEs had been through some phase of gaizhi, while another quarter planned to take some measure of gaizhi. Among the gaizhi firms, 60–70 percent had been partially or fully privatized.4 A 2001 national survey of industrial SOEs estimated that 86 percent had been through gaizhi by the end of 2001 and about 70 percent had been partially or fully privatized.5 The research in this book will show that half of the six cities chosen for interviews planned to go through gaizhi by the end of 2003. In addition, the share of partially or fully privatized firms had risen to more than 70 percent. If this per- formance typifies that of the rest of the country, then privatization in China has already gone further than in many Eastern European and former Soviet Union countries.
In terms of larger SOEs, around 1,400 companies have been listed over the last decade. Their market capitalization is about 40 percent of gross domestic product (GDP),6 and their 65 million or so individ- ual shareholders have become increasingly assertive over the years.
4. Unpublished report of the National Bureau of Statistics. 5. Unpublished report of the SETC. 6. Standard & Poor’s, “Emerging Stock Markets Review: Performance, Valu- ations, and Constituents,” Emerging Markets Database, December 2004.
The regulator, the China Securities Regulatory Commission (CSRC), has stepped up efforts to strengthen corporate governance practices among Chinese listed companies. Of systemic importance for China is the process of divesting state assets through initial public offerings (IPOs) to fund the national social security system.
Some restructuring of SOEs is occurring through the four asset management companies (AMCs) that have been created to take more than $170 billion7 in nonperforming loans from the big four state- owned banks.8 As part of their program, 580 SOEs, accounting for about 40 percent of the state sector’s assets and sales, have been se- lected for debt-equity swaps. The AMCs have emerged as important, and often majority, shareholders in a number of large SOEs. The AMCs have multiple objectives; thus the desire to maximize immedi- ate financial returns to government may conflict with the need for meaningful restructuring of the firms in their portfolios (Steinfeld 2001). Recent regulatory measures, however, that make it easier for foreign investors to buy significant and controlling shares in SOEs are likely to expand the exit options for these AMCs and to create more opportunities for diversification of state ownership through them.
The Chinese government has implemented industry rationaliza- tion programs in a number of industries, closing obsolete plants and reducing capacity to combat oversupply and deflationary pressures. The initiative has so far shown mixed results. In many industries, for each unit of closed capacity several additional units have been created. For example, in the glass industry, in the past few years the govern- ment has closed down 240 small production lines, reducing capacity by 28 million-weight cases. In the meantime, however, 39 bigger and more modern production lines have been built that will increase ca- pacity by 88 million-weight cases, or 32 percent of total production in 2000. Similar stories are reported in textiles and other sectors.
In the strategically important infrastructure and energy sectors where the regulatory framework is still evolving, monopolies have been broken and competition has been introduced. Many companies have been corporatized, and some have been listed on local and inter-
7. All dollar amounts are U.S. dollars. 8. The “big four” are the Agricultural Bank of China (ABC), the Bank of China (BOC), China Construction Bank (CCB), and the Industrial and Commercial Bank of China (ICBC). Together they account for about two-thirds of China’s financial assets.
national exchanges. China has nurtured over 20 giant corporations and conglomerates that have proven competitive in the inter- national market. Some of these companies are laying off tens—or even hundreds—of thousands of employees, not because they are in finan- cial distress (some of them are hugely profitable) but because they wish to position themselves as important international players. As of 2002 the top 12 Chinese transnational corporations, mainly SOEs, con- trolled over $30 billion in foreign assets and had some 20,000 foreign employees and $33 billion in foreign sales.
To address the issue of fragmented management of state assets (Tenev et al. 2002, 26), China established the State-owned Assets Supervision and Administration Commission (SASAC) in March 2003. SASAC acts simultaneously as a shareholder, regulator, man- ager, and supervisor of state assets.
Thus both the scale and scope of transformation have been ex- traordinary. Table 1.1 illustrates the changes that have taken place in China’s industrial sector and in the relative position of SOEs in the economy. Since 1999 the number of SOEs has been reduced dra- matically and they now account for only 15 percent of all industrial enterprises. The decline in the SOEs’ share in total industrial assets has been much less dramatic, however. As of October 2004, SOEs still accounted for more than half of total assets. Although fewer in number, SOEs have become bigger in China. Already larger than the average nonstate enterprise, SOEs have grown much faster over the period—2.5 times, versus 1.4 times for nonstate enterprises. Their share in total enterprise assets has remained roughly constant over the period, at about 50 percent. One notable achievement of enter- prise reforms has been the improved profitability of the SOE sector. The return on state-owned assets has improved, and the profitabil- ity gap between state and nonstate enterprises has narrowed some- what. Reforms still have a long way to travel, however: as of October 2004, about 40 percent of SOEs were making losses, compared with 18 percent for the nonstate sector.
This process of transformation of China’s state sector has led to social unrest and will continue to be socially painful. Around 30 million SOE workers have been laid off since 1998 and, according to the official government statistics, 8.7 million of these have not found new jobs. The number of labor disputes of all kinds rose by 12.5 percent in 2000, and by another 14.4 percent in 2001 to reach 155,000. In 1999 there were 6,767 collective actions (usually strikes or go-slows with a minimum
Loss- making
Average Loss- nonstate SOE asset size Average SOE ROA making enterprises
Total Total SOEs as assets as nonstate asset size profits as nonstate SOEs (% of No of assets profits % of all % of total enterprise SOEs % of total enterprise ROA (% of all non-
Year enterprises RMB bn RMB bn enterprises assets (RMB mn) (RMB mn) profits sector SOEs all SOEs) SOEs)
1999 154,882 11,238 220 37 68 36 134 44 3.5 1.3 41 22 2000 158,749 12,398 426 34 67 39 155 56 4.6 2.9 35 19 2001 168,799 13,418 466 28 65 39 184 50 5.0 2.7 36 19 2002 178,876 14,479 562 24 62 40 210 47 5.4 2.9 35 17 2003 193,483 16,707 815 19 57 46 260 46 6.1 4.0 36 15 2004 212,648 18,984 913 15 53 50 317 49 5.2 4.5 40 18
NOTES: Data for 2004 are until October 2004; ROA is Return on Assets in percent. SOURCE: CEIC.
of three people taking part) involving 251,268 people, an increase of 900 percent relative to 1992. Since 1999 the number of collective disputes has been increasing by about 20 percent per year (see figure 1.1). In the first half of 2004 alone, labor dispute arbitration committees at various levels accepted 135,000 labor dispute cases and handled 6,440 collective labor disputes, which involved 184,000 persons—considerably more than in the past.9 Given the magnitude of the layoffs, however, the level of labor unrest is not extraordinary. In fact, labor seems to be accepting these changes. State employees—perhaps the most powerful interest group in China—refused for some time to accept layoffs but now accept the severance packages. What might explain the change in attitude?
Two economic factors have emerged as being of critical impor- tance in alleviating the social cost of restructuring: the development of the national social security system (there has been a significant in- crease in central budget expenditures in social security in recent years: from 1 percent in 1997 to 6.3 percent in 2002), and promotion of the
Collective labor disputes
1995 1997 1999 2001 2002 2003
FIGURE 1.1 Number of People Employed and Number of Collective Labor
Disputes in State-Owned Enterprises in China, 1995–2003
Note: Data for 2003 are extrapolated from half-year data. Sources: CEIC, National Bureau of Statistics of China; People’s Daily.
9. “Labor disputes on the rise,” People’s Daily, November 1, 2004, http:// english.people.com.cn/200411/01/eng20041101_162341.html.
Year controlled (official)a (official)b (official) (official)c (real)d (real)e Agriculture Nonstate
1998 41 22 12 8 20 26 31 18 59 1999 40 20 13 10 23 26 33 17 60 2000 39 18 14 12 26 28 36 17 61 2001 38 17 16 13 29 29 38 16 62 2002 36 14 19 14 33 31 40 16 64 2003 34 13 22 15 37 34 44 15 66
a. Official collective firms include “red hat” firms as well as gaizhi firms that are actually private firms. b. Domestic private firms include formally registered private firms and getihu. c. Includes official domestic and official foreign private firms. d. Includes collective firms that are in effect private, assuming they account for half the official collective firms (Gregory, Tenev, and Wagle, 2000) and foreign firms that are in reality domestic private firms, assuming they account for a third of the official foreign firms. e. Includes real domestic and real foreign private firms. f. Includes agriculture, which is almost 100 percent private, collective and private firms. SOURCE: Calculated according to a sector-based approach, which derives ownership shares in GDP based on their shares in each of the fol- lowing sectors: farming, forestry, husbandry, and fishery; mining and quarrying; manufacturing; production and supply of electricity, gas, and water; geological prospecting; transportation and communication services; retail trade and catering services; finance and insurance; real estate; social services; education; scientific research; government services; and others.
Estimates about ownership shares in the GDP of the respective sectors are based on available official data on ownership: shares in sector em- ployment and/or sector output, in effect assuming similar levels of productivity across ownership types. All the original data are from Stastical Yearbook of China, 2004.
The methodology and approach are similar to the ones used in Gregory, Tenev, and Wagle, 2000, who provide estimates for ownership shares in GDP for 1998. Here, calculations for 1998 are redone using latest available data. Differences between the current estimate for 1998 and the estimates in Gregory, Tenev, and Wagle are also due to some changes in assumptions; for instance, shareholding firms were included in the private sector share in the 2000 estimates, while here we count shareholding firms as state controlled.
growth of the new private enterprises to absorb workers laid off from the state sector.
Gaizhi and the growth of the de novo private sector have trans- formed the structure of the Chinese economy. Table 1.2 presents esti- mates on the composition of China’s GDP by ownership types for the period 1998–2003. Over the period the share of the official private sector in GDP increased from 20 percent in 1998 to 37 percent in 2003. The private sector is now the dominant sector of the Chinese economy. The share of the private sector is probably even larger if we take into account that a significant percentage of the collective firms are in effect privately controlled and that the private sector is in general more pro- ductive than the other sectors of the economy.
The main question posed by this major, and still unfolding, trans- formation is whether China will succeed in its efforts to reform the state sector and to maintain the delicate balance between tackling its legacy problems while promoting the new sources of growth.
Focus and Empirical Approach of the Study
To shed some light on this question we need a better understanding of the gaizhi process. There has been no systematic study of the magnitude, forms, and consequences of gaizhi. This book aims to fill this gap by look- ing at the types of reforms, their evolution, the key players and the motiv- ations for their decisions, and some outcomes of the gaizhi process.
The analysis is based on a survey of close to 700 enterprises in 11 Chinese cities. The survey was conducted from December 2002 to April 2003. The latest accounting data that most enterprises were able to provide, however, was for year 2001. The survey adopted a research strategy that combines the use of a structured questionnaire given to firms selected by random sampling, with face-to-face interviews with government officials and enterprise management selected to provide insights into the privatization process and its outcomes. While the sam- pling provides quantitative data, the interviews reveal rich qualitative information regarding different government policies and various prob- lems that have been encountered in gaizhi.
The Sample Cities. A major feature of the gaizhi process is that it is largely decentralized.10 Therefore, a significant regional variation in the forms and outcomes of gaizhi was to be expected. To account for this
10. This is changing with the establishment of SASAC.
variation, cities of different sizes and from different regions were selected for the survey and interviews. These 11 cities were, from north to south: Harbin, Fushun, Tangshan, Lanzhou, Weifang, Xining, Zhenjiang, Huangshi, Chengdu, Hengyang, and Guiyang (see figure 1.2).
Harbin and Fushun are located in the northeast, China’s indus- trial powerhouse in the central planning era. Harbin is the capital of Heilongjiang province, and Fushun is a medium-size city in Liaoning province. Tangshan is an old industrial city, the second largest in Hebei province, about 120 kilometers north of Beijing. It survived a severe earthquake in 1976. Xining and Lanzhou are two western cities, the capitals of Qinghai province and Gansu province, respec- tively. Lanzhou is an important industrial base in the northwest, renowned for its heavy chemical industries, while Xining is less in- dustrialized. Chengdu and Guiyang are the capitals of two south-
FIGURE 1.2 Geographic Location of the Eleven Sample Cities
western provinces, Sichuan and Guizhou, respectively. Weifang is a medium-size city in Shandong province. Its industry is mainly made up of small and medium enterprises (SMEs). Zhucheng, one of the two cities that initiated privatization in China, is located in this province. Zhenjiang, in Jiangsu province, Hengyang, in Hunan province, and Huangshi, in Hubei province, are medium-size cities. Figure 1.3 shows the urban population of the 11 cities and their peripheral counties.
Levels of economic development and growth varied among the 11 cities. Figures 1.4 and 1.5 compare per capita incomes in 2001 and per capita growth rates between 1995 and 2001. With a per capita income of RMB18,900, Zhenjiang was the most affluent city. Harbin was the second wealthiest, with a per capita income of RMB11,800. Fushun, Lanzhou, Weifang, Guiyang, and Chengdu had incomes in the range of RMB8,000 to RMB11,300. Tangshan, Xining, Hengyang, and Huangshi had the lowest incomes, between RMB5,000 and RMB6,000.
Per capita GDP grew at an impressive pace in some of the cities over the period. Harbin, Hengyang, Guiyang, and Huangshi registered
Total population Urban population
double-digit growth rates between 1995 and 2001. Per capita GDP growth was also high in Zhenjiang, Fushun, and Chengdu, with growth rates in the range of 9 to 9.7 percent. Tangshan, Lanzhou, and Weifang grew considerably more slowly, with growth rates less than half those of the fastest-growing cities. Xining was the slowest-growing city, with an annual average growth rate of 1.5 percent.
Other economic conditions also varied significantly. Per capita government revenue is an indicator of a city’s fiscal capacity and will affect how local governments are able to assist workers laid off through gaizhi. Chengdu had the healthiest per capita government revenue, easily surpassing the second-wealthiest city, Guiyang (see table 1.3). Per capita government revenue was similar across Guiyang, Zhenjiang, and Harbin. Revenue was lower in Fushun, Xining, Tangshan, and Weifang, and lower still in Huangshi and Hengyang. The Hengyang government collected only RMB200 per person in revenue.
The provincial capitals generally had larger services sectors than the other cities. The services sector was particularly underdeveloped in
0 5,000 10,000 15,000 20,000
SOURCE: Survey data, provincial bureaus of statistics.
Eleven Sample Cities, 2001
Tangshan and Weifang. SOEs still provided most of the employment in all cities except Xining and Zhenjiang, although the data are not strictly comparable across localities. The data on industrial output are more reliable. They show the dominant role of SOEs in the industrial sectors of Fushun, Guiyang, Hengyang, and Huangshi.
The data show that large numbers of workers had been laid off in Fushun and Lanzhou. The category of xiagang represents a type of interim unemployment whereby an SOE worker has been laid off but maintains the relationship with the firm. A massive 44 percent of Fushun’s SOE workers and 25 percent of Lanzhou’s SOE workers were classified as xiagang in 2001. The situation was also of concern in Tangshan, Chengdu, Harbin, and Weifang, where xiagang rates were all above 7 percent.11
11. Caution needs to be taken when interpreting data on xiagang or unemployed workers. It is possible that many of these workers have found other jobs but con- tinue to register as xiagang or as unemployed in order to obtain benefits.
0 2 4 6 8 10 12 14
SOURCE: Survey data, provincial bureaus of statistics.
FIGURE 1.5 Per Capita Growth of Gross Domestic Product in the
Eleven Sample Cities, 1995–2001
Per capita Employment State share in State share in Registered Xiagang Unemployment Real government in services employment industrial output unemployment ratec + xiagang unemployment
revenue (RMB) sector (%) (%)a (%) rate (%)b (%) (1,000) rate (%)d
Chengdu 1,424.8 33.9 63.7 10.8 3.5 7.9 261.3 4.7 Fushun 574.4 33.9 55.7 82.0 2.7 43.5 177.1 43.8 Guiyang 832.9 35.0 69.1 72.7 4.0 4.0 95.5 4.7 Harbin 698.0 33.4 53.0 10.7 3.0 8.8 263.1 5.3 Hengyang 199.7 34.3 40.0 53.1 2.6 3.1 111.4 3.0 Huangshi 330.7 33.7 60.9 61.2 1.4 n.a. n.a. n.a. Lanzhou n.a. 47.2 80.9 n.a. 2.6 25.0 146.1 22.8 Tangshan 511.2 2.3 73.0 28.6 2.8 10.0 81.1 9.1 Weifang 482.3 7.3 50.1 13.9 3.0 7.0 144.8 3.4 Xining 540.5 58.8 48.0 20.9 3.1 n.a. n.a. n.a. Zhenjiang 813.6 28.8 35.2 18.3 3.6 n.a. n.a. n.a.
a. There are no consistent data for state share of employment for all the cities. The table reports three sets of data for the figure. One is the state share in total urban employment. Harbin, Hengyang, Lanzhou, and Weifang use this definition. The second is the state share in all wage employees. Fushun, Huangshi, Tangshan, and Xining use this definition. The third is the state share in the manufacturing sector. Chengdu, Guiyang, and Zhenjiang use this definition. b. The unemployment rate is registered unemployment as a percentage of total city employment. c. The xiagang rate is the number of xiagang workers as a percentage of total SOE employees. d. The real unemployment rate is the sum of registered unemployed and xiagang workers in the city labor force. SOURCES: National Bureau of Statistics of China, China’s Statistical Yearbook: 2002; authors’ estimates.
The official unemployment rates (the share of registered un- employment in the total workforce) in these cities were lower than the xiagang rates. Unemployment is undesirable for both workers and the government, because it severs the links workers had to the old danwei (work unit) and often leads to social unrest. Most unemployed workers are therefore classified as xiagang and placed in a reemployment cen- ter (see chapter 4 for details). To the extent that “xiagang” and “un- employment” both refer to the situation of being laid off, it is sensible to combine those two categories to estimate the real unemployment rate in a city. This is reported in the last two columns of table 1.3.
The large cities of Chengdu and Harbin registered the highest numbers of total unemployed, with more than 260,000 unemployed workers. Fushun had the worst unemployment rate, at 43.8 percent, followed by Lanzhou with 22.8 percent. This was consistent with the large numbers of xiagang workers and the dominance of the state sec- tor in the two cities.
Sampling Methodology and Interviews. The reform of China’s SOEs began in earnest in 1996 after the experiences of Shunde and Zhucheng were supported in the central government policy of “keep the large and let the small go.” For this reason, it was decided to survey all the indus- trial firms that were owned by the 11 city governments at the end of 1995 before gaizhi began. The survey was administered by the SETC of the State Council and its counterparts in the sample cities. The city economic and trade commissions (ETCs) sent out around 1,100 questionnaires to firms and 683 were returned.
The intention of the survey was to sample current and former industrial SOEs owned by municipal governments; however, be- cause district and county governments were involved in the survey in some cities, some district and county firms, including collectives, were included in the sample. These firms were retained in the sam- ple because many of them employed urban workers and had similar practices to the SOEs in terms of relationship with the local govern- ment, internal governance structure, employment, and remunera- tion. A small number of questionnaires were also sent to trading and services firms.
Many of the firms had changed considerably since 1995. All sig- nificant gaizhi events in a firm’s history, such as bankruptcy, mergers, acquisitions, and spin-offs, were recorded. In terms of data collected, if the enterprise had merged with another firm, the new firm was surveyed and data were recorded from the year of the merger. If the firm had
been split up, the largest of the new active firms was surveyed and data were recorded from the year of the split. It was often the case that the old firm had moved production to a new spun-off firm, leaving the old firm only with the name, debts, and the burden of retirees. As a result, the new firm was typically the only active firm. The survey strategy re- sults in an unbalanced panel of firm data, because some firms had a shorter life span.
Sample selection has some special complications in government- assisted surveys. Self-selection by firms, and selection on the part of the city ETC, can bias the results. For instance, local officials may put pres- sure on firms with close ties with the government, usually larger en- terprises and nonprivatized SOEs, to fill in the questionnaire, causing oversampling of nonprivatized SOEs. Where bias may be a problem, national data will be used to support the discussions on the extent of gaizhi, or adjustments will be made to the data.
In addition to the survey, research teams interviewed government officials, bank managers, and firm managers in seven cities: Harbin, Tangshan, Chengdu, Guiyang, Chongqing, Zhenjiang, and Hengyang.12
In each city the research team met with officials from government agencies such as the ETC and the bureaus of finance, labor and social security, and land administration. This gave the teams valuable in- sights into government policies and the methods of gaizhi in each city. The information also served as a reference point for the firm inter- views. The teams also met with the local managers of the four major banks and the city commercial banks.
A total of 270 firms were interviewed across the seven cities. The firm interviews provided important qualitative information regarding gaizhi. They revealed the different attitudes of SOE managers in dif- ferent cities, and provided examples for some of the patterns analyzed in the study.
Sample Distribution. The distribution of the sample firms, shown in table 1.4, varies across the cities because of differing structures of en- terprise ownership and differing response rates. Response rates were poor in Fushun, which returned only 10 questionnaires, Weifang, and Lanzhou. In Xining the total number of firms was small. It is important to keep in mind the uneven distribution of the sample whenever geo- graphic distribution is important to the interpretation.
12. Chongqing was not on the list of the sample cities, but a few firm interviews were conducted there.
Most of the sample firms are categorized by Chinese statistics as SMEs.13 A comparison with national statistics, however, suggests that the sample average was nearly four times the national average over the period 1998–2001 (see figure 1.6). This might be a result of the re- structuring brought about by gaizhi but could also reflect a sample bias toward larger firms. This is likely to be because the survey included mainly industrial firms owned by city governments, and these firms are usually larger than firms owned by district and county governments, which would be included in the national survey. There might also have been a higher response rate from the larger firms with connections to city governments. Within the sample firms, there was a slight decline in the average number of workers employed by firms from 1995 to 2001, as shown in figure 1.6.
Most of the sample firms were in manufacturing, especially in petro- chemicals, electronics, machinery, and textiles (see figures 1.7 and 1.8). This distribution agrees with the national data (see figure 1.9).
13. According to a recent SETC document, an industrial firm is an SME if one of three conditions is met: (1) annual sales revenue is less than RMB100 million; (2) registered capital is less than RMB20 million; or (3) fewer than 2,000 workers are employed
Number of Percent of firms sample firms
Harbin 120 17.6 Fushun 10 1.5 Tangshan 59 8.6 Weifang 30 4.4 Lanzhou 39 5.7 Xining 26 3.8 Huangshi 79 11.6 Zhenjiang 70 10.2 Hengyang 57 8.3 Guiyang 149 21.8 Chengdu 44 6.4 Total 683 100.0
SOURCE: Survey data.
A comparison with a national survey by the SETC, released in early 2002, suggests that the 11-city survey oversampled non-gaizhi SOEs. In the 11-city survey, 370 firms (54 percent) reported having gone through gaizhi by the end of 2002. The data reported to the SETC by 54,644 small and medium-size industrial firms at the end of 2001 showed that 86.1 percent of firms had finished gaizhi by the end of 2001. These firms made up approximately 62 percent of all registered indus- trial SOEs and can be regarded as representative of the SOE population.
In other ways the 11-city survey is representative of the experi- ences that SOEs have had with gaizhi. The extent of different forms of gaizhi reported by the survey matches the findings of national surveys in 1998 and 2001 (see figures 1.10, 1.11, and 1.12). The 1998 survey, carried out by the National Bureau of Statistics, sampled 57,881 firms, or approximately 67 percent of registered industrial SOEs.
The 11-city survey showed that 30 percent of gaizhi cases involved either a public offering or an internal restructuring. A similar share (27 percent) had become employee shareholding firms, 28 percent of firms had been sold or leased out, 11 percent were bankrupt, and the re- maining 4 percent had become joint ventures. The 1998 survey re- vealed broadly similar patterns. The two categories of “introducing new investment” and “spinning off” were largely equivalent to the sur-
Sample average National average
FIGURE 1.6 Average Number of Workers in the Sample Firms
and in Firms Nationally, 1995–2001
Manufacturing, Utilities, and Services, 2001
Primary 5%
Manufacturing 81%
Utilities 1%
Services 13%
FIGURE 1.8 Distribution of Sample Firms by Industrial Sector, 2001
Food and tobacco 10%
in 2001 National Survey.
Food and tobacco 12%
Medicines 2%
Note: Including all SOEs and any other firm with a sales volume of more than RMB5 million. Source: China Industrial Yearbook: 2002.
FIGURE 1.10 Forms of GAIZHI in 375 Sample firms, 2001
Public offering
Merger 14%
Internal restructuring
vey’s categories of “internal restructuring” and “public offering.” Together they made up 30 percent of all gaizhi cases, which is what is found in this study. The figure for employee shareholding, 21 percent, was also comparable to the 27 percent reported here.
The share of sales and leases (27 percent) was almost identical to this study. The share of joint ventures was 3 percent, close to the 4 per- cent found in this study. Incidences of bankruptcy differed: only 5 per- cent of the gaizhi cases were bankruptcies in the 1998 survey, compared with a share of 11 percent in this study. The difference might be because the 1998 survey had a separate category for mergers, and 10 percent of the gaizhi cases were reported as mergers, while this study combines mergers with bankruptcies. The results of the 2001 survey differed again, but the reporting of sales and leases matched both of the other surveys and the incidence of bankruptcy was similar to the 1998 survey.
The Structure of the Study
This study applies descriptive and econometric analysis to survey and official statistical data to examine the progress of gaizhi over the years and across regions. Chapter 2 discusses the main players in the process, their motivation and incentives. Chapter 3 examines the process: the forms, scope, and timing of gaizhi. It also looks at the incentives for firms and local governments to undertake a specific form of gaizhi.
Chapters 4, 5, and 6 look at the outcomes of gaizhi. Chapter 4 fo- cuses on employee issues. It outlines China’s social security system and discusses its function in the gaizhi process. Chapter 5 examines changes in the corporate governance of gaizhi firms. It studies the dynamics of the share structure and the changing roles and influence in the course of gaizhi of various stakeholders. Detailed statistics are presented on the distribution of control rights inside the firm, comparing gaizhi and non-gaizhi firms. Chapter 6 looks at the impact of gaizhi on firm per- formance. Chapter 7 concludes the study by discussing issues related to the fairness and efficiency of the gaizhi process, particularly concern- ing the role of management buy-outs and outside investors. These is- sues are at the center of a lively public debate in China, which is likely to influence future Chinese policies toward gaizhi.
2 The Main Players in Gaizhi
Gaizhi1 is a comprehensive transformation in which many parties have a stake. The process is inevitably complicated and involves compromises among different stakeholders. This chapter looks at the main players in gaizhi. It examines their incentives, concerns, and objectives, and con- siders how they determine the timing and scope of the process. Various hypotheses on the interactions between incentives and the scope of gaizhi are expounded and tested empirically.
How Far Has Gaizhi Progressed?
National data show that there has been a rapid decline in the number of state-owned or state-controlled enterprises across all regions in China. Between 1996 and 2001 the number of SOEs declined at an average an- nual rate of 9.1 percent, from 207,166 to 128,445 (see figure 2.1). The sharpest fall was in 1998. An SOE may cease to exist for three main rea- sons: because it is privatized, merged with another SOE, or liquidated. The data show that around 42 percent of the SOEs that existed in 1996 were privatized, merged, or liquidated over the period.
The western provinces were the most active in the restructuring process. Approximately half of the region’s SOEs had been reformed by the end of 2001, 22.4 percent of them in 1997 alone. Chongqing was the main engine behind this performance, with 76 percent of the city’s firms being reformed in that one year. By the end of 2001, only 15 per- cent of Chongqing’s SOEs were still fully state-owned or majority con- trolled. The eastern provinces were slightly below the national average before 1999 and then slightly above after 1999. The central provinces tracked the national trend throughout the period.
1. The term “gaizhi” has a broader meaning than simply “privatization,” in that gaizhi includes privatization but also many other methods of restructuring.
The average rate of reform of industrial firms was faster than the average for all firms (see figure 2.2). A total of 59 percent of industrial firms were privatized, merged, or liquidated over the period 1996–2001. By 2003, the percentage had increased to 70.
The two national surveys of industrial firms undergoing gaizhi, mentioned in chapter 1, used the end of 1996 as their reference point, providing data that can be compared with the national statistics on SOE reform. Among the 57,881 firms sampled in the 1998 survey, 24 percent were reported to have finished gaizhi by the first quarter of 1998, 27 percent were in the process of gaizhi, and 26 percent were planning to start gaizhi in the coming year. As shown in figure 2.2, the number of industrial SOEs in 1997 was 87 percent of the number in 1996. Therefore, 13 percent of industrial SOEs had been privatized, merged, or liquidated by the end of 1997. From the results of the 1998 national survey reported in chapter 1 we know that 15 percent of all gaizhi were mergers and bankruptcies. This implies that of the 13 per- cent reduction in the number of SOEs, 3.6 percent was due to mergers and bankruptcies and 9.4 percent to privatizations. Therefore, close
of 1996 Number, by Region, 1996–2001
Note: Number of firms fully owned or controlled with dominant shares by the government. East: Liaoning, Beijing, Tianjin, Shandong, Shanghai, Jiangsu, Zhejiang, Fujian, and Guangdong. Central: Heilongjiang, Jilin, Inner Mongolia, Shanxi, Hebei, Henan, Hubei, Anhui, Hunan, Jiangxi, Hainan, and Guangxi. West: Xinjiang, Qinghai, Ningxia, Gansu, Shaanxi, Tibet, Yunnan, Guizhou, Sichuan, and Chongqing. Source: China Industrial Statistical Yearbook: 2002.
to 40 percent of all the gaizhi cases had been privatizations by the time of the 1998 survey.
The share of gaizhi firms would have reached 80 percent by 1999 if the gaizhi plans revealed in the 1998 survey had all been carried out. This prediction seemed to have been fulfilled, as the 2001 survey showed that 86 percent of the 54,644 sample firms had completed gaizhi by that year. Of all the completed cases of gaizhi, 25 percent were through mergers and bankruptcies, as reported in chapter 1. This estimate implies that 21.5 percent of all industrial SOEs had gone through mergers or bankruptcies by 2001. The national data presented in figure 2.2 show that 59 percent of all industrial SOEs had been pri- vatized, merged, or liquidated by 2001. Therefore, about 38 percent of all SOEs had been privatized by that year. This, in turn, implies that 44 percent of all gaizhi cases were privatizations. The estimates about
Percentage of 1996 Number, by Region, 1996–2003
Note: Number of firms fully owned or controlled with dominant shares by the government. East: Liaoning, Beijing, Tianjin, Shandong, Shanghai, Jiangsu, Zhejiang, Fujian, and Guangdong. Central: Heilongjiang, Jilin, Inner Mongolia, Shanxi, Hebei, Henan, Hubei, Anhui, Hunan, Jiangxi, Hainan, and Guangxi. West: Xinjiang, Qinghai, Ningxia, Gansu, Shaanxi, Tibet, Yunnan, Guizhou, Sichuan, and Chongqing. Source: China Statistical Yearbook: 2004.
the extent of privatization are lower-bound estimates, as often bank- ruptcies do not involve liquidations. In any event, the estimates sug- gest that privatization has been significant in China and that gaizhi has become more radical in recent years.
The 11-city survey reveals a similar pattern. Figure 2.3 shows the pace of reform in four cities and the sample average over the period 1995–2001. Just as the national data illustrated, restructuring and pri- vatization had barely begun in 1996 and 1997, but they accelerated considerably in 1998 and 1999. The most dramatic case was Huangshi, where nearly 70 percent of SOEs disappeared in 1999 alone. The most sluggish city was Lanzhou, where reforms and privatization started to take off in 1997 but then stalled, leaving about 80 percent of SOEs still in state hands.
Generally, the southern cities privatized at a faster rate than the northern cities. With the exceptions of Hengyang in the south, all the southern cities had a lower percentage of nonprivatized SOEs than the average and all the northern cities had a higher percentage than the average (see figure 2.4). On average, the number of SOEs in the sample cities decreased by 50 percent in the period 1995–2001.
The firm survey shows that the timing of gaizhi broadly followed a similar pattern to that described in the national statistics and surveys. There were 370 firms that had undertaken gaizhi by the end of 2002
FIGURE 2.3 Privatized State-Owned Enterprises as a Percentage of
1996 Number in Four Chinese Cities, 1995–2001
Source: Survey data.
(see figure 2.5). Less than 10 percent of them had completed gaizhi by 1994, but by the end of the period about 80 percent of firms had done so. Although the pace slowed in 2002, more than 30 firms completed gaizhi that year.
The 11-city survey shows geographic differences in the pace of gaizhi. Figure 2.6 groups the 11 cities into three regions: northern (Harbin, Fushun, and Tangshan), western (Xining, Lanzhou, Chengdu, and Guiyang), and southern (Weifang, Zhenjiang, Huangshi, and Hengyang) and shows the number of gaizhi cases in each region each year. Although the southern region did not start gaizhi as early as the other two regions, its cities moved much faster in terms of numbers of firms and the scope of gaizhi. In the southern cities, gaizhi grew steadily to reach a peak in 2000. The pace in the northern and western cities has been slower and more variable.
0 4020 60 80 100
SOURCE: Survey data.
FIGURE 2.4 Number of State-Owned Enterprises as a Percentage of
1996 Number in Sample Chinese Cities, 2001
FIGURE 2.5 Number of Firms Undertaking GAIZHI in
Sample Cities, Before 1990–2002
Source: Survey data.
Cumulative percentage
40 Number
FIGURE 2.6 Number of GAIZHI Cases by Region, Before 1990–2002
Source: Survey data.
The Key Participants
Because gaizhi involves a comprehensive transformation of the state sector, which had been the foundation of the Chinese economy, a number of players have stakes in the process. The seven key participants in gaizhi have been the central government, the local government, the manage- ment, employees, creditors, outside investors, and the public. The inter- actions among these players shape the form of gaizhi undertaken.
The Central Government. In the early stages of urban reform, gaizhi was a bottom-up process. During his tour of southern China in the spring of 1992, Deng Xiaoping encouraged several localities to experiment with SOE reform. Gaizhi was given greater prominence at the end of 1992 by the 14th Party Congress, when the decision was made to build a socialist market economy with Chinese characteristics. Although the central government had no grand plan to reform the whole SOE sector, more localities were encouraged to undergo gaizhi.
For several years the central government did not make official pronouncements on the reform initiatives, but simply observed the consequences. The zhuada fangxiao policy in 1995, which sanctioned local initiatives, was a result of those observations and marked the be- ginning of active support by the central government for gaizhi. The 15th Party Congress in 1997 formally acknowledged the role of the private sector by stating that private enterprises were an indispens- able part of the national economy. In 1999 the National People’s Congress (NPC) changed the Constitution to endorse the decision made at the 15th Party Congress. Further amendments to China’s Constitution, including explicit clauses on protecting human rights and private property, were passed at the full session of the NPC in March 2004.
The central government’s support for gaizhi came from its desire to transform the planned economy into a market economy. The Chinese government realized in the early 1980s that price liberalization and SOE reform were the two fundamental tasks of that transformation. Price liberalization was completed in the early 1990s (the most significant event was perhaps the abolition of food quotas and price controls in 1993), after which SOE reform became the government’s foremost concern. Although efforts to improve SOE efficiency had continued since the mid-1980s, the government realized that gaizhi had the most chance of solving the SOE problem. The central government also real-
ized at the beginning of gaizhi that “letting the small go” would improve its fiscal situation. Under the decentralized fiscal system, the central government has a strong incentive to transfer the management of smaller firms to local government.
The use of the term “gaizhi,” instead of “privatization,” illustrates the cautious approach taken by the central government. Even that term does not appear frequently in the official media, however, because of a desire to avoid an ideological backlash. The central government’s main concerns are that gaizhi may lead to the loss of state assets (bank loans, in particular), result in massive unemployment, and cause social unrest.
In terms of state assets, the real problem is the conflict of interest between the central government and local governments. While most SOEs belong to local governments, the four major commercial banks belong to the central government. These four state banks are by far the largest creditors to the SOE sector. Since the Chinese fiscal system is highly decentralized, and local and central budgets are largely separate, the central government is able to guard its own interests if it protects the banks.
The central government is very keen to maintain social stability and keep unemployment to a minimum. It therefore pressures local governments to adopt every possible means to maintain employment, and thus social stability, during gaizhi. This creates a conflict of inter- est between the central and local governments over responsibility for the costs of gaizhi.
The interests of the various government agencies involved in gaizhi may differ and in some cases be contradictory. Prior to the last gov- ernment reorganization, the SETC was in charge of SOE operations. It favored a faster pace of privatization and more generous deals for the management. The Ministry of Finance (MOF) was more concerned about whether the value of the assets could be fully recovered. The most significant conflict is between the Ministry of Labor and other gov- ernment agencies. The Ministry of Labor is responsible for unemployed and xiagang (temporarily laid-off) workers, so it resists rapid privati- zation. The trade unions are allied with the Ministry of Labor and also emphasize the rights of workers. These conflicts translate at the local level as well. The slow progress of gaizhi in some cities can be attributed to the conflicts of interest among the different government agencies, especially in cases when the government needs to provide compen- sation to redeploy workers. The establishment of the State-Owned Assets Supervision and Administration Commission (SASAC) had as
one of its objectives the creation of a government agency that would assume ownership over SOE reform. While the new agency addresses some of the issues related to fragmented authority over the manage- ment of state assets, it cannot eliminate all the potential conflicts be- tween various government agencies regarding SOE reform.
In summary, the central government sees gaizhi as a necessary step toward a market economy, but its interests are more complicated than they appear. The conflict of fiscal interest between the central govern- ment and local governments plays an important role in shaping the methods and speed of gaizhi in the country.
The Local Government. The local government plays three roles in re- gard to local SOEs: as the original owner of the SOEs,2 as an em- ployer and therefore the provider of social stability, and as a collector of tax revenues used to provide public services. These three roles are not always complementary, but the top priority of local government is stability.
As owners of state firms, local governments have a big stake in SOE assets. The wage arrears, bank liabilities, and tax arrears of poorly performing SOEs place a burden on local governments, however. In addition, with progress in market liberalization local governments have less control over firms as managers have become more powerful. Managers are more prone to steal from firms if they have significant control rights but no ownership rights.
Local governments must weigh the costs and benefits of re- taining ownership against those of letting the firm go into private hands. If the firm is retained, there is a risk that its assets will dissipate through poor management and theft, but if the firm is privatized the government may obtain some value out of the assets. More importantly, the government can shake off the firm’s liabilities after privatization and may gain from increased tax revenues if the firm’s performance im- proves. Although these incentives may vary among the cities, many local governments have made the pragmatic choice to privatize the SOEs.
In many cases of gaizhi, the local government is unable to cash in on the sale of state assets. Many SOEs already have negative net
2. In theory the central government owns every SOE, but in reality SOEs are ef- fectively owned and controlled by local governments. The official document of the 16th Communist Party Congress signaled a formal transfer of ownership to lo- calgovernments.
assets at the time of gaizhi. Many owe wages, social security pay- ments, taxes, or health insurance premiums. These debts have to be settled before the firm is privatized. Gaizhi often involves layoffs, and layoffs create obligations on local governments to support work- ers who lose their jobs. With a shortage of cash, the local government has to use the firm’s assets to meet these obligations. A constraint on gaizhi practices is the government’s wish to maintain employment and reduce the risk of social instability. This is the overriding con- cern of local governments.
The Management. The firm’s managers usually have a strong incen- tive to support privatization if they believe that they are likely to be beneficiaries in terms of increased autonomy and investment gains. Prior to gaizhi, the authority of managers rests on their ability to please both the government and the firm’s employees. Although managers’ control rights may be strong, they are not backed by any ownership rights and this creates a sense of insecurity. After gaizhi, managers may have, in addition to their decision-making power, ownership stakes that could bring rewards if the firm is run successfully.
Managers may face conflicts of interest when they perceive them- selves as prospective buyers of the enterprise. Some managers may de- liberately run the firm down before privatization in order to lower the privatization price, or they may strip the assets out of the firm. Questions have been raised about whether managers should be allowed to buy the firm at a discount to firm valuation, as those same managers may have been responsible for the failure of the SOE.
Managers bear a significant risk when they buy a firm, especially when they pay cash. Increasingly they are competing against outside buyers, who have the financial resources to redeploy redundant work- ers and inject new investment into the firm but may not want to retain the old management. If an outside buyer is competing to purchase the firm, the managers may oppose gaizhi.
Employees. Many SOEs have tended to overhire, despite the fact that they operate in traditional industries where markets have been shrink- ing. Privatization is an opportunity to downsize the workforce, but then laid-off workers become a burden on the government. Thus employees often have mixed feelings toward gaizhi. It may be seen as the only way to revive the firm, but there is also the risk of redundancy. If gaizhi must
proceed, redeployment after gaizhi becomes the employees’ central concern.
Workers have considerable bargaining power because they are able to resort to collective, sometimes violent, action to force the government to satisfy their demands. Their position has also been strengthened by the government’s aversion to social unrest. The cen- tral government requires that every gaizhi plan must be approved by a conference of the employees. The Supreme Court requires that the settlement of labor claims is the first priority when a firm undergoes gaizhi or bankruptcy. Employees therefore are in the position of secured creditors vis à vis their firms. The top priority given to work- ers’ claims tends to dampen employees’ incentives to monitor man- agement for asset stripping during and before gaizhi.
In most localities, employees who will be continuing with the firm receive compensation, usually a number of free shares, for los- ing their status as state employees. As such, they receive a share of the profits on top of their regular wages and thus can be a positive force pushing for gaizhi.
Creditors. Banks have a huge stake in gaizhi, as most gaizhi firms are in serious debt. Because many firms attempt to evade the repayment of debt—for instance, by falsely declaring bankruptcy and registering a new firm—banks often see gaizhi as being synonymous with attempts at debt evasion. Banks—and the national banks, in particular—have an intrinsic interest in monitoring gaizhi to ensure that the value of their collateral is not eroded in the process. In this sense, their interests tend to coincide with the central government’s concerns about the loss of state assets during gaizhi.
Although the four major state commercial banks are owned by the central government, they are vulnerable because the firm and the local government often collude to squeeze their interests. Furthermore, the central bank leaves little room for commercial banks to write off loans or renegotiate payments. Banks’ quotas for write-off are therefore a constraint on the pace and scope of gaizhi.
The debt problem does not lend itself to a simple solution, such as strengthening the role of the banks during or after gaizhi. The ac- cumulation of nonperforming loans is a consequence not only of the soft budget constraint faced by SOEs and their poor performance but also of failed government policies. The cen