THE VIEW
The View
by

Beijing is checkmated in its plan to curb excess industrial capacity

Making companies bigger won’t sort out the mess facing lumbering state-owned giants

PUBLISHED : Wednesday, 28 September, 2016, 1:58pm
UPDATED : Wednesday, 28 September, 2016, 10:39pm

Is bigger better? There is definitely a smutty answer to that question and it happens to be the same answer currently favoured by the Chinese government, specifically when it agonises over the fate of large state owned enterprises (SOEs).

It thinks that making companies bigger will sort out the mess facing these lumbering giants and believes this will be achieved by fostering mega-mergers, such as that announced last week for Baosteel and Wuhan Iron & Steel or Wisco. Unlike Wisco, Baosteel is a rare animal in the world of Chinese state owned steelmakers because it actually managed to make money. Now it will be taking on the liabilities and inefficiencies of Wisco, both of which are formidable.

However that’s not how things are viewed in Beijing where the Xi administration needs to tackle the lowest level of economic growth in a quarter of a century and where many of the economy’s problems are located in the still massive, still underperforming and money loosing state sector.

We have already seen other mega state companies pushed into mergers, notably Cosco and the China Shipping Group, whose combined business is now the largest container shipping business in the world.

The mega mergers are intended to tackle a clear level of overcapacity in Chinese industry ranging from steel to shipbuilding to coal, base metals and in the rust belt there is considerable overcapacity in the heavy equipment sector. So it is not hard to understand the need to cut capacity and eliminate what is called “wasteful competition” between fellow SOEs. The hope is that mega-mergers will foster economies of scale and boost efficiency.

This sounds like a great idea but the problem is that it’s hardly original and has been tried before with pretty dismal results. We saw more or less the same script emerging in the late 1990s when Beijing ordered massive reductions in the size of state corporations after the morass of bad loans they acquired threatened the survival of China’s banking system.

Massive cuts were made; a degree of consolidation took place and then came the global financial crisis of 2008, which made the government turn to stimulus rather than retrenchment. Without a stimulus programme the government feared the risk of social unrest derived from making massive layoffs in big companies.

Here we are a decade later and much more of the same is being proffered as the answer to China’s industrial problems. Yet who is bold enough to predict that what didn’t work last time and was indeed reversed, will work this time?

The hope is that the mergers will enhance efficiency and competitiveness but how will this actually happen? Contradictorily the easy and most difficult part of the equation is cutting capacity, a move that will, yet again, throw hundreds of thousands of people out of jobs. The political repercussions of this remain to be seen.

What we do know however is the mindset of the people who run these companies and the web of interconnections with other parts of the state bureaucracy. To flourish and survive in state owned enterprises does not necessarily require entrepreneurial flair but it most definitely requires acute political antennae and the right sort of guanxi that ensures availability of financing, clears the path through bureaucratic regulation and generally defines the terms on which raw materials are purchased and finished products or materials are sold, in large part to fellow SOEs.

The hope is that the mergers will enhance efficiency and competitiveness but how will this actually happen

Even if capacity is cut how will efficiency be enhanced? Take the example of Baosteel, widely considered to be a success among SOEs. Its own company data shows that the average worker in its plants makes 269 tonnes of steel per year, this compares with employees of its international counterparts who are making an average 440 tonnes per year. It’s a massive productivity gap that requires a hell of a lot more than capacity cutting to create an internationally competitive company.

Many commentators argue that making Chinese industrial companies more efficient requires a commitment to privatisation, which in turn, suggests the need to create smaller, rather than larger companies. However not only is the state reluctant to relinquish control but there is a very real problem of finding entrepreneurs who will take on the daunting task of turning these companies around.

Then there is the not so small matter of how they could unpick the very strong web of relationships between SOEs and the banks, suppliers and customers who are used to operating under state instructions.

The Baosteel Wisco merger may well end up creating the world’s largest steelmaker but so what if it also ends up simply making lots of steel and loosing lots of money.

There is no easy fix here but the notion that bigger is better defies experience.

Stephen Vines runs companies in the food sector and moonlights as a journalist and broadcaster