SHENG Hong, Director, Unirule Institute of Economics
Translated by MA Junjie, Researcher, Unirule Institute of Economics
In the discourse on Chinese “State” owned enterprises nowadays, the biggest false conception is that of the “state”. Those who control the state-owned enterprises (SOEs) seem to flaunt it to refuse further reforms, and those who criticise SOEs are mostly from “non-state” institutions.
In fact, the “state”, as in State-owned enterprises, refers to the state of the Chinese people according to the existing Constitution of the People’s Republic of China. Therefore, it is explicitly true that “State” owned enterprises are “collectively owned by the whole people of the PRC.” It means the owners of the SOEs are all citizens of China. However, the so-called SOEs today are used explicitly to refer to the managerial entities of the SOEs. It should be noted that when we talk about the “State” in SOEs, it refers to the whole people of China, and the SOE executive groups are entrusted by the “State” to run the enterprises. That is to say, they are a group of individuals.
When we talk about the relationship between the two groups of people— the Chinese citizens as the owners of the SOEs, and the SOE executives as the managers— no matter whether in the light of state theories or property rights theories, let this be said and held true: the owners of SOEs entrust the managers to manage their property in the hope of returns; due to the principal-agent problem, i.e., the goals of the managers and the owners differ, the owners are obliged to oversee the managers in terms of the efficiency of utilising the property and the act of jeopardising the interests of the owners.
In reality, it is impossible for the 1.3 billion owners to supervise the SOE executives, because there is a lack of initiatives and incentives to do such things. The institutional and technical costs are too high. In the existing institutional framework, the State-owned Assets Supervision and Administration Commission (SASAC) is entrusted to undertake supervision of SOEs for the owners, and yet only to our disappointment. We have never seen it conducting its obligations. We have never heard of any disclosure of embezzlement suspects by the SASAC. On the contrary, SASAC has solidified the position for a certain corrupted official as its director. If is understandable that if the corruption case of ZHOU Yongkang and his Oil Gang regarding billions was not successfully overseen by SASAC, lesser corruptive behaviours are mostly left at large.
In this regard, Unirule Institute of Economics, as an NGO founded by some members of the billions of SOE owners, has done concrete work to supervise the performance and operations of SOEs on behalf of their shareholders and owners. The book entitled “China’s State-Owned Enterprises: Nature, Performance and Reform” (English edition published by World Scientific Publishing, available: [Page]http://www.amazon.com/Chinas-State-Owned-Enterprises-Performance-Economics/dp/9814383848) is an example of this endeavour. We took a look at the performance of the executives of the SOEs to see whether they were making profits for us owners or took liberty to work for their own interests. This year, the research was updated with new data of 2013 that enabled us to trace the performance of the SOEs.
The first issue that concerns an owner of an enterprise is whether it is making a profit. Concerning SOEs, the answer – on nominal terms – is yes. From 2001 to 2013, SOEs and SOE controlled industrial companies made an accumulated profit of some RMB 12 trillion, 9.1% for net capital returns. However, shareholders are also those who “pursue the maximisation of income”. We shall, then, ask, whether the nominal profit made by the SOEs is satisfactory. In economic terms, we must consider the concept of opportunity cost. As we discovered, in the same period, the rate of net capital returns of non-state-owned-enterprises was 15.7%, 6.6% higher than that of SOEs. Obviously, it means the SOEs were not making a profit competitive enough compared to their non-state-owned peers. For this, we as shareholders are not satisfied.
The second issue, however, is whether the nominal profits presented in the book by the SOE executives are real. As we know, SOEs use state-owned land for free and exploit the profit of those lands for free, SOEs obtain bank loans at interest rates lower than the market level, and SOEs are heavily subsidised by the government despite their low royalties when utilising natural resources. What’s more, many SOEs have a status of monopoly in the marketplace. Apparently, the real performance of the SOE executives should be measured when put to the same conditions of their peers in non-state-owned enterprises without favourable policies and subsidies. Therefore, it only seems natural to discover the real performance of SOEs without the underpaid costs, the extra subsidies from the government, and the revenues derived from the monopoly status.
Our research of “China’s State-Owned Enterprises: Nature, Performance and Reform” did just that. In this short essay, I have quoted the main conclusions with consolidated data and calculation. For those who are interested in the sources of the data or the methods of calculation, the Chinese version of this report is readily available (http://www.china-review.com/xiazai/20150916.pdf). What’s worth mentioning is that, due to the difficulty of obtaining the data, many of our findings are a result of calculation with indirect data. I’d also appreciate if anyone’s able to provide more accurate and direct data alternatives. If anyone realizes errors in the report, please do not hesitate to point them out.
In 2013, the underpaid land rent by industrial SOEs amounted to some RMB 450.3 billion; the underpayment of low-interest loans accounted for some RMB 951.9 billion; and the various kinds of government subsidies amounted to some RMB 329.8 billion (Chapter 3.4, China’s [Page]State-Owned Enterprises: Nature, Performance and Reform, 2nd edition, Unirule Institute of Economics, 2015). Deducting these unfairly acquired benefits from the nominal profit of RMB 1519.4 billion, we get RMB -328.8 billion. That is to say, the SOEs in China are making a loss with a net rate of returns of -2.51%. Putting this in perspective, from 2001 to 2013, SOEs and state controlled industrial companies have made an accumulated loss of RMB 1,216.6 billion with a real net rate of return of -1.75%. The comparison between the real and the nominal ROR of SOEs and state controlled companies can be seen in the chart below.
To show it more unambiguously, we applied the pie chart below to show the deduction in the form of industrial added value. According to the nominal profit of SOEs, the pie chart shows the industrial added value between 2001 and 2013 as below. The “surplus” equals to the profit that accounts about 21.3% of the industrial added value.
After deduction of underpaid costs and government subsidies, the pie chart is as below.
After deduction of underpaid land rent (7.71%), royalties for utilising natural resources (mines) (1.96%), benefits of low interest rate for loans (10.05%), and government subsidies (3.03%), the surplus disappears, and there emerges a loss of 1.65% of industrial added value (Chapter 4.1, Unirule Institute of Economics, 2015).
Is this deduction too much? It should be noted that this calculation is not a “bold” based on real data that is impossible to obtain. For instance, we did not include the land rent for commercial and service land when calculating the land rent for industrial uses, in the rate of 3% of the land rent level of RMB 700 per square meters. The land rent for commercial and service land is clearly a much larger portion of land rent. According to our estimate, the underpaid land rent by SOEs including the rent for commercial and service land could well amount to over trillions of RMB per year.
On the other hand, the deduction included the profit resulting from the monopolised oil price, but profits of other industries such as the monopolised profits in the banking and telecommunication industries are not included. We undertook another estimate in “Administrative Monopoly in China: Causes, Behaviours, and Termination” (Unirule Institute of Economics, 2015b, available at http://www.unirule.org.cn/xiazai/2012/20120803.pdf). It shows that the benefit of the differentiated interest rate in the banking industry resulted in some RMB 970.6 billion in 2013 (Unirule Institute of Economics, 2015b, Sub-report 4); the benefit of monopoly in the telecommunication industry amounted to at least some RMB 12.5 billion (Sub-report 1).
After such calculations, we as shareholder get to know that the performance sheet presented by SOE executives is a false one. They run the SOEs of state-owned capital (accordingly RMB 100 trillion) as we entrust them to. However, they fail to make a profit. Instead, these SOEs have deprived their shareholders of their returns of other assets (such as land and natural resources). What’s more, these executives boast of their “performance” for rewards, saying that they’ve done a good job. This behaviour itself is even worse than making a loss. To put it in a gentle manner, it’s providing false information; to put it in a more serious manner, it’s deception of the shareholders. [Page]
It is not a surprise why the SOEs claim to have made good performance. It should be noted that the management of SOEs has been improved in the past reforms, however, the issue of state owned property rights failed to solve the problem of incentives. What made it worse is that the executives of SOEs have recently discovered a secret to “improve their performances”, that is to request favourable policies from the government, including the power to set up monopolies. They know well how important it is to get such partialities thanks to the comparison with market competition. If interests can be obtained without making endeavours in the market, then why work hard? One evidence of the low efficiency of SOEs is the excess of employees. For instance, compared to Shell, a Dutch oil company with similar amount of revenue, the number of employees of SINOPEC is 9.6 times that of Shell. On the other hand, the sales revenue per employee of Shell (average productivity) is 10.5 times that of SINOPEC and 18.5% that of CNPC.
The third issue is the false information. Have the nominal profits of SOEs been turned over to us shareholders? The answer is easy, not a penny of that profit was handed in from 1994 to 2007, and a small amount, or almost none, was handed over from 2008 to 2013. Why, then? The small amount of profit handed over by SOEs was given back to them later.
The table above shows a surplus of RMB 29.8 billion if the budget for state-owned capital from 2008 to 2013 was put in the same equation. Compare this amount to the book revenue of over RMB 11 trillion (according to the Ministry of Finance), it is trivial and was later given back to SOEs. Therefore, it makes sense to say that the SOE capital over RMB 100 trillion we entrusted the executives to operate and the input of other state-owned resources has not resulted in any interest for the shareholders since 1994.
The fourth issue is the use of the profit made by the SOEs that was not handed in. It should be noted that without the due procedures of the shareholders and with the low efficiency of the SOEs, much of the profit was reinvested. From 2001 to 2013, the net asset of industrial SOEs increased from RMB 3538.5 billion to RMB 13059.8 billion, an increase of some RMB 9.5 trillion. However, it does not add up with the total book profit of RMB 12 trillion over the years. Besides, the corporate assets also include a certain amount of intangible assets, such as the land use and mining rights, which should have grown alongside the value of the assets. The real investment increase rate is way lower than that of the growth rate of net corporate assets. Where does the profit go then?
We discovered a key document of 2001, i.e., the “Suggestions on Deepening Reforms of the Internal Institutions for Personnel, Labour, and Distribution in State-Owned Enterprises” (State-Economic-Trade Enterprise Reform [2001] No. 230). It stipulates that “the salary level of enterprise’s employees is open to the adjustment by the enterprises in accordance with the local average wage and the performance of the enterprise in the background of the national macro economic adjustment.” This stipulation, as a matter of fact, has granted the SOE executives the power to determine the salary of their employees. As we know, there is a correlation between wage and profit. As there are no official limits to the wage of the SOE employees, they have obtained the power to determine for themselves how much they are paid. [Page]
As the ambiguous and usually unreasonable wages and bonuses are in the form of subsidies for housing, insurance, and other materials rewards, it is impossible to get the statistics on average salary for SOE employees from the officials websites of the National Bureau of Statistics or SASAC. However, we employed the following estimate method to get that figure: by subtracting “fixed-assets depreciation”, “net product tax”, and “profits” from the industrial added value, we get “employees’ wage”. By dividing that number by the number of SOE employees of that year, we get the average industrial SOE employees’ annual wage of 2013, which is RMB 191,000. This number is 3.3 times of that of non-SOE employees. By adopting the same method, we acquired the figures from 2001 to 2013. In the chart below, it can be seen that the average SOE employees’ wage is several times that of non-SOE employees. It becomes extremely obvious after 2001, up to 3.3 times. This can be seen as the result of issuing the “Suggestions on Deepening Reforms of the Internal Institutions for Personnel, Labour, and Distribution in State-Owned Enterprises”. Now we shall be clear about the profits.
SOE Employees‘ Wage is X times that of Non-SOE Employees’
Now let’s move forward and consider the situation for not only the shareholders of the SOEs, but also the Chinese citizens. The fifth issue is, as the SOE executives claim to have made such good “performance”, have they also sacrificed the interest of other groups for their performance? Specifically, as the owner of the state-owned land, we shall ask, where are the land profits? As a consumer, we shall ask, who is bearing the consequences of the monopoly prices? As citizen of the origin of natural resources, we shall ask, where are the royalties for our natural resources? As private entrepreneurs, since non-SOEs are marginalised in the market by the means of administrative monopoly, who shall compensate for the loss, not only in terms of money, but also in terms of opportunities? As clients of the banks, we shall ask, who shall compensate for the losses due to the banks’ monopolised interest rate gap?
For the sake of clarity, let me use one of the charts in our previous research report Opening Up China’s Market of Crude Oil and Petroleum Products: Theoretical Research and Reform Solutions in 2013 to illustrate how oil monopolies in China deprived multiple groups in the society.
How Oil Monopolies Grab Interests
The detailed calculation and methodology is available in the report “Opening the Markets of Crude Oil and of Petroleum Products” (http://www.china-review.com/eat.asp?id=32232). What’s worth noting is the price of petroleum products. Generally, people would think China’s petroleum products’ price is low. The cause of that is the low gas tax rate, i.e., RMB 1 per litre, whereas in European countries the rate is normally 100% to 300% higher. Besides, the “Europe V Standard” is implied in Europe, whereas the “State 3 Standard” is used in most of China, which is lower. Despite these two reasons, the pre-tax price of China’s petroleum products is 31% higher than that of the petroleum products of the same quality in most of the developed world. The chart above is mainly focused on the oil industry. Monopolies in other areas have led to similar results.
The sixth issue is, since we have recognised the performance of SOE executives, and we have noted that the interests of other social groups are deprived, then, how can we still reward these executives as if they were the winners of market competition? As I said, in this game and with these administrative monopoly advantages, even fools can make money. Who is the fool, then, if we still reward these executives? If we still believe that this is a successful model, and the SOEs should still go “bigger and stronger”, who is the bigger fool then?
The seventh issue is, can we accept it that SOE executives argue that SOEs are the “republic’s first-born son”, “the basis of the ruling party” and that shareholders of SOEs should reward them after seeing their wonderful performance? Even if we recognise the importance of the first-born son of the republic, there is no reason for tolerating their wrongdoings. In the Chinese family culture, the “first-borns” are not those who fight over wealth or family heritage, but those who shoulder more duties. Has anyone seen a first-born fighting for his parents’ favours? The fallacy of the “first-born son of the republic” is that SOEs not only fight over favours and interests, but also ruin the chance for their parents to be fair and just. Good parents should treat their children equally. Partiality means injustice to others. The existence of the SOE is the key reason for the unfairness of the government.
It works the same for the “basis of the ruling party.” When it is said that certain people or groups are the “basis,” it understates the importance of other people and groups, resulting in less and less “basis”. When it is said that the basis should be solidified, it entails the harm of the interests of others. When someone argues that favours should be given to certain groups because they are the basis of the country, then what it really means is to shake up the basis of the government. The state belongs to everyone, to all the citizens. The reason why the state is trustworthy is its justness. Any group that jeopardises this justness for its own interest cannot possibly be considered the basis of the state.
The eighth issue is, on the contrary, that can we really expect them to be loyal to the interest of the state if favours and partiality are granted to them? If a country is worth fighting for and dying for, it’s not because the state grants extra interests, but because we believe in the spiritual power of the state. Money cannot buy political loyalty. We have been spreading money to many, but they are not grateful. On the contrary, they giggle. Besides, where does this money come from? Mostly from other members of the society.
In terms of the SOE executives’ interest group, it is all the same. The “Oil Gang” headed by ZHOU Yongkang has accumulated a huge amount of wealth from their corruption in SOEs. We can therefor assume that most of the nearly RMB 100 billion of ZHOU Yongkang’s corruption wealth came from his position in the SOE he served before. Apparently, most of this money was “given” to him by his subordinates in the SOE. And they might probably had played the “first-born son” and the “republic’s basis” card to achieve that. Would the subordinates be loyal to ZHOU Yongkang, or to the state? Would ZHOU Yongkang be more loyal to the state or more harmful to the state after he acquired that money? History has proved that unjust partiality and favour cannot buy loyalty.
The ninth issue is even more serious, i.e., what is a “state”? State is a holy word. According to Mr. JIANG Qing, a leading Neo-Confucianist, a state is a cultural organism transcending generations. It entails a social entity that shares the same tradition, history, and cultural breeds. It is beyond the life and will of any individual member. In order to maintain the state, to provide public good, the members would entrust a group of people to form a government. However, the government is no state, but rather a limited part of the greater organism. That is because, the government is made up by individuals, and each and every one of them is an ordinary person. He or she is limited, he or she may err, and he or she may even seek private interests by using their public positions.
Therefore, a government can benefit the state, and it can harm the state. It depends on how the government is formed, by what rules it runs, and whether there is oversight. In order to determine if there is efficient oversight, we need to, firstly, distinguish “state”, “government”, and “government officials”. Those who are against oversight of the government may try and blur the three. Over the years, they have tried to equalise “government officials” to the “government”, and the “government” to the “state”. Whenever there is criticism of the government, they would press charges of “lack of patriotism”; even when the wrongdoings of the government officials are disclosed by the citizens, some officials even inflicted “treason” on the citizens.
As for SOE executives, they are even more remotely related to the “state”. They are merely the entrusted agents of the state-owned assets. However, over the years, these SOE executives are most successful in linking themselves to the “state”. It’s all because the “State-owned enterprises” starts with “state”, they legitimised their unlawful acts and made the Chinese people accept them. Some really believed and thought “we go out and take the train owned by Family ZHANG, and go for gas at the chain gas station of Family LI for the gas produced by Family ZHAO, and we turn on the lights with the electricity produced by Family LI.” How ridiculous is this! If this is understandable, it is even more appalling to see that most of the products “produced by the state” are not the products of the state. For example, the gas we thought produced by SOEs was, in fact, produced by the affiliates of the “Oil Gang” headed by ZHOU Yongkang. Most of the profits have been taken by ZHOU Yongkang and his subordinates. The citizens did not even get a penny. And yet, all the citizens still purchase the gas at the monopolised price set by Family ZHOU.
If the assets are entrusted to certain agents to run, and those agents take the liberty to name the assets their own and become the owner of the assets, won’t this be the biggest fraud there is on the earth? Besides, the real owners of the assets are left deceived and think it was a good idea and all is legitimate. Aren’t these real owners the biggest fools in the world?
The tenth issue is, as we have discovered the problem of the SOEs, what should we do? Reform, of course. But how? I would propose that the state act as a state, the government as a government, the officials as officials, the enterprises as enterprises, and the executives as executives. More detailed discussion of the measures and steps of the reforms are available in our research reports: “China’s State-Owned Enterprises: Nature, Performance and Reform”, “Administrative Monopoly in China: Causes, Behaviours, and Termination [Page] and Opening the Markets of Crude Oil and of Petroleum Products.”
Then, why haven’t we seen any concrete reforms? The reason does not only involve the continuity of the fraud, but also the development of the whole country. I pointed out in an article before, that “the monopolised SOEs occupy a big proportion of the resources of the country without providing equivalent services and products. The issue of SOEs and administrative monopoly is not an issue concerning the corporate management in the microeconomic term, or the levels of industries in the intermediate term, but the repercussions in macroeconomic terms.” Unirule estimates that should the net asset rate of returns in 2012 hit 6% (which in fact is -0.67%), the GDP growth would have been slowed down by another 2.9%.
Today’s economic situation has given us more direct consequences. China’s economy embraced a big slowdown this year. In the first half of 2015, the eight provinces and cities with a GDP growth rate at or below 7% are those with the most SOEs, especially Heilongjiang, Jilin, and Liaoning Provinces, as well as Shanxi Province. As we know, SOE industries have been a bigger proportion to the economy in Northeast China than the national average, and Shanxi Province has the most SOEs in the country. SOEs do not only drag down economic growth with their low efficiency and unfair competition, but also poison the social environment by their very existence. They show that unfair competition can win the game, and favours and partiality can gain profits. However, this growth pattern is unsustainable. It shows that the SOE reform is not only a theoretical issue, but also a pressing problem.
The eleventh issue is, since the SOE executives and the government officials that come from SOE executive positions are against reforms, how is the reform possible? The answer is, it is possible. SOE reforms bring more benefits than harms. Because SOE executives have been affecting the society in every way over the years, the majority of the society will support the elimination the monopoly, the cancellation of favours, and the existing of the SOEs. Only by following the will of the people will the ruling party’s reign be more politically solid, and the champions of the reform secure a more solid position as leaders.
Even within the SOE executives, there are many who support reforms. There are many talented people in SOEs who are suppressed due to the monopoly status of the SOEs and the favourable policies they get. These people also include those ambitious entrepreneurs whose talents have been wasted in the system. Just like people dislike the unfair distribution within SOEs, these people share the sentiment and wish for change. Reforms can even benefit those who have vested interests. In the long term, wealth gained in unlawful ways may lead to imprisonment and punishment. Such wealth is not real wealth. It can also damage education and morale of wealth for the next generation. It is a critical goal to unleash the SOE executives and employees from an environment that lacks competition, innovation, and that entails unfair distribution and risks of crime.
(This article was originally published by Financial Times Chinese: http://www.ftchinese.com/story/001064643?full=y)
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