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China Economy

Take China’s SOEs out of local government control to halt the zombie firm epidemic

Winston Mok says management of state-owned enterprises should never have been decentralised, as local bosses’ reckless pursuit of growth over profitability lies behind the malaise

PUBLISHED : Monday, 22 August, 2016, 2:32pm
UPDATED : Wednesday, 26 October, 2016, 2:59pm

While fiscal expansion in Japan created bridges to nowhere, it resulted in zombie SOEs in China. So state-owned enterprise reform may be back as a priority for Beijing. While the 100-odd central state-owned giants present problems for the overall economy, they are usually quite profitable, given their market power. The zombies are mostly among the 100,000 regional SOEs.

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This regional SOE problem is rooted in China’s decentralised economic governance, which sees local governments pitted against each other. Such rivalry is a double-edged sword. While interregional competition has been an engine of China’s economic dynamism, it has also caused much of its economic malaise – overcapacity, pollution and high local government debt, for example.

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China’s local governments are supposed to exercise oversight of SOEs in their care. But local cadres often hijack the firms for their own agendas – as they are primarily measured on economic growth, not SOE profitability – and often push for overinvestment, thus destroying economic value and creating zombie SOEs.

What is really needed is a transformation of the economic roles of local governments; they should not be entrusted with supervising SOEs. Their push for SOE expansion, regardless of economic returns, in a dysfunctional interregional competition, has created overcapacity in many industries.

More than local SOEs, it is their local bosses that need to be reined in. Local cadres have used SOEs as a key instrument in their rivalry. Yet, despite talk of separating SOEs from local governments, the two remain entangled.

SOEs and local governments should be under two separate chains of command, insulated from each other

Provincial or municipal state-asset management companies should not report to local cadres, but only to Beijing, to shield them from local interference. In this way, SOEs may perform much better – under a system like Singapore’s Temasek-style governance, free from local political influence. SOEs and local governments should be under two separate chains of command, insulated from each other.

SOE reforms cannot be separated from transforming the economic roles of local governments. In fact, the greatest challenge to reform may be separating SOEs from local states.

The highest priority for local government transformation must be to remove SOEs from their “care”. An integrated change programme could start with restructuring local state-asset management companies which sit between local SOEs and local governments.

It’s clear that SOE management should not have been decentralised. Local governments will continue to play critical roles in China’s economic development, but intervening in SOEs should not be one of them.

Winston Mok, formerly a private equity investor, is a private investor