Hua Sheng and Du Haiyan
State-owned enterprises play a predominant role in the Chinese economy. In 1978, the year just before economic reform started, state-owned enterprises accounted for 21 per cent of industrial output and 92.3 per cent of retail sales. The rest was provided by collectives, with the private sector offering nearly nothing, save for agricultural produce. Furthermore, collectives are by no means genuine co- o p e r a t ive s , bu t a r e p u b l i c e n t e r p r i s e s a t t a c h e d t o a l ow e r administrative hierarchy and therefore less privileged. The economic reform process has witnessed the rise of the private economy, which accounted for nearly 5 per cent of output in 1988; but on the whole reform has changed the environment in which these enterprises operate rather than the ownership structure as such.
A comparison of characteristics of the enterprise system before and after reform
It is rather difficult in a non-market economy like China’s, where prices are distorted and interference from non-economic factors abounds, to define and conduct any statistical analysis of efficiency. There has been an increase in the productivity of both capital and labour between 1978 and 1988, although exactly by how much is uncertain because official statistics are difficult to interpret.
The pre-reform era
Prior to reform, enterprises had no independent objectives or interests. Policies with regard to all aspects of their business, ranging from first investment to final close-down, were all decided by government planning and supervisory departments. The excessive centralization of the planned economy turned state-owned enterprises virtually into government branch offices, with little power over their own personnel, finance, material supplies, and
income distribution. The performance of an enterprise had no connection with the income and welfare of its staff, and daily operations were mainly determined by the mandatory plan.
Moreover, organization within an enterprise was under the control of the Communist Party Committee, which assigned duties to the key members of the enterprise leadership. The manager was only an administrator of the Communist Party Committee decisions.
Such an enterprise system was considered to be suited to the early stage of mass production. However, with the development of the economy, the problem of its low efficiency became increasingly apparent. Enterprises met with no competition outside and issued no rewards inside. As a result, they were characterized by poor management, indifference to changes of the supply-demand pattern, slow response to price fluctuations, and far from optimal use of resources.
After reform
The quest for the greatest possible short-term benefit became a major feature of state-owned enterprises since, as part of the reform of old income distribution system, they were granted rights to retain a certain percentage of their profit and to distribute bonuses. Workers and staff began to associate their own interests with the performance of the enterprise in which they worked. Moreover, enterprises had their profit targets.
The underlying logic is that, when central planning has given way to market mechanisms, enterprise competitiveness and concern for self- development will grow. However, the rational behaviour of state-owned enterprises is confined to their desire for short-term incomes only because wage earners (both workers and managers) are more concerned with short-term profit than with long-term development, in the knowledge that the state as ultimate owner may eventually take all the profits and would cover all losses. With the absence of a comprehensive reform of the country’s economic structure in the true sense of the word, there is a lack of effective discipline of the enterprises’ behaviour.
Approaches to enterprise reform
At the beginning of the enterprise reform process some economists proposed that enterprises should have independent rights, obligations, and benefits.
They developed the idea of decentralizing economic administration and transferring the decision-making power from the central authorities to the individual enterprises.
However, there has been disagreement on how best to achieve this end over the past decade. This disagreement may be represented by three
basic scenarios. The first held that the state should make the enterprise itself autonomous, based on worker and staff decision-making. This scenario played a dominant role during the reform process between 1979 and 1984. The second was tailored to the enterprise manager, separating the rights of ownership and management This scenario has gained dominance since 1985. The third, which was discussed only when the political climate seemed right, advocated dismantling state ownership.
Decentralization towards the rebuilding of genuine enterprises At the outset of reform, the influence of East European theories a n d ex p e r i m e n t s , i n c l u d i n g t h o s e f r o m Yu g o s l av i a , wa s considerable. The lack of a participatory management system was held to be the root cause of the state-owned industry’s low efficiency. The traditional system had failed to transform the interests of workers and staff into a concern for management of the state’s assets. There needed to be a new form of people’s ownership featuring the improvement of their status and the expansion of their democratic rights. The most well-known theory in this regard was the ‘enterprise status theory’, which was the main source of inspiration for the first stage (1978–84) of the reform of state-owned enterprises. This involved increasing the decision-making power of enterprises, and experimentation with various responsibility schemes.
So in the fourth quarter of 1978, the Sichuan provincial authorities, headed by Zhao ZiYang, the premier (1980–7) and the Party General Secretary (1987–9), began a pilot project in the Ningjiang Machinery Factory and in five other state-owned enterprises. These were the very first attempts at enterprise reform in the People’s Republic of China.
Though initiated by a few key figures in local government, they were encouraged by the favourable attitude which began to dominate at the top. By the end of the year, the experiment had spread to 100 enterprises in Sichuan. In July 1979, the experiment was introduced to eight large or medium-sized state-owned industries in Beijing, Tianjin, and Shanghai.
Before the end of 1979, the number of enterprises in the experiment increased nationwide to 4,200. It further increased to 6,600 in 1980, making up 16 per cent of the enterprises covered by the state budget, 60 per cent of the nation’s industrial output value, and 70 per cent of its profit. How much these enterprises could retain from their profit and how much their workers and staff could earn was decided by the results of their performance. Also enterprises were given a certain discretion to choose suppliers and buyers within the state plan, to adjust prices of their products to a small extent according to government regulation, and even to market their products above the requirements of the state economic plan.
In 1981, these experiments were extended to 36,000 industrial enterprises, which included the majority of large enterprises covered by the state budget. (All commercial enterprises had been allowed to retain a percentage of their profit since 1979.) Within industrial enterprises, the rights of factory directors were strengthened, and workers’ congresses installed. The process mentioned above loosened up the state’s control over enterprises. Profit-sharing, mainly in the form of a bonus, led managers and workers to take notice of their performance. After the introduction of the Dual Track Pricing System in 1985, enterprises could also have a free hand to set prices and to sell or buy goods outside the state plan.
However, at the same time, the promotion of autonomy gave rise to a series of problems. In response to the continued ‘soft budget constraint’, rampant irrational activities emerged such as over- investment and bonuses that ate up an increasing portion of profit.
Guidance given on the use of retained profits was ineffective. The all-round concession to the workers and staff eroded state revenues and financial capability. The basic underlying problem was that the government could not find a fair rule on profit-sharing to impose on hundreds and thousands of apparently different enterprises. They competed for a high profit-sharing rate through endless bargaining with government departments.
In order to iron out these problems, in 1983 China started to try to replace the case-by-case profit-sharing system with a newly designed taxation system. The taxation system was expected to serve two purposes. First it was to heighten the enterprise’s sense of responsibility for contributions to the state revenues. The second purpose was to provide an equal footing to all enterprises, so that conditions would be in place for them to compete in the field of production.
To achieve this goal, two steps were envisaged. The first step was to impose a fixed rate of income tax on all enterprises. The second was to be taken in conjunction with reform to correct the distorted price system, together with taxes on natural resources, assets, and value added taxes in some industries.
On 1 June 1983 the first step was launched. All large and medium- sized state-owned enterprises were required to pay 55 per cent of their profit to the state. The after-tax profits were shared through bargaining between the government and enterprise. Their actual profit in 1982 was taken as the bottom line for this part of their contribution, valid for three successive years.
The second step of the tax reform was taken in October 1984. Its operation deviated from the original plan. Due to the difficulty in calculating the tax rates on natural resources, in valuing assets, and
in eliminating the irrationality in the price system, what was adopted was only the regulatory tax, whose rates resulted from the government’s bargaining with individual enterprises. Therefore, the tax reform as a whole failed to set an equal footing for all the enterprises: it simply reduced the bargaining scope from total profit to after-tax profit.
In the fourth quarter of 1984 the inflation of investment and income became so serious that the government appeared unable to assert its macroeconomic control. This seemed to indicate that the simple reform of the state’s concession of power and interests to the enterprise had come to a dead end. The vague concept of enterprise autonomy began to reveal its internal incoherence and (even) contradiction.
Separation of ownership and management
The tendency of managers to pursue the well-being of their workers and staff rather than that of the state (the owner) was widely considered to be one of the main contributors to the failure of the first stage of reform. This led people to attach importance to the role of the manager, to rebuild the incentive mechanism, and to promote the manager’s sense of responsibility for the use of state assets. A large number of experiments was started to increase managerial power which paved the way for the so-called managerial revolution. The major experiments were the leasing system, contractual management, and the assets management responsibility system. These experiments were aimed at reducing administrative interference with the enterprise affairs, supporting the manager’s leadership status, and raising the efficiency of the state assets by extending incentives to managers.
The leasing system
This was applied mainly to the small firms that were barely profitable, if not in the red. Indeed, the leasing system was originally an arrangement to correct the chronic financial losses of some enterprises. The government’s trade administration decided the leasing terms, including the amount of leasing fees, and transferred each enterprise to a voluntary leaseholder. Usually this was the manager. After paying the fees, the net income would be totally at the disposal of the lease holder.
In a gradual process this was developed into a new form of state- owned enterprise management. In this process the leaseholder changed from an individual to a group of individuals, and even to the entire staff of the enterprise. The fees also changed, from a fixed amount to a floating rate, little different from the other profit-sharing system.
The leaseholder was at first granted the power to reform the enterprise management, after the obligations and incomes were all clearly specified. But soon he tended to seek only maximization of profit on his own terms. Moreover, the conflicts between leaseholder and workers had been increasing.
The ‘assets management responsibility system’ (AMRS)
Under this system the enterprise leadership was no longer appointed, as it always had been, by the trade administration. Instead, as with an auction, competition for the top management position was encouraged, and candidates specified the performance they would achieve, generally over a five-year period. This also involved valuing the assets of the enterprise in competition for the management of the second term, through renewed public bidding. The main advantage was the existence of criteria for examining the pragmatic achievements of the manager, thus restraining his short-term behaviour.
This system was first proposed in 1985 and implemented on a trial basis in about twenty cities in 1986 and 1987, yielding certain positive results. However it was seldom the choice of the enterprises themselves because of its strong constraints, the minor concession of state interests, and its complicated operation. In fact no more than 1,000 enterprises have thus far adopted this system.
The contract system
This was an early product of the enterprise reform process. The contractual guarantee of the profit handover to the state, after enterprises gained relatively autonomous status and independent decision-making power in 1979, was the inchoate form of what was later called the ‘contract system’. After tax reform in 1983 this practice ceased in most enterprises.
The contract system became widespread after 1987. Nearly all state- owned enterprises have adopted it. The new contracts usually stress the following three points:
1. the profit share to the state;
2. technological improvement;
3. the linkage between the enterprise’s total wage bill (including bonus and managers’ salaries) and its profit contribution to the state.
Thus when the contractual targets are met both manager and workers can enjoy a substantial increase in income. The contract system also sometimes borrows the AMRS competitive system for the top management positions.
Contracts usually last from three to five years instead of only one year as
in the past. Negotiating contract targets is a complicated bargaining process, but when public bidding for the top management position was introduced, targets could be very competitive and the discipline on the winning bidder was very effective.
However, neither the officers who had the power to appoint managers nor the managers themselves were interested in fair competition. As a result, although there were certain items in the contract which disciplined managers when targets were not met (for example, salary reduction or even dismissal) managers could always find alibis for poor performance in government interference or in its macroeconomic policies. On the other hand, workers and staff in Chinese enterprises not only earn cash income but also obtain pensions and welfare for their families, according to need.
Thus the state has to shoulder responsibility, no matter what happens.
The contract system resulted in greater enthusiasm for both management and labour, yet it failed to bring about the anticipated progress. This was due partly to the fact that government administrators, as representatives of the owner, not only failed to regulate the enterprise’s behaviour effectively, but also sometimes tried to jeopardize the manager’s independence. And the desire for the maximum welfare level for employees (which is extended to their families) did not cease to exert heavy pressure on management, and prompted more widespread short-term-oriented activities. The necessary conditions for normal business competition were still not created when the enterprise was made responsible for its gains, but not for its losses. The lack of a guarantee for the efficiency of the state-owned sector continued.
The experience of China’s enterprise reform seems to indicate that the separation of ownership and management based on Western private property rights would run into insurmountable difficulties in China.
Because of the confusion of the roles of the owner, management, and labour (who are supposed to be the true ‘master’), whatever encouraging signs reform in organization and operation have produced can only be of temporary significance. Soon after the introduction of a new management plan or operational technique, its distortion or even emasculation is common.
The explanation for this is to be found in the endless bargaining between the state and its enterprises.
The consequence of the non-existence of the property rights and the possibilities of further reform
The difficulties facing enterprise reform have led Chinese economists to consider property rights. They have come to realize that the inefficiency of the state-owned sector lies in the absence of property rights. These
would set the pattern of enterprise behaviour and open the opportunities for business competition. This is, so to speak, a ‘congenital defect’ of state ownership. Is it possible to separate the dual role of government as owner and as administrator when the state sector dominates in the economy?
The separation of powers
Some used to argue that the separation of these two functions would prevent or diminish administrative interference. They proposed a series of rules to govern this division of power, and made a few practical attempts to effect their proposals. But the results proved their naivety. When the government plays the dual role of economic a d m i n i s t r a t o r a n d e n t e r p r i s e ow n e r, t h e ow n e r s h i p w o u l d u n avo i d a b l y f u n c t i o n i n a w a y d e t e r m i n e d b y t h e u s e o f administrative power and the workings of the administrative organization. But government officials have no direct interests in the efficiency of the state assets, which are extremely difficult to value. Their true market value is largely associated with the people using them, and administrators can never effectively regulate tens of thousands of enterprises at the same time.
With the idea of limiting the government role, people began to explore the possibilities of recreating the owner within the framework of state ownership. Proposals have been made along two lines. The first, usually called the ‘legal person right’ theory, proposes that a board of directors should be established to consist of representatives of the owner, the manager, and the workers. The underlying rationale is that by dividing the powers of the legal person owner and the ultimate owner, and by building up a mechanism of mutual checks between the two, the legal person owner may generate a resistance to the administrative interference and set up a balance of different interests within the enterprise.
But the reform so far has indicated that such a fictional board of directors cannot truly live up to its expectation. Even worse, when t h e b o a r d i s o r g a n i z e d u n d e r t h e a u s p i c e s o f t h e t r a d e a d m i n i s t r a t i o n , i t w o u l d eve n a c c e n t u a t e a d m i n i s t r a t iv e interference. Despite the weakness of this experiment, the ‘legal p e r s o n fa n t a s y ’ s t i l l h o l d s i t s i n f l u e n c e o n s o m e C h i n e s e economists and their experimental efforts.
The second line is referred to as the ‘owner organization theory’, proposing that a state assets administration should be established outside the enterprises and other government departments.
Functioning as the owner of state assets, this new organization would have the rights to choose the managers, receive benefits from the state investment, and dispose of its earnings and assets—virtually