World Bank And Chinese Think Tank Recommend Overhaul Of China’s Large System Of State Run Enterprises – A Surprise That Such A Sensitive Issue Is Publicly Debated – Economic Reforms Coming Up In Beijing?

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By Paolo von Schirach

February 25, 2012

WASHINGTON – Many believe that China’s spectacular growth rates are due to its ability to expertly manage a combination of state run corporations and relatively new privately owned companies. China seems to be the best and most successful expression of a mixed economy model in which state owned enterprises, SOEs, still control almost half of the entire economy, including most strategic sectors, such as banking and telecoms. But it would appear instead that China has done so well in the past 30 years in spite of state capitalism. And it would also appear that, in order to maintain a high rate of growth, China should make sure that going forward its many SOEs are run as real profit making enterprises, as opposed to being in large part powerful tools to assert government control over the rest of the economy.

China 2030

This is some of what is coming out of a preview of “China 2030“, a report prepared by the World Bank, (acting in an advisory capacity), jointly with the Development Research Center, or DRC, a very influential Chinese think tank that is supervised by China’s top policy-making body, the State Council.

Open debate?

What is most surprising about this report is not really the content, but the fact that it was commissioned in the first place and that its key finding and recommendation are becoming public. Just a few years ago, a document discussing issues that go to the very core of the Chinese state and economy would have never been aired in public. So, I would call this “openness” very good news. At least in principle, this is beginning to look like a debate on public policy.

SOE model worked well

As to the key findings, I am perfect agreement. China did very well in harnessing most of its national resources in a gigantic effort to create an export- led economy. It had all the key components to capture a huge slice of labor intensive manufacturing: cheap land for industrial sites, cheap capital provided by state owned banks and tens of millions of migrant workers willing to move into cities and work in factories for really low wages. What Chinese migrant laborers turned into factory workers lacked in terms of skills they compensated with low wages.

Chinese products, while not the best, especially at the beginning of this industrial effort, were certainly the cheapest. And so it did not matter that inexperienced Chinese workers were not particularly productive.

Besides cheap products, the Chinese were smart enough to understand that in order to gain and keep overseas customers they needed massive infrastructure investments. Cheap labor is a huge asset, but quick reaction time and time to market are equally important.

Tomorrow is about value

But this is the old story. Tomorrow’s story will be about quality, innovation and moving up the value chain. And here is where state run enterprise will show their weaknesses. And this is mostly because SOEs are still large bureaucracies run by government appointees. While China for sure has its own variation on the SOE model, by and large the state is not a good entrepreneur. It was fine when the matter at hand was to mass produce cheap consumer goods for Wal-Mart, with the obvious advantage of ridiculously low labor costs.

But now China has to assert itself by becoming a flexible, innovative and high quality producer. Even intuitively we can appreciate that a state run bureaucracy is not the best instrument to foster innovation. Invariably, SOEs are influenced by politics and tend to allocate resources on priorities that have little to do with increasing value. And, in the long run, this is their fatal weakness, be it in China or anywhere else.

Will there be serious reforms?

That said, reforming the Chinese SOEs system would be a monumental effort, precisely because SOEs are so relevant and so deeply entrenched in the very fabric of the political system. Still, if China wants to rise to the next level economically, this issue will have to be tackled.

Ironically, by privatizing –if it will come to that– large SOEs that have also been used as levers to exert political influence, the Chinese Communist Party would diminish its powerful grip on the Chinese society. Should serious reforms take place, how all this will end up is anybody’s guess. Meantime, we should welcome this Chinese debate, especially if it will be carried out in the open.

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