Invisible hand of the market is better

Chinese state firms need to localize and establish incentive systems

It is often argued that China's state-owned enterprises have reached their peak in their home markets and need to spread wings. But can they find glory in Africa? It's a complex issue.

Economic practices of hundreds of years in most developed countries have proved that most state-owned enterprises should not exist at all and even public products should be bought from private companies.

The problem with state-owned enterprises is that they eat the market share of private companies through, resulting in gross inefficiencies. An even more serious problem is that when state-owned enterprises become huge, they are seldom willing to withdraw from the market. Instead, they intensify their unfair competition to expand their market share until economic problems turn into social crises.

Many economists agree on that developing countries can shorten their time of industrialization by a government's industrial planning, they may not agree that government sets up state-owned enterprises to execute the plan. In fact, tax relief and strict protection of property rights can do a much better job.

But China chose to set up state-owned enterprises to promote economic growth, which is the reason that China's economic growth is driven by investments that are planned by government.

But investments by government are often inefficient. One reason that is not so obvious is that state-owned enterprises' owners are not natural persons - although their agents are. Another reason is that private companies will only invest in the industries where there is real consumer demand and their capital, creativity and diligence can yield profit. State-owned enterprises, on the other hand, invest in industries where there are political achievements (such as GDP and tax growth).

The consequence is easy to reason out. From a macro perspective, since investments are not driven by real consumer demand, there will be excess production capacity and insufficient consumption. In the micro perspective, since the investments will not be supported by consumption, these investments will lose money and produce bad debts.

Unfortunately, all this theory is turning into reality. Most of the state-owned enterprises are losing money or running at low efficiency. Banks continue to produce bad debts and are forced to transfer them to subsidiaries. Local governments are refinancing to pay old bonds.

This economic growth pattern has promoted fast GDP growth in the last 30 years and is now facing serious problems such as huge local government debts, real estate bubbles, grave difficulties in the private sector and rapidly growing currency.

But since China is such a big economy, these government investments have also nurtured a bunch of large state-owned enterprises, many of which are ranked in the Fortune Global 500 list. These companies control China's most important industries for daily life, such as infrastructure, electricity, communications, water supply, healthcare, mining and shipping.

All these industries are badly needed in Africa.

These state-owned enterprises have expanded for years in China's huge market with government support and now have complete management systems, experienced teams, proven and reliable technologies and capacity to build whole industry chains.

But the real question is whether these state-owned enterprises are competitive enough to compete with private companies in developed countries.

China's state-owned enterprises may find it difficult to make money in developed countries, since these countries have sound infrastructure and hence more personalized demands, higher technology and higher standards of security and environmental protection. What's more, their business culture in general distrusts state-owned enterprises.

Africa has recently emerged from unrest and is still in poverty. However, it has rich resources, but not enough spending power. What they need is help to create the necessary living facilities and to meet their daily needs at low costs, all of which are competitive advantages enjoyed by the Chinese state-owned enterprises.

It is interesting to understand the depth of this collaboration. Africa is the second-largest continent with the most developing countries, and a population of more than 1 billion, but still in the initial stages of industrialization. On the other hand China, the biggest developing country, faces an industrial transition and elimination of backward production capacity of state-owned enterprises.

Africa needs China's state-owned enterprises to play a key role in its initial stage of industrialization, while China's state-owned enterprises can use Africa to regain their glory.

But there may still be problems. Although African countries may be indifferent to whether companies operating in their countries are state-owned or not, the Chinese SOEs will have to wrestle with issues such as unclear ownership.

If China's state-owned enterprises are planning to just undertake projects, these problems will not be so severe, but if they want to share the benefits of Africa's long-term economic growth, they need to localize and establish monitoring and incentive systems for long-term operations.

In the long run, China needs to sell state-owned enterprises to the private sector and let the private sector play the bigger role in the cooperation with Africa.

This may sound harsh, but it is probably best for all concerned. Selling SOEs is a better way of reducing the nation's debt, than using the proceeds realized through the overseas expansion of state-owned enterprises.

The author is a lecturer at the Management School of Shanghai University and a research fellow at the China Europe International Business School Lujiazui International Finance Research Center.

(China Daily Africa Weekly 09/13/2013 page9)