State-owned enterprises (SOEs) are a large and ingrained part of China’s economy. For that reason, leaders have worked to improve SOE performance and to reform the sector for decades. Much change has in fact occurred, but the meaning of “reform” has varied through the years. For former Premier Zhu Rongji in the 1990s, SOE reform meant consolidating state control over large SOEs and withdrawal from small ones, which contributed to private sector prosperity and a decade of economic growth. In 2006, the State-owned Assets Supervision and Administration Commission (SASAC), the central nonfinancial SOE owner and overseer formed in 2003, redefined SOE reform as an effort concentrated on seven key industries where the state would retain a dominant role, and nine pillar sectors where the state would “direct” development. President Xi Jinping’s 2015 SOE reform vision stresses managing SOEs based on their “core” industries: those in normal commercial industries should decrease state ownership and maximize profits; those in key industries and pillar sectors should separate commercial and strategic business lines; while those providing public services should focus on cost control and service quality.

We use China’s own classification scheme to assess SOE reform progress. For listed companies where information is available, we gauge SOE revenue relative to all revenue in three clusters: (1) key industries (defense, electricity, oil & gas, telecom, coal, shipping, aviation, and rail – a new one vaguely referred to as a key industry in recent years); (2) pillar industries (autos, chemicals, construction, electronics, equipment manufacturing, nonferrous metals, prospecting, steel, and technology); and (3) normal industries (tourism, real estate, general manufacturing, agriculture, pharmaceuticals, investment, professional services, and general trade). As SOE reforms are implemented, the state firms’ share of revenue should at a minimum decline in normal industries – those that Beijing has identified as suitable to market competition as the decisive factor. To supplement this primary indicator, we look at the share of all industrial assets held by SOEs, leverage ratios at state vs. private firms, SOE vs. private return on assets, SOE vs. private ability to cover interest payments, and the SOE share of urban employment.

Quarterly Assessment and Outlook

Our quarterly assessment of the state of China’s SOE reforms is somewhat more negative than our already negative assessment from the last Dashboard edition. Beijing’s visions for SOE reform are broad and differentiated by sector: the government hopes to make SOEs in strategic sectors more profitable and responsive to policy interests; in non-critical sectors, it intends to allow private companies to play a bigger role. Streamlining the state’s footprint in the economy is critical for improving efficiency and competitive conditions for private players. The government issued numerous SOE reform policies in recent years, but our indicators show that it is not implementing them well. Based on listed company data, our primary indicator shows that the share of revenue taken by SOEs in “normal” industries declined only slightly this quarter, which reflects fading enthusiasm among private investors to participate in reform pilots enabling them to purchase state assets. Meanwhile, SOEs’ share of listed company revenue in “key” and “pillar” industries bounced back, erasing progress made last quarter. Our data also show tight credit conditions empowering SOEs – which have better access to credit – to acquire smaller but more efficient private companies. The financial performance of SOEs is improving as a result, but the competitive environment for private firms is deteriorating.

Policy developments suggest that SOE reform remains mired in internal debate and is not an immediate priority. Beijing expresses intentions to attract more private capital into the state sector and improve its efficiency, yet policymakers appear unwilling to relinquish control. Overcoming this inherent paradox has constrained SOE reforms for decades, well before the 2013 Third Plenum, and remains unresolved. The government announced new rules on trading securities in listed SOEs during the review period, a small step forward in encouraging state withdrawal from listed companies. But any significant change of shareholding will still require regulatory approval. The government also announced a plan to improve SOE efficiency by linking employee salaries to company profitability. The intention of this plan aligns with reform promises, but execution is a risk – the program may incentivize SOEs to acquire more profitable private companies with fewer employees rather than laying off less productive workers.

This Quarter's Numbers

Our primary indicator tracks the share of revenue captured by SOEs among all listed companies in key, pillar, and normal industries to gauge whether the government is fulfilling its promise to reduce state influence. We emphasize normal industries in which Beijing has no explicit design to maintain dominance for state actors. Our data show that SOEs’ share of revenue among all listed companies in normal industries declined by 0.9 percentage points to 14.7% in 1Q2018 after a small pickup last quarter and is now at its lowest level on record. These data are consistent with Beijing’s reform intentions, but the change is mild; there was much more rapid progress in 2014 when the government initiated a mixed ownership program to attract private capital. As various pilots have underwhelmed, private investors’ enthusiasm to invest into state assets is fading, and thus SOE reform has stalled.

Meanwhile, SOEs’ share of revenue among listed companies in key and pillar industries recovered modestly to 85.8% and 44.8%, respectively. Beijing intends to maintain a strong role for the state in these industries, so these data come as no surprise. But the government also intends to attract more private capital into these sectors, even though it considers them critical for national security and competitiveness. In his 2017 government work report issued to the National People’s Congress, for example, Premier Li Keqiang promised to push forward mixed ownership in seven out of the eight key industries. However, our indicator shows that SOEs’ share of revenue in those industries barely changed throughout 2017.

Tight credit conditions resulting from the government’s deleveraging efforts (see Financial Reform) are also empowering larger state-owned firms, which have better access to credit, to acquire smaller mostly private actors. This is contradictory to top-level SOE reform designs. In the industrial sector, SOEs’ share of overall assets increased by 1.2 percentage points this quarter, while private companies’ share decreased by 1 percentage point (see Industrial Assets by Ownership). After acquiring more efficient and less indebted private companies, SOEs exhibited a higher return on assets (see SOE Return on Assets), lower leverage (see SOE Leverage), and improved ability to service their debts (see SOE Interest Coverage Ratio). Meanwhile, all these indicators for private companies deteriorated: with a sharp rise of debt and quickly declining return on assets, private companies were left with a reduced financial buffer to service debt obligations.

This quarter we also have updated data on the share of employment held by private and public firms for 2017. Data show that private companies are attracting more talent than other types of companies – they now employ 31% of the urban workforce, 2.2 percentage points higher than in 2016, while the share for other institutional employers including SOEs declined (see SOE Share of Employment). A lower share of employment for SOEs is consistent with reform intentions to streamline the state sector, though SOEs today still employ more than 14% of the country’s total workforce. Reducing state sector employment by more rationally allocating capital and compressing the state’s role in the economy would unleash great growth potential but would also risk dislocation of these workers, resulting in social tensions. This reality continues to be one of the major constraints on SOE reform efforts.

Beijing expresses willingness to sell off state assets but undertakes policies that strengthen SOE profits and limit market opportunities for private and foreign players.

Policy Analysis

Policies in the review period reflect a lack of urgency about SOE reform. Beijing expresses willingness to sell off state assets but undertakes policies that strengthen SOE profits and limit market opportunities for private and foreign players. A bigger policy breakthrough is needed before our indicators will meaningfully improve.

For now, policy change remains incremental. On May 22, the Ministry of Finance (MoF), the State-owned Assets Supervision and Administration Commission (SASAC), and the China Securities Regulatory Commission (CSRC) issued a notice facilitating the trading of listed SOE shares, effective July 1. The notice granted local governments full authority to manage share sales for their own listed SOEs and gave SOEs more authority to sell shares, issue bonds, or restructure in coordination with other listed or non-listed companies.

On the surface, this appears to be a significant policy improvement given that the central government has historically maintained tight control over the transfer of listed state assets. The new mechanism would provide an important new vehicle for the state to withdraw from some sectors and allow SOEs to operate with more autonomy. But tight constraints remain: any trading of 5% or more of a listed SOEs’ shares, transactions causing state ownership to fall below a “reasonable level,” and other “significant” deals all require SASAC approval. These criteria are so vague that they imply most transactions will still require a regulatory green light. The government’s intention appears to be to find a way to monetize some shares in listed SOEs without relinquishing control of the companies themselves. This may be insufficient to incentivize meaningful private sector participation.

On May 25, China’s State Council issued what will probably prove to be the most important SOE reform policy for the year: a salary reform plan meant to match employee compensation with corporate profitability. The 2013 Third Plenum Decisions promised updated performance metrics for SOE employees; an actual plan to do so was approved this March by the Communist Party’s Comprehensively Deepening Reform Committee. The government was initially expected to announce the plan in July or August of this year. That it came two months earlier signals some urgency to reform the poorly designed salary structure for SOEs, which is based on seniority and political ranking. The current system is a major obstacle to improved efficiency. The plan attempts to improve this structure by linking total salary expenditures to the SOE’s profitability and in the case of SOEs in key and pillar industries to the completion of strategic projects. It also requires SOEs to differentiate salary among staff, rewarding workers who are more productive or exhibit stronger technological competence.

Reducing money available for paying staff in underperforming SOEs should result in layoffs of subpar workers and higher pay for those who remain. There are downsides though: imposing a binding guideline for staff compensation based on profitability would limit the ability of state firms to offer competitive salaries and retain talent in years of underperformance, especially when salary plans need to be approved by state investors every year. The program also carries the risk of perverse incentives – for underperforming SOES, acquiring a more profitable private company with fewer employees might be the easiest pathway toward freeing up funds to pay current employees.

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