Shareholding System Reform in China: Privatizing by Groping for Stones

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Shareholding System Reform in China

Shareholding System Reform in China Privatizing by Groping for Stones

Shu-Yun Ma Professor, The Chinese University of Hong Kong

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© Shu-Yun Ma 2010 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library Library of Congress Control Number: 2009938388

ISBN 978 1 84844 051 7

02

Typeset by Cambrian Typesetters, Camberley, Surrey Printed and bound by MPG Books Group, UK

Contents Acknowledgments

vi

1. 2. 3. 4.

1 7 25

5. 6. 7. 8.

Introduction Shareholding system reform as the Chinese way of privatization Evolution of the shareholding system reform The role of spontaneity and state initiative in the shareholding system reform Foreign participation in China’s privatization and the role of the state China’s privatization through listing state enterprises in Hong Kong Completing privatization through ‘share conversion’ Conclusion: privatizing through groping for stones

References Index

42 61 92 124 134 140 161

v

Acknowledgments Earlier versions of parts of this book appeared in the following journal articles by this author. I am grateful to these publications for permission to reprint the materials here, and am indebted to Edmund Cheng Wai for his editorial assistance in integrating these separate articles into the present book. ‘Shareholding system reform: the Chinese way of privatization’, Communist Economies & Economic Transformation, Vol. 7, No. 2 (June 1995), pp. 159–74. ‘Foreign participation in China’s privatization’, Communist Economies & Economic Transformation, Vol. 8, No. 4 (December 1996), pp. 529–47. ‘The Chinese route to privatization: the evolution of the shareholding system option’, Asian Survey, Vol. 38, No. 4 (April 1998), pp. 379–97. ‘The role of spontaneity and state initiative in China’s shareholding system reform’, Communist and Post-Communist Studies, Vol. 32, No. 3 (September 1999), pp. 319–37. ‘The state, foreign capital and privatization in China’, Journal of Communist Studies and Transition Politics, Vol. 15, No. 3 (September 1999), pp. 54–79. ‘Role of the state in Chinese enterprises listed in Hong Kong’, Pacific Review, Vol. 15, No. 2 (2002), pp. 279–98. ‘Listing Chinese enterprises in Hong Kong and China’s intergovernmental fiscal relations’, Problems of Post-Communism, Vol. 50, No. 6 (November– December 2003), pp. 28–37. ‘China’s privatization: from gradualism to shock therapy?’, Asian Survey, Vol. 48, No. 2 (March/April 2008), pp. 199–214.

vi

1. Introduction Throughout human history, private and public ownerships have been coexisting over time and across societies, giving rise to different forms of economic systems. Capitalism emerged on the basis of private ownership. But the Great Depression and the devastation of the two world wars called for massive government intervention, resulting in large-scale nationalization in post-war Britain. The pendulum began to swing back in the 1980s, when Margaret Thatcher’s conservative government launched a series of privatization programmes (Megginson and Netter, 2003). This was followed by a worldwide wave of transfers of assets from the state to private hands. According to World Bank statistics, from 1989 to 2007 governments in the world received about US$733 billion through privatization (Table 1.1). This book is about the case of China in this process. Initially, most of the privatization activities took place in developed OECD countries (OECD, 2001, p. 43). This was followed by post-communist transition economies in Eastern Europe and Central Asia, which emerged as a major group of participants in the worldwide privatization trend. During the 1990s, proceeds from privatizations in these countries accounted for about 20 per cent of world total. In comparison, China’s share during this period was only about 7 per cent. However, China began to pick up in the early 2000s, and has since emerged as one of the largest privatizing countries. From 2000 to 2007, China alone accounted for over 38 per cent of the world’s proceeds from privatizations (Table 1.1). The above seems to suggest that privatization is an economic prescription based on intensive researches by experts and scholars, exported from developed countries first to post-communist transition economies in Eastern Europe and Central Asia, and subsequently to China as a result of proven powerfulness of privatization as an impetus of economic growth. This, however, is an illusion. The fact is that economic theorists have never reached any consensus about the desirability of privatization. Both private and public ownerships are found to have theoretical advantages and disadvantages, and there are many trade-offs between the two kinds of ownership. That is to say, even at pure theoretical level, privatization has not been proved as a panacea (Roland, 2008).

1

Table 1.1

Proceeds from privatizationa Transition economies in E. Europe and C. Asiab

2

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

China

World Total

US$ billion

Annual change (%)

Share in world total (%)

US$ billion

Annual change (%)

Share in world total (%)

US$ billion

Annual change (%)

0.47 0.83 1.97 2.85 3.78 3.95 9.41 5.45 16.79 7.79 11.17 9.65 7.07 9.59 7.02 13.71 15.63

N.A. 76 139 44 33 4 138 –42 208 –54 43 –14 –27 36 –27 95 14

13 7 8 11 16 18 43 21 25 16 26 25 43 62 36 41 29

N.A. N.A. 0.01 1.26 2.85 2.23 0.65 0.92 9.12 0.61 2.95 10.28 0.96 1.60 6.07 4.12 14.09

N.A. N.A. N.A. 11 479 126 –22 –71 42 893 –93 382 249 –91 67 279 –32 242

N.A. N.A. 0 5 12 10 3 4 14 1 7 26 6 10 31 12 27

3.63 12.66 23.86 26.18 23.66 21.71 21.90 25.36 66.57 50.16 42.35 39.04 16.31 15.56 19.61 33.58 53.06

N.A. 249 88 10 –10 –8 1 16 162 –25 –16 –8 –58 –5 26 71 58

2006 2007 1990–1999 2000–2007 1989–2007

27.43 36.60 63.99 126.70 191.14

75 33 N.A. N.A. N.A.

26 28 20 31 26

50.36 71.54 20.60 159.02 179.60

257 42 N.A. N.A. N.A.

48 54 7 38 25

104.88 132.64 314.41 414.68 732.69

98 26 N.A. N.A. N.A.

Notes: a Proceeds from privatization are defined as ‘all monetary receipts to the government resulting from transactions involving partial and full divestitures, concessions, and releases. Thus, only those transactions that generated revenue for the government from privatization or private sector participation in an existing state-owned enterprise and other government assets are included.’ b Data for 1988–99 cover the following countries: Albania, Armenia, Azerbaijan, Belarus, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Kazakhstan, Kyrgyz Republic, Latvia, Lithuania, Macedonia, Moldova, Montenegro, Poland, Romania, Russian Federation, Serbia, Slovakia, Slovenia, Ukraine, and Uzbekistan. Data for 2000–2007 cover all the above countries, plus Bosnia, Georgia, Herzegovina, and Tajikistan. Moreover, pre-2000 data were collected on an ‘announcement’ basis, whereas data from 2000 on reflect actual flows of receipts. The two sets of data are thus not entirely compatible.

3

Source:

World Bank Privatization Database (http://rru.worldbank.org/privatization).

4

Shareholding system reform in China

Major arguments in favour of privatization include relief of the state’s financial and administrative burdens; enhancement of economic efficiency and productivity; stimulation of private entrepreneurship; and reduction of the public sector, which tends to be monopolistic and bureaucratic. These arguments, however, have been challenged on the grounds that efficiency of the public sector can be improved through greater public accountability and transparency; only profitable activities are privatizable; loss of stable income of the state from profitable public sector activities; adverse impacts on public sector employees, lower-income consumers, and social welfare recipients; and finally high costs of monitoring privatized enterprises. Apart from such lack of theoretical consensus, empirical results of privatizations in both developed and developing countries are also mixed. As ideological faith in privatization declines, even advocates of privatization have to admit that for the strategy to work, sequencing and preconditions of reform are also important (Jomo, 2008; Parker and Saal, 2003). As mentioned, since the early 2000s China has emerged as one of the largest privatizing countries in the world. However, there is no indication that China was theoretically informed to join the above worldwide privatization trend. China did engage in ideological discussion about privatization; but the debate was more about the socialist-legitimacy of privatization, rather than the liberal-economic rationale of the reform. What this book intends to argue is that China’s privatization is not based on any grand blueprint; rather, it is privatization by ‘groping for stones to cross the river’, a well-known metaphor often attributed to Deng Xiaoping, meaning that the reform simply proceeds on a trial-and-error basis, without being guided by any theory. That is to say, though China’s privatization is consistent with the above-mentioned worldwide trend, that general theoretical context does not seem to be directly relevant to the Chinese case. As indicated in Table 1.2, immediately after the Chinese economic reform was launched in 1978, the Chinese economy began to show robust growth. However, according to World Bank statistics, Chinese privatization did not start until 1991 (Table 1.1). Some analysts thus took the Chinese case as showing that economic success could be achieved through restructuring of state enterprises, and that privatization is not necessary (Megginson and Netter, 2001, p. 338). This might be true as far as privatization in the narrow sense – divestiture of existing state enterprises – is concerned. However, if proper attention is paid also to privatization in the broad sense – which includes also development of greenfield private enterprises that is not covered in the World Bank data – the Chinese case shows that ‘privatization is absolutely necessary to achieve sustained intensive growth’ (Chai, 2003, p. 256). The above notwithstanding, this book will focus on China’s privatization

Introduction

Table 1.2 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 Source:

5

China’s real GDP growth (%) 7.6 7.8 5.3 9.0 10.9 15.2 13.5 8.9 11.6 11.3 4.1 3.8 9.2 14.2 13.9

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

13.1 10.9 10.0 9.3 7.8 7.6 8.4 8.3 9.1 10.0 10.1 10.4 11.7 13.0 9.0

China Data Online (http://chinadataonline.org).

in the narrow sense. More specifically, it is about the shareholding system reform, which provides a channel for the transfer of state assets to private hands. We do not intend to examine the effect of this change; rather, our concern is how this reform has evolved, without any pre-existing plan, from a spontaneous local attempt into a nationwide reform programme. That is to say, it is about the emergence of a privatization programme through ‘groping for stones to cross the river’. This book is based on a collection of updated versions of previously published articles. Chapter 2 identifies the shareholding system reform as the Chinese way of privatization, in a political and ideological context in which the term privatization had to be avoided. Chapter 3 traces the evolution of the shareholding system reform, from the early spontaneous attempt in the early 1980s, to the official endorsement of it as the mainstream reform programme in 1997. Chapter 4 examines the role of spontaneity and state initiative in the shareholding system reform, based on three case studies in Foshan, where China’s first industrial shareholding enterprise appeared. Chapter 5 analyses foreign participation in the shareholding system reform, and the role of the state in this process. Chapter 6 discusses how China’s shareholding system reform has been facilitated by Hong Kong as an important venue for the listing of Chinese state enterprises. Chapter 7 traces further the evolution of the shareholding system reform from 1997 to the

6


completion of the reform through the ‘share conversion’ programme in 2005–2006. Finally, Chapter 8 concludes by arguing that the shareholding system reform is consistently gradualist, and the entire process can be characterized as ‘privatizing by groping for stepping stones to cross the river’.

2. Shareholding system reform as the Chinese way of privatization In the early 1990s, almost immediately following the collapse of socialist regimes in Central and Eastern Europe, privatization became one of the most important themes of post-communist transformation in this area. It is argued that restoration of a private sector is the only way through which the economies can be revitalized and political freedom guaranteed. While the necessity of the change has been widely acknowledged, there have been intense debates on what is the optimal speed and method of privatization, resulting in a mushrooming literature on the subject.1 Apparently, the issue of privatization is not as hot in China as in the former Soviet bloc countries. While privatization laws have been passed in a number of Central and East European economies, no similar legislation has been introduced in China (Chai, 1994, p. 237). Although the post-Mao reform had resulted in significant changes in China’s economic system, in the early 1990s the ideological supremacy of public ownership still remained. However, as a matter of fact, as early as the mid-1980s China had already launched trial privatization measures, under the camouflage of ‘shareholding economic reform’. The experiment was interrupted by political conservatism following the summer 1989 Tiananmen demonstrations. Yet the shareholding system not only survived but became so popular that a large number of Chinese state enterprises were lining up to convert into shareholding companies. This wave of reform has hastened the shrinking of the state sector in the economy. Most importantly, it represented the Chinese path to privatization. In this chapter, we will argue that China’s shareholding economic reform is tantamount to privatization, although the latter term is avoided for political and ideological reasons. The change is a continuation of a process that could be traced to the mid-1980s. Yet it does involve a radical departure from earlier reform measures, which touched mainly on issues of management and income distribution but not ownership of state enterprises. Initially, the shareholding experiment was introduced gradually and from above. After 1993, however, the process rapidly accelerated, with widespread spontaneous initiatives from below. These breakthroughs made most Western studies on China’s enterprise reform of that time outdated.

7

8


SCOPE OF DISCUSSION Bornstein defined privatization as follows: In the broadest sense, ‘privatization’ could embrace any increase in private activity, including the creation of brand new (‘start-up’) private enterprises, without any reduction in activity of state enterprises. A narrow, but probably most common, definition of privatization involves the transfer of ownership of state assets to private hands. (Bornstein, 1994a, p. 234)

In China, privatization in the broad sense as defined above began in the late 1970s. After almost three decades of suppression of private economic activities, the watershed Third Plenum of the Eleventh Central Committee of the Chinese Communist Party, held in December 1978, allowed farmers to produce on their small private plots. Capturing this opportunity, a number of ‘youths awaiting job assignment’ and ‘idle people’ began to establish their own new businesses. This was followed by a flow of workers from the state to the private sector, as the latter offered the possibility of higher income and greater freedom. Sources of capital for private firms also expanded, as personal savings soared and more state loans were made available to individual investors. By the end of 2006, there were about 150 000 private enterprises in China, with a total asset of 405 billion yuan (representing 14 per cent of the national total) (ZJN, 2007). The rapid expansion of this private sector economy, consisting mainly of new businesses, has attracted the attention of a number of Western scholars, including Ole Bruun (1993), Ross Garnaut and Ligang Song (eds) (2004), Thomas Gold (1989a, 1989b, 1990, 1991), Willy Kraus (1987, 1991), Barbara Krug (ed.) (2004), Ole Odgaard (1990, 1990/91, 1992), Susan Young (1989, 1995), and David Zweig (1988). The focus of this book, however, is on China’s privatization in the narrow sense: transfer of ownership of state assets to private hands. Unless stated otherwise, the term ‘privatization’ will be used with this meaning. More specifically, we will concentrate on the shareholding system as the Chinese way of privatizing state enterprises. This experiment began in the mid-1980s, several years later than the appearance of new private businesses.2 The downfall of Zhao Ziyang and other reformist leaders in the wake of the 1989 political turmoil forced the shareholding experiment to adopt a low profile. After 1993 the process regained momentum. Yet not much about this reform was known in the English-speaking world for several years.

The Chinese way of privatization

9

SHAREHOLDING SYSTEM REFORM: THE CHINESE WAY OF PRIVATIZATION According to a vice-president of Bank of China, in 1986–87 some Chinese economists and World Bank consultants proposed privatization of Chinese state enterprises through an equal distribution of vouchers among the general public, a ‘shock therapy’ privatization method subsequently used by some East European countries. The suggestion was rejected in favour of a ‘minimum reform package’ without privatization, as this moderate approach was considered economically and politically less risky (Zhou, 1993).3 In the early 1990s, ‘privatization’ (siyouhau) was still politically taboo in China, as the term implies going capitalist and weakening state control. However, Chinese reformers have always been very clever in overcoming this kind of ideological obstacle by playing semantic games. For example, the adoption of a capitalist mode of distributing goods and services is often referred to as ‘marketization’ (sichanghua) or ‘commodification’ (shangpinhua); and the withdrawal of the state from welfare services is called ‘socialization’ (shehuihau) (Wong, 1994, pp. 311, 323–24). In enterprise reform, the cover for privatization is ‘shareholding economic reform’ (gufen jingji gaige).4 The Chinese shareholding system emerged in the mid-1980s, in response to the failure of other efforts to improve the economic efficiency of state enterprises. From 1981 to 1983, the government introduced different versions of profit contract system among state enterprises, as an attempt to translate the successful agricultural household responsibility scheme to the industrial sector. However, enterprises responded by bargaining for a larger share of profits, while leaving losses to the state. The resulting plunge in state budget revenue caused the government to substitute income taxes for remission of profits. The tax-for-profit system lasted only from 1983 to 1985, as the change simply switched the object of bargaining from profit retention ratios to tax rates. In 1986 the government decided to return to the profit contract system (Chen Youngzhong, 1991, pp. 290–92; Lee K. and Mark, 1991, p. 157; Lee K., 1993b, p. 181). Both the profit contract system and the tax-for-profit scheme sought to improve economic efficiency by granting greater income rights to enterprises, while ownership remained in the hands of the state. Under such a property rights arrangement, the primary objective of enterprise managers and workers has been to maximize sales revenue and their say in income distribution, with little concern for cost and profit. The result was rising losses, despite growing production. As Table 2.1 shows, from 1980 to 1992 gross output of Chinese state enterprises increased by less than five times, but losses soared over tenfold.

10

Table 2.1


Output and losses of Chinese state enterprise 1980

1992

Change

(109 yuan) Gross output value Losses

391.6 3.4

1782.4 36.9

4.6 times 10.9 times

Source: ZTN, 1993, pp. 412 and 430.

It is against this background that China launched the shareholding experiment, through which enterprises and individuals are allowed to share with the state not only profits, but also ownership of enterprise assets. Again, the idea was borrowed from the rural sector. Early in 1979, the central government allowed communes and brigades to form joint-stock enterprises. In 1983 an official document stated that, in cooperative economic production, capital and labour were both legitimate bases for distributing returns. This gave rise to a number of joint-stock township and village enterprises. In April 1984, in a seminar held by the State Commission for Restructuring the Economy, a proposal was made to allow workers to invest capital in collective and small state-owned enterprises, and to receive dividends. In July that year the first shareholding company, the Beijing Tianqiao Department Store Company, was established. In October 1984, with the economic reform shifting its focus from the rural to the urban sector, the shareholding experiment was extended to medium and large state enterprises (Chen Youngzhong, 1991, pp. 316–18). As could be expected, the shareholding system caused serious ideological, political, economic and legal debates in China.5 According to advocates of the shareholding reform, the new system serves many functions. These include pooling investment funds, promoting economic integration, reducing enterprises’ myopic behaviour, nurturing management professionals, increasing capital mobility, alleviating inflationary pressure, and enhancing production incentives (Chen Youngzhong, 1991, pp. 68–79). Despite these advantages, the state was very cautious about the potential challenge that the shareholding system might create for the state sector. It thus set several limits to the change. First, the state or its agents (enterprises) should hold the majority of the shares. Second, there should be no expropriation of the state assets. Third, government approval had to be obtained before conversion of state enterprises into shareholding companies. Fourth, some industries (defence, scarce metal and mineral resources, banks, foreign trade corporations and other state-controlled monopolies) were not allowed to adopt the shareholding system (Yang, 1993, pp. 194–95).


11

The political factor was influential in the fate of China’s shareholding reform. In December 1986, the reformist leader Zhao Ziyang, without gaining support from the conservatives, ordered the introduction of the shareholding system in some enterprises in a number of larger cities, including Shanghai, Beijing, Wuhan, Shenyang and Chongqing (Shirk, 1993, p. 310). In October 1987, addressing delegates at the 13th Party Congress, Zhao said that, since China was still at an ‘initial stage of socialism’, the dominant public sector should be supplemented by other forms of ownership as well. Specifically, the shareholding system was recognized as ‘a form of organizing assets of socialist enterprises’, and hence the experiment ‘could continue’. Distribution of dividends to shareholders, ‘as long as it is legal, should be allowed’ (ZBN, 1988, pp. 98–99). With such high-level support, the shareholding scheme was promoted extensively. By 1988 some 3800 enterprises had adopted the new system.6 The loss of power of Zhao Ziyang and other reformist leaders following the 1989 Tiananmen demonstrations caused a setback to the shareholding reform. A strong statement was made that ‘China will not practise privatization’ (BR, 4–10 September 1989, pp. 4–5). Though establishment of shareholding enterprises was not banned, the issue of shares to workers was halted. Complementary reforms were restricted to Shanghai and Shenzhen (ZGJS, pp. 11 and 65). Under this atmosphere, the number of shareholding companies had declined to 3220 by 1991 (see Table 2.2). Many Western observers thus doubted whether the experiment could survive (Bowles and White, 1992, p. 587; Lee K., 1993b, p. 192). However, the trend was reversed in 1992. After the paramount leader Deng Xiaoping called for further reform during his highprofile ‘southern tour’ in January that year, the shareholding experiment reemerged in China’s economic reform agenda. By the end of 1997, about 5400 shareholding companies had been established, with a total capital stock of over 220 billion yuan (ZJN, 1998, p. 718). Table 2.2 Approximate number of shareholding companies in China (at end of year) 1988 1991 1992 1997 Note:

3800 3200 3700 5400

As the data come from different sources, they may not be directly comparable.

Sources: 1988 figure from ZBN, 1989, p. 251; 1991 figure from ZGJS, 1993, p. 66; 1992 figure from ZBN, 1993, p. 239; 1997 figure from ZJN, 1998, p. 718.

12


China’s shareholding enterprises fell under four basic models (Chen Youngzhong, 1991, pp. 165–73): Model A: ‘One Enterprise, Three Types of Owners’ This model was the most common one, particularly in Sichuan and Shenyany provinces. A shareholding company under this model has three types of owners: the state, enterprise, and individual workers of the enterprise. The value of ‘state shares’ (guojia gu) is calculated from the net value of assets created by state investment. The enterprise itself is entitled to a certain amount of ‘enterprise collective shares’ (qiy jiti gu), which are equal to the net value of assets acquired through the enterprise’s own retained funds. Finally, workers of the enterprise are issued ‘individual workers shares’ (zhigong geren gu). Under this model, state shares are risk-free. They are guaranteed a return that is equivalent to the 55 per cent income tax. In contrast, enterprise collective shares bear most of the risk. Their rate of return depends entirely on the financial result of the enterprise’s operation. Individual worker shares receive fixed interest that is roughly the same as that which banks offer on savings deposits, plus an unguaranteed amount of dividends depending on the profits or losses made by the enterprise. Model B: ‘One Enterprise, Four Types of Owners’ Many shareholding companies in Shanghai adopted this model, which consists of four types of owners: the state, the enterprise, other institutions, and individuals. Like Model A, the amounts of state shares and enterprise collective shares are determined respectively by the net value of assets created by state investment and those acquired through the enterprise’s own retained funds. What is different from model A is that shares are also issued to other institutions, known as ‘unit shares’ (danwei gu), and to the general public, known as ‘private individual shares’ (geren siyou gu). Under this model, all four types of owners share equal risk. There is no guaranteed return, and dividends are distributed evenly if they are paid. Model C: ‘One Enterprise, Two Types of Owners’ This model was adopted mainly by shareholding companies in Shenzhen, China’s largest Special Economic Zone. A number of state enterprises here have been auctioned off to institutions and individuals. This process transfers ownership from the state and the original enterprise to the buying institutions and individuals, each holding a certain amount of ‘unit’ shares and private individual shares.


13

Model D: Shareholding Conglomerates Under this model, shareholding conglomerates were formed on the basis of the contribution of capital by different enterprises. Like Model A, there are state shares, enterprise collective shares, and individual worker shares. But in addition to that, in this model there are the unique ‘public-owned enterprise shares’ (gongyou qiye gu). They are owned by the state, but the associated income and voting rights are assigned to the enterprises joining the conglomerate. In short, under the above four models, there are three types of owners and six types of shares, as summarized in Table 2.3. Enterprise collective shares and ‘unit’ shares together are known as ‘corporate shares (faren gu); and worker shares and private individual shares together are known as ‘individual shares’ (geren gu).7 The Chinese shareholding reform is a form of privatization, in the sense that it provides a channel through which assets are transferred from the state to private hands. As another analyst noted, while Chinese reformers had made earlier efforts to create a non-state sector and to introduce a system of managerial incentives in state enterprises, it was only with the adoption of the shareholding reform that China finally pursued ‘privatization as that term is traditionally understood: transferring state ownership rights to private interests (Cao, 2000, p. 15).’ It may be argued that since the state remains the largest owner of enterprise assets, the shareholding reform should more accurately be called corporatization, rather than privatization. Two World Bank economists thus noted that the goal of China’s enterprise reform was to improve efficiency ‘through corporatization, but without going as far as the privatization route being pursued by many other countries in transition’ (Harrold and Lall, 1993,

Table 2.3

Models of China’s shareholding system

Owner

Shares

A

Model B C

State

State shares Public-owned enterprise shares Corporate shares, of which: Enterprise collective shares ‘Unit’ shares Individual shares of which: Worker shares Private individual shares

*

*

*

* *

*

*

*

Institutions

Individuals

D * * *

*

*

14


p. 42, original emphasis). According to van Brabant, corporatization ‘refers to enterprise reforms that alter the firm’s legal position from being a state agent, perhaps with dubious property rights into some joint-stock company, whose property rights are initially entrusted to, but not necessarily all exercised by, some state agency’. Under corporatization the state remains the owner, but the allocation of the usufruct of ownership will be monitored by some state assetmanagement agency (van Brabant, 1991, pp. 11 and 152). However, we regard the Chinese shareholding system as a form of privatization rather than corporatization. This is because, as we will see below, the state’s share in shareholding companies is in decline. State ownership is even absent in a number of shareholding companies. Among those with the state as major shareholder, the state asset-management agency has not acted in the best interests of the state. Some positions as representatives of state assets were vacant (Lee Kuen, 1991, p. 93). As the state is not guaranteed an influential role in Chinese shareholding enterprises, it is our view that the nature of the shareholding reform is closer to privatization than corporatization.

LITERATURE REVIEW The Chinese use of the term shareholding system reform, in avoidance of the label ‘privatization’, seems to have misled some Western scholars to regard privatization as absent in China. For example, Gelb, Jefferson and Singh (1993, p. 425) called property rights changes in China ‘pseudo-privatization’; Rawski (1994) described China’s industrial performance as ‘progress without privatization’; and Rana (1995, p. 2) concluded that China has made ‘little action’ in terms of privatization of small enterprises. None noted the rapidly emerging shareholding system. To this author’s knowledge, Lee Kuen (1991) was the first to recognize the shareholding reform as China’s way of privatization; Chapter 6 of his Chinese Firms and the State in Transition has the title ‘Privatization of State Enterprises: the Emergence of the Shareholding System’. According to Lee, the shareholding experiment represents China’s ‘first effort to solve the problem [of continuing economic inefficiency] by changing the property relations of the enterprise in direction of privatization’ (Lee K., 1991, p. 81). Based on material available in 1988, Lee identified several major features of Chinese shareholding companies which conform to Model A as described in the preceding section. In his view, this system has two major weaknesses. First, the mixed nature of Chinese shareholding enterprises, between nonprofit organizations and profit-seeking corporations, creates a large loophole in the structure of residual claims. Under the shareholding system, a Chinese enterprise is a non-profit organization in the sense that most of its assets are


15

‘donated’ by the state and the enterprise itself, and that the residual claims of the donors are inalienable (since any return to state shares and corporate shares can either go to the state budget or be reinvested in the enterprise). At the same time, the company is a profit-seeking corporation, as there are individual shareholders seeking maximum, alienable residual claims. The coexistence of non-profit donors (the state and the enterprise) with inalienable residual claims, and profit-seeking shareholders (individuals) with alienable residual claims, leaves room for expropriation of state assets, through payment of excessively generous interest and dividends to individual shareholders (Lee K., 1991, pp. 85–92). Second, there is the so-called agency problem, which arises from the absence of a personified holder of state shares. Although state officials are appointed to the shareholders’ council or the board of directors, they have no incentive to protect state assets from expropriation by agents (enterprise managers and individuals) for private benefit. As a result, large amounts of state assets have been expropriated by agents through such practices as undervaluation of state assets and collusion between lower level state bureaucracy and enterprises. In capitalist economies, individual securities holders with investments diversified among many firms generally have no special interest in personally monitoring the detailed operations of any firm. Disciplining of agents is achieved mainly through markets for managerial and labour services, the role of the board of directors, and the market for corporate control. It is the absence of similar mechanisms that makes the agency problem acute in China’s shareholding system (Lee K., 1991, pp. 92–6). These two defects led Lee to the conclusion that ‘the current model of the Chinese shareholding system is not sufficient to significantly increase the organizational efficiency of the enterprise’. He predicted that the Chinese shareholding experiment would wane, or be kept to experimental levels, owing to the increasing number of reports about difficulties in implementation, and the change in political atmosphere following the 1989 Tiananmen demonstrations (Lee K., 1991, pp. 82, 98 and 175). However, further research led Lee to a less pessimistic view. In a subsequent article, Lee and his co-author Mark found that ‘one year or so after the [1989 political] crisis, the shareholding system appears to be regaining its momentum, due in part to continued worsening of economic conditions, for which the conservative faction of the leadership is being blamed’ (Lee K. and and Mark, 1991, pp. 157–58). They repeated the above-mentioned defects of the structure of residual claims and the agency problem of Chinese enterprise, but nevertheless added the point that most of the problem associated with the shareholding system arose in the area of distribution. While admitting that distributional inefficiency did interfere with productive efficiency to a certain extent, they acknowledged some contributions made on the production side by

16


the shareholding system: increase in sources of capital through issue of shares, reduction of arbitrary interference by state authorities, and enhancement of capital mobility (Lee K. and Mark, 1991, pp. 166–67, 170). In a more recent article, Lee (1993b) reiterated most of the above points. He recognized that the shareholding experiment, like the improved contract system, had the advantages of capital polling and incentive enhancement. Both schemes tended to reduce state revenue and create inflation. However, instead of treating these negative consequences as good reasons to reject the reform measures, Lee regarded them as the ‘trade-off’ for the benefits of the change. Yet he maintained his earliest view (Lee K., 1991, p. 98) that the improved contract system had a better chance of survival than the shareholding experiment, since the former would be politically less dangerous and economically less risky (Lee, 1993b, pp. 191–92). While Lee’s major concern is the efficiency effect of China’s shareholding reform, another scholar, Tam (1991), focused on the motive of the change. According to Tam, the issue of enterprise securities and other informal credits has caused the rapid emergence of a capital market in China. The speed of change has been so fast that it ‘has defied the general pattern observed in other developing countries at roughly comparable stages of economic development and monetarisation’ (p. 511). Tam attributed this phenomenon to the inefficiency of the official banking system. As part of the government’s financial mechanism, Chinese state banks allocate funds according to bureaucratic rather than commercial considerations. Their inability to resist demands from local authorities results in excessive credit expansion and rising bad debt. Such a credit rationing system puts smaller state enterprises and private firms in the most disadvantageous position in obtaining funds. To cope with the problem, many of them borrow from informal sources at high interest rates, and some issue shares to raise their own capital. This leads Tam to the conclusion that the emergence of the shareholding system and other informal financial institutions is a disorganized but nevertheless rational response by economic agents to the irrationality of the official banking system. The development is the outcome of spontaneous reactions by enterprises and individuals, now operating with greater autonomy, to seek maximum returns from their activities (Tam, 1991, pp. 512, 522–25). Another researcher, Singh (1990), however, disagreed that share issues would make any significant contribution to the Chinese economy. In his view, the commonly quoted functions of capitalist stock markets – pooling of savings, channelling of capital to users with the greatest need, and efficient utilization of assets – are often hypothetical rather than real. In the Chinese context, the purposes of establishing a stock market include promoting saving and alleviating inflationary pressure, optimizing the volume as well as sectoral allocation of investment, and enhancing micro-efficiency of enterprises. In


17

Singh’s view, the more effective ways to achieve these objectives will be through macroeconomic actions by central planners and promotion of completion in product markets. Instituting a stock market can make matters worse, as volatility of share prices will increase overall instability. Two other scholars, Bowles and White (1992), went further, listing three problems of Chinese share issues. First, the returns to Chinese shares tend to be guaranteed, with little link with the level of risk; second, some unprofitable enterprises issued shares to shore up their financial failures; third, shares were also issued for the purpose of distributing bonuses to workers and allocating scarce goods between enterprises. In these authors’ view, ‘these facets of actual share issues … tended to obstruct any contribution which they might have made to increasing the productivity of financial resources’ (p. 581). Nevertheless, Bowles and White felt that the issue of shares was politically important, as it challenged the ideological and institutional underpinnings of a ‘socialist’ economy. They were thus more interested in the political and ideological debates sparked by the shareholding experiment. They identified four major proposals by Chinese theorists on the issue of ownership reform, moving from more conservative to more radical: (a) keeping the existing ownership structure unchanged but granting more autonomy to enterprises; (b) allowing different types of economic agencies to form shareholding enterprises, on the condition that the state would remain the largest owner; (c) transferring ownership rights from the state to the enterprise itself; (d) privatizing state enterprises through sale of shares to the public. The fundamental issue of this debate, according to Bowles and White, is the compatibility between share issues and socialism. They felt that the major obstacles to moving from option (a) towards (d) ‘are the political objections of those who see even marginal ownership changes as creeping privatization en route to capitalism’. The outcome, therefore, would largely be ‘dictated by political factors’ (Bowles and White, 1992, pp. 584–88). Finally, China’s shareholding reform has attracted attention from the legal profession. Bersani (1993), a US attorney, explained the rules and regulations governing Chinese shareholding enterprises; and Nottle (1993), Chairman of the Hong Kong Securities and Futures Commission, discussed China’s securities regulation framework. Their interpretations of the relevant Chinese laws in Western terms are useful, as they provide a convenient way to see the uniqueness of China’s shareholding system compared with Western one. However, these studies have been overtaken by the adoption of China’s first Company Law in December 1993, which supersedes most of the provisional regulations examined by Bersani and Nottle. To sum up, Western scholars have had mixed views about China’s privatization. Some regarded the change as of negligible scale, while others discussed the shareholding reform as a form of privatization. Contrary to the

18


Western neoclassical belief that privatization is the most effective solution to public sector inefficiency, most researchers on China’s shareholding system reform have been sceptical about the economic effect of the change. Yet many agreed that the shareholding system is a rational economic choice for Chinese enterprises seeking maximum independence from the state, given existing political and ideological constraints. Regarding the future of the reform, the general view has been that the decisive factors would be political rather than economic.

THE PRIVATIZATION DEBATES We argued above that the Chinese shareholding system reform is a form of privatization, in the sense that it provides a channel through which assets are transferred from the state to private hands. Other scholars have described it as ‘a first move in the direction of privatization’ (Lee Kuen, 1991, p. 176), ‘partial privatization’ (Chai and Docwra, 1997, p. 175; Naughton, 2007, p. 469), ‘de facto denationalization’ (You, 1995, p. 54), and ‘piecemeal privatization’ (Parker and Pan, 1996, p. 120). Whatever terms they use, these authors share the view that the shareholding system reform involves privatization, though they may not agree on the extent of that change.8 It is less easy, however, for Chinese scholars to arrive at such a conclusion, as the issue is related to whether the reform is ‘surnamed capitalism or socialism’ (xing zi hai shi xing she) (XB, 14 August 1997). For those who see ideology as having no real influence on political and economic policy, this will not be an important constraint on shareholding system reform. However, as Chen and Sun have shown, Chinese ideological debates about political economy have been crucial in shaping the direction of reform (Chen Feng, 1995; Sun, 1995). Almost two decades of reform have led to the gradual acceptance of ‘marketization’ (shichanghua) and ‘commodification’ (shangpinhua) as means to invigorate the socialist economy. Yet, privatization (siyouhua) is still politically taboo, as it goes in direct conflict with the Marxist cardinal principle of public ownership. There was evidence that the early Chinese advocates of the shareholding system reform in fact knew that what they were proposing was tantamount to privatization. Chen Feng (1995, p. 125) noted that many of the arguments made for the system were actually used to support privatization in the first five months of 1989; when You (1995) conducted private interviews in China in 1992, some Chinese officials even attributed the country’s economic problems to insufficient privatization (p. 35). However, awareness of the political and ideological implications of the term privatization has led Chinese theorists to choose strategically to raise their ideas under the camouflage of shareholding system reform.


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In the mid-1980s when the shareholding experiment had just begun, its defenders took the approach of ‘neutralizing’ the reform. They argued that there is no exclusive linkage between the shareholding system and capitalism; rather, they said the design could benefit both capitalism and socialism (Chen Feng, 1995, pp. 121–22). But the argument failed to convince its opponents, who later brought the reform to a low ebb. After the reform drive regained momentum in 1992, ideological attack against it revived. In early 1997, the conservatives issued two ‘ten-thousand-word articles’ (wan yan shu) claiming that the intention of the shareholding system reform was ‘to convert socialist public ownership in order to achieve privatization.’ One of the articles said that, as a consequence of the reform, ‘the remaining SOEs face the possibility of no longer [being] wholly owned by the state (YZ, April 28–May 4, 1997, p. 12).’ To privatize, according to the conservatives, is not only ideologically wrong but also ‘unconstitutional’ (SCMP, 24 August 1997). In response, three lines of counterargument have emerged that may be termed orthodox, moderate, and aggressive. The ‘orthodox’ approach sought doctrinal support from Marxism. In an internal meeting held in early 1997, the then Party’s General-Secretary Jiang Zemin quoted Engels that ‘capitalist production operated by shareholding companies is no longer private production, but profit-seeking joint production by a large number of people’ (MB, 21 April 1997). Another theorist added that it was Marx’s view that ‘the shareholding system is probably the most effective way to achieve communism’ (JYZ, 1997, No. 6, p. 48). Based on these, the orthodox theorists argued that the shareholding system reform is not privatization but ‘socialization’ (shehuihua) (XB, 15 April 1997; YZ, 28 April–4 May 1997, p. 12).9 It is not a product of capitalism, but an inevitable outcome of mass social production. The conservatives rejected such an approach as a ‘distorted use’ of Engels’s and Marx’s ideas (MB, 24 June and 13 August 1997). The ‘moderate’ defenders of the shareholding system were reluctant to go back to a textual search for Marxist tenets. For them, so long as the reform does not involve sales of original state capital or challenge the leading role of public ownership, the shareholding system should not be labelled privatization. As one senior economic official argued, the reform is based not on the transfer of original state capital but rather the absorption of additional capital from the general public and foreign investors. As such, it is favourable to the control of non-state capital by state capital (CD, 21 June 1995; GZFX, 1995, No. 45, p. 18). Another theorist added that privatization is primarily a ‘political concept’ that involves the objection to the leading role of public ownership. Since the shareholding system reform causes no harm to the state’s dominant role in the economy, it is not privatization (JYZ, 1995, No. 4, p. 43). Some went even further, arguing that the shareholding system in fact strengthens the leading role of public ownership by using a relatively small amount of state

20


capital to control a relatively large amount of social capital (XB, 15 April 1997). The conservatives retorted that if the shareholding system reform could not simply be equated with privatization, similarly it could not be regarded as public ownership. In their view, the system’s role in raising capital and forming collective production should not be exaggerated (MB, 24 June 1997). Finally, the ‘aggressive’ approach attempts to break the privatization taboo. In 1994, one theorist suggested that there are two major forms of privatization: sales and equal distribution. In his view, ‘the feasibility of both forms is worth consideration’ (Xu, 1994, p. 134). Along this line, some proposed that China might try the concept of ‘state-owned privatized enterprises’ (SCMP, 9 March 1997), an oxymoron that state ownership and privatization can be compatible. An even more radical voice argued that privatization is a ‘neutral concept’ that should not be judged by political and ideological criteria. The proponent of this view admitted that if privatization is to mean transfer of ownership of inefficient SOEs to individuals or legal-persons for the sake of improving efficiency, then it is not wrong to regard the shareholding system reform as privatization. Although various forms of hidden privatization such as theft, squander, and private distribution of state assets have been taking place, ‘open, orderly privatization is preferred to hidden, unregulated privatization’ (JYZ, 1995, No. 4, pp. 41–42). Finally, a private economic consultant has even challenged ‘the leading role of public ownership’, saying that it is an ‘outdated slogan’ (MB, 7 August 1997). In the 15th Party Congress held in September 1997, it was a mixture of the old ‘neutralization’ approach and the ‘moderate’ approach that provided the major justification for the shareholding system. In his report presented at the Congress, the then Party’s General-Secretary Jiang Zemin said that the shareholding system is an efficient form of capital organization that can be used by both socialism and capitalism: ‘We cannot say in general terms that the shareholding system is public or private. The key lies in who holds the controlling share.’ Public ownership, according to Jiang, includes not only state ownership and collective ownership but also the state’s and collective’s share in the mixed economy. ‘Under the premise that public ownership is dominant, a decline in the relative proportion of state ownership will not affect the socialist nature of China.’ The entire argument is based on the recognition that China is still at the ‘initial stage of socialism’, during which the dominant public ownership should ‘develop diverse forms of ownership’ (TKP, 13 September 1997). While Zhao Ziyang, the original articulator of the notion of an ‘initial stage of socialism’, remains absent from the public scene, the theoretical base he laid for privatization has been rehabilitated. During 2004–2006, there was another round of ideological debate about the relationship between the shareholding system reform and privatization. It was a response to the Third Plenary Session of the Sixteenth Central Committee of


21

the Chinese Communist Party (held in October 2003), in which a decision was made ‘to implement diverse forms of public ownership and to make the shareholding system the mainstay of the new public ownership’10 (BR, 11–17 December 2003, p. 18; italics added). The italicized part of the statement led to the questions of what is ‘new public ownership’, and how could the shareholding system be made the ‘mainstay’ of it? Shortly after the meeting, Li Yining, a leading theorist of the shareholding system, put forward a theory of ‘new socialization’. According to him, there are four forms of ‘new public ownership’. The first consists of purely state-owned enterprises; the second consists of shareholding enterprises with the state and the general public (organizations or individuals) as shareholders; the third consists of shareholding enterprises with only the general public but not the state as shareholders; and the fourth consists of enterprises owned by privately donated funds. In Li’s view, the first form will continue to exist but only in ‘a few special sectors’, and the fourth form is now limited in size but ‘will surely expand’. It is the second and the third forms – collectively known as ‘public-owned shareholding enterprises’ – that constitute the major component of China’s socialist economy. Moreover, according to Li, when many of the existing private enterprises expand to such a scale that they need to raise capital from outside, they will also be turned into shareholding enterprises. In such a way, the shareholding system forms ‘the mainstay of the new public ownership’, and the expansion of the shareholding system is regarded as ‘new socialization’ (xin gongyou hua) (JXD, 2004, No. 1, pp. 17–20). Li’s view immediately stirred up a debate. Opponents criticized that it is inappropriate to categorize pure privately owned shareholding enterprises – that is, the third form of ‘new public ownership’ identified by Li – under public ownership, otherwise shareholding companies in developed capitalist countries would also be regarded as a form of ‘new public ownership’. While the shareholding system as a modern enterprise system should be promoted, it could become ‘hidden and incremental’ privatization if there is no ‘tight surveillance’ over its operation (JXD, 2004, No. 4, pp. 18–24). Moreover, Li’s view was criticized as having ‘completely neglected the private nature of shareholding enterprises’ (JXD, 2005, No. 1, pp. 55–60). Historically speaking, the shareholding system has long been closely related with capitalist private ownership. Insufficient attention to this will turn ‘potential’ privatization into ‘real danger’ (JXD, 2005, No. 9, pp. 36–40). Most seriously, according to one critic, further reform along Li’s line will make ‘a large number of publicly-owned enterprises exist only in name but not in reality’, and is therefore ‘extremely harmful’ (JXD, 2004, No. 7, pp. 42–44). On the other hand, a supporter of Li defended that China’s shareholding system is ‘public’ in three aspects. First, capital and enterprises are ultimately owned by ‘the general public and labourers’, instead of ‘a few capital holders’;

22


second, assets of shareholding enterprises are ‘social’ but not ‘personal property’; third, ‘the general public and labourers’ have the income right over capital. Therefore, the shareholding system is a form of ‘public ownership with Chinese socialist characteristics’ (JXD, 2004, No. 4, pp. 25–28). Moreover, from a pragmatic point of view, it was argued that the shareholding system is a ‘good form for realizing socialist public ownership’, because it provides a ‘microeconomic foundation’ for public ownership (JXD, 2006, No. 1, pp. 59–61). Another discussant added that ‘as long as the shareholding system can maintain and enhance the value of public capital, it should be regarded as a form of public ownership’ (JXD, 2004, No. 10, pp. 44–47). Finally, quoting Marx’s view that the shareholding system is a good form of transition to communism, a theorist contended that ‘one should not be fearful of saying that the property right of shareholding companies is a higher form of public ownership. This is exactly the manifestation and proof of the functioning of the law of progress from private ownership to public ownership, and is the empirical ground for the inevitable replacement of capitalist private ownership by socialist public ownership’ (JXD, 2005, No. 9, pp. 49–54). After a review of this debate, a scholar concluded that ‘during reform, we should be bold in making innovations, and not be constrained by certain old views. The shareholding system continues to be the main direction of enterprise reform and the major form of realizing public ownership of our country’ (Luo, 2006, p. 48).

OTHER PRIVATIZATION CHANNELS Ideological disagreements notwithstanding, by the mid-1990s a significant amount of resources in China had been transferred from the state to private hands through the shareholding system reform. At the same time, several other channels of privatization had also emerged in China. Auctioning of state enterprises, which began in 1987 but was later halted for ideological reasons, resumed in 1992 (CEN, 22 November 1993, p. 18). Private entrepreneurs were active buyers. For example, when seven state-owned department stores were listed for auction in Shanghai in 1992, six were sold to the same private businessman, and the remainder to another private firm (BR, 15–21 February 1993, p. 30). Enterprise workers also bought state enterprises. In early 1994, the entire Shanghai Lighting Apparatus Factory was sold to its staff for one million yuan (CEN, 25 April 1994, p. 14). To institutionalize this trading of state assets, 25 property rights exchanges had been established across the country. Within a few years, over 10 000 enterprises, many of which were originally state-owned, were sold or merged through these exchanges (CD, 19 February, 25 April, 17 May 1994; CEN, 30 May 1994, pp. 16–17).


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The Third Plenary Session of the Fourteenth Central Committee of the Chinese Communist Party, held in November 1993, gave a further green light to privatization, although the term was still not explicitly used. It was decided at that meeting that selling of major stakes in state enterprises (except arms manufacturers and key industries) to private or foreign investors would be allowed. Small state enterprises would be contracted out, sold or leased to private investors without restriction. Enterprises that remained in the state administrative organs to direct public companies would be removed (FEER, 23 December 1993, p. 46). Among the various privatization measures, the shareholding system was the most accessible to the general public. By the end of 1993 the number of Chinese shareholders had reached 25 million (ZSZ, 25 February 1994, p. 20). In this sense, the shareholding system has resulted in some degree of ‘mass ownership transformation’ in China.11 The Chinese shareholding experiment experienced a series of problems: expropriation of state assets, instability of macroeconomic and political environment, exploitation of legal loopholes, inaccuracy of information, lack of expertise, inadequate supervision of corporations, and unequal distribution of wealth. The state did not seem to have any ready solution. Nevertheless, this has not prevented the government from further implementing the reform. If there was any policy at all, it would be to set just a few vague guidelines, let problems emerge, and then solve them during the course of change.12 Chinese leaders describe this kind of trial-and-error approach as ‘groping for stones to cross the river’. There is no specific theory to guide the reform, but this is exactly what ‘socialism with Chinese characteristics’ is all about.

NOTES 1. 2.

3. 4.

5. 6.

For some discussions on post-communist privatization in the early 1990s, see Csaba (1994), Earle, Frydman and Rapaczynski (eds) (1993), and Milor (1994). At least two scholars, Shirk (1993) and Lee (1993a), have argued that such a strategy of allowing a private economy to emerge and to coexist with the state sector, instead of a headon attack on state enterprises, is a major reason for the success of the Chinese compared with the Soviet reform. For a call by World Bank economists for more extensive privatization in China, see Harrold and Lall (1993, p. 46). The following case illustrates the importance of terminology. In April 1994, a Canadian investment firm told the visiting Chinese Vice-Premier, Zou Jiahua, that since Canada was well experienced in ‘privatizing Crown corporations’, it could help China to dismantle state enterprises. The lack of sensitivity to wording resulted in an abrupt reply: ‘It is wrong to believe that only privately controlled economies can grow, and that publicly controlled economies cannot grow’, Zou said, pointing out that ‘many private enterprises go bankrupt’ (Globe and Mail, 23 April and 15 June 1994). For details of these debates, see Chen Shenshen (1989) and Chen Jianfu (1993). Another source, Ting (1989), quoted the figure as 6000. But the 3800 estimate seems to be more consistent with other available data. See Table 2.2.

24 7. 8.

9. 10. 11. 12.

Shareholding system reform in China Not included here are ‘foreign shares’ (waizi gu) or B-shares, which are sold to foreign (including Hong Kong and Macao) investors. In contrast, Wang Xiaoqiang (1996) argued that ‘in China, from the enterprise contract system to the shareholding system, and as the property rights reform intensifies, we can hardly see any locus of change from public to private ownership’ (p. 186). This is because, according to him, most of the shares of the shareholding companies are held by the state or state-owned institutions, and there are not many shareholders ‘with flesh and blood’. Wang, however, seems to be unaware of the trend that the state’s majority share has been in decline, and this process, however gradual it is, is a kind of privatization. The term ‘socialization’ has also been used as a cover for privatization of social welfare in China. See Wong (1994). In the original source, the term ‘joint-stock system’ was used instead of ‘shareholding system’. We made the change for consistency. In Chinese both terms refer to ‘gufenji’. ‘Mass ownership transformation’ refers to rapid transfer of ownership through issuing vouchers or other means of mass distribution (Thomas, 1993, pp. 173–74). For example, according to a Chinese legislator, when drafting the Company Law many grey areas were intentionally left in order to allow room for future changes (ZSZ, 2 July 1994, p. 20).

3. Evolution of the shareholding system reform In the 15th Chinese Communist Party Congress held in September 1997, the shareholding system (gufenzhi) was endorsed as the ‘mainstream reform programme’ for state-owned enterprises (SOEs) (MB, 12 September 1997). This represented an important move of China to improve economic efficiency in the state sector. In 1996, this sector accounted for 53 per cent of the country’s total investment, and 16 per cent of national employment. There were some 113 800 industrial SOEs. They created a loss of 79 billion yuan, which the state had to cover. In fact, from 1978 to 1996, losses made by industrial SOEs increased by almost nineteen-fold (ZTN, 1997). Since 1978, the Chinese government has been trying different schemes to revitalize SOEs, and the shareholding system represented a major departure from the previous attempts. While all previous programmes focused mainly on the managerial aspects of enterprises, it is only the shareholding system that touched on the nature of ownership of SOEs. The essence of the shareholding system reform (gufen jingji gaige) is to convert SOEs into shareholding enterprises (SHEs). Shares are issued to the state, enterprises, and individuals. This has made it possible for private individuals to acquire at least partial ownership of formerly completely state-owned enterprises. Despite repeated denials by the top leadership, the shareholding system reform is a form of privatization, in the sense that it provides a channel through which state assets are transferred to private hands. However, unlike the rapid privatizations in many East European countries, it took 13 years – from the establishment of the first Chinese shareholding company in 1984 to the formal endorsement of the shareholding system in 1997 – for this option to be recognized as the mainstream reform scheme. This process is yet another manifestation of the gradual and incremental characteristic of China’s reform. This chapter will examine the political and economic context of the Chinese route to privatization. It will first identify the background against which the shareholding system has emerged. It will then trace the evolution of the scheme, examine the impact of the change on the share of state ownership, present an assessment of the results of the experiment up to the mid-1990s, and finally provide an update on the post-1997 development of the reform. 25

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INADEQUACY OF PREVIOUS SOE REFORMS China’s SOE reform began in the late 1970s, shortly after the Maoist leadership fell from power. A number of reform programmes have emerged, and the state has adopted a trial-and-error approach, described by Chinese leaders as ‘groping for stones to cross the river’ (mo zhe shitou guo he). At any particular period of time, different schemes may have coexisted with one another, but only the one that seemed most politically feasible and economically desirable under the prevailing conditions was promoted at the national level. From 1978 to 1997, five such mainstream programmes were introduced in succession: 1. 2. 3. 4. 5.

delegation of greater autonomy to enterprises (1978–80); delivery of contract profit to the state (1981–82); substitution of profit with taxes (1983–86); negotiation of responsibility contracts with enterprises (1987–93); and corporatization of SOEs (1994–97).1

Assessments of the results of the above reforms vary significantly. Huang and Duncan (1997) found that their overall impact on productivity has been negligible. Parker and Pan (1996) presented evidences of an absolute rise in SOE labour productivity, but a relative decline in competitiveness. Broadman (1995) and Naughton (1995) confirmed the contribution of the reforms to SOE performance, but they both noted that more efficiency gains are available if further reform can be introduced. Common to these analyses is the view that despite the growing intensity of the reform, the various schemes were inadequate in the sense that there was very little change in the nature of state ownership. According to standard property rights theory, ownership refers to a bundle of rights that an agent is empowered to exercise over an asset. Those rights include a ‘utilization right’ (the right to utilize an asset); ‘residual control rights’ (those utilization rights that have not been contractually defined); a ‘return right’ (the right to appropriate the returns from an asset); and an ‘alienation right’ (the right to transfer rights over an asset to others through gift or sale). The first four mainstream reform schemes mentioned above assigned to enterprises greater autonomy over production decisions and profit retention. Enterprises thus gained some utilization and return rights from the state. However, as the state could appoint and remove enterprise managers, the utilization and return rights granted to them were limited by the state’s retention of residual control rights. More importantly, the state continued to exercise full alienation rights. The various reforms from 1978–93 thus involved only ‘adjustment of an agency relationship, rather than a shifting of the locus of ownership’ (Putterman, 1995, pp. 1049–51).2

Evolution of the shareholding system reform

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Only the corporatization programme introduced from 1994 to 1997 has had implications for SOEs’ ownership structure. In November 1994, as part of the plan to establish a modern enterprise system, 100 large- and medium-sized SOEs were selected to be corporatized within two years as limited liability companies (LLCs) or SHEs under the Company Law that came into effect on 1 July 1994 (Broadman, 1995, p. 26). According to Article 3 of that law, the major difference between LLCs and SHEs is that in the case of an LLC, each shareholder is liable toward the company to the extent of his or her respective capital contributions; whereas in the case of an SHE, the company’s total capital is divided into equal shares, and each shareholder is liable toward the company to the extent of their respective shareholdings. When an existing SOE is corporatized as an LLC, it becomes either a wholly state-owned LLC (if there is only one state-owned investment entity) or an ordinary state-owned LLC (if there are two or more state-owned investment entities) (Wei, 1995, pp. 32–33). In both cases the state is the sole owner of the enterprise, though it may invest in the enterprise through different entities. Corporatization of SOEs into LLCs thus only limits the state’s liability toward the enterprises but does not change their ownership structure. However, the situation is different if an SOE is corporatized into an SHE. In such cases, the Company Law dictates that the SOE must be incorporated by means of share offer. As sponsor, the state is required only to subscribe not less than 35 per cent of the total shares issued, and the remainder is to be offered to the general public. The aim of these provisions is to avoid over concentration of shares in the hands of the state (Zhang Jianzhong, 1996). As ownership of an SHE is defined under Article 4 of the Company Law by the proportion of shares each shareholder holds, the 35 per cent minimum requirement implies that the state need not be the majority (over 51 per cent) owner, though it can still be the largest shareholder if the other shareholders are highly dispersed, which is often the case in China (GZFX, 1995, No.16, p. 16). Hence, under the corporatization programme, it is the shareholding system reform that has particular impact on SOEs’ ownership structure. However, according to the corporatization blueprint most of the SOEs would be incorporated as LLCs and only a few would be converted into SHEs (Chai and Docwra, 1997, p. 173).3 In other words, although the corporatization programme ‘facilitated eventual privatization and provided an option for new hybrid ownership forms’ (Naughton, 2007, p. 301), it was not intended to be a major breakthrough in terms of state ownership. As such, its results have not been significantly different from previous reforms. The LLCs, still solely state-owned, have remained subject to arbitrary government intervention in their operation (Chai and Docwra, 1997, p. 175). More importantly, the corporatization programme, like the earlier reform schemes, failed to improve SOEs’ financial performance. Under the property rights arrangement with the

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Table 3.1

Output and losses of Chinese industrial state-owned enterprises Billion yuan

Gross industrial output Losses* Note:

*

Change (%)

1994

1996

7018 48

9960 79

42 64

Covers only those industrial SOEs with an independent accounting system.

Source: ZTN (1997).

state remaining as the ultimate owner while SOEs were granted greater utilization and return rights, the primary objective of enterprise managers and workers was to maximize sales revenue and their say in income distribution, with little concern for cost and profits. The result was rising losses, despite growing production. From 1994 to 1996 gross industrial output of Chinese SOEs increased 42 per cent, but losses soared 64 per cent (see Table 3.1). Failing to keep enterprises’ budgets under control, the People’s Bank of China in early 1996 granted tax holidays and additional credits to loss-making enterprises. The move represented a step backward in China’s economic reform, as it repeated the use of administrative measures to protect inefficient producers (SCMP, 26 June and 8 July 1996). In July 1996, a senior Chinese official admitted publicly that the corporatization programme was stalled. A year later, the State Council confirmed that the corporatization experiment would be finished by the end of 1997 and officials were asked to draw conclusions from the experience. This was followed by a statement from Zhu Rongji, the then vice-premier in charge of economic reform, that loss-making SOEs could be taken over by publicly listed companies, suggesting that the corporatization programme would give way to the shareholding system reform (SCMP, 31 July 1997).

EVOLUTION OF THE SHAREHOLDING SYSTEM REFORM4 Early Spontaneous Attempt (1979–88) The idea of the shareholding system reform originated from the rural sector. To solve the problem of capital shortage in villages, in 1979 the central government allowed brigades to withdraw accumulation funds to form joint-


29

stock enterprises. In 1983, an official document stated that capital and labour were both legitimate bases for distributing returns in cooperative economic production. This led to a mushrooming of joint-stock township and village enterprises. In 1984, the central government made it an official policy to encourage farmers to invest in various kinds of enterprises. In 1984, the World Bank sent two delegations to China. They suggested that Chinese reformers should draw on the experience of foreign shareholding systems and proposed the concept of socialist joint-stock ownership, an idea that apparently inspired Chinese theorists (Chen Yongjie, 1995, pp. 3–4). In the same year, the first shareholding company, the Beijing Tianqiao Department Store Company, was established. Next year, the Fushan First Radio Factory in Guangzhou became the first industrial SHE in China. This was followed by the selection of a small number of SOEs in Beijing, Shanghai, and Guangzhou as ‘experimental units’ (shidian) of the shareholding system reform (Chen Youngzhong, 1991, pp. 316–18). In December 1986 the reformist leader Zhao Ziyang, without the support of the conservatives, ordered expansion of the shareholding system experiment (Shirk, 1993, p. 310). Zhao explained to delegates at the 13th Party Congress the following October that, since China was still at an ‘initial stage of socialism’, other forms of ownership should supplement the dominant public sector. Specifically, the shareholding system was recognized as ‘a form of organizing assets of socialist enterprises’, and hence the experiment ‘could continue’ (ZBN, 1988, pp. 98–99). Further official support was given in the 1988 Report of the 3rd Plenum of the 13th Central Committee of the Party, which defended the shareholding system as not being privatization but rather a way to rationalize property rights relations. The favourable political environment led to an expansion of the scale of the shareholding system experiment. In March 1988, there were some 6000 enterprises ‘with shareholding characteristics’. They fell under four major categories: 1. 2. 3. 4.

enterprises issuing shares to employees; enterprises issuing shares to other legal-persons (enterprises or institutions); enterprises issuing shares to the public; enterprises owned by workers on the basis of the capital they contribute to the enterprises.

SHEs came under the first three categories. In 1988, there were about 3800 such enterprises (see Table 3.2). Enterprises in the first two categories are known in China as ‘private placement enterprises’ (dingxiang muji gongsi), as the shares of these enterprises were privately issued to specific employees

30


Table 3.2

Number of shareholding enterprises in China

End of

Total

1988 1989 1990 1991 1992 1993 1994 1995 1996 Source:

3 880 3 880 N.A. 3 220 3 700 11 489 33 000 50 000 N.A.

Listed companies N.A. N.A. 13 14 53 183 291 323 530

Industrial SHEs with an independent accounting system N.A. N.A. N.A. N.A. N.A. 2 579 4 359 5 559 7 760

various issues of ZBN, ZJTGN, ZTN, ZZQTN, ZZSN, and XB, 5 May 1997.

and/or legal-persons. Category 3 enterprises are known as ‘public placement enterprises’ (shehui muji gongsi) (Xiao (ed.), 1995, p. 299). Those in Category 4 are a mixture of SHEs and cooperatives; as such they are called shareholding cooperative enterprises, as distinguished from SHEs. The above early development of the shareholding system, which was basically a spontaneous process (Chen Youngzhong, 1991, p. 2), took place in the absence of a legal framework. The experiment was attempted mainly by smallsized collective enterprises. Shares were issued primarily as a means to raise capital rather than to establish a new form of corporate governance. Most of the shares received guaranteed interest plus high dividends. They could be redeemed when mature, and investors bore little risk. As such, the shares were more like bonds in nature. Only a small amount of the shares were traded overthe-counter in Shanghai, Shenyang, Wuhan, and Zhongqing. Setback (1989–91) The 1987–88 recognition of the shareholding system as an official reform experiment was misinterpreted by some as a green light for national promotion. Capital shortage also caused many enterprises to switch to the shareholding system as a means to raise funds. As a result, a ‘shareholding system fever’ occurred in early 1989. Some places promoted the shareholding system reform without sufficient feasibility studies. Regardless, the contract responsibility system was still the mainstream reform scheme of the time, and so the


31

government issued a note to remind enterprises that the shareholding system reform should focus on consolidating existing SHEs rather than establishing new ‘experimental units’. The note added that the reform was intended to improve overall enterprise efficiency, rather than just to raise funds and distribute returns; that the leading role of public ownership should be maintained; and that the value of state assets should be protected. The fall of Zhao Ziyang and his associates from power in 1989 caused a further political setback to the shareholding system reform. According to ‘incomplete statistics’,5 by the end of 1989 there were some 3800 SHEs in the country, which was the same as the year before (see Table 3.2). It was the intention of the post-Zhao conservative leadership to restrict the shareholding system reform to inter-enterprise investment (that is, Category 2 SHEs), as this involved no sales of state assets to private individuals. In 1990, the State Council issued a document allowing further experimentation of Category 2 SHEs, but freezing those in Categories 1 and 3. The idea of shareholding system reform still appeared in the Party’s Proposal for the 8th Five-Year Plan, but the theme was restricted to the Category 2 option. In other words, the dominant role of public ownership was to be maintained but the scope of the ‘public’ was reduced from the state to legal-persons. Chinese theorists called this a change only in the form, but not the nature, of public ownership and it should thus be distinguished from privatization. However, while the conservative post-Zhao leadership was successful in reducing the overall scale of the shareholding system reform, it could not resist the demand for enlarging the target of share issue from legal-persons and employees to the general public. From 1989 to 1991, the total number of SHEs fell from 3800 to 3200 but the number of Category 3 enterprises rose from 60 to 89. Accompanying this change were the openings of the Shanghai Stock Exchange in December 1990 and the Shenzhen Stock Exchange in July 1991. These bourses provided official markets for the trading of individual shares listed by Category 3 SHEs. Rapid Expansion and Standardization (1992–97) The revamping of the shareholding system regained momentum after paramount leader Deng Xiaoping called for further reform during his high-profile Southern Tour of January 1992.6 The experiment was extended to the whole country with a geographical division of emphasis. Shanghai and Shenzhen were selected as the testing grounds for Category 3 SHEs and public listing of shares. Hainan, Fujian, and Guangdong provinces were to concentrate solely on Category 3 SHEs, and the rest of the country on Category 1 and 2 SHEs. The basic layout was thus clear. Category 3 SHEs and public listing of shares were perceived as the most radical elements of the experiment, so the front

32


line of the reform was limited to the two cities with stock exchanges, Shanghai and Shenzhen. A lower degree of reform (Category 3 SHEs without public listing of shares) was introduced in Hainan, Fujian, and Guangdong provinces, where the country’s Special Economic Zones were located, and the less controversial options (Category 1 and 2) were tried in the rest of the country. The most radical option also turned out to be the most popular. In 1993, the number of listed companies more than tripled (see Table 3.2). To control the pace of expansion, the State Council issued a 5 billion yuan quota for public placements that year, but 5.5 billion yuan worth of new shares, or 10 per cent above quota, were issued in the end (ZSZ, 5 February 1994, p. 4). Still, only a tiny portion (1.6 per cent) of SHEs got listed. Many of the enterprises not granted the Category 3 option resorted to Categories 1 and 2, giving rise to a large number of private placement enterprises. Responding to the need for a legal framework for the further implementation of the reform, in May 1992 the central government promulgated fourteen relevant documents, including the ‘Measures for the Experimentation of Shareholding Enterprises’, ‘Opinions on the Standardization of Shareholding Limited Enterprises’, and ‘Opinions on the Standardization of Limited Companies’. Though not official laws, they provided important guidelines for the shareholding system reform and were used to re-examine and re-endorse previously established SHEs. Also in 1992, the State Council established the Securities Commission and the China Securities Regulatory Commission (CSRC) to monitor development of the securities market. With the adoption of the Company Law in 1994, China finally had an official legislation to regulate SHEs, and previously established SHEs were asked to be ‘standardized’ (guifan hua) in accordance with this new law. As the political and legal environment became more favourable, the shareholding system reform expanded rapidly. From 1993 to 1996, the number of industrial SHEs soared from 2580 to 7760, and the growth in the number of non-industrial SHEs was even faster (see Table 3.2). The reform, originally focused on the coastal region, quickly spread into the inland area. As of the end of 1994, about 24 per cent of the SHEs were located in the central or western part of the country. There was also a sectoral diversification of the shareholding system, with about 57 per cent of the SHEs in the industrial and transportation sectors, 29 per cent in wholesale and retail trade, 4 per cent in construction and real estate, 3 per cent in finance and securities, and 7 per cent in others. In an April 1997 conference held in Hangzhou, it was announced that standardization of the existing 6000 or so SHEs according to the Company Law had been completed. Based on this, the theme of reform would move to ‘positive promotion of the conversion of SOEs into SHEs’ (JGW, 1997, No. 10, p. 6; XB, 15 April 1997). In August, the then Party’s General-Secretary Jiang


33

Zemin and the official People’s Daily (Renmin ribao) revived the theory of ‘initial stage of socialism’, which the disgraced leader Zhao Ziyang had used to justify the shareholding system reform. This was followed by the 15th Party Congress’s endorsement of the shareholding system as the mainstream reform programme. Shareholding cooperative enterprises (Category 4) also received strong support from the central government.7 Originally, shareholding cooperative enterprises were tried out mainly in rural areas. But in August 1997, the State Commission for Economic Restructuring issued a document, ‘Guiding Opinions Concerning Development of Urban Shareholding Cooperative Enterprises’, that encouraged extension of the experiment to the urban sector. According to this document, the Category 4 system is a mixture of the shareholding system and the cooperative system. It is shareholding in the sense that ownership of a shareholding cooperative enterprise is held among its shareholders; and it is cooperative in the sense that the shareholders must also be workers in the enterprise. There should not be a ‘substantial difference’ in the amount of shares held by each worker. When a worker leaves the enterprise, he/she can only transfer his/her shares to other workers in the enterprise. Outsiders are not allowed to hold any shares of such an enterprise. The highest authority in a shareholding cooperative enterprise lies in the workers’ congress, where decisions are made according to the one worker, one vote principle (JS, 7 August 1997). This is different from the shareholding system, under which major decisions are made in the shareholders’ general meeting according to one share, one vote. According to a senior official, the shareholding cooperative system would be applied to medium- and small-sized SOEs, whereas large-sized SOEs would be converted into SHEs or LLCs (XB, 19August 1997).

DECLINE OF STATE OWNERSHIP UNDER THE SHAREHOLDING SYSTEM A variety of shares have emerged under the shareholding system, including state shares (guojia gu), corporate or legal-person shares (faren gu), individual shares (geren gu), and foreign shares (waizi gu). State shares are shares held by the state to represent state ownership. Corporate shares are shares held by corporate legal-persons. Individual shares are shares issued to workers of the issuing SHE, and shares issued to the general public. Finally, foreign shares are Chinese shares held by foreign investors (Xiao (ed.), 1995, pp. 145–47). The reform of the shareholding system has facilitated the decline of the relative proportion of state shares in total capitalization, indicating the diminishing role of state ownership in SHEs.

34


Up to the beginning of 1993, the state managed to maintain the ‘socialist’ nature of SHEs by making itself the largest shareholder of the enterprises. The proportion of state shares in each listed SHE ranged from 51 per cent to over 80 per cent (ZSZ, 4 April 1993, p. 11). However, in a document issued in August 1993 by the National Administration of State Property (NASP), a distinction was made between ‘absolute state-holding enterprises’ and ‘relative state-holding enterprises’. The state’s share in an ‘absolute state-holding enterprise’ must be over 51 per cent, while that in a ‘relative state-holding enterprise’ can range from 35 per cent to 51 per cent (Xiao (ed.), 1995, p. 2086). Such distinction between ‘absolute’ and ‘relative’ state-holding enterprises disappeared in the 1994 Company Law. As mentioned above, the Company Law stipulates that in the conversion of SOEs into SHEs, the state’s minimum share is only 35 per cent. Hence, at least in theory, the state was no longer required to hold more than 35 per cent ownership in any kind of SHEs. In fact, there was even no state share at all in three of the twelve companies which issued shares during January and February 1994 (ZSZ, 26 February 1994, p. 34). It may be argued that if corporate shares are also taken into account, the state still holds a controlling stake of most of the SHEs. Since the holders of corporate shares are state agents or institutions, corporate shares are indirectly owned by the state. In 1993 and 1994, corporate shares accounted for about 45 per cent of the total capital stock of SHEs (ZJTGN, 1994, p. 232; 1995, p. 174). However, according to the aforementioned NASP document, it would be ‘meaningless’ to include corporate shares as an indication of state ownership. This is because different corporate legal-persons cannot be expected to govern an SHE in a unified manner (Xiao (ed.), 1995, p. 2086). Initially, state and corporate shares were both non-negotiable as a safeguard against draining of state assets. However, this restriction led to many problems. First, share prices did not change to reflect enterprise performance. Second, the shares were unable to gain value through exchanges. Third, immobility of these shares both hindered the restructuring of enterprises through merger and takeover, and obstructed the development of a secondary market (ZSZ, 2 July 1994, p. 32; 9 July 1994, p. 27). Hence, Chinese securities experts and officials have reached the consensus that state shares and corporate shares should eventually be made negotiable, but how to implement this remained an open question (ZSZ, 4 April 1993, p. 11; 17 October 1993, p. 18; 26 February 1994, p. 5). In mid-1993, three SHEs openly sold state shares to individual holders despite a ban by the central authorities. There were also cases where state shares were converted into corporate ones and, as with state shares, there was rampant black market trading in the latter type (ZSZ, 13 September 1992, p. 18, and 1 August 1993, pp. 3–4; XB, 18 June 1994). In July 1992 the central authorities approved experimental trading of corporate shares in the Securities


35

Trading Automated Quotations System (STAQS), an over-the-counter trade mechanism established in 1990 for bond exchanges. In April 1993 another similar system, known as National Electronic Trading System (NETS), was added (ZSZ, 27 November 1993, p. 19; 5 December 1993, p. 37).8 However, in July that year, new listing in STAQS and NETS was suspended, as the official experiment provoked unauthorized trading of corporate shares. The number of SHEs with legally tradable corporate shares was thus frozen at 17 (ZSZ, 31 October 1993, p. 3; 22 January 1994, p. 23; 9 April 1994, p. 5). On the other hand, no distinction is made among state shares, corporate shares and individual shares in the 1994 Company Law, suggesting that the three types of shares would be merged. According to some reports, state shares and corporate shares would be respectively referred to as ‘shares held by the state’ and ‘shares held by corporates’ in the Securities Law. Again, the implication is that both would be merged with individual shares (ZSZ, 1 January 1994, p. 9). While the way this would actually be achieved was still unknown at that time, enterprises tried four different spontaneous approaches: (a) to transfer state shares to existing shareholders; (b) to sell to individuals stock rights and stock options on state and corporate shares; (c) to convert state shares into foreign shares; and (d) to trade state shares and corporate shares on an over-the-counter market (ZSZ, 2 July 1994, p. 32). The state’s attitude towards these local initiatives was ambiguous. It banned a Harbin company from using option (a), but did not actually enforce the ruling (ZSZ, 1 August 1993, pp. 3–4). It opposed the use of option (c) by some enterprises in Shanghai and Beijing, but did not take resolute action against noncompliance. These inconsistencies reflected the state’s dilemma over the issue. On one hand, the spontaneous conversion of state and corporate shares into individual and foreign shares helped solve problems arising from the illiquidity of state and corporate shares. On the other hand, concern about loss of state ownership to private individuals and foreign investors prevented the government from making share conversion an official policy. When seniorlevel criticism and irregular activities emerged, the government banned the practice, but did not actually enforce the rule. In any event, the central government’s goal of making state and corporate shares negotiable is unmistakable. In 1995, a Zhuhai company was allowed to buy 12 million state shares of a Shanghai company (GZFX, 1995, No. 15, p. 17). Next year a senior Shenzhen official said that the city was planning to experiment with circulation of state shares and corporate shares, though no concrete proposal was raised (MB, 9 February 1996). In April 1997, six million corporate shares of the Hainan Air Company were auctioned, setting a precedent for transactions involving such shares (GZFX, 1997, No. 18, p. 6). The following month, the CSRC agreed to allow the conversion into individual shares of those stock rights originally issued to corporate shareholders but

36


sold to private individuals (that is, to adopt option (b) mentioned on p. 35). It was permitted with the condition that the private investors must have held the transferred shares for three years before they could be listed. Contemporaneously, a senior NASP official said that public circulation of state shares and corporate shares has the advantage of making the market more open (SCMP, 14 May and 17 June 1997). Another senior NASP official estimated that listing of state shares would enable the state to raise 400 to 500 billion yuan. To speed up this process, he suggested converting state shares and corporate shares into preferential shares (XB, 18 June 1997). In fact, in 1997 there were hot discussions about the public listing of state shares. For example, one Chinese economist claimed that such a move is ‘imperative’ (Ji Jinshan, 1997), while another one cautioned that the ‘scale, timing, and form’ of public listing of state shares must be very carefully planned (Wang Yiming, 1997). Apart from the conversion to individual shares, state ownership of SHEs has also been diluted through new share issues. As the state lacks the funds to purchase new shares, the relative proportion of the shares it holds in an SHE declines each time the company floats new shares. This has caused, for example, the proportion of state shares in the total capital stock of the Shenzhen Development Bank to diminish from 25 per cent in 1988 to 17 per cent in 1994, and that of Shenzhen Wanke Company from 19 per cent to 11 per cent (Wu Jun, 1995). Moreover, when stock dividends and allotments were distributed to individual shareholders, the state was often denied such benefits, reinforcing the decline in the relative proportion of state shares (Fan Bi, 1995). In view of this, in April 1994 the NASP issued an ‘emergent notice’ asking state share holding agents to oppose such discrimination against state shares. The notice stated also that although stock options on state shares could not be traded on the spot market, they could be ‘transferred through negotiations’. The NASP emphasized that this did not contradict an earlier CSRC announcement that stock options on state shares were ‘not to be listed for the time being’. But the two rules made separately by different actors led to confusion and spontaneous attempts to break the restrictions against circulation of corporate shares (GZFX, 1995, No. 10, p. 15; 1996, No. 19, p. 19). Overall, the shareholding system reform facilitated a reduction of state ownership in previously wholly state-owned enterprises. As shown in Table 3.3, from 1990 to 1995 there was a gradual decline in the relative proportion of state shares and corporate shares in the total capital stock of listed companies in Shanghai and Shenzhen. This trend would be expected to grow further, as there were signs that the spontaneous conversion of such shares into individual shares would be officially recognized. But there were three limiting factors. The first was the 35 per cent minimum state ownership requirement on SHEs stipulated in the Company Law. The second was the capacity of the


37

Table 3.3 Capital structure of listed companies in Shanghai and Shenzhen (% in total capital stock) Shanghai

Shenzhen

1990 1992 1993 1994 1995 1992 1993 1994 1995 State shares Corporate sharesa Individual sharesb Total

66 51 55 49 44 16 40 31 29 7 21 16 18 21 42 28 33 32 27 28 28 33 34 42 32 37 39 100 100 100 100 100 100 100 100 100

Notes: Due to an absence of a standard statistical system on stock issue in China, data from these different sources may not be perfectly comparable. a Include corporate shares held by domestic as well as foreign legal-persons. b Include individual shares held by domestic as well as foreign investors, and unlisted shares held by workers. Sources: ZJTGN (1991); ZZSN (1994); and ZZQTN (1996).

existing stock exchanges. Although in the first half of the 1990s there was a dramatic increase in the quota for public share issue, it was still inadequate to absorb the huge amount of state and corporate shares that had accumulated over many years. As of mid-1997, capitalization of un-circulated state and corporate shares was estimated at 540 billion yuan, 25 per cent more than the total capitalization of the two exchanges in Shanghai and Shenzhen (GZFX, 1997, No. 28, p. 10). Finally, as Li D. (1996) noted, given China’s imperfect market conditions, entrepreneurs may want to include the government as an ‘ambiguous owner’. This could be the optimal choice as the infrastructure to support a contract system has yet to develop in China, which may make the cost of executing contracts high enough to justify calls for bureaucratic intervention. In such a situation, the benefits of the presence of a state owner may outweigh its cost.

MIXED RESULTS UP TO THE MID-1990s With the endorsement of the shareholding system, there has been a tendency among Chinese theorists to regard the reform scheme as a panacea (GN, 1997, No. 15, pp. 18–21; XB, 7 May 1997). Yet, preliminary results of the shareholding system reform up to the mid-1990s were quite mixed. According to some surveys conducted in 1994, SHEs acquired a higher degree of autonomy than non-SHEs in terms of production, management, investment, and profit

38


distribution. Within the first year of conversion into SHEs, labour productivity increased by 57 per cent, profit and tax per worker by 85 per cent, sales profit by 49 per cent, profit/capital ratio by 39 per cent, and average wage by 44 per cent (Zhang Zhuoyuan, 1996, pp. 90–91). Another source reported that in 1994 the average sales volume of SHEs rose by 63 per cent, profit by 109 per cent, and net assets by 42 per cent, all of which were significantly higher than those of other kinds of enterprises (ZJTGN, 1995, p. 174). However, other sources (see Table 3.4) reveal that 650 industrial SHEs were loss makers in 1994, more than doubled from the previous year. In 1995, gross industrial output of SHEs fell by 6 per cent, industrial value added by 8 per cent, and profit and tax by 14 per cent. Management at some of these enterprises regretted having undergone the conversion into SHEs, as their firms were less profitable than they had been under the contract responsibility system (JX, 25 February 1995; GZFX, 1995, No. 6, pp. 7 and 17 and No. 15, p. 18). Although there was strong recovery in 1996 in terms of number of new SHEs and industrial output, the growth rate of the profits and taxes generated was behind that of production, suggesting a decline in efficiency. The unsatisfactory performance of SHEs could be attributed to several reasons. First, the state remained as the largest shareholder of most of the SHEs, leading to excessive bureaucratic intervention in their management and operation. Second, SHEs were required to submit to state taxes, dividends, and other kinds of contributions that are 20–30 per cent higher than those of nonSHEs. Third, some enterprises were converted into SHEs primarily for the purpose of raising funds. After the conversion, the funds were used for speculative investments in property and stock markets while management was left Table 3.4

Performance of China’s industrial shareholding enterprises* 1993 1994 1995 1996

Change (%) 1993/94

Number of loss-making SHEs Gross industrial output (billion yuan) Industrial value added (billion yuan) Profit and tax generated (billion yuan) Note: Source:

276

650 N.A. N.A.

146

291

46

84

1994/95 1995/96

135.5

N.A.

N.A.

328

99.6

–6.4

20.1

78 95.3

83.3

–7.9

22.2

24.6 42.6 36.6 37.8

73.1

–14.1

3.3

273

* Enterprises include only industrial SHEs with an independent accounting system. various issues of ZGJTN and ZTN.


39

in the old style. Fourth, the supervisory mechanism stipulated in the Company Law failed to perform its function of checking the power of board chairs and general managers. Moreover, the new supervisory organs conflicted with the old ones, and there was no clear rule on how to ‘harmonize’ their relationship (Tung, 1996; Xue, 1996; ZJTGN, 1994, p. 232; 1996, pp. 119–20). If, as argued earlier, the shareholding system reform is a form of privatization, then its initial results seem to conflict with the liberal economics view that privatization is a panacea for China’s SOEs. Yet, advocates of privatization may argue that the problems with the reform have arisen because the privatization involved has been inadequate and too slow. For them, the ultimate solution to China’s industrial inefficiency lies in further and more rapid privatization. It is not our purpose to enter into this debate. Rather, our intention is to show that, after more than a decade of various attempts, by 1997 a privatization programme under the name of shareholding system had emerged as China’s mainstream SOE reform scheme. While the above seems to suggest that the Chinese path of industrial reform is converging with the international trend of privatization, the Chinese route has demonstrated its own characteristics. Like the other post-Mao reforms such as those concerning prices and currency, the evolution of the shareholding system has been gradual and incremental.9 More interestingly, the intended merge of state and corporate shares with individual shares parallels the unification of dual prices and multiple currency structures. The three cases indicate a common feature of reform in China, which is that Chinese reformers will not tackle a problem with only one programme. Rather, several planned or spontaneous options are attempted simultaneously. The coexistence of different schemes, characterized as ‘dual-track transition’ (Fan Gang, 1994), did cause chaos and breed profiteering in all three cases. But as each option produced its own beneficiaries, the one that emerged as the winner tends to be the one that had the most supporters. This utilitarian approach of pursuing the ‘greatest happiness for the greatest number’ has helped China to identify a reform path that has met the least political resistance. Chinese reformers do not need to read the advice, such as that given by the World Bank (1995a, pp. 175–76), that SOE reform must be ‘politically desirable’ and ‘politically feasible’ to be successful. For them, this is simply common sense.

POST-1997 DEVELOPMENT After the official endorsement of the shareholding system as the mainstream reform programme in 1997, previously established SHEs continued to be urged to reform their governance structure in accordance with the Company Law. This was in recognition of the situation that many existing SHEs were

40


still not ‘standardized’. By the end of 1998, it was reported that a modern ‘legal-person governance structure’ had been installed in most of the SHEs. The enterprises were also required to make sure that their share issuances were in accordance with the Securities Law, which came into effect in 1999. Also in that year, the Fourth Plenary Session of the Fifteenth Central Committee of the Chinese Communist Party decided to further transform SOEs into SHEs, as part of the effort to ‘explore actively various effective forms of realizing public ownership’ (ZJN, 1998, p. 721; 1999, p. 742; 2000, p. 728). Under such party policy, in 2000 the State Economic and Trade Commission of China issued a document that set out ‘basic standards’ for installation of a modern corporate system in large and medium-sized SOEs. According to it, ‘except for enterprises wherein state monopoly should be maintained, other large and medium-sized SOEs should also be gradually reformed into limited companies and SHEs with multiple ownership’. And in 2000–01, a programme of ‘debt-for-equity’ swaps was introduced, whereby a large number of enterprises in heavy debts were required to convert, in accordance with the ‘basic standards’, into limited companies and SHEs (ZJN, 2001, p. 795; 2002, p. 713). In such a way, from 1997 to 2001 the number of SHEs more than tripled from about 72 000 to over 300 000.10 Moreover, the shareholding system reform which originally took place mainly in the manufacturing and construction sectors expanded into the service industry. Since 2002, increasing numbers of SOEs in the financial, military, cultural, health, and transportation sectors have been converted into SHEs (ZJN, 2003, p. 700; 2004, p. 847; 2005, pp. 873–4; 2006, p. 925; 2007, p. 822). That is to say, since 1997 the shareholding system has been promoted at the national level to cover basically all segments of the economy. Finally, in 2005 a ‘share conversion’ programme was introduced, which probably marked the final step of the shareholding system reform as the Chinese form of privatization. We come back to this in detail in Chapter 7.

NOTES 1.

Detailed analyses of these various reform schemes can be found in Broadman (1995), Byrd (1991), Chai and Docwra (1997), Hay et al. (1994), and Peter Lee (1987). 2. For another discussion of China’s economic reform in terms of changes in property rights, see Walder (1994). 3. More specifically, 68 of the 100 SOEs selected for the corporatization experiment have chosen the wholly stated-owned LLC as their legal organization form (JS, 23 November 1997). 4. Unless stated otherwise, this section is based on ZJTGN, various issues. 5. This qualification frequently appears in Chinese discussions on the shareholding system reform, indicating the absence of an official statistical system to cover SHEs. In fact, as Naughton (2007, pp. 301–302) noted, despite Chinese statisticians’ effort to collect infor-


6. 7. 8. 9. 10.

41

mation on changes in the country’s structure of state ownership, there has been a lack of accurate data to reflect the process of privatization through the shareholding system reform. One year before this, Premier Li Peng, who used to be opposed to the shareholding system, gave unexpected support to the reform. His sudden change of position raised ‘unanswered questions about the decision-making process’ in China (You, 1995, pp. 40–41). For details of the evolution of the shareholding cooperative system, see Yao (1996). STAQS was subordinated to the State Commission for Restructuring the Economy, and NETS to the People’s Bank of China (XB, 18 July 1994). The gradualism and incrementalism of the Chinese reform have been well analysed in two major studies, one by a political scientist (Shirk, 1993) and one by an economist (Naughton, 1995). There is a lack of accurate statistics on the size of the Chinese shareholding sector. In 1993, there were reports that China had designed a new statistical system in which shareholding enterprises would be classified under a separate category (CEN, 11 January 1993, p. 13; ZBN, 1993, p. 237). However, official comprehensive data on this sector are still absent. The Almanac of China’s Economy (ZJN) does contain annual data on the number of industrial limited SHEs and their total asset value; but there is no similar information on nonindustrial SHEs.

4. The role of spontaneity and state initiative in the shareholding system reform1 INTRODUCTION At the 15th Chinese Communist Party Congress held in September 1997, the shareholding system (‘gufenzhi’) was endorsed as the ‘mainstream reform programme’ for the Chinese state-owned enterprises (SOEs) (MB, 12 September 1997). The decision came twelve years after the first industrial shareholding enterprise (SHE) appeared in the small, light-industrial city of Foshan, located in south China. It was a spontaneous attempt made by the workers of the factory. Ironically, this pioneer enterprise was also the first industrial enterprise in the city to declare bankruptcy, shortly before the official approval of the shareholding system at the national level. How could a reform programme be adopted right after its first experiment had failed? What implications does the case have for our common perception of China’s trial-and-error approach to reform? Does it show that the strategy of ‘groping for stones to cross the river’, as often cited by Chinese leaders, is or is not working? If incrementalism is the best way to describe China’s transition, what actually happened during the incremental period? Most importantly, what role have spontaneity and the state played in deciding the final reform plan? In this chapter, we tackle the above questions by focusing on the relation between spontaneous attempt and state promotion. The chapter first situates the issue in a theoretical context defining the role of the state in the reform. Two contrasting images of the Chinese state are be identified, and from each a hypothesis is derived about the relative importance of spontaneity and state promotion as providing the major impetus for economic changes. This is followed by a detailed examination of three cases in Foshan, including the above-mentioned first industrial SHE in China. Based on the empirical findings, we argue that although the Chinese state has been dysfunctional in some aspects, particularly at the local level, it has been strong enough to play a developmental role. The basic impetus for change has come mainly from the central government. Local authorities have helped implement the central 42

The role of spontaneity and state initiative

43

policy, though with some distortions. Early spontaneous attempts have not played any significant role in defining the final reform programme.

CONTRASTING IMAGES OF THE CHINESE STATE The role of the state has long been a central concern of political economy. The emergence of welfare economics, Keynesian interventionism, and Marxist socialism culminated in a widespread extension of the role of the state in economic activity in the immediate post-World War II period. The intellectual climate began to change in the late 1960s. A stream of neo-liberalism emerged, forcing the state to reduce its economic role. However, a call for ‘bringing the state back in’ appeared in the mid-1980s, leading to a revival of academic interest in the role of the state in economic change. The debate has been in favour of an autonomous and effective state, seeing it as a necessary condition for successful economic transformation (Chang and Nolan, 1995; Deane, 1989; Evans, 1995; Evans et al. (eds), 1985; Haggard and Kaufman (eds), 1992; Migdal et al. (eds), 1994; Naastepad and Storm (eds), 1996). In the literature on China’s reform, there are two contrasting images of the Chinese state. The first is a strong state perspective, and the second a weak state perspective. Strong State Perspective According to the strong state perspective, the Chinese state has successfully transformed itself from a Maoist totalitarian state into an East-Asian-type developmental state. Developmental states, as defined by Leftwich (1995, p. 401), are ‘states whose politics have concentrated sufficient power, autonomy and capacity at the center to shape, pursue and encourage the achievement of explicit developmental objectives, whether by establishing and promoting the conditions and direction of economic growth, or by organizing it directly, or a varying combination of both.’ Most of the discussions on developmental states have been based on East Asian experience, and it is also within the East Asian context that the concept of developmental state was applied to China. According to White and Wade (1988), East Asian countries such as Taiwan and South Korea are exemplars of ‘capitalist guided economies’. By guiding the development of a capitalist market, the Taiwanese and South Korean governments performed the important functions of developmental states. In China, White and Wade argued, the major theme of the reform has been to shift the balance between the state and market in favour of the latter. The direction of change is towards a ‘socialist guided market’. While basic-level units of production have been granted

44


greater power to make decisions according to market considerations, the state has continued to be interventionist by defining the goals, priority, and paths of development. In this process the socialist state structures play the positive role of developmental state ‘in raising the rate of investment, generating and focusing scarce resources, defining and directing strategic changes in the industrial structure, regulating international ties, generating overall political support and establishing a social structure favorable to accumulation ‘ (p. 15). In such a way, the ‘capitalist guided economies’ in Taiwan and South Korea and the ‘socialist guided market’ in China are grouped under the same category of developmental state. According to Unger and Chan (1996), the Chinese developmental state works through a three-tier corporatism.2 At the national level, there is ‘peak corporatism’ that emphasizes strong though indirect state control of the designated organizations; at each lower layer of regional government – the province, city, county, township and village – there is ‘regional corporatism’ by which the regional government organizes power among associations operating at that level; finally, a form of ‘micro-corporatism’ is emerging in some state enterprises to mediate between management and workers. For Jean Oi, it is regional corporatism that has been the driving force of China’s economic growth. She agreed that the essence of developmental state lay in an appropriate balance between state intervention and market; however, effective state intervention need not come from the centre: ‘[t]here is a need for strong state capacity, but this capacity should exist at both the local and the central levels’ (Oi, 1995, p. 1147). In the case of China, state intervention has been most effective at the local level. Oi called this phenomenon ‘local state corporatism’, which refers ‘to the workings of a local government that coordinates economic enterprises in its territory as if it were a diversified business corporation’ (Oi, 1992, pp. 100–101; original italics). Such local state corporatism, according to Oi, ‘is a qualitatively new variety of developmental state’ (Oi, 1995, p. 1133). The strong state perspective would hypothesize that economic changes are mainly the result of active state intervention. The state plays the developmental role of identifying the major priorities, mobilizing resources and interests to achieve the goals, and regulating the changes. While the central state seeks to create a macro environment that is favourable to the reform, regional authorities actively promote the development agenda at the local level. Workers’/managers’ initiatives, if any, are screened by the state; those that are in line with the state’s development strategy are co-opted into the national reform programme, while those that are not are suppressed or neglected. In short, the state is in charge, and spontaneous attempts play only a secondary role.


45

Weak State Perspective The weak state perspective regards the Chinese state as experiencing a trend of ‘serious decay’ that began in the 1960s. According to this view, the traumatic events of the Cultural Revolution destroyed the existing institutions of political control, and the Maoist preference for political loyalty over technical ability resulted in an incompetent bureaucracy. The post-Mao reform has caused unintended effects that have produced an ‘erratic state’: ideology has lost its mobilization power; old institutions have been eroded without replacement; central authority has been challenged by local and regional interests; and state governance has been undermined by rampant corruption (Pye, 1990; Schram (ed.), 1987; Walder (ed.), 1995). As regards the notion of a developmental state, Breslin (1996) argues that China is not a developmental state in many respects, including the bias of the economic reform in favour of the political interest of the ruling elite; its lack of knowledge and experience in utilizing and controlling market mechanisms; and the existence of conflicts among elites over the content and direction of the reform. Not only is the Chinese state not developmental, according to Breslin, but also the country has been suffering from ‘dysfunctional development’ in three ways. In the first place, political demands from within the partystate and other societal groups have undermined the relative autonomy of the Chinese state, making it unable to formulate a coherent and effective national development strategy. Second, the decentralization of decision-making power down to the local level has weakened the central state’s ability to coordinate national development. Finally, as a result of the open-door policy, China’s national development strategy has now been subject to the influence of the country’s external economic relations. Hence, in Breslin’s view, it would be a mistake to conceptualize China as a developmental state. Similarly, McCormick (1996) argues that the Chinese state is fundamentally different from the developmental states of Taiwan and South Korea. According to him, a real developmental state should be ‘hard’ not only in its exercise of effective authority to promote economic growth, but also in its possession of technical competence and the commitment to national goals that overrides the temptation of corruption. While the Chinese state is rather ‘hard’ in the authoritarian sense, it lacks the technical capacity and political autonomy required to manage economic development in the manner of the developmental states of South Korea and Taiwan. Moreover, the central authorities in China are unable to impose discipline on the local authorities in a range of critical issues. The Chinese state is thus, in McCormick’s view, not developmental. The weak state perspective would hypothesize that the state fails to present a well-designed reform blueprint. It lacks the technical as well as institutional

46


strength required to implement a reform programme effectively. The direction of change is unclear, and there is a lack of commitment to development on the part of state officials. Workers’/managers’ initiatives are free to emerge, and the state reacts passively to each new change. If anything resembling a reform programme exists, it is nothing more than an aggregate of individual spontaneous attempts. In short, the state does not play any developmental role, and changes, good or bad, are mainly the result of spontaneity.

SHAREHOLDING SYSTEM REFORM IN FOSHAN3 The essence of China’s shareholding system reform was to convert SOEs into SHEs. Shares were issued to the state, legal-entities, and individuals. This has made it possible for private individuals to acquire at least partial ownership of formerly completely state-owned enterprises. In fact, under the shareholding system the relative share of state ownership has been in decline. As argued in Chapter 2, the reform blueprint was tantamount to privatization, despite repeated denials by the top leadership because of ideological concerns. Then, given such political sensitivity of the programme, how could it emerge? Who initiated it in the first place? Was it a spontaneous attempt, or a careful design by the state? To answer these questions, in June 1998 the author made a series of research trips to Foshan, the birthplace of China’s shareholding system reform. Foshan is located at the southern part of Guangdong Province, about 200 kilometres northwest of Hong Kong and the Shenzhen Special Economic Zone. The city spreads over 77 km2, with a population of 430 000. Administratively, Foshan is a ‘district-level city’ (diji shi) consisting of two urban districts and four ‘county-level cities’ (xianji shi). As such, it has less autonomy than Shenzhen, which is of ‘semi-provincial level’ (fu sheng ji) (SAO (ed.), 1997, p. 1). Like most other coastal areas in China, Foshan has achieved dramatic economic growth since the late 1970s. From 1978 to 1995, its per capita gross domestic product (at current prices) increased at an average annual rate of 17 per cent, and per capita savings at 35 per cent. During this period, the share of industry in gross output value rose from about 50 per cent to 95 per cent (see Table 4.1). Such rapid industrialization was achieved through specialization in light industries including electronics, textiles, and ceramics. By 1994, Foshan’s per capita gross domestic product had reached 14 400 yuan, the sixth highest in the country. Most households, including those in the villages, possess their own television sets, refrigerators, washing machines, air-conditioners, and telephones. In short, Foshan has emerged as one of the wealthiest cities in China (FMPCPD and FD (eds), 1997, pp. 6–15).


Table 4.1

Major economic indicators of Foshan

Gross domestic product (current price; billion yuan) Per capita gross domestic product (yuan) Gross industrial and agricultural output value (constant price; billion yuan) Gross industrial output value (billion yuan) Gross agricultural output value (billion yuan) Per capita bank savings (yuan) Average wage (yuan) Per capita agricultural income (yuan) Source:

47

1978

1995

Average annual growth (%)

1 577 4

52 16 800 109

18.6 16.8 19.8

2 2 70 587 227

104 5 15 100 9 065 3 920

23.2 6.2 34.8 16.4 17.1

FMPCPD and FD (eds), 1997, p. 13.

Nevertheless, Foshan has not been part of China’s economic core. Most of the state enterprises in the city are owned by the municipal government and rarely by the central or provincial authorities. With light industry accounting for over 60 per cent of gross industrial output, Foshan has received only limited central capital support, which has been prioritized for heavy industrial and infrastructural development. According to the ninth national Five-Year Plan (1996–2000), Guangdong Province was to concentrate on the development of automobile, petrochemical, machinery, and electronics industries. Foshan has been weak in most of these selected key sectors (FMPCPD and FD (eds), 1997, p. 163; FPCC and FU (eds), 1994, p. 9; Lu and Ding (eds), 1998, p. 49; Zhou, 1997, p. 3). Initial operations of the shareholding system reform began in Foshan in 1982. Most of them took the forms of inter-enterprise investment, joint-stock township and village enterprises, and Sino–foreign joint ventures. In that early stage, the issuing of shares to individuals was rare, particularly among industrial enterprises (FR, 25 November 1987). In January 1986, the Shengping Departmental Store in Foshan was made the first and only one retail firm in the city to try the shareholding system. Although Shengping achieved remarkable improvement in its economic performance after the reform, its experience was not extended to other enterprises due to ideological reasons. This changed only after the 13th Party Congress, held in October 1987, at which the then Party Chairman, Zhao Ziyang, provided theoretical justification for the shareholding experiment. According to Zhao, since China was still at an ‘initial stage of socialism’, the dominant state sector should be supplemented by other forms of ownership. Specifically, the shareholding system was recognized as

48


‘a form of organizing assets of socialist enterprises’, and hence the experiment ‘could continue’. In April 1988, the Foshan municipal government organized a public seminar to discuss the feasibility of issuing shares by enterprises, an idea that had once been banned as ‘capitalist’ (FN, 18 November 1987, 18 April 1988; ZBN, 1988, pp. 98–99). The shareholding experiment suffered a political setback following the downfall of Zhao and his associates in summer 1989, as mentioned in Chapter 3. The reform in Foshan was halted accordingly. It was the paramount leader Deng Xiaoping’s high-profile ‘southern tour’ in January 1992 that revived the shareholding experiment. Local party leaders and government officials in Foshan followed Deng’s call for an open mind toward the shareholding system. By October 1992, a total of 27 large and medium-size enterprises in the city had been approved by the provincial government to be converted into SHEs, and eleven of them had issued internal shares to the workers. Induced by the stock fever in Shenzhen, some Foshan enterprises issued internal shares to the public, followed by speculative trading of the internal shares, in defiance of the State Council’s ban on such activities. The illegal practices were subsequently banned by the Foshan municipal government. On the other hand, the local authority established a guideline for the shareholding system reform: ‘dare trying, look for quality but not quantity, and avoid chaos’. Finally, the 15th Chinese Communist Party Congress, which endorsed the shareholding system as the national SOE reform program, provided further impetus to the reform. Enterprise directors and managers in Foshan praised the Congress for confirming the ideological legitimacy of the shareholding system (FR, 1 April 1992, 21 April 1992; 7 August 1992; 31 October 1992, 11 December 1992; 26 September 1997). In short, the fate of the shareholding system reform in Foshan was conditioned by the larger political environment. This can be further illustrated by reviewing the annual work reports of the Foshan municipal government (see Table 4.2). The shareholding system reform was first mentioned in the 1987 report, when the reformist leader Zhao was promoting his theory of ‘initial stage of socialism’. The reform disappeared in the 1990 report, following the political unrest in the summer of 1989. The scheme reappeared and was given more concrete terms in the 1992 report, after Deng’s ‘southern tour’. Since then the shareholding system has been included as a regular item in the annual report. In the following, we describe how the shareholding scheme has been tested in three industrial enterprises in Foshan. The first, the Foshan First Radio Factory, was the first industrial SHE in China.4 It was a case of a spontaneous and failed attempt. The second, the Foshan Tongbao Shareholding Limited Company, and the third, the Foshan Electrical and Lighting Co. Ltd., are both the examples of state-led and successful reform. The former tried the ‘internal shareholding system’, while the latter the ‘public shareholding system’.

Table 4.2 Notes on the shareholding system reform made in the Foshan municipal government annual work reports Date of delivery Review of previous year’s achievement of the report

Next year’s work target

8 April 1986 15 May 1987

Nil Nil

10 May 1988

5 May 1989 49

17 April 1990 26 April 1991 18 March 1992

Nil ‘The shareholding experiment was launched among large- and medium-size SOEs.’ Some enterprises ‘tried the shareholding system.’

‘Continued to introduce the shareholding experiment. Some enterprises issued public bonds with approval.’ Nil ‘The shareholding system was tried in selected enterprises.’ ‘Strengthened theoretical research in the shareholding system reform, and began initial planning for the introduction of the reform.’

‘To actively promote the shareholding system. Enterprises that fulfill the necessary conditions, upon approval, may issue public shares and bonds.’ ‘To use the shareholding system as a means to rationalize the interest relations among the state, enterprises, and workers.’ Nil ‘To actively and stably experiment with the shareholding system reform.’ ‘To actively introduce the shareholding experiment and to develop the stock market. To select those enterprises or groups that fulfill the necessary conditions to adopt shareholding transformation, and invite other enterprises and internal workers to buy the shares. To establish a batch of stock issuers and brokers, in order to be prepared for further development of the stock and securities market.’

Table 4.2 Continued Date of delivery Review of previous year’s achievement of the report

Next year’s work target

13 April 1993

‘To use the shareholding system to speed up the conversion of enterprises’ internal shares, and to strive for gradual transformation of one-third of the large- and medium-size state-owned enterprises into shareholding enterprises with legal-entities as the major shareholder.’ ‘To continue to expand and standardize the shareholding system experiment; … to introduce the shareholding reform among selected enterprises that are of high quality, large scale, and those that fit into the state’s manufacture policy.’ ‘To promote various forms of modern corporates (including shareholding limited companies).’ ‘To vivify enterprises through different forms of enterprise reform, including the shareholding system.’

26 April 1994 50

28 March 1995 7 May 1996

9 April 1997

‘Actively and stably promoted the internal shareholding system. With provincial approval, 36 enterprises in the city have been identified for the internal shareholding system transformation, and 30 enterprises have been reformed into shareholding enterprises.’ ‘Forcefully promoted the shareholding system transformation. The city has already established 36 shareholding companies, with a total capital of 8.8 billion shares that could raise 3.6 billion yuan. (Several enterprises) have been publicly listed.’ ‘Organized and established standardized shareholding enterprises.’ ‘Organized and established standardized shareholding enterprises, and released part of the share ownership to foreign investors and workers.’ ‘The city has 33 standardized shareholding enterprises.’

‘To standardize, according to the Company Law, enterprises that have been transformed (into modern corporates, including shareholding companies).’

Sources: FR, 23 April 1986; 15 May 1988; 23 May 1988; 26 May 1989; 2 May 1990; 26 April 1991; 27 March 1992; 22 April 1993; 6 May 1994; 28 March 1995; 15 May 1996; 17 April 1997.


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The Case of Spontaneous Shareholding Reform: Foshan First Radio Factory The Foshan First Radio Factory was established in the 1960s, specializing in the production of audio-visual equipment and supplies. It was one of the 100 key enterprises under the Ministry of Machine and Electronics. In the 1980s, the country’s rapid economic growth and the quick emergence of a middle class led to a strong demand for household electrical appliances. The First Radio’s Diamond Brand products – including radios, recorders, laser-disc players, televisions, and video-recorders – were highly popular, and won a number of quality awards. The factory emerged as the largest maker of this line of products in the country, and earned remarkable profits (FN, 1993, p. 94; 1994, pp. 316–17; 1995, p. 288; FR, 17 August 1988, 9 September 1988, 31 October 1988, 23 December 1991, 31 October 1997). As the First Radio’s business was lucrative, workers in the factory were induced to invest in the factory in order to gain a share of the growing profits. On the other hand, being a light industrial enterprise that was not prioritized to receive state support, the factory had to look for capital supply from other sources. Such a situation led to a spontaneous shareholding scheme that consisted of ‘state shares’ (guojia gu), ‘enterprise collective shares’ (qiye jiti gu), and ‘individual worker shares’ (zhigong geren gu). It was a standard ‘One Enterprise, Three Types of Owners’ (yiqi sanzhi) model:5 State shares The value of state shares was calculated as the sum of the net value of the fixed assets created by past state investment, of the after-tax profits earmarked for re-investment, and of the working capital received from the state. This type of shares represented 95.7 per cent of the factory’s total capital stock. Enterprise shares Enterprise collective shares were converted from the retained profits that were designated for workers’ welfare and bonus use. They accounted for 1.43 per cent of the total capital. Worker shares Each worker was allowed to buy up to five individual worker shares, each worth 100 yuan. The fund so raised constituted 2.87 per cent of the total capital. According to the above scheme, the state shares were risk-free. Before the reform, the enterprise would submit to the state 55 per cent of its income as tax. Now, the state would still be guaranteed that same amount of revenue, but in the form of return to state shares. In contrast, enterprise shares bore most of the risk. Their rate of return depended entirely on the financial result of the

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enterprise’s operation. Worker shares received fixed interest calculated according to the prevailing bank interest rate, plus an unguaranteed amount of dividends depending on the availability of after-tax profits. In other words, by investing in the factory, workers could earn a return that would not be lower than what could be earned by saving the money in banks. Such a favourable arrangement for the workers was not surprising, given that the scheme originated with them. In October 1985, the First Radio was converted into an SHE, making it the first large-size industrial enterprise in China to experiment with the shareholding system. In January 1986, the restructuring was officially approved by the Foshan Municipal Institutional Reform Office (FR, 5 March 1986; Chen Youngzhong, 1991, pp. 165–66, 316–17). Entering the 1990s, as China had passed its initial economic take-off stage, the growth of household demand for electrical appliances began to slow down. On the other hand, being one of the most popular producers of audio-visual goods in the country, First Radio became the major target of competition of other enterprises, including those in the industrially strong Shanghai. Faced with the increasingly difficult domestic market, First Radio attempted to switch to export. The initial result was favourable, and up to 1992 the factory continued to make profits (FR, 20 December 1989, 10 March 1990, 12 December 1990, 10 March 1992; Zhou, 1997, pp. 3–4). However, the situation began to change in 1993, when Zhu Rongji was appointed new governor of the People’s Bank of China. Under Zhu’s austerity programme, the Chinese banks were ordered to impose strict credit control. This dealt a severe blow to First Radio, as its capital supply depended mainly on bank loans. Being a light industrial firm in the ‘peripheral’ Foshan, First Radio had very little state investment but a high debt ratio. Deterioration of the financial condition of First Radio made the factory unable to pay dividends to the workers. As the worker shares failed to yield to the workers a return higher than the bank interest, the shareholding experiment was not mentioned any more. In August 1997, after several years of difficult operation, First Radio declared bankruptcy. Three months later the factory’s assets were auctioned for 71.5 million yuan. At the time of bankruptcy, the factory had a staff of about 1000. Those who were still holding the worker shares asked for a buyout. Their demand was met, and the city government spent about 500 000 yuan to redeem the shares, presumably from the proceeds of the auction. The fact that the worker shares received guaranteed higher-than-bank-interest return when profits were available, and were redeemable when the factory liquidated indicated that the ‘shares’ were more like bonds than stock (FR, 31 October 1997; 7 January 1997). The closure of First Radio was publicized in the local newspaper as the first case of bankruptcy and auction of an industrial enterprise in Foshan. However,


53

the fact that First Radio was the first industrial SHE in China was not mentioned, in order not to hurt the then national promotion of the shareholding system. Subsequently, the model initiated by First Radio was banned. Rather than being regarded as a kind of spontaneous reform attempt, the practice has been called ‘illegal fund raising’ (feifa jizi). The Case of State-led ‘Internal Shareholding System’: Foshan Tongbao Shareholding Limited Company The Foshan Tongbao Shareholding Limited Company was originally the Foshan Mould Factory, established in 1966 with less than 30 workers. After ten years of small-scale production of simple mouldings, the factory was ordered by the state to switch to make spray nozzles, despite the fact that it did not have the technology nor market knowledge in this line of product. In 1982, the factory was on the brink of bankruptcy. It survived only on a state subsidy (FR, 6 December 1993). In 1985, the state granted Foshan Mould Factory permission to determine its own market orientation. After careful research, the factory switched to make thermostats for rice-cookers. The new product was very well received, immediately turning the factory’s long-term losses into profits. In that year, the enterprise was re-named Foshan Temperature Control Device Factory. It subsequently moved to manufacture higher value-added products, including thermal sensors for refrigerators and air-conditioners. By 1992, the factory had emerged to be one of the largest producers of this equipment in the country, controlling about half of the domestic market. It was one of the 28 Foshan enterprises that produced an annual output value of over 100 million yuan, and profit and tax of over 10 million yuan (FR, 14 January 1993; 11 March 1993). In 1992, after Deng’s call for further economic reform, the Foshan city government began searching for high-quality enterprises for the shareholding system reform. Being one of the most profitable firms in the city, Foshan Temperature Control Device Factory was selected to experiment with the ‘internal shareholding system’ (neibu gufen zhi), under which the shares could only be traded among the workers but not sold to the public. Initially, both management and workers of the factory were hesitant about the state’s call for change. The managers were concerned that the conversion would mean stricter regulatory control of the enterprise, and the workers were unsure about the implications of the change for their jobs and incomes. To persuade the factory to adopt the proposed reform, Foshan officials held a number of meetings with the managers and workers, and granted tax concessions to the enterprise.6 On the other hand, the managers were attracted by the fund-raising function of the shareholding system. The factory finally accepted the city government’s nomination as one of the first experimental SHEs in Foshan. In 1993, with the

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provincial government’s approval, the factory was made a formal SHE, and was renamed Foshan Tongbao. Profits have grown remarkably since the change, and the enterprise has been widely promoted as a successful case of the shareholding experiment (FR, 14 January 1993; 29 July 1993; 6 December 1993; 14 February 1994; 25 March 1994; 8 April 1994; 14 February 1996; 16 August 1996; 1 March 1997; 17 June 1997). At the time of founding, Foshan Tongbao had a total capital of 36 million yuan, divided into the same number of shares. The capital structure was divided as follows: State shares The total net value of the assets (except land) of the old Foshan Temperature Control Device Factory was converted into 18 million state shares, representing 50 per cent of the total capital of the new Foshan Tongbao. The state shares were held by the Jing Zhao Corporation, a business agent of the Foshan State Property Bureau. Legal-entity shares A total of 10.8 million shares were issued to several other enterprises, forming 30 per cent of the total capital. The largest legalentity shareholder was an enterprise established by some former workers of Foshan Tongbao. Worker shares Workers who had worked in the factory for over three years were allowed to buy up to 3000 worker shares, and those who had worked for over five years were allowed to buy up to 6000 shares. As there was no guaranteed return to the shares, workers’ response to the offer was mild. Nevertheless, the enterprise managed to issue 7.2 million worker shares, raising 20 per cent of the total capital. As an experiment of the ‘internal shareholding system’, Foshan Tongbao has not been allowed by the state to list its worker shares in the Shenzhen Stock exchange, despite the company’s continuous applications for listing. Being blocked from raising funds in the stock market, Foshan Tongbao resorted to issuing shares to foreign (mainly Hong Kong) investors and to stock allotment (pei gu, that is, issuing shares to existing shareholders). After several rounds of such new share issues, by 1998 total capital of the company had increased to 99.8 million shares, and the capital structure had undergone the changes shown in Table 4.3. The fact that foreign investors have emerged to be the second-largest shareholder has been because all the domestic shareholders – the state, the legalentities, and the workers – lacked the capital to subscribe fully to the new shares issued in each allotment. As foreign shares have exceeded 25 per cent of the total capital, Foshan Tongbao has become a Sino-joint venture SHE, and


Table 4.3

55

Capital structure of Foshan Tongbao, 1993 and 1998

Shares

State Legal-entity Worker Foreign

1993 (%)

1998 (%)

50 30 20 Nil

38 20 12 30

could thus enjoy the preferential treatment available to this type of firm. Even though the foreign investors have been interested only in the profit and not in the management of the company, the state has been concerned with the gradual loss of share of ownership to foreigners. To maintain its position as the largest shareholder, since 1997 the state has required Foshan Tongbao to obtain prior approval before any further new share issues. The Case of State-led ‘Public Shareholding System’: Foshan Electrical and Lighting Company Limited The predecessor of Foshan Electrical and Lighting Co. Ltd. was the Foshan Light Bulb Factory, established in 1958. In 1979, the value of its annual output was merely five million yuan. That year, the factory abolished the life employment system. Redundant workers were laid off, replaced by contract and temporary labour recruited from the villages. Moreover, the egalitarian wage structure was changed into a differential pay scheme based on productivity. In 1980, the management was streamlined, and an annual performance evaluation scheme was introduced. The factory, renamed in 1984 as Foshan Electrical and Lighting, was among the first SOEs in the city to adopt this kind of labour reform. At the same time, strict disciplinary actions were taken against irregular activities such as over-invoicing and forgery. These measures made Foshan Electrical and Lighting one of the 500 most efficient enterprises in China. In 1991, the company produced a total output valued at over 300 million yuan, and generated more than 40 million yuan of tax and profits, the highest of all light bulb producers in the country (FELCLAR, 1997, p. 1; FELCD, 1992; FR, 18 June 1992; 9 December 1992). In 1992, in response to Deng’s call for a further reform of the shareholding system, the Foshan city government named four enterprises to experiment with the ‘public shareholding system’ (gongzhong gufen zhi), under which the shares could be listed for public trading. Foshan Electrical and Lighting, due to its impressive record, was included as one of the four enterprises.7 It had a founding capital of 230 million yuan, 50 per cent of it being state shares

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(converted from the total net value of the assets of the factory), 30 per cent legal-entity shares, and 20 per cent worker shares (FR, 3 August 1992; 29 October 1992). In 1993, Foshan Electrical and Lighting issued its first A-shares, or publicly listed shares available to domestic investors, at the Shenzhen Stock Exchange. Several allotments were made to A-shareholders in subsequent years. In 1995, the company issued its first B-shares, or publicly listed shares available to foreign investors. In the same year, the worker shares that were issued when the company was founded were also listed as A-shares. By 1997, the capital structure had undergone the changes shown in Table 4.4 (FELCLAR, 1997, pp. 6–7; FR, 10 August 1995; 30 September 1995). Foshan Electrical and Lighting has been one of the most successful cases of the public shareholding system. In 1997, the company made a net profit of 134 million yuan, compared to only 19 million in 1991 (FELCLAR, 1997, p. 19; FELCD, 1992). It won the award of Best Comprehensive Performance among the some 300 companies listed in the Shenzhen Stock Exchange. However, at the time when the city government named Foshan Electrical and Lighting for the experiment, both the managers and workers of the enterprises were hesitant about the change, being uncertain as to the result. They finally accepted the state’s initiative, mainly because of the capital-raising function of the shareholding scheme. In the subsequent issue of A-shares and listing of worker shares, the attitude of the management and the workers became very positive, since more capital could be raised and the shares could become more liquid. Yet, the making of Foshan Electrical and Lighting into a public SHE was still mainly the outcome of the state’s decision rather than the enterprise’s initiative. In 1992 (that is, a year before the public listing of the company’s shares), the Guangdong provincial government had a quota of five enterprises in the Shenzhen Stock Exchange. Foshan Electrical and Lighting was then ranked at the top of the shortlist, due to its high profitability and standard business practice. Table 4.4 Capital structure of Foshan Electrical and Lighting, 1992 and 1997 Shares

State Legal-entity Worker A-shares B-shares

1992 (%)

1997 (%)

50 30 20 Nil Nil

24 19 (Listed as A-shares) 30 27


57

Like Foshan Tongbao, a clear trend in the capital restructuring of Foshan Electrical and Lighting has been the dilution of public ownership and expansion of private investment from domestic and foreign investors. This has been the result of the lack of capital of the state and legal-entities to maintain their original share of ownership in each round of new share issues. Although the state was no longer the majority shareholder, it still had the controlling interest because the other shareholders were rather dispersed. Nevertheless, to avoid further decline of its ownership, since 1997 the state has required the company to obtain prior approval before any new share issue.

THE ROLE OF THE CHINESE STATE IN THE REFORM China’s industrial shareholding system reform began with a spontaneous attempt by the Foshan First Radio Factory in 1985. The state authorities, both central and local, did not play any role except by giving an ex post endorsement. This might tempt one to think that the 1997 national endorsement of the shareholding system represented the triumph of workers’/managers’ initiative over state design. That is, the weak state perspective seemed to apply. Our case studies, however, show that just the contrary is true. We have no evidence as to whether the Chinese state authorities had considered the case of First Radio before endorsing the shareholding system as the national reform programme. But as the fundamental reason for the state to launch the shareholding system was to improve the performance of the enterprise through the restructuring of ownership, the failure of First Radio suggested that the model adopted by this particular factory should be avoided. In particular, the spontaneous shareholding reform, which tended to pass the risk from the initiators (workers and managers) to the enterprises, was certainly not in the interest of the state. The Chinese state has been strong enough to prevent the practice from prevailing, by banning workers’ and managers’ spontaneous fund-raising activities. When the shareholding system was endorsed as the national reform programme, the experience of First Radio was not mentioned at all, indicating that its early attempt was not regarded as part of the shareholding experiment. The state defined not only the content, but also the origin of the reform. The transformation of Foshan Tongbao and Foshan Electrical and Lighting into SHEs was the immediate result of Deng Xiaoping’s 1992 call for further reform. The direction of reform came from the central government. The local government in Foshan responded immediately by naming two of the best enterprises in the city for the experiment. There was no initiative from factory managers and workers. On the contrary, they were hesitant, as the new system affected their income and job security. Nevertheless, the local government

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managed to obtain consensus through offering incentives to the targeted enterprises, without resort to an administrative order. It has also been able to separate the two enterprises for the different types of experiment: ‘internal shareholding system’ and ‘public shareholding system’, despite Foshan Tongbao’s continuous request for switching from the former to the latter. The state, both central and local, has been in charge of the whole process. Our case studies show that the Chinese state has been successful in leading SOEs to accept the challenges of market forces. As Chen A. (1998) noted, a major obstacle to China’s economic reform has been the inertia of the enterprises and their dependence on state protection. The spontaneous reform of First Radio was not an indication of entrepreneurship;8 rather, the workers of the factory simply sought to earn higher income without bearing any risk. When Foshan Tongbao and Foshan Electrical and Lighting were invited to share the profit as well as the risk with the state, the managers and the workers hesitated. By persuading these model enterprises to participate in the shareholding experiment and by promoting their success, the state set examples to other SOEs that risk-taking might pay. Apart from defining the direction of the reform, the central state has developed a regulatory framework for the new system. As mentioned in Chapter 3, in May 1992 the central government promulgated fourteen documents to guide the reform, including the ‘Measures for the Experimentation of the Shareholding Enterprises’, ‘Opinions on the Standardization of Limited Shareholding Enterprises’, and ‘Opinions on the Standardization of Limited Companies’. Though not official laws, these guidelines were used to re-examine and re-endorse previously established SHEs. In the same year, the State Council formed the Securities Commission and the China Securities Regulatory Commission to monitor development of the securities market. In 1994, the Company Law was endorsed as the official legislation to regulate SHEs. Previously established SHEs were required to be ‘standardized’ (guifan hua) in accordance with this new law. In short, the Chinese state played a developmental role in reforming the shareholding system. It defined the overall direction of reform, provided political momentum to the change, and mobilized enterprises to participate. The earliest, spontaneous attempt, which was inconsistent with the general framework of the national reform programme, was allowed to go bankrupt, while other similar fund-raising activities were outlawed. A regulatory framework gradually emerged under the state’s auspices. Spontaneity was suppressed, and the state took the initiative. The strong state perspective thus prevailed. Nevertheless, this is not to say that the Chinese state is developmental in all respects. It also exhibits dysfunctional features. The state’s objective of achieving economic efficiency through ownership reform has been constrained by socialist ideology, and its autonomy in conducting the share-


59

holding experiment depended on the macro political environment. Lacking the technical capacity and institutional strength to ensure a smooth introduction of the reform, the shareholding system has led to an unintended dilution of state ownership.9 The trial-and-error, incremental approach seemed more like a passive response to unforeseen problems, than an actively planned strategy. The Chinese state has been particularly dysfunctional at local levels. While our case studies demonstrate the positive role played by the Foshan officials in introducing the reform of the shareholding system in the city, there have been reports that the local government has not been very active in promoting the programme (Lu and Ding (eds), 1998, p. 65). More importantly, some local authorities have manipulated central government policies to their advantage. For example, to control the pace of the reform of the shareholding system, the central government has maintained a separation between ‘internal shareholding system’ and ‘public shareholding system’. An annual quota, divided among regions, was issued for the conversion of internal SHEs into public SHEs. However, entrusting power to local authorities to fill up the quotas has bred corruption. While the earlier public SHEs were listed in recognition of their remarkable performance, many of the more recent ones, based on information obtained from our fieldwork, became listed companies only by paying a ‘standard price’ to local officials. This means that the reduction of the strength of the Chinese state from the central to local levels challenges the notions of ‘regional corporatism’ (Unger and Chan, 1996) and ‘local state corporatism’ (Oi, 1992, 1995). Our case studies also show a gradual loss of state ownership to foreign investors. This is consistent with the general trend of increasing foreign participation in China’s shareholding system reform. However, as will be argued in Chapter 5, this has not been the result of the influence of foreign investors on the Chinese government to grant them better access to state assets. Rather, it was the local officials and enterprise managers that have been most active in selling shares to foreign investors. Hence, contrary to the classical dependency analysis, there is little indication that the Chinese state has become a mere agent of the capitalist center. It is largely the local agents rather than foreign capital that have weakened the developmental capacity of the Chinese state. This alerts us to the tendency of the dependency analysis of placing too much emphasis on the role of the central state, neglecting the influence of local actors. Overall, despite some dysfunctional aspects, particularly at the local level, the Chinese state has been strong enough to play a developmental role in the evolution of the shareholding system. Spontaneous attempts have been replaced by state-led incremental reform. For further theoretical generalization, it may be useful to compare our conclusion with the Russian case, where spontaneous privatization took place almost immediately after the collapse of

60


the Soviet regime. Some scholars have argued that the difference in the form and speed of privatization in China and Russia can be attributed to the presence of a strong state in China, and a weak state in Russia (Burawoy, 1996; Roland, 1995). A more careful comparison of China’s shareholding system reform and Russia’s privatization, focusing on the role of the state, may further our understanding of the explanatory power of the state in explaining economic changes.

NOTES 1.

The author is indebted to the South China Programme, Hong Kong Institute of Asia-Pacific Studies, Chinese University of Hong Kong, for providing financial support for the research work for this chapter. 2. There have been numerous definitions of corporatism. The most widely used one, offered by Schmitter (1974, pp. 93–94), says that corporatism is ‘a system of interest representation in which the constituent units are organized into a limited number of singular, compulsory, noncompetitive, hierarchically ordered and functionally differentiated categories, recognized or licensed (if not created) by the state and granted a deliberate representational monopoly within their respective categories in exchange for observing certain controls on their selection of leaders and articulation of demands and supports.’ 3. Unless stated otherwise, all information in this section is obtained from interviews, conducted in June 1998, with Foshan officials and factory managers. The present author is indebted to the late Professor Lin Dahui, former Dean of Business School, Foshan University, for arranging some of the interviews, and sharing with the author some invaluable information from his personal collection. This project would not have been completed without Professor Lin’s support. His enthusiasm in promoting research activities and academic exchanges will be remembered. This section also contains information gathered from numerous issues of Foshan Daily. Three former students of the author – Tse So Han, Tsoi Hung Ping, and Watt Wai Yeung – rendered excellent research assistance in this regard. 4. The Shengping Departmental Store mentioned above was a commercial SHE, whereas First Radio was an industrial one. Our focus is on the latter type SHE. 5. China’s early shareholding enterprises fell under four basic models, and the ‘One Enterprise, Three Types of Owners’ model was the most common one. See Chapter 2. 6. The standard profit-tax rate on SHEs was originally proposed at 33 per cent. After negotiation, the rate was reduced to 15 per cent, which was the same as that applicable to SOEs. 7. The three other companies being Foshan Porcelain Company, Foshan Plastic Materials Company, and the Xinghua Commercial Group. 8. This seems to disagree with the ‘entrepreneurial state’ thesis. See Duckett (1998). 9. For details of such trends, see Chapter 3.

5. Foreign participation in China’s privatization and the role of the state According to World Bank statistics, during 1988–93, 2655 privatization transactions were recorded in 93 countries. Total sales revenue amounted to US$271 billion. Of this worldwide privatization, developing countries accounted for about 85 per cent of the total number of transactions, and 35 per cent of total sales revenue (Sader, 1995, p. 3). A major constraint of privatization efforts in developing countries has been the lack of domestic capital. This has prompted many developing countries to allow sales of state assets to foreign investors, at the political and economic risk of exposing the national economy to external influence (Harrell, 1993, p. 46; Welfens, 1994, p. 36). World Bank statistics indicate that during 1988–93 about 30 per cent of the total number of privatization transactions in developing countries involved foreign capital; the foreign share amounted to 35 per cent of the revenue generated by privatization (Sader, 1995, p. 13).1 In the light of this global trend, this chapter will examine the role of foreign participation in China’s privatization. The Chinese case is important for several reasons. First, the country possesses one of the largest state-owned sectors in the world. In 1991 Chinese state-owned enterprises (SOEs) accounted for about 20 per cent of the country’s gross domestic product, almost double the average of developing economies.2 Second, in 1980–92 China’s gross domestic product grew by over 9 per cent annually, compared to the world average of 3 per cent (World Bank, 1994, pp. 164–65). This has made the country a leader in the contexts of both Third World development and post-communist transformation. Third, after more than a decade of opening, China has emerged as the largest recipient of foreign capital among developing countries. In 1990–95, net private capital flows to China (comprising direct investment, private loans, and portfolio equity flows) amounted to US$166 billion, representing 24 per cent of the total absorbed by all developing countries (World Bank, 1996, Vol. 1, p. 11). Finally, the Chinese case is theoretically important from a dependent development perspective. As will be discussed in the last section of this chapter, while there has been significant foreign participation in the country’s privatization, the Chinese state has played a ‘market-facilitating’ role, instead of becoming a mere agent of the capitalist center. Classical dependency analysis thus does not seem valid. 61

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Before proceeding to discuss the Chinese case, we need to clarify our working definition of privatization again. As mentioned in Chapter 2, we will use the term privatization in the narrow sense as defined by Bornstein (1994a, p. 234): transfer of ownership of state assets to private hands. This definition, however, is broader than the one employed in the World Bank statistics cited above, which covers ‘the complete or partial transfer of control over publicly–owned assets to the private sector in exchange for a payment’ (Sader, 1995, p. 2). Owing to lack of data, the World Bank statistics do not include divestitures of SOEs in the forms of shutting down operations and mothballing assets. Mass privatization through vouchers is also excluded. This restriction understates the scale of privatization in Eastern Europe, where free distribution has been important. However, it does not affect our analysis of the Chinese case, since so far there has been no case of voucher privatization in China.

SHAREHOLDING SYSTEM REFORM AND VARIETY OF CHINESE SHARES As mentioned in Chapter 2, China has achieved significant privatization under the camouflage of ‘shareholding economic reform’ (gufen jinji gaige). The essence of this reform is to convert SOEs into shareholding enterprises (SHEs). Shares are issued to the state, enterprises, and individuals. Through this process state assets are transferred from the state to private hands, and it is in this sense that we regard the shareholding economic reform as a form of privatization. Under the shareholding system, a variety of shares have emerged. In terms of type of owner, Chinese shares can be classified into state shares (guojia gu), corporate or ‘legal-person’ shares (faren gu), and individual shares (geren gu). In terms of place of listing, there are A-shares and B-shares listed domestically, H-shares listed in Hong Kong, and N-shares listed in New York. As will be discussed below, the demarcation among these different types of shares has become increasingly blurred, which is a major characteristic of the Chinese privatization. But for analytical purpose, we need to be conceptually clear about their differences. Initially, state shares and corporate shares were prohibited from being transferred, as a safeguard against privatization. On the other hand, to create an open market for the transaction of transferable individual shares, China established a stock exchange in Shanghai in 1990, and another one in Shenzhen in 1991. Shares listed on the two exchanges are known as A-shares and B-shares. A-shares are traded in the Chinese currency, yuan, and are reserved for domestic enterprises and individuals; whereas B-shares are traded

Table 5.1

Types of Chinese shares Non-transferable, and not publicly listed

63

Owner

State

Place of listing Shanghai and Shenzhen Stock Exchanges Enterprises

Domestic investors

Foreign investors

Hong Kong New York Stock Exchange Stock Exchange Foreign investors

Foreign investors

Foreign shares Type of shares

State

Corporate

Individual, or A-shares

B-shares

H-shares

N-shares

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in foreign currency, and are available only to foreign individual and institutional investors (ZC, 1993, p. 50). In addition, some Chinese enterprises have issued shares in the Hong Kong Stock Exchange and the New York Stock Exchange, known respectively as H-shares and N-shares (World Bank, 1995b, Vol. 2, pp. 132–33). Despite different names and places of listing, B-shares, Hshares, and N-shares are all held by foreigners. As such, they are collectively known as foreign shares (waizi gu). The various types of Chinese shares are summarized in Table 5.1. In the next section, we will discuss the increasing role of foreign shares, as an indication of the expansion of foreign involvement in China’s privatization.

MAJOR FORMS OF FOREIGN PARTICIPATION Expansion of B-share Market When the Shanghai and Shenzhen Stock Exchanges were opened respectively in 1990 and 1991, shares of only one type, A-shares, were listed. These shares were only available to domestic investors, and are denominated in yuan. With such a nationality restriction, and given the inconvertibility of the Chinese currency, foreign investors were excluded from the A-share market. Foreigners were first allowed to participate in China’s stock market in February 1992, when another type of share, B-shares, began listing on the two exchanges. These shares are reserved for foreign investors, and are traded in US dollars in Shanghai, and in Hong Kong dollars in Shenzhen. Since English is not China’s official language, the Chinese authorities have abolished the term B-shares, replacing it with ‘domestically listed foreign shares’ (jingnei shangshi waizi gu) (ZZB, 15 August 1994). But for convenience, the term Bshare has continued to be used on most occasions, a practice which we will follow. Issue of B-shares serves two major purposes. The first is to obtain external equity financing. Enterprises intending to issue B-shares thus have to prove a need for foreign exchange. By the end of 1995, altogether 70 Chinese enterprises had listed B-shares, raising a total of US$2.3 billion (see Table 5.2). Second, the B-share market serves as an instrument for absorbing international financial techniques, as B-share issuers have to prepare financial statements according to international accounting standards. Though A-share issuers are not required to comply with this rule, practices in the B-share market are expected to have spillover effects (Goldstein and Folkerts-Landau, 1994, pp. 102–103). A special feature of the Chinese approach to the development of securities markets can be seen by putting the above two objectives together. It has been

Table 5.2

Chinese foreign share issues B-shares Number of listings

65

1992 1993 1994 1995 1992–95 Note: Source:

*

18 23 17 12 70

Fund raised (US$ million) 722 647 516 375 2260*

H-shares

N-shares

Number of listings

Fund raised (US$ million)

Number of listings

Fund raised (US$ million)

0 6 9 2 17

0 1052 1276 256 2584

1 2 3 0 6

80 197 1033 0 1.31

Other sources put this figure at US$3 billion (JS, 4 February 4 1996; XB, 4 March 1996). Credit Lyonnais Securities (Asia) Ltd. I am indebted to Howard Wong, statistician of Credit Lyonnais, for compiling this table.

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a common goal of liberalizing capital markets to upgrade companies’ financial management and disclosure practices towards international standards. But rather than adopt an absolute set of international codes and wait for most enterprises to meet it, the Chinese authorities grant enterprises not ready to meet international financial standard opportunities in the A-share market, and let the more capable ones enter the B-share market. No administrative measures have been used to force A-share issuers to meet B-share issue requirements. Nevertheless, B-share issue as a source of foreign exchange serves as a strong incentive for enterprises to internationalize their financial management. Shortly after its inception, however, the B-share market went into a state of almost continuous decline. Occasional rallies notwithstanding, the general price trend was downward, and turnover was low, making B-shares rather illiquid. This has been attributed to a number of factors: vague government policy; undeveloped legal framework; failure of companies to publish financial results on time and in accordance with international requirement; inefficient dissemination of company information; investors’ concerns about rights issues and companies’ investment behaviour; high transaction cost; small size of the market; competition from H-shares and N-shares (we will return to this point later); and unstable value of the yuan (Nottle, 1993, p. 512; ZZB, 3 September 1994; JS, 9 November 1994). Positive views on B-shares do exist, arguing that in general B-share companies have sound financial standing and high investment value (ZZB, 24 September 1994; 17 June 1995; 18 November 1995). Nevertheless, the B-share market has remained bearish and inactive. Despite the unsatisfactory performance of the B-share market, the government decided to further the B-share experiment in three major respects. First, it allowed expansion of the proportion of B-shares in a company’s total capital stock. In August 1995, with the approval of the China Securities Regulatory Commission (CSRC), the central regulator of China’s securities market, and the Ministry of Machine-Building Industry, the Shenzhen-listed Jiangling Auto Company sold 80 per cent of its B-shares to Ford Motor Company of the United States. While Jiangling remained the largest shareholder, controlling 51 per cent of the company’s total capital stock, the transaction gave Ford about 20 per cent of Jiangling’s shares, making the US company the secondlargest shareholder. Together with shares held by other foreign investors, Bshares accounted for 25 per cent of Jiangling’s total capital stock. Before this, the general proportion of B-shares in a Chinese company’s total capital stock was about 10 per cent (JS, 17 August 1994; 23 August 1995; CD, 24 August 1995; ZZB, 25 August 1995). Second, plans were made to increase the supply of B-shares significantly. Issuers would mostly be enterprises in energy, transportation, telecommunications, key raw materials, and high-technology sectors. More importantly, issue of B-shares was given priority over A-shares. Since early 1996, enterprises

Foreign participation and the role of the state

67

applying to issue both A-shares and B-shares must first issue the latter. The increase in the supply of B-shares led to the concern that prices would be forced further down (XB, 6 February 1996; MB, 30 January and 7 February 1996). But there was the opposite view that ‘the problem with China’s Bshares market is that it is too small, not too big’. In March 1996, the seventy Shanghai and Shenzhen B-shares were capitalized at a mere US$2 billion. Foreign investors have hesitated to enter such an illiquid market, in which any transaction can have a dramatic impact on the price of a stock (SCMP, 1 April 1996). The government thus aimed to activate the market by enlarging its scale. Finally, locational restrictions on B-share issuers were removed, thereby allowing a geographic expansion of B-share issuers. Originally, only Shanghai and Shenzhen enterprises could issue B-shares. Both the Shanghai and the Shenzhen Stock Exchanges were established on the basis of local rules and regulations. Such localism made it difficult for high-quality enterprises of other areas to raise foreign exchange by issuing B-shares. Although some Shanghai and Shenzhen enterprises tried to ‘lend’ their B-share issue quota to enterprises from other areas, the attempt was not successful owing to lack of legal basis. This condition came to an end in December 1995, when the State Council promulgated the country’s first national law on B-shares.3 The new law, which immediately replaced local rules and regulations set by the Shanghai and Shenzhen authorities, does not place any locational restriction on B-share issuers and thereby provides a legal basis for geographic expansion of the B-share market (XB, 22 January 1996). Weakening of Separation between A-share and B-share Markets As mentioned above, the A-share market was not supposed to open to foreign investors. However, in July 1994, in the midst of a year-long decline of Ashare prices, the Chinese securities authorities announced a series of market ‘rescue’ measures, one of which was to allow foreign funds to enter the Ashare market by establishing Sino–foreign joint venture investment companies on a trial basis.4 In response to this and other measures,5 during the ensuing week the Shanghai and Shenzhen A-share indexes skyrocketed by 113 per cent and 74 per cent respectively. About a year later, a senior central bank official said that the government would adopt a two-step approach to implement the plan. The first step would be to allow ‘reliable’ foreign investors to buy only shares of enterprises which had issued A-shares and B-shares or H-shares. This would be followed by a further opening of the A-share market, upon satisfactory result of the first step (CD, 7 August 1995). In addition to the direct advantage of enlarging capital sources, the opening of the A-share market to Sino–foreign fund companies was expected to have

68


two other positive effects. First, to attract foreign investors, A-share companies would be induced to improve their management and disclosure. Second, Chinese fund managers may absorb skills and experiences from their foreign partners. On the other hand, Chinese securities experts realized that there were still many obstacles to the participation of foreign funds in the A-share market: inconsistency of A-share companies’ accounting system with international standards; lack of standard requirements on company information disclosure; international capital immobility owing to foreign exchange controls and currency inconvertibility; absence of relevant legal framework; shortage of professional fund managers and supervisors; high volatility of A-share prices; and confusion caused by co-existence of too many types of shares. Finally, concern has been raised that the limited size of the A-share market may lead to foreign control of the Chinese stock markets (ZZB, 3 September and 9 December 1994; JS, 22 December 1994). The above limitations notwithstanding, provisions were made for the gradual opening of the A-share market to foreign funds. On the other hand, there was a similar relaxation of the border of the B-share market to domestic investors. According to the above-mentioned first national law on B-shares, in addition to foreign and Hong Kong, Macao and Taiwan investors, B-shares would also be available to two other types of investors: Chinese citizens residing abroad, and other investors approved by the CSRC. The first newly added category would allow the increasing number of Chinese citizens earning foreign exchange abroad to invest in B-shares. While what the second category, ‘other investors approved by the CSRC’, actually refers to was unclear, it was reported that this is a provision for allowing domestic residents to use private foreign exchange savings to invest in B-shares (JS, 17 August 1994).6 Before clarification from the central government, a senior Shenzhen official confirmed that Chinese investors holding foreign exchange would be allowed to buy B-shares in the city.7 In fact, Shenzhen residents who have relatives and friends in Hong Kong have been buying B-shares through them (SCMP, 9 March 1996). The new law may thus be seen merely as a legalization of existing practice. According to one report, about 16 000 Shanghai B-share buyers are local Chinese, five times the number of Hong Kong investors (XB, 18 March 1996). Hence there has been a gradual mutual opening of the A-share and B-share markets to their respective specified investors. At the same time, with the introduction of H-shares and N-shares, B-shares have lost their unique function of raising external equity financing (we will return to this point later). These developments have led to the speculation that the A-share and B-share markets will eventually be merged into one. However, there have been warnings that the move should be ‘natural’, and be carried out ‘at the proper time’ (ZZB, 23 September and 22 November 1994; JS, 27 January 1995).


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According to a joint study by the CSRC and the World Bank, the separation of A-share and B-share markets produces a series of problems, including price distortion across markets, illegitimate transactions due to possibilities for arbitrage, reduced liquidity, and barriers to the spillover of learning benefits from the B-share to the A-share market. Two arguments have generally been offered against merger of the two markets. The first is the limited convertibility of the Chinese currency, and the second the possibility of crowding out of domestic participation by foreign inflows. The joint study by the CSRC and the World Bank finds both arguments unconvincing, as a range of alternative solutions and safeguards are available. However, the market segregation has the advantage of reducing the domestic market’s vulnerability to external shock. A pullout of foreign capital from China would have a direct impact on the price of foreign shares, but not domestic shares. This would save China from a financial crisis like that which occurred in Mexico in early 1995 (World Bank, 1995b, Vol. 2, pp. 127–29). It also makes the Chinese case different from Eastern European equity markets, where international flows have caused significant fluctuations (IHT, 25 April 1996). Hence it seemed that the Chinese central government’s policy would be to maintain two separated markets in the foreseeable future. The chances are high, however, that the separation will be weakened further by local initiatives. Conversion of State Shares and Corporate Shares into Foreign Shares As mentioned in Chapter 3, there have been cases of spontaneous conversion of non-transferable state shares and corporate shares into transferable individual shares. Similar activities have also taken place between state shares, corporate shares and foreign shares. In February 1994, the board of directors of the Shanghai Dazhong Taxi Company made a proposal to convert the company’s corporate shares into B-shares. The case, which is the first of its kind, drew immediate public attention. Initially the CSRC said that ‘under current circumstances, it is impossible to carry out conversion of corporate shares into Bshares’, since the proposed move would involve sale of state assets to foreign investors and revision of A-share and B-share market regulations. However, within a few months the CSRC changed its mind and approved the proposal. By converting 10 million corporate shares into B-shares, the proportion of Bshares in Shanghai Dazhong’s total capital stock was increased to about 48 per cent, while that of state shares and individual shares declined respectively to 44 per cent and 8 per cent (Li and Yu, eds, 1995, pp. 56–57). About six months later the Shanghai Diesel Engine Company followed suit by converting 10 million corporate shares into B-shares (JS, 27 November 1994). In August 1995 Beijing Light Bus sold 40 million corporate shares to Isuzu Motor and Itochu of Japan, giving the Japanese partners a combined 25 per

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cent stake in the Chinese company (Karmel, 1996, p. 551). The case set a precedent of direct foreign acquisition of shares in a Chinese enterprise through the stock market. A legal basis for such practice did exist in a provisional regulation promulgated at the beginning of 1995, according to which a SHE may change into a ‘foreign-invested’ SHE by selling over 25 per cent of its shares to foreign shareholders for hard currency. However, the case raised senior leaders’ concern about the leak of state assets to foreign hands. The threat became more real as a Japanese executive was appointed general manager of Beijing Light Bus. There was also criticism about the improper disclosure of news about the transaction when the case was still under consideration by the CSRC. The central authority kept silent on this case, but became more cautious about other applications of the same kind. According to one report, senior Chinese leaders, including the former Premier Li Peng, have criticized the Beijing Light Bus transaction (ZZB, 11, 14 and 17 August 1995; JS, 22 August and 19 October 1995; SCMP, 23 February 1996). Consequently, in September 1995 the State Council banned conversion of state shares and corporate shares into foreign shares (ZSZ, 2 December 1995). In defiance of this rule, however, the Sichuan Guanghua Chemical Fibre announced that it had sold 35 million state shares, or 60 per cent of the company’s state shares, to Nimrod, the parent company of New York-listed China Industrial Holding.8 The announcement was made in January 1996, but the company said that the transaction was actually concluded in August 1995, the month before this type of transaction was made illegal. This broke the disclosure rules which require major transactions to be reported within three days. Consequently, the CSRC ordered suspension of the listing of Sichuan Guanghua’s shares on the Shanghai Stock Exchange for two days, and launched an investigation into the deal. A few days later, Nimrod made an announcement that the transaction was legal and had been approved by the National Bureau of State-Owned Property. The Chinese securities authorities were silent on Nimrod’s response (ZZB, 26 January 1996; SCMP, 27 January 1996; MB, 30 January 1996; YZ, 11 February 1996). In short, the Chinese state has been ambiguous on the issue of conversion of state shares and corporate shares into foreign shares. On the one hand, the practice may help to solve problems caused by the non-transferability of state shares and corporate shares mentioned in the previous section. In April 1995 state shares and corporate shares in total accounted for about 68 per cent of the entire capital stock of all SHEs in China, whereas the proportion of foreign shares stood at approximately 11 per cent. It was hoped that foreign capital could play a greater role in supplementing domestic funds to absorb the huge amount of non-transferable state shares and corporate shares (JS, 7 June and 4 August 1995; ZZB, 30 August 1995). On the other hand, concern about loss of state ownership to foreign hands and lack of established rules have prevented


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the government from making share conversion an official policy. When senior level criticisms and irregular activities emerged, the government banned the practice, but did not actually enforce the rule. Foreign Listing Listing of Chinese SOEs on foreign stock exchanges began in the early 1990s, when some enterprises purchased controlling stakes in publicly quoted Hong Kong companies, thereby obtaining ‘backdoor listings’ on the Hong Kong Stock Exchange (SEHK).9 This practice allowed Chinese enterprises to bypass both China’s restrictions on sales of equity abroad, and Hong Kong’s regulations on new listings. By means of ‘backdoor listings’, a Chinese enterprise could raise financing through new rights issues, and significantly reduce its effective tax rate by establishing a joint venture with the overseas-registered company that it controlled (Goldstein and Folkerts-Landau, 1994, p. 99; ZZB, 21 February 1995). Well-known Chinese enterprises that have undertaken ‘backdoor listings’ include China Resources, China Travel, China Overseas Land and Investment, and China International Trade and Investment Corporation. Their shares are often referred to as ‘red chips’. It has been estimated that during 1991–93 Chinese companies used about US$2.7 billion to obtain 29 ‘backdoor listings’ in Hong Kong. Initially, neither the Chinese nor Hong Kong authorities discouraged these activities. However, as the practice went on, some companies were found to have muddled accounts, substandard disclosure and inflated assets. In many cases it was not clear whether the funds raised from rights issues were actually used for the intended purpose. There were also indications that Chinese enterprises used ‘backdoor listings’ as a way to transfer state assets out of China.10 To maintain the reputation of the SEHK, from May to September 1993 the Hong Kong authorities took a series of actions to tighten rules on ‘backdoor listings’ and rights issues. In May 1994, the Chinese government banned the practice of ‘backdoor listings’ on overseas stock markets (Goldstein and Folkerts-Landau, 1994, p. 99; ZSZ, 2 July 1994). On the other hand, the spontaneous ‘backdoor listing’ activities led both Chinese and Hong Kong authorities to the view that there was a real need to regulate Chinese enterprises’ access to the Hong Kong equity capital market. In 1992 China announced that nine Chinese SOEs would be officially listed on the SEHK. During 1993 Chinese and Hong Kong securities authorities worked closely to develop a regulatory framework for the listings. Between July 1993 and May 1994 shares of the nine selected Chinese SOEs were launched in Hong Kong, raising a total of US$1.5 billion. Chinese shares listed on the SEHK are known as H-shares. In 1993, by purchasing 13 per cent of the Hshares of Tsingtao Brewery, Anheuser-Busch acquired 5 per cent of the entire

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capital of the Chinese company. In the following year, through a similar method Atlantic Richfield and Asea Brown Boveri respectively acquired 9.9 per cent and 1.9 per cent ownership of Zhenhai Refinery and Harbin Power Equipment (Goldstein and Folkerts-Landau, 1994, pp. 99–100; Special Correspondent, 1994, p. 29; Hernandez, 1995, p. 4). By the end of 1995 a total of 17 Chinese enterprises had issued H-shares, raising a total of US$2.6 billion (Table 5.2). Chinese enterprises have also listed shares on the New York Stock Exchange (NYSE), known as N-shares. From 1992–94, six Chinese companies raised a total of US$1.3 billion through N-shares issues (Table 5.2). Apart from the advantage of prestige, listing on the NYSE allows Chinese companies to raise funds more cheaply due to NYSE’s higher price/earnings ratios than SEHK’s. On the other hand, the NYSE, contrary to its normal practice of requiring intending share issuers to provide a three-year track financial record, accepts Chinese enterprises for listing based on one year’s audited accounts and unaudited results for the previous two years, whereas the SEHK requires all H-share issuers to provide three years of audited statements. The NYSE’s special treatment of Chinese enterprises led to criticisms that it was lowering its regulation standards to lure Chinese companies (FEER, 4 August 1994, pp. 90–91; Goldstein and Folkerts-Landau, 1994, p. 100). In fact, listing of Chinese enterprises on the SEHK and NYHK has induced stock exchanges in other places, including Britain, Japan, Australia and Singapore, to seek agreements with China, in order to secure ‘a slice of the Chinese listing pie’ (World Bank, 1995b, Vol. 2, p. 135; SCMP, 29 March 1996). As of the mid-1990s, Chinese shares were listed on stock exchanges in Hong Kong, the United States, Canada, Australia, Singapore, and Norway (JS, 12 May 1995).11 A series of advantages of international listings have been claimed. First and foremost, overseas listing provides a direct channel for Chinese enterprises to raise equity capital abroad. Second, it serves as an ongoing source of corporate governance, forcing the enterprises to continue restructuring and improving efficiency. Third, overseas listing speeds up development of the Chinese securities market towards international standards. Fourth, it helps promotion of Chinese enterprises’ global business by establishing an international presence. Fifth, listing abroad reduces the state’s intervention of foreign-listed enterprises. Finally, listing on the SEHK strengthens Hong Kong’s status as an international financial centre (JS, 4 February and 25 May 1994). On the other hand, there were concerns that foreign listings would have a negative impact on the domestic securities market. As the highest quality enterprises were selected for foreign listings, domestic investors were left only with less favourable choices. Moreover, issue of H-shares and N-shares created unfavourable competition for B-shares. Lastly, foreign listings involved significant transaction and adjustment costs (JS, 4 February 1994).


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In this debate about whether to encourage Chinese shares to be listed abroad, the pro side gained the upper hand over the cons. A senior CSRC official confirmed that China would continue the policy of international listings. Eighteen enterprises, mostly in the transportation industry, were ‘actively preparing’ for foreign listings (MB, 31 January 1996). However, it has been argued that overseas listing contributes only to the internationalization of Chinese enterprises’ sources of financing; it is further development of the Bshare market that would lead to a real internationalization of China’s securities market itself (ZZB, 9 February 1996). Mergers and Acquisitions Foreign investors could also participate in China’s privatization through mergers and acquisitions (M&A). The emergence of M&A in China stemmed from the huge financial losses of Chinese SOEs. As of 1995, about half of the some 100 000 Chinese SOEs were in the red. The losses, which amounted to a total of over 40 billion yuan, used to be covered by the state. However, the central government has made it clear that SOEs cannot expect endless support from the state. Hopeless enterprises have been urged to merge or go bankrupt, and a number of property rights exchanges have been established across the country to facilitate M&A. In 1995, there were 330 cases of merger and over 100 of bankruptcy (CD, 19 February, 25 April and 17 May 1994; CEN, 30 May 1994; MB, 15 March 1996). The state’s encouragement of M&A, however, was restricted to domestic enterprises. Foreign involvement was sensitive. As a semantic game to avoid political and ideological obstacles, foreign acquisitions of Chinese SOEs through M&A have been conducted under the name of ‘grafting into foreign capital’ (jiajie waiz). Debates on whether foreign investors should be allowed to participate in China’s M&A activity have focused on the so called ‘Zhongce phenomenon’. Zhongce is the Chinese name of China Strategic Investment (CSI), a Hong Kong-based company with Hong Kong and US capital. From 1992 to 1994, CSI spent 3.3 billion yuan to acquire over 51 per cent stake in more than 100 Chinese SOEs, restructuring them into 35 ‘Sino–foreign joint ventures’. Some of the most profitable ventures were then listed on foreign exchanges, including the NYSE, generating huge profits for CSI. As ‘Chinese characteristics’ (Zhongguo tese) of the takeover, the terms of the ‘joint ventures’ are for 50 years, and CSI promises to share with the Chinese side the responsibility of arranging employment for existing staff and settling retired workers (Hernandez, 1995, p. 6; Hu, 1994, pp. 74–76).12 In a Chinese theorist’s view, strictly speaking, what the CSI case involved is only formation of joint ventures, not M&A (JS, 23 August 1994). However, as a foreign investment consultant observed,

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Shareholding system reform in China joint venture is the Chinese approach to M&A. … In the West, M&As are generally undertaken through the issuance and sales of new shares. In China, however, since most of the enterprises belong to the state, the M&A has to be structured as a joint venture. The Chinese enterprise would then inject its state assets as its portion of the paid-up capital, while the foreign party would put up the cash. (Hernandez, 1995, p. 6)

Having been legalized since 1979, establishment of joint ventures is politically and ideologically much less controversial than M&A. Many foreign investors have thus chosen to conduct M&A in China under the banner of joint venture (XB, 19 April 1996). Hence, in the Chinese context, M&A can be regarded as a specific form of joint venture. However, there is the difference that, whereas joint venture usually refers to formation of new enterprises and ‘creation of new economic composition’, M&A involves injection of foreign capital into existing SOEs (Hu, 1994, p. 75).13 Since only M&A but not joint venture would result in transfer of state ownership to foreign hands, we regard M&A in particular but not joint venture in general as a form of foreign participation in China’s privatization.14 CSI’s activities in China have caused a serious debate among Chinese theorists. Supporters of the case argue that through ‘grafting into foreign capital’, CSI has successfully retooled its Chinese subsidiaries, turning them into profit-making enterprises. Apart from capital, the Hong Kong company has also brought in advanced management. This would produce a demonstration effect for the overall restructuring of Chinese SOEs (Hu, 1994). Moreover, CSI’s takeovers were said to be consistent with global M&A practice and trends, and are compatible with Chinese law. They would promote development and standardization of China’s property rights exchange market (Li S.G., 1994). It was argued that although the CSI case is not perfect, it is a ‘feasible choice for the utilization of foreign capital by Chinese SOEs’ (GS, 6 August 1994). The more cautious view is that China still lacks the theory and practice to draw conclusions about CSI’s activities. Any immature judgment may lead to wrong policy decisions (Qin, 1994). Chinese SOEs gained only CSI’s initial limited investment, but lost their own chance to raise funds overseas (JS, 7 December 1994). An editorial in Jingji ribao (Economic Daily) warned that exaggeration of the positive impact of the case had led to the ‘unhealthy tendency’ of choosing the best enterprises for ‘grafting into foreign capital’. Too much attention had been paid to the amount of foreign capital absorbed, without any concern for enterprise performance, expropriation of state assets, the motives of foreign investors, and loss of state ownership (JR, 1 November 1995). High-profile reports have been made on a serious labour dispute in a CSI subsidiary in China, leading to further challenge against M&A by foreign investors (MB, 16 November 1995). In March 1996 a front-page article in the


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authoritative Jinrong shibao (Securities Daily) made a severe attack on CSI, criticizing the company for ‘reaping profit without actual investment’ (kongshou taoli) (JS, 18 May 1996). Chinese leaders were also divided over the CSI issue. Many senior central government officials took the CSI-model as a feasible way to revitalize Chinese SOEs (MB, 16 November 1995). On the other hand, the then VicePremier Zhu Rongji, the country’s economic tsar, allegedly condemned the speculative nature of CSI’s maneuvering in China, and ordered regulation of sales of stakes in SOEs. Despite disagreement among the top leadership, the practice of ‘grafting into foreign capital’ has become increasingly common in China. According to one estimate, in 1994 foreign firms invested US$19.7 billion in 490 M&A transactions, up from $15.2 billion in 1993. In fact, a survey conducted by an international consultancy and accounting firm indicates that China has emerged as the most popular target country in the world for M&A activity (Hernandez, 1995, pp. 4 and 6). M&A by foreign investors in China have shown six major trends. First, foreign buyers have shifted their targets from small and loss-making SOEs to medium-size and more efficient key enterprises. Second, foreign investors have asked for a bigger stake in the enterprises. Third, while earlier M&A were rather dispersed and random, foreign investors have shown particular interest in a few selected sectors such as tyre-making and pharmaceutical industries. Fourth, after M&A, some enterprises have been listed abroad. Fifth, through installments, foreign investors have used a small amount of capital to acquire a controlling stake in Chinese companies. Sixth, after M&A, individual enterprises have been grouped into conglomerates (ZSZ, 22 April 1995). The central government regarded the third and fourth trends, and the tendency to underprice state assets, as ‘chaos’ that should be corrected (CEN, 18 December 1995). In view of the above, the central government’s policy was to regulate foreign M&A activity, in order to make it an official means to retool SOEs. In mid-1995, the State Economic and Trade Commission issued a notice requiring ‘grafting into foreign capital’ projects to be approved by it (CEN, 31 July 1995). In early 1996 a spokesperson for the Commission said that rules were being drafted to attract foreign investment in loss-making SOEs. According to him, the government was hoping to encourage foreigners to invest ‘more in existing state enterprises than in establishing new companies’ (SCMP, 29 March 1996; my own emphasis). As mentioned, in the Chinese context investment in existing SOEs distinguishes M&A from formation of joint ventures. The statement just quoted thus suggests that M&A was replacing joint ventures as the major form of China’s utilization of foreign capital.

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THE CHINESE CASE IN COMPARATIVE PERSPECTIVE We have now identified the major forms of foreign participation in China’s privatization. Although there has been no official privatization programme in China, the country’s shareholding economic reform has enabled foreign investors to acquire ownership of Chinese state assets. At the end of April 1995 foreign shares represented over 10 per cent of all Chinese shareholding enterprises’ capital stock (JS, 7 June 1995).15 However, measured in terms of the share of foreign exchange in total privatization revenue, in 1993 foreign involvement accounted for almost 60 per cent of China’s privatization, compared to merely 5 per cent in 1991.16 Despite the rapid increase during the period, the extent of foreign participation in China’s privatization remained smaller than in other transitional economies in Europe and Central Asia (TEECA) (Table 5.3). TEECA are eager to attract foreign participation in their privatization projects because foreign investors are believed to be ‘active and “responsible” owners’, who can bring in immediate economic benefits to the host countries Table 5.3 Share of foreign exchange in total privatization revenue in the developing world (%) 1988 1989 1990 1991 1992 1993 1988–93 1994 Developing World East Asia and the Pacific Europe and Central Asia Latin America and the Caribbean Middle East and North Africa South Asia Sub-Saharan Africa China

9 6 70

14 0 67

32 0 26

38 11 56

31 30 60

44 46 67

34 31 57

65 69 51

8

13

35

37

24

33

30

21

0 0 0 0

7 3 1 0

0 36 51 0

19 0 20 5

28 3 28 9

48 2 88 59

44 2 28 23

25 37 83 N.A.

Note: Data on the developing world include various forms of privatization, such as direct sales of public assets to private investors in the form of public offerings or private placement, and contracting out of government services through concessions or licensing agreements (Sader, 1995, p. 2). Data on China, however, cover only privatization through issuance of A-shares, B-shares, and H-shares. The two sets of data are therefore not perfectly comparable. Moreover, the actual share of foreign participation in China’s privatization should be more than is indicated in the table, because the Chinese data do not include purchase of A-shares by foreigners, conversion of state shares and corporate shares into foreign shares, issue of N-shares, and mergers and acquisitions by foreigners. Source: 1988–93 data on the developing world are from Sader (1995, p. 34), and 1994 data from the World Bank (I am indebted to Andrea Anayiotos, consultant, IECIF, the World Bank, for providing me with the 1994 data). Data on China are from Liu (ed.) (1993, p. 806).


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through raising efficiency, internationalization, and integration in the world economy (Artisien-Maksimenko and Rojec, 2001, p. 3). Specifically, as supply of domestic capital in TEECA has been scarcer than in China, there has been a heavier reliance on foreign participation in TEECA’s privatization than in China. Privatization in TEECA took place before formation of wealth in the private sector. With a ratio of domestic money stock of 30 per cent to 50 per cent of the national output, and given the low savings rate of 2 per cent to 7 per cent of disposable income, people in TEECA generally lack the necessary funds to buy state assets. As a result, the privatization deals have mostly been concluded with foreign companies (Welfens, 1994, p. 36; Frydman and Rapaczynski, 1994, pp. 60 and 157). In comparison, when privatization in China began, earlier economic reform had significantly augmented people’s consumption and investment power. From 1980 to 1992 the money stock in proportion to China’s gross domestic product rose rapidly, from 26 per cent to 67 per cent, and the domestic saving ratio from 30 per cent to 37 per cent (World Bank, 1994, p. 184; 1995c, p. 172). With only a few exceptions, such as Poland17 and Russia18, foreign participation was generally regarded by TEECA governments as a major highway to privatization. The keyword was ‘sell everything’. But in reality, foreign investors were often frustrated by a range of problems, including restrictions on foreign owners’ personnel policy, inheritance of liabilities, and unforeseen environmental costs (Major, 1993, pp. 91–92). Among TEECA, Hungary has been the most receptive to foreign participation in privatization: equal treatment between foreign investors and Hungarian citizens, and between joint ventures and domestic enterprises; no specific limit on the objective and share of foreign investment; complete legal protection to every foreign investment; free redemption and repatriation of profits; and no restriction on appointment of foreign directors. Between 70 per cent and 80 per cent of Hungarian stocks were transacted in Vienna rather than the domestic Budapest Stock Exchange. In mid-1992 foreign investment accounted for 70 per cent of the Hungarian government’s receipts from privatization (Faur, 1993, pp. 204–6; Meszaros, 1993, pp. 199–202; Simoneti, 1993, p. 100; Torok, 1993, pp. 379–80). Initially, China, like Hungary, did not set any specific limit on the share of foreign ownership.19 No restriction was mentioned in a set of provisional regulations published in January 1995.20 The concern for loss of control of Chinese enterprises to foreign investors led to voices arguing that a ceiling of 50 per cent should be imposed on foreign ownership (CEN, 5 June 1995; JS, 20 October 1995). Then, in June 1995, the Chinese government published a document21 specifying in which sectors foreign investment was encouraged, restricted or prohibited. It stipulated that the state had to hold a majority (over 51 per cent) share in some types of transportation, energy, and machine-building projects. Strategic sectors such as media and military production would be

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completely closed to foreign participation (CEN, 24 and 31 July, 30 October 1995). In addition to this direct ownership restriction, foreign investors have been discouraged from the Chinese market by factors such as corruption, absence of legal framework, foreign exchange control, and political uncertainties (Karmel, 1996, pp. 533–43). According to one study, these indirect barriers are even more important than direct ownership restrictions in preventing global equity market integration (Bekaert, 1993). Nevertheless, China, as a late participant of the global privatization trend, has achieved impressive results in the competition for international capital. The wave of worldwide privatization has led to the situation where ‘there are too many assets (enterprises) searching for too few buyers’ (Lieberman, 1993, p. 15). Although the Chinese environment for foreign involvement in privatization has not been particularly attractive compared with other developing countries, it has managed to capture a significant proportion of international capital, thanks to the country’s rapid economic growth and the huge potential of its domestic market.22 According to World Bank records, from 1992 to 1995 over US$2 billion international capital was raised in the form of closed-end funds earmarked for China’s securities market. The amount accounts for about 22 per cent of the total for all developing countries (Table 5.4). In short, as part of the global trend, there has been growing foreign participation in China’s privatization. While the country has not had any official privatization programme for foreign investors, significant amounts of state assets have been transferred to the hands of foreign investors through the shareholding economic reform. The securities market has served as an important channel for this process, and foreign participation tends to promote China’s integration into the world economy (Karmel, 1996). The creation of domestic wealth by earlier economic reform has reduced China’s desperation for foreign capital. In fact, while privatization to foreign owners has improved enterprise performance in TEECA, China has benefited mainly from privatization to domestic owners (Estrin et al., 2009). However, foreign involvement has the unique advantages of supply of convertible funds, introduction of advanced technology and management and marketing skills, establishment of links with the world economy, provision of impetus to domestic enterprise reform and restructuring, and speeding up capital market development. On the other hand, China shares some general concerns about sales of SOEs to foreign investors: loss of national patrimony to foreign hands; exposure of ‘basic’ or ‘strategic’ sectors to foreign control; and foreign ‘exploitation’ of the national economy (Bornstein, 1994a, p. 242; JS, 21 September and 26 October 1995; ZZB, 23 August 1995 and 16 January 1996). The increasing share of foreign involvement in China’s privatization suggests that the pro side has gradually won over the con side. However, given that a clear legal framework is still absent and the issue remains politically sensitive,


Table 5.4

Closed-end country funds for China

Launch year

Name of fund

1992

Cathay Clemente (Holdings) Ltd. China Fund (HKSE) China Fund Inc. China Investment Company China Investment and Development Fund Credit Lyonnais China Growth Fund Greater China Fund Jardine Fleming China Region Fund Lloyd George-Standard Charter China Fund Ltd. Shanghai Fund (Cayman) Ltd. Shanghai Fund (Cayman) Ltd. Wardley China Fund Ltd. China Investment Trust Plc. Templeton China World Fund Inc. Jardine Fleming China Region Ltd. Fleming Chinese Investment Trust Plc. CH China Investments Ltd. Shanghai Growth Investment Ltd. Guangdong Development Fund Ltd. Templeton Dragon Fund Ltd. AusChina corp Ltd. Total

1993

1994

1995

Source:

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Initial capitalization (US$ million) 59.4 50.0 120.0 27.0 31.4 20.0 94.2 96.0 49.0 17.7 8.8 89.9 18.5 298.9 46.2 90.8 23.7 104.0 97.0 795.0 5.2 2142.6

World Bank (1995d; 1996).

foreign participation in China’s privatization has remained a matter that ‘can be practised, but not said’ (nenggan bu nengshuo), a distinct feature that characterizes China’s reform.

THE STATE, FOREIGN CAPITAL, AND DEPENDENT DEVELOPMENT The Chinese case has theoretical significance. Since the 1970s, political science has undergone a shift of interest from a society-centred to a state-centred perspective. The role of the state as a key conceptual variable in political

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analyses has been restored.23 A major impact of this on development studies has been the revision of classical dependency theory into dependent development theory. According to classical dependency theory, such as that of Andre Frank (1969), the world economy consists of chains of dependency extending from the ‘centre’ to the ‘periphery’. The centre expropriates and appropriates a large part, if not all, of the economic surplus of the periphery. Such dependency makes development of the periphery impossible. In this model, Third World states are mere agents of the centre, and thus are not expected to play any positive role in development. However, on the basis of the case of Brazil, Peter Evans (1979) argued against the rather deterministic view of classical dependency theory. According to him, development can be achieved despite dependency if a ‘triple alliance’ of foreign capital, the state and the national bourgeoisie can be formed. In this model, although the state is constrained by the centre’s interests, it also has its own interests in local capital accumulation. By playing an active role, the state can be ‘one of the keys to the movement from a situation of classical dependence to one of dependent development’ (Evans, 1987, pp. 211–12). While the dependent development analysis was originally developed in the context of Latin America, York Bradshaw and his associates applied it to African and East Asian countries (Bradshaw and Tshandu, 1990; Bradshaw, Kim, and London, 1993). In their view, a distinction should be made between the effects of international trade and foreign direct investment. Whereas trade relationships are likely to be mutually beneficial, foreign direct investment is conducive to development only if the host government maintains effective control over multinational corporations. The implication is that dependent development is available only to countries with relatively strong states. The dependent development thesis’s emphasis on the state’s control over foreign capital has led many to suggest socialism as the prescription for classical dependency.24 It is expected that the characteristically strong state apparatuses of socialist countries will make rational use of foreign capital for national economic development, without subordinating the domestic economy to the capitalist centre. In reality, however, most socialist countries chose to avoid classical dependency by breaking ties with the capitalist world economy, rather than to achieve dependent development by commissioning the state to regulate foreign capital. The effectiveness of the socialist state in converting classical dependency into dependent development is thus largely untested. The opening of China to foreign trade and investment since the late 1970s has made the country a good case for the examination of the role of the socialist state in dependent development. Unlike most post-communist countries, where the original socialist state structures had collapsed before they were integrated into the global capitalist market, the Chinese communist party-state


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has remained to be the chief initiator and designer of the country’s reform. Among other surviving socialist states, China is the largest economy that has adopted an open economic policy. It is thus important to investigate the role of the Chinese state in the governance of foreign capital in the country. The findings will have implications not only for surviving socialist states, but also for post-communist countries searching for a new role of the state in the economy.25 There have been three studies on China’s control over foreign direct investment in the country, conducted by Kleinberg (1990), Pearson (1991), and Lee C. (1997). These scholars all found that the Chinese state has played a positive role in directing foreign capital towards national economic development, and has been able to prevent multinationals from repatriating surplus out of the country. The Chinese state thus seems to be strong enough to save the country from the fate of classical dependency.26 This may be true as far as foreign direct investment – the focus of all these three studies – is concerned. As noted, compared with trade, foreign direct investment requires a higher degree of control by the host government if such investment is to produce positive effects in the host country. Unlike the three studies mentioned above, in this chapter we have examined how foreign capital has participated in China’s privatization mainly through portfolio equity flows. Compared with trade and foreign direct investment, portfolio equity flows tend to exhibit a much higher degree of volatility, and should thus be subject to even closer state scrutiny. Is the Chinese state strong enough to carry out this task, so that classical dependency can be turned into dependent development? We tackle this question by focusing on the role of the Chinese state in governing the acquisition of state assets by foreign capital. We begin by examining different approaches to conceptualizing the Chinese state. China as a Developmental State The search for new approaches to conceptualize the Chinese state began in the 1980s, as the traditional Leninist-totalitarian model failed to capture the increasingly complex political, economic, and social dynamics in post-Mao China. The first major alternative that emerged was the developmental state approach. Developmental states, as defined by Leftwich, are those states ‘whose politics have concentrated sufficient power, autonomy and capacity at the centre to shape, pursue and encourage the achievement of explicit developmental objectives, whether by establishing and promoting the conditions and direction of economic growth, or by organizing it directly, or a varying combination of both.’ Such states can be found in Asia, Africa, and, historically, Europe, according to Leftwich (1995, pp. 401 and 420). Yet most of the discussions on developmental states have been based on East Asian experience (Douglass, 1994; Onis, 1991; Thompson, 1996).

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It is also in the East Asian context that the concept of developmental state was applied to China. According to White and Wade (1988), East Asian countries such as Taiwan and South Korea are exemplars of ‘capitalist guided economies’. By guiding the development of the capitalist market, the Taiwanese and South Korean governments perform the important functions of developmental states. In China, White and Wade argue, the major theme of the reform has been to shift the balance between the state and market in favour of the latter. The direction of change is towards a ‘socialist guided market’. While basic-level units of production have been granted greater power to make decisions according to market considerations, the state has continued to be interventionist by defining the goals, priorities, and paths of development. In this process the socialist state structures play the positive role of the developmental state. Hence, according to White and Wade, the ‘capitalist guided economies’ in Taiwan and South Korea and the ‘socialist guided market’ in China can be grouped under the same conceptual category of ‘developmental state’. However, Breslin (1996) argued that the Chinese state is not developmental. Rather, it has been suffering from ‘dysfunctional development’ in three aspects. In the first place, political demands from within the party-state and other societal groups have undermined the relative autonomy of the Chinese state, making it unable to formulate a coherent and effective national development strategy. Second, the decentralization of decision-making power to local level has weakened the central state’s ability to coordinate national development. Finally, as a result of the open door policy, China’s national development strategy has been subject to the influence of external economic factors. Hence, in Breslin’s view it would be a mistake to apply the concept of developmental state to the case of China. China as a Corporatist State The concept of ‘developmental state’ seeks to define a balance between the state and market, but it says nothing about how interests in the state and market are organized, and how they interact with each other. It is here that we need to turn to corporatism. There have been a number of definitions of corporatism. The most widely used one, put forward by Schmitter, says that corporatism is: a system of interest representation in which the constituent units are organized into a limited number of singular, compulsory, noncompetitive, hierarchically ordered and functionally differentiated categories, recognized or licensed (if not created) by the state and granted a deliberate representational monopoly within their respective categories in exchange for observing certain controls on their selection of leaders and articulation of demands and supports. (Schmitter, 1974, pp. 93–94)


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While most corporatist cases are found in Europe (Schmitter, 1993, p. 197), Lee, Peter Nan-Shong (1991) applied the concept to synthesize two conflicting images of the Chinese state: on the one hand, the Chinese state is seen as dominant in defining industrial policy, but on the other hand it seems powerless in improving industrial performance in the post-Mao era. According to Lee, as the Chinese state realized the institutional and functional constraints on its domination, it has had to ‘license’ industrial power to enterprises, in exchange for their cooperation in extracting resources from the economy.27 In such a way, the formerly totalitarian Chinese state has ‘metamorphosed’ into a corporatist state. From a different angle, Unger and Chan (1996) discuss China’s corporatism in an ‘East Asian context’.28 Their starting point is that corporatism stresses consensus, cooperation, and goal-oriented harmony. As such, it is favoured by East Asian countries such as Taiwan, South Korea and China, because corporatism tends to bring about political and social stability that is favourable to rapid economic growth. In the case of China, when the state decided to relax its control over the economy and society, it needed a mechanism through which power could be decentralized in an orderly manner. Using corporatist measures, the Chinese state gradually changed from a direct command system to one that rules indirectly through authorized agencies, which are the numerous state-created and state-led associations and organizations. In each sector, only one surrogate is recognized as the valid representative. As the state plays a leading role in such institutionalization of sectoral interests, Unger and Chan’s analysis synthesizes the usual ‘state versus societal corporatism’ division into state-led societal corporatism.29 Unger and Chan noted that the hierarchy of Chinese corporatism consists of three levels. At the national level, there is ‘peak corporatism’ that emphasizes firm though indirect state control of the designated organizations. At each lower layer of regional government – province, city, county, township and village – there is ‘regional corporatism’ by which the regional government organizes power among associations operating at that level. Finally, a form of ‘micro-corporatism’ is emerging in some state enterprises to mediate between management and workers. It is through this three-tier corporatism that sectoral interests are organized to provide a politically and socially stable environment for economic development (Unger and Chan, 1996, pp. 107–28). For Oi (1992 and 1995), it is regional corporatism that has been the driving force of China’s economic growth. According to Oi, a major characteristic of China’s fiscal reform has been the assignment to local governments of property rights over increased income. Induced by this, local officials have entered into a wide range of business activity. While local officials may reap personal benefits from this, an objective result has been the speeding up of local economic development. Oi called this phenomenon ‘local state corporatism’,

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which refers to ‘the workings of a local government that coordinates economic enterprises in its territory as if it were a diversified business corporation’(Oi, 1992, pp. 100–101; original italics). A different assessment of the effect of China’s fiscal reform is that the change has caused a significant decline of central state capacity (Wang S.G., 1995). One may derive from this the view that the rise of ‘local state corporatism’ has weakened the Chinese state’s ability to perform the role of a developmental state. Oi agreed that ‘there is a need for strong state capacity, but this capacity should exist at both the local and the central levels’ (Oi, 1995, p. 1147). The essence of the developmental state is an appropriate balance between state intervention and the market. For Oi, that effective state intervention need not come from the centre; the Chinese case proves the success of ‘strong local state intervention’ (Oi, 1992, p. 124). In this sense, ‘local state corporatism … is a qualitatively new variety of developmental state’ (Oi, 1995, p. 1133). Despite Oi’s use of the term ‘corporatism’, in her analysis one finds little use of the standard corporatist framework as summarized by Schmitter. In fact, Oi admitted that her use of the term ‘corporatism’ differs from the common usage. By corporatism Oi referred mainly to the ‘merger of state and economy’ (1992, p. 100). Such a feature, however, may better be conceptualized as state entrepreneurialism, to which we now turn. China as an Entrepreneurial State A common weakness of the concepts of ‘developmental state’ and ‘corporatist state’ is that they fail to differentiate the Chinese state from other East Asian states. It is true that China shares many developmental and corporatist characteristics with Taiwan and South Korea. But it is only the Chinese state that itself runs profit-seeking, risk-taking business. This unique feature of the Chinese state is captured by Blecher (1991) and Duckett (1996) in their idea of the entrepreneurial state. According to Blecher, ‘what is distinctive about the entrepreneurial state is the establishment and operation by state agencies of enterprises not merely to assist the agency in carrying out its assigned task, but in order to earn profits’ (1991, p. 268). He found that state agencies in Guanghan County in Sichuan Province have been engaged in a wide range of entrepreneurial activity, including construction, banking, and manufacturing. Likewise, Duckett observed that state bureaux in Tianjin had adapted to marketization by setting up large numbers of new enterprises that operate on the newly emergent markets. These new enterprises were established for the purpose of generating profits for their bureaux. This helps state bureaux to reduce their financial burden and streamline state administration. State entrepreneurialism has thus become a survival strategy of state bureaux.


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Both Blecher and Duckett see the concept of entrepreneurial state as a useful supplement to that of the developmental state. Blecher noted that there is a ‘tendency to exclude entrepreneurship from the developmental role of the state’ (1991, p. 266). In the developmental state approach, the role of the state is restricted to the creation, promotion and administration of an environment that is favourable to development. But the state itself refrains from being engaged in entrepreneurial activity. An entrepreneurial state exceeds this limit. In this model, state agencies ‘are directly and feverishly involved in starting new enterprises, procuring finance, scrambling for inputs and competing for output markets’ (1991, p. 287). In Blecher’s view, both the developmental state and entrepreneurial state perspectives are useful for the understanding of political and economic changes in China. He found that the developmental state model tends to be applicable to places where the socialist planning legacy is strong, geographical location is remote, and links to the larger economy are weak; whereas state entrepreneurialism is likely to be found in localities where the planning structure was devastated during the Cultural Revolution period, the emphasis of reform is on retooling state enterprises rather than promoting private businesses, connections with major economic centres are available, and the economic base is relatively strong and balanced (1991, pp. 283–85). From another angle, Duckett also noted the complementarity of the concepts of developmental state and entrepreneurial state. According to her, the term ‘entrepreneurial state’ refers collectively to the independent activities of state bureaux, but it is not a comprehensive model of the state. While business has become an important focus of bureaux’ work, they still carry out their other administrative functions. For this reason, the entrepreneurial state does not necessarily challenge the ‘developmental state’ model. (Duckett, 1996, p. 189)

Whereas Blecher held that locational conditions determine the applicability of each model, Duckett argued that the developmental state perspective is more suitable for national analyses, and the entrepreneurial state model for regional studies. In her view, the developmental state model focuses ‘on the developmental capacity of the central leadership or government and higher echelons of the national bureaucracy. … The concept of state entrepreneurialism helps refine the notion of the developmental state by disaggregating it and examining its constituent parts’ (Duckett, 1996, p. 189). In short, Blecher and Duckett agreed that both developmentalism and entrepreneurialism can be found in the Chinese state, depending on which locality or level of analysis the focus of study is concerned with. Whereas developmentalism hypothesizes autonomous state intervention in the form of creating, promoting and administering a favourable market environment at the national and macro level, entrepreneurialism predicts direct involvement of the state in business activity at the local and microeconomic level.

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China as a Market-Facilitating State While developmentalism and entrepreneurialism complement each other, Howell (1993) combines the two perspectives into the idea of the marketfacilitating state. Contrary to the liberal view, Howell argued that China’s reform and opening has not led to a retreat of the state. Rather, to adapt to the new environment and to meet new requirements, the state has undergone a process of major restructuring, resulting in a market-facilitating state that possesses the following four key features: first, it is entrepreneurial, that is, it both promotes entrepreneurship and engages itself in risk-taking, profit-seeking economic pursuits; second, it is legalistic, that is, it legally defines relations between economic actors in the market-place and settles economic disputes through the law; third, it is technocratic, that is, the state is run by technically and professionally qualified people; and finally it is regulatory, that is, it seeks to regulate the market at the macro-economic level whilst withdrawing through deregulation from the tangle of the microlevel. (Howell, 1993, p. 181)

Among the four features, entrepreneurialism is captured by the entrepreneurial state perspective, whereas the legalistic, technocratic, and regulatory functions are the key elements of a typical developmental state. Hence, the ‘market-facilitating state’ perspective can be seen as a combination of the entrepreneurial state and developmental state models. The hypotheses of developmentalism and entrepreneurialism mentioned above thus apply also to the market-facilitating state perspective. Howell observed that a larger number of ‘quasi-state institutions’ have emerged in China. ‘They are quasi-state in that they are set up and owned by the state but are supposed to behave like business enterprises’ (Howell, 1993, pp. 193–94). These quasi-state institutions are responsible for their own profits and losses, and display greater economic initiative and innovation than other state enterprises. As such, they constitute what Blecher and Duckett called entrepreneurial state. But more than entrepreneurialism, Howell noted, these quasi-state institutions also performed the function of mediation between the state and foreign capital. For example, the China International Trade and Investment Corporation is a government entity directly under the State Council. It is run as a business corporation to deal with foreign traders and investors. This conflicts with Evans’s ‘triple alliance’ model (see above), in which the state acts only as a neutral mediator between national bourgeoisie and foreign capital. The open policy has also made the Chinese state more legalistic, Howell noted. In order to create a legal environment that is more favourable to foreign trade and investment, China has devised a number of laws and regulations on joint ventures, taxation, patents, foreign exchange management, accounting, customs, and entry and exit procedures. Another consequence of the opening


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up of China has been the cultivation of, in Howell’s word, ‘a layer of technical and professional cadres’. To equip the state with the manpower that is capable of handling technical matters related to foreign trade, investment, and technology transfer, a large number of more educated, younger, and bettertrained professionals have been recruited into state or quasi-state institutions. This has made the Chinese state increasingly technocratic. Finally, as foreign economic activity demands greater flexibility and initiative at the lower level, the open policy has transformed the role of the state from being commanding to regulatory. Economic decision-making power has been decentralized from the centre to provincial, municipal, and even enterprise level. Instead of a microeconomic planner, the state has become a macroeconomic regulator of the country’s market-oriented foreign trade and investment framework (Howell, 1993, pp. 186–200). In short, according to the market-facilitating state perspective, the Chinese state has responded positively to the new external political-economic environment brought about by the open policy. It has become both entrepreneurial and developmental (legalistic, technocratic and regulatory). This contrasts sharply with the classical dependency perspective, which hypothesizes that entering into economic relations with the capitalist centre will reduce the peripheral state to a mere agent of the capitalist centre.

CONCLUSION As has been shown, there has been growing foreign participation in China’s privatization. While the country has not had any official privatization programme for foreign investors, significant amounts of state assets have been transferred to the hands of foreign investors through the shareholding economic reform. As of the mid-1990s, there were over 700 listed SHEs in China. Total capitalization, at about 1600 billion yuan, represents 24 per cent of gross domestic product (GN, 1997, No. 20, p. 10). Measured in terms of the share of foreign exchange in total capital raised through share issue, in 1995 foreign involvement accounted for 74 per cent of China’s privatization, compared with 46 per cent in 1992 (ZZQTN, 1996, p. 35).30 The Chinese state does exhibit some features of the developmental state in inviting foreign participation in the country’s privatization. The expansion of the B-share market and the gradual opening of the A-share market to foreign investors were deliberate policies defined explicitly and autonomously by the central state in order to obtain external equity financing and international financial techniques. When signs of illiquidity emerged, the state acted to activate the market by enlarging its scale. The form of state intervention has been at the macro- but not microeconomic level.

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However, there have also been signs of ‘dysfunctional development’ in the flow of foreign capital to the Chinese state sector. Bureaucrats in general lack the professional knowledge required for the construction and operation of a financial market. More importantly, the central state has not been able to steer local authorities to remain on the intended locus of reform. As a result, the carefully designed separation between the A-share and B-share markets was weakened; large amounts of state shares and corporate shares were converted into foreign shares; state assets were transferred out of the country through ‘backdoor listings’ on foreign exchanges; and mergers and acquisitions of Chinese SOEs by foreign investors remained unregulated. In these respects, the Chinese state has not been an active designer or an effective executor of a national development strategy; rather, it has been a passive respondent to unexpected situations and local initiatives. In general, the expansion of foreign participation in China’s privatization owes at least as much to the dysfunctional activity of local authorities as it does to the plans and strategies of the developmental state. With regard to the corporatist state perspective, we see limited relevance of it to our case. We do not find any attempt on the part of the state to corporatize the interests of foreign buyers of Chinese state assets. Although the strong local initiatives which played an important role in the sales of state assets to foreign hands can be comprehended in terms of ‘local state corporatism’, as suggested by Oi, such activities can better be captured by the developmental state and entrepreneurial state perspectives. To the extent that no corporatist measure has been employed to manage different interests arising from foreign participation in privatization, the corporatist state perspective is of little use. In comparison, the market-facilitating state perspective, which combines the ideas of developmental state and entrepreneurial state, provides the best description of the role of the Chinese state in the sales of state assets to foreign investors. Developmentalism is reflected in the state’s effort to develop a legal framework for the settlement of disputes (that is, legalistic), to invite both domestic and foreign experts to give advice (that is, technocratic), and to limit its intervention to the macro- but not micro-level (that is, regulatory). But such developmentalism has been limited by the dysfunctionalism mentioned above. On the other hand, state entrepreneurialism is reflected in the state’s role as a shareholder; that is, the state itself is engaged in entrepreneurial activity.31 In dealing with foreign investors, state officials were primarily motivated by considerations of profit and efficiency. These entrepreneurial and developmental activities can be embraced by the market-facilitating perspective. The growth of foreign participation in China’s privatization can thus be seen as made possible by the market-facilitating state. As regards the role of foreign capital, although some foreign (in particular Hong Kong) investors have attempted to make use of China’s legal loopholes to increase their hold-


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ings of Chinese shares and to make abnormal profits (as in the Zhongce case), in general there is little lobbying from foreign investors for the relaxation of restrictions on sales of state assets to them. The pressure for change has come mainly from domestic (in particular local) rather than international sources. Hence, contrary to the classical dependency analysis, there is no indication that the Chinese state has become a mere agent of the capitalist centre. It is largely local authorities, rather than foreign capital, that bring about signs of ‘dysfunctional development’. This alerts us to the tendency of ‘dependency analysis’ to place too much emphasis on the role of national-level state actors, neglecting the influence of local authorities. In any event, to the extent that the Chinese state, central or local, is market-facilitating, it seems to be capable of avoiding classical dependence, and of bringing about dependent development.

NOTES 1.

2. 3. 4. 5. 6. 7.

8.

9. 10.

The World Bank maintains a global privatization database recording privatization projects that have taken place in developing countries since 1988 (Sader, 1995, p. 2). The database covers transactions involving domestic and foreign investors. However, according to information obtained from the author’s personal correspondence with the World Bank, in the case of China only those with foreign participation are included. A list of China’s privatization transactions involving foreign participation can be found in World Bank (1995d, Vol. 1, pp. 131–32; 1996, pp. 130–31). The Chinese figure is derived from data in CSY, and the developing economies’ figure is obtained from World Bank (1995a, pp. 268–69). ‘Regulations of the State Council on domestically listed shares for overseas investors.’ Full text in CEN (29 April 1996). This does not apply to joint venture investment companies formed by foreign investors and Chinese non-bank and non-financial institutions (CD, 19 September 1995). The other market ‘rescue’ measures included temporary suspension of new listings and new issues of A-shares, development of Chinese mutual funds, and provision of financing to high-quality securities firms (ZZB, 30 July 1994; CEN, 22 August 1994). By the end of 1995 private foreign exchange savings at the Bank of China, which accounted for about 60 per cent of the country’s total, had reached US$13.7 billion (CD, 28 January 1996). Such high-profile moves to allow domestic investors to trade B-shares have upset the central government, prompting the People’s Bank of China to persuade Shenzhen securities authorities to enforce the official ban on the practice. While there has been a warning that a crackdown on the trading of B-shares by domestic Chinese ‘could be imminent’, Shenzhen-based analysts believed that the chances of a complete ban were not high because it would seriously damage the market (SCMP, 25 and 26 June 1996). Rather than direct defiance, some foreign investors have found alternatives to bypass the restriction. For example, the St. Gobain Group of France acquired stakes in the White Dove Shenzhen United Company and the White Dove Kaifeng Abrasives Factory by injecting capital into the holding company of the Chinese enterprises, the Henen White Dove Group (CEN, 29 January 1996). Apart from Hong Kong, ‘backdoor listing’ activities of Chinese enterprises can also be found in other places, such as Canada (MC, 1 November 1993, pp. 42–44). In February 1995 problems of ‘red chip’ companies drew international attention as the chairman of two Hong Kong-listed subsidiaries of China’s Capital Iron and Steel Corporation, or Shougang, was arrested in Beijing on charges of corruption. After purchase of a listed shell

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11. 12. 13. 14. 15.

16. 17. 18. 19.

20. 21. 22. 23. 24. 25. 26.

27. 28.

Shareholding system reform in China company in Hong Kong in 1992, Shougang injected a pile of state assets into four other subsequent acquisitions. Shares of the ‘Shougang empire’, which had been worth US$1.4 billion prior to the arrest, slumped by a fifth, and shares of other ‘red chip’ companies were also dumped (EC, 25 February 1995, pp. 68–70; FEER, 2 March 1995, p. 16). A Hong Kong-based expert in Chinese securities called all Chinese shares listed on international exchanges other than Hong Kong ‘I-shares’ (Wu P., 1994, p. 46). But this is not a common term. For more cases of ‘grafting into foreign capital’, see Tung (1995, pp. 13–15), and Ji, Y. (1995, pp. 35–36). According to incomplete statistics, among the 260 000 foreign-invested enterprises in China, 70–80 per cent were formed in conjunction with existing Chinese enterprises (CEN, 3 June 1996). On this point, we differ from a World Bank study, which includes joint venture in general as a privatization technique (Sader, 1995, pp. 19–20). According to another source, at the end of 1994 foreign shares represented less than 2 per cent of all Chinese shareholding enterprises’ capital stock (JS, 10 January 1995). It is not clear whether this figure is comparable with the 10 per cent mentioned in the main text. The actual share of foreign exchange in China’s privatization revenue should be more than the quoted per centage. See note to Table 5.3. In Poland, foreign investors may not buy more than 10 per cent of an enterprise (Frydman and Rapaczynski, 1994, p. 23). In Russia, there are many indirect restrictions against foreign participation in privatization (Fedorov, 1993; Bornstein, 1994b, pp. 445–46; Radygin, 1995, p. 12; Schrader, 1994, p. 263). In the case of Hungary, even 100 per cent foreign ownership is allowed (except in the banking sector). But this has not resulted in foreign domination of Hungarian enterprises. Instead, foreign investors have largely remained minority stakeholders in Hungarian companies listed on the Budapest exchange. Two possible reasons have been suggested for this. Firstly, Hungarian managers may be regarded as competent enough so that external control by foreign investors is not deemed necessary. Secondly, special deals involving underpricing of state assets may have been offered by Hungarian insiders, in exchange for an assurance of maintaining their managerial control (Earle, Frydman, and Rapaczynski, 1993, p. 11; Frydman and Rapaczynski, 1994, p. 113). Namely, ‘Provisional regulations on the establishment of foreign-funded joint stock companies Ltd’. Namely, ‘Guiding directory on industries open to foreign investment’. According to Chinese analysts, foreign investors are attracted to China’s privatization mainly by the country’s growth potential, and the access to China’s market and land (ZZB, 23 and 30 August 1995). See Skocpol (1985). Although statist theorists have been successful in ‘bringing the state back in’, they have received criticisms from Almond (1988), Cammack (1989), Colburn (1988), Migdal, Kohli, and Shue (eds) (1994), and Mitchell (1991). See, for example, Cardoso and Faletto (1978). In fact, there have been views that for post-communist transition to be successful, there is a need to re-build effective state intervention mechanisms in post-Leninist states. See Cirtautas (1995) and Ellman (1995). In Kleinberg’s own words, ‘The effectiveness of state intervention into China’s economic relations invalidates the “dependent development” model as a description of multinational corporate investment in Communist countries’ (Kleinberg, 1990, p. 256). What Kleinberg actually meant by ‘dependent development’ was ‘classical dependency’. He did not make any distinction between the two concepts. Such a ‘licensing’ aspect of Chinese corporatism, according to Kerr and MacKay (1997), leads to endemic corruption, poorly defined property rights, and high transaction cost. For a note on the different uses of the term corporatism by Lee and Chan, see Chan (1993, p. 36, fn. 17).

Foreign participation and the role of the state 29. 30.

31.

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According to Pearson (1994, p. 33), such ‘state-led societal corporatism’ allows the socialist regime to pre-empt the emergence of autonomous groups. The actual extent of foreign involvement in China’s privatization should be larger than the figures here suggest, because they cover only privatization through issue of B-shares and Hshares, and do not include purchase of A-shares by foreigners, conversion of state shares and corporate shares into foreign shares, issue of N-shares, and mergers and acquisitions by foreigners. For a detailed analysis of the Chinese state as a shareholder, see World Bank (1997).

6. China’s privatization through listing state enterprises in Hong Kong H-SHARE COMPANIES AND RED CHIPS IN HONG KONG When China launched its economic reform in the late 1970s, foreign capital shortage was a major constraint to the country’s development.1 To cope with the problem, a number of channels have been opened to absorb foreign capital, namely foreign loans, direct foreign investment, and other means. Initially, most foreign capital was obtained in the form of foreign loans. From 1979 to 1991, China utilized US$52.7 billion foreign loans, representing 66 per cent of the total amount of foreign capital utilized during this period. Since 1992, direct foreign investment has emerged to be the largest source of foreign capital. From 1992 to 2000, China absorbed $320 billion direct foreign investment, accounting for 73 per cent of all the foreign capital utilized during this period. Other means include processing and assembly, compensation trade, international lease, and portfolio equity flows (PEFs). Their share in total foreign capital utilized has been negligible most of the time, with the exceptions of 11 per cent in 1997 and 15 per cent in 2000 (CSY, 2001, p. 602). What happened in 1997 and 2000 was a dramatic increase in the issue of foreign shares. Officially, there are two major types of Chinese foreign shares, B-shares and H-shares. They are both Chinese shares traded in a foreign currency (US dollar or Hong Kong dollar), with the difference that B-shares are listed on the Shanghai and Shenzhen Stock Exchanges, and H-shares on the Hong Kong Stock Exchange (SEHK).2 Before 1997, the average annual amount of PEFs absorbed through B-shares was only $0.6 billion, and that through Hshares $1.2 billion. But the amount raised through B-shares soared to $1 billion in 1997, and that through H-shares to $4.3 billion and $6.8 billion respectively in 1997 and 2000 (CSRCW, 6 December 2001; CSY, 2001, pp. 586 and 642). At the very beginning, Chinese securities officials regarded B-shares only as a transitional device to solve the dilemma between the need to acquire PEFs on the one hand, and the intention to shelter the domestic stock market from external shock on the other (Liu (ed.), 1998, p. 2). The plan was that when the domestic stock market had become mature enough, B-shares would be merged with domestic shares, or A-shares.3 On the other hand, the infrastructural inferiority of China’s embryonic stock market relative to the established one in 92

Listing state enterprises in Hong Kong

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Hong Kong has made B-shares less attractive to foreign investors than Hshares.4 Owing to these reasons, the task of absorbing PEFs has fallen largely on H-shares. In fact, during 1993–97 total PEFs obtained through H-shares amounted to $9 billion, almost triple the amount absorbed through B-shares. Although the subsequent Asian financial crisis produced a heavier blow to Hong Kong than to China, due to the greater financial opening of the former than the latter, from 1998 to 2000 the amount of PEFs obtained through Hshares was thirty times that through B-shares (CSRCW, 6 December 2001; CSY, 1998, pp. 578 and 628). Officially, H-share companies refer to those ‘incorporated in the People’s Republic of China and approved by the China Securities Regulatory Commission for a listing in Hong Kong. … The letter H stands for Hong Kong’ (SEHKW). While only a handful of central agents were involved in the nomination of H-share companies, other authorities may obtain PEFs by establishing the so-called red chips. Red chips are ‘Hong Kong-listed companies which are at least 35 per cent owned, directly or indirectly, by state institutions, provincial or municipal organizations in the mainland’ (SEHKW). As such, they ‘typically represent the interests of China’s leading ministries, the State Council, and provincial and municipal authorities’ and thus can be regarded as ‘extensions of governmental organizations operating within investment and cash-raising guidelines laid down by a holding company and a controlling government body’ (De Trenck et al., 1998, pp. 26 and 44). There are three major ways to form a red chip. First, a Chinese enterprise operating in Hong Kong lists its Hong Kong assets in the SEHK. Second, a Chinese enterprise operating in Hong Kong moves its mainland assets to Hong Kong, and then lists them in the SEHK. Third, a Chinese enterprise purchases controlling stakes in an inactive listed company in Hong Kong (Huang and Gao, 1999, pp. 390–91). The last method, known as ‘backdoor listing’, has been the most common one, adopted by about half of all existing red chips (McGuinness, 1999, p. 245). In a typical ‘backdoor listing’, a red chip uses state capital to purchase a shell company in Hong Kong, and subsequently raises funds through new rights issues. This contrasts with the case of H-share companies, which are listed mainly through an initial public offering (IPO), where new and/or existing shares are offered to local and international investors (see Table 6.1) (McGuinness, 1999, p. 9). In short, H-share companies and red chips are two different types of Chinese vehicles for the acquisition of PEFs, the former being official and the latter unofficial. ‘Red chips differ from H-share companies in that they are not mainland-incorporated companies but may be incorporated in Hong Kong or elsewhere overseas’ (SEHKW). In terms of scope of business, most H-share companies are engaged in infrastructure industries, while red chips have very diversified business interests (McGuinness, 1999, p. 10). 5

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Table 6.1


H-share and red-chip enterprises compared

H-share enterprises

Red-chip enterprises

Incorporated in China

Incorporated in Hong Kong

Mainland enterprises restructured for listing in Hong Kong

Hong Kong listed company with at least 35% mainland Chinese interest

Creation monitored by central government

Established through local government initiative

Funds raised through IPO

Funds raised through shell companies

Examples: Guangzhou Shipyard International Company Northeast Electrical Company

Example: Guangdong Investment

THE DEBATE The debate about the merits and demerits of H-share listing can be traced back to December 1991, when a Chinese study group led by a deputy director of the State Commission for Economic System Reform (SCESR) visited Hong Kong upon SEHK’s invitation. After the study, the group concluded that listing Chinese state-owned enterprises (SOEs) in Hong Kong had the advantages of helping to maintain Hong Kong’s stability and prosperity, especially during the political handover of Hong Kong in 1997; raising foreign capital for Chinese SOEs; and promoting the international presence of Chinese SOEs. On the other hand, the study group identified a list of disadvantages: less technology spillover effect than direct foreign investment; need to share profit with foreign shareholders; and competition with China’s domestic stock exchanges. On balance, the study group advised the State Council that the gains from listing Chinese SOEs in Hong Kong were ‘large’, while the losses were ‘small’. The State Council responded by giving a cautious green light to the plan (Liu (ed.), 1998, pp. 2–5). On 15 July 1993, Tsingtao Brewery began listing on the SEHK, making it the first H-share company (Liu (ed.), 1998, pp. 11–12). But as early as the mid-1980s, some Chinese SOEs were already absorbing PEFs in Hong Kong through the ‘back door’, thereby forming the so-called red chips. Examples include the Beijing-backed CITIC Beijing’s acquisition of the Ka Wah Bank in 1986, and the Fujian Provincial Government’s acquisition of Min Xin in 1987 (Morgan, 1998, p. 8). The practice of ‘backdoor listing’ allowed Chinese institutions to bypass


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both China’s restrictions on sales of equity abroad, and Hong Kong’s regulations on new listings. By this means, a red chip could raise financing through new rights issues, reduce its effective tax rate by establishing a joint venture with the overseas-registered company that it controlled, and obtain foreign loans at a much lower cost. Officially speaking, formation of a red chip requires approval of the State Council, if the project involves assets that are held at the national level and above $30 million. In practice, however, this rule can be avoided by breaking a large acquisition into a number of smaller transactions over a period of time (De Trenck et al., 1998, pp. 52–53, 56; Goldstein and Folkerts-Landau, 1994, p. 99). Initially, neither the Chinese nor Hong Kong authorities discouraged these ‘backdoor listing’ activities. However, as the practice went on, some companies were found to have muddled accounts, sub-standard disclosure and inflated assets. In many cases it was not clear whether the funds raised from rights issues were actually used for the intended purpose. There were also indications that some red chips used ‘backdoor listings’ as a way to transfer state assets out of China. To maintain the reputation of the SEHK, from May to September 1993 the Hong Kong authorities took a series of actions to tighten rules on ‘backdoor listings’ and rights issues. On the other hand, Chinese securities officials urged enterprises seeking foreign listing to apply for central approval, rather than to look for ‘roundabout ways’. In May 1994, the Chinese government officially banned the practice of ‘backdoor listings’ on overseas stock markets (Goldstein and Folkerts-Landau, 1994, p. 99; Ko, 1993; ZZSN, 1994, p. 61; ZSZ, 2 July 1994). The above moves, however, turned out to be ineffective. For example, in 1996 the China Ocean Shipping Company managed to make Shun Shing a red chip through ‘backdoor listing’. In June 1997, the Chinese government issued another ban against such practices, and set a series of guidelines for asset injection by red chips (De Trenck et al., 1998, pp. 79–80; He et al. (eds), 1999, p. 1361; Yau, 1998, p. 10). On 1 July 1999, the Securities Law of China came into effect. According to Article 29 of this first comprehensive Chinese law on securities, domestic enterprises intending to issue securities overseas directly or indirectly, or to list and trade their securities overseas, must obtain prior approval from the securities regulatory authority of the State Council. In late 1999, the central government tightened its grip on red chips by requiring them to seek approval for large-scale asset restructuring and capital deployment. Moreover, priority was given to the listing of H-shares over red chips (MB, 10 December 1999; SCMP, 4 November 1999). Hence, in the Chinese debate about listing shares in Hong Kong, the focus has been on whether the process is under the control of the central securities regulatory agents. Predictably, the ‘official’ view is that the advantages of listing H-share companies in Hong Kong outweigh the disadvantages, as long as

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the process is centrally administered. In contrast, red chips’ uncontrolled ‘backdoor listing’ activities should be outlawed. Implicit in such a line of thought is that state control is desirable. Such a view, however, is inconsistent with the neoclassical economic belief in the merit of privatization, which holds that withdrawal of state interest in business enterprises is a necessary, though not sufficient, condition for market efficiency. As Steven Cheung, a strong advocate of privatization in China, advised Chinese leaders, ‘for state-owned resources that are salable, sell’ (Cheung, 1989, p. 8). Similarly, the World Bank contended that ‘the [Chinese] government should completely withdraw from inherently competitively structured industries where small and medium sized firms predominate’ (World Bank, 1997, p. xiii, italics in original). Listing of Chinese SOEs in Hong Kong, whether through the formation of H-share companies or red chips, is a major form of foreign participation in China’s privatization, or what one scholar called ‘informal privatization through internationalization’ (Ding, 2000a). Such a move, according to the above neoclassical logic, should lead to improvement in economic efficiency. As noted by some scholars, an SOE situated in the international market may be expected to behave like a competitive private firm (Ding, 2000a, p. 127). However, while listing enterprises in Hong Kong has helped China to raise a significant amount of PEFs, it has contributed little to the enhancement of economic efficiency. This is due mainly to the residual role of the state. The experience of privatization in the Czech Republic, Hungary, and Russia showed that, due to the specific economic, social, and political objectives of the government, residual state holdings would lead to conflicts of interest that would hinder efficient operation of enterprises (Pistor and Turkewitz, 1996, pp. 217–42). A World Bank economist also noted that ‘[i]f the state is to maintain a stake in firms after privatization, its share should be small and temporary, and its stance relatively passive, although it should continue to monitor the firm to prevent fraud and asset-stripping’ (Gray, 1996, pp. 194–95). We present three cases below – the Guangzhou Shipyard (an H-share company), Guangdong Investment (a red chip), and Northeast Electrical (another H-share company) – to show that the residual role of the state in Chinese enterprises listed in Hong Kong has resulted in a similar set of problems, namely assetstripping, and submission to non-economic (social and political) factors.

CASE STUDY 1: GUANGZHOU SHIPYARD INTERNATIONAL COMPANY Background Producing eight ships of total tonnage of 188 000 dwt in 2000, Guangzhou


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Shipyard International Company (GSIC) is China’s fifth largest shipbuilder. The company was established in 1993 on the basis of Guangzhou Shipyard, an SOE founded in the 1950s to build barges for military and civilian use. During China’s first Five-Year Plan period (1953–57), very limited resources were earmarked for Guangdong’s heavy industrial development, due to the province’s strategically vulnerable location. Nevertheless, the few infrastructure projects designated to Guangdong included the construction of two new shipyards, namely the Guangzhou First Shipbuilding Factory and the Guangzhou Ship-repairing and Shipbuilding Factory. The reason for prioritization of the shipbuilding industry in Guangdong was to utilize the advantage of the province’s long coastline, and to enhance the country’s sea transportation as well as coastal defence capability in the south. In 1958, the two shipyards were merged to form Guangzhou Shipyard. In 1960, Guangzhou Shipyard was placed under the direct administration of the Ministry of the Third Machinery Industry. Constrained by the central plan, the shipyard had little incentive to grow. It took 17 years (1958–74) for the net value of Guangzhou Shipyard’s fixed assets to double (Liu (ed.), 1998, pp. 179–80; Lu and Xu, 1999, pp. 40–43; Tang, 1989, pp. 24–28 and 149–51; WGSIC). Originally a large part of the Guangzhou Shipyard’s products were for military use, such as guided-missile destroyers, escorts, and supply ships (Liu (ed.), 1998, p. 180; Tang, 1989, p. 151). When China launched its economic reform in the late 1970s, the company began to shift more resources to the production of ships for civilian use, and to explore the overseas market. In 1982, the enterprise was put under the administration of the China State Shipbuilding Corporation (CSSC), a new entity established under the direct leadership of the State Council. Guangzhou Shipyard’s business then began to expand and diversify. Nevertheless, as an SOE, the company had to submit a large part of its revenue to the state, and to provide costly social welfare to its workers. Consequently, only limited capital was left for technological renovation. Although in 1990 Guangzhou Shipyard was included in the national Eighth Five-Year Plan as one of the key SOEs for renovation, still insufficient capital was allocated to the enterprise (Liu (ed.), 1998, pp. 180–81; WGSIC). In January 1992, paramount leader Deng Xiaoping called for further reform during his high profile ‘southern tour’. The move gave political momentum to the then emerging shareholding system reform. Taking this opportunity, Guangzhou Shipyard applied for conversion into a shareholding enterprise. After reviewing the company’s track record, CSSC recommended the State Commission for Economic System Reform (SCESR) to include Guangzhou Shipyard in the first batch of enterprises to experiment with ‘standardization of shareholding enterprises’ (Liu (ed.), 1998, p. 182).

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Listing in Hong Kong In June 1993, GSIC was established as a new shareholding company to take over the production and business operations of the old Guangzhou Shipyard, while workers’ welfare responsibilities were left to Guangzhou Shipyard (see below for the reason for such an arrangement). In August, GSIC began listing in Hong Kong. Through the issuance of 145 million H-shares, the company raised over $42 million. The IPO was over-subscribed by 77 times. In October, GSIC issued over 126 million A-shares, listed on the Shanghai Stock Exchange. After these changes, CSSC (as the state representative) retains a 42.6 per cent stake in the company, while overseas and Hong Kong investors hold 31.8 per cent, and Chinese domestic public investors 25.6 per cent. With such ‘foreign’ participation, in October 1994 GSIC became a Sino–foreign limited joint stock company, thereby entitling it to a series of preferential treatments. In July 1999, the original CSSC split into two corporations, the new CSSC and China Shipbuilding Industry Corporation. The new CSSC has since inherited the original CSSC’s controlling stake of GSIC. Both the original and the new CSSC are under the direct control and administration of the State Council (CSFSY; CSRCW; GSICBI, 6 December 2001; WGSIC). The ownership structure of GSIC is shown in Figure 6.1. GSIC was among the first batch of the nine Chinese SOEs that were approved to list H-shares. Two central authorities, the People’s Bank of China (PBC) and SCESR, were responsible for the selection of these earliest H-share companies. During the selection period (mid-1992), all securities matters in China were under the supervision of PBC. But in October 1992, when the first China State Shipbuilding Corporation (State-share holder)

42.6%

Domestic Chinese (A-share holders)

Overseas and Hong Kong investors (H-share holders)

25.6%

31.8%

Guangzhou Shipyard International Company

Source:

WGSIC.

Figure 6.1 Ownership structure of Guangzhou Shipyard International Company


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nine H-share companies had been selected and were preparing for the IPOs, the State Council Securities Commission (SCSC) was established to replace PBC as the national regulator of securities affairs. The new agent was responsible for macro policy issues relating to the securities markets, with an independent entity, the China Securities Regulatory Commission (CSRC), as its executive arm (Wang J.X., 1997, p. 233; World Bank, 1995b, Vol. 2, p. 22). It is important to note that all the above agents – SCESR, PBC, and SCSC/CSRC – were central authorities. The role of local governments was small. In fact, early in China’s first major regulations on the securities market – Circular of the State Council on Strengthening the Macro Regulation of the Securities Market (17 December 1992) – it was clearly stated that all matters related to the issue and listing of foreign shares by Chinese enterprises must be centrally arranged and approved by SCSC/CSRC. ‘Local authorities and departments should not go their own way.’ This rule was further emphasized in a subsequent State Council circular (Xiao (ed.), 1995; 1993–95, pp. 2049–50). As mentioned, GSIC was established to take over the production and business operations of the old Guangzhou Shipyard, while workers’ welfare responsibilities were left to Guangzhou Shipyard. Through a series of contractual relations, Guangzhou Shipyard provided housing, catering, health, childcare, education, and retiree management services to GSIC. Guangzhou Shipyard continued to pay pensions to the 1500 workers who retired from the enterprise before 1990, whereas GSIC was responsible only for the pension of the 500 workers who retired after that year. Such arrangements significantly reduced the welfare burden of GSIC and thus enhanced its profit potential, thereby facilitating the listing of the company (Liu (ed.), 1998, pp. 179 and 185). In fact, this kind of financial costuming is a common practice of H-share companies (De Trenck et al., 1998, p. 25; Steinfield, 1998, pp. 146–49). Company Performance after Listing Once listed, an H-share company is regulated by a number of laws and regulations. As a Chinese shareholding enterprise, it is subject to China’s Company Law, and as a Hong Kong listed company, it is required to observe applicable Hong Kong laws and codes. In addition, it has to satisfy a series of requirements jointly stipulated by securities authorities in China and Hong Kong. That is to say, H-share enterprises are subject to double supervision (SEHK, 1998, p. 6). On the first trading day of GSIC’s H-shares (6 August 1993), the share price closed at HK$2.4, which was 15 per cent above the IPO price. In 1993, the company made an annual after-tax profit of 106 million yuan, 24 per cent higher than the amount predicted in the prospectus. In 1994, the profit jumped

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by 74 per cent, reaching 183 million yuan. Although there was a gradual decline in profit after that year, the company did not suffer any loss until 2000. Throughout the period from 1994 to 1999, there was positive return on equity. The net asset value per share even rose from 2.62 to 2.73 yuan. Yet, the company’s H-share price dived from the 1994 high of HK$5.6 to the 1999 low of HK$0.3 (Table 6.2; Xiao (ed.), 1995, p. 1710; ZJ, June 1994, p. 28). In fact, since 1993 the general trend of all H-share prices has been a downward one, as investors’ confidence has been weakened by problems including substandard disclosure of company information and lack of transparency in operations.6 In the case of GSIC, the first annual report of the company indicated that the profit attributable to shareholders included a ‘public welfare fund’ of 11 million yuan. Some financial analysts charged that such accounting practice was inappropriate and ‘misleading’, as the fund was not distributable to shareholders. GSIC counter-argued that ‘the public welfare fund constituted a part of shareholder equity.’ Foreign investors were forced to accept this as part of ‘the costs of doing business in China for [H-share]) companies’ (FT, 6 May 1994; Liu (ed.), 1998, p. 187; SCMP, 14 April 1994). Another instance was that GSIC used the yuan’s official exchange rate for foreign currency conversion in its 1993 annual report, while all the other Hshare companies of the time had used a swap market rate. GSIC’s conversion method resulted in a favourable exchange difference of 86 million yuan when China unified the official and swap market rates on 1 January 1994. The case drew the concern of accounting experts in Hong Kong, as GSIC’s practice was against the territory’s accounting standards that required the adoption of a Table 6.2

Financial indicators of Guangzhou Shipyard

Turnover (million yuan) Profit after tax (million yuan) Profit attributable to shareholders (million yuan) Return on equity (%) Net asset value per share (yuan) Earnings per share (yuan) H-share price (high–low) (HK$)

Sources:

GSICAR; WGSIC.

1994

1995

1996

1997

1998

1999

2000

1530

1834

2061

1682

1865

2281

2222

183

102

33

36

22

6

–728

183

101

33

40

19

1.0

–729

14.15 2.62

7.69 2.66

2.51 2.68

2.96 2.71

1.41 2.73

0.07 2.73

0.370

0.205

0.067

0.080

0.038

0.002 –1.473

5.60– 2.10

3.80– 1.74

2.43– 1.40

4.25– 1.14

1.16– 0.35

0.87– 0.30

Nil 1.26

0.67– 0.32


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market rate, which ‘made it difficult to obtain a full picture of the operational profitability of the group’ (SCMP, 6 and 25 August 1994). In 1998, as a consequence of the Asian financial crisis, some Chinese nonbank financial institutions were unable to repay overdue deposits to many of their clients, including H-share companies. Taking the case very seriously, CSRC summoned the senior managements of all the H-share companies to report their financial conditions. In October, CSRC sent investigation teams to selected H-share companies, including GSIC. It was later disclosed that, as of end of 1998, GSIC’s deposit in the troubled non-bank financial institutions amounted to 519 million yuan, of which 378 million yuan was overdue. In 1999, the company wrote off 10 per cent of the overdue deposits as bad debts, resulting in the decline in profit in that year and the loss in 2000 (GSICAR; MB, 12 November and 31 December 1998; 26 April 1999; SCMP, 26 and 27 April 1999; WGSIC).

CASE STUDY 2: GUANGDONG INVESTMENT The Parent (Guangdong Enterprises Holding) and its Listed Flagship (Guangdong Investment) The Guangdong Enterprises Holdings (GEH) Limited was established in 1980 (under the name of Guangdong Enterprises Limited until 1986) as a product of China’s economic decentralization. By a series of ‘special policies’ promulgated during 1979–1981, Guangdong province obtained a high degree of autonomy over its investment priorities. In return, it was required to raise its own capital to finance development projects, without relying on resources allocated by the central government. One major strategy adopted by Guangdong leaders was to maximize the province’s strength in absorbing foreign capital arising from its proximity with Hong Kong. To do so, they convinced the central government to grant them the power to establish three Special Economic Zones, to approve foreign investment projects that did not affect national balances, and to utilize foreign investment in infrastructure. Moreover, to create a separate entity to conduct business, the Ministry of Foreign Trade and the Guangdong Foreign Trade Bureau co-founded the Guangdong Province Foreign Trade Corporation, with GEH as its subsidiary in Hong Kong. Apart from being Guangdong’s ‘window company’, GEH also served as the umbrella of a number of prefectural companies looking for international business opportunities through Hong Kong (Cheung, 1998, pp. 125–30; De Trenck et al., 1998, p. 153; Vogel, 1989, pp. 80–87, 248, 354–55, 443). The original nature of GEH, however, was not favourable to the company’s effort of raising PEFs. As a provincial government-owned trading company, it

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did not have the profit potential to attract public investors. To solve the problem, GEH resorted to ‘backdoor listing’. In 1987, GEH acquired the controlling stake of Union Globe Development Limited, turning this Hong Kong listed-company (incorporated in 1973) into a red chip. In 1988, Union Globe was re-named Guangdong Investment (GI), which has since then been the listed flagship of GEH (CH, 1987, p. 497; WGIL). The basic structure of GI is similar to that of GEH, with the major difference that many of the lucrative businesses of GEH were injected into GI. Through a series of complex asset shuffling, earnings were transferred from the parent to the listed company, while debts went from the listed company to the parent. The whole purpose was to produce a high–yield image of GI, at the expense of lower profitability of GEH (De Trenck et al., 1998, pp. 158–62). Between 1988 and 1991, GI was engaged mainly in property development. In 1992, after Deng’s southern tour, the company began to expand by acquiring subsidiaries, many of which were from the parent, GEH. These included a tour company, a malt plant, a brewery, a curtain wall specialist, and some hotels and properties (see Table 6.3). As income-generating businesses, they contributed positively to GI’s earnings growth, and thus sustained the share prices. Between 1994 and 1997, the return on equity ranged from 7.4 per cent to 10.3 per cent, and share price soared from the 1994 low of HK$3.6 to the 1997 high of HK$12.3 (Table 6.4; see also De Trenck et al., 1998, pp. 168–71; WGIL). Hence, GI continued to be attractive to public investors, at least on paper, by receiving favourable injections from GEH. Such a high-yield image of GI enabled the group to raise more funds. From 1994 to 1997, the group received $183 million net through issue of share capital. Moreover, it managed to spin off four of its subsidiaries: Guangnan Holdings in 1994,7 Guangdong Tannery in 1996, and Guangdong Brewery and Guangdong Building Industries in 1997. During 1994–97, the net proceeds from the shares issued on the IPOs of GI’s subsidiaries amounted to $103 million (WGHL; WGIL). The fund so raised enabled GI to make more acquisitions. Through such rolling of acquisitions and fund raisings, the group built up an empire that, as of end of 1998, consisted of twenty-four subsidiaries in Hong Kong, eight in British Virgin Islands, thirty-one in mainland China, and one each in Bermuda, Cayman Islands, and Singapore. They covered a wide business scope that included hotels and tours, transportation, property, building materials, timber and furniture, brewing, leather, energy, finance, and wholesale and retailing (WGIL). Failure and Government Bailout GI, however, suffered a drastic decline in business in 1998. The recession in


Table 6.3

Selected acquisitions by Guangdong Investment

Date

Name of company (and stake) acquired

1987 Jun 91 Nov 91 Dec 91

New Cathay Hotel (from GEH; stake unknown) Cameron Centre (stake unknown) Citybus (20%) Guangdong Tour (stake unknown), Guangzhou Malt (44.2%); Panyu site (4.1m sq ft) (from GEH; stake unknown) Shenzhen Brewery (24.5%); Guangdong Hotel and Irving Court, Cao Yang Village, and a Guangzhou property (70%); Full Arts (80%) (from GEH) Weili Washing Machines (60.8%) CIL (5%) Zhongshan Power’s 50 MW plant (95%) Shenzhen Brewery (additional 40%) Wharney and Guangdong hotels (from GEH) Full Arts (additional 10%) 300 MW Shaoguan Power (45.9%) Nanhai Tannery (75.6%) Guangnan Hang (34.7%; from GEH) Nanfang Dept Store (56%) 2x125 MW Meixian generators (12.5%) Nanhai Tannery (additional 24.4%) Guangzhou-Zhuhai expressway (20%) 50 000 KW generator in Zhongshan Power plan (95%) Guangdong Transport (51%) Guangdong Yingde Highway (70%) Maxfitter (100%) Shenzhen Brewery (additional 10.5%) A car park lot in Hong Kong (60%) 12 residential units and car parks in Hong Kong (100%) Paul Y-ITC Construction (3.2%) Nam Fong (10%) Guangdong Regency Hotel, Zhuhai (100%) Guangdong Finance (100%) Guangdong Fur (100%) Shenzhen Guangdong Hotel (additional 29% from GEH)

Jun 92

Dec 92 Jul 93 Sept 93 Dec 93 Apr 94 May 94 Jun 94 Aug 94 Nov 94 Jun 95 Apr 96 Jun 96 Sept 96 Mar 97 May 97 May 97 July 97 July 97 July 97 Aug 97 Sept 97 Sept 97 Nov 97 Nov 97 Apr 98 Dec 99

103

Fund spent (approximate amount in US$ million) N.A. 20 6.4 64

100

38 1.9 28 17 105 2.4 71 24 14 22 14 36 14 30 192 20 50 18 29 42 17 45 83 58 1.4 N.A.

Sources: 1987 and 1999 data from WGIL; 1991–96 data from De Trenck et al. (1998, pp. 169–70); 1997–98 data from CPY (1998).

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Table 6.4

Financial indicators of Guangdong Investment

Turnover (HK$ million) Profit after tax (HK$ million) Profit attributable to shareholders (HK$ million) Return on equity (%) Net asset value per share (HK$) Earnings per share (basic; HK$) Share price (high–low) (HK$) Sources:

1994

1995

1996

1997

1998

1999

3528

4309

6472 7145

6281

5359

597

841

764

897

–1982 –2453 –1272

437

579

604

750

–2072 –2377 –1356

8.64 2.55

10.28 2.82

7.38 3.51

8.80 3.51

0.391 –0.833 –0.957 –0.544

0.269

0.290

0.280

6.15– 3.58

4.88– 2.85

7.50– 12.30– 4.38 3.50

Nil 2.43

5.15– 1.05

Nil 1.77

2.05– 0.82

2000 4948

Nil 3.24

0.73– 1.50

GI2000ARA; TDW; WGIL.

Hong Kong, slowdown of growth in China, negative sentiment among the banking community towards lending in Asia, renminbi devaluation, and major flooding in China made operating conditions difficult in every industry in which GI had interests. Reflecting this situation, the group’s share price dived by 85 per cent from August 1997 to June 1998. Nevertheless, some financial analysts still counted on support from GEH, believing that the favourable asset injections from the parent would give ultimate support to the business shape of GI. For example, in June 1998 the investment firm Core Pacific-Yamaichi advised its clients to buy GI’s shares, on the ground that ‘[t]he relationship with its parent company gives [GI] a major competitive edge when identifying and acquiring high growth investment projects’ (CPY, 1998:1, 6; GIAR1998). The parent itself, however, was soon found to be in trouble. In October 1998, one of Guangdong’s largest financial institutions – Guangdong International Trust and Investment Corporation (GITIC) – was closed down due to severe liquidity problems. The news immediately alerted investors to the financial situation of other ‘window companies’ of Guangdong, including GEH, leading to the downgrading of GEH’s international credit rating. In January 1999, GEH announced that it had outstanding debts of $2.9 billion. Being unable to meet the debt obligations, the group was technically bankrupt (MB, 13 January 1999; SCMP, 8, 23, 25 and 29 October 1998; 13, 19 and 20 January 1999). Yet, GEH survived by receiving support from the Guangdong provincial government. In January 1999, it was revealed that the provincial government


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would inject up to 30 billion yuan into GEH. In May, the provincial government proposed a bailout plan under which the provincial government and creditors would share the responsibility of restructuring GEH. According to this plan, the provincial government would inject the Dongshen Water Project – which supplies more than 70 per cent of Hong Kong’s water – into GI. On the other hand, total debts worth about $5.9 billion in GEH would be restructured through the issue of new debts, notes and preference shares. After more than a year of negotiation with creditor banks, the plan was finally confirmed in December 2000. In addition, GI disposed of two of its subsidiaries to GEH and issued 2.3 billion new shares to GEH, while GEH would inject a cash sum of $20 million into GI. Such a debt-restructuring plan has helped GI return to the black after three years (1998–2000) of losses. In the first half of 2001, the company registered a net profit of $16.5 million (Table 6.4; XB, 27 January 1999; MB, 30 January 1999; SCMP, 26 May 1999; 23 and 28 December, 2000; 22 September 2001; WGIL). The above moves – to close down GITIC but save GEH – were carried out by the Guangdong provincial government, but under direct instruction of the central government. GITIC was liquidated under an order from Dai Xianglong, the then governor of China’s central bank, in a bid to give a clear signal that the central government would not pay for the debts of local financial institutions. The case of GEH was handled by Wang Qishan, a senior central official appointed in early 1998 by the then Premier Zhu Rongji as deputy governor of Guangdong to strengthen the central government’s grip on the province. It was with Zhu’s support that Wang designed the rescue plan.8 Though it was the central government’s decision to bail out GEH, it was up to the Guangdong provincial government to pay for the cost. The Dongshen Water Project, which was injected into GI to keep the company afloat, is a provincial asset (MB, 30 January 1999; SCMP, 7 January and 8 October 1998, 4 April 2000). The reason why the central government saved GEH but not GITIC was that GEH had five listed companies in Hong Kong. Liquidation of the group would cause a severe blow to the Hong Kong economy, a situation that the central government wanted to avoid. Hence, in the restructure plan, GI – GEH’s listed flagship in Hong Kong and a constituent stock of the Hang Seng Index9 – was given the first priority to use the injected assets to repay its debts (CD, 8 March 1999; MB, 26 May 1999; SCMP, 26 May 1999; XB, 26 May and 17 December 1999). Ambiguous Role of the State Many reasons have been cited for the failure of GEH: sudden reversal of market conditions; wrong assessment of risk and return when making

106


investment decisions; and improper debt management (MB, 13 January 1999; XB, 13 January 1999). To be sure, GEH was just another victim of the Asian financial crisis, which caused financial trouble to a vast number of companies in the region. Substandard financial supervision that invited embezzlement was also a factor.10 However, a more fundamental problem is the ambiguous role of the state in GEH. Commenting on the case of GEH, an unspecified source said that, ‘the key to the problem is the availability of easy money’ (SCMP, 17 December 1999). Similarly, an investment company’s research reported that the failure of GEH ‘highlights the fact that many China companies mismanaged financial resources and made poor investment decisions during the days of easy credit’ (AACR, 1999). The question is, why was so much ‘easy money’ and ‘easy credit’ made available to GEH? The answer lies in the ambiguous relation between GEH and the state. On the one hand, GEH emphasized that it is an independent business entity that bears its own risk, despite the state-owned nature of the group. For example, in GEH’s prospectuses for $250 million and $500 million note issues in 1997, it was stated that [w]hile the company is owned and supported by the [Guangdong] government, it is not a sub-division of that government, or the central government. [GEH’s] obligations, including its obligations under the notes, must be satisfied out of its own assets, and are not guaranteed or otherwise supported by the Guangdong government or the central government. (SCMP, 11 March 1999)

However, like most other Chinese enterprises, GEH had few financial records of its own to meet foreign bankers’ lending requirements. Senior executives of the group, who were at the same time provincial officials, thus resorted to government backing by issuing letters of comfort. This was also the case in the two GEH note issues mentioned above, which carried letters of comfort from the Guangdong government. In the foreign bankers’ view, although such documents were legally non-binding, they did imply moral obligation (SCMP, 11 March 1999). More importantly, the state-owned nature of GEH and the previous injections of high-yield provincial assets to its subsidiaries created an expectation that loans to the group had low sovereign risk. While the central government attempted to make it clear that such expectations were not always valid by closing down GITIC, its rescue of GEH gave a conflicting signal. The irony is that not only had the public listing of GEH’s subsidiaries in Hong Kong failed to enhance corporate governance of the group, it was this status that necessitated government bailout. In fact, the financial conditions of both GSIC and GI were distorted by the role of the state. GSIC was made profitable on paper by leaving most of the welfare expenditures to the state-owned Guangzhou Shipyard. This was necessary in order to make the company attractive to foreign investors. As a World


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Bank economist observed, China’s enterprise reform has focused on ‘de-linking social services from enterprises’ and ‘discharging State shareholder functions in SOEs’ (Broadman, 2001, p. 864). The problem is that non-state shareholders may exploit this policy to their advantage by taking all the valuable assets while leaving the liabilities to the state. The financial strength of the company is artificial in the sense that a major part of the costs of inefficiency have been absorbed by the state. As long as China’s social safety net is weak, achievement of real economic efficiency through laying off redundant resources (in particular labour) remains difficult (World Bank, 1999, p. 30). In the case of GI, the company’s high-yield image was created by receiving favourable asset injections from its parent GEH. More importantly, the value of the state assets tends to dissipate after the transfer, not due to any business pattern, but as a result of stripping of state assets.11 This is particularly likely when local governments are involved, as the central government’s control becomes less effective (Ding, 1999, pp. 33–34; 2000a, pp. 128–33; 2000b, pp. 3–10 and 14–20; Smyth, 2000, pp. 5–6). Moreover, the bailout of GI by the central government shows that listing Chinese enterprises in Hong Kong does not necessarily imply improvement of corporate financial discipline. The political consideration of the economic stability of Hong Kong, which heads the list of ‘special motives’ of Chinese state investment abroad (Ding 2000a, p. 130), has softened the budget constraint. In short, while listing enterprises in Hong Kong has helped China to raise significant amount of PEFs, it has contributed little to the improvement of the companies’ economic performance. Rather, the residual role of the state in these enterprises has resulted in problems such as asset-stripping and submission to non-economic (social and political) factors. Contrary to neoclassical economic belief, privatization and internationalization of SOEs do not necessarily lead to enhancement of economic efficiency.

CASE STUDY 3: NORTHEAST ELECTRICAL COMPANY Background The above two case studies may prompt one to the view that while both Hshare enterprises and red-chip firms exhibited distorted corporate financial conditions, the former type of companies tended to be better regulated than the latter type because H-share enterprises were officially formed under direct scrutiny of the central government, whereas most of the red chips were established through ‘backdoor listing’ under local initiative. Such a conclusion, however, is not entirely accurate, as it does not take into consideration the importance of the fiscal relationship between the central government and the

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concerned local governments. Our third case study, which is on an H-share enterprise that nearly became the first case of bankruptcy and delisting of its kind, will show that under China’s decentralized fiscal system, an H-share enterprise owned by a local government may behave like a red chip. Northeast Electrical Transmission and Transformation Machinery Manufacturing Company (referred to here as ‘Northeast Electrical’) is an Hshare enterprise. There are two major reasons for the selection of this company as a case study. First, it is a large, heavy-industrial SOE, and heavy industry is one of the major sectors where Chinese intergovernmental fiscal relations are least defined. Moreover, because of the number of interested parties and the amount of resources that must be allocated, restructuring heavy-industrial enterprises has been much more complicated than reconfiguring light-industrial enterprises. As a result, the state’s role in reforming heavy-industrial enterprises is quite sensitive. In fact, in Liaoning Province, the home of Northeast Electrical and a centre of China’s heavy-industrial sector, many of the reforming enterprises are still heavily dependent on preferential government contracts (Smyth and Zhai, 2003). Second, in December 2001 CCIC Finance filed a petition in Hong Kong to liquidate Northeast Electrical. The subsequent public interest in the case and Beijing’s reaction revealed that the long arm of the state could still reach into a ‘foreign’-listed enterprise. In short, the case of Northeast Electrical illustrates the conflict between residual state intervention and foreign privatization. Restructuring and Conversion into an H-Share Enterprise Northeast Electrical is located in Shenyang, the capital of Liaoning province. It manufactures, exports, and develops new technologies for electrical transmission and transformation machinery. Its predecessor, the Northeast Electrical Transmission and Transformation Equipment Group Corporation (NET), was established in 1985 to coordinate a loose association of 26 enterprises involved in manufacturing electrical equipment in northeast China (WNETTMMC). In 1992, NET was restructured into a private placement company by issuing shares to carefully selected employees and legal-persons. In the spring of that year, reform of China’s shareholding system gained momentum when paramount leader Deng Xiaoping called for further changes during his highprofile southern tour. That triggered a dramatic increase in the number of listed companies in China. To control the pace of expansion, the state established a quota for public placements. Many of the enterprises not granted public placement thus resorted to private placement, giving rise to a large number of private placement enterprises, including NET (Liu (ed.), 1998, p. 386). When NET went private, shares were issued to three categories of legal-


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persons: NET itself, six of the SOEs that comprised NET, and a number of NET’s subsidiaries. Such a large transfer of state assets had not been officially endorsed, and the group’s property holdings and organizational structure were not clearly defined (Liu (ed.), 1998, p. 336). In fact, this was a common problem among privately listed Chinese companies. The Chinese Company Law had not yet been published, and shareholding enterprises were regulated only by an unofficial document, ‘Opinions on the Standardization of Shareholding Limited Enterprises’ (gufen youxian gongsi guifan yijian). According to the ‘Opinions’, since only the interests of individual employees and legal-persons, but not the general public, would be involved in the formation of privately listed companies, the rules governing this type of company could be less strict than those for publicly listed companies (Xiao (ed.), 1995, pp. 299–300). Northeast Electrical also faced the inherent problem that while its major sponsor, NET, was a ‘specifically itemized group enterprise’ (dan lie qiye jituan) in the 1990 national plan, the groups’ institutional and property relations remained ambiguous. Administratively, Northeast Electrical was assigned to the Shenyang Municipal Machine-Industry Administration, but at the same time its constituent enterprises reported to the machine-building industry bureaus of different cities, such as Shenyang, Jinzhou, and Fuxin, leading to unclear institutional affiliations and leadership (Liu (ed.), 1998, pp. 336–37). In late 1993, when Northeast Electrical was still experimenting with shareholding reform, the Liaoning provincial government and the State MachineBuilding Industry Bureau nominated Northeast Electrical as a candidate for H-share listing. In March 1994, the State Council Securities Commission endorsed the recommendation and included Northeast Electrical in the second wave of Chinese enterprises listed in Hong Kong. Northeast Electrical also became the first H-share company from Liaoning province (Liu (ed.), 1998, p. 337). The confusion surrounding Northeast Electrical’s financial background did not prevent the company from being approved for listing by the Hong Kong Stock Exchange, because such problems were considered typical for Chinese state enterprises at the early stage of reform. In addition, investors were already advised that Northeast Electrical, like other H-share enterprises, was a ‘high-risk’ company.12 Northeast Electrical underwent restructuring yet again to prepare for its conversion from a private-placement company to an H-share enterprise. Two of NET’s six constituent SOEs withdrew from Northeast Electrical because of their unfavourable financial history. Moreover, separate entities were established to take over Northeast Electrical’s non-revenue-generating facilities such as schools, childcare centres, hospitals, canteens, housing, and sanatoriums. Some of the unprofitable components, as well as the social-service obligations, remained with NET (Liu (ed.), 1998, pp. 337–38; WNETTMMC). The

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whole purpose of these moves was to enhance the Northeast Electrical’s profit potential, thereby facilitating the listing of the company. This kind of financial window-dressing is a common practice among H-share enterprises (De Trenck et al., 1998, p. 25; Steinfield, 1998, pp. 146–49). At the same time, the Liaoning provincial government and the agencies that manage state assets officially confirmed NET’s right to hold and manage state assets. Subsequently NET injected assets into Northeast Electrical, which in turn issued shares to the state (state shares), legal-persons (legal-person shares), employees (internal-employee shares), overseas and Hong Kong investors (H-shares), and domestic Chinese investors (A-shares). Northeast Electrical went public on the Hong Kong Stock Exchange in July 1995. By offering some 258 million H-shares, the company raised $60 million. Later in the year, Northeast Electrical listed 30 million A-shares in the domestic Shenzhen Stock Exchange, raising 150 million yuan (approximately $18 million) (Liu (ed.), 1998, p. 140, pp. 338–39; WNETTMMC). In the first three years that it was listed in Hong Kong (1996–98), Northeast Electrical made a profit of 174 million yuan ($21 million). However, it subsequently lost nearly 1.3 billion yuan ($157 million) from 1999 to 2001 (see Table 6.5). In June 2001, the company was served with a writ from the High Court of Hong Kong regarding a past due note against its assets held by a banking consortium led by CCIC Finance. The judgment ordered repayment of the $40 million principal and $1.6 million interest. In December, CCIC filed a liquidation petition, making Northeast Electrical the first H-share company to face possible liquidation and delisting (XB, 10 November 2001; SCMP and XB, 29 December 2001; WNETTMMC).

Table 6.5

Financial indicators of Northeast Electrical

Turnover (million yuan) Profit after tax (million yuan) Profit attributable to shareholders (million yuan) Return on equity (%) Net asset value per share (yuan) Earnings per share (yuan) H-share price (high–low) (HK$) Source:

WNETTMMC.

1996

1997

1998

1999

2000

2001

1353

1563

1541

1398

1312

1279

83.8

83.8

6.8 –168.4 –366.8 –785.6

83.8

84.0

6.4 –168.3 –364.7 –780.1

5.15 1.86 0.096 1.67– 0.86

4.91 1.96 0.096 3.65– 0.80

0.37 N.A. N.A 1.96 1.77 1.29 0.007 –0.193 –0.418 1.26– 0.83– 0.56– 0.26 0.33 0.27

N.A N.A. –0.893 N.A.


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In May and June 2002, Northeast Electrical and its creditors concluded a 65 per cent loan-repayment agreement, and the liquidation petition was withdrawn. This was made possible mainly by the sale of Shenyang Transformer, a subsidiary of Northeast Electrical, to the Shenyang municipal government for 150 million yuan ($18 million). Most of the cash raised would be used to settle part of Northeast Electrical’s debts (JR, 31 May and 12 June 2002; XB, 12 June 2002). In fact, Northeast Electrical, through its parent, NET, is ultimately controlled by the Shenyang municipal government.13 Although local officials had insisted that the municipal government would not rescue Northeast Electrical, observers expected that the state would eventually step in, since it would not allow an H-share company to collapse (PR, 11 March 2002; SCMP, 25 January 2002; STD, 28 November 2001; XB, 25 and 26 January 2002). Indeed, the government bailout of Northeast Electrical agrees with our earlier observation that the budgetary constraints of Chinese companies listed in Hong Kong are not strong enough to ensure economic efficiency because of the residual role of the state in these enterprises. Although partially privatized with foreign participation, H-share companies are still managed in accordance with the state’s non-economic objectives, such as maintaining Hong Kong’s prosperity and the reputation of state firms. Government Bailout and Intergovernmental Fiscal Relations Our earlier analysis of GSIC and GI might lead one to the view that H-share enterprises are better managed than red chips, because H-share companies were organized under direct central government scrutiny, whereas most red chips were established through informal local channels. The case study of Northeast Electrical, however, does not support this generalization. Northeast Electrical is an H-share enterprise, but like the red chip GI, it survived only with a government bailout. Northeast Electrical and GI are both owned by local governments, while GSIC is under the direct control and administration of the central government. This raises the issue of intergovernmental fiscal relations in China. Since the 1980s, intergovernmental fiscal relations in China have undergone several reforms. Before 1980, all taxes and profits were remitted to the central government in Beijing, which redistributed the revenue among local governments based on whether it approved their spending plans. In 1980, to give local governments an incentive to collect and explore new sources of revenue, a contract-responsibility system was introduced under which central and local governments shared agreed proportions of revenue. The contracts turned out to be too negotiable and often unenforceable, however, resulting in a significant haemorrhage of revenue from the centre to local governments. In

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1994, alarmed by the political and economic implications of its weakened fiscal power and declining state capacity, the central government replaced the revenue-sharing scheme with a tax-assignment system that has effectively recentralized revenues (Bahl, 1999, pp. 88–129; Ma, 1997, pp. 6–9; Wang S.G. and Hu, 2001). On the expenditure side, before the reforms, sub-national governments were simply local cashiers for the central budget. Since 1980, under the fiscal decentralization, the central government sets general guidelines on the acceptable level of local expenditures but leaves the details to local officials. In principle, the state budget defines the division of expenditure responsibilities between the central and local governments. The centre pays for services that benefit the nation as a whole, while local governments finance functions of regional or local concern. In practice, however, this division is not always clear, particularly in heavy industry, transportation, telecommunications, education, science, and health care. Sub-national governments frequently lobby to have local projects financed by the central budget (Bahl, 1999, pp. 70–75; Ma, 1997, pp. 10–11; Zhang L.Y., 1999, p. 131) In sum, since 1980 fiscal decentralization has complicated intergovernmental relations in China. Each level of governments strives to maximize its revenue share but minimize its expenditure responsibilities. While the 1994 fiscal reform institutionalized the revenue side of the fiscal relations, there has been strong resistance to change on the expenditure side. As a result, there are many grey areas of fiscal responsibility, leaving such decisions to political considerations (Bahl, 1999, p. 71; Wang and Hu, 2001, p. 213; Zhang L.Y., 1999, p. 131). This situation is key to understanding the problems faced by Chinese enterprises listed in Hong Kong. GSIC, the H-share enterprise, is controlled and run by the central government through a centrally owned parent company CSSC; GI, the red-chip firm, is owned by the Guangdong provincial government through a provincial parent company GEH. Northeast Electrical, the H-share company, is owned by the Shenyang municipal government through a municipal enterprise group (NET) (see Table 6.6). Northeast Electrical and GSIC are both H-share enterprises but are owned by different levels of government. While Northeast Electrical is an H-share enterprise and GI is a red chip, they are both owned by local governments. Moreover, the Shenyang municipal government, which owns Northeast Electrical, is one of the nine designated ‘line-item cities’. In 1984 nine municipal governments were awarded direct fiscal relations with the central government, making their budgetary status equivalent to that of a province (Bahl, 1999, pp. 138–39). In other words, Northeast Electrical and GI are similar in that they are both Hong Kong-listed branches of parent companies owned by a provincial government.

Table 6.6 Level of state ownership of Guangzhou Shipyard, Guangdong Investment and Northeast Electrical Guangdong Investment

Northeast Electrical

State owner

Central Government

Guangdong Provincial Government

Shenyang Municipal Government

Parent company

China State Shipbuilding Corporation (CSSC)

Guangdong Enterprise Holding (GEH)

H-share enterprise: Guangzhou Shipyard International Company (GSIC)

Red chip: Guangdong Investment (GI)

113

Guangzhou Shipyard

Listed branch in Hong Kong

Northeast Electrical Transmission and Transformation Equipment Group Corporation (NET) H-share enterprise: Northeast Electrical

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When Northeast Electrical and GI were making profits, their parent companies received incomes from them. Any resulting tax went to the respective local government according to the 1994 fiscal reforms (Bahl, 1999, p. 107). However, when the financial state of the two companies deteriorated so seriously that they were on the brink of bankruptcy, the role of the respective local governments was ambiguous. As an H-share company, Northeast Electrical was supposed to have satisfied the state’s financial and managerial requirements. Its collapse would damage foreign investors’ confidence and China’s plan to list state enterprises on overseas markets. In the case of GI, although it is a red chip not included in the official listing plan, Chinese leaders did not want to see the company going into bankruptcy, because this would have been a severe blow to a Hong Kong economy already in deep recession. Therefore bailing out Northeast Electrical and GI was necessary to maintain the credibility of China’s shareholding-system reform and the prosperity of Hong Kong. The Shenyang municipal government and Guangdong provincial government would unquestionably subscribe, in principle, to these policy objectives of the central government, but who would provide the financing, Beijing or the relevant local government? This fiscal division of authority remains unclear. As mentioned, bailing out Northeast Electrical and GI would help maintain the confidence of foreign investors in Chinese H-share enterprises and would alleviate Hong Kong’s economic difficulties. However, any benefits from the achievement of these policy objectives would be available to China as a whole, including Shenyang city and Guangdong province, even if the respective local governments did not contribute a single yuan to the bailout. In political economy jargon, the benefits of rescuing Northeast Electrical and GI are ‘public goods’ that tend to invite free riders. Given that local governments have been assigned definite income rights over local enterprises, while expenditure responsibilities have not been clearly defined, it would be rational for the Shenyang municipal government and Guangdong provincial government to maximize their revenues from Northeast Electrical and GI, respectively, but avoid paying for the mismanagement of these companies. It is exactly such logic that led to the failure of the two companies. According to Northeast Electrical’s annual report, the company suffered losses due to increasing market competition and sluggish technological and managerial restructuring (WNETTMMC). The more fundamental problem, though, was a tremendous flow of cash to its municipally owned parent, NET. In August 1996, NET had issued bonds worth about $2 million to Northeast Electrical. When the bonds matured in October 1999, NET did not redeem them. Instead, Northeast Electrical provided an unsecured $2 million loan to NET. Northeast Electrical’s shareholders were not informed of this arrangement until the Hong Kong Stock Exchange made it public. The backroom deal


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was rejected in a subsequent special meeting of shareholders. No information was given about whether the loan has ever been repaid (JR, 26 July 2000). In fact, by 1999 NET had received loans of about $60 million from Northeast Electrical. Instead of repaying the accumulated debt, NET deeded a hotel to Northeast Electrical to offset the debt. But the hotel, located in Shenyang, was itself losing money (MB, 8 February 2001). Such sweetheart loans from listed companies to their unlisted parents for undisclosed purposes are quite common in China’s domestic stock market (FEER, 11 July 2002). The case of Northeast Electrical shows that it can also occur with a Chinese company listed in Hong Kong. On the other hand, when Northeast Electrical received the liquidation petition, the Shenyang Municipal Government was quite firm that it would not rescue the company, as the estimated cost, 500–600 million yuan ($60–72 million), was deemed too high. A municipal official even said that ‘losing an H-share listing status is no big deal. It costs just 50 to 60 million yuan [$6–7.2 million] to buy a shell company’. However, the central government intervened, forcing the Shenyang municipal government as well as the Liaoning provincial government to draw funds from their budgets to save Northeast Electrical (PR, 11 and 27 March 2002; SCMP, 25 January 2002; XB, 15 and 26 January 2002). This is much like the case of GI, where the local government (Guangdong province) agreed to bail out the financially troubled parent company, Guangdong Enterprises Holding, only under strong pressure from the central government. Thus the cases of Northeast Electrical and GI are similar in that both enterprises served as a source of income for locally owned parent companies. However, in the face of financial crisis, the local governments were unwilling to draw funds from their respective budgets to rescue the companies. The bailout was possible only because the central government intervened. This finding is consistent with Huang’s (1996 and 2001) contention that fiscal decentralization induces Chinese local governments to free-ride on public goods provided by the central government, but they have sometimes been prevented from doing so because of the presence of a highly centralized political system. Our study also lends support to Steinfeld’s (1998) argument that the presence of a strong state with the legitimate authority to create and maintain regulatory institutions is important for achieving economic efficiency. In contrast, the emphasis by Oi (1999) on property-rights reform seems insufficient to explain the case of Northeast Electrical, where budget constraints remained soft despite the fact that the company had been partially privatized with international participation. A consideration of intergovernmental fiscal relations helps explain why the H-share enterprise Northeast Electrical has behaved like the red chip GI. This leads to the conclusion that, due to the residual presence of the state, privatized

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and internationalized enterprises are often managed in accordance with political rather than economic considerations, and this keeps them from achieving economic efficiency. It makes no difference whether the company is an Hshare enterprise or a red chip. What is important is the level of the government that owns the company. Under China’s decentralized fiscal system, the financial management of a locally owned listed branch tends to be less regulated than that of a centrally owned one, because the local government has inducements to maximize income from the listed branch but not clearly defined economic responsibility for proper management of the company. In the event of company failure, the local government is reluctant to provide financial assistance. However, if the failure threatens to interfere with the central government’s policy objectives, it will likely force the local government to use local funds to bail out the company. Ironically, then, it is the political strength of the central government that softens the budget constraints of Chinese enterprises listed in Hong Kong.

CHALLENGES FOR HONG KONG AND THE INVISIBLE HAND OF BEIJING In light of all this, it is not surprising that political factors influence the management of Chinese SOEs. However, this is not the norm in Hong Kong. Will the growing number of listed Chinese enterprises conflict with the free market principle of the Hong Kong Stock Exchange? The case of Northeast Electrical shows that the state-owned – and thus state-backed – nature of Hshare companies does, to some extent, politicize the Hong Kong stock market. According to one report, the Chinese central government considered the attempt to force Northeast Electrical into bankruptcy as an ‘ill-intended move’ by a ‘hostile power’. CCIC Finance, the major creditor that filed the liquidation petition, consists of the First Chicago Bank of USA (30 per cent), the Industrial Bank of Japan (30 per cent), the Bank of China Hong Kong Branch (30 per cent), and the China Resources group (10 per cent). Although the last two were China-related enterprises, CCIC Finance was essentially under US management. It is not clear whether the epithet ‘hostile power’ referred to the US business interest. In any case, after Northeast Electrical received the liquidation petition, the Chinese central government, through its Hong Kong representative, urged CCIC Finance to accept a 60 per cent loan-repayment proposal and mobilize other creditors to opposite the petition (PR, 27 November 2001; 11 March 2002). The intervention of the Chinese central government politicized the operations of Northeast Electrical and challenged Hong Kong’s judicial independence. The company, claiming a legal privilege similar to diplomatic


117

immunity, declared that because it was incorporated in China and its parent (NET) was a state-owned enterprise, the liquidation proceedings could only be heard in mainland China, not in Hong Kong. Creditors and local experts in Hong Kong countered that the liquidation petition was within Hong Kong’s jurisdiction. The dispute became a test of Hong Kong’s rule of law. In January 2002, trading of Northeast Electrical’s H-shares was suspended, and for the first time the company admitted that the lawsuit in Hong Kong would affect its operations. Nevertheless, it did not make an appearance at all the court hearings (JR, 27 November 2001; SCMP, 28 November and 29 December 2001; XB, 3 and 26 January, 30 April, 14 May 2002). While Northeast Electrical was saved by the government bailout, the challenges that Chinese SOEs pose to Hong Kong’s financial status remain. By the end of 2001, Chinese companies accounted for 23 per cent of total market capitalization in Hong Kong, compared to less than 1 per cent in 1991. By the mid-2000s, about 70 per cent of the new funding raised in the Hong Kong stock market has come from mainland Chinese enterprises. The Hong Kong Stock Exchange wants to maintain its unique role as the largest ‘foreign’ venue for listing Chinese enterprise, but the generally poor performance of H-share companies has hurt its reputation. As of mid-2002, about 80 per cent of the red chips and H-share enterprises were trading below their IPO prices (SCMP, 16 July 2002; PI). More importantly, the political rules behind Chinese SOEs have challenged the long-established free-market principle of the Hong Kong stock market. As one scholar noted, the state’s involvement in Chinese enterprises listed in Hong Kong ‘represents not only the deviation from the internationally accepted practice, but also the exposure of domestic hazards of a planned economy to a market economy.’ Such interference from the Chinese government ‘may go beyond the control of the securities regulations in Hong Kong and even the Government of the Special Administration Region’ (Zhang X.C., 1999, p. 75). The case of Northeast Electrical shows that this concern is not unfounded. With the transfer of Hong Kong’s sovereignty to China in 1997 and the further economic integration of Hong Kong with the mainland, the Hong Kong stock market has become even more subject to the influence of China’s domestic economic policy. One example is the Chinese government’s use of the Hong Kong stock market as an outlet for state shares. In the early 1990s, when ideology was still hindering reform of China’s shareholding system reform, the Chinese government was, by law, the largest shareholder in the country’s shareholding enterprises. The proportion of state shares in listed companies ranged from 51 per cent to more than 80 per cent. This changed in 1994, when the newly implemented Company Law reduced the minimum level of state ownership to 35 per cent. As of mid-2000, however, the state still held some 60 per cent of the total shares of listed state enterprises, and the

118


market value of the state shares amounted to about 3 trillion yuan ($360 billion). Finding an outlet for the huge portfolio of state shares has long been a major obstacle to reform of the shareholding system, yet the government is badly in need of funds to support its national social-security system. This issue is becoming more and more important as China’s population ages. The amount required is estimated at one trillion yuan ($120 billion) for the urban sector alone. One plan for addressing this growing need is for the government to cash in part of its state shares (FEER, 11 July 2002; MB, 9 and 27 October 2000). The state-share sale plan, however, faced strong resistance from China’s domestic securities sector. Their primary concern was the impact on stock prices. From May to October 2001, although just a fraction of state holdings was actually released to the market, share prices in the Shanghai Stock Exchange plunged by 35 per cent. Since then, any indication of further sales of state shares has caused similar market panic. In June 2002, the government gave in by suspending the state-share sale plan, resulting in an immediate 9 per cent jump in Chinese stock prices (FEER, 11 July 2002; MB, 25 June 2002). Hong Kong, however, is excluded from the policy freeze. According to China’s provisional rules on the sale of state shares promulgated in June 2001, whenever a state enterprise issues new shares, it must simultaneously sell off an amount of state shares equal to 10 per cent of the value of the fund raised by the IPO. This rule, while suspended for new issuance of domestic shares, remains in effect for H-shares. The exception is justified by the claim that the Hong Kong stock market is ‘mature’ enough to absorb the state shares (MB, 9 July 2001 and 24 June 2002; XB, 16 July 2002). There has been no serious consideration on the Chinese side about the impact of the state-share sale plan on Hong Kong’s stock market, however, nor has the Hong Kong Stock Exchange ever been consulted.14 In other words, Hong Kong apparently has no say in deciding whether to serve as an outlet for Chinese state shares. The Northeast Electrical case shows that state involvement in Chinese enterprises listed in Hong Kong has made these enterprises less efficient and has threatened the free-market foundation of the Hong Kong economy. The exclusion of Hong Kong from the national ban on the state-share sale plan suggests that the Chinese government might use the Hong Kong stock market as a venue for state fund-raising rather than as a stage to improve corporate governance. Both cases would have serious implications for Hong Kong’s financial autonomy. This, perhaps, should not be surprising, given the unequal power relationship between China and Hong Kong.


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RECENT DEVELOPMENTS15 General Within about 20 years, the influence of Chinese enterprises in the Hong Kong stock market became dominant. As of March 2009, 470 Chinese enterprises (including red chips, H-share companies, and non-H-share private enterprises) were listed in the SEHK. They accounted for 37 per cent of the market in terms of total number of companies listed, 61 per cent in terms of market capitalization, and 70 per cent in terms of equity turnover (SEHKW). While red chips were more popular from the mid-1980s through the 1990s, H-share enterprises have become more common since 2000, especially after the IPOs of some gigantic enterprises such as Industrial and Commercial Bank of China Limited, Bank of China, and China Construction Bank (Guo, 2009, pp. 59–60). On the other hand, the Chinese government has continued its policy of tightening regulation of red chips. For example, in 2006 a new set of rules was announced such that red chips that plan to launch IPOs are required to report to the State Administration of Foreign Exchange 30 days in advance about how the capital raised would be transmitted to the mainland (SCMP, 18 July 2006). In 2007, Chinese enterprises raised over US$47 billion in the SEHK, representing 65 per cent of the total. During the year, 85 per cent of the total value of IPOs, or US$32 billion, was raised by Chinese enterprises; and the ten largest IPOs were all launched by Chinese enterprises. Due largely to the activities of Chinese enterprises, the SEHK emerged to be the seventh largest in the world in terms of market capitalization, fifth in terms of total equity funds raised, and fourth in terms of IPOs (HKSAR Government, 2007, pp. 66–68 and 84). To strengthen its position, the SEHK has continued its effort to attract Chinese enterprises to list shares in Hong Kong. Measures in this regard include setting up offices in major Chinese cities, organizing workshops and seminars to introduce listing requirements in Hong Kong, and developing Hshare-related products such as H-shares Index Futures, H-shares Index Options, and Mini H-shares Index Futures. As stated in its 2007–2009 Strategic Plan, it is the mission of SEHK to make Hong Kong into ‘a leading international marketplace for securities and derivatives products focused on Hong Kong, Mainland China and the rest of Asia’ (SEHKW). On the other hand, however, there were signs that with the growth of China into one of the world’s largest foreign exchange owners, the Chinese government has attached less importance to listing H-shares in Hong Kong as a source to raise foreign capital. In 2006, an informal ‘A before H’ policy was introduced, by which Chinese enterprises were encouraged to list A-shares before listing H-shares (WSJ, 18 April 2007). It was not until September 2008,

120


when new issuance of A-shares was suspended in the wake of a slump in the domestic stock market, that the restriction on H-share listing was relaxed (RN, 12 March 2009; SCMP, 11 September 2008). That is to say, the domestic Ashare market seems to have gained a higher priority than the H-share market in the Chinese government’s overall financial policy consideration. In the following, we update the developments of the three case companies examined above. This shows that, after more than one or two decades of listing of these H-share or red-chip enterprises in the international financial centre Hong Kong, the state is still playing a residual yet influential role in the cases of Guangzhou Shipyard and Guangdong Investment, and corporate governance is still not up to standard in the case of Northeast Electrical. Guangzhou Shipyard International Company As mentioned above, following the Asian financial crisis, Guangzhou Shipyard International Company (GSIC) wrote off 10 per cent of its overdue deposits as bad debts in 1999, resulting in the decline in profit in that year and the loss in 2000. From then on to 2005, the company’s shares were traded at around HK$1 to 2. But business began to pick up in the next year, due to rising demand and the state’s support for the shipbuilding industry. In 2007, GSIC received orders that would keep the company busy for at least four years. Moreover, it gained a significant amount of non-operating income from investment and financial derivative instruments. The company’s net profit more than tripled, and the share price rocketed to about $68 by the end of the year (Table 6.7; XB, 18 December 2007). To meet soaring demand, GSIC attempted to enhance its production capacity through developing new production sites and acquiring Wenchong Shipyard from its parent CSSC (MB, 1 July 2008; SCMP, 2 September 2008). However, a major turnaround occurred in 2008. Demand for shipbuilding declined on the one hand, while cost rose on the other, resulting in cancellations and delays from ailing shipowners. The situation was made worse by the international financial tsunami. GSIC’s net profit fell by about 13 per cent in that year, and share price dived to about $3 in October. In light of this, the state intervened by providing subsidies to domestic vessel buyers and relaxing credits for ship exporters (SCMP, 13 February and 11 March 2009). Guangdong Investment Guangdong Investment enjoyed steady growth of turnovers and profits in the early 2000s (Table 6.7), thanks largely to the Dongshen Water Project injected into the company in the government bailout of 1999. By this project, Guangdong Investment acquired the exclusive right to supply water from


Table 6.7

121

Financial indicators of the three case companies, 2003–2008 2003

2004

2005

2006

2007

2008

2840

2363

2729

3322

5907

6984

24

58

140

277

960

840

24

61

135

267

939

820

Guangzhou Shipyard Turnover (million yuan) Profit after tax (million yuan) Profit attributable to shareholders (million yuan) Return on equity (%) Net asset value per share (yuan) Earnings per share (yuan) H-share price (high–low) (HK$)

3.73 1.33 0.050 1.95– 0.62

8.48 15.29 21.13 38.28 29.86 1.45 1.78 2.55 4.96 5.55 0.123 0.273 0.539 1.897 1.66 1.98– 2.275–14.70– 68.50– 44.40– 1.08 1.420 1.45 12.50 3.30

Guangdong Investment Turnover (HK$ million) Profit after tax (HK$ million) Profit attributable to shareholders (HK$ million) Return on equity (%) Net asset value per share (HK$) Earnings per share (HK$) Share price (high–low) (HK$)

5164

5109

549

656

6689

7590

1449

1079

1510

179

1998

1995

1107

896

1303

1507

197

1877

12.39 1.70 0.201 1.77– 0.97

8.92 11.36 11.94 12.74 12.76 1.81 1.91 2.07 2.30 2.50 0.160 0.227 0.250 0.278 0.305 2.75– 3.025– 3.800– 5.63– 4.54– 1.13 2.050 2.625 3.51 1.66

Northeast Electrical Turnover (million yuan) Profit after tax (million yuan) Profit attributable to shareholders (million yuan) Return on equity (%) Net asset value per share (yuan) Earnings per share (yuan) H-share price (high–low) (HK$)

623

342

546

466

640

518

31

22

42

23

–319

–71

28

21

27

30

–311

–69

4.93 0.65 0.032 1.160– 0.510

2.71 0.88 0.024 1.410– 0.540

3.34 0.92 0.031 0.860– 0.410

Sources: NTC; annual reports of individualcompanies; Datastream.

3.56 –60.72 –22.18 0.95 0.59 0.36 0.034 –0.36 –0.08 1.020– 3.79– 1.95– 0.610 0.90 0.27

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Guangdong Province to Hong Kong, and the non-exclusive right to supply water to some other Chinese cities in the Pearl River Delta (including Shenzhen and Dongguan) (NTC). In 2008, water supply accounted for 45 per cent of the company’s revenue, while major department store (28 per cent), electricity (12 per cent), real estate (10 per cent), hotel and highway (5 per cent) businesses accounted for the rest (XB, 24 April 2009). In fact, Guangdong Investment benefits from the state’s political attention to the stable supply of water to Hong Kong at a stable price. For example, in 2009 the company received from the Guangdong provincial government a grant of 652 million yuan as a subsidy for freezing the price of water supply to Hong Kong from 2006 to 2008, and for infrastructure modification works. According to a new agreement, the price of water supply to Hong Kong would increase by 18.6 per cent in 2009, and 6.3 per cent each year in 2010–2011, resulting in a water bill of about HK9.4 billion to Hong Kong over this three-year period (MB, 11 March 2009; XB, 24 April 2009). That is to say, Guangdong Investment can be expected to continue to receive a stable income through providing water supply with the provincial government’s backup. Northeast Electrical With the government bailout in 2002, Northeast Electrical’s losses were turned into profits. However, a loss of 319 million yuan emerged in 2007 (Table 6.7). This was due mainly to the failure of a former holding subsidiary of the company, Jinzhou Power Capacitor, to repay a loan of 22.9 million yuan guaranteed by Northeast Electrical. The news shocked the market, as it was not the first time that shareholders of Northeast Electrical had had to pay the cost for the company’s debt litigation (ETN, 18 March 2008; XB, 15 January 2008). This is reminiscent of Northeast Electrical’s loss in the late 1990s due to its sweetheart loans to its parent company, as mentioned above. There have been other cases of corporate misgovernance of Northeast Electrical. For example, in 2003 the company was found to have over-stated its net profit by one million yuan (XB, 19 August 2003). And then in December 2008, the Hong Kong Stock Exchange, after a long investigation, censured 17 former and current directors of Northeast Electrical for failing to disclose five connected transactions. Again, this was not the first time that this company was reprimanded for disclosure problems (SCMP, 9 December 2008). All these incidents lead to doubts about whether privatization of Chinese SOEs through listing in Hong Kong would ensure improvement of corporate governance.16


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NOTES 1. After three decades of opening, China’s foreign capital constraint has been very much relaxed. By the end of 2008, the country had accumulated a foreign exchange reserve of close to US$2 trillion, or about 40 per cent of the world’s total (CD, 20 May 2009). 2. There are also Chinese shares listed in New York, Singapore, London, and Tokyo, known respectively as N-, S-, L-, and T-shares (McGuinness, 1999, p. 10). Being of a small amount, they will not be covered in our analysis. As of November 2001, there was only one Chinese enterprise solely listed in New York, and one in Singapore (CSRCW, 6 December 2001). 3. China’s B-share market reform in February 2001 seems to suggest that the government has changed the plan (Ma, 2001, pp. 153–54). 4. Similarly, due to the infrastructural deficiencies of the Budapest Stock Exchange, 70–80 per cent of trade in Hungarian stocks has been transacted in the Austrian stock market, where Hungarian companies were also quoted (Meszaros, 1993). It has been the idea of some ‘Austrian equity visionaries’ that Vienna could be made into ‘a Hong Kong for eastern Europe’ (EM, January 1997, pp. 83–88). 5. The differences between H-share companies and red chips have often caused confusion (De Trenck et al., 1998, p. 44). For example, Edward Steinfeld (1998, p. 124) mistakenly called the Ma’anshan Iron and Steel Company ‘king of the red chips’. In fact the company is an H-share company. 6. Other factors leading to the poor performance of H-share prices include over-packaging of Hshare companies for listing purposes, the withdrawal of investment funds from Asia, competition from red chips, China’s economic retrenchment, unsatisfactory management of H-share companies, inefficient utilization of capital raised, and inadequate understanding of the international capital market (Huang and Gao, 1999, p. 407; Liu (ed.), 1998, pp. 126–36; Niu, 1997, p. 496). 7. The company was sold back to GEH in 1995 (see Table 6.3). 8. The appointment of Wang Qishan to handle the GEH crisis has been interpreted as a move of the central government to assert its authority in Guangdong (STD, 28 October 1999). 9. Guangdong Investment was a Hang Seng Index constituent from November 1994 to December 1999 (De Trenck et al., 1998, p. 154; SCMP, 7 December 1999). 10. The sudden deterioration of the financial conditions of Guangnan, a subsidiary of GEH, in 1998 was believed to be a result of bribery and fraud. Several former senior executives of the company were arrested for alleged corruption (SCMP, 30 January and 9 September 1999; 17 January 2000). 11. But advocates of ‘backdoor listing’ counter-argue that such an approach will not lead to stripping of state assets because: (1) the value of the shell companies will increase since the price of the shares tends to rise after acquisition by Chinese enterprises; (2) Chinese state enterprises maintain effective control by holding the controlling stake of the shell companies; (3) the value of the state assets injected into shell companies is assessed in accordance with Chinese and international standards; (4) capital can be more efficiently utilized by issuing shares (Wu Z.Y., 1995, pp. 103–104). These arguments, however, do not stand empirical testing, at least not in our case study. 12. Author interview with a senior executive of the Hong Kong Stock Exchange (12 August 2002). 13. According to standard property-rights theory, ownership refers to a bundle of rights that an agent is empowered to exercise over an asset. These include utilization rights (the right to utilize an asset), residual control rights (the rights to appropriate the returns from an asset), and alienation rights (the rights to transfer rights over an asset to others through gift or sale). See Putterman, 1995, pp. 1049–50. 14. Author interview with a senior executive of the Hong Kong Stock Exchange (12 August 2002). 15. The author is indebted to Fung Kin Hang for his assistance in the updating work of this section. 16. Such a finding challenges Tobin and Sun’s (2009) view that Chinese SOEs, through listing on the Hong Kong Stock Exchange and other foreign venues, gain ‘collateral benefits’ such as transfer of better governance practices to China.

7. Completing privatization through ‘share conversion’1 BACKGROUND As mentioned, for political, economic, and ideological reasons, ‘privatization’ (siyouhua) has been taboo in China. But de facto privatization has been underway since the mid-1980s, under the name of ‘shareholding system reform’ (gufenzhi gaige). Under this reform, various types of shares have emerged, including state shares (guojia gu), legal-person shares (faren gu), individual shares (geren gu), and foreign shares (waizi gu), defined according to the type of owner (see Table 7.1). Initially, only individual shares and foreign shares could be traded on the Shanghai and Shenzhen Stock Exchanges. As a safeguard against loss of state control over enterprises, state shares were made nontradable and legal-person shares could only be transferred among ‘legal-persons’ (that is, enterprises or institutions) (Walter and Howie, 2003, pp. 80–81). Since most legal-persons are actually state entities, legal-person shares and state shares are collectively known as state-owned shares (guoyougu). The nontradability of state-owned shares led to many problems. First, state assets were made ‘dead’ (that is, obsolete) and thus less valuable. Second, property rights of enterprises could Table 7.1

Types of Chinese shares

Type of share State-owned shares, of which: State shares Legal-person shares

Official holders

State Council authorized representatives Enterprises, institutions, or authorized social groups

Individual shares

Public retail investors, or employees of the companies that issue the shares

Foreign shares

Foreign investors

Source:

Based on Walter and Howie, 2003, p. 77.

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Completing privatization through ‘share conversion’

125

not be clearly defined among individual investors. Third, capital mobility and economic restructuring were hindered. Finally, the development of a secondary stock market was obstructed (Cheng, Liu, and Wang, 2000, pp. 51–52, 317–23; ZJS, 22 January 2003). Although public trading of state-owned shares in the two stock exchanges in China was officially disallowed, transactions of this type of share actually took place over the counter or through direct negotiations, at discounts of up to 80 per cent of market prices. This resulted in what is known as ‘reduction of holding of state-owned shares’ (RHSOS, or guoyougu jianchi). In 1994, a private enterprise in the southern city of Zhuhai purchased from the state 35.5 per cent of the shares of a listed state-owned enterprise (SOE), the first case of spontaneous RHSOS in China (NR, 25 June 2002). Similar activities in subsequent years led to a decline in the proportion of state-owned shares in the capital structure of China’s listed companies from 69 per cent in 1993, to 61 per cent in 1997 (see Table 7.2). Such a sale of state assets in parallel markets may be called ‘privatization with Chinese characteristics’ (Walter and Howie, 2003, pp. 16, 203–206). At the 15th Chinese Communist Party Congress, held in 1997, the shareholding system reform, after more than a decade of evolution, was finally endorsed as the ‘mainstream reform’ for SOEs. It might then have been expected that the proportion of state ownership in Chinese enterprises would fall further. However, this has not been the case. From 1997 to 2004, there were only minor changes in the relative size of the state sector. As explained below, hidden under such stability were some fluctuations in China’s privatization process during this period. A breakthrough finally occurred in May 2005, when a ‘share conversion’ pilot reform programme was introduced. The pace of change since then has become much speedier than before, leading some scholars to interpret the latest reform as ‘shock therapy’ (see next chapter).

Table 7.2 Proportion of state-owned shares in the capital structure of Chinese listed companies (year-end figure) Year % Year % Source:

1992

1993

1994

1995

1996

1997

1998

1999

65

69

65

62

61

61

61

61

2000

2001

2002

2003

2004

2005

2006

2007

61

64

64

63

62

55

35

30

CSFSY, 2008, p. 181.

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This chapter analyses the share conversion reform within the perspective of China’s two-decade-long privatization attempt, and argues that the latest change represents a major, and probably final, step along this line. This specific form of privatization through the share system has been largely overlooked in many major studies of changes in China’s state ownership, such as the one published by the World Bank (Yusuf, Nabeshima and Perkins, 2006). The fact is that the share system has provided an important channel through which assets have been transferred from the state to private hands. Throughout the past decade, despite some ebbs and flows, the reform has been in basic continuity, providing yet another indication of China’s incrementalist reform approach. The following discussion will trace the policy’s evolution from the official endorsement of the shareholding system reform in 1997 to completion of the share conversion reform in late 2006.

1997–2000: IMPLICIT PRIVATIZATION As mentioned above, the 15th Chinese Communist Party Congress held in 1997 marked the formal endorsement of the shareholding system as the ‘mainstream reform’ for SOEs. A three-year target was set to eliminate the deficits of most large- and medium-sized SOEs through ‘strategic restructuring’; the stock market was expected ‘to serve the function of relieving SOEs’ difficult conditions’. This was followed by a wave of RHSOS through backdoor listing (that is, SOEs used state shares to purchase inactive listed companies). From 1997 to 1998, there were over 100 such cases of transfer of state-owned shares to private enterprises. In 1999, a Central Committee meeting of the Chinese Communist Party decided that ‘under the premise that the state maintains controlling interest, the holding of state-owned shares could be appropriately reduced’. The originally unofficial and spontaneous RHSOS was thus made an official policy. In the same year, the Ministry of Finance announced a two-step RHSOS programme: in the first stage, to reduce the proportion of state-owned shares in total capital from 62 per cent to 51 per cent, and then further down to about 30 per cent in the second stage (JR, 25 June 2002; Lan and Wang, 2001, pp. 28 and 42). To facilitate RHSOS, SOEs were given higher priority for listing shares on the stock market (Zhang, 2004, p. 2035). Once a firm was listed, the rights issues, stock dividends, and listing of employee shares tended to dilute state ownership. According to a survey of over 1000 Chinese listed companies, the proportion of state ownership decreased from the pre-listing average of 45 per cent, to the post-listing level of 31 per cent (Wang, Xu and Zhu, 2004, pp. 472–76). But the newly listed companies, being SOEs, came to the market with a high proportion of state-owned shares. For example, in the year 2000


127

PetroChina offered more than 17 million H-shares (Chinese shares listed in Hong Kong) to raise about US$3.1 billion. While this was the largest H-shares float by China, the offer represented only 10 per cent of PetroChina’s enlarged share capital, and parent China National Petroleum Corp still retained a 90 per cent stake after the offer (RN, 27 March 2000). Put together, the above two contradictory trends largely offset each other, explaining why the relative size of state ownership in China’s listed companies remained unchanged at 61 per cent from 1997 to 2000 (see Table 7.2; and Walter and Howie, 2003, pp. 135, 201–203). That is to say, the lack of further decline in the relative size of state ownership during this period did not suggest any stalemate in China’s privatization; just the contrary, it was because more SOEs embarked for privatization by converting themselves into listed companies. In absolute terms, however, this resulted in the further accumulation of nontradable state-owned shares.

2001–2002: PENSION-DRIVEN PRIVATIZATION The situation outlined above produced a great threat to the stock market because the growing amount of nontradable state-owned shares meant that any RHSOS would cause a sudden increase in the supply of shares on the stock market. According to one estimate, to reduce the proportion of state-owned shares by each percentage point requires the sale of 36 billion yuan (about US$5 billion) worth of state assets at market price. This had a tremendous bearish implication for share prices. During August–September 2000, when there was news that a formal RHSOS programme would be introduced, the Shanghai Stock Exchange Index plummeted by about 11 per cent in a month. On the other hand, some state-owned share offers were under-subscribed. As a result, the first-round RHSOS was laid aside by the end of the year. However, the plan was revived in June 2001, when a set of provisional measures for raising money for the National Social Security Fund (described below) through RHSOS was announced (Fu, 2006, pp. 13–14; NR, 25 June 2002; ZX, 17 August 2000). The original purpose of RHSOS was to solve the economic inefficiency problems arising from the nontradability of state-owned shares. But by 2000, a more imperative factor – raising money for a newly established national pension fund – had emerged as the major driving force for selling state assets. The background of this was that China’s pension system, run on a pay-as-yougo basis, was unable to sustain its rapidly aging population. A computer simulation exercise estimated that in 2000 China was suffering from an implicit pension debt of around 46 to 64 per cent of the country’s gross domestic product (Wang, Xu, Wang, and Zhai, 2004).

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In view of the problem, since the early 1990s the Chinese government has worked to establish a new pension system in line with World Bank recommendations. Under this new system, workers are required to contribute part of their current income to finance their future retirement. But to collect these revenues, the central government has to delegate some administrative power to local authorities, leading to the standard principal/agent problem, whereby the agent (local authorities) may not act in the interest of the principal (central government). By making use of their advantage in the asymmetry of information, local authorities have used contributions from current workers to cover pension payments to current retirees. In effect, contributions from over 100 million workers have been stolen, and the size of their ‘empty accounts’ is estimated to range from two trillion to seven trillion yuan (about $0.28 trillion to $1 trillion) (Frazier, 2004, pp. 48–56). To form a ‘fund of last resort’ in case of financial default by local authorities, a National Social Security Fund was established in September 2000 under the direct administration of the central government. According to a set of ‘provisional measures’ announced in June 2001, regular initial public offerings and rights issues would be subject to a 10 per cent ‘tax’ by tying them to sales of state-owned shares, in order to raise revenue for the new pension scheme. The revenues obtained from such RHSOS would be transferred to the National Social Security Fund. This policy immediately triggered a slump in share prices, with the Shanghai Stock Exchange Index falling by 32 per cent in four months. The market finally rebounded in October when the China Securities Regulatory Commission cancelled part of the provisional measures (Leckie, 2003, p. 149; Naughton, 2007, p. 474; NR, 25 June 2002). Apparently it was the concern for social stability that led to the suspension of the RHSOS programme. According to official statistics, the number of stock market investors in China soared from 2.2 million in 1992 to 68.8 million in 2002 (see Table 7.3). Collapse of the stock market would mean serious loss of wealth of this growing sector of the country’s population, leading to potential social unrest. These official figures, however, are misleading. According to Walter and Howie, after adjusting for double counting, inactive accounts, and other factors, the number of actual holders of shares might range only from 5 million to 10 million, with less than 1 million active traders. More important, institutional investors (securities firms) accounted for the majority of secondary market trading. These dahu (‘big shots’) and market manipulators formed the ‘rich minority (which) successfully duped the government into protecting their positions’ (Walter and Howie, 2003, pp. 139–58). Another source reported that it was the ‘concerted effort’ of some 20 securities firms that led to the suspension of the RHSOS programme (Naughton, 2002).


Table 7.3

129

Number of stock market investors in China (year-end figure)

Year

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Million

2.2

7.8

10.6

12.4

23.1

33.3

39.1

44.8

58.0

66.5

68.8

Source:

CSFSY, 1999 and 2003.

While the threat of social unrest because of the stock market slump might be a fake one, China’s social order will be in real danger if the new pension system collapses. This is because failure to honour pension payments means a breach of social contract; unpaid pensioners thus would have a high degree of legitimacy to protest (Frazier, 2004, pp. 56–60). Therefore, it was imperative for the central government to look for alternative ways of RHSOS, in order to raise capital for the National Social Security Fund. In view of this, shortly after suspension of the provisional measures, the government invited public suggestions on how to achieve RHSOS. Within a month, over 4000 proposals were received (NR, 25 June 2002; ZHB, 4 January 2002). In December 2001, then-Premier Zhu Rongji urged the China Securities Regulatory Commission to ‘introduce new measures for re-launching RHSOS’ so as to provide financing for the pension fund. He noted that this was premised on the stability of the stock market, and he set no timetable for the plan. Nevertheless, this could not prevent another round of market anxiety. As a result, share prices, after a strong but short recovery, dived again in early 2002 (WB, 23 January 2002; XR, 19 December 2001). Moreover, the stock market rejected the RHSOS plan by reducing initial public offerings and rights issues. As can be seen in Table 7.4, the amount of funds raised through these two means in 2002 was only about half of that of the previous year. By the middle of 2002, it became politically necessary for the government to intervene, as the new leadership of the Chinese Communist Party was due to assume power in the 16th National Congress of the Party to be held later Table 7.4 Amount of funds raised by China’s listed companies (billion yuan) Year

Initial public offerings

Rights issues

Total

2000 2001 2002 2003

85.2 61.4 50.0 47.2

51.0 42.3 5.7 7.0

136.2 103.7 55.7 54.2

Source:

Fu, 2006, p. 17.

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that year and stability has always been the overriding concern during such power transitions. Consequently, in June 2002 the RHSOS programme was halted again. In contrast to the similar announcement made a few months earlier by the China Securities Regulatory Commission, this time the decision was made at the State Council level. More importantly, the government promised that ‘no further concrete implementation measures would be introduced.’ As a result, the relative size of state ownership in China’s listed companies re-expanded from 61 per cent in 2000, to 64 per cent in 2001 and 2002. The situation was back to square one, but the stock market reacted with a 10 per cent upsurge on the day after the announcement of the decision (see Table 7.2; CZ, 22 February 2002; LB, 25 June 2002; SZB, 24 June 2002; ZJS, 2 July 2002). The fundamental reason for the failure of pension-driven privatization was that two conflicting programmes – RHSOS and the social security reform – were linked together. The essence of RHSOS was to transfer assets from the state to the market. As such, it had to yield to ‘market’ forces, in the sense that there should be a price differential between state-owned shares and individual shares, in order to reflect their difference in tradability. That is to say, from the RHSOS perspective, nontradable state-owned shares were sellable only at a discount to market prices. In contrast, the new pension fund called for a maximum return from the sale of state assets; any sale of state-owned shares at prices lower than those of individual shares was regarded as ‘depletion of state assets’. It is under such a mind-set that the June 2001 ‘provisional measures’ required the sale of state-owned shares at the same ‘market’ price of initial public offerings of individual shares and rights issues. The slump of share prices was simply a ‘market’ rejection of the over-pricing of state-owned shares. Critics of the pension-driven privatization therefore argued that there was nothing wrong with RHSOS; the problem was just with the price set (DB, 2 July 2002; GS, 22 January 2002; YW, 4 February 2002; ZGJCD, 28 June 2002; ZW, 6 March 2002). Ironically, even the National Social Security Fund, which was supposed to be a chief beneficiary of RHSOS, also favoured cancellation of the programme. While RHSOS was intended to raise capital for the pension fund, its negative impact on share prices would reduce the value of the equities held by the fund. Hence, after RHSOS was halted in June 2002, the National Social Security Fund responded by injecting capital into the stock market, leading to a sharp rise in share prices (SDB, 27 June 2002). That is to say, the stock market has co-opted the pension fund into being a supporter of market reform. In a few years’ time, the pension fund even emerged as the largest institutional investor in Hong Kong and became a sophisticated and influential player in the Hong Kong stock market (XB, 15 October 2006).


131

2003–2004: DEADLOCK The end of the pension-driven privatization programme meant that RHSOS through the stock market was no longer feasible. However, this did not actually end the sale of state assets. Rather, the old practices of privatization through over-the-counter transactions and direct negotiations between SOEs and private enterprises resumed (XC, 12 February and 13 June 2003; ZGJCD, 28 June and 15 August 2002). This resulted in rampant management buyouts, or insider privatizations, by which former managers of SOEs seized control of the enterprises. To prevent depletion of state assets in these unregulated exchanges, a high-powered central agency, the State-Owned Assets Supervision and Administration Commission (hereafter, State Asset Commission), was established at the 10th National People’s Congress in March 2003. Charged with ‘unified authority, duty, and responsibilities’ over 196 SOEs directly under the State Council, the State Asset Commission absorbed power of control over these enterprises from various state bureaucracies, including the Ministry of Finance, the State Economics and Trade Commission, and other specialized bodies under the State Council and the Party (Naughton, 2003 and 2005a). Immediately after its inception, the State Asset Commission suspended all management buyouts and began to explore ways to establish a ‘unified, standardized national market’ for transactions of state assets. As a central government agent representing the state’s interest, its primary concern was to defend the value of state assets. The objective was to sell nontradable state-owned shares ‘at good prices’ with reference to the market prices of tradable shares listed in the secondary market. On the other hand, the China Securities Regulatory Commission was more concerned with the interest of share investors. As such, it was very sensitive to any sale of state-owned shares by the State Asset Commission, because of the bearish implication of the increase in share supply. The tension between the two commissions resulted in a deadlock in China’s privatization process through 2003–04, with the relative size of state ownership in China’s listed companies remaining almost unchanged at 62–63 per cent during this period (see Table 7.2; DB, 21 February 2004; GJB, 9 February 2004; Naughton, 2005a; Naughton, 2007, pp. 316–19, 323–25; SZB, 4 February 2004; XB, 11 April 2003; ZW, 21 July 2003).

2005–2006: FURTHER PRIVATIZATION UNDER THE SHARE CONVERSION REFORM A breakthrough occurred in late April 2005, when a share conversion pilot reform programme was launched. The official Chinese name of this reform, guquan fenzhi, suggests that its purpose was to solve the ‘division’ (fenzhi)

132


between ‘equities’ (gu) and ‘rights’ (quan). This division is a historical problem arising from the coexistence of nontradable state-owned shares and tradable individual shares, which has resulted in a ‘dualistic’ market consisting of ‘different types of equities, different prices, and different rights’ (Fu, 2006, p. 3). The term has thus been translated into English as ‘equity division reform’ (CD, 20 November 2006; CIICN, 1 May 2005; GNW, 9 January 2006; XFNN, 7 November 2005). This, however, is misleading, because what the reform aimed at was exactly to eliminate the ‘division’. This article thus follows Naughton (2005b) to name this reform ‘share conversion’. Under the share conversion pilot reform, from May to June 2005 altogether 45 listed companies were asked to initiate their own plans to convert nontradable state-owned shares into tradable shares. Apart from approval by the China Securities Regulatory Commission, each plan also had to be acceptable to the company’s board of directors and at least two-thirds of the individual shareholders. To secure such support, more than 90 per cent of the companies proposed to offer bonus shares to existing individual shareholders. The China Securities Regulatory Commission explained that the primary purpose of the reform was to solve the problem of nontradability of the large amount of stateowned shares, instead of cashing them in (Fu, 2006, pp. 15 and 24–25; HKS, 2 May 2005; Naughton, 2005a; XJR, 21 June 2005; ZX, 15 May 2005). The plans initiated by the pilot companies proposed that, on average, every ten tradable individual shares would receive three bonus shares from the state. The reform programme thus meant a concession of state interest to individual shareholders, which was against the original position of the State Asset Commission. But with the agency’s organization extended from central to local levels, it became holder of an increasing amount of industrial assets, and a more flexible approach to the problem of nontradability of state-owned shares would be to its advantage.2 The State Asset Commission thus became less resistant to the share conversion plan, making the share conversion reform politically feasible. As the reform proceeded, not only the State Asset Commission and the China Securities Regulatory Commission but also the Ministry of Finance, the People’s Bank of China, the Ministry of Commerce, and the State Administration of Taxation supported the change (Naughton 2005b; 2007, p. 475; SJB, 21 July 2005; SZB, 27 June 2005; ZS, 26 April 2006; ZZB, 8 January 2006). The pilot programme was completed within four months after its introduction, and in early September 2005, the share conversion reform was officially launched nationwide. By late April 2006, a year after the introduction of the pilot programme, 868 listed companies accounting for about 70 per cent of total market capitalization had already completed conversion of nontradable shares into tradable shares, or were in the process of doing so. The rest were mainly those firms consistently posting losses, or whose market capitalization


133

was too small, or those facing disciplinary actions. They were pressured by the China Securities Regulatory Commission to join the reform by the end of the year, otherwise they would be merged, acquired, or delisted. In May 2006, initial public offerings, which had been suspended since the introduction of the reform, resumed. All the shares of the newly listed companies were tradable. That is to say, new listings would no longer increase the accumulation of nontradable shares (SCMP, 19 June 2006; ZGB, 30 December 2005; ZXQB, 13 June 2006; ZZB, 29 April 2006). According to the State Asset Commission, the share conversion reform, in contrast with the RHSOS programme, did not necessarily mean diminished state ownership because state-owned shares, after they are made tradable, may still be retained by the state. It was stipulated that within the first three years of the reform no more than 15 per cent of the state-owned shares could be sold. Moreover, the state may even choose to increase its shareholding (MB, 23 September 2005; SJB, 21 July 2005; XJR, 21 June 2005). However, this does not seem likely to happen, given that the state lacks the capital as well as the incentive to do so. On the other hand, by making state-owned shares tradable, it has become easier for Chinese ‘legal persons’ to cash in the state-owned shares they hold. Hence, the share conversion reform, though in itself a share conversion rather than an RHSOS programme, has significantly speeded up the process of privatization in China. As indicated in Table 7.2, in 2005 the relative size of state ownership in China’s listed companies fell sharply, from 62 per cent to 55 per cent. A year later, it was reported that over 95 per cent of China’s listed companies had completed, or were undergoing, the share conversion reform (GR, 19 January 2007). On the other hand, on the basis of the success of the share conversion reform, the RHSOS programme was resumed in July 2007, for the purpose of raising money for the national pension fund. This time, the stock market did not react with panic, as there is the restriction that a state-share-holder could not sell more than 5 per cent of its holdings within three financial years, unless approved by the State Asset Commission (MB, 8 July 2007; XB, 7 July and 13 October 2007). Nevertheless, this has opened up another channel for the transfer of state assets to private hands, thereby intensifying the trend of privatization in China. By the end of 2007, the proportion of state ownership had already plummeted to 30 per cent (Table 7.2).

NOTES 1. 2.

The author is indebted to Charlotte Chan, Jester Chan, and Elton Ma for their research assistance in the work on this chapter. This is in line with the observation that local governments are the major promoters of privatization in China. See Liu, Sun and Woo (2006).

8. Conclusion: privatizing through groping for stones SHARE CONVERSION AS ‘SHOCK THERAPY’? The ‘share conversion’ reform discussed in the last chapter represents an important breakthrough in China’s privatization. By issuing bonus shares to individual shareholders, it has diluted state ownership in China’s listed companies; and by making state-owned shares tradable, it has facilitated further sale of state assets in the stock market. In late 2006, Shang Fulin, chairperson of the China Securities Regulatory Commission and a proposer of the share conversion reform, announced that the reform ‘had basically been accomplished’. That is to say, it took only about 20 months (from May 2005 to end of 2006) to complete the whole share conversion reform. The stock market welcomed the change with a 167 per cent rise in total capitalization during this period, and it was widely expected that a ‘golden decade’ for China’s stock market would ensue. As asserted by a Chinese commentator, the share conversion reform was the ‘fastest and smoothest’ change in China’s economic system reforms (NR, 10 January 2007; SZB, 15 January 2007; ZS, 22 January 2007). This dramatic change has led some Chinese scholars to interpret the share conversion reform as ‘shock therapy’. The announcement of the reform on 30 April 2005 (the day before the stock exchanges closed for the weeklong May Day holiday) without any major hints in advance was described as a ‘sudden attack’ of the stock market and ‘an arrow that has no return’ (SZB, 8 May 2006). When the list of the first batch of pilot companies for the reform was announced, trading of the shares of these companies was suspended immediately. Hua Sheng of Yanjing Overseas Chinese University explained this as a ‘shock therapy’ approach to prevent market speculation. Guo Shiping of Shenzhen University noted that at such a critical moment, ‘[S]hock therapy might as well be used to search for a solution for the market’ (CW, 10 May 2005; GJB, 7 June 2005). Another scholar, Xie Maoshi of Hunan Business School, complained that giving bonus shares to individual shareholders was ‘unreasonable’ and that the share conversion reform was not much different from making all shares tradable all of a sudden, through ‘shock therapy’ (DR, 26 November 2005). 134

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The above brings us to the debate over shock therapy and gradualism. The gradual reform of China since the early 1980s on the one hand, and the sudden switch to the market economy of many former Soviet bloc countries in the 1990s on the other, has resulted in a hot discussion about which approach is more desirable. As China’s reform continues to produce higher economic growth than that of most former Soviet bloc countries, this debate about shock therapy and gradualism has in general concluded in favour of the latter.1 Many former advocates of rapid switch from plan to market have given up their earlier belief in the big bang approach, and a supporter of China’s gradual transition even claimed that ‘We Are All Gradualists Now’ (Rawski, 1999, p. 153; original italics). But in what sense is China’s reform gradual? If we follow the so-called ‘slow-fast characterization’ of the debate between shock therapy and gradualism (Sachs and Woo, 2000, pp. 6),2 the answer to this question would be that the Chinese reform is a gradual one because it has been taking place at a slower pace than those in most of the former Soviet bloc countries. However, there are many cases in the Chinese reform – such as the introduction of the agricultural household responsibility system, and the restructuring of property rights of small state-owned enterprises – in which speed of introduction was by no means slow (Wang X., 1998, p. 145; Wang D., 2005, p. 15). Moreover, while shock therapists favoured ‘the faster the better’, and gradualists cautioned to wait till ‘conditions are appropriate’, both failed to spell out an appropriate speed of change (Brada, 1995, p. 186). Hence, it is problematic to distinguish between shock therapy and gradualism simply with a slow-fast schema. As will be elaborated below, a more meaningful criterion would be whether the transition is characterized by the coexistence of new and old systems, that is, a dual-track one.

SHOCK THERAPY, GRADUALISM, AND DUAL-TRACK TRANSITION The debate between shock therapy and gradualism appeared in the 1990s, when former socialist regimes were confronted with choices of post-communist transition strategies. Shock therapy is originally a psychiatric measure sometimes used as a last resort to treat mental patients. The theory is that by stimulating nerve cells through electrical shocks, mental conditions of patients can be expected to return to ‘normal’ (Brabant, 1995, p. 158). Applied to postcommunist transition, normalcy is defined in terms of Western capitalist economies, and shock therapy is the reform package (typically consisting of privatization, liberalization, and internationalization of economic activities) that aims at creating instantaneously such a ‘normal’ system in former

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centrally planned economies (Aslund, 2002, p. 70; Sachs and Woo, 2000, p. 8). To achieve this, any unfavourable institutions are to be destroyed first, followed by immediate construction of new ones (Murrell, 1993, pp. 112–19). In contrast, gradualism does not pre-assume any normal destination. Rather, it holds that goals of reform are contingent upon available knowledge and institutional settings, which cannot be changed overnight (Murrell, 1993, pp. 119–22). Even if market is accepted as the presumed goal of transition, market itself is ‘a source of information’ from which actors learn to become entrepreneurial, and is an ‘evolving institution’ that needs to adapt to circumstantial conditions (Brabant, 1995, pp. 160–70). Since contingency is important, the role of blueprint in reform must be limited. In the case of Chinese gradualism, the reform is regarded as ‘one without-a-theory, rather than a deliberate approach’. Instead of consciously adhering to any guiding theory, China’s reform strategy is ‘informed by an intensely pragmatic mindscape and facilitated by a set of historically situated structural factors’ (Zhu, 2007, p. 1504). It is therefore not a revolution with a clear vision at the onset, but an evolution characterized by learning-by-doing (Jin and Haynes, 1997, pp. 80–84). If gradualism was so defined, then China’s gradual reform would best be understood in terms of ‘groping for stones to cross the river’, a well-known metaphor often attested to Deng Xiaoping (Tao and Xu, 2006, p. 178; Zhu, 2007, p. 1504). It refers to the situation that, since the reform has no master plan, it can only proceed on a trial-and-error basis, leading to ‘a succession of approved small steps towards the far riverbank’ (Hope, Yang and Li, 2003, p. 2). Under this approach, throughout the Chinese reform ‘No ultimate goal was announced, nor any timetable for the transition’ (McMillan and Naughton, 1992, p. 130). It is a gradual reform strategy, not because it is slower than shock therapy, but because its goal – the other side of the river – is not predefined. Without any pre-defined normalcy, gradualists are sceptical of the workability of ‘utopian social engineering’, or reforms based on target blueprints (Murrell, 1992, pp. 3–11). Consequently, they tend to attach less significance ‘to the details of the imagined endpoint for the immediate tasks to be undertaken’, and prefer a ‘dual economy’ than ‘an immediate economy-wide liberalization’ (Murrell, 1993, p. 122). In the case of China, as Naughton (2007) noted, the adoption of a dual-track system could be regarded as ‘the most characteristic feature of China’s initial departure from the planned economy’ (p. 91). As mentioned at the beginning of this chapter, the fact that it took only about 20 months to complete the share conversion reform has led some Chinese scholars to interpret the change as a kind of shock therapy. However,

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it should be noted that these Chinese scholars were using the term ‘shock therapy’ only in a very general sense, and this should not lead to the view that China has switched from its long-followed gradualism to shock therapy. Although it is true that the share conversion reform was introduced much faster than China’s other reform programmes, this alone does not amount to a fundamental change in approach to reform. Apart from speed, how a new system replaces an old one is another important criterion to distinguish the two major approaches of reform. Gradualism involves dual-track transition, whereby new and old systems coexist until the former is ready to completely take over the latter. In contrast, under shock therapy the old system is destroyed before the new system is established and there is thus no overlap (Murrell, 1993, pp. 113 and 122). According to such a definition, share conversion reform falls clearly under the gradualist category. When the shareholding system reform began to emerge in China in the mid-1980s, existing political, economic, and ideological constraints allowed tradability only for individual shares, but not for stateowned shares. This resulted in the ‘equity division’ into two separate markets: an official stock market for tradable individual shares and a parallel market for nontradable state-owned shares. Through the share conversion reform, all shares were made tradable, thereby merging the two markets into one, after they had been in coexistence for about two decades. For China, this is just another case of ‘dual-track transition’, following the unification of dual prices and multiple currencies.3 Put in such broad perspective, the share conversion reform is part of the two-decade-long evolution of China’s shareholding system. The problem that the share conversion reform intends to solve – the coexistence of tradable and nontradable shares – was born with the establishment of the first shareholding company in 1984. It took 13 years for the shareholding system reform to evolve from a spontaneous experiment into an official reform programme in 1997. Then after three years (1997–2000) of implicit privatization, the imperative need to raise capital for the National Social Security Fund spurred an attempt at speedier sale of state assets from 2001 to 2002. But in face of strong market rejection, the ‘reduction of holding of state-owned shares’ programme was scrapped, followed by a deadlock from 2003 to 2004. As a compromise, in 2005 the state agreed to issue bonus shares to individual shareholders, under the name of the share conversion reform. It was a Chinese-style ‘management by exception’, a plan introduced at the time when Chinese top leaders found it imperative to solve the market distortion and official corruption due to the dual-track system in the stock market (Bell and Feng, 2009). The whole process was consistent with the gradual, incremental, trial-and-error approach described by Chinese leaders as mo zhe shitou guo he (to cross a river by groping for stones).

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ENTERING THE POST-SHARE-CONVERSION ERA In short, China’s two-decade-long privatization attempt has finally been accomplished through the share conversion reform. From 2002 to 2007, the number of state-owned enterprises declined by about 10 000 per year, while profits rose by an average of 250 billion yuan per year (ZJN, 2008, p. 833). In 2005, only 188 billion yuan were raised through shares and rights issues. But in 2006 and 2007, after the implementation of the share conversion reform, the amount soared to 559 billion yuan and 843 billion yuan respectively (ZJN, 2007, p. 821; 2008, p. 831). The capital market has thus served as an important channel for Chinese state enterprises to privatize through initial public offerings. In fact, a comparative study on post-communist privatization noted that ‘no country utilized the capital markets to the extent the Chinese did’ (Lieberman, Kessides and Gobbo, 2008, p. 21). Then what next? According to a 2007 report of the China Securities Regulatory Commission, there are three major challenges for the country’s capital market in the post-share-conversion era. First, resources will be further allocated according to market principle; the less efficient elements of the market will be sloughed off through competition. Second, there will be greater demand for regulation and institutionalization of the market. Finally, internationalization and the increasing competition that follows will require further reform and development of the capital market. Looking into the future, the report predicts that more capital market products will appear, the size of the capital markets will expand, the prosperity of the market will become more sustainable, the Chinese economy as a whole will become more efficient, and more wealth will be created (SZB, 16 February 2007). Such an optimistic outlook for the post-share-conversion era lasted throughout 2007. During the year, the Shanghai Composite Index jumped by 97 per cent, and the Shenzhen Component Index even by 166 per cent. However, market sentiment began to turn around towards the end of 2007, and further worsened along with the worldwide financial tsunami in the following year. In 2008, both the Shanghai Composite Index and the Shenzhen Component Index plummeted by about 65 per cent. Some leftists argued that the crisis in the western financial market showed the superiority of the socialist economy over the capitalist market (PR, 20 February 2009). Moreover, critics of the share conversion reform attributed the downturn to this reform. But Shang Fulin, chairperson of the China Securities Regulatory Commission, argued that share conversion is an indispensable reform but not a panacea. The reform continued amid criticisms. In 2008, share conversion was completed or being implemented in 46 listed companies, leaving only about 50, out of the total of over 1600 Chinese listed companies, unreformed (ESJB, 7 January 2009; ZR, 15 January 2009). Chinese reformers, however, have become

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increasingly aware that further reform must be guided by ‘more detailed’ policy design and vision, instead of relying on ‘groping for stones’ (SS, 12 January 2009). ‘If the initial stage of the Chinese reform that began in 1978 could be metaphored as one crossing a river, now thirty years after, the Chinese reform is like a ship sailing in the sea’ (Ibid.). Finally, as the Chinese economy enters the post-share-conversion era, our study of China’s corporate governance reform has to move accordingly to a post-privatization perspective. Studies on post-privatization in other former socialist countries find that accomplishment of privatization does not automatically lead to economic success. For example, data collected by Broadman (2000) from Russia’s industrial firms suggest that ownership changes did not necessarily result in restructuring. Similarly, Prasnikar, Svejnar, and Domadenik’s (2000) study of Slovenian firms finds that the pace of restructuring depends more on the power dynamic among interest groups than on ownership structure. Moreover, according to Kogut and Spicer’s (2002) comparative case analysis of post-privatization market formation in Russia and the Czech Republic, without effective state regulation and trust, ‘markets’ are used for political contests rather than for economic competition. Yet there are also studies that support post-privatization optimism. For example, Earle and Estrin (2003) found evidence about the positive impact of privatization on Russian labour productivity; and Earle and Telegdy (2002) obtained similar econometric results from Romanian industrial corporations. Now that China has entered into the post-share-conversion era, continuing studies of Chinese enterprise performance will contribute to this literature by providing new data and perspectives for the comparative analysis of post-privatization in former socialist economies.

NOTES 1. 2. 3.

For reviews of the Western debate about shock therapy and gradualism, see Aslund (2002, pp. 70–112) and Brabant (1998, pp. 102–108). Sachs and Woo referred to that debate as one between ‘experimentalist school’ and ‘convergence school’. These two schools correspond more or less to gradualism and shock therapy respectively in our context. For other discussions on China’s ‘dual-track transition’, see Jin and Haynes (1997), Lau, Qian and Roland (2000), and Opper (2001).

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Index A-shares and B-shares 66, 67–9, 87 Guangzhou Shipyard International Company (GSIC) 98 listings 119–20 nature of 62–3 Northeast Electrical Company 110 acquisitions 73–5 agency problem 15 Anheuser-Busch 71–2 Asea Brown Boveri 72 Atlantic Richfield 72 B-shares and A-shares 66, 67–9, 87 expansion of market 64–7 growth of 92–3 listings 65 nature of 62–3 backdoor listing Guangdong Investment (GI) 102, 112–16 process of 93 reduction of holding of state-owned shares (RHSOS) 126 state control of 95–6 Beijing Light Bus 69–70 Beijing Tianqiao Department Store Company 10, 29 Bersani, Matthew 17 Blecher, M. 84–5 Bornstein, Morris 8, 62 Bowles, Paul 17 Brabant, Jozef M. van 14 Bradshaw, York 80 Breslin, Shaun G. 45, 82 Broadman, Harry G. 26, 139 Capital Iron and Steel Corporation 89–90 CCIC Finance 110–11, 116 Chan, Anita 44, 83

Chen Aimin 58 Chen Feng 18 Cheung, Steven 96 China closed-end country funds 79 as corporatist state 82–4, 88 dependent development theory 79–81 as developmental state 81–2, 85, 86, 87–8 economic growth 5, 46–7, 61 as entrepreneurial state 84–5, 86, 88 foreign capital in 61, 76–9 and the Hong Kong Stock Exchange (SEHK) 116–20 ideological debate 10, 17, 18–22 as market-facilitating state 86–7, 88–9 privatization in 1, 2–3, 4–6, 7, 8, 138–9 state enterprise losses 9–10 state ownership, decline in 33–7 China International Trade and Investment Corporation 86 China Ocean Shipping Company 95 China Securities Regulatory Commission (CSRC) approval of share listings 99, 131 B-shares 66 conversion of corporate shares 35–6, 69 establishment of 32 Guangzhou Shipyard International Company (GSIC) 101 reduction of holding of state-owned shares (RHSOS) 129 share conversion reform 132, 133, 138 China State Shipbuilding Corporation (CSSC) 97–8, 112, 113 China Strategic Investment (CSI) 73–5 classical dependency theory 79–81

161

162


closed-end country funds 79 commodification 9, 18 Company Law regulation of shareholding enterprises (SHEs) 32, 34, 35, 58 state ownership 117 supervisory mechanism 39 corporate governance 106–7 corporate shares 33, 34–7, 62–4, 69–71 corporatism 44, 83–4 corporatist state 82–4, 88 corporatization 13–14, 27–8 Czech Republic 96, 139 Dai Xianglong 105 Deng Xiaoping 11, 31, 48, 97, 136 dependency theory 79–81 dependent development theory 79–81 developing countries 61, 76–9 developmental state 43–4, 45–6, 81–2, 85, 86, 87–8 Domadenik, Polona 139 domestically listed foreign shares see Bshares Dongshen Water Project 105 dual-track transition 39, 135–7 Duckett, Jane 84–5 Duncan, Ron 26 Earle, John S. 139 Eastern Europe 2–3, 7, 69, 135 Engels, Friedrich 19 enterprise (collective) shares 12, 13, 51–2 entrepreneurial state 84–5, 86, 88 equity division reform see share conversion reform Estrin, Saul 139 Europe 76, 81 Evans, Peter 80 fiscal decentralization 111–16 Ford Motor Company 66 foreign capital 61, 76–9, 92 foreign direct investment (FDI) 92 foreign investors capital flows 61, 76–9, 92 Foshan Tongbao Shareholding Limited Company 54 increasing participation 64–75

privatization in other developing countries 61, 76–9 shareholding system reform 59 state role 79–89 foreign loans 92 foreign shares 33, 63, 64, 69–71, 124 foreign stock exchange listing 71–3 Foshan Electrical and Lighting Company Limited 55–7, 58 Foshan First Radio Factory 51–3, 57, 58 Foshan, shareholding system reform in 46–57, 58 Foshan Tongbao Shareholding Limited Company 53–5, 58 Frank, Andre 80 Fujian 31 Fushan First Radio Factory 29 Gelb, Alan 14 gradualism 135–7 grafting into foreign capital 73–5 Guangdong 31, 97 Guangdong Enterprises Holdings (GEH) Limited 101–7, 113 Guangdong International Trust and Investment Corporation (GITIC) 104, 105 Guangdong Investment (GI) 94, 101–7, 112–16, 120–22 Guangzhou 29 Guangzhou Shipyard International Company (GSIC) 94, 96–101, 112–13, 120, 121 Guo Shiping 134 H-share companies Guangzhou Shipyard International Company (GSIC) 94, 96–101, 112–13, 120, 121 nature of 93–4 Northeast Electrical Company 107–17, 118, 121, 122 H-shares effects of 94–6 growth of 92–3 Guangzhou Shipyard International Company (GSIC) 98–101 listings 65, 71–2, 92–6, 119–20 nature of 62, 63, 64 PetroChina 127

Index Hainan 31 Hainan Air Company 35 Harbin Power Equipment 72 Hong Kong Stock Exchange (SEHK) Chinese share listings 116–20 Guangdong Investment (GI) 101–7, 112–16 Guangzhou Shipyard International Company (GSIC) 98–101 H-share listings 65, 71–2, 92–6, 119–20 National Social Security Fund 130 Northeast Electrical Company 107–17, 118, 122 Howell, Jude 86 Howie, Fraser J.T. 128 Hua Sheng 134 Huang, Yasheng 115 Huang, Yiping 26 Hungary 77, 96 incrementalism shareholding system reform 137 shareholding system reform in Foshan 46–57 and state reform influence 42–3, 57–60 individual shares 33, 34–7, 62–4, 124 individual workers shares 12, 13 institutional investors 128 intergovernmental fiscal relations 111–16 internal-employee shares 110 internal shareholding system 53, 59 Isuzu Motor 69–70 Itochu 69–70 Jefferson, Gary 14 Jiang Zemin 19, 20, 32–3 Jiangling Auto Company 66 joint ventures 73–5 Kleinberg, R. 81 Kogut, Bruce 139 Lee Chyungly 81 Lee Kuen 14–16 Lee, Peter N.S. 83 Leftwich, Adrian 43, 81 legal-entity shares 54, 55, 56

163

legal-person shares 33, 62–4, 110, 124–5 Li, David D. 37 Li Peng 70 Li Yining 21–2 limited liability companies (LLCs) 27 local government see regional government management buyouts 131 Mark, Shelley 15 market-facilitating state 86–7, 88–9 marketization 9, 18 Marx, Karl 19, 22 mass ownership transformation 23 McCormick, B.L. 45 mergers 73–5 Min Xin 94 N-shares 62, 63, 64, 65, 72 National Electronic Trading System (NETS) 35 National Social Security Fund 127–31 Naughton, Barry 26, 132, 136 new public ownership 21–2 New York Stock Exchange (NYSE) 72 Nimrod 70 Northeast Electrical Company 94, 107–17, 118, 121, 122 Northeast Electrical Transmission and Transformation Equipment Group Corporation (NET) 108–11, 113, 114–15, 117 Nottle, Robert 17 Oi, Jean 44, 83–4, 115 Pan, Weihwa 26 Parker, David 26 Pearson, M.M. 81 pension fund 127–31 People’s Bank of China (PBC) 28, 52, 98–9 PetroChina 127 Poland 77 political objections 10, 17, 18–22 portfolio equity flows (PEFs) acquisition of 92–3 Guangdong Investment (GI) 94, 101–7, 112–16, 120–22

164


Guangzhou Shipyard International Company (GSIC) 94, 96–101, 112–13, 120, 121 Hong Kong Stock Exchange (SEHK) listings 92–6 Northeast Electrical Company 94, 107–17, 118, 121, 122 Prasnikar, Janez 139 private individual shares 12, 13 private placement enterprises 29–30 privatization advantages 1, 4 channels of 22–3, 124–6 corporatist state 82–4, 88 vs. corporatization 13–14, 27–8 definition 8, 62 dependent development theory 79–81 developmental state 81–2, 85, 86, 87–8 disadvantages 1, 4 dual-track transition 39, 135–7 entrepreneurial state 84–5, 86, 88 foreign investors 61, 76–9 foreign participation, sources of 64–75 future of 138–9 gradualism 135–7 ideological debate 10, 17, 18–22, 94–6 market-facilitating state 86–7, 88–9 origins of 7, 8 pattern of 4–6 proceeds from 1, 2–3 reduction of holding of state-owned shares (RHSOS) 125, 126–31, 133 regional government role 88–9 share conversion reform 125, 131–3, 134, 137, 138 share types 62–4 shareholding enterprises (SHEs), performance of 39 shock therapy 134–7 spread of 8 state ownership, decline in 33–7 terminology 9 worldwide trends in 1–3, 7, 61 profit contract system 9 public-owned enterprise shares 13

public placement enterprises 30 public shareholding system 55, 59 Rana, P.B. 14 Rawski, T. 14 red chip companies effects of 94–6 Guangdong Investment (GI) 94, 101–7, 112–16, 120–22 Hong Kong Stock Exchange (SEHK) 117 nature of 93–4 reduction of holding of state-owned shares (RHSOS) 125, 126–31, 133 regional government corporatism 83–4 Foshan, reform in 46–57, 58 Guangdong Investment (GI) 101–7, 112–16 intergovernmental fiscal relations 111–16 Northeast Electrical Company 107–17, 118 pension reform 128 privatization role 88–9 reform role 59 regulation market-facilitating state 86–7 of mergers and acquisitions 75 of securities listings 95–6 of shareholding system reform 32, 58 residual claims 14–15 rural sector 28–9 Russia 59–60, 77, 96, 139 Schmitter, Philippe C. 82 Securities Commission 32, 58 Securities Law 40, 95 Securities Trading Automated Quotations System (STAQS) 35 Shang Fulin 134, 138 Shanghai 12, 31, 37 Shanghai Dazhong Taxi Company 69 Shanghai Diesel Engine Company 69 Shanghai Lighting Apparatus Factory 22 Shanghai Stock Exchange fluctuations in 138

Index Guangzhou Shipyard International Company (GSIC) 98 reduction of holding of state-owned shares (RHSOS) 127, 128 share listings 31, 62, 64, 67 state share sales 118 share conversion reform 125, 131–3, 134, 137, 138 share issues 17, 36 share types 62–4 shareholding conglomerates 13 shareholding cooperative enterprises 30, 33 shareholding enterprises (SHEs) companies, number of 11, 29, 30, 31, 32, 40 corporatization 27–8 enterprise models 12–13, 51 evolution of 29–33, 39–40 foreign investors 87 in Foshan 46–57, 58 performance of 37–9 regulation of 10, 32, 34, 35, 58 shareholders, number of 23 and state-owned enterprises (SOEs) 25, 28–33, 39–40 state ownership, reduction in 33–7 shareholding system reform development of 10–11, 124–6 effects of 37–40 enterprise models 12–13, 51 evolution of 5–6, 28–33, 39–40, 137 in Foshan 46–57, 58 Guangzhou Shipyard International Company (GSIC) 97 ideological debate 10, 17, 18–22 literature review 14–18 origins of 7 privatization, future of 138–9 regulation of 32, 58 share issues 17, 36 share types 62–4 spontaneity in 42–3, 57–60 state role 10, 43–6, 57–60 Shengping Departmental Store 47 Shenyany 12 Shenzhen 12, 31, 37, 46 Shenzhen Development Bank 36 Shenzhen Stock Exchange 31, 62, 64, 67, 138

165

Shenzhen Wanke Company 36 shock therapy 134–7 Shougang 89–90 Shun Shing 95 Sichuan 12 Sichuan Guanghua Chemical Fibre 70 Singh, Ajit 16–17 Singh, Inderjit 14 social security 99, 106–7, 109, 118, 127–31 socialist guided markets 82 socialist states 80–81 socialization 9, 19 South Korea 43, 45, 82, 83 Spicer, Andrew 139 spontaneity shareholding system reform in Foshan 46–57 and state reform influence 42–3, 57–60 state bailout by 110–16 enterprise models, role in 12–13 expropriation of state assets 14–15 foreign investors 79–89 Foshan, reform in 46–57, 58 Guangdong Investment (GI) 105, 106–7, 112–16, 120–22 and the Hong Kong Stock Exchange (SEHK) 116–18 intergovernmental fiscal relations 111–16 ownership, decline in 33–7 securities listing controls 95–6 share of shareholding companies 14 shareholding system reform 10, 28–33, 43–6, 57–60 and spontaneous reform 42–3, 57–60 State Commission for Economic System Reform (SCESR) 97, 98 State Council Securities Commission (SCSC) 99 state enterprises 9–10, 22–3 State-Owned Assets Supervision and Administration Commission (State Asset Commission) 131, 132 state-owned enterprises (SOEs) conversion to shareholding enterprises (SHEs) 25, 28–33, 39–40

166


corporatization of 27–8 decline in 33–7 foreign participation 64–75, 87 Guangzhou Shipyard International Company (GSIC) 94, 96–101, 112–13, 120, 121 Hong Kong Stock Exchange (SEHK) listings 94–6, 119–20 losses 28 Northeast Electrical Company 94, 107–17, 118, 121, 122 reduction of holding of state-owned shares (RHSOS) 125, 126–31, 133 reforms 26–8 share conversion reform 125, 131–3 size of 61 state-owned shares 124–5 state shares conversion of 34–7, 69–71 Foshan Electrical and Lighting Company Limited 55–6 Foshan First Radio Factory 51 Foshan Tongbao Shareholding Limited Company 54, 55 Guangzhou Shipyard International Company (GSIC) 98 Hong Kong Stock Exchange (SEHK) listings 117–18 nature of 33, 124–5 Northeast Electrical Company 110, 118 reduction of holding of state-owned shares (RHSOS) 125, 126–31, 133 share conversion reform 125, 131–3

shareholding enterprises, models of 12, 13 shareholding system reform 62–4 Steinfeld, Edward 115 Sun, Yan 18 Svejnar, Jan 139 Taiwan 43, 45, 82, 83 Tam, On Kit 16 tax-for-profit system 9 Telegdy, Álmos 139 transitional economies in Europe and Central Asia (TEECA) 76–9 Tsingtao Brewery 71–2, 94 Unger, Jonathan 44, 83 Union Globe Development Limited 102 unit shares 12, 13 Wade, Robert 43, 82 Walter, Carl E. 128 Wang Qishan 105 welfare benefits 99, 106–7, 109, 118, 127–31 White, Gordon 17, 43, 82 worker shares 51, 52, 54, 55, 56 World Bank 29, 96 Xie Maoshi 134 You, Ji 18 Zhao Ziyang 11, 20, 29, 31, 33, 47–8 Zhenhai Refinery 72 Zhongce phenomenon 73 Zhu Rongji 28, 52, 75, 129

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Financial Reform and Economic Development in China

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