SHENG Hong: This Round of Reform of the State-Owned Enterprises Is a Total Failure

The Central Committee of the Communist Party of China and the State Council issued Directive Suggestions on Deepening the Reform of State Owned Enterprises. A new round adjustments is looming upon the biggest employer group in China, the state owned enterprises.

Professor SHENG Hong, famous economist and Director of Unirule Institute of Economics, has been advocating for second reform of state owned enterprises(SOE) since 2010. He pinpointed the main problems of Chinese SOEs, such as monopolistic market status, profit handover, and cronyism. Recently, China_Review interviewed him on the new round of SOE reform.

China_Review: Now that the second round of SOE reform has been announced, what’s your take on it since you’ve been advocating SOE reform since 2010?

SHENG Hong: In the last SOE reform, the main focus was for governments to loosen control and let SOEs to keep part of the profit. In the past, SOEs were under heavy constraints. Such a reform stimulated the incentives of SOE executives and staff. But now the situations has changed: SOEs are totally out of control, and they have not handed over profit to the government for many years. On the contrary, SOEs are deciding how to use the profit that’s supposed to be handed over to the government. Besides, the favourable institutions and policies have facilitated SOEs to get monopolistic market status, to use state owned land for free, to loans with very low interest, and to obtain natural resources at very low costs. The second round of SOE reform should be solving these problems. That’s why I don’t see the point of the new Suggestions and their influence on the new round of SOE reform.

SHENG Hong: Reforms are meant to solve problems. This Suggestions on SOE reform does not address any of the problems I mentioned, such as the monopolistic market status of SOEs, the free and low cost use of state owned resources, the profit handover issue, and the limitless distribution issue within the SOEs. These are the real problems. What’s even worse, as I see it, is that the very existence of SOE is the problem. It is because of these SOEs that government do not treat SOEs and non-SOEs on equal terms, which destroys the justness of the government; SOE executives and government officials can transform, meaning government officials are the same group of people like SOE executives. Due to these reasons, the government can hardly treat SOEs and non-SOEs equally, which is a breach of fundamental principle of the existence of governments. Governments are supposed to be guardian of justice. As SOEs are granted with favourable policies and monopolistic power, how can private enterprise compete with them on that ground? SOEs are not fair players in the market. SOEs are violating the basic institution of the market economy.

Due to the monopolistic SOEs, a big amount of resources are occupied, resulting in a loss of multiple trillion RMB a year.^{^[1]} China’s economy is slowing down, and I think a major cause is the existence of SOEs and the shield of SOE monopolies. It is an urgent problem that’s losing us several dozen billions RMB on a daily basis. If this problem is not addressed, then what’s the point of reform?

China_Review: The Suggestions stipulates that “SOEs are to be made bigger and stronger.” What’s your take on that?

SHENG Hong: In my opinion, it is absolutely wrong to make SOEs bigger and stronger. Why should SOEs be bigger and stronger? SOEs are not common enterprises. They are not supposed to be competing with private enterprises in profit making areas. I don’t think SOEs should be doing anything that’s profit making. Besides, SOEs get their monopolistic market status by political resources, they get free resources with political power. This is serious harm to the Chinese people.

China_Review: So the Suggestions also categories SOEs into commercial and public purpose SOEs?

SHENG Hong: First of all, the problems we are talking about are not considered problems at all by them. The problems we can hardly deem as problems are considered by them serious and severe. What is the point of the reform plan, then? Different voices and criticisms in the society are totally ignored. To make SOEs bigger and stronger? How can you call it reform at all? This is anti-reform. This is doing something totally anti-reform in the name of reform. This is deceiving the media.

The Reform Fails to Reach Interest Groups: Even Idiots can Make Money with Monopolistic Market Power

China_Review: This reform does not influence the interest groups in the high level SOE executives.

SHENG Hong: It is the key issue that the interest of the interest groups are not influenced at all. I can tell what’s up in their sleeves after so many years of study on the SOE issue. This is what interest groups are good at: they talk about reform to fool the media. The media should cool off a little bit, because this is not reform. It’s not genuine reform at all. So many times, the media and the people are fooled. They’re easily excited by reforms without knowing what real reforms are. Calm down, and take it easy.

China_Review: We’ve been expecting this document since last year when 22 provinces handed in SOE reforms plans. However, we are disappointed.

SHENG Hong: Right. There is no concrete action at all. At least don’t get fooled by them, and be cool minded.

China_Review: Besides monopoly, there is also internal management issues of SOEs. You mentioned before that SOE executives control the distribution of bones and rewards. The Suggestions claims to manage SOEs in a mixed manner, with a combination of appointment and recruitment. Would such measures take effect in terms of influencing the interest of high level SOE executives?

SHENG Hong: We can hardly say so, actually. For example, the mixed style management that can be categorised into commercial and public. Let’s start with the commercial SOEs. The performance of the SOEs is used to assess them. However, the performance data is not real. Where do you get profit? As you have monopolistic power, you don’t need to pay land rent, you also get low interest loans, you can obtain the oil extraction grant at RMB 30 per ton, whereas everybody else pays RMB 400 per ton. The terms are totally unfair. How do you suggest I should measure your real performance then?

Another area is finance. Banks make a lot of profit, but do you know where the profit comes from? The difference of interest rate for deposit and loans is determined by the central bank, which hasn’t quite changed over the years but only at small margins. The reason is basically to cater to the interest of the interest groups. The interest rate gap between deposit and loans remains 3% over a dozen years. The interest rate gap acts like monopolistic price and price regulation. As the government determines the 3% interest rate gap. But it is not acceptable, because normally the gap should be between 1.5% and 2%. In market economy countries, it is competition that determines this gap. However, in China’s case, it is the administrative departments that determine this gap that is not the real result of competition. Then, how do you really assess if these people, the SOE executives, are really making an effort to make profit? In this condition, even idiots can make profit with monopolistic powers.

Besides, in SOEs like CNPC and Sinopec, there is also a problem of redundant personnel with low efficiency but high paycheques. How do you assess this? How do you suggest I should assess the SOEs’ performance when the market environment is man-made and the performance itself is man-made? The underpaid land rent amounts to at least 1 trillion RMB per year for SOEs. Now that SOEs claim to have made about 1 trillion RMB profit. That basically means, the profit they claim to have made equals the land rent they should have paid. What’s their contribution, then? For any private enterprise, if their land rent is underwritten, their profit would have skyrocketed. It’s simple mathematics. The performance is not real before calculating full cost.

The Temasek Model Is Unnecessary: State-Owned Assets Should be Returned to the People

China_Review: This time the Suggestions introduced the Temasek Model from Singapore as a model for state-owned assets management, which transforms management of assets to management of capital. A state-owned assess operation centre is set up, and the State-owned Assets Supervision and Administration Commission(SASAC) claims that it will not manage certain operations of the SOEs, but focus on management of the state-owned capital.

SHENG Hong: It is suspicious to manage only the capital instead of assets. Other issues regards whether SOEs are affected, whether shareholdings can be sold, whether there’s an exit mechanism for SOEs, etc..

SHENG Hong: I think the Temasek Model is absolutely unnecessary. It is only mentioned every now and then, because there are some people in China who want to keep SOEs in the game. What’s the point of the Temasek Model? Why do you need state-owned capital to make profits for the people? Totally unnecessary. The exit of state in the market and the leading role of private enterprises should be the best way.

SHENG Hong: The Temasek Model means operation of the state-owned capital, not state-owned enterprises, operate in the form of private enterprises, while maintaining that the capital is state-owned. What’s at issue is, why do we need the state-owned capital in the first place? Totally unnecessary. The state-owned capital can be returned to the Singapore people since it comes mainly from the revenue of taxation. It does not make much sense to have such a thing discussed further.

The Merger of Centrally-Owned Enterprises(COEs) Is a Disaster. Spin-Off Is Better for Central Management

China_Review: You proposed for the demerger of SOEs, to divide CNPC and Sinopec into small enterprises before. However, now we see that after the merger of the Chins South Railways(CSR) and China North Railways(CNR), more and more centrally owner enterprises(COEs) are conducting mergers. What are the likely outcome?

SHENG Hong: It can be anticipated that after the mergers and reorganisations, the monopolies will get more powerful, which means no good to the society, consumers, or private enterprises. The logic is simple, when the monopolies get more powerful, it gets harder to control them, or to constrain them. After the mergers of the COEs, the central government will find it more difficult to manage them. The COEs will get more power to come against the central government. We have already seen that COEs such as CNPC and Sinopec are not under control by the National Development and Reform Commission（NDRC）or the National Energy Administration. They are too big to control. You can’t deny that. If the Three Buckets of Oil^{^[2]} merged into one big conglomerate, it is impossible for the central government to control. Then what is the central government faced with, a monopoly or a competitor? It is a totally different situation for Premier LI Keqiang to negotiate with the only one monopolistic oil enterprise than with three or five oil companies.

I used this example before. When there was only one China Telecom, the negotiation between it and the central government was tough. Then there was China Unicom, the table was turned. If the central government really wants reform, mergers should not be the right path, but demerger. For instance, the CNPC and SINOPEC should be divided into several smaller enterprises instead of merged into one big oil company. If the central government really want to control the SOEs in general, demerger is better than mergers. A scholar named JIA Yi in Han Dynasty once said,

China_Review: The Suggestions states that SOEs are to be managed by the Party.

SHENG Hong: It is just as before, that the SOEs are managed by the Party. In the past they were managed by the Central Organisation Department of the Party. A lot of problems.

China_Review: But it never said so before. It’s the first time to assert this.

SHENG Hong: This statement marks a wrong direction for SOE reforms. History told us that when problems occur, one think more control is needed; however, the more you control, the worse the situation gets. Mechanisms matter, not control. The Great Famine of 1959~1962 was a result of control. Think about it, do you really need to control agriculture? Farmers know how to grow crops, and the market works. DENG Xiaoping did not control to that extent. In the past, the government controlled the production of steel, but the production of steel never exceeded 300 billion tons. Yet now, there is no control over the production, we get over 8,000 million tons of steel on a yearly basis. Besides, there should be institutions even if control is what you want to do. Daily reports never quite work as there will be false information. The alternative is market competition. The market does not deceive. If I were a monopoly, like the CNPC, you would not even know my real cost at all. However, with market competition, the cost is easy to figure. Competition reveals the real cost.

SHENG Hong: The more you control, the worse the situation gets. Reforms are not conducted by control. Take a look at all the industries, which develops from control? It is the market that really matters, along with the incentives of the people, and the wisdom of entrepreneurs. If we fail to recognise this plain fact, the reform is bound to fail. There are so many corrupted officials, however, they were all selected by the Central Organisation Department of the Party, weren’t they? Such as JIANG Jiemin, or the corrupted executives in the CNPC case? The institutions lacks constraints, and then institutional failures would occur.

China_Review: When the Suggestions came out, we have reviewed the history of the SOEs, such as the CNPC, SINOPEC, China Telecom, and China Unicom which did not exist before. China Unicom and China Telecom came to existence from the former Ministry of Industry and Information. It was former Premier ZHU Rongji who order to have them established to facilitate competition. So do you think the reform is conducted on this direction now?

SHENG Hong: In the past, China Telecom belonged to the former Ministry of Post and Telecommunication. Other departments, such as the former Ministry of Electronics and the former Ministry of Railways, wanted to get involved for interest. China Unicom was a result of involvement of several departments and ministries. To break monopoly with the power within the system is a useful approach, even without the participation of private enterprises. For instance, regarding the reform of the oil system, we proposed that instead of allowing private enterprises to participate and compete with the existing oil SOEs, other SOEs should be allowed for competition first, such as Chemchina, CITIC Group, and China Huaneng Group. These companies also have the motivation to compete in the oil industry. We should support the competition between SOEs in the system, as long as they are not monopolies. The purpose for them is to make profits. This should be the driving force for reforms, just like when China Unicom was created to break the monopoly in the telecom industry.

China_Review: One thing I don’t quite understand is that it seems the marketisation of SOEs in the first ten years of this century has stagnated after the establishment of China Telecom, China Unicom, the CNPC, and the SINOPEC in the late 1990s. What do you think caused this stagnation of SOE reforms?

SHENG Hong: I suppose it is because the interest groups now get a hand of the situation. At first, everybody did not understand what market economy was. Then SOE executives and government officials began to come around and believed they would make more interest for themselves if competitors were kicked out of the game. Another background we should keep in mind is that in the 1990s, the SOEs were in tough situations in general. There was an issue of survival for SOEs. In ZHU Rongji’s time, debt problems even made headlines in newspapers. Around 2000, resources prices were low, including prices of oil, coal, and land. Resource related SOEs were not doing well back then. Then, the SOEs realised monopolies would benefit them, and ZHU Rongji thought it was also a good idea for SOEs to survive. People didn’t quite realise this when the Three Buckets of Oil were established in 1999. The oil price was low, and it was the best time to set up monopolies. The main purpose was to survive, therefore, there was not much objection politically. That is the backdrop. But what

^{^[1]} For SOE caused loss of national wealth, please refer to: http://www.unirule.org.cn/index.php?c=article&id=295

^{^[2]} The Three Buckets of Oil refers to CNPC, SINOPEC, and CNOOC.