2019 Position Paper

In October 2019, China marked the 70^th anniversary of the founding of the People’s Republic of China. Undoubtedly, the scale of the celebrations was intended to be commensurate with the country’s impressive development over the last seven decades, and the accomplishments of the last four in particular. Meanwhile, another significant anniversary from much further back in China’s history is likely to slip by mostly unobserved: 2,100 years ago, the course of the Western Han Dynasty was set when China’s brightest minds were called upon to debate key aspects of the economic system of the time.

The ensuing ‘Discourses on Salt and Iron’ boiled down to two different factions arguing over the state’s involvement in the economy. One side demanded the state remove itself from the market and end its monopolies on salt and iron production and distribution, while the other defended the importance of holding on to these industrial commanding heights.

Little has changed in the intervening 21 centuries.

China’s salt monopoly, which once employed a 25,000-strong salt police force to enforce its dominance, only saw the initial stages of liberalisation just two years ago. The steel industry, with a slow influx of private players taking up market share, is perhaps more advanced; but while China has six of the world’s ten largest steel producers by volume, only two are privately owned, and they only occupy the sixth and ninth rankings. The contemporary discourse also encompasses a wide variety of sectors in addition to iron and salt, but the core characteristic remains unchanged; which is, as one debater put it in 81 BC, “the state competes with the people”.

This situation has been exacerbated by the profound changes that have taken place in recent years, with the government pursuing SOE reform with Chinese characteristics. Rather than cutting SOEs down to a manageable size—determining the industries that would be most appropriate for them to operate in and privatising the rest—the goal has been to make them “stronger, better and bigger”.

This has resulted in a truly resurgent state-owned economy, with SOEs impacting sectors far beyond those in which they have major presence. Financing flows to private firms have dried up, from 57 per cent of all non-financial corporate loans in 2013, to a measly 11 per cent in 2016. This comes at the same time that Chinese SOEs have seized a much greater share of funding, jumping from 35 per cent to 80 per cent in the same timeframe.

The screws have also been tightened on the private sector with SOEs imposing abnormally long payment periods in their agreements, which act as de facto loans from suppliers. This has unfairly impacted a great many European firms directly, but far more have suffered indirect effects, such as when their local partners have struggled to make ends meet as a result, leading to disruptions to both upstream supplies and downstream demand.

The benefits that many SOEs currently enjoy from their vertical monopoly position comes at the expense of sound market competition. This happens for example in the energy sector, where some of the same firms that produce energy also own the grid – a huge, unfair advantage over private energy companies, which must pay competitors to deliver their product to customers.

Conflicts of interest also occur, with SOE executives and regulators frequently switching hats over time, which adds another layer of unfairness for private companies to overcome. For example, the high thresholds that have been set for obtaining various operating licences in the financial services sector have seriously restricted the meaningful participation of international finance companies in the markets they have only recently been allowed to enter.

From all this, it could be assumed that China’s current leadership has simply arrived at the same conclusions that the Western Han Dynasty came to 21 centuries ago. Fortunately, this is not the case: a robust debate is underway in Beijing, with different voices throughout the government periodically spilling out into the public forum.

‘Competitive neutrality’, the principle that the government should provide equal treatment to all enterprises, regardless of ownership, has been on the lips of some of China’s most important economic policymakers in recent months. Former and current People’s Bank of China governors Zhou Xiaochuan and Yi Gang both spoke on the concept in late 2018, followed by the new and powerful State Administration for Market Regulation, the State Council and even Premier Li Keqiang in his 2019 Work Report.

Competitive neutrality would put an end to China’s ‘economic caste system’, whereby it differentiates and favours state-owned over private first and foremost, and then local over foreign. The greatest benefit of abandoning such a system, and developing strong institutions to provide recourse when enterprises encounter unequal treatment, would be the resulting surge of confidence in China’s market and the accompanying boost in investment.

Realising competitive neutrality and embarking on true SOE reform is key to achieving a variety of goals: ushering in a true market economy, making the most of China’s entrepreneurial potential and accelerating development. This would be an enormously positive next step for China’s reform agenda, while bringing a decisive end to a debate that has been rumbling on for 2,100 years.