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Chairman Mao Never Left Board as Communists Dominate China Inc.

A sculpture of a hand holding a bottle of Great Wall wine
A sculpture of a hand holding a bottle of Great Wall wine stands next to the Beijing-Tibet expressway in Shacheng, Hebei province, China. Phototgrapher: Nelson Ching/Bloomberg

By most measures, Zhejiang Gonow Auto Co. was one of China’s private-enterprise success stories. Established in 2003, the company produces microvans popular with farmers and sells pickup trucks as far afield as Iran and Peru.

Last year, founder Miao Xuezhong began building sport utility vehicles in Shandong province and opened a third assembly line in Hangzhou, a city known in imperial times for its poets and courtesans. Gonow’s main factory in the eastern city of Taizhou displays flags of 30 of the nations where its products are sold, including Egypt, Libya and Saudi Arabia.

The popularity of Gonow’s products may have doomed its chances to remain in private hands, Bloomberg Markets magazine reports in its November issue.

In April, the company agreed to merge with Guangzhou Automobile Group Co., a state-owned auto company run by Zhang Fangyou, a Communist Party operative since 1975 who was chosen for the job by government officials.

Zeng Yehui, head of brand management at Gonow, says a state edict pushing consolidation in the car industry influenced the decision to merge.

“The policy didn’t push us to cooperate, but it did encourage us and guide us,” he says. “The cooperation between Guangzhou Auto and Gonow is in accordance with the country’s policy direction.”

Four years ago, China’s leadership decreed that certain “pillar” industries, including automaking, telecommunications, mines, energy production and steel manufacturing, should be dominated by companies under government control.

Beijing Consensus

Today, those newly assertive state-owned enterprises (SOEs) are snapping up domestic rivals, expanding their market share and elbowing aside Western investors such as the Washington- based Carlyle Group in the quest for assets. Their rise comes as China surpasses Japan to become the world’s second-largest economy, and has helped inspire a new school of thought called the Beijing Consensus, which holds that state-directed capitalism can help developing nations avoid the financial upheavals associated with free markets.

The increasing clout of the SOEs has also triggered a debate among Western investors over whether China’s communists are building businesses better able to compete on the world stage or shoring up their own power by creating monopolies run by the party elite.

Preferential Policies

The State-owned Assets Supervision and Administration Commission (SASAC), created in 2003 to manage government enterprises, held $935.1 billion in domestic businesses at the end of 2009, including majority stakes in the parent companies of China Telecom Corp. and PetroChina Co. That’s up from $825.5 billion of investment in 2008.

Those companies enjoy easy access to capital from China’s state-owned banks. Last year, SOEs helped fuel their expansions thanks to loans from institutions such as the Bank of China Ltd. and Industrial & Commercial Bank of China Ltd., which altogether issued a total of $1.4 trillion in new lending.

At the same time the state is stepping up its role as an investor, it’s also issuing preferential policies for homegrown businesses. In November 2009, the government announced a plan to encourage companies to promote “indigenous innovation,” which foreign business groups said amounted to preferential treatment.

That move drew a protest from Western investors, who said the guidelines would limit trade and foreign investment. A month later, 34 trade groups led by the American and European Union chambers of commerce complained that the policy could effectively cut off foreign companies from the 741 billion yuan ($111 billion) government procurement market.

Western Protest

“My concern is that it will lead to an increase in the number of state-owned enterprise oligopolies supported by industrial policy,” says Christian Murck, a former Chase Manhattan banker who’s president of the Beijing-based American Chamber of Commerce in China. “The government will be more deeply involved in picking winners, rescuing losers and structuring industrial sectors instead of relying on competition and market forces.”

The U.S. Congress is stepping up the pressure on President Barack Obama’s administration to confront China on its unwillingness to let its currency rise more quickly in value against the dollar. Lawmakers say an undervalued yuan unfairly boosts Chinese exports.

‘Strategic Restructuring’

As Western officials grow restive, some money-losing SOEs are snapping up profitable competitors.

In September 2009, Shandong Iron & Steel Group, a state-owned company based in Jinan, said it would acquire rival Rizhao Steel Holding Group Co. as part of a government mandate to strengthen the country’s steelmaking industry. Shandong had a loss of 6.2 million yuan in the nine months before the deal was announced; Rizhao posted a profit in the first six months of 2009, according to Hong Kong-based Kai Yuan Holdings Ltd., which owned part of the steelmaker.

In May, China North Industries Group Corp., the country’s biggest weapons maker, signed a “strategic restructuring” agreement with Xuzhou Construction Machinery Group Co., the country’s eighth-biggest maker of commercial vehicles and trucks.

The state-owned arms maker pledged to invest 15 billion yuan in Xuzhou’s home province through 2015. China North succeeded where the Carlyle Group had failed. The buyout firm had offered $375 million to purchase 85 percent of XCMG in 2005, only to be stymied by the rules restricting foreign investment in strategic industries. Subsequent approaches by Carlyle to buy reduced stakes in the company failed to win government approval.

Buffett Visit

State-owned companies are also beginning to tread on territory until now dominated by private companies.

In August, SASAC announced an effort to spur innovation in the auto industry when 16 state-owned car and energy companies formed an association to develop new technologies for electric vehicles. Conspicuously absent from the group: privately held BYD Co., the country’s biggest maker of electric cars, which is 10 percent owned by Warren Buffett’s Berkshire Hathaway Inc.

“BYD is a young and promising company experiencing dynamic growth,” Buffett said on a Sept. 27 visit to the southern Chinese city of Shenzhen, where the manufacturer is based. “BYD will play a leading role in the future.” The company’s share price has slumped 16.9 percent this year.

There was another indication of China’s plans to compete with free market rivals in September when Wang Jianzhou, chairman of state-controlled China Mobile Ltd., said his company planned to start an Internet search engine next year, taking on privately owned Baidu Inc.

Biggest Purchase

On Oct. 11, state-owned Cnooc Ltd., China’s biggest offshore oil producer, made the biggest acquisition of a U.S. oil and gas asset by a Chinese company when it announced the purchase of a one-third stake in Chesapeake Energy Corp.’s Eagle Ford shale gas project in Texas.

Huang Yasheng, a professor of political economy and international management at Massachusetts Institute of Technology, says the best way to measure the influence of government-controlled companies is to look at the amount of fixed-asset investment as a percentage of gross domestic product. Much of that spending is directed to projects that boost the fortunes of state-owned companies such as Zhuzhou CSR Times Electric Co., a train equipment manufacturer, and China National Materials Co., which supplies cement makers.

By that yardstick, the state is gaining. In 2009, fixed-asset investment totaled 19.4 trillion yuan, or 58 percent of the country’s 33.5 trillion yuan economy. In 2005, those investments made up 41.2 percent of the economy, according to figures from China’s National Bureau of Statistics. In the first seven months of 2010, sales at all state-owned companies rose 38.8 percent from the year-earlier period, to 16.9 trillion yuan, according to the Finance Ministry.

New Aphorism

The phenomenon of centrally planned capitalism has inspired a new four-character Chinese aphorism: “The state advances and private companies retreat.” The popularity of the term -- often cited on blogs -- prompted the Communist Party to issue a statement in November 2009 saying that the phrase did not reflect official policy.

On visits to several Beijing-based state-owned companies on June 30 and July 1, including to the headquarters of Cnooc, Vice Premier Zhang Dejiang made clear who was in control.

“This year, the centrally administered enterprises have earnestly carried out the decisions and plans of the Communist Party and State Council,” he said.

Less than three weeks later, the State Council published a directive reminding managers of state-run enterprises that Beijing needed to be consulted on major issues such as mergers and acquisitions and overseas investments.

Better Managed

Stephen Roach, chairman of Morgan Stanley Asia, says that the state-controlled behemoths that trade shares on the New York, Shanghai and Hong Kong stock exchanges are often well-managed. That distinguishes them from the inefficient, over-staffed SOEs of the past, he says.

“Today’s SOEs are very different from their predecessors,” Roach says. “The management of these companies are much more accountable to a broad cross-section of international investors.”

Roach adds that China’s leaders showed a steadier hand than their Western counterparts in keeping their economy growing, thanks to a 4 trillion yuan stimulus program announced in 2008. The country’s GDP grew 9.1 percent last year even as the global economy contracted 0.6 percent, according to the International Monetary Fund. China’s GDP will expand 10.5 percent this year, the IMF said in July. In contrast, it estimates that the U.S. economy will grow 3.3 percent, with the euro zone expanding by just 1 percent.

“When they set policy, China’s leaders excel in execution and implementation of that policy,” Roach says.

Capitalist Hybrids

China’s success in keeping its economy on the move may inspire nations from Angola to Myanmar to shun free markets and democracy, as the Washington Consensus gives way to a Beijing Consensus based on state-led capitalism and authoritarian government, says Stefan Halper, a senior research fellow at Magdalene College, Cambridge University.

“The most powerful asset in China’s global presentation is its market authoritarian model,” Halper says. “It is seizing the imagination of the developing world.”

China’s capitalist hybrids such as China State Construction Engineering Corp. build ports in Sri Lanka, railroads in Tanzania and cricket stadiums in Jamaica and Antigua.

Nina Wu, co-manager of the New York-listed Dreyfus Greater China Fund, which invests in stocks in China, Hong Kong and Taiwan, says China’s policies are making state-owned companies more attractive.

Investor Preference

“For similar companies, I prefer SOEs over private companies,” says Wu, 41, who’s based in Hong Kong. “They have natural monopoly powers in each sector.” Her $1 billion fund has gained 6.8 percent in the year to Oct. 11 after a 120 percent rise last year.

The six biggest companies on the Shanghai Stock Exchange Composite Index count the government as their largest shareholder, as do five of the six biggest on Hong Kong’s Hang Seng Index.

On March 22, China’s premier, Wen Jiabao, confronted concerns about state control of enterprise before a group of international executives, including Ford Motor Co.’s Alan Mulally and Rio Tinto Plc’s Tom Albanese, in Beijing’s Great Hall of the People.

“China will not pursue its interests at a cost to others,” Wen told the CEOs. “The Chinese government welcomes multinationals from around the world.”

New Rules

In May, China’s State Council went further to address investor concerns by publishing “36 new rules” designed to encourage more private involvement in telecommunications, financial services, mining, logistics, water and oil. Any multinational setting up a research and development center in the favored industries will win tax breaks, and investments under $300 million can be approved by local authorities without Beijing’s oversight.

Zhang Yi, a Shanghai-based partner at the King & Wood law firm, said in an analysis that the 36 rules would do little to reduce the chokehold state enterprises have on many industries.

“The likelihood that private capital may enter in these industries is very slim unless the private investors are protected by special policies,” Zhang wrote.

Last year, 108 companies overseen by SASAC reported a profit of 3.99 trillion yuan on sales of 12.6 trillion yuan, the commission reported on its website.

Many of their top executives are picked by the Communist Party’s Organization Department, the unit that vets candidates for the country’s most prestigious positions, from university presidents to provincial political bosses.

Western Rivals

As SOEs grow stronger, they’ll be able to take on Western rivals, says Jonathan Anderson, Beijing-based chief emerging-markets economist at UBS AG.

“China wants to have its Sony, wants to have its Samsung and wants to have its Hyundai,” says Anderson, former China country head for the IMF. The first step in the quest is to clean up the small and inefficient companies in the steel, auto and rare-earth-mining industries, he says.

China first embraced private enterprise as a way to move its economy away from agricultural subsistence under Deng Xiaoping in the late 1970s. Deng dismantled the collective farms that had failed to adequately feed the country’s growing population, letting peasants till their own plots and set up businesses. He also established coastal foreign-trade zones and formalized relations with the U.S.

Reaction to Unrest

MIT’s Huang says the emergence of state-run companies can be traced to the Communist Party’s reaction to the 1989 Tiananmen Square demonstrations. Deng and then-party head Jiang Zemin shifted the country’s development model from rural, profit-minded entrepreneurs and farmers to inner-city development led by state-owned companies and foreign-backed enterprises, partly to quell urban unrest.

In 2001, China entered the World Trade Organization to gain greater access to international markets. In return, the government pledged to drop tariffs, crack down on the counterfeiting of Western goods and end favorable treatment of domestic investors.

Those promises persuaded then-U.S. President Bill Clinton to push for congressional approval for legislation paving the way for China’s WTO accession, saying in 2000 that membership would help shift China away from an economy dominated by state-owned firms.

“That system was a big source of the Communist Party’s power,” Clinton said in a March 8, 2000, speech in Washington. “Now people are leaving those firms, and when China joins the WTO, they will leave them faster.”

State’s Hand

The U.S. and other Western nations overestimated the Communist Party’s openness to free enterprise, says Jim McGregor, a Beijing-based senior counselor at APCO Worldwide, a public-affairs group that advises such clients as government-owned China Cosco Holdings Co. He says that China’s leaders never promised to dismantle the SOEs.

“We all had these preconceived notions of what would happen in China once it joined the WTO, and I think China had its own notions of what it would do,” he says.

The hand of the state can be found even in China’s nascent wine industry, which is dominated by such state-controlled companies as Cofco Ltd. Travelers on the expressway from Beijing to Zhangjiakou pass the company’s vineyards -- 30 kilometers (19 miles) from the Great Wall of China -- where a 12-meter-high (40-foot-high) steel hand emerges from the earth, clutching a bottle of the company’s flagship Great Wall wine.

‘You Cannot Compete’

Judy Leissner, the Hong Kong-born chief executive officer of Grace Vineyard, a family-owned grower in neighboring Shanxi province, says she’s resigned to being a small player in a growing industry.

“You cannot compete with the big guys,” Leissner, 32, says. “Whatever they do, we avoid.”

If China’s leaders need evidence of how private enterprise benefits its citizens, they could find it in Taizhou, home to Gonow, the privately held automaker that lost its independence. At the base of emerald-colored mountains, peasants tend rice paddies near BMW and Lexus dealers catering to the newly wealthy. Near the expressway on the two-hour drive from Wenzhou to Taizhou are hundreds of private factories making everything from electric pumps to synthetic leather.

Guangzhou Auto, which will control a 51 percent stake in Gonow, says the joint venture will expand sales.

“We believe, that with the support of good government policies, actively seeking organic cooperation between state-owned enterprises and private companies can strengthen indigenous innovation and brands, can be mutually beneficial, and can create new competitive advantages,” the company said in a statement.

Arranged Marriages

Chen Xueli, 39, Gonow’s crew-cut-sporting vice president who once served in China’s special naval forces, says Guangzhou’s cash will help the company upgrade its production facilities, where workers currently put together cars with muscle power, unassisted by robots. Gonow’s entrepreneurial spirit won’t be broken by the merger, Chen says.

“It’s like marrying your girlfriend,” he says.

In their quest to solidify control over the economy, China’s leaders are likely to encourage many more such arranged marriages.

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