Overhauling China Inc.?

Beijing's new catchword: Privatization

First came President Jiang Zemin's call in May for greater privatization of the Chinese economy at a speech to ranking cadres at the Central Party School. Then, economic czar Zhu Rongji, who many expect to become the next premier, used his widely publicized 12-day tour across China's northern Rust Belt in July to lecture ailing state enterprises on the need to shape up.

It has all the markings of a political crusade. Much the way the late Deng Xiaoping got the capitalist bandwagon rolling with his 1992 sweep through South China, the Communist Party hierarchy has been out on the hustings to rally consensus for a new wave of bold economic reforms. The initiatives are now being debated between swims and seafood banquets at the leadership's annual retreat at China's coastal resort of Beidaihe. They are likely to be unveiled at this fall's Party Congress, the confab conducted every five years to chart the country's future course.

The agenda is expected to be far-reaching. A key feature: promoting a wave of mergers meant to consolidate unwieldy, massively overbuilt industries ranging from cars to consumer appliances. Thousands of government-owned factories are to be sold or pushed into bankruptcy. Instead, Beijing will focus on nurturing some 1,000 conglomerates, not unlike the business groups of Japan and South Korea, to lead China into the 21st century.

NEXT LEVEL. Combined with other reforms, such as national pension and health-care systems that will relieve the heavy social-welfare burdens of employers, the goal is not only to keep the state sector from financial collapse. It also is aimed at pushing China's economy to the next level, producing industrial conglomerates big and efficient enough to compete globally. Says Denis Simon, director of Andersen Consulting's China Strategy Group: "China needs to recast its entire industrial architecture."

Such reforms could bring wrenching pain in a country where urban unemployment already is near 15%. But the timing has rarely been better. After four years of tight-money policies, Zhu seems to have engineered a remarkably soft landing for the once overheated economy. In this year's first six months, the economy grew 9.5%. Retail inflation is just 1.8%, after hitting 24% in 1994. China is posting big trade surpluses, and foreign reserves top $121 billion. This comes at a time when neighbors such as Thailand, South Korea, and Malaysia have been hit by plunging currencies and flat export growth.

China's leadership is now free to concentrate on the economy. Two major tests of stability this year--the death of Deng and the July handover of Hong Kong--have passed without incident. In his quest to assume Deng's mantle, Jiang would like to be known as the leader who turned China into a modern industrial power. And Zhu would like to burnish his claim to the premiership when conservative Li Peng retires next spring. Besides, many city and provincial governments are already jumping on the reform bandwagon as they try to salvage their industries.

That's not to say the leadership isn't in for a daunting challenge. For starters, there's the magnitude of the problem. According to a June World Bank report, about half of China's 118,000 state enterprises lost money in 1996, up from one-third two years ago. Still, they suck up 75% of domestic credit. Thus, the banking system is a nightmare: At least 20% of loans are nonperforming.

Beijing will have to proceed gingerly to avoid a social backlash. Jiang is taking "a no-pain, no-gain approach to the economy," says one Western diplomat. "That's not a very popular position." Already, there are reports of rising worker unrest. In July, hundreds of people hit the streets to protest a textile factory closure in Sichuan Province. The nervous provincial government agreed to pay workers until they find new jobs. That doesn't bode well for Beijing. According to official estimates, 15 million workers--12.5% of the workforce at state enterprises--will have to be laid off in the coming years.

Chinese leaders know they can't procrastinate. Indeed, many authorities at the local level aren't waiting for Beijing to settle on a game plan. Take housing reform. To spur the movement toward private ownership, authorities in the eastern city of Nanjing banned local enterprises from renting new apartments to their employees. Instead, they must sell them to workers.

MORE MERGERS. Local governments are tackling another major problem: enormous overcapacity because too many factories make similar goods. In Shanghai, the city has already idled 230,000 workers in its effort to consolidate its bloated textile sector. So far, the city has sent 150,000 of these workers to training centers to study computers, accounting, and other new skills.

Shanghai also is at the forefront of mergers. The city recently established the Yangtze River Region Asset & Equity Exchange, a bourse for buying and selling holdings of state enterprises in 11 provinces. Among the first deals brokered by the exchange was the sale of a bankrupt rubber plant in Chongqing for $12 million to the Shanghai Huayi (Group) Co., a diversified industrial conglomerate. "There are more transregional mergers than ever," says the exchange's president, Zhang Hailong, who expects the bourse to handle $2.4 billion worth of deals this year.

But that is only a small start given what needs to be done. Numerous industries are overcrowded with rivals, few of them big enough to compete efficiently. China has 123 car and truck plants, for example, that made just 1.47 million units last year--less than one-sixth the output of Detroit's Big Three. Yet at last count, 22 Chinese municipal, provincial, and regional governments still are targeting auto manufacturing. There are 189 motorcycle factories, and so many televisions were being churned out that Beijing has banned new plants.

To spur consolidation, Beijing has earmarked $3.7 billion to ease the pain of mergers and bankruptcies. It also plans to modernize its stock and bond markets so that companies can depend less on banks for financing. What's more, Jiang has said that state enterprises should have a much broader ownership base and that government ownership of less than 51% of shares is acceptable.

For China, which still officially clings to Marxism as a guiding principle, the implications of Jiang's message are huge. Predicts Goldman Sachs (Asia) Executive Director Shan Li: "The 15th Party Congress will be the Congress of privatization." If so, China's communist leaders will have crossed an ideological threshold even Deng dared not breach.

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