The Reality of China’s State-Owned and Privately Owned Enterprises

Company logo at the Huawei
Company logo at the Huawei office in Beijing, Dec. 6, 2018.
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By Sebastian Lee

China’s economy is never absent in financial media coverage over the past decade, when it was growing at an astonishing speed. Not even the 2008 financial crisis was able to slow it down. Now, confronted by the US trade war, China is facing enormous headwinds to continue furthering its success story.

Among all aspects in China’s economy, the struggle between State-Owned Enterprise (SOE) and Privately Owned Enterprise (POE) and their roles in China’s ambition to spread its influence abroad are rarely reported. POEs are often viewed as inferior as compared to SOEs in securing the Chinese authority’s policy and financial support. However, the arrest of Huawei’s CFO Meng Wanzhou and the criminal cases claimed by the US Department of Justice have revealed tactics the Chinese Communist Party (CCP) is using to challenge the new world order. Many have become keen to take a fresh look at the mechanism behind China’s SOEs and POEs.

Ownership Matters

The level of hardship in a company’s journey to success has everything to do with its type of ownership in China. SOEs can easily gain excessive power in resource allocation, financial support, favourable policies and, when facing threats, suppressing opponents. As a result, left with little breathing room, POEs can only survive in areas where SOEs have not laid their hands on or don’t bother to enter due to lack of scale.

There is a classic example in China’s oil and gas industry where almost the entire value chain is in the grip of top SOEs: China National Petroleum Corporation (CNPC) and China Petrochemical Corporation (Sinopec). They are so big that even investors from the same industry hardly know the existence of their POE peers.

Source:https://en.wikipedia.org/wiki/Fortune_Global_500

Speaking of state control, POEs have long been restricted from directly importing crude oil. In order to utilise refining facilities to produce refined oil products like gasoline and diesel for the domestic market, they have to purchase crude oil with marked-up prices from the SOEs who are designated importers with licences granted by the government.

The Chinese government shows no effort to hide the fact that SOEs monopolise all the lucrative industries and hold all key parts of supply chains wherever it sees fit. Government ownership offers absolute power over how business should be run and who should be included in the beneficial groups. It is then not difficult to imagine the challenges POEs have been facing just to survive.

Well, from the surface of the struggle, it seems like the CCP just want SOEs to generate more money than POEs because the profit of SOEs goes to the CCP. To do so, they just have to be in control. But, upon deeper thought, one may recall a fundamental pillar of communist ideology that never intends to share its prosperity with POEs.

Predetermined Fate of POEs

During 1966-1976, the Culture Revolution (a political campaign initiated by Mao Zedong to eliminate political opponents and Chinese traditional culture to reinforce communism ideology) cost China the golden chance to grow its economy in the post-war period like what Japan did. At the end of the 1970s, the state economy could not satisfy the Chinese people’s demand to feed their families and grow their wealth. It had no choice but to allow the emergence of privately-owned businesses that were once banned during the Cultural Revolution. At one time, small and medium establishments sprung up across China. People were embracing the dream opportunity to return to normal life and connect with the outside world.

Unwilling to loosen its grip, the CCP continues to plant the idea that one-party rule is the best choice for Chinese people. However, after four decades of the so-called “Economic Reform and Open-Up”, which has led to accumulation of private assets, one tends to forget that “Abolition of Private Property” sits in the core of Communist Manifesto. In 2018, China’s state media started to re-advocate ideas of exterminating private property:

 

“China will continue to implement policies to retain state-owned business’ prominent status while encouraging POEs to grow to a certain scale… But the communist should never forget the ultimate goal of Abolition of Private Property.”

~ Qiushi (a periodical published by CCP’s party school), 30 June 2018

 

“The leapfrog development of POEs at this stage is to meet the Chinese people’s demand for better lives… Communism’s ultimate goal is Abolition of Private Property.”

~ Hu Xijin, Global Times, 13 September 2018

The words of the CCP’s prominent mouthpiece sound absolutely absurd to the outside world. Yet the communists never attempt to hide their goal to harvest POEs after they become valuable or demolish them when they turn out to be threats to the SOEs.

Take the oil and gas industry again as an example. In 2015, China granted crude oil import licences to independent privately owned ‘teapot refiners’ (a name used to describe their small size as opposed to SOEs) to showcase its encouragement of domestic competition. Then it realised it had opened a floodgate. According to Reuters, because of the teapots’ strong buying spree, China’s import of crude oil surged from 1.2 million barrels per day (bpd) in 2016 to 2 million bqd by 2018. It accounts for almost a fifth of China’s total crude oil import.

The teapots wasted no time to establish offices in Hong Kong and Singapore, and spread investment in infrastructure to sustain long-term growth potentials. Hengyuan Petrochemical in Shandong Province even purchased Royal Dutch Shell’s 51 percent shares in a refinery in Malaysia. It is a rare acquisition completed by a Chinese company of this kind.

The situation did not escape the state’s radar. POEs’ successes are considered as corroding the market share of SOEs and disrupting the ‘harmonious business environment’. Mounting complaints swamped China’s industry bureau. In 2018, a new consumption tax was introduced to some refined oil products in response to “alleged use of illicit invoice by teapot refiners to evade the taxes” (Reuters). The net income of the teapots fell off the cliff. On the other side of the coin, their state rivals, namely Petrochina and Sinopec, recorded their highest profits in the last three to four years.

Exceptions: Wolves Among Sheep

Academic studies and media coverage on China’s economy generally perceive POEs’ inferiority to SOEs as a given fact. After all, it is China where the state dictates beneficiaries in each industry. However, few have analysed in detail the contradictory emergence of some very successful POEs: Huawei, Alibaba, Tencent, Baidu. International media tend to show them as a result of the Chinese government’s tolerance of national champions. Their success is considered to be partly attributed to their iconic leader — an indispensable element to successful enterprises like the late Steve Jobs in Apple.

After the arrest of Huawei’s CFO, however, the public has begun to understand the true logic behind the successful path of POEs even when they stand in the core of China’s most sensitive industries.

According to Sina, a Chinese news portal, Huawei received $10 billion in loans from China Development Bank (CDB) in the early 2000s. China’s state media Xinhua also reported that CDB signed a strategic cooperation agreement with Huawei. A banker familiar with financial industries The Epoch Times spoke to commented that China Export & Credit Insurance corporation (Sinosure) often offers exclusively preferential credit insurance terms to facilitate Huawei’s bids to telecom equipment sales contracts.

This appears contrary to the popular belief of POEs’ born inferiority. Why Huawei? In December 2018, The Epoch Times’ exclusive report concluded that Huawei plays a key role in identified core technologies including satellite GPS, internet infrastructure, and semiconductors. If you peel back the disguise of its POE status, Huawei was founded by a former People’s Liberation Army officer and aided by state financial institutions, with its rapid business growth partly supported by government contracts, including those abusing human rights and domestic surveillance. A 172-page internal document from Huawei in 2015, which was leaked to the internet, revealed a training manual for Chinese internet police to monitor, analyse, and process video contents. It also showed Huawei’s involvement with the CCP’s Golden Shield Project for censorship and the Skynet system for surveillance.

It is then not difficult to explain Huawei’s mysterious path in becoming the world’s largest telecommunications equipment supplier in terms of its annual turnover. POEs who are dying to secure bank loans and can barely live under CCP’s mercy can only envy Huawei’s money piles.

10-telecom-equipment-companies-revenue
Source:https://www.statista.com/statistics/314657/top-10-telecom-equipment-companies-revenue/

The distorted business phenomenon in China unfortunately leads to an understanding among POEs: the quickest way to success, or the most basic way to survive, is toeing the CCP line.

The CEO of Baidu, China’s dominant search engine, admitted that censorship is a reality in China. Google was driven out of China’s market because it refused to plant censorship in its search engine. With no competition, Baidu seized ninety-nine percent of the search market and helped make China “the biggest prison for netizens”, according to Paris-based Reporters without Borders.

In 2018, South China Morning Post reported that Baidu has stepped up its efforts to police online content deemed sensitive by China authorities by applying its cutting-edge AI technology for its autonomous driving cars. Censorship, a tool to play nice with CPP, can only escalate.

Jack Ma, the founder of Alibaba group, once said “be in love with them (Chinese government), but don’t marry them”, to describe Alibaba’s relationship with Chinese authority. In 2015, Alibaba made a very “un-Alibaba” move to buy a Hong Kong independent newspaper, South China Morning Post. It is widely perceived by the public as a means of showing loyalty to CCP, which needs an influential international media to promote China’s soft power. In November 2018, China’s state-run People’s Daily revealed Jack Ma’s identity as a CCP member. It attracted mounting concerns among investors on CCP’s role in Alibaba’s business. In February 2019, Reuters reported that Alibaba is behind the development of a CCP propaganda app, Xuexi Qiangguo, which became a huge hit in China. The app is a play on the government propaganda theme of applying President Xi Jinping’s thoughts.

All these events do not follow the characteristics of an independent POE that claims no government control. Why does Alibaba need to play along? Notwithstanding Alibaba’s large share volumes traded in the US and its marvellously built super payment app that the Chinese cannot live without, the Chinese authority holds the ultimate right to determine the fate of any POE. Like it or not, whether you are allowed to flirt with the government or get married is never the company’s call.

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