Full privatization is no panacea

A study of Chinese companies challenges Western arguments that full privatization is the panacea

Economic instability caused by the financial crisis in Western economies raises concerns for policymakers in developing countries. In particular, there is concern about the free market development model proposed by the Washington consensus. Policymakers in developing countries are therefore beginning to see China as a role model with respect to economic development.

The free market model calls for the liberalization of markets with less regulation and state interference. This creates an economic environment where business success is financially rewarded and financial reward motivates business decision-making. Full privatization is a key feature of the state reducing its role in the economy. China, however, has stubbornly followed its own, different path to economic development, with both full and partial privatization being a feature. Given China's status as a role model, it is well worth reflecting on its privatization program.

China's privatization program originally formed part of the authorities' decentralization initiatives in the 1980s. It was a key component of a broader corporatization agenda that required the nation's State-owned enterprises to establish more Western-style governance structures that included shareholders, CEO positions and boards of directors. Under the popular slogan "retain the large, release the small", many State-owned enterprises (SOEs) were converted in an attempt to turn them into profitable businesses.

Partial privatization was allowed from 1993. This involved selling a minority stake in SOEs to private individuals, although the sale of a majority controlling stake to private investors was prohibited on ideological grounds.

Calls for restructuring grew as non-performing loans accumulated, and the pressure was magnified by the 1997 Southeast Asian financial crisis, which exposed the unwillingness of State-owned banks to impose budget constraints on SOEs. The central government was further spurred into action by its desire to join the World Trade Organization.

The corporate restructuring of SOEs was a key part of Premier Zhu Rongji's three-year program, beginning in 1998, to transform the fortunes of some of the country's largest enterprises. This shift towards the corporatization and privatization of SOEs provided clear incentives for managers to improve the performance of their companies.

Advocates of full privatization for China's SOEs argue that they are less efficient than private firms for two reasons. First, the "political view" contends that the state promotes social and political objectives that enter into direct conflict with the objective of maximizing profits. Second, the "managerial view" emphasises the absence of any effective incentives that would drive SOE managers to seek the greatest possible profits. Both views claim aggregate welfare would be maximized if ownership and control rights in SOEs are privatized and firms' decision processes are wholly depoliticized.

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