China economy

The three dangers of China’s mixed-ownership reform

In reality there is an inequality of power between state and private capital

PUBLISHED : Tuesday, 07 August, 2018, 11:48am
UPDATED : Tuesday, 07 August, 2018, 11:04pm

Mixed ownership is Beijing’s latest catchword in its reform of the state sector. Last month Chinese Vice-Premier Liu He became head of the State-owned Enterprises Reform Leading Group, a move that may speed up the process. However, mixed ownership reform may also lead to corruption, insider control and unfair competition.

Mixed ownership allows private investors to hold stakes in state companies and state funds to take stakes in private firms.

Before 2013, reforms were only one way, with private funds flowing into state-owned enterprises, but now China’s state sector has become stronger and is again advancing into fields from which it had withdrawn, often in the name of mixed ownership.

In theory, private and state firms can compete on an equal basis. In reality, there is an inequality of power between state and private capital and this inequality carries risks.

Ownership reform a gateway to state enterprises for private equity

Firstly, it helps the state sector expand as the private sector shrinks. Generally, China’s state enterprises enjoy credit support from banks (most banks are state owned as well) and the bond market, and their demand for private capital is limited.

Only struggling state businesses or local governments with a serious shortage of funding, present opportunities for private investment. But these partnerships can be very dangerous for private investors.

For instance, in the late 1990s the Shanxi government encouraged private investors to buy into coal mines when coal prices were low and mining profit margins were thin. Then when coal prices shot up and mining became a lucrative business, the private-sector investors were kicked out.

It is easy for SOEs to reject private investment bids for stakes. On the other hand, when the state wants to get a foothold in private firms, it is not easy for those companies to say no. They need to think about the consequences of offending SOEs and, more importantly, their powerful owners.

In the name of mixed ownership reform, state capital may expand its reach to all sectors, which could prove to be the biggest setback for market reforms since 1978.

Secondly, mixed ownership reform increases opportunities for corruption. The latest vaccine scandal is raising questions about the history of Changchun Changsheng Bio-technology, the vaccine producer at the centre of the storm. It was a state-owned enterprise, but became a privately-owned business in 2003 when Gao Junfang, who worked for the SOE on an annual salary of about 60,000 yuan (US$8,803), managed to pay 41.6 million yuan for a controlling 35 per cent stake.

Before her arrest this month for producing inferior vaccines for children and forging data in the production of a rabies vaccine, Gao’s personal wealth had reached US$1 billion.

Changchun Changsheng highlights the risks involved in state-private capital exchange, where state enterprise insiders can siphon off state assets into their own pockets. Mixed ownership reform may worsen the situation. Before the reform, Gao had to find 41.6 million yuan to buy state assets, even it was much cheaper compared to the market price. Under mixed ownership, she could have transferred the state assets with nearly zero loss to her shell company, as the state capital is allowed to flow to the private sector.

Lastly, mixed ownership reform leads to unfair competition in the market. Political power is a special resource in business. A field survey done by Unirule Institute of Economics shows that over 90 per cent of small and medium-sized private business owners have political aspirations, such as membership of the ceremonial people’s congress or political consultative committees. On average, they said they are willing to pay one million yuan for this membership.

Chinese state enterprises post record level of profits

By introducing state investors, they can get access to people with “political resources” – the power to speed up project approvals for instance. A company with hybrid private-public ownership may take advantage of public administrations and the market to secure extra profits. That is why Chinese private business owners are willing to marry their businesses with state funds despite the great risk of being taken over by the state.

It’s a form of unfair competition that leads to a situation of “bad money drives out good”. Entrepreneurs will not compete over products or service quality but over the power level of their backers. Entrepreneurs who believe in the market will gradually disappear.

The root of the problem lies with the privileged status of the SOEs and interest groups feasting on the state economy. Unless these fundamental issues are addressed, mixed ownership will delay the reforms needed for China’s state sector.