China’s latest plan to sustain its recovery amid growing economic uncertainties involves allowing private investors to participate in industries that were previously monopolized by state-owned enterprises (SOEs). It’s a great idea – provided there is sufficient deregulation for it to actually work
The State Council said last week that water projects, power generation, mining, and logistics – currently SOE fiefdoms – would be opened up in order to extend the depth and breadth of private investment across the economy as a whole. This came after a similar announcement in March concerning education, welfare, transport infrastructure, telecom, energy, public utilities, scientific and technological programs for national defense, affordable housing and cultural industries.
The government has also pledged to improve financing services and simplify administrative procedures for private involvement in these areas. Private operators in China have long been restrained by barriers such as unfair competition and limited access to funding.
According to the National Development and Reform Commission (NDRC), the new guidelines constitute the most comprehensive package targeting the expansion of private investment since the country’s reform and opening began in 1978. In other quarters it is being touted as the third major regulatory reform since 1949, following agricultural reforms of the 1980s and the restructuring of state-owned enterprises in the 1990s.
These claims are premature and excessive. The initiative should be seen for what it is: A sign that Beijing will further phase out its massive stimulus package in the second half and it wants private-sector investment to help fill the gap. Economic growth rebounded to 11.9% in the first quarter but analysts believe it may ease to below 9% in 2011 as public investment in roads, railways and power decelerates.
Private investment shrank in the wake of the downturn and, although it is now returning, the government recognizes that a more diversified base of investment would better serve the long-term health of the economy.
As it stands, private investment is permitted in about half of China’s 80-odd industries and accounts for a “very low” percentage in areas traditionally monopolized by government-owned companies, according to the NDRC. Non-state investment accounts for just 13.6% of spending in the power and thermal heating industries, 9.6% in financial services, and 7.5% in transport and postal services.
The NDRC admits that previous initiatives aimed at securing fairer market for private businesses – notably in 2005 – were not properly implemented. This time it hopes the detail of the rules can deliver something different.
The rules are only the starting point, however. The key to spurring participation is the creation of a more favorable credit and business environment in which private players are able to compete with state rivals.
The most important issue in this regard is solving the fund-raising problem for private companies to facilitate their acquisitions of state assets. For a long time, Chinese banks have been unwilling to lend to private companies, preferring the large amounts and government backing that comes with serving SOEs. The high capital and profit thresholds required to qualify for a public listing have also prevented smaller firms from tapping capital markets for funding.
Although the central government this time vowed to improve financing services for private companies by strengthening the venture capital investment system, it may still take years for the sector to grow big enough to offer sufficient funding. A near-term solution is the expansion of government-led start-up funds that encourage banks to loan to private companies by acting as guarantor and covering most of the lending costs.
In addition, preferential policies should also be directed to private companies with innovation capabilities. State firms should step out of sectors including bio-medicine, alternative energy, environmental protection and recycling so that private players can flourish.
Even then, the playing field will not be level. With prices of raw materials, labor and land all rising, private firms lack the economies of scale and bargaining power required to minimize costs. In many cases, they also lack pricing power in selling, which makes it difficult to pass on costs to the consumer.
Well-capitalized SOEs with a tight grip over their supply chains and their customers – and under less pressure to keep an eye on the bottom line – have no such problems.
Competition is therefore difficult, but partnership may just as much of a headache. A private firm that buys a minority stake in a large project would have little say in the management and certainly wouldn’t be allowed powers of supervision.
As a result, many private investors may choose to stay on the sidelines, despite the central government’s encouragement. The dilemma is simple: If they don’t think they can make money, they won’t make a move. This means they won’t be interested in public utilities where price controls ensure that improved living standards, not maximizing profit, is the primary goal. As for industries that do present lucrative opportunities, private players don’t believe state firms would be willing to withdraw.
Relaxing restrictions is not enough. The central government must implement aggressive pro-private sector policies – and also force SOE exits – if it wants entrepreneurs to enter traditionally state-controlled industries.