Transcript The Post-Industrial East Asian City

Under New Ownership
Shahid Yusuf
DECRG
World Bank
December 2005
Enterprises and Growth
Enterprise sector responsible for much of China’s
remarkable growth
But cost of growth is high
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Investment equals 45 percent of GDP, the highest
sustained rate of investment for any country in recent
history.
Most growth is from input of capital and labor. Share
of total factor productivity increase is one quarter of
overall growth. In industrial countries, share is onehalf or more.
Enterprises and Growth (cont’d)
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Cost of growth related to inefficiency and low
profitability of many enterprises, especially SOEs.
Enterprise problems imperil banking sector
NPLs of banks amount to 9 percent of GDP, not
including those taken over by asset management
companies.
Enterprise inefficiencies also reflected in high
consumption of energy and raw material, and
associated environmental damage.
Enterprise efficiency and competitiveness good for
growth and for overall welfare.
Attributes of Successful Firms
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Quality of management and strategy focused
on competitiveness to assure longer term
growth.
Organizational capability, especially
adaptability and resilience in the face of
shocks.
Flexible internal labor market to maximize
gains from training and efficient use of
workforce.
Attributes of Successful Firms (cont’d)
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Culture of innovativeness and openness to
ideas.
Emphasis on core strengths and effective use
of subcontracting and outsourcing.
Skills and readiness to operate internationally,
to market abroad and manage a multicultural
workforce.
Do Chinese Firms Have these
Attributes?
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Some do. Mainly private firms and joint
ventures. Also a few SOEs (e.g., CIMC).
Majority of SOEs do not.
SOEs constrained by national/subnatoinal
objectives, management skills, high degree of
vertical integration, diversifed activities, labor
market rigidities, lack of innovativeness, and
localized or domestic market orientations.
Why Do SOEs Matter?
Share of state sector in industrial output shrinking:
now close to one-fifth.
 But, one-half of industrial value added is in the state
sector.
 State sector holds two-thirds of net fixed assets.
 Absorbs nearly two-thirds of bank loans.
 Growth in total factor productivity is less than onefifth of collectively or privately-owned enterprises.
SOEs still strongly influence the performance of China’s
economy
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Fifteen Years of Enterprise Reform
1980-95
Enterprise reform dates back to early 1980s.
Has been through several stages:
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Negotiated profit retentions;
Simplified administrative controls;
Selling of above plan output;
Flexibility in hiring workers or contract;
Management contracting.
Productivity gains from giving enterprises
more autonomy disappointingly small.
Is Privatization the Key
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Western countries adopted privatization in
mid-1980s after other policies to reform
public enterprises proved unsuccessful. Many
transition economies followed from the early
1990s.
By end 2002, privatizations had generated
$1.1 trillion for government, one-third in
developing and transition economies.
Is Privatization the Key (cont’d)
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On balance, privatization has helped raise
profitability, labor productivity, growth of
sales and sales per employee.
Manufacturing firms have performed better
than others. Also banks.
One decade’s experience shows that fast
reformers among transition economies, after
initial difficulties, did better than slow
reformers.
Why Privatization Works
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Change in objectives: clearer focus on
profitability and growth.
Market-based incentives reinforced by private
ownership, displace administrative incentives.
New management, stronger governance
mechanisms and stronger minority
shareholder rights.
Why Privatization Works (cont’d)
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Competitive pressures from product market
and financial markets.
Greater flexibility in restructuring operations
and hiring/firing workers.
Pitfalls of Privatization
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Continuing significant government share and
influence on decision-making a handicap
Many companies initially go through a period
of losses after privatization.
External recruitment of management and
BOD that exercises effective oversight
important, or else governance remains weak.
Ability to shed excess workers and sideline
businesses and rationalize production vital for
success.
China’s Strategy Since 1996
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Privatization, divestiture and closure of small
SOEs.
Start at corporatizing MLSOEs. Creation of
Limited Liability Companies (LLCs) and
Limited Liability Shareholding Companies
(LLSCs).
FDI in MLSOEs.
Research Objective: Comparing Impact
of Ownership on Performance
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Main objective of the empirical exercise is:
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Did reformed enterprises perform better?
If so, what were the main contributing factors?
Factors associated with better performance were:
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Ownership, competition, hard budget constraint, role
of managers (appointment, turnover, incentives,
autonomy), and corporate governance (shareholder
meetings and board of governors).
Data Description
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The data is based on survey conducted by China
National Bureau of Statistics, Enterprise Survey
Organization.
Information collected from 736 firms for the period
1996-2001. Sample of enterprises drawn from five
cities (Beijing, Chongqing, Guangzhou, Shanghai,
Wuhan); and from 7 subsectors, electronic
components, electric equipment, consumer products,
vehicle and vehicle parts, garment, general machinery,
and textile.
Of these firms, 140 were never reformed, 266
reformed, 330 were never SOEs.
Estimation Strategies
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Used Cobb-Douglass production function (as
most researchers of this topic do), along with
city, industry, and year dummies.
Also used panel regression to take full
advantage of the both cross-section and timeseries dimension of the data.
Findings
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Ownership
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Firms with 100% state ownership perform the
worst in all specification
Joint venture firms are the best performers,
followed by LLSCs and LLCs.
Competition
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Paradoxically, firms in more competitive
markets seem to perform less well than those
faced with less competition.
Findings (cont’d)
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Corporate governance
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Having a board of governors is performanceenhancing.
Having a shareholder meeting also tends to
improve performance, if and only if one-shareone-vote is instituted.
Manager
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Firms with managers appointed by the
government perform less well.
Changing of managers did not have any effect.
Findings (cont’d)
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Hard Budget
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A priori, one would expect a hard budget
constraint to have a positive effect on
performance, but such an effect not apparent
from the tests
Concluding Observations
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Study shows that if the objective is to raise the
performance of firms, then ownership reform is
desirable.
Such reform should include at least the following:
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Managers should not be appointed (or approved) by
the government
The shareholder meetings needs to align the financial
stake and the voting rights (one-share-one-vote)
There should not be any restrictions on the ownership
(i.e. foreign ownership)
Concluding Observations (cont’d)
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Full privatization better than partial
privatization with continuing substantial
government ownership or control rights.
Successful privatization can be assisted by
several complementary factors
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An effective national social safety net, and
scope for flexibility managing enterprise
workforce
Adequate supply of experienced managers
Concluding Observations (cont’d)
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Legal and audit institutions to sustain
corporate governance, rules, minority
shareholder rights, and bankruptcy laws
Well functioning financial markets to
discipline managers
Thank You