China's State Enterprise Reform

From Marx to the Market

John Hassard, Jackie Sheehan, Meixiang Zhou, Jane Terpstra-Tong, Jonathan Morris

• Publisher: Routledge
• Year: 2007
• ISBN:
  9781134195190
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Based on extensive original research, this book provides a comprehensive overview of the current status of state enterprise reform in China.

Chinese State Enterprise Reform considers the relationship between public ownership and public enterprises, and the historical evolution of China's economic reform programme since 1978, including assessments of the Contrast Responsiblity System, which operated from the early 1980s to the early 1990s, and the Group Company Experiments, which began in the 1990s. It discusses the relations between workers, managers, and the state in post-Dengist China, the implications of the reform programme for human resources management in state enterprises, the nature of labour representation, and organization under tate capitalism and the problems of surplus labour and reemployment.

Part I

Economic transition in
theory and practice

1 Theorizing state-enterprise reform

Introduction

SOEs were widely established in industrial countries between the 1930s and 1950s and rapidly expanded among developing nations in the 1960s and 1970s. They were built with state ownership for reasons of social and economic justice. The rationale was that SOEs could avoid problems resulting from market failure. However, from the late 1970s and especially throughout the 1980s and 1990s, SOEs worldwide experienced widespread denationalization and privatization, perhaps the most dramatic case being that of the United Kingdom under the Thatcher government.

This global phenomenon of the privatization of SOEs is defined, according to Cook and Kirkpatrick (1997: 2) as ‘the transfer of productive assets from public to private ownership’. Faced with the challenges of government failure, SOE reform and privatization have been seen as key policy instruments in the improvement of economic efficiency (Cook and Kirkpatrick 1988, 2000; World Bank 1995, 1996; Yarrow and Jasinski 1996; Cook et al. 1998; Frydman et al. 1999; Shirley and Walsh 2000; Brown and Earle 2001; Estrin et al. 2001; Nolan 2003; Bhaumik and Estrin 2005). In particular, privatization is perceived as a means to promote market forces and shift the balance between the public and private sectors of the economy.

There are various reasons for the rise and fall of the SOEs. The global phenomenon of a shift from state to private ownership of public enterprises has been accompanied by a literature that carries with it a debate over whether it is competition or ownership change (from public to private) that matters most in the improvement of economic efficiency. The combined force of literature debating principal-agent, property rights and public choice theories concludes that enterprises operating under public ownership are less efficient when compared with their private sector counterparts (Galal et al. 1994; World Bank 1995; Shirley and Walsh 2000).

In contrast, strong arguments against this ownership-solution viewpoint emerge from the writings of those advocating the competition-solution view, especially in relation to state-enterprise transition in developing countries. The competition-solution view argues that a competitive environment is more important than ownership per se and that a change in ownership is favoured only within a competitive market. In other words, where there is a lack of competitive product and capital markets, ownership change (privatization) alone has very limited success (see Yarrow 1986, 1999; Vickers and Yarrow 1988; Cook and Kirkpatrick 1988, 1997, 2000; Cook 1997; Carlin et al. 2001; Nolan 2003).

A third voice on SOE transformation has suggested that the foremost need is to reform the management practices related to public enterprises at both the state and enterprise levels. Among those who have argued for improved management rather than ownership change are Stiglitz (1993), Davey (1995), Korten (1995), Nolan (1995) and Farazmand (1999, 2001, 2004). This position was supported earlier by the World Bank, before the bank shifted, from the late 1980s, towards advocating ownership change (Cook 1997). (For example, the World Development Report for 1983 stated that ‘the key factor determining the efficiency of an enterprise is not whether it is publicly or privately owned, but how it is managed’ (World Bank 1983: 50).)

This chapter examines research evidence related to the arguments introduced above. First, in order to establish a basic framework for understanding the nature of SOE operations and sources of SOE problems, we analyse the main reasons and objectives for the establishment of public enterprises. Second, we examine debates concerning the mechanisms for improving public-enterprise performance, with this analysis focusing on our three main issues of ownership, competition and management reform. And third, we examine the literature on the labour effects associated with SOE transformation.

Reasons for establishing SOEs

A considerable body of literature has suggested that the establishment of the SOE was essentially a remedy for market failure. Various forms of market failure prevented the economy from achieving efficient resource allocation. Economic analysis rationalized government intervention in productive activities as a response to such specific market imperfections. The establishment of public enterprises could provide a way for direct government participation (Yarrow and Jasinski 1996; Cook and Kirkpatrick 2000). These justifications were coupled with arguments that public enterprises facilitated economic independence and planned development. Where there is market failure, and the unregulated pursuit of profit does not lead to the maximization of economic efficiency, public enterprise can be established to correct the misalignment of public and private objectives.

Other reasons for the establishment of SOEs were explored by Cook and Kirkpatrick (1988, 2000) and Van De Walle (1989). First, it was considered that SOEs in general would provide government access to much-needed sources of revenue. ‘Governments mistakenly believed that [SOEs] would generate large profits with which they would be able to finance investment in priority sectors of the economy’ (Van De Walle 1989: 602). Second, there were ideological and political reasons. For example, public production could be made to appear more attractive in an ideological climate in which the private sector was held in low esteem and a large public role in the economy was seen as necessary for rapid and sustained development. It could also secure for the government valuable industrial information and the control of strategic industries. As such, public enterprise could be justified both for reasons of employment creation and national security. And third, SOEs could be used as a counterweight to the concentration of private economic power or as a remedy for short supply/risk aversion on the part of private entrepreneurs, or to strengthen the economic position of particular ethnic groups or geographical regions, or to overcome critical economic bottlenecks. Cook and Kirkpatrick (2000) state that public enterprises are often established by governments for reasons quite different from, and often incompatible with, profit-maximization. Public enterprises often operate in non-competitive markets; the absence of competition is one reason for creating them.

The mainstream public ownership literature discusses issues such as those outlined above, and especially the remedying of market failure, the redistribution of economic resources, and the political benefits to industrial concerns (see Yarrow and Jasinski 1996; Cook and Kirkpatrick 2000). Yarrow and Jasinski (1996) summarized the various objectives of public ownership as follows:

1. Remedying market failures/inefficiencies. Public ownership can provide one possible means for dealing with the perceived inefficiencies of certain types of market.
2. Redistributing economic resources. As with market failure, there may be a number of ways to achieve the desired redistribution of resources, for example by various combinations of taxes and subsidies. Such redistribution considerations often strongly influence the introduction of an enterprise or industry into the public sector. For instance, a public utility absorbs subsidies for one group of consumers from the profits made by another group of consumers.
3. Creating political benefits. The political benefits include prestige projects that can often be favoured by politicians in accordance with political needs and preferences. A public enterprise can receive patronage from politicians.
4. Achieving strategic goals. More often than not, for reasons of military or national security, or as a necessary counterweight to foreign ownership, governments have designated certain sectors of the economy to be of ‘strategic’ importance for economic development. Public ownership is one way of channelling resources to such strategic sectors.

SOE problems

It is commonly argued that as a result of central planning, public enterprises regularly failed to meet strategic targets for efficiency and performance. Major reasons cited were that social welfare burdens and government intervention adversely affected the SOEs’ ability to optimize economic effectiveness. As such, the divestiture of the government/state ownership of public enterprises has been the pervasive economic paradigm for nearly three decades. Subsequently, privatization has been implemented across the globe, which involves the extension of market principles to goods and services financed and/or produced by governments.

As a result, the phenomenon of public-enterprise transition (mainly through privatization) has been the principal theme of a considerable body of social and economic literature. A number of studies have claimed that public enterprises as a whole are less efficient than private firms and thus frequently cause resource misallocation (Alchian 1965; Killick 1983; Boardman and Vining 1989; World Bank 1995; Shirley and Walsh 2000). Shirley (1983) and Kikeri et al. (1994) summarized the common problems of public enterprises as follows: unclear, multiple or sometimes conflicting objectives (both social and economic); bureaucratic intrusion; over-centralization of decision-making; inadequate capitalization; lack of managerial skills; and excessive personnel costs.

The World Bank (1995) suggested that public enterprises had the following inherent problems of information and incentives: (i) information asymmetry, due to managers’ information advantages. Under this condition, managers were able to use their knowledge of the enterprise to negotiate with government – the owner of the enterprise – for targets which frequently favoured themselves. (ii) Inefficient incentives and impaired profit-orientation, due to controlled prices and political intervention. Compared with private firms, penalties and rewards in/for SOEs were not employed properly, which resulted in resource waste and poor performance. (iii) Deficits and lossmaking, notably the burden on government arising from loss-making SOEs absorbing too many state subsidies and thus contributing to the undermining of macroeconomic stability.

In the face of the problems associated with public ownership, a general perception that government strategic development planning had ‘failed’ emerged in many economies. Growing concern with the apparent inefficiency of state enterprises led to a variety of policy attempts to improve SOE performance and thus economic efficiency. Among them privatization has been an instrument widely implemented in developed, developing and transitional economies. In the 1980s and 1990s, reform of SOEs generally incorporated a policy priority for a dramatic shift from public ownership to private ownership and thus toward diminishing the government’s role in economic strategy (Kikeri et al. 1994; World Bank 1997a; Cook et al. 1998; Overseas Economic Cooperation Fund (OECF) 1998; Cook and Kirkpatrick 2000; Shirley and Walsh 2000). Divestiture or privatization as a means to shrink the public sector featured prominently in these attempts, while other solutions embraced the introduction of competition and management reform. The arguments reflected in the public-enterprise reform debate can therefore be classified into three groups: Group one emphasizes ownership change as a means to address the SOEs’ problems, with policy priority being given to privatization (the ‘ownership-solution’ group). Group two stresses the importance of the competitive market in tackling SOE problems, with policy priority being given to promoting competition to foster a competitive market (the ‘competition-solution’ group). And Group three advocates the reform of management within the system, with policy priority being given to improving SOE management at both macro-state level and micro-enterprise level, in terms of developing institutions and internal firm management (the ‘management-solution’ group). The following sections examine the public ownership debate in relation to these three groups of literature.

Ownership-solution literature

The ownership-solution literature advocates privatization – a shift of the majority of ownership from public to private hands (Nellis 1999) – as a measure to improve economic efficiency. It argues that ownership (property rights) is crucially important, given the assumption that the state will use public enterprises for political purposes rather than profit-maximization, and that this will have an adverse effect on enterprise performance in any market structure (Shirley and Walsh 2000). After Alchian’s (1965) early study of SOEs, the conclusion of which was that they are inherently less efficient than private firms, the extensive ownership-solution literature has argued that private ownership is invariably superior to public ownership. The key reason is that public ownership has innate problems of information processing and incentivization, which can only be solved by private ownership. Shirley (1999: 117) supports this view, suggesting that ‘[the] literature, through comparing the performance of enterprises before and after privatization or a privatized firm with a counterfactual, has generally favoured private ownership in both competitive and, although more ambiguously, regulated monopoly markets’ (see also Galal et al. 1994; Megginson et al. 1994; Martin and Parker 1997). Furthermore, Shirley and Walsh (2000) maintain, from examining 52 empirical studies from the early 1970s, that results across sectors and countries show clear support for private ownership, although the theoretical arguments on private versus public ownership are less clear cut.

The theoretical grounds of ownership change are rooted in theories of government behaviour and corporate governance, including public choice, property rights and principal-agent theories (Cook 1997; Shirley 1999). Public choice theory advocates that deductive models of how government agencies behave are developed with clear directions for policy analysis and normative recommendations (Dunleavy 1986). It is suggested that public managers, bureaucrats and politicians alike will use their control of SOEs to serve their own interests, rather than to enhance the state firm’s efficiency (Shirley 1999). In the public sector, interests of income, power and prestige can be enhanced by increases in managers’ budgets, whereas in the private sector, increased profits are the source of such rewards. It is assumed that under public ownership managers will constantly petition for ever-growing budgets and transfers. If SOEs are constantly requesting higher budgets (as the SOE interest groups are often budget-maximizers), while politicians can allocate funds to a variety of purposes besides transfers to SOEs, it is anticipated that SOE managers will have something to offer the politicians in return. Thus bribery (signally of politicians) and other forms of corruption are felt likely to take place within public ownership, often at the expense of efficiency. As Cook notes, ‘this body of theory attributes poor performance of publiclyowned agencies to a divergence of “interests” between bureaucrats and politicians that run government and the public interest in general’ (1997: 890). Similarly, Shleifer and Vishny (1994) suggest that SOE efficiencies can be reduced by political meddling resulting from public ownership.

Property rights theory argues that individuals respond to incentives and that the pattern of incentives is influenced by the property rights structure. The theory suggests that when a company has little or no right to be a residual claimant – that is, no individual or group has a clearly specified right to claim any residual benefits or surplus left after other claims are met – it will operate with low levels of efficiency (Demsetz and Lehn 1985; Grossman and Hart 1986). It is assumed that business people in private firms are profitmaximizers, with private property rights being exclusive and voluntarily transferable. In SOEs however it is virtually impossible to transfer state ownership rights from one individual or group to another. This inability to transfer ownership rights is viewed by privatization advocates to result in economic systems that are inherently less efficient than those based on private property. It is claimed that the owners of a private firm have more powerful incentives to monitor management behaviour (and thus to ensure enterprise efficiency) than the owners of state enterprises. The rule is: the greater the personal financial investment, the greater the interest in the operation of the firm. As in an SOE the manager has no wealth invested in the firm and no rights to share profits, he or she is therefore less motivated to pursue efficiency. As Shirley (1999: 116) argues ‘since no one can clearly benefit from an SOE’s efficient operation, no one will be strongly motivated to hold management accountable for performance’. According to this theory, private ownership with clarified property rights represents a solution to SOE problems of efficiency and effectiveness.

A third theoretical argument for ownership change comes from principalagent theory, which again concerns the issue that the aim of decision-makers in privately owned firms should be the maximization of profit. In this theory, there exists a pri...