Prospects of China and the US securing a deal to end the trade war are dwindling. This is the fourth in a series of long reads examining the elements of any deal that Beijing would be willing to agree to, those that are considered achievable in the long run, as well as the red lines, on which Beijing is unlikely to ever budge. Part four focuses on the complex issue of state subsidies for traditional industries. In the protracted negotiations to end the US-China trade war, high on Washington’s list of demands has always been that Beijing remove state subsidies for its dominant state-owned enterprises. In addition to more than 100 industrial conglomerates, China’s 55,000 other state-owned enterprises (SOEs) under local government control remain the backbone of many local economies. Even as it tries to move up the industrial value chain, the employment and social stability brought by these companies – often in traditional sectors – means that scrapping subsidies is one issue on which China is unlikely to give much ground in talks with the United States. This picture becomes clear on journeys into some of China’s manufacturing hinterlands, where state-owned industrial behemoths still dominate local economies. Deyang, a city of 3.6 million people in Sichuan province, is home to one of China’s most infamous SOEs, China National Erzhong, a giant machinery manufacturer that became a poster child for the inefficiencies of the country’s bloated heavy industry sectors. Erzhong also provided the government with a cautionary tale of the dangers of social unrest, after thousands of workers took to the streets to protest widespread lay-offs in 2015 – scenes the government is desperate to avoid being repeated. A long letter of complaint displayed at the protest in bold red ink and subsequently shared widely on social media, read: “Why do the hard working labourers have to bear the bitter fruit?” – a pointed message to China’s ruling Communist Party. Huang Sufen was among the first workers forced to take “voluntary” redundancy from Erzhong in 2014, a euphemistic term often used by SOEs to avoid having their lay-offs labelled as redundancies so as to quell potential worker opposition. The protests have long since subsided and today there is an air of calm in the sprawling residential communities around Erzhong’s factories, where Huang speaks in hushed, nostalgic tones about better times, when she inherited the “iron rice bowl” – a term used for stable, lifelong jobs in China – from her father. A few h undred metres from the tightly secured eastern gate, senior citizens sit quietly on benches on street corners, whiling away a midweek afternoon. Circles of people in their 50s sit cross-legged playing cards on the concrete ground, while younger residents occupy the tea houses that litter the neighbourhood, engrossed in games of mahjong. Revisiting the area brings sadness to Huang’s voice. “We are the wounded and declining generation,” she said. The 46-year-old is still technically an Erzhong worker, so she preferred to give an alias, for fear of losing her benefits. She receives a monthly income of about 1,500 yuan (US$217) and ongoing corporate pension and medical benefits until her retirement age, in exchange for accepting the voluntary departure. She never imagined losing the job, even as Erzhong lurched from one catastrophe to another. Erzhong (Deyang) Heavy Equipment, its listed platform, saw its losses jump from 139 million yuan (US$20.1 million) in 2011 to 8 billion yuan (US$1.16 billion) just three years later, before eventually being forcibly absorbed into China National Machinery Industry Corporation (Sinomach), a Beijing-based state firm in 2013. The company was set up in 1958, after souring relations with China’s then “big brother”, the Soviet Union, prompted Beijing to relocate its military production facilities to remote western regions. Even today, Erzhong provides parts for the mammoth Three Gorges hydropower station, landing gear and frames for China’s flagship C919 airliner, and also manufactures key components for China’s own nuclear power generator. In this respect, it provides a link from China’s heavy industrial past and what it hopes to be a hi-tech innovative future. There is a reason Deyang is known as China’s city of equipment manufacturing. However, it is also abundantly clear why Erzhong became synonymous with the most inefficient parts of China’s state economy. Few Chinese companies embody the state subsidies the US wishes to quash better than Erzhong, which pales in comparison with SOEs such as PetroChina and China Mobile, both regulars on the Fortune 500. Erzhong became so unprofitable that its “merger” with Sinomach was a mechanism to avoid its complete collapse. This is a case study of the general Chinese government desire to see so-called zombie companies merge or be absorbed, rather than die a natural death, therefore shedding thousands of jobs. However, some redundancies were unavoidable. “How could such an old factory collapse in just a few years?” Huang asked sadly. “We [workers] were at an awkward age. No normal enterprises would hire us. How can we live? Many of my former male colleagues worked as security guards, while females would work as supermarket cashiers or waitresses at hotpot restaurants.” We [workers] were at an awkward age. No normal enterprises would hire us. How can we live? Huang Sufen Erzhong’s woes are largely blamed on its decision to build a new 5.2 billion yuan (US$753 million), 80,000 tonne forge in Zhenjiang, a city on the Eastern Yangtze River, with an outlet to the East China Sea that would technically make its cumbersome machinery easier to export. However, the forge failed – it added capacity to industrial sectors that were already bloated, and with construction starting in 2008, it was built at a time when the global economy was in a downturn. In his 2018 book, China’s Great Wall of Debt , Dinny McMahon singled out the Zhenjiang investment, writing: “The real source of distress was the company’s reckless expansion”, adding that it “would duplicate much of what Erzhong already did in Sichuan”. It was only when Sinomach took the reins that the extent of Erzhong’s zombification was revealed. It employed 15,589 people in Deyang, 12,997 permanent staff and 2,592 contractors. The annual employment bill of 1.3 billion yuan (US$188.25 million) was killing the loss-making factory in Deyang. Embarrassingly, Sinomach found that non-production staff accounted for just two-fifths of the total workforce, but it lacked high-end researchers, experienced international salespeople and skilled workers. Since the merger, details of the levels of subsidies still received by Erzhong are unavailable, but its community facilities have been transferred to the government as a means of reducing costs and many of its orders are made by other government owned firms. The knock-on effects of Erzhong’s decline, however, are still being felt through the local community. The through flows have obviously lessened, and business turns increasingly bad day after day, but rent keeps soaring Wang Rong Wang Rong, who has run a small stuffed bun restaurant since 2001, vividly recalls the streams of morning shift workers, speaking in the dialect of faraway Shandong in China’s east, snapping up more than 100 yuan (US$14.48) worth of buns in a few minutes. Those contractors have long since vanished. “The through flows have obviously lessened, and business turns increasingly bad day after day, but rent keeps soaring,” she said, standing alone at her shop entrance. Times could be about to get tougher, with locals on the streets discussing rumours that another local SOE – Dongfang Electric – could be merged with two other centrally owned giants, Shanghai Electric and Harbin Electric, after suffering huge losses in the wind turbine sector. “There could be some restructuring, but we still wait and see,” said a Dongfang Electric worker, who only provided a surname of Huo. “Both Erzhong and Dongfang Electric have long been reliable suppliers of military products and key participants of government missions. Shouldn’t they receive more government help?” Erzhong was wasteful, but strategically important: neither local nor central government could afford the sort of social unrest that comes with widespread redundancies, which is why the street protests that followed the 2,000 lay-offs are viewed in Beijing as anathema to US demands that China stop subsidising its SOEs. Around 753 miles away, the city of Liuzhou in Guangxi province, also lives in the shadows of subsidised SOEs, with the communities that have built up around them dependent on their success. Giants like Liuzhou Steel, Liugong Group, Dongfeng Liuzhou Motor, Guangxi Automobile Group and SGMW – a joint venture between SAIC Motor and General Motors – dominate the city’s three industrial pillars of vehicles, metallurgy and machinery. According to official data, 600,000 of Liuzhou’s 4 million residents work in heavy industry, while 367.3 billion yuan (US$53 billion) or 72 per cent of its total 507.7 billion yuan in economic output came from the big three industries in 2018. It is easy to see why locals are opposed to any reform to the subsidies programme that could place their livelihoods under threat. Huge swathes of the city are carved into industrial development zones, with some factories directly employing up to 20,000 people and feeding thousands of downstream suppliers across the city and province, along with countless fruit and meat vendors, schools, shops, restaurants, hair salons and farmers nearby. Each of these facilities has its own ecosystem and, in some respects, can be viewed as a small city in its own right. “There is no doubt that SOEs are the backbone of the local economy. Without them, the industrial chain in Liuzhou and even Guangxi will collapse,” said Wang Tao, a local supplier of components to some of the car industry SOEs . Wang would be loathe to see China meet US demands to remove the safety net, and said he “supports government subsidies to stabilise the SOEs and the local economy”. “Car manufacturing in Liuzhou has been greatly impacted by the decline in the domestic market this year. Many private companies nearby that make auto parts for SOEs are worried because of fewer new orders. In my factory, I hired over 70 people last year, [but I am] now only keeping about 30 skilled and experienced ones. I cannot afford to support so many workers. As far as I know, there are at least 7,000 workers from downstream suppliers that have lost their jobs this year,” Wang said. To support Guangxi’s automotive SOEs, local authorities have released a new round of subsidies. State-owned Dongfeng Liuzhou Motor and Guangxi Automobile Group, and the partly government-owned SGMW – will receive 110 million yuan (US$15.9 million), 20 million yuan and 150 million yuan in bonuses if they sell 35,000, 31,000 and 380,000 vehicles, respectively, between May and August. Individual customers, meanwhile, receive up to 38,000 yuan in subsidies (US$5,500) when purchasing a vehicle produced by an SOE. Unsurprisingly, workers in the city’s steel industry also consider government subsidies vital. Liuzhou Steel, one of the top 50 steel enterprises in the world, covers an area of 13 square kilometres in the city, has total assets of more than 40 billion yuan (US$5.8 billion), and employs 15,000 people. We think that working for SOEs is a very stable iron rice bowl. Many families in Liuzhou have friends and relatives who work for SOEs or their suppliers Liu Jiahe, truck driver in Liuzhou “My workmates and I know nothing about the trade war. It seemed unrelated to our lives. We locals must hope that these SOEs can become bigger and stronger. I am a skilled worker in the power generation department of Liuzhou Steel. My monthly income is about 4,000 yuan (US$579). It is much better and more stable than [a job in] the average private enterprise. Most of my classmates and friends work in Liuzhou’s SOEs,” said an employee in his 30s, who preferred not to be named. Liu Jiahe, a driver in Liuzhou who works for several local SOEs, said that SOE salaries dwarf those in the private sector. “Therefore, we think that working for SOEs is a very stable iron rice bowl. Many families in Liuzhou have friends and relatives who work for SOEs or their suppliers,” he said. In September at a state-run petroleum plant in the country’s rust-belt, President Xi Jinping said that China should not give up on SOEs or diminish the role of state firms. While the concept of the “iron rice bowl” – that is, cradle to grave support for state employees and their families – has gradually ebbed away, these entities act as a buffer for many levels of unelected government officials and help shield them from unrest that could threaten their positions. The recent direction of China’s economy, meanwhile, has directed more resources towards the SOEs, at the expense of the private sector. Both on the ground in the towns reliant on the jobs they bring, and in the corridors of power in Beijing, these enterprises are acknowledged as being far from perfect, but – especially as China’s economic growth slows – there is little appetite for the type of reform Washington is demanding. The fifth part in this series on the trade war will look at China’s continued subsidies of hi-tech industries and where that features in trade talks with the United States.