The Australia-China Chamber of Commerce and Industry of New South Wales

Newsletter No. 24

19 October 2000





Brief Background to the SOE Problem

The Good News

Are the Results Believable?

The Tasks Remaining

Ideology Versus Practicality







The focus for this Newsletter is Reform of State-Owned Enterprises.  We mentioned in previous E-Letters that the problems associated with lagging state-owned enterprises are “being addressed” and that an early solution would release fiscal resources of provincial and municipal governments in China for other development activities. 

We collected information during the past few months to indicate that substantial progress has been made in restructuring state-owned enterprises (SOEs).  Not surprisingly, some difficulties remain but they differ from those that were encountered in the early 1990s.








When China made its transition from a centrally planned economy to a market-directed economy in the 1980s, the central government elected to proceed in a gradual, step-by-step manner.  The process therefore differed substantially from the “shock therapy” associated with economic reform in Russia in the early 1990s.

China’s strategy was of course dependent upon a number of factors, including the desire to achieve their objective with “Chinese characteristics”.  It was most likely influenced also by a number of social welfare considerations: 

·         The gradual lifting of price controls avoided a hyper-inflated economy that would have eroded the savings of most, if not all, ordinary Chinese. 

·         The relatively slow rate of retrenchment of SOE employees kept the level of unemployment to a more socially acceptable level. 

·         The slow expansion of the legal framework, and the accompanying removal of discriminatory regulations, allowed time for SOEs to adjust to a different set of rules for commercial activity.

The Chinese strategy nevertheless carried a number of anxiety-creating features: 

·         Corruption by party cadres at various times threatened to undermine public confidence in the overall reform process.

·         Many SOEs retained connections with owning authorities and continued to operate on a privileged basis, thus remaining protected from the full exposure to market conditions. 

·         The lack of clearly defined rules appeared to encourage undisciplined behaviour.

About the same time as Western experts were “deeply and swiftly engaging themselves in the process of transforming the political and economic orders of the former Soviet republics” attention was directed to the substantial operating losses of most SOEs in China.  The task of keeping the SOEs afloat was beginning to strain China’s banking system. 

Early in 1998, at the peak of the East Asian financial crisis, Premier Zhu Rongi initiated a three-year program that would allow the “vast majority" of China’s large and medium-size SOEs to achieve “their goal of exchanging losses for profits” by the end of this year.  Assessing progress at this time therefore seems appropriate.








Zhu Rongi’s objective was re-phrased as the “three majority” goal and included the following:

1.  Companies owned by the government and firms whose stocks are controlled by the government in the majority of regions must turn a profit:  At the end of July, this goal was realised.  Out of the 30 regions or provinces, excluding Tibet, 25 have broken even or have made a profit.

2. The majority of industries must turn losses into profits.  All 14 industry groupings except for the coal and military industries made profits.

3. The majority of companies must make up for their financial losses and begin making a profit: 55 percent of the 6,599 medium-to-large companies in the red in 1997 have already reversed their loss-making situations.

In the first seven months of this year, SOEs generally showed more impressive gains than other industrial enterprises.  SOE profits increased by 190 per cent to RMB 113.21 billion, compared to a smaller gain of 110 per cent for all industrial enterprises, though the level of profits for the latter was larger at RMB 202.24 billion. 

From January to July, Chinese industrial enterprises paid RMB 272.21 billion in taxes, up 17.3 percent from the same period last year. Taxes paid by SOEs increased similarly, rising by 16.3 percent to RMB 194.15 billion during the same period.

In the January-July period, the country’s money-losing enterprises suffered losses of RMB 78.53 billion, which is 10 percentage points less than during the same period last year.  SOEs did slightly better in monetary terms with losses of RMB 52.01 billion, which is 9 percentage points less than last year.

China’s 516 key SOEs experienced a 93.4 percent increase in profits to RMB 100.04 billion in the first seven months of this year. They also paid 20.6 percent, or RMB 129.42 billion, more in taxes.








The better-than-expected performance of SOEs is broadly consistent with that of the Chinese economy as a whole.  In August of this year, exports rose by 27 per cent, and a whopping 55 per cent rise in imports indicated a more active domestic economy.  Government investment in fixed capital rose by 13 per cent and retail sales, which had been lagging for several years, increased by 9 per cent in August.

Revenue from major taxes such as value-added tax, stamp duty and income tax increased sharply in the first nine months of this year, producing a budget surplus of RMB 10.8 billion.  This contrasts with small-to-moderate budget deficits over the past several years.

Chinese authorities place much of the credit for the faster moving economy on an active fiscal policy that began in 1998.  It undoubtedly contributed, but the most important factor in lifting economic activity was the return to normal trading conditions in the crisis-affected East Asian nations. 

Since most of the relevant SOEs are under the control of provincial and municipal governments, restructuring methods differ somewhat, but a few patterns can be noted.

Privatisation.  In the early 1990s, Qingdao (Shandong Province) had a poorly reformed industrial structure with a large percentage of state ownership.  Most of these enterprises had a relatively high proportion of low-yield assets. 

The municipal authorities began to reform the asset structure of its SOEs in 1994, and during the past six years, 253 enterprises were completely privatised or abandoned (163 were sold, 15 declared bankruptcy and 75 had their registration cancelled).  Although these 253 companies comprise only 15 per cent of all state enterprises under the municipal government, state-owned assets in Qingdao now constitute less than half of all industrial capital in the municipality.

Shareholder restructuring.  A combination of mergers and transfers of ownership to holding companies that exert financial control of SOEs is being used widely as an alternative to full privatisation.  For example, the Municipal Government of Beijing recently reallocated 12 previously city-owned companies (in motor vehicles, machinery and pharmaceutical sectors) into five shareholding companies and four group corporations.

The official transfer of ownership not only cuts the ties with former administrative and regulatory branches of the municipal government, it also allows wider scope to dispose of state assets, rationalise land-use rights and reallocate capital. 

Many more small and medium sized SOEs in Beijing are likely to be partially privatised within the next several years.  This will result in part-ownership by the state, with a majority of shares held by the private sector.  The main methods of achieving ownership reform include forming joint-stock companies, which are expected to encourage employees to become investors and shareholders.

Removing the welfare burden.  The number of industrial workers employed by SOEs in Dalian (Liaoning Province) was more than 300,000 several years ago.  That figure now stands at about 170,000.  In addition, SOE-affiliated schools and hospitals in the city (employing more than 500,000) were either taken over by the municipal government or have become independent.

Re-employment service centres have been established to provide free technical training, job information and consulting services for SOE employees who were made redundant.  A one-time payment of RMB 10,000 is available to laid-off workers who choose to start a business of them own, or seek employment in non-state-owned enterprises.  This is equivalent to about two years of normal unemployment benefits in the municipality.

Other contributions to SOE balance sheets.  We mentioned in a previous E-Letter that debt-equity swaps are being facilitated, thus enabling debt-ridden SOEs to acquire sufficient funds to re-equipment their factories.  Although a breakdown of data is not available, a number of Chinese officials indicated that foreign participation in these swaps was particularly successful, with cross-border mergers and acquisitions becoming a major form of foreign direct investment in China. 

A number of SOEs alleviated their financial difficulties by co-operating with foreign enterprises or by moving to new locations.  In Dalian alone, 97 SOEs sold their land-use rights in the inner city and relocated in the suburbs.

Turnaround in lagging industries.  China is the world’s largest producer and exporter of clothing and textiles, with SOEs contributing approximately 25 per cent of total output and a slightly smaller percentage of industrial value added.  Since the early 1990s, however, the international competitiveness of the industry in China (especially in clothing) has been eroded, mainly due to the improved export performance of India and Pakistan.

SOEs in the industry felt the competitive pressure more severely, with less than 10 per cent showing a profit during the past several years.  The industry as a whole operated in the red for 6 years.

In 1998, the State Council, through its Office for Reconstruction of Economic Systems (SCORES), decided to use the industry as a “test case” for restructuring.  Loss-making SOEs were supported while mergers were arranged to reduce the size of the workforce and rationalise equipment.  The resulting cutbacks increased unemployment in a number of areas and put the textile machinery industry in the doldrums.

The restructuring was basically completed at the end of last year, and profitability of the industry began to improve.  Total profits are expected to exceed RMB 20 billion this year, while contributions from SOEs in the industry are likely to be more than RMB 5 billion.  Sales of textile machinery increased sharply and are expected to reach RMB12 billion by the end of this year.

Significant, but less dramatic, turnarounds occurred with the motor vehicle and pharmaceuticals industries.

Thus, while the percentage of SOEs that “turned the corner” could be questioned, the substantial improvements for a large number of loss-making enterprises seem clear.  The trend is far more favourable now than it was during most of the 1990s.








One of the biggest problems facing the restructuring authorities is achieving a more balanced and consistent set of reforms across provinces and industries.  Most of the current progress is concentrated in cities such as Shanghai, Beijing, Dalian and Qingdao.  Hopefully these successes can be used as “pattern setters”, but they have nevertheless depended largely on the resources available to the municipal authorities and this cannot be easily replicated by other cities in China. 

Shareholding restructuring.  According to figures provided by the State Development Planning Commission, from 1994 to the end of 1999, 2,016 of the 2,473 SOEs selected for reform had converted to a limited company system as defined by the Corporate Law.  This comprises less than half of all SOEs, and those that were not selected for reform will most probably be more difficult to convert.

Even partial privatisation of SOEs requires a considerable effort on the part of management to value assets and to produce a financial statement that will enable potential non-state investors to form a reasonable and reliable opinion of the appropriate share price. 

Recent regulations to protect shareholders make this task even more costly.  According to a new regulation issued by the China Securities Regulatory Commission, a company planning to go public must appoint an intermediary institution possessing a securities business engagement certificate to undertake a verification of investment risks, an asset appraisal and an audit for the period since the company was founded.

According the SCORES, at the end of 1997 there were 1,007 companies listed on China’s share markets, with a total of 284.6 billion shares.  Of these, 192.7 billion shares, or 67.8 per cent of the total, were state and corporate shares.  It was recommended that state and corporate holdings be reduced to 30 per cent in order to produce a more vigorous market in share trading.  Such a quantity of shares cannot be released within a short period of time and would, in any case, create difficulties for share offerings by newly converted SOEs.

This suggests that recent progress in restructuring SOE shareholding is a relatively small part of what is needed to complete the task.

Alternative welfare systems.  Efforts to replace the “iron rice bowl” responsibilities of SOEs with alternative welfare systems have resulted in a mixed and highly variable set of arrangements.  For example, former SOE employees who retired from the workforce receive pensions from banks, post offices and/or social organisations.  Although some cities have pension, unemployment and health insurance schemes, there is little uniformity in the way they are funded or managed.

Coverage of benefits is far from complete.  Among the 7 million workers who were laid off by the end of June, 220,000 are not covered by government unemployment subsidies.  In addition, among the 6.77 million registered with re-employment service centres, 170,000 have received no unemployment allowances and 330,000 have not been given the full amount of basic living allowances due them.

At the present time, there are about 19,000 elementary and secondary schools run by SOEs, making up one-third of all such schools nationwide.  There are 7,287 SOE-operated hospitals, accounting for nearly 40 percent of all hospitals in China. 

Progress made by the major cities in separating these community service obligations from SOEs demonstrates that a separation is possible, but that in itself does not assist the less wealthy cities in achieving it.

Managerial ability.  China's State Council recently established boards of supervisors to conduct inspections on the acquisition and maintenance of state assets in key state-owned enterprises.  Members of the boards will inspect the financial operations of the enterprises, including management and business activities of enterprise leaders, but will not participate in or interfere with the day-to-day decision-making of the enterprises.

The first group of 27chairpersons to these boards of supervisors were appointed for 67 enterprises.  Nine others will be sent to 33 enterprises after completing professional training.  The boards are instructed to report to the State Council with an appraisal of managerial skills within the respective enterprises.  This would seem to be the first step in identifying SOE training needs.  That is, of course, and important step, but is likely to pale in comparison with the task of meeting those needs.








A large percentage of SOEs is likely to remain under government ownership and control for some time.  This does not necessarily imply, however, that majority ownership by the state is being retained for ideological reasons.  Rather, it more likely reflects the desire of the central government to avoid a concentration of ownership in the hands of a few, thus preventing (or at least limiting) the emergence of mainland tycoons.

Since economic reform began in 1979, Beijing authorities sought to increase national wealth and also to reallocate it in a way that was broadly consistent with a socialist view.  Growing disparities in income, particularly among regions, suggests that less attention was given to distributional aspects, but those aspects were never taken off the agenda.

Recent statistics show that in the last four years (which were not particularly good years), real income in rural and urban areas increased by an annual average of 5.4 percent and 5.6 percent, respectively.  Disposable income per capita in urban areas reached RMB 5,854.  Per capita net income for farmers was RMB 2,210.  This, together with information about consumer expenditure and the proportion of home ownership in major urban areas (now about 59 per cent), is evidence of a growing middle class in China, and that growth is likely to be nurtured at all three levels of government.

SOE reform is likely to follow that nurturing.  Central government revenue from reformed SOEs (by way of company taxes) is already greater than the income previously derived from sole ownership of those enterprises.  As long as this continues a greater amount of ownership will be passed to the private sector, with sufficient regulatory controls put into place to ensure a satisfactory dispersion of that ownership.

It is likely that progress in such an objective will be relatively slow, but it is also more likely to produce a China-preferred system.








References to Russia: 

Stephen F. Cohen, Failed Crusade: America and the Tragedy of Post-Communist Russia, W. W. Norton & Co., 2000.

SOE News:


People’s Daily:

China Daily (including Business Weekly):

Some similarity exists in the articles reported by the three sources mentioned above.  Selected articles are listed as follows:


Ministry of Finance to boost enterprises’ financial, asset management, 13.10.00.

New regulation governs companies planning to go public prior to issuing stock, 5/10/00.

Beijing spins off more SOEs into private sector, 29/9/00.

Qingdao to unload 35 SOEs through property-rights exchange market, 28/9/00.

China set to achieve “three majority” goal as SOEs reap profits, 13/9/00.

US$26.6b of state-owned shares to become negotiable, 12/9/00.

China lays off almost 2 million SOE workers in 1H, 5/9/00.

People’s Daily:

100 SOEs under strengthened supervision, 12/10/00.

SOE reform may introduce cross-border “M&A”, 12/10/00.

State Council sends chairpersons to boards of supervisors in 100 SOEs, 18/8/00.

Overseas listing pushes China's SOEs reform, 16/8/00.

SOEs reform goal within reach, but deeper issues remain unsolved, 1/8/00.

China Daily:

China’s SOEs embrace modern enterprise system, 16/10/00.

Laid-off workers of SOEs find new jobs, 1/10/00.


Send comments to:

Return to the Index Page