China’s SOE Reform—The Wrong Path
A key component of China’s SOE reform strategy—mergers of the largest firms in the same industry—seems very unlikely to improve the efficiency of bloated state-owned enterprises. Instead, the government should increase competition by allowing the entry of private firms into sectors where a handful of state firms exercise market power and it should subject money-losing state owned firms to hard budget constraints. These policies offer the best prospect for increasing productivity and sustaining China’s economic growth.
The most recent merger, orchestrated by the State-owned Assets Supervision and Administration Commission (SASAC), involved the takeover of the China International Travel Service Group Corporation by the China National Travel Service (HK) Group Corporation. Other recent mega mergers of state firms subordinate to SASAC include China’s two largest train makers--CNR Corp and CSR Corp; the two largest mining and metals companies--China Metallurgical Group and China Minmetals Corp; and the two largest shippers--China Ocean Shipping Group (COSCO) and China Shipping Group.
These mega mergers may satisfy the ambition of the Chinese Communist Party to have more prominent national champions, but they aren’t likely to improve the efficiency of SOEs. Most of the firms involved were huge even prior to merging, so presumably they should have already captured any available economies of scale. Prior to the merger COSCO, for example, was already operating the world’s second largest fleet. On the other hand, these mergers drastically reduce competition in key sectors, undermining the prospect for sustained productivity gains.
The history of mergers undertaken by SASAC over the past decade confirms the merger strategy is ill-founded. When SASAC was set up at the national level it controlled about 200 of China’s largest non-financial SOEs. By 2014 mergers within this group of firms had reduced their number to 113. The average size of these SASAC firms rose dramatically and an increasing number of them (more than 100 this year compared to 10 in 2000) made their way on to the Fortune Global 500 list, in which firms are ranked by revenue. The economic performance of SASAC firms, as measured by return on assets, however, was never impressive and declined dramatically as more mergers took place. Indeed, as shown in the figure below, the returns of SASAC firms are mediocre, actually well below the cost of capital in recent years. More mega mergers are likely to slow rather than enhance China’s economic growth.
Figure 1. Returns on Assets of Central SASAC Enterprises
Source: Lardy, Nicholas R. Markets over Mao. Peterson Institute for International Economics, 2014: Table 2.1.