China's Business Reforms

Institutional Challenges in a Globalised Economy

Russell Smyth, On Kit Tam, Malcolm Warner, Cherrie Jiuhua Zhu

• Publisher: Routledge
• Year: 2004
• eBook ISBN: 9781134283255
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

China's recent economic reforms have led to impressive growth, and an unprecedented enthusiasm for establishing foreign enterprises in China. Since 1993, China has been the second largest recipient of foreign direct investment in the world and is now considered to be the world's third biggest economy. Its greater economic integration with the rest of the world, especially since its accession to the World Trade Organisation (WTO), has further accelerated its market-oriented economic reforms. China is now opening its protected markets and beginning to submit to the rule of international law. This ongoing transition and increasing participation in the world economy has resulted in significant changes in human resource management and social welfare practices in China's enterprises. The book examines the key areas, all of which are linked, where China is grappling with institutional reforms as it opens up to the outside world: state-owned enterprise reform, capital markets and financial reform, human resources and labour market reform, social welfare reform, and China's accession to the WTO and the growth of the private sector.

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Institutional challenges for China's business reforms in a globalized economy

Russell Smyth, On Kit Tam, Malcolm Warner and Cherrie Jiuhua Zhu

1.1 Introduction

The reform of China's economy and business environment and the opening up to the outside world over the last 25 years have occurred against a backdrop of increasing globalization and integration into the world economy. Indeed, we will argue that it is likely that the latter changes have been the driving force behind the former. Most observers of China's reforms are united in the view that these have been successful in terms of promoting economic growth and improving the living standards of the masses, often with reservations vis-a-vis the increasing inequality of income and wealth. Few would question that the average Chinese is better off today than when the market reforms commenced in the late 1970s. ‘Winners’, on the whole, are likely to outnumber ‘losers’.

However, China has clearly encountered problems and challenges in the building of new institutions required for the economy and society to function and thrive in the complex processes of marketization and globalization. Foremost among these from the perspective of business is the restructuring of Chinese state-owned enterprises (SOEs), reform of the financial and banking system and concomitant reforms to labour markets and social welfare provision, albeit with ‘Chinese characteristics’. China has now moved to a more efficient system of resource allocation. The link between economic restructuring and globalization was most recently brought into sharp focus following China's accession to the World Trade Organisation (WTO), with China's enterprises confronted with increasing levels of competition from foreign sources.

The essays in this edited volume collectively provide an overview of how China's economic reforms have evolved and how policy-makers and market participants are responding to the challenges of increased global competition. Many of them provide a fair degree of detailed analysis about how this has come to pass. Section One of the book, which consists of the next five chapters, examines corporate governance reform in SOEs and listed companies and the development and restructuring of China's financial sector. It is fair to say that these are the two major institutional reforms that have occupied the business policy agenda in China over the last decade. Section Two of the book contains chapters on the evolution of human resource management (HRM) and labour market reform. One of the accompanying features of the increasing marketization of SOEs and corporate governance reform in listed companies has been the evolution of HRM in China and the growing pressures of unemployment as SOEs change their work practices. The chapters in Section Two review these developments.

Section Three of the volume focuses on the changing nature of social welfare provision. There is increasing recognition among many scholars that globalization is more than likely a ‘double-edged sword’ (see Guan 2001a, Kapstein 2000, Milanovic 2003). While the globalization process has contributed to rising incomes in developing countries such as China through increased trade and investment flows, it has also made the need to create a sophisticated social protection regime to protect those who are made vulnerable from increased competition more pressing. These include the elderly, the unemployed and those in poor health. The chapters in Section Three examine how China has responded to the need to develop a social protection regime to protect the ‘losers’ from the globalization process and, at the same time, make the marketization process sustainable into the future. The final section of the book contains two chapters assessing the impact of China's accession to the WTO on the economy and the emergence of the private sector and new breed of entrepreneur in China. We conclude the book with these two chapters since both examine topics that look to the future of Chinese business. How China adapts to being a member of the WTO will be probably the most important issue for business in China in coming years. The emerging importance of private enterprises has been one of the major developments in China's business reforms in recent times and it is likely that private enterprise will play an even greater role in the future as the state-owned sector shrinks further. In the remainder of this chapter, we provide an overview of the institutional challenges facing China's reforms and examine the contents of the chapters that make up the balance of this volume in greater detail.

1.2 Section one: corporate governance and financial reform

Effective corporate governance, most authorities in the field agree, helps protect and enhance the interests of stakeholders in a company, particularly shareholders. Corporate governance now occupies the centre stage of enterprise reform in China (Tenev et al. 2002). The Fourth Plenum of the Chinese Communist Party's Fifteenth Central Council, held in September 1999, identified corporate governance as ‘the core’ of the modern enterprise system. The main tenet of China's approach to corporate governance development is the adoption of key features from the Anglo-American model of corporate governance, which requires the existence of certain institutional conditions including a well functioning financial and regulatory system for it to operate effectively (Tam 1999). The 1997 Asian financial crisis and the problematic mass privatization in Russia have highlighted the importance of having effective corporate governance arrangements in emerging and transitional economies (Frydman et al. 1996, Estrin and Rosevear 1999, Claessens et al. 2000). For a developing ‘transitional economy’ such as China, in which the government retains considerable influence, even if the apparatus of the old command economy has been virtually dismantled, the role of corporate governance is now widely accepted by scholars and policy-makers to be critical to the country's enterprise and financial reform and to the development of a globally competitive economy (Chen 2003, Clarke 2003, Walter and Howie 2003). Globalization and corporate governance issues are now more intertwined than ever before, problems of corruption notwithstanding. With fast expanding international trade and inward foreigndirect investment, the need to develop effective corporate governance and an efficient financial and banking system has taken on added significance.

Chapter 2 by Dic Lo and Russell Smyth, Chapter 4 by Alice de Jonge and Chapter 6 by Jayne Godfrey and Wei Lu examine different aspects of corporate governance development in Chinese enterprises. In Chapter 2, Lo and Smyth provide an overview of reform of SOEs, focusing on the contribution of large SOEs and enterprise groups. There is a spirited debate in the literature on the role of large SOEs. Some authors see large SOEs as inefficient ‘dinosaurs’ dragging down the state-owned sector (see for example McNally and Lee 1998, Shieh 1999). Others, more controversially, argue that large SOEs have played a vital role in China's economic success through supplying producer goods and establishing substantial linkages which have fuelled growth in downstream industries (Nolan 1996, Nolan and Zhang 2002). Lo and Smyth, whose sympathies lie with the second camp, focus on the positive contribution of large SOEs at a time when the role of the state sector has been shrinking. To explain how the share of large SOEs has held up over time, they offer a ‘non-orthodox’ account of industrial restructuring and changing corporate governance, focusing on the match (or mismatch) between the institutions and external demand conditions.

In Chapter 4, de Jonge examines the emerging corporate governance structures of listed companies, focusing on the internal structure of Chinese-incorporated companies listed on the Hong Kong Stock Exchange (H-share enterprises). This démarche is particularly timely in a period when high profile accounting and corporate governance scandals in the United States have emphasized to the business community the need for improved corporate governance standards in securities markets throughout the world. De Jonge examines the way in which recent developments and reforms in laws and regulations governing H-share enterprises have started to alter the composition of boards and the relationship between shareholders and management. The chapter demonstrates both how things are changing for the better and the many deficiencies that still need to be addressed.

Another aspect of corporate governance reform, which was highlighted by the US-based Enron and WorldCom collapses and other non-US ‘basket-cases’ such as the Italian conglomerate Parmalat, has been the need to develop sound financial reporting practices. Godfrey and Lu positively address this issue in Chapter 6. Existing research points to differences in the manner in which investors in developed countries value the intangible assets reported in firms’ financial statements. There is no research, however, into the association between the market value of firms in developing countries and their book values of intangible assets. Since the promulgation of China's first ‘Western-style’ accounting standard in 1992, accounting standards and regulations issued by the Chinese government have become increasingly internationally compatible. This move opened up opportunities to examine the economic relevance of accounting in the emerging economy of China. Using a large sample of Australian and Chinese companies, Godfrey and Lu investigate the value relevance of capitalized intangible assets, both in aggregate and as individual capitalized items. One of their main findings is that in China, the book value of intangible assets is a very small proportion of the book value of total assets and none of the capitalized, intangible asset book values are significantly associated with the market value of equity. They cogently discuss the implications of this for financial reporting reform.

The 1990s saw the establishment of new nationwide shareholding banks, significant expansion of the insurance sector, development of a domestic capital market and the emergence of consumer and housing finance. The financial sector and particularly the securities market, however, still face many challenges that are inextricably tied up with corporate governance reform and in particular reform of the SOEs. These state firms receive the bulk of funds allocated through the formal credit system and non-commercial considerations, such as the need to sustain loss-making SOEs, continue to influence bank lending (see OECD 2002 for an overview). In 1999 the Chinese government announced an equity-for-debt swap (EDS) scheme to restructure the SOEs and clear up the bad loans of the state-owned banks. As Kym Brown and Michael Skully discuss in Chapter 3, official figures reported before the asset management companies took over bad loans were that non-performing loans were in the 25–30 per cent range, but in practice the actual percentage of non-performing loans was much higher. The limited empirical evidence which is available suggests that to this point the EDS has had limited success in restructuring SOEs or improving the bad loan situation of the banks. The problem is that in the end the EDS is only a financial scheme, an accounting solution to the problem of bad debts, while SOE reform is a real socio-economic problem that is subject to serious socio-economic and political constraints (see Smyth et al. 2004).

Different aspects of the relationship between enterprise reform, foreign investment and banking reform in China are emphasized in Chapter 3, by Brown and Skully, and Chapter 5 by On Kit Tam. Brown and Skully compare China's financial system with others in the Asia-Pacific region, emphasizing the banking system and its reform progress. The international perspective is interesting given China's emerging financial importance in East Asia. As a proportion of GDP, China has the largest domestic banking system in East Asia and, when combined with international borrowings, it is third behind Hong Kong and Singapore. Brown and Skully make several recommendations for further reform to China's financial sector, including: the full publication of financial statistics; the continued workout of non-performing loans; more bank supervisors; the development of other financing options for investors; and the removal of unprofitable SOE funding to policy banks.

In Chapter 5, Tam analyses the main issues influencing the entry of foreign banks into China's banking sector, with particular reference to the government's aim to promote economic development in the western region. It is generally recognized that the Chinese banking sector has lagged behind other sectors in the reform process. As demonstrated by the beneficial impacts from the entry of foreign insurance companies in China during the last decade, Tam argues that an increase in the level of market competition in China's banking sector from foreign banks will help the reform of this important economic sector while at the same time enhancing the country's foreign investment environment, particularly in the western region. One of the implications of China's integration into the global economy has been increasing regional disparities between the coastal provinces that attract the bulk of foreign investment and the lower-income central and western provinces. In response to these income divergences, through the ninth Five-Year Plan (1996–2000) and the State Council's special administrative office, the Leading Group for Western Development, development of western China is now seen as a priority. Multilateral lending agencies are also targeting funds towards the development of western China. Tam argues that more rapid liberalization of market entry for foreign banks will assist in the economic development of China's western region. He discusses how the entry of foreign banks into the region can have a positive effect on the flow of foreign direct investment into the region, thereby reducing the big regional income disparities.

1.3 Section two: human resources and labour market reform

China's labour force has experienced a profound transformation since the late 1970s, which has been a direct as well as an indirect result of enterprise restructuring to improve global competitiveness vis-a-vis the wider forces of globalization (see Warner 1995). In 1978, most of the labour force was employed in rural communes or in urban SOEs; by the end of the 1990s, one third of the rural labour force was engaged in non-agricultural activities and about three-fifths of the urban labour force was employed outside the state sector, in urban collectives, joint ventures and private enterprises (Fleisher and Yang 2003). Prior to 1978, HRM in China was characterized by the ‘three irons’ policy consisting of the ‘Iron armchair’ (tie jiaoyi), Iron rice-bowl’ (tie fanwan) and ‘Iron pay’ (tie gongzi). Labour arrangements under central planning were characterized by labour allocation by labour bureaus, the hukou (residence registration system), and strict control of the dang’an (personal file) by the danwei (work unit or employing organization; see Meng 2000).

However, as Shuming Zhao discusses in Chapter 7, since the commencement of market reforms, HRM has undergone somewhat of a revolution. The labour contract system, earlier pioneered in Shenzhen, was first introduced nationally by way of a Labour Regulation in 1986 to cover new entrants into state and collective enterprises. In 1987, regulations calling for an extension of fixed-term contracts to incumbent workers were introduced. This step provided enterprises with some autonomy to make hiring decisions for the first time, and increased the risk of being laid off for employees who did not meet their employment obligations (Fleisher and Yang 2003), although these same regulations left a large residual role for planners to meet regional employment targets (Meng and Kidd 1997). A managerial responsibility system has also been introduced to link managerial performance and compensation (Groves et al. 1995), and by the second half of the 1990s some managers in SOEs were being employed on three-year contracts, which could be terminated for failure to meet performance criteria (Morris et al. 2001:711). As Zhao considers in more depth in Chapter 7, there have been related reforms to the hukou and dang’an systems to make labour markets more flexible.

Since the late 1990s, unemployment has become a major problem in China, with huge numbers of workers being laid off from SOEs. The xiagang (lay-off) reforms were first experimented with in 1994 and were officially launched in 1997 with the intention of resolving the problem of inefficiency in the state sector by furloughing a quarter of its workers within four years (1997–2001) (Appleton et al. 2002). Between 1998 and 2002 there were 26 million workers laid off from SOEs (Armitage 2003, Solinger 2003). This large-scale shedding of labour has become a major socio-economic problem given that studies have found that those workers who have borne the brunt of the redundancies are the least able to find alternative work. This situation has the potential to create a ‘lumpenproletariat’ with feelings of betrayal (Morris et al. 2001). For example, using household survey data for 1999/2000, Appleton et al. (2002) found that the risk of retrenchment was highest for the most vulnerable in society—namely women, the less educated, the low-skilled and the middle-aged, and that the duration of unemployment was longest for those in poor health, the less educated and women with children. The problem of redundancies has been exacerbated by China's integration into the global economy, as the state-owned sector has been confronted with increasing levels of competition from the time of China's accession to the WTO. Over the last two decades the ‘Gini coefficient’, measuring income inequality, has gone up from around 0.20 in the Maoist days to over 0.45 in the post-Deng era, more in line with other Asian economies.

In Chapter 8, Grace Lee and Malcolm Warner argue that unemployment, hand in hand with poverty, now poses a serious threat to both social stability and the rule of the Chinese Communist Party, and that this demands an urgent human resources policy response. This concern is reflected in widespread documentation of worker unrest, with labour protest an everyday event in China's cities (Morris et al. 2001, Solinger 2003). In their chapter Lee and Warner first examine the issues of employment and unemployment in China, explaining that the low official rate of joblessness of around 4 per cent, is in reality double that figure (possibly, indeed, even more), then move on to explain the institutional changes that brought the problem about, using Shanghai as a case study to explore the policy responses. However, although they find that the labour programme in Shanghai may have been relatively successful at first, they conclude by arguing that this does not necessarily mean that it would also succeed if implemented nationwide; its success in Shanghai, they suggest, is due primarily to the particularly rapid growth of the local economy there.

1.4 Section three: social welfare reform

Prior to the introduction of market reforms, China's social security system was predominantly a danwei-based (work-unit-based), defined-benefit, ‘pay-as-you-go’ type, primarily restricted to the public sector and confined to urban areas. For those who qualified, coverage was comprehensive. This policy included: old age care; health care; insurance for injury, disability or death irrespective of whether they were work-related; maternity benefits; and funeral subsidies (see Dong and Ye 2003 for an overview). However, by the mid-1980s it was clear that social security was lagging behind economic reform. The main problem was that that the danwei-based welfare system undermined the competitiveness of SOEs because it imposed a significant financial burden on the enterprise. The strategy now is to offload more of the welfare costs, either onto the individual or the community, or both.

In response to the increasing financial pressure on SOEs, commencing with the ‘Decision of the Chinese Communist Party Central Committee on the Reform of the Economic System’ in October 1984, the state has adopted a series of social welfare reforms nationally. A critical feature of the ‘Decision’ was the requirement that enterprises practise independent accounting and assume responsibilities for their own profits and losses, therefore breaking the traditional tie between government and work-based social security (Dong and Ye 2003). Subsequent reforms have centred on the implementation of a number of social insurance programmes designed to cover the major risks confronting individuals working in both public and private sectors in a market economy (Saunders and Shang 2001, Zhu 2002, Whiteford 2003). The new social insurance regime is financed by individuals, enterprises and government. It has two major objectives (Nyland et al. 2004). One is to relieve enterprises in the public sector of the full responsibility for welfare provision and ensure that the burden is shouldered fairly between the major stakeholders. The other is to have the same social security system established in the private sector to protect employees and to curtail the prevalence of free-riding.

Currently, all firms are required to pay a prescribed amount of social insurance. The national regulations mandate that employers must contribute 20 per cent of the wage bill for pension insurance, although in practice the amount varies between provinces from 15 per cent to 30 per cent. Employers are also required to contribute...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Figures
• Tables
• Contributors
• 1: Institutional challenges for China's business reforms in a globalized economy
• Section One
• Section Two
• Section Three
• Section Four
• Bibliography