AFTER protracted debate, Chinese economists have decided that the time has come to make a complete switch from the system of contract management of state enterprises to one of shareholdings. Advocates of the contract system are quick to cite the success of Capital Iron and Steel (Shougang) to support their view that this form of organisation holds the key to the future of China's state enterprises. But this view is out of touch with reality and cannot stand up to rigorous cross-examination. There is no doubt that measures taken by Shougang to improve its internal management have worked: labour productivity is up, cost is down and economies are being made in use of raw materials and fuel. But these measures have little to do with the suitability of the organisational form for state enterprises. Indeed, they have little relevance to the income distribution between an enterprise and the state. In the Chinese context, the contract management responsibility system has a specific meaning. The contract essentially separates ownership and management between the state and the enterprise, with the enterprise taking on the role of the contractor. As the contractor, the enterprise is obliged to reimburse part of its profit or income to the state, according to the terms of the contract. How the enterprise chooses to run its management, allocate its production quota to its other plants, and check its work-teams are, essentially, problems of internal management and have nothing to do with how income is distributed between an enterprise and the state. In reality, Shougang can hardly be called a typical example of the contract management responsibility system, because its contract system was tailored to meet its needs and is unsuitable for other state enterprises. There is no doubt that the contract system has played a key role in Shougang's rejuvenation. But only Shougang has been able to enjoy the special treatment accorded by the state, which is unwilling to extend it to other enterprises. Another steel giant, Maanshan Iron & Steel, has chosen the shareholding system. Anshan Iron & Steel and Wuhan Iron & Steel are also moving in that direction. They did not try to emulate Shougang's contract system because it cannot be replicated. In general, most enterprises under the contract system have pushed the system to the limit. Yet glaring weaknesses continue to show up. There is still no clear demarcation between the Government and the enterprise, the definition of property rights, system of checks, and stemming of the losses of state assets. The state is unhappy because state-owned enterprises continue to lose money while declaring profitability, and state assets are still being eroded. Factory managers are displeased because they are hamstrung by the government departments controlling them, despite being promised management autonomy. Workers are exasperated because salaries are put on hold as the enterprise is awash in red ink. There seems no way out under the contract system. Money-losing enterprises cannot be sued for bankruptcy in the courts and, even if they can, the basic problem is unresolved. The view from top to bottom of the hierarchy is unanimous: the key to the future of state enterprises lies with the shareholding system or, perhaps, the company system since this embraces two organisational forms - limited liability companies and companies limited by shares. Most state-owned enterprises would be best suited to becoming limited liability companies, and should be encouraged to pick this system. In general, state-owned enterprises, including those involved in infrastructure development and primary industries, are expected to be converted to the shareholding system before the end of the decade. So what is to be done about Shougang? Forced by the trend of the times, it too will have to move towards the shareholding or company system sooner or later, as its contract methods become outmoded. Under the jungle law of the ''survival of the fittest'', the choice facing Shougang is switch to the shareholding system or languish. Professor Li Yining is head of Beijing University's department of economics and management and a standing committee member of the National People's Congress.