October 31, 2011    Volume 18, No. 17

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China Is Not A 'Market-Based Economy'; State-Owned Companies Constitute 50 Percent of China's Non-Agricultural Output And Act As The Communist Party's 'Foreign Agents'

By Richard McCormack

When China joined the World Trade Organization in 2001, it promised that it would transform its economy away from state control with a goal of becoming a "market-based economy." That has not been the case.

According a study from the U.S.-China Economic and Security Review Commission, Chinese state-owned enterprises remain huge, and their economic influence has grown along with China's economy. "The Chinese Communist Party is not pursuing a free market in which all aspects of China's economy are determined solely by market forces," says the study.

These massive government-owned companies have access to unlimited and virtually free capital resources. They act as "instruments of Chinese foreign policy," says the study. They acquire foreign technology and overseas resources, and they push their weight around with foreign companies, even having their government owners jail executives at competing firms when they don't like their contract terms.

They are active in the United States, winning government contracts at a time when U.S. firms are struggling, especially in the construction and steel industries. And they are partnering with global technology leaders, like the recent venture between General Electric and the Chinese government-owned China Commercial Aircraft Corp., which is aggressively developing a jetliner that will compete directly against Boeing.

"In a world in which central planning has been so utterly discredited, it would be natural to conclude that the Chinese government and, by extension, the Chinese Communist Party have been abandoning the institutions associated with the communist economic system, such as reliance on state-owned enterprises, as fast as possible," says the study. "Such a conclusion would be wrong."

State-owned companies account for more than 40 percent of China's non-agricultural GDP, according to the study. "If the contributions of indirectly controlled entities, urban collectives and public township and village enterprises are considered, the share of GDP owned and controlled by the state is approximately 50 percent."

That is a big number in an economy that recently surpassed Japan's to become the second largest in the world. Many of these state-owned companies are among the largest in the world.

It is difficult to determine if Chinese companies in the sub-tiers of industries are controlled by the state. There is little ownership information provided on English-language Chinese company websites. "It's not that easy to drill down," says report co-author Andrew Szamosszegi of Capital Trade Inc., based in Washington, D.C. "The only way to determine if a company is owned or operated by the government is to get into the registration documents in China and not everyone can look at those." For American companies setting up joint ventures, dealing with a Chinese company is like "a black box, and you just don't know" if the ownership includes a government entity, says Szamosszegi .

What is known, is that the state-owned enterprises will play a central role in China's economy over the coming decade, since the Chinese government is committed to state ownership.

American companies will have to compete with these behemoths, as they strike out across the globe with full support of the Chinese government flush with $3.2 trillion in foreign reserves. "China's latest five-year plan indicates it is pursuing a 'national champion' strategy for certain industries that the government views as important," according to the study. "These national champions are likely to be state-owned enterprises or entities they directly control."

Skepticism by some economists over whether these government companies will self destruct under the weight of bureaucratic managers who can't keep up with fast-changing markets and technology is likely wrong, says Szamosszegi. "I have heard that a lot and I'm sympathetic to that view, but you have to look at the results. The issue is not whether they are creating imbalances in China that will bite them in the end, but whether in the process of creating those imbalances, they are also influencing job destruction and the overall economic well being of the United States. That's the key."

The Chinese government is using its state-owned enterprises to acquire foreign technology. It did this in high-speed rail, by requiring Kawasaki Heavy Industries, Siemens and Bombardier to enter into joint ventures and licensing agreements with state-owned companies (China South Locomotive & Rolling Stock Corp.), and then abandoned them once they siphoned off their knowhow. It is doing this in the steel industry, and the government "appears to be using the same approach with current efforts to develop a civilian aviation industry," says the study.

It will be tough for U.S. companies to compete with these government-backed entities, according to the research. In looking at recent U.S. regulatory filings made by the Chinese state-owned corporations that have raised money in the United States, they found that Chinese government-owned banks are providing them with access to capital at a time when it is hard for U.S. firms -- especially small- and medium-sized ones -- to secure loans from private banks in the United States. The Chinese companies get below-market interest rates on loans from state-owned banks. Their debts are forgiven by state-owned banks, and, in some cases "the loans are simply forgotten."

They receive favorable tax treatment, large capital injections when they need them and they benefit from policies that give them preference over foreign companies in the Chinese government procurement market. They receive preferential access to raw materials and electricity that allows them to undercut foreign producers. Even the subsidiaries of Chinese state-owned enterprises that have raised capital in the United States and other market economies "continue to receive support from the Government of China," according to the study.

China's government uses the firms to "facilitate structural change in the Chinese economy, to acquire technology from foreign firms and to secure raw materials from beyond China's borders," says the USCC study.

China's State Owned Assets and Supervision and Administration Commission of the State Council remains actively involved in the management of the state-owned enterprises. This organization appoints and promotes top executives who follow the government's policy guidance. "When it joined the WTO in 2001, China promised that the government would not influence directly or indirectly, the commercial decisions of state-owned enterprise," according to the study. "China does not appear to be keeping this commitment. The state does influence the commercial decisions of state-owned enterprises and the most recent five-year guidance does not herald a change in this regard. If anything, China is doubling down and giving state-owned enterprises a more prominent role in achieving the state's most important economic goals."

For U.S. companies that have set up shop in China in order to grow sales, especially in emerging or strategic industries, "the Chinese market may become far less hospitable."

The government-owned Chinese companies are active in the United States. They are supplying steel to Bechtel Corp.; they have provided $350-million worth of steel to the new Bay Bridge project in California. China Construction America, a subsidiary of China State Construction Engineering Corp. Ltd., a Chinese government owned entity, "has been successful in procuring construction contacts in South Carolina and New York," according to the study. "Its South Carolina projects include public schools (e.g. at the University of South Carolina); the Chancery Building of the Chinese Embassy in Washington, D.C., and renovation of the Alexander Hamilton Bridge (with Almar Intl.), the largest single-phase project ($407 million) overseen by the New York State Department of Transportation. . . Indeed a Harvard Business School case study of China Construction America demonstrates that the firm's state support was critical to the firm's success, and that CCA's revenues have been growing at a time when U.S. non-residential construction was crashing."

State-owned enterprises control 61 percent of Chinese shipbuilding industry; 76.6 percent of the petroleum and petrochemical industry; 92 percent of the electrical power generating industry; 76 percent of China's air transportation sector; 59 percent of China's coal industry; 96 percent of China's telecom services industry; 74 percent of the country's automobile industry; 17 percent of the steel production sector; 20 percent of the construction industry; and 19.5 percent of the non-ferrous metals industry.

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