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The Hidden Losses of SOEs
Summary:Corruption cases like those unfolding at CNPC lead to great losses of state-owned assets, but the very structure of these SOEs create far greater losses.


By the EO Editorial Board

Issue 636, Sept 9, 2013
News, page 1
Translated by Zhu Na
Original article:

The corruption scandal at China National Petroleum Corporation (CNPC) continues to unfold. 

Recently, Jiang Jiemin (蒋洁敏), the former director of The State-owned Assets Supervision and Administration Commission (SASAC) and former chairman of CNPC, was placed under investigation for corruption. He marks the fifth senior CNPC official to fall in the last few weeks. 

We still don’t know how much was lost because of these corruption cases, but CNPC is a central state-owned enterprise holding trillions of yuan in state-owned assets. After the corruption probe was revealed, the company’s market value fell by up to ten billion yuan.

This case has once again underscored how state-owned assets can easily be stripped away through “transactional losses.”  This refers to when state assets are sold on the cheap rather than at a fair price, either through incompetence or corruption.

But there’s another way that state-owned assets are stripped away that causes much bigger losses, but receives much less attention. Scholars call this "systematic loss" (体制性流失), referring to assets being poorly managed because of the overall system. This includes reasons like poor accountability, perverse incentives and a lack of competition.

Systematic loss isn’t new. During the massive restructuring of state-owned enterprises more than a decade ago, there was much discussion about how to balance the two kinds of loss. Transactional loss could be addressed through better supervision mechanisms, but it’s difficult to avoid systematic loss if the entire system isn’t changed.

Today, transactional loss resulting from rent-seeking and black-box operations is more likely to raise concerns, but systematic loss seems to have fallen off the radar.

After the large-scale restructuring, the Board of Directors system started to gradually be piloted. SASAC established an assessment system with a comprehensive index for centrally-administrated state-owned enterprises (COEs), and over the past decade, state-owned assets have increased more than ten-fold. Our question is, is there still systematic loss of state-owned assets happening?

We believe the answer is yes. On one hand, state-owned enterprises achieved outstanding performance in recent years by seizing the opportunities from China's rapid economic growth. But the pace of reform has slowed and the space for systematic loss never disappeared. Today's state-owned enterprises, especially COEs, are much larger than in the past. Because of their enormous weight in the Chinese economy, any slight move can cause enormous ripples. In the future, the cost of preventing systematic loss will continue to increase.

This is not a deliberate exaggeration meant to scare people. Take the example of COEs investing overseas. In 2005, China National Offshore Oil Corp’s acquisition of Unocal Corporation failed. In 2009, Aluminum Corp. of China’s acquisition of Rio Tinto failed. Then in 2012, China Railway Construction Corp. lost 1.39 billion yuan on a light rail project in Saudi Arabia. Steel giant Shougang lost 10 billion yuan its Caofeidian mill project. And China Metallurgical Group Corporation (MCC)’s 2012 consolidated financial statements showed that 68 of its subsidiaries were operating at a loss.

Many COEs have blindly chased dreams of becoming larger and stronger by overzealously seeking acquisitions that ended up creating enormous losses. But it was never explained to us who exactly footed the bill for these huge losses caused by bad COE decisions. 

Jing Tianliang (经天亮), chairman of MCC said in an internal meeting that his company’s losses were caused by blind mergers and acquisitions, bad decisions and poor management.  By contrast, many COE officials choose to just blame the losses on the country’s economic downturn.

But systematic loss can’t simply be accounted for by macroeconomic factors. The assets of COEs together total over 30 trillion yuan. According to a conservative estimate by a source from SASAC, the inefficiently used assetsheld by these COEs account for about 1 percent of that, or at least 300 billion yuan.

These funds have gone to waste for years, yielding less than the interest on a bank deposit. Production equipment that some COEs have spent big on has been sitting idle and generating no economic output whatsoever. But these kinds of losses are difficult to discover and quantify. And unlike corruption and other transactional losses, it’s hard to figure out who’s to blame.

In a private company, the risk of bankruptcy would prevent much of these overly-risky projects from getting past the drawing board. But COE officials know their companies won’t go out of business. In one way or another, the losses will be covered – often by taxpayers.

For years people have been calling for the separation of government from enterprises. But this still hasn’t been achieved and it will be difficult to introduce a standardized version of board governance across the SOE sector. This leaves a lot of space for systematic loss.

SOEs’ multiple responsibilities have also made it difficult to self-manage in the same manner as private companies. Some strategic decisions are made according to business logic and others according to administrative logic, that is to say, some take economics into account whereas others are made according to political calculation.

But how can one define which is which? And how do we measure what’s a normal operating loss and what’s a systematic loss of state assets?

Reform of SOEs has been stagnant.  In addition to separating government from business, we also need diversification of equity among competitive enterprises. Recently, SASAC encouraged COEs to actively seek all kinds of social capital, optimize the structure of property rights and accelerate equity diversification. This is a positive signal, and will also be a big test for the new head of SASAC.


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