Authors: Paul Hubbard and Patrick Williams, ANU

Last year’s Third Plenum decision was remarkable not only for promoting the ‘decisive role of the market in allocating resources but also for seeing this as being consistent with ‘the dominant position of public ownership’ and ‘the leading role of the state-owned sector’.

State-owned enterprises (SOEs) remain ubiquitous in the Chinese economy despite three decades of market reform, although now they account for only 30 per cent of industrial output. Urban SOEs produced almost 80 per cent of Chinese industrial output at the beginning of market reforms in 1978. Ongoing market competition, and the corporatisation and privatisation of many loss-making SOEs in the 1990s, has seen the SOE share of the industrial sector shrink. But the decision to let go of small loss-making SOEs wasn’t a decision to quit particular economic sectors. State assets remain spread not just through the industrial sector but also in transport, real estate, construction and hospitality.

The ubiquity of SOEs in the modern Chinese economy doesn’t imply their dominance of the economy. As a matter of policy, the state retains a majority shareholding in firms relating to defence, energy and telecommunications — as well as a majority stake in some industrial leaders. But non SOEs have more than twice the assets in ordinary competitive sectors of the economy. On average there is a significant volume of non-state capital invested in SOEs. Of the US$7 trillion dollars in net SOE assets, only $3.2 trillion is state equity.

Not all SOEs have evolved in the same way.

To understand modern SOEs it’s necessary to contrast the giant, central SOEs dominating strategic industries from Beijing with the tens of thousands of provincially and locally owned SOEs, across all sectors with various degrees of state ownership.

China’s largest companies are almost all central SOEs and state owned banks. Of the top 50 firms in 2011, central SOEs control 72 per cent of the total revenue, with other central financial enterprises and the post office making up a further 17 per cent. Sinopec’s 2011 revenue was only marginally below that of the Australian government. Leaders of the most important state companies are appointed by the Communist Party, and displayed prominently in the party’s public ‘Chinese Leadership Cadre Database’ alongside Politburo members, government ministers, judges and provincial governors.

The leading private firm, Huawei Technologies, is ranked just 39th in terms of revenue.

Looking further down the list, central SOEs and banks control more than half of the revenue of China’s top 500 firms. Provincial SOEs are next — controlling roughly a quarter of the revenue. Provincial SOEs are highly fragmented, with supervision spread across 36 provincial-level asset management commissions and 442 sub-branches. Hebei Iron and Steel, for example, China’s largest steel producer, accounted for less than six per cent of national steel output, while Japan’s Nippon Steel produced 45 per cent of Japan’s total in 2013.

Provincial SOEs collectively control more state equity than the central government. Still, they are more likely to be competing against each other as well as with private firms, and under local political pressure to be more profitable, rather than being positioned as ‘national champions’.

The forces that have supported China’s rapid development in the decades after reform are fading, as the productivity benefits from structural change slow and China moves toward the technology frontier. Capital efficiency rather than gross investment will be an important determinant of the next phase of China’s growth — so improving the efficiency of state owned capital is a priority.

The Third Plenum of the 14th Central Committee meeting in 1993 established China’s ‘socialist market economy’. Twenty years of economic development later, the decision on comprehensively deepening reform, agreed to a year ago in the Third Plenum of the 18th Central Committee, has not backed down from public ownership.

The decision states ‘we must unswervingly consolidate and develop the public economy, persist in the dominant position of public ownership, give full play to the leading role of the state-owned sector, and continuously increase its vitality, controlling force and influence’.

But slowing growth and concerns about the misuse of state privilege for private gain mean SOEs are attracting even closer scrutiny. The scope for local government rent-seeking by protecting local SOEs is being hemmed in by central government priorities to crack down on corruption and for sustained economic growth.

Wholesale privatisation is not on the table, but non-state capital is being brought in to dilute the state’s ownership share of SOE assets. This should both be palatable to China’s policymakers and also, importantly, help improve the overall performance of the economy, thanks to increased market discipline.

Giant central SOEs may be politically important to Beijing, but most SOEs are provincial and local businesses operating in competitive, rather than monopolistic, environments.

Provincial governments still try to create market environments that favour local SOEs, partly to protect local industry and partly for rent extraction using state-protected monopolies. This is a reflex of local governments everywhere, but remains an acute challenge for China’s central government to try to prevent.

Provincial SOEs only enjoy a ‘leg up’ until the provincial border. Neighbouring SOEs compete fiercely with each other for profitable opportunities in the national and, increasingly, international market. Industrial goods prices and price movements correlate across China, which reflects a competitive market. Competition curbs room for rent-seeking local governments, and pushes the continued corporatisation of provincial SOEs.

Instead of worrying about SOEs per se, policymakers need to deal with anticompetitive market structures and socially harmful behaviour, irrespective of whether the firms are state-owned or not. Foreign governments and businesses need to look beyond the ‘state owned enterprise’ label when assessing risk. A large, central oil SOE is not the same as a provincial SOE in construction or hotels.

Chinese SOEs are here to stay for some time, even as the practical distinction between state and non-state enterprise fades away. And in sectors of particular political or strategic interest, the Chinese authorities will naturally consider all available instruments — not simply formal state ownership — in order to pursue their goals.

Paul Hubbard is a doctoral candidate at the Crawford School of Public Policy, The Australian National University. He is currently on leave from the Australian Treasury as a Sir Roland Wilson Scholar. The views in this paper do not reflect those of the Australian Treasury.

Patrick Williams is a visitor at Peking University as a 2014 Prime Minister’s Endeavour Award Postgraduate Scholar, and graduate student at the Australian National University.