Chinas Corporate Reform and Its Economic Effects

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Ci’ Crre Rer I Ecic Eec

PARK Bun-Soon

ChIna’s EConomIC GRowthand statE-ownEd EntERpRIsEs

The Chinese economy was a planned economy

rom 1949 to 1978 wherein state-owned enter-

prises (SOEs) played a central role. Materials

and capital were distributed and supplied to

enterprises through the state or state banks.

Management was appointed by the Commu-nist Party, and the government not only con-

trolled and distributed the output o these

companies, but also covered any losses. From

this perspective, the state itsel served as a large

Feature

enterprise. SOEs lacked independence in deci-

sion-making and incentives, with their employ-

ees enjoying the same bene its as public ser-

vants. Under this backdrop, the productivity

and eiciency o these companies remained

low, and the Chinese economy ell behind.

When its market opened up in 1978, China

kicked o economic development by attractingoreign direct investment and promoting ex-

ports. Since then, China has achieved rapid

economic growth. Ater 1990, China’s annual

economic growth averaged 12.3% during

1991-1995, 8.6% in 1996-2000, 9.6% in 2001-2005,

and 11.2% in 2006-2008. China’s GDP shot up

to US$4.402 trillion in 2008, equivalent to

30.9% o that o the US and 89% o Japan’s. Al-

though lagging behind the US in terms o the

volume o goods imports, China outpaced the



US and Japan in exports, with its oreign re-

serves nearing US$2 trillion.

China’s nominal GDP accounted or a mere

1.7% o the world total in 1990, much lower than

Japan’s 9.0%. In 2008, however, China account-

ed or 7.3%, similar to Japan’s 8.1%. In light o

purchasing power parity, China’s GDP ac-

counted or 11.4% o the world total, ar higher

than Japan’s 6.4%. This represents a remarkable

expansion rom 1990 when the GDPs o China

and Japan stood at 3.6% and 9.0%, respectively.

|Table 1 Economic Indicators of Major Economies (2008)

Note: The goods exports and imports and oreign reserves o the euro area is a sum o the EU countriesSource: Statistical authorities o each country, EIU and IMF

Nominal GDP (Unit: billion US$) 4,402

1,429

1,132

1,946

44010.5

China

1,320

13,633

5,320

5,574

520

-91-0.7

Euro area

494

4,924

776

756

1,031

1573.2

Japan

128

Goods Exports (Unit: billion US$)

Goods Imports (Unit: billion US$)

Current Account (Unit: billion US$, %)

Foreign Reserves (Unit: billion US$)

Population (Unit: 1 million People)

PARK Bun-Soon

The rapid economic growth o China can be at-

tributed to its outward-oriented growth strate-gy, with growth concentrated in the industrial

sector, which includes manuacturing, electrici-

ty, gas, waterworks, and mining. According to

the data compiled by the Chinese statistical au-

thority, the number o Chinese industrial com-

panies that have an annual production o over 5

million yuan stood at 337,000 as o 2007. The in-

dustry employed 78.75 million people, with its

combined production and assets estimated at

40.5 trillion yuan and 35.3 trillion yuan, respec-

14,265

1,300

2,100

-673-4.7

78

US

304



China’s Corporate Reform and Its Economic Effects

tively. Manuacturing companies accounted or

313,000 or 93.0% o the total number o compa-nies, and also accounted or roughly 35.4 tril-

lion yuan or 87.3% o total production, 72.3% o

total assets and 87.1% o total employment. By

corporate size, large companies accounted or

0.9% o the total number o companies, 34.8%

o production, 39.3% o assets and 23.1% o em-

ployment, indicating that large companies are

relatively capital-intensive, while small compa-

nies are labor-intensive.

Although it is dicult to say that the technolo-

gy, productivity and corporate structure o Chi-

nese companies are at a world-class level, their

sales and assets are certainly on a global scale.

This is particularly so or China’s fagship com-

panies that dominate domestic markets in tele-

communications, petroleum, oil reining, steel

and airlines. From a sales perspective, Petrochi-

na has grown into one o the global leaders withsales o 835 billion yuan (more than US$128 bil-

lion) in 2007 likewise China Telecom with

4), although this partly refected a massive stock

market boom in China up to that point.

Chinese manuacturi ng companies also

achieved unrivaled growth in terms o produc-

tion scale. Shanghai Automobile Group, or ex-

ample, sold 1.69 million units in 2007, although

it did not have its own brand. Although still

lagging behind in quality compared to their

Japanese and Korean rivals, China’s electron-

ics companies such as TCL and Haier are rap-

idly catching up on the back o strong price

competitiveness.

ChIna’s CoRpoRatE REfoRm

China’s corporate reorm took place hand-in-

hand with, and laid down the oundations or,

its economic growth. This corporate reorm

took place on two levels. First, corporatizationand privatization were carried out to improve

the governance structure o state companies

|Table 2 China’s Industrial Sector in 2007

Source: China Statistical Yearbook (2007)

By Industry

ByCorporate

Size

Total

15,831

313,046

300,262

336,768

28,568

265,503

96,022

353,037

5,444

19,622

7,529

27,155

23,298

353,631

142,620

405,177

705

6,856

7,891 58,967 2,08928,248 314

3,472

Number o Firms Asset ProftsProductionEmployment

(10,000 people)

7,875

Mining

Manuacturing

Waterworks,Electric and Gas

Small Firms

2,910 138,731 11,412140,858 1,823

33,596 118,284 8,215121,699 2,580

Large Firms

Medium-Sized Firms

(Unit: 100 million yuan)



Corporate reform took

place on two levels. First,

corporatization and

privatization were

carried out to improve thegovernance structure of

state companies. Second,

financial reform was

implemented to promote

corporate restructuring

PARK Bun-Soon

porate sector, the Chinese government expand-

ed the range o autonomy or the state compa-

nies rom 1979 onwards, among others, giving

entrepreneurs more leeway in the decision-mak-

ing process and introducing a perormance-

based contract system. Under the perormance-

based contract system, the management signed

contracts with the state concerning the level o perormance in categories o sales, proits and

investment. I the management outperormed,

they were allowed to share the proits. This ap-

proach o gradual reorm is credited with rais-

ing the productivity o state-owned enterprises

during the 1980s. However, it had its limits in

terms o reorming the sector, as on one hand

successul management was able to share the

prots rom their perormance, but on the other

ailed entrepreneurs did not have to take any re-sponsibility or their ailures.

The government introduced the management

leasing and responsibility system or small SOEs

in the mid-1980s. Under this system, an entrepre-

neur leases an SOE rom the state in return or

paying a certain portion o proits to the state.

The State Council established regulations on

this leasing system in May 1988 which led main-

ly to the privatization o township-and village-

level enterprises (TVEs). Corporatization served

as another means or privatization. Initially, cor-

poratization took the orm o exchanging o

stock between SOEs, but private ownership o

stocks was later allowed. Shenyang Motors Cor-

poration1 issued stocks to the public in August

1988 and became the irst company to be incor-

porated among China’s large enterprises.

Since the “Nanshun Speech” by Deng Xiaop-

ing corporatization has been actively used as a




China also made a

concerted effort to

cultivate its own business

conglomerates. By

benchmarking the

industrial policies of Korea and Japan and

their highly efficient and

competitive business

groups, China aimed at

creating “National Champion” companies

that could compare

favorably with their rivals

in Korea and Japan

rate system. Corporatization may be seen as the

stage prior to complete privatization, what al-

lows a reduction o state intervention and im-

provement o corporate governance structure.

It also decentralizes managerial authority rom

the state toward national agencies and other

SOEs, enabling enterprises to be checked and

balanced by shareholders. From an economicperspective, corporatization also enables enter-

prises to expand the scope and methods o

und-raising, enabling them to not rely solely on

subsidies rom the government and state banks.

At the 4th Plenary Session o the 15th Central

Committee o the Communist Party held in

1999, China approved the stock ownership sys-

tem, enabling itsel to own the stakes o SOEs

that are incorporated. The state also decided toturn most o the mid-and large-sized SOEs, ex-

cluding those specializing in strategic industries,

into corporations mainly through asset sales and

IPOs. The State Council established the State-

owned Assets Supervision and Administration

Commission (SASAC) in 2003. On behal o the

state, the SASAC was set up to perorm the role

o an investor, to supervise and manage state-

owned assets and to implement the reorm and

restructuring o state enterprises. Under the

guideline o the central government, the SASAC

is also responsible or the appointment and dis-

missal o top executives at SOEs, perormance

evaluation and the provision o rewards.

In its move towards privatization, the state had

a speci ic interest in the development o large

companies and the creation o business con-

glomerates. At the 5th Plenary Session o the14th Central Committee o the Communist

Party in 1995 China adopted the “Zhuada



PARK Bun-Soon

orm) into public limited companies, with the

state only playing the role o shareholder. China

also ormulated a blueprint aimed at advancing

three to ive Chinese SOEs into the world’s top

500 rankings by 2000. To this end, the state se-

lected six SOEs, including Baosteel, Haier and

Changhong, as enterprises to receive support.

China also made a concerted eort to cultivate

its own business conglomerates. By benchmark-

ing the industrial policies o Japan and Korea

and their highly eicient and competitive busi-

ness groups, China aimed at creating “National

Champion” companies that could compare a-

vorably with their rivals in Korea and Japan.

This brought about a vertical integration

throughout major industries, which had also

occurred in Japan and Korea. Mergers provedto be an eective way o ostering these business

groups. In 1997 alone, as many as 3,000 irms

were merged, and 15.5 billion yuan worth o na-

tional assets were re-distributed. It was during

this period that large-scale business groups were

created through mergers in the areas o petro-

chemicals, steel and air transportation.

China ultimately pursued the listing o SOEs.

|Table 3 Number of China’s Listed Stocks

1,160

1,224

A,B within China

1,088

1,287

1,377

1 381

60

75

H in Overseas

52

93

111

122

112

111

B within China

114

111

110

109

2001

2002

2003

2000

2004

2005

Even beore its ull-ledged drive towards turn-

ing SOEs into corporations, China set up a

stock exchange market in Shanghai in Decem-

ber 1990 and in Shenzhen in July 1991. State-

owned companies became privatized at a rapid

pace through the stock market; the number o

listed companies rose to 53 in 1992 rom 14 in

1991. China applied a “planned distribution-based” quota system or stock issuance until

March 2001. Ater determining the list o com-

panies to go public and the scale o IPO stocks,

the state allocated quotas to each ministry and

provincial government. Although this had the

adverse eect o in luencing relations between

enterprises and the administrative ministry on

the selection o the IPO irms, the number o

the companies which issued A- and B-type

stocks in China increased to 1,088 in 2000.

The overseas listing (H stocks) o Chinese rms

has increased sharply since 2000. The number o

Chinese irms which issued H stocks remained

low at 52 until 2000 but saw a three-old jump to

143 in 2006. Particularly since 2002, the number

o companies that issued H stocks increased

sharply, indicating the trend o attracting capital

rom overseas markets. In practice, the Chinese




rms showed great interest in listing themselves

on Hong Kong and New York stock markets

rom the 2000s. This move was also welcomed

by the international nancial community.

Despite the act that the state allowed SOEs to

go public, it still remained reluctant to transer

ownership totally to private hands. It dividedthe stocks into tradable and non-tradable types

and restricted the trading o some stocks, aim-

ing at using the privatization o SOEs through

IPOs as a und raising window or these com-

panies rather than as a means to protect the in-

vestors. However, the existence o non-tradable

stocks that account or two-thirds o total

stocks served as a actor that distorted the capi-

tal markets. Since the size o tradable stocks

was smaller than those o non-tradable ones,the owners o tradable stocks had no option but

to have more interest in prot-making than par-

ticipating in management, causing the stock

market to become a veritable casino.

Financial reorm took place in lockstep with

corporate reorm. For a long time, state banks

extended loans to SOEs under the guidance o

the government, and when SOE perormance

deteriorated, a huge amount o bad loans were

let in the banks. Indeed, the percentage o bad

loans in the portolios o the our major state

banks exceeded 40% until the early 2000s,

emerging as one o the biggest economic prob-

lems acing China. To reorm the inancial

structure, the Chinese government issued spe-

cial bonds in August 1998, aimed at enabling

state banks to improve their capital adequacy

ratios. The government also set up an assetmanagement company (AMC) at each o the

our major banks as a way to dispose o the

Ater normalizing the inancial structure o

state banks through the disposal o bad loans

and the injection o public unds, China started

attracting oreign capital in order to enlarge the

capital o the banks. An increasing number o

oreign inancial institutions and institutional

investors developed interest in the Chinese

banks, in l ight o China’s rapid economic

growth since its entry into the World Trade Or-

ganization, low interest rates prevailing in the

international markets centering on the US since

2001, and the completed restructuring o the

Chinese inancial industry. Until early 2006,

they invested US$3.78 billion in the Industrial

and Commercial Bank o China, US$5.095 bil-

lion in the Bank o China and US$3.97 billion in

the China Construction Bank. Most o these in-vestors were international nancial institutions.

Despite the fact that the

state allowed SOEs to go

public, it still remained

reluctant to transfer the

ownership totally to private hands. It divided

the stocks into tradable

and non-tradable types

and restricted the

trading of some stocks



PARK Bun-Soon

2005 and turned itsel into a gigantic bank with

assets o US$70 billion. The Bank o Chinaraised US$9.7 bil lion through the IPO o a

10.5% stake at the Hong Kong stock exchange

in May 2006. The Industrial and Commercial

Bank o China also raised US$19 billion

through IPOs at the Hong Kong and Shanghai

stock markets in October 2006. The processes

undergone by these Chinese banks show that

the Chinese government’s attempts to trans-

orm the Chinese banking and inancial mar-

kets have been successul.

%

|Figure 1 Change in Weight of SOEs in Chinese Economy

80

70

60

50

01998

10

30

20

40

1999 2000 2001 2002 2003 2004 2005 2006 2007

Number o Companies

Employment

Total Output

Total Assets

fRuIts of thE REfoRm

The reorm o state-owned enterprises occurred

contemporaneously with the rapid growth o

the Chinese economy and contributed to rais-

ing the overall competitiveness o the Chinese

economy. This reorm brought about a drastic

change in China’s corporate structure, with the

weight o SOEs in the Chinese economy declin-

ing. Within the industrial sector, the share o

SOEs in the total number o companies stood at

6.1% in 2007, a sharp decline rom 39.2% in 1998,

Source: Chinese Statistics Yearbook (2008)

|Table 4 Performance of Industrial Sector

1998

2000

2002

2004

2005

375 63.7 2.2

5.1

5.2

5.9

5 9

60.8

175.8

155.1

142.2

137.9

1370

58.7

58.0

57 8

341

304

62.2

67.9

75.8

93.7

102 8

240

4,103

5,260

6,101

7,296

9 256254

Proft/ Output Ratio

Debt RatioDebt-to-

Equity RatioOutput/

Asset RatioOutput per Firm(10,000 yuan)

Employmentper Firm (1 person)

(Unit: %)




with its share in total employment plunging to

22.1% in 2007 rom 56.1% in 1998. In contrast,

total assets o SOEs registered a relatively milddecline to 44.8% in 2007 rom 68.8% in 1998, in-

dicating that SOEs still play a major role in the

industrial sector. In terms o total output, SOEs

saw their share all to 29.5% in 2007 rom 49.6%

in 1998, indicating that SOE reorm has not yet

been completed with high shares o output.

Second, corporate eciency has been improved

substantially. For the Chinese industrial sector,

employment per rm registered a sharp decline,

while the eciency o assets improved. The out-

put/asset ratio nearly doubled to 114.8% in 2007

rom 62.2% in 1998. The debt-to-equity ratio de-

clined to 135.2% in 2007 rom 175.8% in 1998.

Corporate proitability, as represented by the

prot/output ratio, improved sharply to 6.7% in

2007 rom 2.2% in 1998. SOEs achieved great

improvement in their asset eciency and prot-

ability through employment adjustment andstructural reorm.

have achieved a sharp improvement in both net

prot-to-sales ratio and operating prot-to-sales

ratio since 2005. The net prot-to-sales ratio ellto 2.9% in 2005 rom 8.8% in 1999 and then re-

covered to 6.3% in 2007. The operating proit-

to-sales ratio also rose to 7.5% in 2007 rom 4.0%

in 2005. These igures indicate that the restruc-

turing o the corporate and nancial sector has

been completed to some extent. The strengthen-

ing o the competitiveness o Chinese rms has

also been mirrored in the stock market. Al-

though the direction o the stock market does

not always refect the level o corporate compet-

itiveness, the Chinese stock market has enjoyed

a boom since Chinese banks attracted oreign

capital through restructuring and global liquid-

ity became abundant in 2005.

Third, the scale o China’s large companies is

increasing rapidly. Five Chinese companies

ranked in the world’s top 500 companies in 1998.

This igure rose to 19 in 2006 and 26 in 2008,higher than Korea’s 15 and India’s 72. The size o

Chinese irms has been increasing sharply es-

(Unit: %)|Figure 2 Trend in Profitability of Listed Companies

12

10

0

2

6

4

8

2007

Net Proft/Sales

Operating Proft/Sales

20062005200420032002200120001999

9.69.0

6.05.4

6.05.8

4.0

5.6

7.5

6.3

4.2

2.9

4.44.73.9

4.7

7.9

8.8

Source: SERI



PARK Bun-Soon

drive or internationalization. Chinese compa-

nies are now emerging as global companies and

a number o these companies are building their

own brands in the global marketplace.

a nEw ChaLLEnGE

The Chinese economy has achieved rapid

growth in the past 30 years amid a drastic

change in the economic environment, and Chi-

nese enterprises have been leading the way or

this growth by undergoing extensive restructur-

ing. However, the environment in which the

Chinese companies are operating is rapidly de-

teriorating. Indeed, adverse eects o such rap-

id growth have begun to show. China’s produc-

tion costs have risen during this period, while

the investment environment has deteriorated.

The value o the yuan is on a secular rise. The

government has also implemented a number o

policy changes, especially or the improvement

o labor’s working conditions that is putting

more pressure on both domestic and oreigncompanies in the coastal regions o China.

After more than 30 years of serving as the main

driver of China’s rapid economic growth by

undergoing a string of self-reforms, Chinese

companies now face a new challenge of how to

strengthen their competitiveness further to fit theirexpanded scale

Chinese stock market has been no exception.

The Shanghai Composite Index, which once

surpassed the level o 6,000, ell below 2,000 at

one stage. Moreover, despite the overall im-

provement in e iciency, productivity andsoundness on the part o Chinese companies,

some large companies still have a long way to

go. China’s large companies, and even some o

its global companies, still remain a mix between

state- and privately-owned companies. More-

over, they oten occupy a monopolistic position

in the nation’s key markets despite having gone

private, leaving many reorms still to be done.

Ater more than 30 years o serving as the main

driver o China’s rapid economic growth by un-

dergoing a string o sel-reorms, Chinese com-

panies now ace a new challenge o how to

strengthen their competitiveness urther to it

their expanded scale.



ExEcutivE SuMMARiES

012 China’s Corporate Reform and Its Economic Effects PARK Bun-Soon

From 1978 onwards, China has pursued a vigorous reorm o

its corporate sector, ranging rom expanding the management

autonomy o state-owned enterprises to privatization. Despite

signifcant improvement in the efciency and competitiveness o

Chinese companies, corporate sector reorm still remains a work

in progress.

Inward and Outward Internationalization of Chinese Firms KIM Icksoo

Since the mid-1990s, Chinese companies are accumulating

strategic assets more through “outward” internationalization, i.e.,

outward overseas direct investment and M&A. Internationalization

has led to sharp improvement in Chinese frms’ core competency

and global competitiveness, leading to sophistication o Chinese

exports and an increase in global market share.

Chinese Firms’ Corporate Strategies in the Economic Downturn

WANG Xianyi

Chinese frms have adopted a three-pronged strategy in response

to the global economic downturn: 1) corporate restructuring, 2)

catering to strong domestic demand, and 3) seeking to increase

market share in overseas markets including by using their strong

fnances to invest in new production bases in overseas markets.

Assessment of Chinese Companies’ Competitiveness

QUI Gang, XU Liyan, SUN Xiaofei

Competitiveness o Chinese irms is assessed rom three per-

spectives: 1) scale and diversity o business activity, 2) proftability

and ability to innovate, and 3) degree to which they have moved

on rom serving domestic markets to global markets.

Protecting the Domestic Financial System from Crisis Contagion KIM Sungmin

022

032

040

052



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