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Chinese companies, like companies everywhere, do best when they are privately
run. In China, however, the state is never far away
IN 1992 two Chinese cities, one just south of Beijing, the other just north of
Hong Kong, were in desperate shape even by the standards of a desperately poor
country. Their municipally run companies were in danger of bankrupting not only
themselves but the cities too. Zhucheng, near Beijing, was best known as the
birthplace of Jiang Qing, Mao Zedong s despotic, doctrinaire fourth wife, who
died in jail in 1991. Two-thirds of its revenues were being eaten by corporate
losses. Shunde, a small city in Guangdong, was buried in debt.
Meanwhile, the authorities in Beijing were becoming concerned that the state
banking system, already creaking under the weight of bad debt, would be unable
to bear even more. With the quiet acquiescence of the central government,
Zhucheng and Shunde ignored doctrine, old laws and 40 years of failed policies
in search of a better approach.
In a carefully constructed phrase subsequently endorsed, in 1993, by the
all-powerful State Council, the two cities engaged in gaizhi, which means
changing the system and implies the diversification of ownership. Put more
simply, in words that even now the Chinese government cannot bring itself to
utter, they started to privatise many of their companies. They thus began one
of the Chinese state s first attempts to change its relationship with its
enterprises. Jiang Qing would not have approved.
At first Shunde and Zhucheng turned their firms over to employees. In 1997,
again before a broader shift in national policy, the two began selling
companies directly to existing managements. Shunde, in particular, thrived. Two
of the companies that emerged, a maker of bottle caps and a trader of duck
feathers, are now among the world s largest appliance manufacturers, Midea and
Galanz. Other factories have spread like wild flowers among what were once rice
fields and fish farms.
Early signs of success led to modification of the rules on the ownership of
companies. In 1995 the State Council endorsed a policy to retain the large,
release the small . In 1997 it approved a huge shift of ownership from the
central government to municipalities with the explicit goal of expediting
privatisations. These changes provided the foundation for the dramatic efforts
in the late 1990s of Zhu Rongji, the then prime minister, that are reputed to
have remade China s economy.
The short version is that Mr Zhu closed thousands of companies and broke the
iron rice bowl , a guarantee of living standards for the masses, in an effort
to shake China out of economic lethargy. Between 1995 and 2001 the number of
state-owned and state-controlled enterprises fell from 1.2m to 468,000 and the
number of jobs in the urban state sector fell by 36m or from 59% to 32% of
total urban employment.
A longer version is that the process involved many more companies and has never
ceased, and that the method has changed constantly. As some companies were
transformed or closed, others were created, with various forms of state
backing. The result has been non-stop experimentation with incentives and
structures.
Privatisation remains a thorny issue in a country where private property became
a constitutional right only in 2004 and where the right to own productive
assets remains unclear. Many vibrant, purely private companies have sprung up
despite this uncertainty, but take care to stay out of the limelight.
Meanwhile, China s various experiments with privatisation have created several
categories of companies which still have close ties to the state (see table).
A taxonomy of privatisation
The first category comprises the vast banks and transport, energy and telecoms
providers that were, and to some extent still are, government ministries.
Gordon Orr, chairman of McKinsey s China business, calls this version 1.0 of
the modern state-controlled company. Although these entities have gained a lot
of attention outside China, they account for perhaps 1% of privatised
companies.
The relationship between the state and most other businesses is less direct and
more subtle. A second category contains joint ventures between private (often
foreign) companies and firms backed by the state. A third consists of companies
that are largely in private rather than state ownership, but in which the state
remains influential nevertheless. Recently another class has started to emerge,
in which the state plays the role of a venture capitalist: local governments
invest in or create funds that back companies that they hope will bring both
jobs and financial returns.
Start with the behemoths. Most of these huge companies have been turned into
vaguely conventional-looking businesses. They have been restructured,
recapitalised and rebranded. A minority of their equity has been sold to the
public and is traded on the stockmarket. They have recognisable corporate
structures with boards of directors, chief executives, chief financial officers
and sundry other chiefs; and they publish financial reports with carefully
presented accounts and dull letters from the bosses. They are steadily climbing
up global rankings, symbols of China s growing industrial heft.
However, few contend that they are truly private companies. The proportion of
shares issued is typically no more than 30%. They receive subsidised loans from
state-controlled banks, they are given land cheaply and they usually enjoy a
sheltered monopoly or oligopoly. Control by the government is never far away.
The state appoints their senior managers including a Communist Party committee
headed by a party secretary.
Often, say insiders, these companies doings reflect not so much the explicit
orders of the government as managers anticipation of what will earn its
endorsement. An ambitious manager s career prospects depend on the party s
Organisation Department, which oversees official appointments and company
bosses frequently move on to senior jobs in the ministries that oversee them.
Direct control may have been severed, but rule by inferred command continues.
This model provides the government with continuing control of enterprises
critical to the functioning of the economy. In particular, it facilitates the
execution of big capital projects such as high-speed railways, steel plants,
telecommunications networks and ports.
However, this comes at a cost. There are plenty of opportunities for graft. A
close relationship between regulators and operating companies can mean that
problems (with safety, as well as economic matters) are overlooked. The lack of
commercial orientation frequently means that too many employees throughout the
company are unproductive. At the top, there are often cushy, well-paid jobs for
the children of the well connected. And the commercial and regulatory
privileges of these companies crowd out private alternatives.
At home, it is hard to argue that any of the really big Chinese firms the
banks, the telecoms firms and petrol companies draw customers because of any
special appeal rather than their ubiquity and a lack of competitors. Abroad,
despite their size, they are yet to become the global champions that the
Chinese government would like them to be, even though the Chinese have sought
for many years to learn from foreign corporations. This may be partly because
the Chinese giants ties to the state limit the extent to which they can
imitate foreign multinationals, with senior managers from many countries.
In the late 1990s John Thompson, then head of IBM s international operations,
and some colleagues attending a conference in Beijing were asked to visit Jiang
Zemin, the president of China. Mr Jiang asked the IBMers how such a big company
was managed centrally. He also asked how corporations and the American courts
dealt with corruption a worry, said Mr Jiang, when Chinese ministries were
being privatised. Some months later, Mr Thompson recalls, Mr Jiang asked Lou
Gerstner, IBM s chief executive, if the company would play host to a delegation
of newly minted Chinese chief executives and some ministers. The group spent
several days at IBM s executive-education centre in New York state. They then
visited other organisations to learn more about how American capitalism was run
and regulated.
Yet there was an unbridgeable gap between IBM and China s behemoths. In most
successful global companies, a priority for executives from the home country is
to prepare local managers who may one day accede to senior jobs at
headquarters. The company becomes international inside as well as out. But
because the Chinese giants are still in essence tied to the state, their
leaders must remain Chinese.
Evidence of how these entities have performed is muddy because so much of their
environment is distorted: for example, given cheap enough money and strong
enough protection for their franchise, even corporate sluggards can show good
profits and return on equity. However, in 2006 three Chinese academics began a
vast study of the performance of privatised companies, summarised in a recent
working paper*. Jie Gan of Cheung Kong Graduate School of Business, Yan Guo of
Peking University and Chenggang Xu of the University of Hong Kong conclude that
the return on assets and profitability per employee for companies that have
undergone partial share offerings is indistinguishable from those that were not
privatised at all.
One driver better than two
The second category of firms, joint ventures, is also small in number (2% of
the academics sample). Such ventures involve a bargain between the two sides.
Often the private partner is a Western company hoping to gain access to a huge
and growing economy. In return the Chinese gain Western know-how. For the
Westerners, this involves obvious risks beyond the usual differences of opinion
in a joint venture: that they will be pushed aside once the Chinese have
acquired their knowledge.
In carmaking, where there have been several prominent joint ventures, a
squeeze-out of the Western partner was part of the initial plan, says Michael
Dunne, a car-industry consultant, and subtle moves along these lines emerge
sporadically. Recently, for example, the government has pushed the Western
companies to form indigenous brand joint ventures with intellectual-property
and export rights. And at the end of 2009, Shanghai Automotive Industry
Corporation bought an additional 1% of its venture with General Motors, gaining
majority control.
Ms Gan, Mr Guo and Mr Xu find that, overall, joint ventures have yielded
similarly lacklustre financial results to the partially privatised behemoths.
However, carmaking appears to be an exception. Early ventures involving
Peugeot-Citro n and General Motors flopped, but that is now ancient history.
More than 20 ventures are currently in existence and although financial
information is hard to come by, they seem to be doing well.
This may be because in cars joint ventures have been run more as private
companies and less as state-owned entities, when compared with other
industries. An explanation, says Mr Dunne, lies in the incentives of the two
sides. The senior Chinese representative, inevitably appointed by the
government, is rarely a car person. He brings valuable political contacts and
is likely to move back to a political job eventually. Meanwhile he has little
interest in disrupting a venture that produces profits and jobs. Foreign
carmakers are interested chiefly in the success of the company. The two sides
interests turn out to be aligned, or at least not in conflict.
These same incentives, says Mr Dunne, also explain why the efforts of the
Chinese joint-venture partners to develop their own brands have yet to produce
much success, despite their access to Western technology, vast resources and
political pull. The careers of the Chinese partners are tied to the state, not
the car market.
Private management, party influence
The third group, largely in private hands, contains the most successful
privatised companies: the half that ended up in the hands of their managers.
According to the three academics, management buy-outs have done much better
than behemoths, joint ventures or firms privatised through other methods (such
as leases or sales to outsiders or employees). This probably has much to do
with another finding: that the degree of government control declined most in
this group of companies. In only 1% of these firms did the state have a
shareholding of more than 20%, against a sample average of 19%. And in only 16%
of them did the state have strong control of corporate decision-making,
against 31% overall. The state has thus forgone ownership in an effort to
achieve better results. It does, however, continue to exert influence, notably
through party representatives.
Consider the state s involvement with the three Chinese car companies that have
done most to build their brands: BYD, Chery and Geely. They are still under the
state s wing, being thought to receive ample financial help from the provinces
where they operate (though much the same could be said of many carmakers in the
West). Their leaders surely would not last if the state disapproved of them.
Yet they are not state-controlled, unlike the behemoths or the Chinese partners
in joint ventures. The bosses are not political appointees but charismatic
businessmen in pursuit of commercial goals.
There are similar ventures in other industries: ZTE and Huawei, two
telecoms-equipment giants; Lenovo, a maker of PCs, in which the Chinese Academy
of Sciences has a large minority stake; and TCL, an electronics firm. The
number of companies in this group continues to swell, even if they are less
well known than these. As a rule, they are in industries designated as
strategic notably anything to do with energy, be it wind, solar or stored and
can also be found in medical equipment, drugs and technology. Such companies
benefit from protection against foreign encroachment, research-and-development
subsidies, and subsidised purchases from state customers. Someone involved with
a foreign health-care company says that buyers connected with the Chinese state
demand such generous terms with payment delayed for up to a year that only
domestic providers, backed by accommodating credit from state banks, can bid
for orders.
The fostering of successful private companies becomes particularly attractive
in markets in which state entities have plainly been found wanting. The
clearest example is the internet, in which China s state-controlled news
providers and broadcasters have the resources and content to succeed but have
failed to create much of a buzz. From private internet companies, which were
never state-owned, the buzz is deafening. Their managers have often trained
abroad. Competition is rampant although foreign companies face impediments and
quick wits are essential for success. Employees often receive a significant
amount of compensation in that most Western of forms: shares or share options.
Many of these companies, because of their listings in overseas markets, or
backing from foreign investors, could technically be considered foreign, a
cause of some scathing criticism in China.
Yet even these companies depend on the good graces of the state. The Western
firms that some of them imitated find obstacles in their way in China. Baidu,
China s leading internet-search company, profited hugely in the past from being
a conduit for pirated Western entertainment. Alibaba, a facilitator of
e-commerce, has used Chinese ownership laws to take a large slice of Yahoo! s
valuable stake in its electronic-payment company, Alipay. Relations with
officialdom are not always smooth. Beijing s Communist Party chief recently
warned Sina, a social-media firm, that it was too slow to delete remarks that
displeased the party. And recent programmes on CCTV, the state broadcaster,
have criticised Baidu s business methods.
Back to the cities
The success of this third group of companies has encouraged the development of
the fourth. Officials in cities and provinces have created hundreds of
municipally backed funds to invest in promising ventures. According to Z-Ben
Advisors, a research and consulting firm, the biggest of these, CDB Capital, a
private-equity fund established only in 2009, has raised 40 billion yuan ($6.3
billion) and has a target of 60 billion yuan.
Some of these official investors have brought in foreign partners, including
big private-equity firms such as Blackstone, Carlyle and TPG. Infinity Group,
an Israeli venture-capital firm, has 12 funds, ten of which have direct ties to
different Chinese cities. Its earliest effort, founded in 2004 with money from
the Israeli and Chinese governments and private sources, has had much success
creating companies combining Chinese manufacturing and Israeli technology.
In theory, making the state into a purely financial investor rather than an
operating partner, as in Shunde and Zhucheng 19 years ago, should be
beneficial: entrepreneurs, not bureaucrats, run the business. Practice is
rarely so neat. Cities back companies that provide local jobs. That affects
acquisitions and disposals, where factories are built and where research takes
place. Worse, China s private-equity industry has become another lucrative
billet for the children of powerful officials.
It is also troubling that little is disclosed about the operations and returns
of these public funds. Many may be managed cleverly and provide money for
municipalities and jobs for their citizens; others, though, may turn out to be
financial black holes. Equally troubling, they receive favourable attention
from local governments, to the disadvantage of China s most dynamic sector, its
truly private companies.
Taken collectively, these iterations of state engagement reflect how China s
government has not only held on to economic control but found subtle ways to
extend it. At the very least, they constitute an important series of
large-scale economic experiments with implications for China s economy and,
because of China s size, the world s too. Some may see in this a path to
follow. China has come far since the trials in Shunde and Zhucheng, but the
state has always controlled the itinerary.
of Chinese Firms .
Sep 3rd 2011 | BEIJING | from the print edition