The Economist Europe – July 22-28, 2017

The EconomistJuly 22nd 2017 55

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1

A

CCORDING to company lore, Yunnan

Baiyao, a musty-smelling medical

powder, played a vital role during the Long

March. As China’s Communist troops fled

from attacks in the 1930s, trekking thou-

sands of miles to a new base, they spread

its yellow granules on their wounds to

stanch bleeding. To this day, instructions

on the Yunnan Baiyao bottle recommend

application after being shot or stabbed.

Many Chinese households keep some in

stock to deal with more run-of-the-mill

cuts. But the government has recently put

its maker into service to treat a different

kind of ailment: the financial weakness of

state-owned enterprises (SOEs).

Yunnan Baiyao has emerged as a

poster-child of China’s new round ofSOE

reform. The company, previously owned

by the south-western province of Yunnan,

sold a 50% stake to a private investor earlier

this year. The same firm had tried to buy a

slice of Yunnan Baiyao in 2009 but was

blocked. Its success this time has been held

up in the official press as proof that a push

to overhaul sluggish state companies is at

last gaining momentum under Xi Jinping,

China’s president.

But for many investors and analysts, the

Yunnan Baiyao case proves justthe oppo-

site: thatSOEreforms are stuck in a rut. The

sale, after all, left half the company in state

hands. And a traditional Chinese medical

powder is far removed from industries

such as energy and finance, which the gov-

pand the Chinese economy by nearly 10%,

or about $1trn, over the next decade.

The fate of China’s state firms is also a

global concern. By international stan-

dards, they are already massive. China’s

200 biggestSOEs account for 18% of global

revenues of integrated oil and gas compa-

nies, 6% in carmaking and 5% in construc-

tion (see chart 2). A series of mega-mergers

currently under way is concentrating even

more power in the hands of a few, giving

them the heft to barge into new markets.

For foreign firms this can smack of unfair

competition, as if they are fighting against

the Chinese state. The temptation for other

countries to block foreign investments by

SOEs will only increase, setting the stage

for bitter disputes.

Market failure

Back in 2013 Mr Xi seemed to grasp that

change was needed. He vowed that market

forces would play a “decisive role” in allo-

cating resources and declared that reform

ofSOEs was a priority. Although a big-bang

privatisation was never on the cards, the

hope was that the government would

make SOEs better run, more competitive

and less coddled. There has been a bewil-

dering array of directives and pilot pro-

grammes since then but little real progress.

The fear is that the reforms, taken together,

not only fail to solve the most pressing pro-

blems, but might even be aggravating

them. SOEs are gettingbigger, not smaller;

their management has become more con-

servative; and their deficiencies are begin-

ning to infect the economy more widely.

Keeping track of all the different experi-

ments that fall under the heading of “SOE

reform” is a full-time job. When Mr Xi put it

on the agenda in 2013, the government

broke it down into 34 separate initiatives,

farmed out to different departments and

agencies. Ithas since published at least 36

ernment deems strategic and is less willing

to open to private capital.

It is hard to overstate the importance of

gettingSOEreforms right. In the 1980s,

when China was starting to open to the

world, the state sector dominated its econ-

omy, accounting for nearly four-fifths of

output. A big factor behind China’s re-

markable growth since then has been the

relative decline ofSOEs, to the point that

they account for less than a fifth of output

today. As state firms stood still, a vibrant

private sector sprouted around them.

Over the past few years the state sector

has, by several measures, stopped shrink-

ing. There are still more than 150,000SOEs

in operation, two-thirds owned by local

governments and the rest under central

control. Private firms are much more pro-

ductive, but state firms gobble up a dispro-

portionate share of resources. They take

about half of all bank loans and are the

main culprits behind China’s big increase

in corporate debt. Since 2015 investment by

SOEs has grown faster than private-sector

investment, reversing a decades-long trend

(see chart 1 on nextpage).

For China this has the makings of a da-

maging cycle. As growth slows, the govern-

ment leans on SOEs to spend more; but this

drives up their debt further and so weighs

on the economy. Putting a stop to this se-

quence is vital for China if it is to become

wealthy. TheIMFestimates that an ambi-

tious programme ofSOEreform could ex-

China Inc

Reinstatement

SHANGHAI

Reforms meant to fix China’s ailing government-owned firms instead have

emboldened them

Finance and economics

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