Selling Off the State in China
China's latest batch of ugly data offers a stark message to President Xi Jinping: Whatever he's doing to prop up growth isn't working. Even worse than the 5.5 percent drop in exports last month was the 13.8 percent plunge in imports, indicating that domestic demand is weaker than the external sector.
The good news is Xi is changing tack. Rather than just tossing more stimulus at the economy and stocks, he's redoubling efforts to reform the inefficient and opaque state-owned enterprises at the root of so many of China's vulnerabilities. In other words, Xi is finally working to strengthen China's foundations rather than papering over the cracks. The bad news is that Xi could just as easily be making things worse.
Beijing is targeting the public sale of shares in SOEs in order to inject some market discipline into the companies’ governance, according to documents seen by Bloomberg News. The plan includes steps to increase the number of outside directors on boards, devise appropriate executive salary levels and promote consolidation. But the overriding focus is on encouraging private capital to pile into SOEs, rather than wholesale reforms to make them more competitive first. As such, China may just be engineering a huge corporatist land grab -- one that harkens back to the days Russia sold off its own state companies to a now-loathed class of oligarchs.
If Moscow could undo any decision of the last 25 years it would be that epic carve-up of Soviet-era assets. Rather than transform Russia into an innovative industrial powerhouse, the privatization bonanza created a handful of young billionaire monopolists. In a 2008 retrospective, The Guardian described the oligarchs as "about as popular with your average Russian as a man idly burning bundles of £50s outside an orphanage." Russia has since devolved into a graft-ridden petro-state that's becoming a smaller and smaller blip on investors' radar screens.
China, needless to say, can't afford that outcome, and not just because it lacks Russia's natural resources. The country very much needs a big, thriving private sector. The problem is that at the moment, political connections still matter greatly in the Chinese corporate world. Odds are, the best-placed tycoons will get first crack at share sales, possibly on sweetheart terms. And if they press for continuing cheap loans from state banks, the misallocation of capital that plagues the Chinese economy will only continue.
To beat the middle-income curse, China needs to create hundreds of millions of new, good-paying jobs in nimble industries. That means leveling the playing field and creating the right incentives for young game-changers to disrupt an economy burdened by overcapacity. Entrusting the process to a group of greedy tycoons would set back China’s growth potential. Corrupt as is it is, Xi's Communist Party is at least nominally charged with sharing the fruits of China's 7 percent growth. Robber barons have few such compunctions.
China can avoid that fate by not putting the cart before the proverbial horse. There are more than 150,000 SOEs, accounting for roughly 80 percent of the CSI 300 Index in China. We're talking about the core of the world’s No. 2 economy. Rather than just creating new national champions, China must use this opportunity to consolidate industries in ways that increase efficiency, innovation and competition. That means modernizing SOEs before privatizing them -- weeding out under-performing executives, dumping unprofitable businesses, increasing transparency and tightening the corporate-reporting process.
Once companies are ready for sale, Beijing should sell them off in their entirety and not maintain huge public stakes (as is currently envisioned). For all the focus over trading in the A shares of PetroChina, for example, the state owns 97 percent of China's biggest oil and gas producer. Really, who wants to buy shares in a "private" company when the government could ban you from dumping your holdings? The privatization process must be open, fair and rigorous.
Finally, Xi needs to institutionalize his anti-graft campaign. So far, it's looked more like an effort to eliminate rivals and settle political scores than a broad and methodical push to clean up China Inc. A clear list of rules, red lines for malfeasance and indications of how cases will be pursued legally are needed to keep these new entities from becoming just as corrupt and bloated as their state-owned counterparts.
Xi's heart is in the right place. But he should remember, veering in the direction of Russia won't take China where it wants to go.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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