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Why China Is Still So Far From A Free-Market Economy

Taking inventory
Taking inventory
Zhu Xiaochun


BEIJING - Most agree that state-owned enterprises, which have long been at the core of China's economy, must be reformed. That begins with fundamental changes in the way that such entities are managed, both by increasing the separation between state oversight and individual management, and the separation between management and ownership.

The establishment in 2003 of the SASAC, the main body that oversees China’s state-owned enterprises, has helped create a more independent system and established a wide variety of rules and regulations. The effect has been that these enterprises, especially those owned by the central government, are getting stronger and bigger. More and more of them are making it into the rankings of the world’s Top 500 companies.

However, this doesn’t mean that China has found the right path to truly make these enterprises compatible with the market economy.

We are convinced that only private companies can truly be separate from the public administration. The reason is simple. In markets, property rights belong to the private firms, which means they are truly independent. The government has no authority over the way they are handled, except to create a legal framework in which they operate.

Meanwhile, state-owned enterprises' property rights belong, in theory, to the people, but the custodian is the government: thus these firms are tantamount to being government-owned. This is why talk about “the separation between administration and enterprises” is not convincing. On one hand if the state does not interfere with the state-owned firms’ operation it will behave contrary to its role as the trustee of the people. On the other hand, if it does interfere this contradicts the economics of property rights.

For instance, a core power in an enterprise is the right to make high-level personnel appointments. But in Chinese state-owned firms, the power is still in the hands of relevant government departments. Any major decision must be approved by the SASAC. This demonstrates that there is no real separation between the government and the enterprises.

A recent SASAC report lauded the supposed reform in the management of state-owned firms, including “the full respect of the property rights of the legal person and autonomy in management as an independent market entity.” But again, the meaning of the so-called “property right of the legal person” is not any true kind of property right. Without governmental approval, no state-owned entity is entitled to dispose of any of their assets. So what sort of reform is this?

As for the operational autonomy such as strengthening supervision, improving assessment and accountability, performance-based salary, and financial control…etc., they are just the norm for any private company.

First step: property rights

The essential step in any real reform is the reform of property rights. As long as this remains unchanged, in other words, where a real owner is absent, the fundamental shortcoming of the state-owned firms will not improve.

Here, the owner refers to the true owner who would take full responsibility for the firm’s gains or losses. In brief, as long as the situation remains the same, China’s state-owned enterprises can only stay as what they were meant to be, and can only assume the mission handed to them of providing public goods to society. They can never be the economic entities they would be in a market economy.

And with state-owned entities currently so inflated that they have become the country’s main economic bodies, it implies that this country doesn’t operate a market economy, or at least not a full one.

Take China’s five state-owned banks, for instance. As long as we insist that these large banks belong to the state, the state will be obliged to assume the obligation and responsibility of securing their deposits.

Whether it’s about the implementation of the deposit insurance system or interest rate marketization, the first reform would be to privatize the banks. At the very least, they need to get rid of their “fully state-controlled” nature, so as to become mixed-ownership banks that conform to the essence of a modern enterprise system.

It’s ludicrous to imagine that you can just immerse state-owned firms or state-owned banks completely in the market, and let the law of “survival of the fittest” play out. Like other industries, were China’s banks to undergo real reform, the reform of their property rights has to be the initial step.

Macroeconomic data shows that China is at great risk for an economic downturn. On the one hand, stimulus policies are needed to curb this decline, but on the other hand, there is excess production capacity in many sectors. The profit margins of the small and medium size companies, in particular the private ones, have been squeezed.

As all experts point out today, new reforms are necessary. We sincerely hope that China’s reform of its system of state-owned enterprises will withstand the pressure and take risks on the path toward success.

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