A model of reform for state firms
CHINA'S fast-growing township and village enterprises can offer a solution to the formidable task of reforming the moribund state sector, according to Credit Lyonnais Securities.
In November, the brokerage pioneered a four-day visit to Suzhou and Wuxi in Jiangsu province, one of the three major areas for the booming enterprises.
Township and village enterprises have multiplied in different areas along the coast in the last 15 years.
The best known are found in the Pearl River Delta in Guangdong, south Jiangsu, and Wenzhou in Zhejiang province.
The Pearl River Delta model is predominantly associated with foreign investment, while Wenzhou's has developed on the back of individual private enterprise.
The south Jiangsu model consists of collectives set up and run by township governments.
'Our most interesting finding was that their lack of state support may be a blessing in disguise under certain circumstances, as it has driven them to compete in the market,' Credit Lyonnais says in its latest China Monitor.
Compared with state-owned enterprises shackled by state planning and social welfare obligations, township and village enterprises have operational flexibilities which have enabled them to chalk up faster industrial output growth than state-owned or collective enterprises in recent years.
Credit Lyonnais finds that the managements of most township and village enterprises base their decisions on market demand.
The brokerage says one solution to the current state sector reforms is to encourage the healthier township and village enterprises to merge and acquire ailing small and medium-sized state firms.
By mergers, the better-performing enterprises could help absorb surplus workers who have been made redundant by state sector reform.
Township and village enterprises only began to develop in 1978 when Deng Xiaoping launched economic reforms in rural areas.
The introduction of the household responsibility system allowed farmers to sell part of their output in the market. Their accumulated wealth was then invested in industrial ventures in the community.
The development of the enterprises received a boost in the early 1990s with the relaxation of economic policy.
As a result of their regional nature, one major characteristic of the enterprises is the important role played by township governments and provincial banks in providing financial resources.
Their financing requirements are smaller than those of state firms, which explains why most are engaged in light, less capital-intensive industries.
But they also face problems.
Their ambiguous ownership structure could restrict development and lead to similar problems as in state firms, such as management disputes over ownership rights or potential loss of state assets through transfer pricing.
In addition, the political role of township governments could hinder their growth, if retained earnings are channelled into areas such as infrastructure development and public utilities rather than higher-return businesses, the brokerage says.
Regional protectionism will also hinder their cross-region expansion.
Credit Lyonnais projects there will be roles for both state-owned enterprises and township and village enterprises in future.
State firms will retain their dominant position in capital-intensive and strategic sectors such as banking, insurance, power, steel and airlines.
Township and village enterprises will serve sectors with low capital requirements, mainly in light industries.
The brokerage voices concern that township and village enterprises have been restricted from expanding to scale-economy businesses because of lack of technical assistance from industry ministries.
They will also be hit by high interest charges under the tight monetary policy, as they do not receive state loans at the same preferential rate as state firms.
The real challenge will come when they start to mature and face a changing economic profile and increased competition, Credit Lyonnais says.
The key is whether they can evolve into independent businesses without interference by the government.
Credit Lyonnais says the enterprises may eventually prove to have been transitional, but their success will be to have changed China's economic and social system.
'[Township and village enterprises] appear to be an agent for change within the Chinese system,' Credit Lyonnais says.
'They have injected a degree of free enterprise into the economy and promoted a competitive spirit.
'As wealth accumulation by the new elite and middle class grows, it is likely that more and more enterprises will be established independent of government involvement and geared towards maximising profits.'