Shareholding System Reform in China

Shareholding SystemReform in ChinaPrivatizing by Groping for Stones

Shu-Yun MaProfessor, The Chinese University of Hong Kong

Edward ElgarCheltenham, UK • Northampton, MA, USA

© Shu-Yun Ma 2010

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02

Contents

Acknowledgments vi

1. Introduction 12. Shareholding system reform as the Chinese way of privatization 73. Evolution of the shareholding system reform 254. The role of spontaneity and state initiative in the shareholding

system reform 425. Foreign participation in China’s privatization and the role of

the state 616. China’s privatization through listing state enterprises in

Hong Kong 927. Completing privatization through ‘share conversion’ 1248. Conclusion: privatizing through groping for stones 134

References 140Index 161

v

vi

Acknowledgments

Earlier versions of parts of this book appeared in the following journal articlesby this author. I am grateful to these publications for permission to reprint thematerials here, and am indebted to Edmund Cheng Wai for his editorial assis-tance in integrating these separate articles into the present book.

‘Shareholding system reform: the Chinese way of privatization’, CommunistEconomies & Economic Transformation, Vol. 7, No. 2 (June 1995), pp.159–74.‘Foreign participation in China’s privatization’, Communist Economies &Economic Transformation, Vol. 8, No. 4 (December 1996), pp. 529–47.‘The Chinese route to privatization: the evolution of the shareholding systemoption’, Asian Survey, Vol. 38, No. 4 (April 1998), pp. 379–97.‘The role of spontaneity and state initiative in China’s shareholding systemreform’, Communist and Post-Communist Studies, Vol. 32, No. 3 (September1999), pp. 319–37.‘The state, foreign capital and privatization in China’, Journal of CommunistStudies and Transition Politics, Vol. 15, No. 3 (September 1999), pp. 54–79.‘Role of the state in Chinese enterprises listed in Hong Kong’, Pacific Review,Vol. 15, No. 2 (2002), pp. 279–98.‘Listing Chinese enterprises in Hong Kong and China’s intergovernmentalfiscal relations’, Problems of Post-Communism, Vol. 50, No. 6 (November–December 2003), pp. 28–37.‘China’s privatization: from gradualism to shock therapy?’, Asian Survey, Vol.48, No. 2 (March/April 2008), pp. 199–214.

1. Introduction

Throughout human history, private and public ownerships have been coexist-ing over time and across societies, giving rise to different forms of economicsystems. Capitalism emerged on the basis of private ownership. But the GreatDepression and the devastation of the two world wars called for massivegovernment intervention, resulting in large-scale nationalization in post-warBritain. The pendulum began to swing back in the 1980s, when MargaretThatcher’s conservative government launched a series of privatizationprogrammes (Megginson and Netter, 2003). This was followed by a world-wide wave of transfers of assets from the state to private hands. According toWorld Bank statistics, from 1989 to 2007 governments in the world receivedabout US$733 billion through privatization (Table 1.1). This book is about thecase of China in this process.

Initially, most of the privatization activities took place in developed OECDcountries (OECD, 2001, p. 43). This was followed by post-communist transi-tion economies in Eastern Europe and Central Asia, which emerged as a majorgroup of participants in the worldwide privatization trend. During the 1990s,proceeds from privatizations in these countries accounted for about 20 per centof world total. In comparison, China’s share during this period was only about7 per cent. However, China began to pick up in the early 2000s, and has sinceemerged as one of the largest privatizing countries. From 2000 to 2007, Chinaalone accounted for over 38 per cent of the world’s proceeds from privatiza-tions (Table 1.1).

The above seems to suggest that privatization is an economic prescriptionbased on intensive researches by experts and scholars, exported from devel-oped countries first to post-communist transition economies in Eastern Europeand Central Asia, and subsequently to China as a result of proven powerful-ness of privatization as an impetus of economic growth. This, however, is anillusion. The fact is that economic theorists have never reached any consensusabout the desirability of privatization. Both private and public ownerships arefound to have theoretical advantages and disadvantages, and there are manytrade-offs between the two kinds of ownership. That is to say, even at puretheoretical level, privatization has not been proved as a panacea (Roland,2008).

1

2

Table 1.1 Proceeds from privatizationa

Transition economies in China World TotalE. Europe and C. Asiab

US$ Annual Share US$ Annual Share US$ Annual billion change in world billion change in world billion change

(%) total (%) (%) total (%) (%)

1989 0.47 N.A. 13 N.A. N.A. N.A. 3.63 N.A.1990 0.83 76 7 N.A. N.A. N.A. 12.66 2491991 1.97 139 8 0.01 N.A. 0 23.86 881992 2.85 44 11 1.26 11 479 5 26.18 101993 3.78 33 16 2.85 126 12 23.66 –101994 3.95 4 18 2.23 –22 10 21.71 –81995 9.41 138 43 0.65 –71 3 21.90 11996 5.45 –42 21 0.92 42 4 25.36 161997 16.79 208 25 9.12 893 14 66.57 1621998 7.79 –54 16 0.61 –93 1 50.16 –251999 11.17 43 26 2.95 382 7 42.35 –162000 9.65 –14 25 10.28 249 26 39.04 –82001 7.07 –27 43 0.96 –91 6 16.31 –582002 9.59 36 62 1.60 67 10 15.56 –52003 7.02 –27 36 6.07 279 31 19.61 262004 13.71 95 41 4.12 –32 12 33.58 712005 15.63 14 29 14.09 242 27 53.06 58

3

2006 27.43 75 26 50.36 257 48 104.88 982007 36.60 33 28 71.54 42 54 132.64 261990–1999 63.99 N.A. 20 20.60 N.A. 7 314.41 N.A.2000–2007 126.70 N.A. 31 159.02 N.A. 38 414.68 N.A.1989–2007 191.14 N.A. 26 179.60 N.A. 25 732.69 N.A.

Notes:a Proceeds from privatization are defined as ‘all monetary receipts to the government resulting from transactions involving partial and full divestitures,concessions, and releases. Thus, only those transactions that generated revenue for the government from privatization or private sector participation in an exist-ing state-owned enterprise and other government assets are included.’b Data for 1988–99 cover the following countries: Albania, Armenia, Azerbaijan, Belarus, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Kazakhstan,Kyrgyz Republic, Latvia, Lithuania, Macedonia, Moldova, Montenegro, Poland, Romania, Russian Federation, Serbia, Slovakia, Slovenia, Ukraine, andUzbekistan. Data for 2000–2007 cover all the above countries, plus Bosnia, Georgia, Herzegovina, and Tajikistan. Moreover, pre-2000 data were collected onan ‘announcement’ basis, whereas data from 2000 on reflect actual flows of receipts. The two sets of data are thus not entirely compatible.

Source: World Bank Privatization Database (http://rru.worldbank.org/privatization).

Major arguments in favour of privatization include relief of the state’sfinancial and administrative burdens; enhancement of economic efficiencyand productivity; stimulation of private entrepreneurship; and reduction ofthe public sector, which tends to be monopolistic and bureaucratic. Thesearguments, however, have been challenged on the grounds that efficiency ofthe public sector can be improved through greater public accountability andtransparency; only profitable activities are privatizable; loss of stableincome of the state from profitable public sector activities; adverse impactson public sector employees, lower-income consumers, and social welfarerecipients; and finally high costs of monitoring privatized enterprises. Apartfrom such lack of theoretical consensus, empirical results of privatizations inboth developed and developing countries are also mixed. As ideologicalfaith in privatization declines, even advocates of privatization have to admitthat for the strategy to work, sequencing and preconditions of reform arealso important (Jomo, 2008; Parker and Saal, 2003).

As mentioned, since the early 2000s China has emerged as one of thelargest privatizing countries in the world. However, there is no indicationthat China was theoretically informed to join the above worldwide privati-zation trend. China did engage in ideological discussion about privatization;but the debate was more about the socialist-legitimacy of privatization,rather than the liberal-economic rationale of the reform. What this bookintends to argue is that China’s privatization is not based on any grand blue-print; rather, it is privatization by ‘groping for stones to cross the river’, awell-known metaphor often attributed to Deng Xiaoping, meaning that thereform simply proceeds on a trial-and-error basis, without being guided byany theory. That is to say, though China’s privatization is consistent with theabove-mentioned worldwide trend, that general theoretical context does notseem to be directly relevant to the Chinese case.

As indicated in Table 1.2, immediately after the Chinese economic reformwas launched in 1978, the Chinese economy began to show robust growth.However, according to World Bank statistics, Chinese privatization did notstart until 1991 (Table 1.1). Some analysts thus took the Chinese case asshowing that economic success could be achieved through restructuring ofstate enterprises, and that privatization is not necessary (Megginson andNetter, 2001, p. 338). This might be true as far as privatization in the narrowsense – divestiture of existing state enterprises – is concerned. However, ifproper attention is paid also to privatization in the broad sense – whichincludes also development of greenfield private enterprises that is notcovered in the World Bank data – the Chinese case shows that ‘privatizationis absolutely necessary to achieve sustained intensive growth’ (Chai, 2003,p. 256).

The above notwithstanding, this book will focus on China’s privatization

4 Shareholding system reform in China

in the narrow sense. More specifically, it is about the shareholding systemreform, which provides a channel for the transfer of state assets to privatehands. We do not intend to examine the effect of this change; rather, ourconcern is how this reform has evolved, without any pre-existing plan, froma spontaneous local attempt into a nationwide reform programme. That is tosay, it is about the emergence of a privatization programme through ‘grop-ing for stones to cross the river’.

This book is based on a collection of updated versions of previouslypublished articles. Chapter 2 identifies the shareholding system reform asthe Chinese way of privatization, in a political and ideological context inwhich the term privatization had to be avoided. Chapter 3 traces the evolu-tion of the shareholding system reform, from the early spontaneous attemptin the early 1980s, to the official endorsement of it as the mainstream reformprogramme in 1997. Chapter 4 examines the role of spontaneity and stateinitiative in the shareholding system reform, based on three case studies inFoshan, where China’s first industrial shareholding enterprise appeared.Chapter 5 analyses foreign participation in the shareholding system reform,and the role of the state in this process. Chapter 6 discusses how China’sshareholding system reform has been facilitated by Hong Kong as an impor-tant venue for the listing of Chinese state enterprises. Chapter 7 tracesfurther the evolution of the shareholding system reform from 1997 to the

Introduction 5

Table 1.2 China’s real GDP growth (%)

1979 7.6 1994 13.11980 7.8 1995 10.91981 5.3 1996 10.01982 9.0 1997 9.31983 10.9 1998 7.81984 15.2 1999 7.61985 13.5 2000 8.41986 8.9 2001 8.31987 11.6 2002 9.11988 11.3 2003 10.01989 4.1 2004 10.11990 3.8 2005 10.41991 9.2 2006 11.71992 14.2 2007 13.01993 13.9 2008 9.0

Source: China Data Online (http://chinadataonline.org).

completion of the reform through the ‘share conversion’ programme in2005–2006. Finally, Chapter 8 concludes by arguing that the shareholdingsystem reform is consistently gradualist, and the entire process can be char-acterized as ‘privatizing by groping for stepping stones to cross the river’.


2. Shareholding system reform as theChinese way of privatization

In the early 1990s, almost immediately following the collapse of socialistregimes in Central and Eastern Europe, privatization became one of the mostimportant themes of post-communist transformation in this area. It is arguedthat restoration of a private sector is the only way through which theeconomies can be revitalized and political freedom guaranteed. While thenecessity of the change has been widely acknowledged, there have beenintense debates on what is the optimal speed and method of privatization,resulting in a mushrooming literature on the subject.1

Apparently, the issue of privatization is not as hot in China as in the formerSoviet bloc countries. While privatization laws have been passed in a numberof Central and East European economies, no similar legislation has been intro-duced in China (Chai, 1994, p. 237). Although the post-Mao reform hadresulted in significant changes in China’s economic system, in the early 1990sthe ideological supremacy of public ownership still remained. However, as amatter of fact, as early as the mid-1980s China had already launched trialprivatization measures, under the camouflage of ‘shareholding economicreform’. The experiment was interrupted by political conservatism followingthe summer 1989 Tiananmen demonstrations. Yet the shareholding system notonly survived but became so popular that a large number of Chinese stateenterprises were lining up to convert into shareholding companies. This waveof reform has hastened the shrinking of the state sector in the economy. Mostimportantly, it represented the Chinese path to privatization.

In this chapter, we will argue that China’s shareholding economic reform istantamount to privatization, although the latter term is avoided for politicaland ideological reasons. The change is a continuation of a process that couldbe traced to the mid-1980s. Yet it does involve a radical departure from earlierreform measures, which touched mainly on issues of management and incomedistribution but not ownership of state enterprises. Initially, the shareholdingexperiment was introduced gradually and from above. After 1993, however,the process rapidly accelerated, with widespread spontaneous initiatives frombelow. These breakthroughs made most Western studies on China’s enterprisereform of that time outdated.

7

SCOPE OF DISCUSSION

Bornstein defined privatization as follows:

In the broadest sense, ‘privatization’ could embrace any increase in private activity,including the creation of brand new (‘start-up’) private enterprises, without anyreduction in activity of state enterprises. A narrow, but probably most common,definition of privatization involves the transfer of ownership of state assets toprivate hands. (Bornstein, 1994a, p. 234)

In China, privatization in the broad sense as defined above began in thelate 1970s. After almost three decades of suppression of private economicactivities, the watershed Third Plenum of the Eleventh Central Committeeof the Chinese Communist Party, held in December 1978, allowed farmersto produce on their small private plots. Capturing this opportunity, anumber of ‘youths awaiting job assignment’ and ‘idle people’ began toestablish their own new businesses. This was followed by a flow of work-ers from the state to the private sector, as the latter offered the possibilityof higher income and greater freedom. Sources of capital for private firmsalso expanded, as personal savings soared and more state loans were madeavailable to individual investors. By the end of 2006, there were about150 000 private enterprises in China, with a total asset of 405 billion yuan(representing 14 per cent of the national total) (ZJN, 2007). The rapidexpansion of this private sector economy, consisting mainly of new busi-nesses, has attracted the attention of a number of Western scholars, includ-ing Ole Bruun (1993), Ross Garnaut and Ligang Song (eds) (2004), ThomasGold (1989a, 1989b, 1990, 1991), Willy Kraus (1987, 1991), Barbara Krug(ed.) (2004), Ole Odgaard (1990, 1990/91, 1992), Susan Young (1989,1995), and David Zweig (1988).

The focus of this book, however, is on China’s privatization in thenarrow sense: transfer of ownership of state assets to private hands. Unlessstated otherwise, the term ‘privatization’ will be used with this meaning.More specifically, we will concentrate on the shareholding system as theChinese way of privatizing state enterprises. This experiment began in themid-1980s, several years later than the appearance of new private busi-nesses.2 The downfall of Zhao Ziyang and other reformist leaders in thewake of the 1989 political turmoil forced the shareholding experiment toadopt a low profile. After 1993 the process regained momentum. Yet notmuch about this reform was known in the English-speaking world forseveral years.


SHAREHOLDING SYSTEM REFORM: THE CHINESE WAYOF PRIVATIZATION

According to a vice-president of Bank of China, in 1986–87 some Chineseeconomists and World Bank consultants proposed privatization of Chinesestate enterprises through an equal distribution of vouchers among the generalpublic, a ‘shock therapy’ privatization method subsequently used by some EastEuropean countries. The suggestion was rejected in favour of a ‘minimumreform package’ without privatization, as this moderate approach was consid-ered economically and politically less risky (Zhou, 1993).3

In the early 1990s, ‘privatization’ (siyouhau) was still politically taboo inChina, as the term implies going capitalist and weakening state control.However, Chinese reformers have always been very clever in overcoming thiskind of ideological obstacle by playing semantic games. For example, theadoption of a capitalist mode of distributing goods and services is oftenreferred to as ‘marketization’ (sichanghua) or ‘commodification’ (shangpin-hua); and the withdrawal of the state from welfare services is called ‘social-ization’ (shehuihau) (Wong, 1994, pp. 311, 323–24). In enterprise reform, thecover for privatization is ‘shareholding economic reform’ (gufen jingjigaige).4

The Chinese shareholding system emerged in the mid-1980s, in response tothe failure of other efforts to improve the economic efficiency of state enter-prises. From 1981 to 1983, the government introduced different versions ofprofit contract system among state enterprises, as an attempt to translate thesuccessful agricultural household responsibility scheme to the industrialsector. However, enterprises responded by bargaining for a larger share ofprofits, while leaving losses to the state. The resulting plunge in state budgetrevenue caused the government to substitute income taxes for remission ofprofits. The tax-for-profit system lasted only from 1983 to 1985, as the changesimply switched the object of bargaining from profit retention ratios to taxrates. In 1986 the government decided to return to the profit contract system(Chen Youngzhong, 1991, pp. 290–92; Lee K. and Mark, 1991, p. 157; Lee K.,1993b, p. 181).

Both the profit contract system and the tax-for-profit scheme sought toimprove economic efficiency by granting greater income rights to enterprises,while ownership remained in the hands of the state. Under such a propertyrights arrangement, the primary objective of enterprise managers and workershas been to maximize sales revenue and their say in income distribution, withlittle concern for cost and profit. The result was rising losses, despite growingproduction. As Table 2.1 shows, from 1980 to 1992 gross output of Chinesestate enterprises increased by less than five times, but losses soared overtenfold.

The Chinese way of privatization 9

It is against this background that China launched the shareholding exper-iment, through which enterprises and individuals are allowed to share withthe state not only profits, but also ownership of enterprise assets. Again, theidea was borrowed from the rural sector. Early in 1979, the central govern-ment allowed communes and brigades to form joint-stock enterprises. In1983 an official document stated that, in cooperative economic production,capital and labour were both legitimate bases for distributing returns. Thisgave rise to a number of joint-stock township and village enterprises. In April1984, in a seminar held by the State Commission for Restructuring theEconomy, a proposal was made to allow workers to invest capital in collec-tive and small state-owned enterprises, and to receive dividends. In July thatyear the first shareholding company, the Beijing Tianqiao Department StoreCompany, was established. In October 1984, with the economic reform shift-ing its focus from the rural to the urban sector, the shareholding experimentwas extended to medium and large state enterprises (Chen Youngzhong,1991, pp. 316–18).

As could be expected, the shareholding system caused serious ideological,political, economic and legal debates in China.5 According to advocates of theshareholding reform, the new system serves many functions. These includepooling investment funds, promoting economic integration, reducing enter-prises’ myopic behaviour, nurturing management professionals, increasingcapital mobility, alleviating inflationary pressure, and enhancing productionincentives (Chen Youngzhong, 1991, pp. 68–79). Despite these advantages,the state was very cautious about the potential challenge that the shareholdingsystem might create for the state sector. It thus set several limits to the change.First, the state or its agents (enterprises) should hold the majority of the shares.Second, there should be no expropriation of the state assets. Third, govern-ment approval had to be obtained before conversion of state enterprises intoshareholding companies. Fourth, some industries (defence, scarce metal andmineral resources, banks, foreign trade corporations and other state-controlledmonopolies) were not allowed to adopt the shareholding system (Yang, 1993,pp. 194–95).


Table 2.1 Output and losses of Chinese state enterprise

1980 1992 Change(109 yuan)

Gross output value 391.6 1782.4 4.6 timesLosses 3.4 36.9 10.9 times

Source: ZTN, 1993, pp. 412 and 430.

The political factor was influential in the fate of China’s shareholdingreform. In December 1986, the reformist leader Zhao Ziyang, without gainingsupport from the conservatives, ordered the introduction of the shareholdingsystem in some enterprises in a number of larger cities, including Shanghai,Beijing, Wuhan, Shenyang and Chongqing (Shirk, 1993, p. 310). In October1987, addressing delegates at the 13th Party Congress, Zhao said that, sinceChina was still at an ‘initial stage of socialism’, the dominant public sectorshould be supplemented by other forms of ownership as well. Specifically, theshareholding system was recognized as ‘a form of organizing assets of social-ist enterprises’, and hence the experiment ‘could continue’. Distribution ofdividends to shareholders, ‘as long as it is legal, should be allowed’ (ZBN,1988, pp. 98–99). With such high-level support, the shareholding scheme waspromoted extensively. By 1988 some 3800 enterprises had adopted the newsystem.6

The loss of power of Zhao Ziyang and other reformist leaders following the1989 Tiananmen demonstrations caused a setback to the shareholding reform.A strong statement was made that ‘China will not practise privatization’ (BR,4–10 September 1989, pp. 4–5). Though establishment of shareholding enter-prises was not banned, the issue of shares to workers was halted.Complementary reforms were restricted to Shanghai and Shenzhen (ZGJS, pp.11 and 65). Under this atmosphere, the number of shareholding companies haddeclined to 3220 by 1991 (see Table 2.2). Many Western observers thusdoubted whether the experiment could survive (Bowles and White, 1992, p. 587; Lee K., 1993b, p. 192). However, the trend was reversed in 1992. Afterthe paramount leader Deng Xiaoping called for further reform during his high-profile ‘southern tour’ in January that year, the shareholding experiment re-emerged in China’s economic reform agenda. By the end of 1997, about 5400shareholding companies had been established, with a total capital stock of over220 billion yuan (ZJN, 1998, p. 718).


Table 2.2 Approximate number of shareholding companies in China (at endof year)

1988 38001991 32001992 37001997 5400

Note: As the data come from different sources, they may not be directly comparable.

Sources: 1988 figure from ZBN, 1989, p. 251; 1991 figure from ZGJS, 1993, p. 66; 1992 figurefrom ZBN, 1993, p. 239; 1997 figure from ZJN, 1998, p. 718.

China’s shareholding enterprises fell under four basic models (ChenYoungzhong, 1991, pp. 165–73):

Model A: ‘One Enterprise, Three Types of Owners’

This model was the most common one, particularly in Sichuan and Shenyanyprovinces. A shareholding company under this model has three types ofowners: the state, enterprise, and individual workers of the enterprise. Thevalue of ‘state shares’ (guojia gu) is calculated from the net value of assetscreated by state investment. The enterprise itself is entitled to a certain amountof ‘enterprise collective shares’ (qiy jiti gu), which are equal to the net valueof assets acquired through the enterprise’s own retained funds. Finally, work-ers of the enterprise are issued ‘individual workers shares’ (zhigong geren gu).Under this model, state shares are risk-free. They are guaranteed a return thatis equivalent to the 55 per cent income tax. In contrast, enterprise collectiveshares bear most of the risk. Their rate of return depends entirely on the finan-cial result of the enterprise’s operation. Individual worker shares receive fixedinterest that is roughly the same as that which banks offer on savings deposits,plus an unguaranteed amount of dividends depending on the profits or lossesmade by the enterprise.

Model B: ‘One Enterprise, Four Types of Owners’

Many shareholding companies in Shanghai adopted this model, which consistsof four types of owners: the state, the enterprise, other institutions, and indi-viduals. Like Model A, the amounts of state shares and enterprise collectiveshares are determined respectively by the net value of assets created by stateinvestment and those acquired through the enterprise’s own retained funds.What is different from model A is that shares are also issued to other institu-tions, known as ‘unit shares’ (danwei gu), and to the general public, known as‘private individual shares’ (geren siyou gu). Under this model, all four typesof owners share equal risk. There is no guaranteed return, and dividends aredistributed evenly if they are paid.

Model C: ‘One Enterprise, Two Types of Owners’

This model was adopted mainly by shareholding companies in Shenzhen,China’s largest Special Economic Zone. A number of state enterprises herehave been auctioned off to institutions and individuals. This process transfersownership from the state and the original enterprise to the buying institutionsand individuals, each holding a certain amount of ‘unit’ shares and privateindividual shares.


Model D: Shareholding Conglomerates

Under this model, shareholding conglomerates were formed on the basis of thecontribution of capital by different enterprises. Like Model A, there are stateshares, enterprise collective shares, and individual worker shares. But in addi-tion to that, in this model there are the unique ‘public-owned enterprise shares’(gongyou qiye gu). They are owned by the state, but the associated income andvoting rights are assigned to the enterprises joining the conglomerate.

In short, under the above four models, there are three types of owners and sixtypes of shares, as summarized in Table 2.3. Enterprise collective shares and‘unit’ shares together are known as ‘corporate shares (faren gu); and workershares and private individual shares together are known as ‘individual shares’(geren gu).7

The Chinese shareholding reform is a form of privatization, in the sensethat it provides a channel through which assets are transferred from the stateto private hands. As another analyst noted, while Chinese reformers had madeearlier efforts to create a non-state sector and to introduce a system of manage-rial incentives in state enterprises, it was only with the adoption of the share-holding reform that China finally pursued ‘privatization as that term istraditionally understood: transferring state ownership rights to private interests(Cao, 2000, p. 15).’ It may be argued that since the state remains the largestowner of enterprise assets, the shareholding reform should more accurately becalled corporatization, rather than privatization. Two World Bank economiststhus noted that the goal of China’s enterprise reform was to improve efficiency‘through corporatization, but without going as far as the privatization routebeing pursued by many other countries in transition’ (Harrold and Lall, 1993,


Table 2.3 Models of China’s shareholding system

ModelOwner Shares A B C D

State State shares * * *Public-owned enterprise shares *

Institutions Corporate shares, of which:Enterprise collective shares * * *‘Unit’ shares * *

Individuals Individual shares of which:Worker shares * *Private individual shares * *

p. 42, original emphasis). According to van Brabant, corporatization ‘refers toenterprise reforms that alter the firm’s legal position from being a state agent,perhaps with dubious property rights into some joint-stock company, whoseproperty rights are initially entrusted to, but not necessarily all exercised by,some state agency’. Under corporatization the state remains the owner, but theallocation of the usufruct of ownership will be monitored by some state asset-management agency (van Brabant, 1991, pp. 11 and 152).

However, we regard the Chinese shareholding system as a form of privati-zation rather than corporatization. This is because, as we will see below, thestate’s share in shareholding companies is in decline. State ownership is evenabsent in a number of shareholding companies. Among those with the state asmajor shareholder, the state asset-management agency has not acted in the bestinterests of the state. Some positions as representatives of state assets werevacant (Lee Kuen, 1991, p. 93). As the state is not guaranteed an influentialrole in Chinese shareholding enterprises, it is our view that the nature of theshareholding reform is closer to privatization than corporatization.

LITERATURE REVIEW

The Chinese use of the term shareholding system reform, in avoidance of thelabel ‘privatization’, seems to have misled some Western scholars to regardprivatization as absent in China. For example, Gelb, Jefferson and Singh(1993, p. 425) called property rights changes in China ‘pseudo-privatization’;Rawski (1994) described China’s industrial performance as ‘progress withoutprivatization’; and Rana (1995, p. 2) concluded that China has made ‘littleaction’ in terms of privatization of small enterprises. None noted the rapidlyemerging shareholding system.

To this author’s knowledge, Lee Kuen (1991) was the first to recognize theshareholding reform as China’s way of privatization; Chapter 6 of his ChineseFirms and the State in Transition has the title ‘Privatization of StateEnterprises: the Emergence of the Shareholding System’. According to Lee,the shareholding experiment represents China’s ‘first effort to solve the prob-lem [of continuing economic inefficiency] by changing the property relationsof the enterprise in direction of privatization’ (Lee K., 1991, p. 81).

Based on material available in 1988, Lee identified several major featuresof Chinese shareholding companies which conform to Model A as describedin the preceding section. In his view, this system has two major weaknesses.First, the mixed nature of Chinese shareholding enterprises, between non-profit organizations and profit-seeking corporations, creates a large loopholein the structure of residual claims. Under the shareholding system, a Chineseenterprise is a non-profit organization in the sense that most of its assets are


‘donated’ by the state and the enterprise itself, and that the residual claims ofthe donors are inalienable (since any return to state shares and corporate sharescan either go to the state budget or be reinvested in the enterprise). At the sametime, the company is a profit-seeking corporation, as there are individualshareholders seeking maximum, alienable residual claims. The coexistence ofnon-profit donors (the state and the enterprise) with inalienable residualclaims, and profit-seeking shareholders (individuals) with alienable residualclaims, leaves room for expropriation of state assets, through payment ofexcessively generous interest and dividends to individual shareholders (LeeK., 1991, pp. 85–92).

Second, there is the so-called agency problem, which arises from theabsence of a personified holder of state shares. Although state officials areappointed to the shareholders’ council or the board of directors, they have noincentive to protect state assets from expropriation by agents (enterprisemanagers and individuals) for private benefit. As a result, large amounts ofstate assets have been expropriated by agents through such practices as under-valuation of state assets and collusion between lower level state bureaucracyand enterprises. In capitalist economies, individual securities holders withinvestments diversified among many firms generally have no special interestin personally monitoring the detailed operations of any firm. Disciplining ofagents is achieved mainly through markets for managerial and labour services,the role of the board of directors, and the market for corporate control. It is theabsence of similar mechanisms that makes the agency problem acute inChina’s shareholding system (Lee K., 1991, pp. 92–6).

These two defects led Lee to the conclusion that ‘the current model of theChinese shareholding system is not sufficient to significantly increase theorganizational efficiency of the enterprise’. He predicted that the Chineseshareholding experiment would wane, or be kept to experimental levels,owing to the increasing number of reports about difficulties in implementa-tion, and the change in political atmosphere following the 1989 Tiananmendemonstrations (Lee K., 1991, pp. 82, 98 and 175).

However, further research led Lee to a less pessimistic view. In a subse-quent article, Lee and his co-author Mark found that ‘one year or so after the[1989 political] crisis, the shareholding system appears to be regaining itsmomentum, due in part to continued worsening of economic conditions, forwhich the conservative faction of the leadership is being blamed’ (Lee K. andand Mark, 1991, pp. 157–58). They repeated the above-mentioned defects ofthe structure of residual claims and the agency problem of Chinese enterprise,but nevertheless added the point that most of the problem associated with theshareholding system arose in the area of distribution. While admitting thatdistributional inefficiency did interfere with productive efficiency to a certainextent, they acknowledged some contributions made on the production side by


the shareholding system: increase in sources of capital through issue of shares,reduction of arbitrary interference by state authorities, and enhancement ofcapital mobility (Lee K. and Mark, 1991, pp. 166–67, 170).

In a more recent article, Lee (1993b) reiterated most of the above points.He recognized that the shareholding experiment, like the improved contractsystem, had the advantages of capital polling and incentive enhancement. Bothschemes tended to reduce state revenue and create inflation. However, insteadof treating these negative consequences as good reasons to reject the reformmeasures, Lee regarded them as the ‘trade-off’ for the benefits of the change.Yet he maintained his earliest view (Lee K., 1991, p. 98) that the improvedcontract system had a better chance of survival than the shareholding experi-ment, since the former would be politically less dangerous and economicallyless risky (Lee, 1993b, pp. 191–92).

While Lee’s major concern is the efficiency effect of China’s shareholdingreform, another scholar, Tam (1991), focused on the motive of the change.According to Tam, the issue of enterprise securities and other informal creditshas caused the rapid emergence of a capital market in China. The speed ofchange has been so fast that it ‘has defied the general pattern observed in otherdeveloping countries at roughly comparable stages of economic developmentand monetarisation’ (p. 511).

Tam attributed this phenomenon to the inefficiency of the official bankingsystem. As part of the government’s financial mechanism, Chinese state banksallocate funds according to bureaucratic rather than commercial considera-tions. Their inability to resist demands from local authorities results in exces-sive credit expansion and rising bad debt. Such a credit rationing system putssmaller state enterprises and private firms in the most disadvantageous posi-tion in obtaining funds. To cope with the problem, many of them borrow frominformal sources at high interest rates, and some issue shares to raise their owncapital. This leads Tam to the conclusion that the emergence of the sharehold-ing system and other informal financial institutions is a disorganized butnevertheless rational response by economic agents to the irrationality of theofficial banking system. The development is the outcome of spontaneous reac-tions by enterprises and individuals, now operating with greater autonomy, toseek maximum returns from their activities (Tam, 1991, pp. 512, 522–25).

Another researcher, Singh (1990), however, disagreed that share issueswould make any significant contribution to the Chinese economy. In his view,the commonly quoted functions of capitalist stock markets – pooling ofsavings, channelling of capital to users with the greatest need, and efficientutilization of assets – are often hypothetical rather than real. In the Chinesecontext, the purposes of establishing a stock market include promoting savingand alleviating inflationary pressure, optimizing the volume as well as sectoralallocation of investment, and enhancing micro-efficiency of enterprises. In


Singh’s view, the more effective ways to achieve these objectives will bethrough macroeconomic actions by central planners and promotion of comple-tion in product markets. Instituting a stock market can make matters worse, asvolatility of share prices will increase overall instability.

Two other scholars, Bowles and White (1992), went further, listing threeproblems of Chinese share issues. First, the returns to Chinese shares tend tobe guaranteed, with little link with the level of risk; second, some unprofitableenterprises issued shares to shore up their financial failures; third, shares werealso issued for the purpose of distributing bonuses to workers and allocatingscarce goods between enterprises. In these authors’ view, ‘these facets ofactual share issues … tended to obstruct any contribution which they mighthave made to increasing the productivity of financial resources’ (p. 581).

Nevertheless, Bowles and White felt that the issue of shares was politicallyimportant, as it challenged the ideological and institutional underpinnings of a‘socialist’ economy. They were thus more interested in the political and ideo-logical debates sparked by the shareholding experiment. They identified fourmajor proposals by Chinese theorists on the issue of ownership reform,moving from more conservative to more radical: (a) keeping the existingownership structure unchanged but granting more autonomy to enterprises;(b) allowing different types of economic agencies to form shareholding enter-prises, on the condition that the state would remain the largest owner; (c)transferring ownership rights from the state to the enterprise itself; (d) priva-tizing state enterprises through sale of shares to the public. The fundamentalissue of this debate, according to Bowles and White, is the compatibilitybetween share issues and socialism. They felt that the major obstacles tomoving from option (a) towards (d) ‘are the political objections of those whosee even marginal ownership changes as creeping privatization en route tocapitalism’. The outcome, therefore, would largely be ‘dictated by politicalfactors’ (Bowles and White, 1992, pp. 584–88).

Finally, China’s shareholding reform has attracted attention from the legalprofession. Bersani (1993), a US attorney, explained the rules and regulationsgoverning Chinese shareholding enterprises; and Nottle (1993), Chairman ofthe Hong Kong Securities and Futures Commission, discussed China’s securi-ties regulation framework. Their interpretations of the relevant Chinese lawsin Western terms are useful, as they provide a convenient way to see theuniqueness of China’s shareholding system compared with Western one.However, these studies have been overtaken by the adoption of China’s firstCompany Law in December 1993, which supersedes most of the provisionalregulations examined by Bersani and Nottle.

To sum up, Western scholars have had mixed views about China’s privati-zation. Some regarded the change as of negligible scale, while othersdiscussed the shareholding reform as a form of privatization. Contrary to the


Western neoclassical belief that privatization is the most effective solution topublic sector inefficiency, most researchers on China’s shareholding systemreform have been sceptical about the economic effect of the change. Yet manyagreed that the shareholding system is a rational economic choice for Chineseenterprises seeking maximum independence from the state, given existing polit-ical and ideological constraints. Regarding the future of the reform, the generalview has been that the decisive factors would be political rather than economic.

THE PRIVATIZATION DEBATES

We argued above that the Chinese shareholding system reform is a form ofprivatization, in the sense that it provides a channel through which assets aretransferred from the state to private hands. Other scholars have described it as‘a first move in the direction of privatization’ (Lee Kuen, 1991, p. 176),‘partial privatization’ (Chai and Docwra, 1997, p. 175; Naughton, 2007, p.469), ‘de facto denationalization’ (You, 1995, p. 54), and ‘piecemeal privati-zation’ (Parker and Pan, 1996, p. 120). Whatever terms they use, these authorsshare the view that the shareholding system reform involves privatization,though they may not agree on the extent of that change.8

It is less easy, however, for Chinese scholars to arrive at such a conclusion,as the issue is related to whether the reform is ‘surnamed capitalism or social-ism’ (xing zi hai shi xing she) (XB, 14 August 1997). For those who see ideol-ogy as having no real influence on political and economic policy, this will notbe an important constraint on shareholding system reform. However, as Chenand Sun have shown, Chinese ideological debates about political economyhave been crucial in shaping the direction of reform (Chen Feng, 1995; Sun,1995). Almost two decades of reform have led to the gradual acceptance of‘marketization’ (shichanghua) and ‘commodification’ (shangpinhua) asmeans to invigorate the socialist economy. Yet, privatization (siyouhua) is stillpolitically taboo, as it goes in direct conflict with the Marxist cardinal princi-ple of public ownership.

There was evidence that the early Chinese advocates of the shareholdingsystem reform in fact knew that what they were proposing was tantamount toprivatization. Chen Feng (1995, p. 125) noted that many of the argumentsmade for the system were actually used to support privatization in the first fivemonths of 1989; when You (1995) conducted private interviews in China in1992, some Chinese officials even attributed the country’s economic problemsto insufficient privatization (p. 35). However, awareness of the political andideological implications of the term privatization has led Chinese theorists tochoose strategically to raise their ideas under the camouflage of shareholdingsystem reform.


In the mid-1980s when the shareholding experiment had just begun, itsdefenders took the approach of ‘neutralizing’ the reform. They argued thatthere is no exclusive linkage between the shareholding system and capitalism;rather, they said the design could benefit both capitalism and socialism (ChenFeng, 1995, pp. 121–22). But the argument failed to convince its opponents,who later brought the reform to a low ebb. After the reform drive regainedmomentum in 1992, ideological attack against it revived. In early 1997, theconservatives issued two ‘ten-thousand-word articles’ (wan yan shu) claimingthat the intention of the shareholding system reform was ‘to convert socialistpublic ownership in order to achieve privatization.’ One of the articles saidthat, as a consequence of the reform, ‘the remaining SOEs face the possibilityof no longer [being] wholly owned by the state (YZ, April 28–May 4, 1997, p.12).’ To privatize, according to the conservatives, is not only ideologicallywrong but also ‘unconstitutional’ (SCMP, 24 August 1997).

In response, three lines of counterargument have emerged that may betermed orthodox, moderate, and aggressive. The ‘orthodox’ approach soughtdoctrinal support from Marxism. In an internal meeting held in early 1997, thethen Party’s General-Secretary Jiang Zemin quoted Engels that ‘capitalistproduction operated by shareholding companies is no longer private produc-tion, but profit-seeking joint production by a large number of people’ (MB, 21April 1997). Another theorist added that it was Marx’s view that ‘the share-holding system is probably the most effective way to achieve communism’(JYZ, 1997, No. 6, p. 48). Based on these, the orthodox theorists argued thatthe shareholding system reform is not privatization but ‘socialization’ (shehui-hua) (XB, 15 April 1997; YZ, 28 April–4 May 1997, p. 12).9 It is not a productof capitalism, but an inevitable outcome of mass social production. Theconservatives rejected such an approach as a ‘distorted use’ of Engels’s andMarx’s ideas (MB, 24 June and 13 August 1997).

The ‘moderate’ defenders of the shareholding system were reluctant to goback to a textual search for Marxist tenets. For them, so long as the reformdoes not involve sales of original state capital or challenge the leading role ofpublic ownership, the shareholding system should not be labelled privatiza-tion. As one senior economic official argued, the reform is based not on thetransfer of original state capital but rather the absorption of additional capitalfrom the general public and foreign investors. As such, it is favourable to thecontrol of non-state capital by state capital (CD, 21 June 1995; GZFX, 1995,No. 45, p. 18). Another theorist added that privatization is primarily a ‘politi-cal concept’ that involves the objection to the leading role of public ownership.Since the shareholding system reform causes no harm to the state’s dominantrole in the economy, it is not privatization (JYZ, 1995, No. 4, p. 43). Somewent even further, arguing that the shareholding system in fact strengthens theleading role of public ownership by using a relatively small amount of state


capital to control a relatively large amount of social capital (XB, 15 April1997). The conservatives retorted that if the shareholding system reform couldnot simply be equated with privatization, similarly it could not be regarded aspublic ownership. In their view, the system’s role in raising capital and form-ing collective production should not be exaggerated (MB, 24 June 1997).

Finally, the ‘aggressive’ approach attempts to break the privatization taboo.In 1994, one theorist suggested that there are two major forms of privatization:sales and equal distribution. In his view, ‘the feasibility of both forms is worthconsideration’ (Xu, 1994, p. 134). Along this line, some proposed that Chinamight try the concept of ‘state-owned privatized enterprises’ (SCMP, 9 March1997), an oxymoron that state ownership and privatization can be compatible.An even more radical voice argued that privatization is a ‘neutral concept’ thatshould not be judged by political and ideological criteria. The proponent ofthis view admitted that if privatization is to mean transfer of ownership of inef-ficient SOEs to individuals or legal-persons for the sake of improving effi-ciency, then it is not wrong to regard the shareholding system reform asprivatization. Although various forms of hidden privatization such as theft,squander, and private distribution of state assets have been taking place, ‘open,orderly privatization is preferred to hidden, unregulated privatization’ (JYZ,1995, No. 4, pp. 41–42). Finally, a private economic consultant has even chal-lenged ‘the leading role of public ownership’, saying that it is an ‘outdatedslogan’ (MB, 7 August 1997).

In the 15th Party Congress held in September 1997, it was a mixture of theold ‘neutralization’ approach and the ‘moderate’ approach that provided themajor justification for the shareholding system. In his report presented at theCongress, the then Party’s General-Secretary Jiang Zemin said that the share-holding system is an efficient form of capital organization that can be used byboth socialism and capitalism: ‘We cannot say in general terms that the share-holding system is public or private. The key lies in who holds the controllingshare.’ Public ownership, according to Jiang, includes not only state ownershipand collective ownership but also the state’s and collective’s share in themixed economy. ‘Under the premise that public ownership is dominant, adecline in the relative proportion of state ownership will not affect the social-ist nature of China.’ The entire argument is based on the recognition that Chinais still at the ‘initial stage of socialism’, during which the dominant publicownership should ‘develop diverse forms of ownership’ (TKP, 13 September1997). While Zhao Ziyang, the original articulator of the notion of an ‘initialstage of socialism’, remains absent from the public scene, the theoretical basehe laid for privatization has been rehabilitated.

During 2004–2006, there was another round of ideological debate about therelationship between the shareholding system reform and privatization. It wasa response to the Third Plenary Session of the Sixteenth Central Committee of


the Chinese Communist Party (held in October 2003), in which a decision wasmade ‘to implement diverse forms of public ownership and to make the share-holding system the mainstay of the new public ownership’10 (BR, 11–17December 2003, p. 18; italics added). The italicized part of the statement ledto the questions of what is ‘new public ownership’, and how could the share-holding system be made the ‘mainstay’ of it? Shortly after the meeting, LiYining, a leading theorist of the shareholding system, put forward a theory of‘new socialization’. According to him, there are four forms of ‘new publicownership’. The first consists of purely state-owned enterprises; the secondconsists of shareholding enterprises with the state and the general public (orga-nizations or individuals) as shareholders; the third consists of shareholdingenterprises with only the general public but not the state as shareholders; andthe fourth consists of enterprises owned by privately donated funds. In Li’sview, the first form will continue to exist but only in ‘a few special sectors’,and the fourth form is now limited in size but ‘will surely expand’. It is thesecond and the third forms – collectively known as ‘public-owned sharehold-ing enterprises’ – that constitute the major component of China’s socialisteconomy. Moreover, according to Li, when many of the existing private enter-prises expand to such a scale that they need to raise capital from outside, theywill also be turned into shareholding enterprises. In such a way, the share-holding system forms ‘the mainstay of the new public ownership’, and theexpansion of the shareholding system is regarded as ‘new socialization’ (xingongyou hua) (JXD, 2004, No. 1, pp. 17–20).

Li’s view immediately stirred up a debate. Opponents criticized that it isinappropriate to categorize pure privately owned shareholding enterprises –that is, the third form of ‘new public ownership’ identified by Li – under publicownership, otherwise shareholding companies in developed capitalist coun-tries would also be regarded as a form of ‘new public ownership’. While theshareholding system as a modern enterprise system should be promoted, itcould become ‘hidden and incremental’ privatization if there is no ‘tightsurveillance’ over its operation (JXD, 2004, No. 4, pp. 18–24). Moreover, Li’sview was criticized as having ‘completely neglected the private nature ofshareholding enterprises’ (JXD, 2005, No. 1, pp. 55–60). Historically speak-ing, the shareholding system has long been closely related with capitalistprivate ownership. Insufficient attention to this will turn ‘potential’ privatiza-tion into ‘real danger’ (JXD, 2005, No. 9, pp. 36–40). Most seriously, accord-ing to one critic, further reform along Li’s line will make ‘a large number ofpublicly-owned enterprises exist only in name but not in reality’, and is there-fore ‘extremely harmful’ (JXD, 2004, No. 7, pp. 42–44).

On the other hand, a supporter of Li defended that China’s shareholdingsystem is ‘public’ in three aspects. First, capital and enterprises are ultimatelyowned by ‘the general public and labourers’, instead of ‘a few capital holders’;


second, assets of shareholding enterprises are ‘social’ but not ‘personal prop-erty’; third, ‘the general public and labourers’ have the income right over capi-tal. Therefore, the shareholding system is a form of ‘public ownership withChinese socialist characteristics’ (JXD, 2004, No. 4, pp. 25–28). Moreover,from a pragmatic point of view, it was argued that the shareholding system isa ‘good form for realizing socialist public ownership’, because it provides a‘microeconomic foundation’ for public ownership (JXD, 2006, No. 1, pp.59–61). Another discussant added that ‘as long as the shareholding system canmaintain and enhance the value of public capital, it should be regarded as aform of public ownership’ (JXD, 2004, No. 10, pp. 44–47). Finally, quotingMarx’s view that the shareholding system is a good form of transition tocommunism, a theorist contended that ‘one should not be fearful of saying thatthe property right of shareholding companies is a higher form of public owner-ship. This is exactly the manifestation and proof of the functioning of the lawof progress from private ownership to public ownership, and is the empiricalground for the inevitable replacement of capitalist private ownership bysocialist public ownership’ (JXD, 2005, No. 9, pp. 49–54). After a review ofthis debate, a scholar concluded that ‘during reform, we should be bold inmaking innovations, and not be constrained by certain old views. The share-holding system continues to be the main direction of enterprise reform and themajor form of realizing public ownership of our country’ (Luo, 2006, p. 48).

OTHER PRIVATIZATION CHANNELS

Ideological disagreements notwithstanding, by the mid-1990s a significantamount of resources in China had been transferred from the state to privatehands through the shareholding system reform. At the same time, severalother channels of privatization had also emerged in China. Auctioning ofstate enterprises, which began in 1987 but was later halted for ideologicalreasons, resumed in 1992 (CEN, 22 November 1993, p. 18). Private entre-preneurs were active buyers. For example, when seven state-owned depart-ment stores were listed for auction in Shanghai in 1992, six were sold to thesame private businessman, and the remainder to another private firm (BR,15–21 February 1993, p. 30). Enterprise workers also bought state enter-prises. In early 1994, the entire Shanghai Lighting Apparatus Factory wassold to its staff for one million yuan (CEN, 25 April 1994, p. 14). To institu-tionalize this trading of state assets, 25 property rights exchanges had beenestablished across the country. Within a few years, over 10 000 enterprises,many of which were originally state-owned, were sold or merged throughthese exchanges (CD, 19 February, 25 April, 17 May 1994; CEN, 30 May1994, pp. 16–17).


The Third Plenary Session of the Fourteenth Central Committee of theChinese Communist Party, held in November 1993, gave a further green lightto privatization, although the term was still not explicitly used. It was decidedat that meeting that selling of major stakes in state enterprises (except armsmanufacturers and key industries) to private or foreign investors would beallowed. Small state enterprises would be contracted out, sold or leased toprivate investors without restriction. Enterprises that remained in the stateadministrative organs to direct public companies would be removed (FEER,23 December 1993, p. 46).

Among the various privatization measures, the shareholding system wasthe most accessible to the general public. By the end of 1993 the number ofChinese shareholders had reached 25 million (ZSZ, 25 February 1994, p. 20).In this sense, the shareholding system has resulted in some degree of ‘massownership transformation’ in China.11

The Chinese shareholding experiment experienced a series of problems:expropriation of state assets, instability of macroeconomic and political envi-ronment, exploitation of legal loopholes, inaccuracy of information, lack ofexpertise, inadequate supervision of corporations, and unequal distribution ofwealth. The state did not seem to have any ready solution. Nevertheless, thishas not prevented the government from further implementing the reform. Ifthere was any policy at all, it would be to set just a few vague guidelines, letproblems emerge, and then solve them during the course of change.12 Chineseleaders describe this kind of trial-and-error approach as ‘groping for stones tocross the river’. There is no specific theory to guide the reform, but this isexactly what ‘socialism with Chinese characteristics’ is all about.

NOTES

1. For some discussions on post-communist privatization in the early 1990s, see Csaba (1994),Earle, Frydman and Rapaczynski (eds) (1993), and Milor (1994).

2. At least two scholars, Shirk (1993) and Lee (1993a), have argued that such a strategy ofallowing a private economy to emerge and to coexist with the state sector, instead of a head-on attack on state enterprises, is a major reason for the success of the Chinese compared withthe Soviet reform.

3. For a call by World Bank economists for more extensive privatization in China, see Harroldand Lall (1993, p. 46).

4. The following case illustrates the importance of terminology. In April 1994, a Canadianinvestment firm told the visiting Chinese Vice-Premier, Zou Jiahua, that since Canada waswell experienced in ‘privatizing Crown corporations’, it could help China to dismantle stateenterprises. The lack of sensitivity to wording resulted in an abrupt reply: ‘It is wrong tobelieve that only privately controlled economies can grow, and that publicly controlledeconomies cannot grow’, Zou said, pointing out that ‘many private enterprises go bankrupt’(Globe and Mail, 23 April and 15 June 1994).

5. For details of these debates, see Chen Shenshen (1989) and Chen Jianfu (1993).6. Another source, Ting (1989), quoted the figure as 6000. But the 3800 estimate seems to be

more consistent with other available data. See Table 2.2.


7. Not included here are ‘foreign shares’ (waizi gu) or B-shares, which are sold to foreign(including Hong Kong and Macao) investors.

8. In contrast, Wang Xiaoqiang (1996) argued that ‘in China, from the enterprise contractsystem to the shareholding system, and as the property rights reform intensifies, we canhardly see any locus of change from public to private ownership’ (p. 186). This is because,according to him, most of the shares of the shareholding companies are held by the state orstate-owned institutions, and there are not many shareholders ‘with flesh and blood’. Wang,however, seems to be unaware of the trend that the state’s majority share has been in decline,and this process, however gradual it is, is a kind of privatization.

9. The term ‘socialization’ has also been used as a cover for privatization of social welfare inChina. See Wong (1994).

10. In the original source, the term ‘joint-stock system’ was used instead of ‘shareholdingsystem’. We made the change for consistency. In Chinese both terms refer to ‘gufenji’.

11. ‘Mass ownership transformation’ refers to rapid transfer of ownership through issuingvouchers or other means of mass distribution (Thomas, 1993, pp. 173–74).

12. For example, according to a Chinese legislator, when drafting the Company Law many greyareas were intentionally left in order to allow room for future changes (ZSZ, 2 July 1994, p.20).


3. Evolution of the shareholding systemreform

In the 15th Chinese Communist Party Congress held in September 1997, theshareholding system (gufenzhi) was endorsed as the ‘mainstream reformprogramme’ for state-owned enterprises (SOEs) (MB, 12 September 1997).This represented an important move of China to improve economic efficiencyin the state sector. In 1996, this sector accounted for 53 per cent of the coun-try’s total investment, and 16 per cent of national employment. There weresome 113 800 industrial SOEs. They created a loss of 79 billion yuan, whichthe state had to cover. In fact, from 1978 to 1996, losses made by industrialSOEs increased by almost nineteen-fold (ZTN, 1997).

Since 1978, the Chinese government has been trying different schemes torevitalize SOEs, and the shareholding system represented a major departurefrom the previous attempts. While all previous programmes focused mainly onthe managerial aspects of enterprises, it is only the shareholding system thattouched on the nature of ownership of SOEs. The essence of the shareholdingsystem reform (gufen jingji gaige) is to convert SOEs into shareholding enter-prises (SHEs). Shares are issued to the state, enterprises, and individuals. Thishas made it possible for private individuals to acquire at least partial owner-ship of formerly completely state-owned enterprises. Despite repeated denialsby the top leadership, the shareholding system reform is a form of privatiza-tion, in the sense that it provides a channel through which state assets aretransferred to private hands.

However, unlike the rapid privatizations in many East European countries,it took 13 years – from the establishment of the first Chinese shareholdingcompany in 1984 to the formal endorsement of the shareholding system in1997 – for this option to be recognized as the mainstream reform scheme. Thisprocess is yet another manifestation of the gradual and incremental character-istic of China’s reform. This chapter will examine the political and economiccontext of the Chinese route to privatization. It will first identify the back-ground against which the shareholding system has emerged. It will then tracethe evolution of the scheme, examine the impact of the change on the share ofstate ownership, present an assessment of the results of the experiment up tothe mid-1990s, and finally provide an update on the post-1997 development ofthe reform.

25

INADEQUACY OF PREVIOUS SOE REFORMS

China’s SOE reform began in the late 1970s, shortly after the Maoist leader-ship fell from power. A number of reform programmes have emerged, and thestate has adopted a trial-and-error approach, described by Chinese leaders as‘groping for stones to cross the river’ (mo zhe shitou guo he). At any particu-lar period of time, different schemes may have coexisted with one another, butonly the one that seemed most politically feasible and economically desirableunder the prevailing conditions was promoted at the national level. From 1978to 1997, five such mainstream programmes were introduced in succession:

1. delegation of greater autonomy to enterprises (1978–80);2. delivery of contract profit to the state (1981–82);3. substitution of profit with taxes (1983–86);4. negotiation of responsibility contracts with enterprises (1987–93); and5. corporatization of SOEs (1994–97).1

Assessments of the results of the above reforms vary significantly. Huangand Duncan (1997) found that their overall impact on productivity has beennegligible. Parker and Pan (1996) presented evidences of an absolute rise inSOE labour productivity, but a relative decline in competitiveness. Broadman(1995) and Naughton (1995) confirmed the contribution of the reforms to SOEperformance, but they both noted that more efficiency gains are available iffurther reform can be introduced. Common to these analyses is the view thatdespite the growing intensity of the reform, the various schemes were inade-quate in the sense that there was very little change in the nature of state owner-ship.

According to standard property rights theory, ownership refers to a bundleof rights that an agent is empowered to exercise over an asset. Those rightsinclude a ‘utilization right’ (the right to utilize an asset); ‘residual controlrights’ (those utilization rights that have not been contractually defined); a‘return right’ (the right to appropriate the returns from an asset); and an ‘alien-ation right’ (the right to transfer rights over an asset to others through gift orsale). The first four mainstream reform schemes mentioned above assigned toenterprises greater autonomy over production decisions and profit retention.Enterprises thus gained some utilization and return rights from the state.However, as the state could appoint and remove enterprise managers, theutilization and return rights granted to them were limited by the state’s reten-tion of residual control rights. More importantly, the state continued to exer-cise full alienation rights. The various reforms from 1978–93 thus involvedonly ‘adjustment of an agency relationship, rather than a shifting of the locusof ownership’ (Putterman, 1995, pp. 1049–51).2


Only the corporatization programme introduced from 1994 to 1997 has hadimplications for SOEs’ ownership structure. In November 1994, as part of theplan to establish a modern enterprise system, 100 large- and medium-sizedSOEs were selected to be corporatized within two years as limited liabilitycompanies (LLCs) or SHEs under the Company Law that came into effect on1 July 1994 (Broadman, 1995, p. 26). According to Article 3 of that law, themajor difference between LLCs and SHEs is that in the case of an LLC, eachshareholder is liable toward the company to the extent of his or her respectivecapital contributions; whereas in the case of an SHE, the company’s total capi-tal is divided into equal shares, and each shareholder is liable toward thecompany to the extent of their respective shareholdings. When an existingSOE is corporatized as an LLC, it becomes either a wholly state-owned LLC(if there is only one state-owned investment entity) or an ordinary state-ownedLLC (if there are two or more state-owned investment entities) (Wei, 1995, pp.32–33). In both cases the state is the sole owner of the enterprise, though itmay invest in the enterprise through different entities. Corporatization ofSOEs into LLCs thus only limits the state’s liability toward the enterprises butdoes not change their ownership structure.

However, the situation is different if an SOE is corporatized into an SHE.In such cases, the Company Law dictates that the SOE must be incorporatedby means of share offer. As sponsor, the state is required only to subscribe notless than 35 per cent of the total shares issued, and the remainder is to beoffered to the general public. The aim of these provisions is to avoid overconcentration of shares in the hands of the state (Zhang Jianzhong, 1996). Asownership of an SHE is defined under Article 4 of the Company Law by theproportion of shares each shareholder holds, the 35 per cent minimum require-ment implies that the state need not be the majority (over 51 per cent) owner,though it can still be the largest shareholder if the other shareholders are highlydispersed, which is often the case in China (GZFX, 1995, No.16, p. 16).

Hence, under the corporatization programme, it is the shareholding systemreform that has particular impact on SOEs’ ownership structure. However,according to the corporatization blueprint most of the SOEs would be incor-porated as LLCs and only a few would be converted into SHEs (Chai andDocwra, 1997, p. 173).3 In other words, although the corporatizationprogramme ‘facilitated eventual privatization and provided an option for newhybrid ownership forms’ (Naughton, 2007, p. 301), it was not intended to be amajor breakthrough in terms of state ownership. As such, its results have notbeen significantly different from previous reforms. The LLCs, still solelystate-owned, have remained subject to arbitrary government intervention intheir operation (Chai and Docwra, 1997, p. 175). More importantly, the corpo-ratization programme, like the earlier reform schemes, failed to improveSOEs’ financial performance. Under the property rights arrangement with the

Evolution of the shareholding system reform 27

state remaining as the ultimate owner while SOEs were granted greater utiliza-tion and return rights, the primary objective of enterprise managers and work-ers was to maximize sales revenue and their say in income distribution, withlittle concern for cost and profits.

The result was rising losses, despite growing production. From 1994 to1996 gross industrial output of Chinese SOEs increased 42 per cent, but lossessoared 64 per cent (see Table 3.1). Failing to keep enterprises’ budgets undercontrol, the People’s Bank of China in early 1996 granted tax holidays andadditional credits to loss-making enterprises. The move represented a stepbackward in China’s economic reform, as it repeated the use of administrativemeasures to protect inefficient producers (SCMP, 26 June and 8 July 1996). InJuly 1996, a senior Chinese official admitted publicly that the corporatizationprogramme was stalled. A year later, the State Council confirmed that thecorporatization experiment would be finished by the end of 1997 and officialswere asked to draw conclusions from the experience. This was followed by astatement from Zhu Rongji, the then vice-premier in charge of economicreform, that loss-making SOEs could be taken over by publicly listed compa-nies, suggesting that the corporatization programme would give way to theshareholding system reform (SCMP, 31 July 1997).

EVOLUTION OF THE SHAREHOLDING SYSTEMREFORM4

Early Spontaneous Attempt (1979–88)

The idea of the shareholding system reform originated from the rural sector.To solve the problem of capital shortage in villages, in 1979 the centralgovernment allowed brigades to withdraw accumulation funds to form joint-


Table 3.1 Output and losses of Chinese industrial state-owned enterprises

Billion yuan Change

1994 1996(%)

Gross industrial output 7018 9960 42Losses* 48 79 64

Note: * Covers only those industrial SOEs with an independent accounting system.

Source: ZTN (1997).

stock enterprises. In 1983, an official document stated that capital and labourwere both legitimate bases for distributing returns in cooperative economicproduction. This led to a mushrooming of joint-stock township and villageenterprises. In 1984, the central government made it an official policy toencourage farmers to invest in various kinds of enterprises.

In 1984, the World Bank sent two delegations to China. They suggested thatChinese reformers should draw on the experience of foreign shareholdingsystems and proposed the concept of socialist joint-stock ownership, an ideathat apparently inspired Chinese theorists (Chen Yongjie, 1995, pp. 3–4). Inthe same year, the first shareholding company, the Beijing TianqiaoDepartment Store Company, was established. Next year, the Fushan FirstRadio Factory in Guangzhou became the first industrial SHE in China. Thiswas followed by the selection of a small number of SOEs in Beijing, Shanghai,and Guangzhou as ‘experimental units’ (shidian) of the shareholding systemreform (Chen Youngzhong, 1991, pp. 316–18).

In December 1986 the reformist leader Zhao Ziyang, without the support ofthe conservatives, ordered expansion of the shareholding system experiment(Shirk, 1993, p. 310). Zhao explained to delegates at the 13th Party Congressthe following October that, since China was still at an ‘initial stage of social-ism’, other forms of ownership should supplement the dominant public sector.Specifically, the shareholding system was recognized as ‘a form of organizingassets of socialist enterprises’, and hence the experiment ‘could continue’(ZBN, 1988, pp. 98–99). Further official support was given in the 1988 Reportof the 3rd Plenum of the 13th Central Committee of the Party, which defendedthe shareholding system as not being privatization but rather a way to ratio-nalize property rights relations.

The favourable political environment led to an expansion of the scale of theshareholding system experiment. In March 1988, there were some 6000 enter-prises ‘with shareholding characteristics’. They fell under four major cate-gories:

1. enterprises issuing shares to employees;2. enterprises issuing shares to other legal-persons (enterprises or institu-

tions);3. enterprises issuing shares to the public;4. enterprises owned by workers on the basis of the capital they contribute

to the enterprises.

SHEs came under the first three categories. In 1988, there were about 3800such enterprises (see Table 3.2). Enterprises in the first two categories areknown in China as ‘private placement enterprises’ (dingxiang muji gongsi), asthe shares of these enterprises were privately issued to specific employees


and/or legal-persons. Category 3 enterprises are known as ‘public placemententerprises’ (shehui muji gongsi) (Xiao (ed.), 1995, p. 299). Those in Category4 are a mixture of SHEs and cooperatives; as such they are called sharehold-ing cooperative enterprises, as distinguished from SHEs.

The above early development of the shareholding system, which was basi-cally a spontaneous process (Chen Youngzhong, 1991, p. 2), took place in theabsence of a legal framework. The experiment was attempted mainly by small-sized collective enterprises. Shares were issued primarily as a means to raisecapital rather than to establish a new form of corporate governance. Most ofthe shares received guaranteed interest plus high dividends. They could beredeemed when mature, and investors bore little risk. As such, the shares weremore like bonds in nature. Only a small amount of the shares were traded over-the-counter in Shanghai, Shenyang, Wuhan, and Zhongqing.

Setback (1989–91)

The 1987–88 recognition of the shareholding system as an official reformexperiment was misinterpreted by some as a green light for national promo-tion. Capital shortage also caused many enterprises to switch to the share-holding system as a means to raise funds. As a result, a ‘shareholding systemfever’ occurred in early 1989. Some places promoted the shareholding systemreform without sufficient feasibility studies. Regardless, the contract responsi-bility system was still the mainstream reform scheme of the time, and so the


Table 3.2 Number of shareholding enterprises in China

Industrial SHEs with an independent

accountingEnd of Total Listed companies system

1988 3 880 N.A. N.A.1989 3 880 N.A. N.A.1990 N.A. 13 N.A.1991 3 220 14 N.A.1992 3 700 53 N.A.1993 11 489 183 2 5791994 33 000 291 4 3591995 50 000 323 5 5591996 N.A. 530 7 760

Source: various issues of ZBN, ZJTGN, ZTN, ZZQTN, ZZSN, and XB, 5 May 1997.

government issued a note to remind enterprises that the shareholding systemreform should focus on consolidating existing SHEs rather than establishingnew ‘experimental units’. The note added that the reform was intended toimprove overall enterprise efficiency, rather than just to raise funds anddistribute returns; that the leading role of public ownership should be main-tained; and that the value of state assets should be protected.

The fall of Zhao Ziyang and his associates from power in 1989 caused afurther political setback to the shareholding system reform. According to‘incomplete statistics’,5 by the end of 1989 there were some 3800 SHEs in thecountry, which was the same as the year before (see Table 3.2). It was theintention of the post-Zhao conservative leadership to restrict the shareholdingsystem reform to inter-enterprise investment (that is, Category 2 SHEs), as thisinvolved no sales of state assets to private individuals. In 1990, the StateCouncil issued a document allowing further experimentation of Category 2SHEs, but freezing those in Categories 1 and 3. The idea of shareholdingsystem reform still appeared in the Party’s Proposal for the 8th Five-Year Plan,but the theme was restricted to the Category 2 option. In other words, thedominant role of public ownership was to be maintained but the scope of the‘public’ was reduced from the state to legal-persons. Chinese theorists calledthis a change only in the form, but not the nature, of public ownership and itshould thus be distinguished from privatization.

However, while the conservative post-Zhao leadership was successful inreducing the overall scale of the shareholding system reform, it could not resistthe demand for enlarging the target of share issue from legal-persons andemployees to the general public. From 1989 to 1991, the total number of SHEsfell from 3800 to 3200 but the number of Category 3 enterprises rose from 60to 89. Accompanying this change were the openings of the Shanghai StockExchange in December 1990 and the Shenzhen Stock Exchange in July 1991.These bourses provided official markets for the trading of individual shareslisted by Category 3 SHEs.

Rapid Expansion and Standardization (1992–97)

The revamping of the shareholding system regained momentum after para-mount leader Deng Xiaoping called for further reform during his high-profileSouthern Tour of January 1992.6 The experiment was extended to the wholecountry with a geographical division of emphasis. Shanghai and Shenzhenwere selected as the testing grounds for Category 3 SHEs and public listing ofshares. Hainan, Fujian, and Guangdong provinces were to concentrate solelyon Category 3 SHEs, and the rest of the country on Category 1 and 2 SHEs.The basic layout was thus clear. Category 3 SHEs and public listing of shareswere perceived as the most radical elements of the experiment, so the front


line of the reform was limited to the two cities with stock exchanges, Shanghaiand Shenzhen. A lower degree of reform (Category 3 SHEs without public list-ing of shares) was introduced in Hainan, Fujian, and Guangdong provinces,where the country’s Special Economic Zones were located, and the lesscontroversial options (Category 1 and 2) were tried in the rest of the country.

The most radical option also turned out to be the most popular. In 1993, thenumber of listed companies more than tripled (see Table 3.2). To control thepace of expansion, the State Council issued a 5 billion yuan quota for publicplacements that year, but 5.5 billion yuan worth of new shares, or 10 per centabove quota, were issued in the end (ZSZ, 5 February 1994, p. 4). Still, only atiny portion (1.6 per cent) of SHEs got listed. Many of the enterprises notgranted the Category 3 option resorted to Categories 1 and 2, giving rise to alarge number of private placement enterprises.

Responding to the need for a legal framework for the further implementa-tion of the reform, in May 1992 the central government promulgated fourteenrelevant documents, including the ‘Measures for the Experimentation ofShareholding Enterprises’, ‘Opinions on the Standardization of ShareholdingLimited Enterprises’, and ‘Opinions on the Standardization of LimitedCompanies’. Though not official laws, they provided important guidelines forthe shareholding system reform and were used to re-examine and re-endorsepreviously established SHEs. Also in 1992, the State Council established theSecurities Commission and the China Securities Regulatory Commission(CSRC) to monitor development of the securities market. With the adoption ofthe Company Law in 1994, China finally had an official legislation to regulateSHEs, and previously established SHEs were asked to be ‘standardized’(guifan hua) in accordance with this new law.

As the political and legal environment became more favourable, the share-holding system reform expanded rapidly. From 1993 to 1996, the number ofindustrial SHEs soared from 2580 to 7760, and the growth in the number ofnon-industrial SHEs was even faster (see Table 3.2). The reform, originallyfocused on the coastal region, quickly spread into the inland area. As of theend of 1994, about 24 per cent of the SHEs were located in the central or west-ern part of the country. There was also a sectoral diversification of the share-holding system, with about 57 per cent of the SHEs in the industrial andtransportation sectors, 29 per cent in wholesale and retail trade, 4 per cent inconstruction and real estate, 3 per cent in finance and securities, and 7 per centin others.

In an April 1997 conference held in Hangzhou, it was announced that stan-dardization of the existing 6000 or so SHEs according to the Company Lawhad been completed. Based on this, the theme of reform would move to ‘posi-tive promotion of the conversion of SOEs into SHEs’ (JGW, 1997, No. 10, p.6; XB, 15 April 1997). In August, the then Party’s General-Secretary Jiang


Zemin and the official People’s Daily (Renmin ribao) revived the theory of‘initial stage of socialism’, which the disgraced leader Zhao Ziyang had usedto justify the shareholding system reform. This was followed by the 15th PartyCongress’s endorsement of the shareholding system as the mainstream reformprogramme.

Shareholding cooperative enterprises (Category 4) also received strongsupport from the central government.7 Originally, shareholding cooperativeenterprises were tried out mainly in rural areas. But in August 1997, the StateCommission for Economic Restructuring issued a document, ‘GuidingOpinions Concerning Development of Urban Shareholding CooperativeEnterprises’, that encouraged extension of the experiment to the urban sector.According to this document, the Category 4 system is a mixture of the share-holding system and the cooperative system. It is shareholding in the sense thatownership of a shareholding cooperative enterprise is held among its share-holders; and it is cooperative in the sense that the shareholders must also beworkers in the enterprise. There should not be a ‘substantial difference’ in theamount of shares held by each worker. When a worker leaves the enterprise,he/she can only transfer his/her shares to other workers in the enterprise.Outsiders are not allowed to hold any shares of such an enterprise. The high-est authority in a shareholding cooperative enterprise lies in the workers’congress, where decisions are made according to the one worker, one voteprinciple (JS, 7 August 1997). This is different from the shareholding system,under which major decisions are made in the shareholders’ general meetingaccording to one share, one vote. According to a senior official, the share-holding cooperative system would be applied to medium- and small-sizedSOEs, whereas large-sized SOEs would be converted into SHEs or LLCs (XB,19August 1997).

DECLINE OF STATE OWNERSHIP UNDER THESHAREHOLDING SYSTEM

A variety of shares have emerged under the shareholding system, includingstate shares (guojia gu), corporate or legal-person shares (faren gu), individualshares (geren gu), and foreign shares (waizi gu). State shares are shares heldby the state to represent state ownership. Corporate shares are shares held bycorporate legal-persons. Individual shares are shares issued to workers of theissuing SHE, and shares issued to the general public. Finally, foreign sharesare Chinese shares held by foreign investors (Xiao (ed.), 1995, pp. 145–47).The reform of the shareholding system has facilitated the decline of the rela-tive proportion of state shares in total capitalization, indicating the diminish-ing role of state ownership in SHEs.


Up to the beginning of 1993, the state managed to maintain the ‘socialist’nature of SHEs by making itself the largest shareholder of the enterprises. Theproportion of state shares in each listed SHE ranged from 51 per cent to over80 per cent (ZSZ, 4 April 1993, p. 11). However, in a document issued inAugust 1993 by the National Administration of State Property (NASP), adistinction was made between ‘absolute state-holding enterprises’ and ‘rela-tive state-holding enterprises’. The state’s share in an ‘absolute state-holdingenterprise’ must be over 51 per cent, while that in a ‘relative state-holdingenterprise’ can range from 35 per cent to 51 per cent (Xiao (ed.), 1995, p.2086). Such distinction between ‘absolute’ and ‘relative’ state-holding enter-prises disappeared in the 1994 Company Law. As mentioned above, theCompany Law stipulates that in the conversion of SOEs into SHEs, the state’sminimum share is only 35 per cent. Hence, at least in theory, the state was nolonger required to hold more than 35 per cent ownership in any kind of SHEs.In fact, there was even no state share at all in three of the twelve companieswhich issued shares during January and February 1994 (ZSZ, 26 February1994, p. 34).

It may be argued that if corporate shares are also taken into account, thestate still holds a controlling stake of most of the SHEs. Since the holders ofcorporate shares are state agents or institutions, corporate shares are indirectlyowned by the state. In 1993 and 1994, corporate shares accounted for about 45per cent of the total capital stock of SHEs (ZJTGN, 1994, p. 232; 1995, p.174). However, according to the aforementioned NASP document, it would be‘meaningless’ to include corporate shares as an indication of state ownership.This is because different corporate legal-persons cannot be expected to governan SHE in a unified manner (Xiao (ed.), 1995, p. 2086).

Initially, state and corporate shares were both non-negotiable as a safeguardagainst draining of state assets. However, this restriction led to many prob-lems. First, share prices did not change to reflect enterprise performance.Second, the shares were unable to gain value through exchanges. Third, immo-bility of these shares both hindered the restructuring of enterprises throughmerger and takeover, and obstructed the development of a secondary market(ZSZ, 2 July 1994, p. 32; 9 July 1994, p. 27). Hence, Chinese securities expertsand officials have reached the consensus that state shares and corporate sharesshould eventually be made negotiable, but how to implement this remained anopen question (ZSZ, 4 April 1993, p. 11; 17 October 1993, p. 18; 26 February1994, p. 5). In mid-1993, three SHEs openly sold state shares to individualholders despite a ban by the central authorities. There were also cases wherestate shares were converted into corporate ones and, as with state shares, therewas rampant black market trading in the latter type (ZSZ, 13 September 1992,p. 18, and 1 August 1993, pp. 3–4; XB, 18 June 1994). In July 1992 the centralauthorities approved experimental trading of corporate shares in the Securities


Trading Automated Quotations System (STAQS), an over-the-counter trademechanism established in 1990 for bond exchanges. In April 1993 anothersimilar system, known as National Electronic Trading System (NETS), wasadded (ZSZ, 27 November 1993, p. 19; 5 December 1993, p. 37).8 However,in July that year, new listing in STAQS and NETS was suspended, as the offi-cial experiment provoked unauthorized trading of corporate shares. Thenumber of SHEs with legally tradable corporate shares was thus frozen at 17(ZSZ, 31 October 1993, p. 3; 22 January 1994, p. 23; 9 April 1994, p. 5).

On the other hand, no distinction is made among state shares, corporateshares and individual shares in the 1994 Company Law, suggesting that thethree types of shares would be merged. According to some reports, state sharesand corporate shares would be respectively referred to as ‘shares held by thestate’ and ‘shares held by corporates’ in the Securities Law. Again, the impli-cation is that both would be merged with individual shares (ZSZ, 1 January1994, p. 9). While the way this would actually be achieved was still unknownat that time, enterprises tried four different spontaneous approaches: (a) totransfer state shares to existing shareholders; (b) to sell to individuals stockrights and stock options on state and corporate shares; (c) to convert stateshares into foreign shares; and (d) to trade state shares and corporate shares onan over-the-counter market (ZSZ, 2 July 1994, p. 32).

The state’s attitude towards these local initiatives was ambiguous. It banneda Harbin company from using option (a), but did not actually enforce theruling (ZSZ, 1 August 1993, pp. 3–4). It opposed the use of option (c) by someenterprises in Shanghai and Beijing, but did not take resolute action againstnoncompliance. These inconsistencies reflected the state’s dilemma over theissue. On one hand, the spontaneous conversion of state and corporate sharesinto individual and foreign shares helped solve problems arising from the illi-quidity of state and corporate shares. On the other hand, concern about loss ofstate ownership to private individuals and foreign investors prevented thegovernment from making share conversion an official policy. When senior-level criticism and irregular activities emerged, the government banned thepractice, but did not actually enforce the rule.

In any event, the central government’s goal of making state and corporateshares negotiable is unmistakable. In 1995, a Zhuhai company was allowed tobuy 12 million state shares of a Shanghai company (GZFX, 1995, No. 15, p.17). Next year a senior Shenzhen official said that the city was planning toexperiment with circulation of state shares and corporate shares, though noconcrete proposal was raised (MB, 9 February 1996). In April 1997, sixmillion corporate shares of the Hainan Air Company were auctioned, setting aprecedent for transactions involving such shares (GZFX, 1997, No. 18, p. 6).The following month, the CSRC agreed to allow the conversion into individ-ual shares of those stock rights originally issued to corporate shareholders but


sold to private individuals (that is, to adopt option (b) mentioned on p. 35). Itwas permitted with the condition that the private investors must have held thetransferred shares for three years before they could be listed.Contemporaneously, a senior NASP official said that public circulation of stateshares and corporate shares has the advantage of making the market moreopen (SCMP, 14 May and 17 June 1997). Another senior NASP official esti-mated that listing of state shares would enable the state to raise 400 to 500billion yuan. To speed up this process, he suggested converting state sharesand corporate shares into preferential shares (XB, 18 June 1997). In fact, in1997 there were hot discussions about the public listing of state shares. Forexample, one Chinese economist claimed that such a move is ‘imperative’ (JiJinshan, 1997), while another one cautioned that the ‘scale, timing, and form’of public listing of state shares must be very carefully planned (Wang Yiming,1997).

Apart from the conversion to individual shares, state ownership of SHEshas also been diluted through new share issues. As the state lacks the funds topurchase new shares, the relative proportion of the shares it holds in an SHEdeclines each time the company floats new shares. This has caused, for exam-ple, the proportion of state shares in the total capital stock of the ShenzhenDevelopment Bank to diminish from 25 per cent in 1988 to 17 per cent in1994, and that of Shenzhen Wanke Company from 19 per cent to 11 per cent(Wu Jun, 1995). Moreover, when stock dividends and allotments were distrib-uted to individual shareholders, the state was often denied such benefits, rein-forcing the decline in the relative proportion of state shares (Fan Bi, 1995). Inview of this, in April 1994 the NASP issued an ‘emergent notice’ asking stateshare holding agents to oppose such discrimination against state shares. Thenotice stated also that although stock options on state shares could not betraded on the spot market, they could be ‘transferred through negotiations’.The NASP emphasized that this did not contradict an earlier CSRC announce-ment that stock options on state shares were ‘not to be listed for the timebeing’. But the two rules made separately by different actors led to confusionand spontaneous attempts to break the restrictions against circulation of corpo-rate shares (GZFX, 1995, No. 10, p. 15; 1996, No. 19, p. 19).

Overall, the shareholding system reform facilitated a reduction of stateownership in previously wholly state-owned enterprises. As shown in Table3.3, from 1990 to 1995 there was a gradual decline in the relative proportionof state shares and corporate shares in the total capital stock of listed compa-nies in Shanghai and Shenzhen. This trend would be expected to grow further,as there were signs that the spontaneous conversion of such shares into indi-vidual shares would be officially recognized. But there were three limitingfactors. The first was the 35 per cent minimum state ownership requirement onSHEs stipulated in the Company Law. The second was the capacity of the


existing stock exchanges. Although in the first half of the 1990s there was adramatic increase in the quota for public share issue, it was still inadequate toabsorb the huge amount of state and corporate shares that had accumulatedover many years. As of mid-1997, capitalization of un-circulated state andcorporate shares was estimated at 540 billion yuan, 25 per cent more than thetotal capitalization of the two exchanges in Shanghai and Shenzhen (GZFX,1997, No. 28, p. 10). Finally, as Li D. (1996) noted, given China’s imperfectmarket conditions, entrepreneurs may want to include the government as an‘ambiguous owner’. This could be the optimal choice as the infrastructure tosupport a contract system has yet to develop in China, which may make thecost of executing contracts high enough to justify calls for bureaucratic inter-vention. In such a situation, the benefits of the presence of a state owner mayoutweigh its cost.

MIXED RESULTS UP TO THE MID-1990s

With the endorsement of the shareholding system, there has been a tendencyamong Chinese theorists to regard the reform scheme as a panacea (GN, 1997,No. 15, pp. 18–21; XB, 7 May 1997). Yet, preliminary results of the share-holding system reform up to the mid-1990s were quite mixed. According tosome surveys conducted in 1994, SHEs acquired a higher degree of autonomythan non-SHEs in terms of production, management, investment, and profit


Table 3.3 Capital structure of listed companies in Shanghai and Shenzhen(% in total capital stock)

Shanghai Shenzhen

1990 1992 1993 1994 1995 1992 1993 1994 1995

State shares 66 51 55 49 44 16 40 31 29Corporate sharesa 7 21 16 18 21 42 28 33 32Individual sharesb 27 28 28 33 34 42 32 37 39Total 100 100 100 100 100 100 100 100 100

Notes: Due to an absence of a standard statistical system on stock issue in China, data from thesedifferent sources may not be perfectly comparable.a Include corporate shares held by domestic as well as foreign legal-persons.b Include individual shares held by domestic as well as foreign investors, and unlisted sharesheld by workers.

Sources: ZJTGN (1991); ZZSN (1994); and ZZQTN (1996).

distribution. Within the first year of conversion into SHEs, labour productiv-ity increased by 57 per cent, profit and tax per worker by 85 per cent, salesprofit by 49 per cent, profit/capital ratio by 39 per cent, and average wage by44 per cent (Zhang Zhuoyuan, 1996, pp. 90–91). Another source reported thatin 1994 the average sales volume of SHEs rose by 63 per cent, profit by 109per cent, and net assets by 42 per cent, all of which were significantly higherthan those of other kinds of enterprises (ZJTGN, 1995, p. 174).

However, other sources (see Table 3.4) reveal that 650 industrial SHEswere loss makers in 1994, more than doubled from the previous year. In 1995,gross industrial output of SHEs fell by 6 per cent, industrial value added by 8per cent, and profit and tax by 14 per cent. Management at some of these enter-prises regretted having undergone the conversion into SHEs, as their firmswere less profitable than they had been under the contract responsibilitysystem (JX, 25 February 1995; GZFX, 1995, No. 6, pp. 7 and 17 and No. 15,p. 18). Although there was strong recovery in 1996 in terms of number of newSHEs and industrial output, the growth rate of the profits and taxes generatedwas behind that of production, suggesting a decline in efficiency.

The unsatisfactory performance of SHEs could be attributed to severalreasons. First, the state remained as the largest shareholder of most of theSHEs, leading to excessive bureaucratic intervention in their management andoperation. Second, SHEs were required to submit to state taxes, dividends, andother kinds of contributions that are 20–30 per cent higher than those of non-SHEs. Third, some enterprises were converted into SHEs primarily for thepurpose of raising funds. After the conversion, the funds were used for specu-lative investments in property and stock markets while management was left


Table 3.4 Performance of China’s industrial shareholding enterprises*

1993 1994 1995 1996 Change (%)

1993/94 1994/95 1995/96

Number of loss-making 276 650 N.A. N.A. 135.5 N.A. N.A.SHEs

Gross industrial output 146 291 273 328 99.6 –6.4 20.1(billion yuan)

Industrial value added 46 84 78 95.3 83.3 –7.9 22.2(billion yuan)

Profit and tax generated 24.6 42.6 36.6 37.8 73.1 –14.1 3.3(billion yuan)

Note: * Enterprises include only industrial SHEs with an independent accounting system.

Source: various issues of ZGJTN and ZTN.

in the old style. Fourth, the supervisory mechanism stipulated in the CompanyLaw failed to perform its function of checking the power of board chairs andgeneral managers. Moreover, the new supervisory organs conflicted with theold ones, and there was no clear rule on how to ‘harmonize’ their relationship(Tung, 1996; Xue, 1996; ZJTGN, 1994, p. 232; 1996, pp. 119–20).

If, as argued earlier, the shareholding system reform is a form of privatiza-tion, then its initial results seem to conflict with the liberal economics viewthat privatization is a panacea for China’s SOEs. Yet, advocates of privatiza-tion may argue that the problems with the reform have arisen because theprivatization involved has been inadequate and too slow. For them, the ulti-mate solution to China’s industrial inefficiency lies in further and more rapidprivatization. It is not our purpose to enter into this debate. Rather, our inten-tion is to show that, after more than a decade of various attempts, by 1997 aprivatization programme under the name of shareholding system had emergedas China’s mainstream SOE reform scheme.

While the above seems to suggest that the Chinese path of industrial reformis converging with the international trend of privatization, the Chinese routehas demonstrated its own characteristics. Like the other post-Mao reformssuch as those concerning prices and currency, the evolution of the sharehold-ing system has been gradual and incremental.9 More interestingly, theintended merge of state and corporate shares with individual shares parallelsthe unification of dual prices and multiple currency structures. The three casesindicate a common feature of reform in China, which is that Chinese reform-ers will not tackle a problem with only one programme. Rather, severalplanned or spontaneous options are attempted simultaneously. The coexistenceof different schemes, characterized as ‘dual-track transition’ (Fan Gang,1994), did cause chaos and breed profiteering in all three cases. But as eachoption produced its own beneficiaries, the one that emerged as the winnertends to be the one that had the most supporters. This utilitarian approach ofpursuing the ‘greatest happiness for the greatest number’ has helped China toidentify a reform path that has met the least political resistance. Chinesereformers do not need to read the advice, such as that given by the World Bank(1995a, pp. 175–76), that SOE reform must be ‘politically desirable’ and‘politically feasible’ to be successful. For them, this is simply common sense.

POST-1997 DEVELOPMENT

After the official endorsement of the shareholding system as the mainstreamreform programme in 1997, previously established SHEs continued to beurged to reform their governance structure in accordance with the CompanyLaw. This was in recognition of the situation that many existing SHEs were


still not ‘standardized’. By the end of 1998, it was reported that a modern‘legal-person governance structure’ had been installed in most of the SHEs.The enterprises were also required to make sure that their share issuances werein accordance with the Securities Law, which came into effect in 1999. Alsoin that year, the Fourth Plenary Session of the Fifteenth Central Committee ofthe Chinese Communist Party decided to further transform SOEs into SHEs,as part of the effort to ‘explore actively various effective forms of realizingpublic ownership’ (ZJN, 1998, p. 721; 1999, p. 742; 2000, p. 728).

Under such party policy, in 2000 the State Economic and TradeCommission of China issued a document that set out ‘basic standards’ forinstallation of a modern corporate system in large and medium-sized SOEs.According to it, ‘except for enterprises wherein state monopoly should bemaintained, other large and medium-sized SOEs should also be graduallyreformed into limited companies and SHEs with multiple ownership’. And in2000–01, a programme of ‘debt-for-equity’ swaps was introduced, whereby alarge number of enterprises in heavy debts were required to convert, in accor-dance with the ‘basic standards’, into limited companies and SHEs (ZJN,2001, p. 795; 2002, p. 713).

In such a way, from 1997 to 2001 the number of SHEs more than tripledfrom about 72 000 to over 300 000.10 Moreover, the shareholding systemreform which originally took place mainly in the manufacturing and construc-tion sectors expanded into the service industry. Since 2002, increasingnumbers of SOEs in the financial, military, cultural, health, and transportationsectors have been converted into SHEs (ZJN, 2003, p. 700; 2004, p. 847; 2005,pp. 873–4; 2006, p. 925; 2007, p. 822). That is to say, since 1997 the share-holding system has been promoted at the national level to cover basically allsegments of the economy. Finally, in 2005 a ‘share conversion’ programmewas introduced, which probably marked the final step of the shareholdingsystem reform as the Chinese form of privatization. We come back to this indetail in Chapter 7.

NOTES

1. Detailed analyses of these various reform schemes can be found in Broadman (1995), Byrd(1991), Chai and Docwra (1997), Hay et al. (1994), and Peter Lee (1987).

2. For another discussion of China’s economic reform in terms of changes in property rights,see Walder (1994).

3. More specifically, 68 of the 100 SOEs selected for the corporatization experiment havechosen the wholly stated-owned LLC as their legal organization form (JS, 23 November1997).

4. Unless stated otherwise, this section is based on ZJTGN, various issues.5. This qualification frequently appears in Chinese discussions on the shareholding system

reform, indicating the absence of an official statistical system to cover SHEs. In fact, asNaughton (2007, pp. 301–302) noted, despite Chinese statisticians’ effort to collect infor-


mation on changes in the country’s structure of state ownership, there has been a lack ofaccurate data to reflect the process of privatization through the shareholding system reform.

6. One year before this, Premier Li Peng, who used to be opposed to the shareholding system,gave unexpected support to the reform. His sudden change of position raised ‘unansweredquestions about the decision-making process’ in China (You, 1995, pp. 40–41).

7. For details of the evolution of the shareholding cooperative system, see Yao (1996).8. STAQS was subordinated to the State Commission for Restructuring the Economy, and

NETS to the People’s Bank of China (XB, 18 July 1994).9. The gradualism and incrementalism of the Chinese reform have been well analysed in two

major studies, one by a political scientist (Shirk, 1993) and one by an economist (Naughton,1995).

10. There is a lack of accurate statistics on the size of the Chinese shareholding sector. In 1993,there were reports that China had designed a new statistical system in which shareholdingenterprises would be classified under a separate category (CEN, 11 January 1993, p. 13;ZBN, 1993, p. 237). However, official comprehensive data on this sector are still absent. TheAlmanac of China’s Economy (ZJN) does contain annual data on the number of industriallimited SHEs and their total asset value; but there is no similar information on non-industrial SHEs.


4. The role of spontaneity and stateinitiative in the shareholding systemreform1

INTRODUCTION

At the 15th Chinese Communist Party Congress held in September 1997, theshareholding system (‘gufenzhi’) was endorsed as the ‘mainstream reformprogramme’ for the Chinese state-owned enterprises (SOEs) (MB, 12September 1997). The decision came twelve years after the first industrialshareholding enterprise (SHE) appeared in the small, light-industrial city ofFoshan, located in south China. It was a spontaneous attempt made by theworkers of the factory. Ironically, this pioneer enterprise was also the firstindustrial enterprise in the city to declare bankruptcy, shortly before the offi-cial approval of the shareholding system at the national level.

How could a reform programme be adopted right after its first experimenthad failed? What implications does the case have for our common perceptionof China’s trial-and-error approach to reform? Does it show that the strategyof ‘groping for stones to cross the river’, as often cited by Chinese leaders, isor is not working? If incrementalism is the best way to describe China’s tran-sition, what actually happened during the incremental period? Most impor-tantly, what role have spontaneity and the state played in deciding the finalreform plan?

In this chapter, we tackle the above questions by focusing on the relationbetween spontaneous attempt and state promotion. The chapter first situatesthe issue in a theoretical context defining the role of the state in the reform.Two contrasting images of the Chinese state are be identified, and from eacha hypothesis is derived about the relative importance of spontaneity and statepromotion as providing the major impetus for economic changes. This isfollowed by a detailed examination of three cases in Foshan, including theabove-mentioned first industrial SHE in China. Based on the empirical find-ings, we argue that although the Chinese state has been dysfunctional in someaspects, particularly at the local level, it has been strong enough to play adevelopmental role. The basic impetus for change has come mainly from thecentral government. Local authorities have helped implement the central

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policy, though with some distortions. Early spontaneous attempts have notplayed any significant role in defining the final reform programme.

CONTRASTING IMAGES OF THE CHINESE STATE

The role of the state has long been a central concern of political economy. Theemergence of welfare economics, Keynesian interventionism, and Marxistsocialism culminated in a widespread extension of the role of the state ineconomic activity in the immediate post-World War II period. The intellectualclimate began to change in the late 1960s. A stream of neo-liberalism emerged,forcing the state to reduce its economic role. However, a call for ‘bringing thestate back in’ appeared in the mid-1980s, leading to a revival of academicinterest in the role of the state in economic change. The debate has been infavour of an autonomous and effective state, seeing it as a necessary conditionfor successful economic transformation (Chang and Nolan, 1995; Deane,1989; Evans, 1995; Evans et al. (eds), 1985; Haggard and Kaufman (eds),1992; Migdal et al. (eds), 1994; Naastepad and Storm (eds), 1996).

In the literature on China’s reform, there are two contrasting images of theChinese state. The first is a strong state perspective, and the second a weakstate perspective.

Strong State Perspective

According to the strong state perspective, the Chinese state has successfullytransformed itself from a Maoist totalitarian state into an East-Asian-typedevelopmental state. Developmental states, as defined by Leftwich (1995,p. 401), are ‘states whose politics have concentrated sufficient power, auton-omy and capacity at the center to shape, pursue and encourage the achieve-ment of explicit developmental objectives, whether by establishing andpromoting the conditions and direction of economic growth, or by organizingit directly, or a varying combination of both.’

Most of the discussions on developmental states have been based on EastAsian experience, and it is also within the East Asian context that the conceptof developmental state was applied to China. According to White and Wade(1988), East Asian countries such as Taiwan and South Korea are exemplarsof ‘capitalist guided economies’. By guiding the development of a capitalistmarket, the Taiwanese and South Korean governments performed the impor-tant functions of developmental states. In China, White and Wade argued, themajor theme of the reform has been to shift the balance between the state andmarket in favour of the latter. The direction of change is towards a ‘socialistguided market’. While basic-level units of production have been granted

The role of spontaneity and state initiative 43

greater power to make decisions according to market considerations, the statehas continued to be interventionist by defining the goals, priority, and paths ofdevelopment. In this process the socialist state structures play the positive roleof developmental state ‘in raising the rate of investment, generating and focus-ing scarce resources, defining and directing strategic changes in the industrialstructure, regulating international ties, generating overall political support andestablishing a social structure favorable to accumulation ‘ (p. 15). In such away, the ‘capitalist guided economies’ in Taiwan and South Korea and the‘socialist guided market’ in China are grouped under the same category ofdevelopmental state.

According to Unger and Chan (1996), the Chinese developmental stateworks through a three-tier corporatism.2 At the national level, there is ‘peakcorporatism’ that emphasizes strong though indirect state control of the desig-nated organizations; at each lower layer of regional government – theprovince, city, county, township and village – there is ‘regional corporatism’by which the regional government organizes power among associations oper-ating at that level; finally, a form of ‘micro-corporatism’ is emerging in somestate enterprises to mediate between management and workers.

For Jean Oi, it is regional corporatism that has been the driving force ofChina’s economic growth. She agreed that the essence of developmental statelay in an appropriate balance between state intervention and market; however,effective state intervention need not come from the centre: ‘[t]here is a needfor strong state capacity, but this capacity should exist at both the local and thecentral levels’ (Oi, 1995, p. 1147). In the case of China, state intervention hasbeen most effective at the local level. Oi called this phenomenon ‘local statecorporatism’, which refers ‘to the workings of a local government that coor-dinates economic enterprises in its territory as if it were a diversified businesscorporation’ (Oi, 1992, pp. 100–101; original italics). Such local state corpo-ratism, according to Oi, ‘is a qualitatively new variety of developmental state’(Oi, 1995, p. 1133).

The strong state perspective would hypothesize that economic changes aremainly the result of active state intervention. The state plays the developmen-tal role of identifying the major priorities, mobilizing resources and intereststo achieve the goals, and regulating the changes. While the central state seeksto create a macro environment that is favourable to the reform, regionalauthorities actively promote the development agenda at the local level.Workers’/managers’ initiatives, if any, are screened by the state; those that arein line with the state’s development strategy are co-opted into the nationalreform programme, while those that are not are suppressed or neglected. Inshort, the state is in charge, and spontaneous attempts play only a secondaryrole.


Weak State Perspective

The weak state perspective regards the Chinese state as experiencing a trendof ‘serious decay’ that began in the 1960s. According to this view, the trau-matic events of the Cultural Revolution destroyed the existing institutions ofpolitical control, and the Maoist preference for political loyalty over technicalability resulted in an incompetent bureaucracy. The post-Mao reform hascaused unintended effects that have produced an ‘erratic state’: ideology haslost its mobilization power; old institutions have been eroded without replace-ment; central authority has been challenged by local and regional interests;and state governance has been undermined by rampant corruption (Pye, 1990;Schram (ed.), 1987; Walder (ed.), 1995).

As regards the notion of a developmental state, Breslin (1996) argues thatChina is not a developmental state in many respects, including the bias of theeconomic reform in favour of the political interest of the ruling elite; its lackof knowledge and experience in utilizing and controlling market mechanisms;and the existence of conflicts among elites over the content and direction ofthe reform. Not only is the Chinese state not developmental, according toBreslin, but also the country has been suffering from ‘dysfunctional develop-ment’ in three ways. In the first place, political demands from within the party-state and other societal groups have undermined the relative autonomy of theChinese state, making it unable to formulate a coherent and effective nationaldevelopment strategy. Second, the decentralization of decision-making powerdown to the local level has weakened the central state’s ability to coordinatenational development. Finally, as a result of the open-door policy, China’snational development strategy has now been subject to the influence of thecountry’s external economic relations. Hence, in Breslin’s view, it would be amistake to conceptualize China as a developmental state.

Similarly, McCormick (1996) argues that the Chinese state is fundamen-tally different from the developmental states of Taiwan and South Korea.According to him, a real developmental state should be ‘hard’ not only in itsexercise of effective authority to promote economic growth, but also in itspossession of technical competence and the commitment to national goals thatoverrides the temptation of corruption. While the Chinese state is rather ‘hard’in the authoritarian sense, it lacks the technical capacity and political auton-omy required to manage economic development in the manner of the devel-opmental states of South Korea and Taiwan. Moreover, the central authoritiesin China are unable to impose discipline on the local authorities in a range ofcritical issues. The Chinese state is thus, in McCormick’s view, not develop-mental.

The weak state perspective would hypothesize that the state fails to presenta well-designed reform blueprint. It lacks the technical as well as institutional


strength required to implement a reform programme effectively. The directionof change is unclear, and there is a lack of commitment to development on thepart of state officials. Workers’/managers’ initiatives are free to emerge, andthe state reacts passively to each new change. If anything resembling a reformprogramme exists, it is nothing more than an aggregate of individual sponta-neous attempts. In short, the state does not play any developmental role, andchanges, good or bad, are mainly the result of spontaneity.

SHAREHOLDING SYSTEM REFORM IN FOSHAN3

The essence of China’s shareholding system reform was to convert SOEs intoSHEs. Shares were issued to the state, legal-entities, and individuals. This hasmade it possible for private individuals to acquire at least partial ownership offormerly completely state-owned enterprises. In fact, under the shareholdingsystem the relative share of state ownership has been in decline. As argued inChapter 2, the reform blueprint was tantamount to privatization, despiterepeated denials by the top leadership because of ideological concerns. Then,given such political sensitivity of the programme, how could it emerge? Whoinitiated it in the first place? Was it a spontaneous attempt, or a careful designby the state? To answer these questions, in June 1998 the author made a seriesof research trips to Foshan, the birthplace of China’s shareholding systemreform.

Foshan is located at the southern part of Guangdong Province, about 200kilometres northwest of Hong Kong and the Shenzhen Special EconomicZone. The city spreads over 77 km2, with a population of 430 000.Administratively, Foshan is a ‘district-level city’ (diji shi) consisting of twourban districts and four ‘county-level cities’ (xianji shi). As such, it has lessautonomy than Shenzhen, which is of ‘semi-provincial level’ (fu sheng ji)(SAO (ed.), 1997, p. 1).

Like most other coastal areas in China, Foshan has achieved dramaticeconomic growth since the late 1970s. From 1978 to 1995, its per capita grossdomestic product (at current prices) increased at an average annual rate of 17per cent, and per capita savings at 35 per cent. During this period, the share ofindustry in gross output value rose from about 50 per cent to 95 per cent (seeTable 4.1). Such rapid industrialization was achieved through specialization inlight industries including electronics, textiles, and ceramics. By 1994,Foshan’s per capita gross domestic product had reached 14 400 yuan, the sixthhighest in the country. Most households, including those in the villages,possess their own television sets, refrigerators, washing machines, air-condi-tioners, and telephones. In short, Foshan has emerged as one of the wealthiestcities in China (FMPCPD and FD (eds), 1997, pp. 6–15).


Nevertheless, Foshan has not been part of China’s economic core. Most ofthe state enterprises in the city are owned by the municipal government andrarely by the central or provincial authorities. With light industry accountingfor over 60 per cent of gross industrial output, Foshan has received onlylimited central capital support, which has been prioritized for heavy industrialand infrastructural development. According to the ninth national Five-YearPlan (1996–2000), Guangdong Province was to concentrate on the develop-ment of automobile, petrochemical, machinery, and electronics industries.Foshan has been weak in most of these selected key sectors (FMPCPD and FD(eds), 1997, p. 163; FPCC and FU (eds), 1994, p. 9; Lu and Ding (eds), 1998,p. 49; Zhou, 1997, p. 3).

Initial operations of the shareholding system reform began in Foshan in1982. Most of them took the forms of inter-enterprise investment, joint-stocktownship and village enterprises, and Sino–foreign joint ventures. In that earlystage, the issuing of shares to individuals was rare, particularly among indus-trial enterprises (FR, 25 November 1987). In January 1986, the ShengpingDepartmental Store in Foshan was made the first and only one retail firm inthe city to try the shareholding system. Although Shengping achieved remark-able improvement in its economic performance after the reform, its experiencewas not extended to other enterprises due to ideological reasons. This changedonly after the 13th Party Congress, held in October 1987, at which the thenParty Chairman, Zhao Ziyang, provided theoretical justification for the share-holding experiment. According to Zhao, since China was still at an ‘initialstage of socialism’, the dominant state sector should be supplemented by otherforms of ownership. Specifically, the shareholding system was recognized as


Table 4.1 Major economic indicators of Foshan

1978 1995 Averageannualgrowth

(%)

Gross domestic product (current price; billion yuan) 1 52 18.6Per capita gross domestic product (yuan) 577 16 800 16.8Gross industrial and agricultural output value 4 109 19.8

(constant price; billion yuan)Gross industrial output value (billion yuan) 2 104 23.2Gross agricultural output value (billion yuan) 2 5 6.2Per capita bank savings (yuan) 70 15 100 34.8Average wage (yuan) 587 9 065 16.4Per capita agricultural income (yuan) 227 3 920 17.1

Source: FMPCPD and FD (eds), 1997, p. 13.

‘a form of organizing assets of socialist enterprises’, and hence the experiment‘could continue’. In April 1988, the Foshan municipal government organizeda public seminar to discuss the feasibility of issuing shares by enterprises, anidea that had once been banned as ‘capitalist’ (FN, 18 November 1987, 18April 1988; ZBN, 1988, pp. 98–99).

The shareholding experiment suffered a political setback following thedownfall of Zhao and his associates in summer 1989, as mentioned in Chapter3. The reform in Foshan was halted accordingly. It was the paramount leaderDeng Xiaoping’s high-profile ‘southern tour’ in January 1992 that revived theshareholding experiment. Local party leaders and government officials inFoshan followed Deng’s call for an open mind toward the shareholdingsystem. By October 1992, a total of 27 large and medium-size enterprises inthe city had been approved by the provincial government to be converted intoSHEs, and eleven of them had issued internal shares to the workers. Inducedby the stock fever in Shenzhen, some Foshan enterprises issued internal sharesto the public, followed by speculative trading of the internal shares, in defi-ance of the State Council’s ban on such activities. The illegal practices weresubsequently banned by the Foshan municipal government. On the other hand,the local authority established a guideline for the shareholding system reform:‘dare trying, look for quality but not quantity, and avoid chaos’. Finally, the15th Chinese Communist Party Congress, which endorsed the shareholdingsystem as the national SOE reform program, provided further impetus to thereform. Enterprise directors and managers in Foshan praised the Congress forconfirming the ideological legitimacy of the shareholding system (FR, 1 April1992, 21 April 1992; 7 August 1992; 31 October 1992, 11 December 1992; 26September 1997).

In short, the fate of the shareholding system reform in Foshan was condi-tioned by the larger political environment. This can be further illustrated byreviewing the annual work reports of the Foshan municipal government (seeTable 4.2). The shareholding system reform was first mentioned in the 1987report, when the reformist leader Zhao was promoting his theory of ‘initial stageof socialism’. The reform disappeared in the 1990 report, following the politicalunrest in the summer of 1989. The scheme reappeared and was given moreconcrete terms in the 1992 report, after Deng’s ‘southern tour’. Since then theshareholding system has been included as a regular item in the annual report.

In the following, we describe how the shareholding scheme has been testedin three industrial enterprises in Foshan. The first, the Foshan First RadioFactory, was the first industrial SHE in China.4 It was a case of a spontaneousand failed attempt. The second, the Foshan Tongbao Shareholding LimitedCompany, and the third, the Foshan Electrical and Lighting Co. Ltd., are boththe examples of state-led and successful reform. The former tried the ‘internalshareholding system’, while the latter the ‘public shareholding system’.


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Table 4.2 Notes on the shareholding system reform made in the Foshan municipal government annual work reports

Date of delivery Review of previous year’s achievement Next year’s work targetof the report

8 April 1986 Nil Nil15 May 1987 ‘The shareholding experiment was launched Nil

among large- and medium-size SOEs.’10 May 1988 Some enterprises ‘tried the shareholding system.’ ‘To actively promote the shareholding system.

Enterprises that fulfill the necessary conditions, uponapproval, may issue public shares and bonds.’

5 May 1989 ‘Continued to introduce the shareholding ‘To use the shareholding system as a means toexperiment. Some enterprises issued public rationalize the interest relations among the state, bonds with approval.’ enterprises, and workers.’

17 April 1990 Nil Nil26 April 1991 ‘The shareholding system was tried in selected ‘To actively and stably experiment with the

enterprises.’ shareholding system reform.’18 March 1992 ‘Strengthened theoretical research in the ‘To actively introduce the shareholding experiment

shareholding system reform, and began initial and to develop the stock market. To select thoseplanning for the introduction of the reform.’ enterprises or groups that fulfill the necessary

conditions to adopt shareholding transformation, and invite other enterprises and internal workers to buy theshares. To establish a batch of stock issuers and brokers, in order to be prepared for further development of the stock and securities market.’

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Table 4.2 Continued

Date of delivery Review of previous year’s achievement Next year’s work targetof the report

13 April 1993 ‘Actively and stably promoted the internal ‘To use the shareholding system to speed up theshareholding system. With provincial approval, conversion of enterprises’ internal shares, and to36 enterprises in the city have been identified strive for gradual transformation of one-third of the for the internal shareholding system large- and medium-size state-owned enterprises intotransformation, and 30 enterprises have been shareholding enterprises with legal-entities as the reformed into shareholding enterprises.’ major shareholder.’

26 April 1994 ‘Forcefully promoted the shareholding system ‘To continue to expand and standardize thetransformation. The city has already established shareholding system experiment; … to introduce the 36 shareholding companies, with a total capital of shareholding reform among selected enterprises that8.8 billion shares that could raise 3.6 billion yuan. are of high quality, large scale, and those that fit into(Several enterprises) have been publicly listed.’ the state’s manufacture policy.’

28 March 1995 ‘Organized and established standardized ‘To promote various forms of modern corporates shareholding enterprises.’ (including shareholding limited companies).’

7 May 1996 ‘Organized and established standardized ‘To vivify enterprises through different forms of shareholding enterprises, and released part of the enterprise reform, including the shareholding system.’share ownership to foreign investors and workers.’

9 April 1997 ‘The city has 33 standardized shareholding ‘To standardize, according to the Company Law,enterprises.’ enterprises that have been transformed (into modern

corporates, including shareholding companies).’

Sources: FR, 23 April 1986; 15 May 1988; 23 May 1988; 26 May 1989; 2 May 1990; 26 April 1991; 27 March 1992; 22 April 1993; 6 May 1994; 28 March1995; 15 May 1996; 17 April 1997.

The Case of Spontaneous Shareholding Reform: Foshan First RadioFactory

The Foshan First Radio Factory was established in the 1960s, specializing inthe production of audio-visual equipment and supplies. It was one of the 100key enterprises under the Ministry of Machine and Electronics. In the 1980s,the country’s rapid economic growth and the quick emergence of a middleclass led to a strong demand for household electrical appliances. The FirstRadio’s Diamond Brand products – including radios, recorders, laser-discplayers, televisions, and video-recorders – were highly popular, and won anumber of quality awards. The factory emerged as the largest maker of thisline of products in the country, and earned remarkable profits (FN, 1993, p. 94;1994, pp. 316–17; 1995, p. 288; FR, 17 August 1988, 9 September 1988, 31October 1988, 23 December 1991, 31 October 1997).

As the First Radio’s business was lucrative, workers in the factory wereinduced to invest in the factory in order to gain a share of the growing profits.On the other hand, being a light industrial enterprise that was not prioritizedto receive state support, the factory had to look for capital supply from othersources. Such a situation led to a spontaneous shareholding scheme thatconsisted of ‘state shares’ (guojia gu), ‘enterprise collective shares’ (qiye jitigu), and ‘individual worker shares’ (zhigong geren gu). It was a standard ‘OneEnterprise, Three Types of Owners’ (yiqi sanzhi) model:5

State shares The value of state shares was calculated as the sum of the netvalue of the fixed assets created by past state investment, of the after-tax prof-its earmarked for re-investment, and of the working capital received from thestate. This type of shares represented 95.7 per cent of the factory’s total capi-tal stock.

Enterprise shares Enterprise collective shares were converted from theretained profits that were designated for workers’ welfare and bonus use. Theyaccounted for 1.43 per cent of the total capital.

Worker shares Each worker was allowed to buy up to five individual workershares, each worth 100 yuan. The fund so raised constituted 2.87 per cent ofthe total capital.

According to the above scheme, the state shares were risk-free. Before thereform, the enterprise would submit to the state 55 per cent of its income astax. Now, the state would still be guaranteed that same amount of revenue, butin the form of return to state shares. In contrast, enterprise shares bore most ofthe risk. Their rate of return depended entirely on the financial result of the


enterprise’s operation. Worker shares received fixed interest calculatedaccording to the prevailing bank interest rate, plus an unguaranteed amount ofdividends depending on the availability of after-tax profits. In other words, byinvesting in the factory, workers could earn a return that would not be lowerthan what could be earned by saving the money in banks. Such a favourablearrangement for the workers was not surprising, given that the scheme origi-nated with them. In October 1985, the First Radio was converted into an SHE,making it the first large-size industrial enterprise in China to experiment withthe shareholding system. In January 1986, the restructuring was officiallyapproved by the Foshan Municipal Institutional Reform Office (FR, 5 March1986; Chen Youngzhong, 1991, pp. 165–66, 316–17).

Entering the 1990s, as China had passed its initial economic take-off stage,the growth of household demand for electrical appliances began to slow down.On the other hand, being one of the most popular producers of audio-visualgoods in the country, First Radio became the major target of competition ofother enterprises, including those in the industrially strong Shanghai. Facedwith the increasingly difficult domestic market, First Radio attempted toswitch to export. The initial result was favourable, and up to 1992 the factorycontinued to make profits (FR, 20 December 1989, 10 March 1990, 12December 1990, 10 March 1992; Zhou, 1997, pp. 3–4).

However, the situation began to change in 1993, when Zhu Rongji wasappointed new governor of the People’s Bank of China. Under Zhu’s austerityprogramme, the Chinese banks were ordered to impose strict credit control.This dealt a severe blow to First Radio, as its capital supply depended mainlyon bank loans. Being a light industrial firm in the ‘peripheral’ Foshan, FirstRadio had very little state investment but a high debt ratio. Deterioration of thefinancial condition of First Radio made the factory unable to pay dividends tothe workers. As the worker shares failed to yield to the workers a return higherthan the bank interest, the shareholding experiment was not mentioned anymore.

In August 1997, after several years of difficult operation, First Radiodeclared bankruptcy. Three months later the factory’s assets were auctionedfor 71.5 million yuan. At the time of bankruptcy, the factory had a staff ofabout 1000. Those who were still holding the worker shares asked for abuyout. Their demand was met, and the city government spent about 500 000yuan to redeem the shares, presumably from the proceeds of the auction. Thefact that the worker shares received guaranteed higher-than-bank-interestreturn when profits were available, and were redeemable when the factoryliquidated indicated that the ‘shares’ were more like bonds than stock (FR, 31October 1997; 7 January 1997).

The closure of First Radio was publicized in the local newspaper as the firstcase of bankruptcy and auction of an industrial enterprise in Foshan. However,


the fact that First Radio was the first industrial SHE in China was notmentioned, in order not to hurt the then national promotion of the sharehold-ing system. Subsequently, the model initiated by First Radio was banned.Rather than being regarded as a kind of spontaneous reform attempt, the prac-tice has been called ‘illegal fund raising’ (feifa jizi).

The Case of State-led ‘Internal Shareholding System’: Foshan TongbaoShareholding Limited Company

The Foshan Tongbao Shareholding Limited Company was originally theFoshan Mould Factory, established in 1966 with less than 30 workers. Afterten years of small-scale production of simple mouldings, the factory wasordered by the state to switch to make spray nozzles, despite the fact that it didnot have the technology nor market knowledge in this line of product. In 1982,the factory was on the brink of bankruptcy. It survived only on a state subsidy(FR, 6 December 1993).

In 1985, the state granted Foshan Mould Factory permission to determineits own market orientation. After careful research, the factory switched tomake thermostats for rice-cookers. The new product was very well received,immediately turning the factory’s long-term losses into profits. In that year, theenterprise was re-named Foshan Temperature Control Device Factory. Itsubsequently moved to manufacture higher value-added products, includingthermal sensors for refrigerators and air-conditioners. By 1992, the factory hademerged to be one of the largest producers of this equipment in the country,controlling about half of the domestic market. It was one of the 28 Foshanenterprises that produced an annual output value of over 100 million yuan, andprofit and tax of over 10 million yuan (FR, 14 January 1993; 11 March 1993).

In 1992, after Deng’s call for further economic reform, the Foshan citygovernment began searching for high-quality enterprises for the shareholdingsystem reform. Being one of the most profitable firms in the city, FoshanTemperature Control Device Factory was selected to experiment with the‘internal shareholding system’ (neibu gufen zhi), under which the shares couldonly be traded among the workers but not sold to the public. Initially, bothmanagement and workers of the factory were hesitant about the state’s call forchange. The managers were concerned that the conversion would mean stricterregulatory control of the enterprise, and the workers were unsure about theimplications of the change for their jobs and incomes. To persuade the factoryto adopt the proposed reform, Foshan officials held a number of meetings withthe managers and workers, and granted tax concessions to the enterprise.6 Onthe other hand, the managers were attracted by the fund-raising function of theshareholding system. The factory finally accepted the city government’s nomi-nation as one of the first experimental SHEs in Foshan. In 1993, with the


provincial government’s approval, the factory was made a formal SHE, andwas renamed Foshan Tongbao. Profits have grown remarkably since thechange, and the enterprise has been widely promoted as a successful case ofthe shareholding experiment (FR, 14 January 1993; 29 July 1993; 6 December1993; 14 February 1994; 25 March 1994; 8 April 1994; 14 February 1996; 16August 1996; 1 March 1997; 17 June 1997).

At the time of founding, Foshan Tongbao had a total capital of 36 millionyuan, divided into the same number of shares. The capital structure wasdivided as follows:

State shares The total net value of the assets (except land) of the old FoshanTemperature Control Device Factory was converted into 18 million stateshares, representing 50 per cent of the total capital of the new FoshanTongbao. The state shares were held by the Jing Zhao Corporation, a businessagent of the Foshan State Property Bureau.

Legal-entity shares A total of 10.8 million shares were issued to severalother enterprises, forming 30 per cent of the total capital. The largest legal-entity shareholder was an enterprise established by some former workers ofFoshan Tongbao.

Worker shares Workers who had worked in the factory for over three yearswere allowed to buy up to 3000 worker shares, and those who had worked forover five years were allowed to buy up to 6000 shares. As there was no guar-anteed return to the shares, workers’ response to the offer was mild.Nevertheless, the enterprise managed to issue 7.2 million worker shares, rais-ing 20 per cent of the total capital.

As an experiment of the ‘internal shareholding system’, Foshan Tongbao hasnot been allowed by the state to list its worker shares in the Shenzhen Stockexchange, despite the company’s continuous applications for listing. Beingblocked from raising funds in the stock market, Foshan Tongbao resorted toissuing shares to foreign (mainly Hong Kong) investors and to stock allotment(pei gu, that is, issuing shares to existing shareholders). After several roundsof such new share issues, by 1998 total capital of the company had increasedto 99.8 million shares, and the capital structure had undergone the changesshown in Table 4.3.

The fact that foreign investors have emerged to be the second-largest share-holder has been because all the domestic shareholders – the state, the legal-entities, and the workers – lacked the capital to subscribe fully to the newshares issued in each allotment. As foreign shares have exceeded 25 per centof the total capital, Foshan Tongbao has become a Sino-joint venture SHE, and


could thus enjoy the preferential treatment available to this type of firm. Eventhough the foreign investors have been interested only in the profit and not inthe management of the company, the state has been concerned with the grad-ual loss of share of ownership to foreigners. To maintain its position as thelargest shareholder, since 1997 the state has required Foshan Tongbao toobtain prior approval before any further new share issues.

The Case of State-led ‘Public Shareholding System’: Foshan Electricaland Lighting Company Limited

The predecessor of Foshan Electrical and Lighting Co. Ltd. was the FoshanLight Bulb Factory, established in 1958. In 1979, the value of its annual outputwas merely five million yuan. That year, the factory abolished the life employ-ment system. Redundant workers were laid off, replaced by contract andtemporary labour recruited from the villages. Moreover, the egalitarian wagestructure was changed into a differential pay scheme based on productivity. In1980, the management was streamlined, and an annual performance evalua-tion scheme was introduced. The factory, renamed in 1984 as FoshanElectrical and Lighting, was among the first SOEs in the city to adopt this kindof labour reform. At the same time, strict disciplinary actions were takenagainst irregular activities such as over-invoicing and forgery. These measuresmade Foshan Electrical and Lighting one of the 500 most efficient enterprisesin China. In 1991, the company produced a total output valued at over 300million yuan, and generated more than 40 million yuan of tax and profits, thehighest of all light bulb producers in the country (FELCLAR, 1997, p. 1;FELCD, 1992; FR, 18 June 1992; 9 December 1992).

In 1992, in response to Deng’s call for a further reform of the shareholdingsystem, the Foshan city government named four enterprises to experimentwith the ‘public shareholding system’ (gongzhong gufen zhi), under which theshares could be listed for public trading. Foshan Electrical and Lighting, dueto its impressive record, was included as one of the four enterprises.7 It had afounding capital of 230 million yuan, 50 per cent of it being state shares


Table 4.3 Capital structure of Foshan Tongbao, 1993 and 1998

Shares 1993 1998(%) (%)

State 50 38Legal-entity 30 20Worker 20 12Foreign Nil 30

(converted from the total net value of the assets of the factory), 30 per centlegal-entity shares, and 20 per cent worker shares (FR, 3 August 1992; 29October 1992).

In 1993, Foshan Electrical and Lighting issued its first A-shares, or publiclylisted shares available to domestic investors, at the Shenzhen Stock Exchange.Several allotments were made to A-shareholders in subsequent years. In 1995,the company issued its first B-shares, or publicly listed shares available toforeign investors. In the same year, the worker shares that were issued whenthe company was founded were also listed as A-shares. By 1997, the capitalstructure had undergone the changes shown in Table 4.4 (FELCLAR, 1997, pp.6–7; FR, 10 August 1995; 30 September 1995).

Foshan Electrical and Lighting has been one of the most successful casesof the public shareholding system. In 1997, the company made a net profit of134 million yuan, compared to only 19 million in 1991 (FELCLAR, 1997,p. 19; FELCD, 1992). It won the award of Best Comprehensive Performanceamong the some 300 companies listed in the Shenzhen Stock Exchange.However, at the time when the city government named Foshan Electrical andLighting for the experiment, both the managers and workers of the enterpriseswere hesitant about the change, being uncertain as to the result. They finallyaccepted the state’s initiative, mainly because of the capital-raising function ofthe shareholding scheme.

In the subsequent issue of A-shares and listing of worker shares, the attitudeof the management and the workers became very positive, since more capitalcould be raised and the shares could become more liquid. Yet, the making ofFoshan Electrical and Lighting into a public SHE was still mainly the outcomeof the state’s decision rather than the enterprise’s initiative. In 1992 (that is, ayear before the public listing of the company’s shares), the Guangdong provin-cial government had a quota of five enterprises in the Shenzhen StockExchange. Foshan Electrical and Lighting was then ranked at the top of theshortlist, due to its high profitability and standard business practice.


Table 4.4 Capital structure of Foshan Electrical and Lighting, 1992 and1997

Shares 1992 1997(%) (%)

State 50 24Legal-entity 30 19Worker 20 (Listed as A-shares)A-shares Nil 30B-shares Nil 27

Like Foshan Tongbao, a clear trend in the capital restructuring of FoshanElectrical and Lighting has been the dilution of public ownership and expan-sion of private investment from domestic and foreign investors. This has beenthe result of the lack of capital of the state and legal-entities to maintain theiroriginal share of ownership in each round of new share issues. Although thestate was no longer the majority shareholder, it still had the controlling inter-est because the other shareholders were rather dispersed. Nevertheless, toavoid further decline of its ownership, since 1997 the state has required thecompany to obtain prior approval before any new share issue.

THE ROLE OF THE CHINESE STATE IN THE REFORM

China’s industrial shareholding system reform began with a spontaneousattempt by the Foshan First Radio Factory in 1985. The state authorities, bothcentral and local, did not play any role except by giving an ex post endorse-ment. This might tempt one to think that the 1997 national endorsement of theshareholding system represented the triumph of workers’/managers’ initiativeover state design. That is, the weak state perspective seemed to apply. Our casestudies, however, show that just the contrary is true.

We have no evidence as to whether the Chinese state authorities hadconsidered the case of First Radio before endorsing the shareholding systemas the national reform programme. But as the fundamental reason for the stateto launch the shareholding system was to improve the performance of theenterprise through the restructuring of ownership, the failure of First Radiosuggested that the model adopted by this particular factory should be avoided.In particular, the spontaneous shareholding reform, which tended to pass therisk from the initiators (workers and managers) to the enterprises, wascertainly not in the interest of the state. The Chinese state has been strongenough to prevent the practice from prevailing, by banning workers’ andmanagers’ spontaneous fund-raising activities. When the shareholding systemwas endorsed as the national reform programme, the experience of First Radiowas not mentioned at all, indicating that its early attempt was not regarded aspart of the shareholding experiment. The state defined not only the content, butalso the origin of the reform.

The transformation of Foshan Tongbao and Foshan Electrical and Lightinginto SHEs was the immediate result of Deng Xiaoping’s 1992 call for furtherreform. The direction of reform came from the central government. The localgovernment in Foshan responded immediately by naming two of the bestenterprises in the city for the experiment. There was no initiative from factorymanagers and workers. On the contrary, they were hesitant, as the new systemaffected their income and job security. Nevertheless, the local government


managed to obtain consensus through offering incentives to the targeted enter-prises, without resort to an administrative order. It has also been able to sepa-rate the two enterprises for the different types of experiment: ‘internalshareholding system’ and ‘public shareholding system’, despite FoshanTongbao’s continuous request for switching from the former to the latter. Thestate, both central and local, has been in charge of the whole process.

Our case studies show that the Chinese state has been successful in leadingSOEs to accept the challenges of market forces. As Chen A. (1998) noted, amajor obstacle to China’s economic reform has been the inertia of the enter-prises and their dependence on state protection. The spontaneous reform ofFirst Radio was not an indication of entrepreneurship;8 rather, the workers ofthe factory simply sought to earn higher income without bearing any risk.When Foshan Tongbao and Foshan Electrical and Lighting were invited toshare the profit as well as the risk with the state, the managers and the work-ers hesitated. By persuading these model enterprises to participate in the share-holding experiment and by promoting their success, the state set examples toother SOEs that risk-taking might pay.

Apart from defining the direction of the reform, the central state has devel-oped a regulatory framework for the new system. As mentioned in Chapter 3,in May 1992 the central government promulgated fourteen documents to guidethe reform, including the ‘Measures for the Experimentation of theShareholding Enterprises’, ‘Opinions on the Standardization of LimitedShareholding Enterprises’, and ‘Opinions on the Standardization of LimitedCompanies’. Though not official laws, these guidelines were used to re-exam-ine and re-endorse previously established SHEs. In the same year, the StateCouncil formed the Securities Commission and the China SecuritiesRegulatory Commission to monitor development of the securities market. In1994, the Company Law was endorsed as the official legislation to regulateSHEs. Previously established SHEs were required to be ‘standardized’ (guifanhua) in accordance with this new law.

In short, the Chinese state played a developmental role in reforming theshareholding system. It defined the overall direction of reform, provided polit-ical momentum to the change, and mobilized enterprises to participate. Theearliest, spontaneous attempt, which was inconsistent with the general frame-work of the national reform programme, was allowed to go bankrupt, whileother similar fund-raising activities were outlawed. A regulatory frameworkgradually emerged under the state’s auspices. Spontaneity was suppressed, andthe state took the initiative. The strong state perspective thus prevailed.

Nevertheless, this is not to say that the Chinese state is developmental in allrespects. It also exhibits dysfunctional features. The state’s objective ofachieving economic efficiency through ownership reform has beenconstrained by socialist ideology, and its autonomy in conducting the share-


holding experiment depended on the macro political environment. Lacking thetechnical capacity and institutional strength to ensure a smooth introduction ofthe reform, the shareholding system has led to an unintended dilution of stateownership.9 The trial-and-error, incremental approach seemed more like apassive response to unforeseen problems, than an actively planned strategy.

The Chinese state has been particularly dysfunctional at local levels. Whileour case studies demonstrate the positive role played by the Foshan officialsin introducing the reform of the shareholding system in the city, there havebeen reports that the local government has not been very active in promotingthe programme (Lu and Ding (eds), 1998, p. 65). More importantly, some localauthorities have manipulated central government policies to their advantage.For example, to control the pace of the reform of the shareholding system, thecentral government has maintained a separation between ‘internal sharehold-ing system’ and ‘public shareholding system’. An annual quota, dividedamong regions, was issued for the conversion of internal SHEs into publicSHEs. However, entrusting power to local authorities to fill up the quotas hasbred corruption. While the earlier public SHEs were listed in recognition oftheir remarkable performance, many of the more recent ones, based on infor-mation obtained from our fieldwork, became listed companies only by payinga ‘standard price’ to local officials. This means that the reduction of thestrength of the Chinese state from the central to local levels challenges thenotions of ‘regional corporatism’ (Unger and Chan, 1996) and ‘local statecorporatism’ (Oi, 1992, 1995).

Our case studies also show a gradual loss of state ownership to foreigninvestors. This is consistent with the general trend of increasing foreign partic-ipation in China’s shareholding system reform. However, as will be argued inChapter 5, this has not been the result of the influence of foreign investors onthe Chinese government to grant them better access to state assets. Rather, itwas the local officials and enterprise managers that have been most active inselling shares to foreign investors. Hence, contrary to the classical dependencyanalysis, there is little indication that the Chinese state has become a mereagent of the capitalist center. It is largely the local agents rather than foreigncapital that have weakened the developmental capacity of the Chinese state.This alerts us to the tendency of the dependency analysis of placing too muchemphasis on the role of the central state, neglecting the influence of localactors.

Overall, despite some dysfunctional aspects, particularly at the local level,the Chinese state has been strong enough to play a developmental role in theevolution of the shareholding system. Spontaneous attempts have beenreplaced by state-led incremental reform. For further theoretical generaliza-tion, it may be useful to compare our conclusion with the Russian case, wherespontaneous privatization took place almost immediately after the collapse of


the Soviet regime. Some scholars have argued that the difference in the formand speed of privatization in China and Russia can be attributed to the pres-ence of a strong state in China, and a weak state in Russia (Burawoy, 1996;Roland, 1995). A more careful comparison of China’s shareholding systemreform and Russia’s privatization, focusing on the role of the state, may furtherour understanding of the explanatory power of the state in explainingeconomic changes.

NOTES

1. The author is indebted to the South China Programme, Hong Kong Institute of Asia-PacificStudies, Chinese University of Hong Kong, for providing financial support for the researchwork for this chapter.

2. There have been numerous definitions of corporatism. The most widely used one, offered bySchmitter (1974, pp. 93–94), says that corporatism is ‘a system of interest representation inwhich the constituent units are organized into a limited number of singular, compulsory,noncompetitive, hierarchically ordered and functionally differentiated categories, recognizedor licensed (if not created) by the state and granted a deliberate representational monopolywithin their respective categories in exchange for observing certain controls on their selectionof leaders and articulation of demands and supports.’

3. Unless stated otherwise, all information in this section is obtained from interviews, conductedin June 1998, with Foshan officials and factory managers. The present author is indebted tothe late Professor Lin Dahui, former Dean of Business School, Foshan University, for arrang-ing some of the interviews, and sharing with the author some invaluable information from hispersonal collection. This project would not have been completed without Professor Lin’ssupport. His enthusiasm in promoting research activities and academic exchanges will beremembered. This section also contains information gathered from numerous issues ofFoshan Daily. Three former students of the author – Tse So Han, Tsoi Hung Ping, and WattWai Yeung – rendered excellent research assistance in this regard.

4. The Shengping Departmental Store mentioned above was a commercial SHE, whereas FirstRadio was an industrial one. Our focus is on the latter type SHE.

5. China’s early shareholding enterprises fell under four basic models, and the ‘One Enterprise,Three Types of Owners’ model was the most common one. See Chapter 2.

6. The standard profit-tax rate on SHEs was originally proposed at 33 per cent. After negotia-tion, the rate was reduced to 15 per cent, which was the same as that applicable to SOEs.

7. The three other companies being Foshan Porcelain Company, Foshan Plastic MaterialsCompany, and the Xinghua Commercial Group.

8. This seems to disagree with the ‘entrepreneurial state’ thesis. See Duckett (1998).9. For details of such trends, see Chapter 3.


5. Foreign participation in China’sprivatization and the role of the state

According to World Bank statistics, during 1988–93, 2655 privatization trans-actions were recorded in 93 countries. Total sales revenue amounted toUS$271 billion. Of this worldwide privatization, developing countriesaccounted for about 85 per cent of the total number of transactions, and 35 percent of total sales revenue (Sader, 1995, p. 3). A major constraint of privatiza-tion efforts in developing countries has been the lack of domestic capital. Thishas prompted many developing countries to allow sales of state assets toforeign investors, at the political and economic risk of exposing the nationaleconomy to external influence (Harrell, 1993, p. 46; Welfens, 1994, p. 36).World Bank statistics indicate that during 1988–93 about 30 per cent of thetotal number of privatization transactions in developing countries involvedforeign capital; the foreign share amounted to 35 per cent of the revenuegenerated by privatization (Sader, 1995, p. 13).1

In the light of this global trend, this chapter will examine the role of foreignparticipation in China’s privatization. The Chinese case is important forseveral reasons. First, the country possesses one of the largest state-ownedsectors in the world. In 1991 Chinese state-owned enterprises (SOEs)accounted for about 20 per cent of the country’s gross domestic product,almost double the average of developing economies.2 Second, in 1980–92China’s gross domestic product grew by over 9 per cent annually, compared tothe world average of 3 per cent (World Bank, 1994, pp. 164–65). This hasmade the country a leader in the contexts of both Third World developmentand post-communist transformation. Third, after more than a decade of open-ing, China has emerged as the largest recipient of foreign capital among devel-oping countries. In 1990–95, net private capital flows to China (comprisingdirect investment, private loans, and portfolio equity flows) amounted toUS$166 billion, representing 24 per cent of the total absorbed by all develop-ing countries (World Bank, 1996, Vol. 1, p. 11). Finally, the Chinese case istheoretically important from a dependent development perspective. As will bediscussed in the last section of this chapter, while there has been significantforeign participation in the country’s privatization, the Chinese state hasplayed a ‘market-facilitating’ role, instead of becoming a mere agent of thecapitalist center. Classical dependency analysis thus does not seem valid.

61

Before proceeding to discuss the Chinese case, we need to clarify our work-ing definition of privatization again. As mentioned in Chapter 2, we will usethe term privatization in the narrow sense as defined by Bornstein (1994a,p. 234): transfer of ownership of state assets to private hands. This definition,however, is broader than the one employed in the World Bank statistics citedabove, which covers ‘the complete or partial transfer of control overpublicly–owned assets to the private sector in exchange for a payment’ (Sader,1995, p. 2). Owing to lack of data, the World Bank statistics do not includedivestitures of SOEs in the forms of shutting down operations and mothballingassets. Mass privatization through vouchers is also excluded. This restrictionunderstates the scale of privatization in Eastern Europe, where free distribu-tion has been important. However, it does not affect our analysis of theChinese case, since so far there has been no case of voucher privatization inChina.

SHAREHOLDING SYSTEM REFORM AND VARIETY OFCHINESE SHARES

As mentioned in Chapter 2, China has achieved significant privatization underthe camouflage of ‘shareholding economic reform’ (gufen jinji gaige). Theessence of this reform is to convert SOEs into shareholding enterprises(SHEs). Shares are issued to the state, enterprises, and individuals. Throughthis process state assets are transferred from the state to private hands, and itis in this sense that we regard the shareholding economic reform as a form ofprivatization.

Under the shareholding system, a variety of shares have emerged. In termsof type of owner, Chinese shares can be classified into state shares (guojia gu),corporate or ‘legal-person’ shares (faren gu), and individual shares (geren gu).In terms of place of listing, there are A-shares and B-shares listed domesti-cally, H-shares listed in Hong Kong, and N-shares listed in New York. As willbe discussed below, the demarcation among these different types of shares hasbecome increasingly blurred, which is a major characteristic of the Chineseprivatization. But for analytical purpose, we need to be conceptually clearabout their differences.

Initially, state shares and corporate shares were prohibited from beingtransferred, as a safeguard against privatization. On the other hand, to createan open market for the transaction of transferable individual shares, Chinaestablished a stock exchange in Shanghai in 1990, and another one inShenzhen in 1991. Shares listed on the two exchanges are known as A-sharesand B-shares. A-shares are traded in the Chinese currency, yuan, and arereserved for domestic enterprises and individuals; whereas B-shares are traded


63

Table 5.1 Types of Chinese shares

Non-transferable, Place of listingand not publiclylisted Shanghai and Shenzhen Hong Kong New York

Stock Exchanges Stock Exchange Stock Exchange

Owner State Enterprises Domestic Foreign Foreign Foreign investors investors investors investors

Foreign shares

Type of State Corporate Individual, B-shares H-shares N-sharesshares or A-shares

in foreign currency, and are available only to foreign individual and institu-tional investors (ZC, 1993, p. 50). In addition, some Chinese enterprises haveissued shares in the Hong Kong Stock Exchange and the New York StockExchange, known respectively as H-shares and N-shares (World Bank, 1995b,Vol. 2, pp. 132–33). Despite different names and places of listing, B-shares, H-shares, and N-shares are all held by foreigners. As such, they are collectivelyknown as foreign shares (waizi gu). The various types of Chinese shares aresummarized in Table 5.1. In the next section, we will discuss the increasingrole of foreign shares, as an indication of the expansion of foreign involvementin China’s privatization.

MAJOR FORMS OF FOREIGN PARTICIPATION

Expansion of B-share Market

When the Shanghai and Shenzhen Stock Exchanges were opened respectivelyin 1990 and 1991, shares of only one type, A-shares, were listed. These shareswere only available to domestic investors, and are denominated in yuan. Withsuch a nationality restriction, and given the inconvertibility of the Chinesecurrency, foreign investors were excluded from the A-share market.

Foreigners were first allowed to participate in China’s stock market inFebruary 1992, when another type of share, B-shares, began listing on the twoexchanges. These shares are reserved for foreign investors, and are traded inUS dollars in Shanghai, and in Hong Kong dollars in Shenzhen. Since Englishis not China’s official language, the Chinese authorities have abolished theterm B-shares, replacing it with ‘domestically listed foreign shares’ (jingneishangshi waizi gu) (ZZB, 15 August 1994). But for convenience, the term B-share has continued to be used on most occasions, a practice which we willfollow.

Issue of B-shares serves two major purposes. The first is to obtain externalequity financing. Enterprises intending to issue B-shares thus have to prove aneed for foreign exchange. By the end of 1995, altogether 70 Chinese enter-prises had listed B-shares, raising a total of US$2.3 billion (see Table 5.2).Second, the B-share market serves as an instrument for absorbing internationalfinancial techniques, as B-share issuers have to prepare financial statementsaccording to international accounting standards. Though A-share issuers arenot required to comply with this rule, practices in the B-share market areexpected to have spillover effects (Goldstein and Folkerts-Landau, 1994, pp.102–103).

A special feature of the Chinese approach to the development of securitiesmarkets can be seen by putting the above two objectives together. It has been


65

Table 5.2 Chinese foreign share issues

B-shares H-shares N-shares

Number of Fund raised Number of Fund raised Number of Fund raisedlistings (US$ million) listings (US$ million) listings (US$ million)

1992 18 722 0 0 1 801993 23 647 6 1052 2 1971994 17 516 9 1276 3 10331995 12 375 2 256 0 01992–95 70 2260* 17 2584 6 1.31

Note: * Other sources put this figure at US$3 billion (JS, 4 February 4 1996; XB, 4 March 1996).

Source: Credit Lyonnais Securities (Asia) Ltd. I am indebted to Howard Wong, statistician of Credit Lyonnais, for compiling this table.

a common goal of liberalizing capital markets to upgrade companies’ financialmanagement and disclosure practices towards international standards. Butrather than adopt an absolute set of international codes and wait for most enter-prises to meet it, the Chinese authorities grant enterprises not ready to meetinternational financial standard opportunities in the A-share market, and let themore capable ones enter the B-share market. No administrative measures havebeen used to force A-share issuers to meet B-share issue requirements.Nevertheless, B-share issue as a source of foreign exchange serves as a strongincentive for enterprises to internationalize their financial management.

Shortly after its inception, however, the B-share market went into a state ofalmost continuous decline. Occasional rallies notwithstanding, the generalprice trend was downward, and turnover was low, making B-shares ratherilliquid. This has been attributed to a number of factors: vague governmentpolicy; undeveloped legal framework; failure of companies to publish finan-cial results on time and in accordance with international requirement; ineffi-cient dissemination of company information; investors’ concerns about rightsissues and companies’ investment behaviour; high transaction cost; small sizeof the market; competition from H-shares and N-shares (we will return to thispoint later); and unstable value of the yuan (Nottle, 1993, p. 512; ZZB, 3September 1994; JS, 9 November 1994). Positive views on B-shares do exist,arguing that in general B-share companies have sound financial standing andhigh investment value (ZZB, 24 September 1994; 17 June 1995; 18 November1995). Nevertheless, the B-share market has remained bearish and inactive.

Despite the unsatisfactory performance of the B-share market, the govern-ment decided to further the B-share experiment in three major respects. First,it allowed expansion of the proportion of B-shares in a company’s total capi-tal stock. In August 1995, with the approval of the China Securities RegulatoryCommission (CSRC), the central regulator of China’s securities market, andthe Ministry of Machine-Building Industry, the Shenzhen-listed JianglingAuto Company sold 80 per cent of its B-shares to Ford Motor Company of theUnited States. While Jiangling remained the largest shareholder, controlling51 per cent of the company’s total capital stock, the transaction gave Fordabout 20 per cent of Jiangling’s shares, making the US company the second-largest shareholder. Together with shares held by other foreign investors, B-shares accounted for 25 per cent of Jiangling’s total capital stock. Before this,the general proportion of B-shares in a Chinese company’s total capital stockwas about 10 per cent (JS, 17 August 1994; 23 August 1995; CD, 24 August1995; ZZB, 25 August 1995).

Second, plans were made to increase the supply of B-shares significantly.Issuers would mostly be enterprises in energy, transportation, telecommunica-tions, key raw materials, and high-technology sectors. More importantly, issueof B-shares was given priority over A-shares. Since early 1996, enterprises


applying to issue both A-shares and B-shares must first issue the latter. Theincrease in the supply of B-shares led to the concern that prices would beforced further down (XB, 6 February 1996; MB, 30 January and 7 February1996). But there was the opposite view that ‘the problem with China’s B-shares market is that it is too small, not too big’. In March 1996, the seventyShanghai and Shenzhen B-shares were capitalized at a mere US$2 billion.Foreign investors have hesitated to enter such an illiquid market, in which anytransaction can have a dramatic impact on the price of a stock (SCMP, 1 April1996). The government thus aimed to activate the market by enlarging itsscale.

Finally, locational restrictions on B-share issuers were removed, therebyallowing a geographic expansion of B-share issuers. Originally, only Shanghaiand Shenzhen enterprises could issue B-shares. Both the Shanghai and theShenzhen Stock Exchanges were established on the basis of local rules andregulations. Such localism made it difficult for high-quality enterprises ofother areas to raise foreign exchange by issuing B-shares. Although someShanghai and Shenzhen enterprises tried to ‘lend’ their B-share issue quota toenterprises from other areas, the attempt was not successful owing to lack oflegal basis. This condition came to an end in December 1995, when the StateCouncil promulgated the country’s first national law on B-shares.3 The newlaw, which immediately replaced local rules and regulations set by theShanghai and Shenzhen authorities, does not place any locational restrictionon B-share issuers and thereby provides a legal basis for geographic expansionof the B-share market (XB, 22 January 1996).

Weakening of Separation between A-share and B-share Markets

As mentioned above, the A-share market was not supposed to open to foreigninvestors. However, in July 1994, in the midst of a year-long decline of A-share prices, the Chinese securities authorities announced a series of market‘rescue’ measures, one of which was to allow foreign funds to enter the A-share market by establishing Sino–foreign joint venture investment companieson a trial basis.4 In response to this and other measures,5 during the ensuingweek the Shanghai and Shenzhen A-share indexes skyrocketed by 113 per centand 74 per cent respectively. About a year later, a senior central bank officialsaid that the government would adopt a two-step approach to implement theplan. The first step would be to allow ‘reliable’ foreign investors to buy onlyshares of enterprises which had issued A-shares and B-shares or H-shares.This would be followed by a further opening of the A-share market, uponsatisfactory result of the first step (CD, 7 August 1995).

In addition to the direct advantage of enlarging capital sources, the openingof the A-share market to Sino–foreign fund companies was expected to have

Foreign participation and the role of the state 67

two other positive effects. First, to attract foreign investors, A-share compa-nies would be induced to improve their management and disclosure. Second,Chinese fund managers may absorb skills and experiences from their foreignpartners. On the other hand, Chinese securities experts realized that there werestill many obstacles to the participation of foreign funds in the A-share market:inconsistency of A-share companies’ accounting system with internationalstandards; lack of standard requirements on company information disclosure;international capital immobility owing to foreign exchange controls andcurrency inconvertibility; absence of relevant legal framework; shortage ofprofessional fund managers and supervisors; high volatility of A-share prices;and confusion caused by co-existence of too many types of shares. Finally,concern has been raised that the limited size of the A-share market may leadto foreign control of the Chinese stock markets (ZZB, 3 September and 9December 1994; JS, 22 December 1994).

The above limitations notwithstanding, provisions were made for the grad-ual opening of the A-share market to foreign funds. On the other hand, therewas a similar relaxation of the border of the B-share market to domesticinvestors. According to the above-mentioned first national law on B-shares, inaddition to foreign and Hong Kong, Macao and Taiwan investors, B-shareswould also be available to two other types of investors: Chinese citizens resid-ing abroad, and other investors approved by the CSRC. The first newly addedcategory would allow the increasing number of Chinese citizens earningforeign exchange abroad to invest in B-shares. While what the second cate-gory, ‘other investors approved by the CSRC’, actually refers to was unclear,it was reported that this is a provision for allowing domestic residents to useprivate foreign exchange savings to invest in B-shares (JS, 17 August 1994).6

Before clarification from the central government, a senior Shenzhen officialconfirmed that Chinese investors holding foreign exchange would be allowedto buy B-shares in the city.7 In fact, Shenzhen residents who have relatives andfriends in Hong Kong have been buying B-shares through them (SCMP, 9March 1996). The new law may thus be seen merely as a legalization of exist-ing practice. According to one report, about 16 000 Shanghai B-share buyersare local Chinese, five times the number of Hong Kong investors (XB, 18March 1996).

Hence there has been a gradual mutual opening of the A-share and B-sharemarkets to their respective specified investors. At the same time, with theintroduction of H-shares and N-shares, B-shares have lost their unique func-tion of raising external equity financing (we will return to this point later).These developments have led to the speculation that the A-share and B-sharemarkets will eventually be merged into one. However, there have been warn-ings that the move should be ‘natural’, and be carried out ‘at the proper time’(ZZB, 23 September and 22 November 1994; JS, 27 January 1995).


According to a joint study by the CSRC and the World Bank, the separationof A-share and B-share markets produces a series of problems, including pricedistortion across markets, illegitimate transactions due to possibilities for arbi-trage, reduced liquidity, and barriers to the spillover of learning benefits fromthe B-share to the A-share market. Two arguments have generally been offeredagainst merger of the two markets. The first is the limited convertibility of theChinese currency, and the second the possibility of crowding out of domesticparticipation by foreign inflows. The joint study by the CSRC and the WorldBank finds both arguments unconvincing, as a range of alternative solutionsand safeguards are available. However, the market segregation has the advan-tage of reducing the domestic market’s vulnerability to external shock. A pull-out of foreign capital from China would have a direct impact on the price offoreign shares, but not domestic shares. This would save China from a finan-cial crisis like that which occurred in Mexico in early 1995 (World Bank,1995b, Vol. 2, pp. 127–29). It also makes the Chinese case different fromEastern European equity markets, where international flows have causedsignificant fluctuations (IHT, 25 April 1996). Hence it seemed that the Chinesecentral government’s policy would be to maintain two separated markets in theforeseeable future. The chances are high, however, that the separation will beweakened further by local initiatives.

Conversion of State Shares and Corporate Shares into Foreign Shares

As mentioned in Chapter 3, there have been cases of spontaneous conversionof non-transferable state shares and corporate shares into transferable individ-ual shares. Similar activities have also taken place between state shares, corpo-rate shares and foreign shares. In February 1994, the board of directors of theShanghai Dazhong Taxi Company made a proposal to convert the company’scorporate shares into B-shares. The case, which is the first of its kind, drewimmediate public attention. Initially the CSRC said that ‘under current circum-stances, it is impossible to carry out conversion of corporate shares into B-shares’, since the proposed move would involve sale of state assets to foreigninvestors and revision of A-share and B-share market regulations. However,within a few months the CSRC changed its mind and approved the proposal.By converting 10 million corporate shares into B-shares, the proportion of B-shares in Shanghai Dazhong’s total capital stock was increased to about 48 percent, while that of state shares and individual shares declined respectively to44 per cent and 8 per cent (Li and Yu, eds, 1995, pp. 56–57). About six monthslater the Shanghai Diesel Engine Company followed suit by converting 10million corporate shares into B-shares (JS, 27 November 1994).

In August 1995 Beijing Light Bus sold 40 million corporate shares to IsuzuMotor and Itochu of Japan, giving the Japanese partners a combined 25 per


cent stake in the Chinese company (Karmel, 1996, p. 551). The case set aprecedent of direct foreign acquisition of shares in a Chinese enterprisethrough the stock market. A legal basis for such practice did exist in a provi-sional regulation promulgated at the beginning of 1995, according to which aSHE may change into a ‘foreign-invested’ SHE by selling over 25 per cent ofits shares to foreign shareholders for hard currency. However, the case raisedsenior leaders’ concern about the leak of state assets to foreign hands. Thethreat became more real as a Japanese executive was appointed generalmanager of Beijing Light Bus. There was also criticism about the improperdisclosure of news about the transaction when the case was still under consid-eration by the CSRC. The central authority kept silent on this case, but becamemore cautious about other applications of the same kind. According to onereport, senior Chinese leaders, including the former Premier Li Peng, havecriticized the Beijing Light Bus transaction (ZZB, 11, 14 and 17 August 1995;JS, 22 August and 19 October 1995; SCMP, 23 February 1996).

Consequently, in September 1995 the State Council banned conversion ofstate shares and corporate shares into foreign shares (ZSZ, 2 December 1995).In defiance of this rule, however, the Sichuan Guanghua Chemical Fibreannounced that it had sold 35 million state shares, or 60 per cent of thecompany’s state shares, to Nimrod, the parent company of New York-listedChina Industrial Holding.8 The announcement was made in January 1996, butthe company said that the transaction was actually concluded in August 1995,the month before this type of transaction was made illegal. This broke thedisclosure rules which require major transactions to be reported within threedays. Consequently, the CSRC ordered suspension of the listing of SichuanGuanghua’s shares on the Shanghai Stock Exchange for two days, andlaunched an investigation into the deal. A few days later, Nimrod made anannouncement that the transaction was legal and had been approved by theNational Bureau of State-Owned Property. The Chinese securities authoritieswere silent on Nimrod’s response (ZZB, 26 January 1996; SCMP, 27 January1996; MB, 30 January 1996; YZ, 11 February 1996).

In short, the Chinese state has been ambiguous on the issue of conversionof state shares and corporate shares into foreign shares. On the one hand, thepractice may help to solve problems caused by the non-transferability of stateshares and corporate shares mentioned in the previous section. In April 1995state shares and corporate shares in total accounted for about 68 per cent of theentire capital stock of all SHEs in China, whereas the proportion of foreignshares stood at approximately 11 per cent. It was hoped that foreign capitalcould play a greater role in supplementing domestic funds to absorb the hugeamount of non-transferable state shares and corporate shares (JS, 7 June and 4August 1995; ZZB, 30 August 1995). On the other hand, concern about loss ofstate ownership to foreign hands and lack of established rules have prevented


the government from making share conversion an official policy. When seniorlevel criticisms and irregular activities emerged, the government banned thepractice, but did not actually enforce the rule.

Foreign Listing

Listing of Chinese SOEs on foreign stock exchanges began in the early 1990s,when some enterprises purchased controlling stakes in publicly quoted HongKong companies, thereby obtaining ‘backdoor listings’ on the Hong KongStock Exchange (SEHK).9 This practice allowed Chinese enterprises to bypassboth China’s restrictions on sales of equity abroad, and Hong Kong’s regula-tions on new listings. By means of ‘backdoor listings’, a Chinese enterprisecould raise financing through new rights issues, and significantly reduce itseffective tax rate by establishing a joint venture with the overseas-registeredcompany that it controlled (Goldstein and Folkerts-Landau, 1994, p. 99; ZZB,21 February 1995).

Well-known Chinese enterprises that have undertaken ‘backdoor listings’include China Resources, China Travel, China Overseas Land and Investment,and China International Trade and Investment Corporation. Their shares areoften referred to as ‘red chips’. It has been estimated that during 1991–93Chinese companies used about US$2.7 billion to obtain 29 ‘backdoor listings’in Hong Kong. Initially, neither the Chinese nor Hong Kong authoritiesdiscouraged these activities. However, as the practice went on, some compa-nies were found to have muddled accounts, substandard disclosure andinflated assets. In many cases it was not clear whether the funds raised fromrights issues were actually used for the intended purpose. There were also indi-cations that Chinese enterprises used ‘backdoor listings’ as a way to transferstate assets out of China.10 To maintain the reputation of the SEHK, from Mayto September 1993 the Hong Kong authorities took a series of actions totighten rules on ‘backdoor listings’ and rights issues. In May 1994, the Chinesegovernment banned the practice of ‘backdoor listings’ on overseas stockmarkets (Goldstein and Folkerts-Landau, 1994, p. 99; ZSZ, 2 July 1994).

On the other hand, the spontaneous ‘backdoor listing’ activities led bothChinese and Hong Kong authorities to the view that there was a real need toregulate Chinese enterprises’ access to the Hong Kong equity capital market.In 1992 China announced that nine Chinese SOEs would be officially listed onthe SEHK. During 1993 Chinese and Hong Kong securities authorities workedclosely to develop a regulatory framework for the listings. Between July 1993and May 1994 shares of the nine selected Chinese SOEs were launched inHong Kong, raising a total of US$1.5 billion. Chinese shares listed on theSEHK are known as H-shares. In 1993, by purchasing 13 per cent of the H-shares of Tsingtao Brewery, Anheuser-Busch acquired 5 per cent of the entire


capital of the Chinese company. In the following year, through a similarmethod Atlantic Richfield and Asea Brown Boveri respectively acquired 9.9per cent and 1.9 per cent ownership of Zhenhai Refinery and Harbin PowerEquipment (Goldstein and Folkerts-Landau, 1994, pp. 99–100; SpecialCorrespondent, 1994, p. 29; Hernandez, 1995, p. 4). By the end of 1995 a totalof 17 Chinese enterprises had issued H-shares, raising a total of US$2.6 billion(Table 5.2).

Chinese enterprises have also listed shares on the New York StockExchange (NYSE), known as N-shares. From 1992–94, six Chinese compa-nies raised a total of US$1.3 billion through N-shares issues (Table 5.2). Apartfrom the advantage of prestige, listing on the NYSE allows Chinese compa-nies to raise funds more cheaply due to NYSE’s higher price/earnings ratiosthan SEHK’s. On the other hand, the NYSE, contrary to its normal practice ofrequiring intending share issuers to provide a three-year track financial record,accepts Chinese enterprises for listing based on one year’s audited accountsand unaudited results for the previous two years, whereas the SEHK requiresall H-share issuers to provide three years of audited statements. The NYSE’sspecial treatment of Chinese enterprises led to criticisms that it was loweringits regulation standards to lure Chinese companies (FEER, 4 August 1994, pp.90–91; Goldstein and Folkerts-Landau, 1994, p. 100). In fact, listing ofChinese enterprises on the SEHK and NYHK has induced stock exchanges inother places, including Britain, Japan, Australia and Singapore, to seek agree-ments with China, in order to secure ‘a slice of the Chinese listing pie’ (WorldBank, 1995b, Vol. 2, p. 135; SCMP, 29 March 1996). As of the mid-1990s,Chinese shares were listed on stock exchanges in Hong Kong, the UnitedStates, Canada, Australia, Singapore, and Norway (JS, 12 May 1995).11

A series of advantages of international listings have been claimed. First andforemost, overseas listing provides a direct channel for Chinese enterprises toraise equity capital abroad. Second, it serves as an ongoing source of corpo-rate governance, forcing the enterprises to continue restructuring and improv-ing efficiency. Third, overseas listing speeds up development of the Chinesesecurities market towards international standards. Fourth, it helps promotionof Chinese enterprises’ global business by establishing an international pres-ence. Fifth, listing abroad reduces the state’s intervention of foreign-listedenterprises. Finally, listing on the SEHK strengthens Hong Kong’s status as aninternational financial centre (JS, 4 February and 25 May 1994).

On the other hand, there were concerns that foreign listings would have anegative impact on the domestic securities market. As the highest qualityenterprises were selected for foreign listings, domestic investors were left onlywith less favourable choices. Moreover, issue of H-shares and N-sharescreated unfavourable competition for B-shares. Lastly, foreign listingsinvolved significant transaction and adjustment costs (JS, 4 February 1994).


In this debate about whether to encourage Chinese shares to be listedabroad, the pro side gained the upper hand over the cons. A senior CSRC offi-cial confirmed that China would continue the policy of international listings.Eighteen enterprises, mostly in the transportation industry, were ‘activelypreparing’ for foreign listings (MB, 31 January 1996). However, it has beenargued that overseas listing contributes only to the internationalization ofChinese enterprises’ sources of financing; it is further development of the B-share market that would lead to a real internationalization of China’s securi-ties market itself (ZZB, 9 February 1996).

Mergers and Acquisitions

Foreign investors could also participate in China’s privatization through merg-ers and acquisitions (M&A). The emergence of M&A in China stemmed fromthe huge financial losses of Chinese SOEs. As of 1995, about half of the some100 000 Chinese SOEs were in the red. The losses, which amounted to a totalof over 40 billion yuan, used to be covered by the state. However, the centralgovernment has made it clear that SOEs cannot expect endless support fromthe state. Hopeless enterprises have been urged to merge or go bankrupt, anda number of property rights exchanges have been established across the coun-try to facilitate M&A. In 1995, there were 330 cases of merger and over 100of bankruptcy (CD, 19 February, 25 April and 17 May 1994; CEN, 30 May1994; MB, 15 March 1996).

The state’s encouragement of M&A, however, was restricted to domesticenterprises. Foreign involvement was sensitive. As a semantic game to avoidpolitical and ideological obstacles, foreign acquisitions of Chinese SOEsthrough M&A have been conducted under the name of ‘grafting into foreigncapital’ (jiajie waiz). Debates on whether foreign investors should be allowedto participate in China’s M&A activity have focused on the so called ‘Zhongcephenomenon’. Zhongce is the Chinese name of China Strategic Investment(CSI), a Hong Kong-based company with Hong Kong and US capital. From1992 to 1994, CSI spent 3.3 billion yuan to acquire over 51 per cent stake inmore than 100 Chinese SOEs, restructuring them into 35 ‘Sino–foreign jointventures’. Some of the most profitable ventures were then listed on foreignexchanges, including the NYSE, generating huge profits for CSI. As ‘Chinesecharacteristics’ (Zhongguo tese) of the takeover, the terms of the ‘jointventures’ are for 50 years, and CSI promises to share with the Chinese side theresponsibility of arranging employment for existing staff and settling retiredworkers (Hernandez, 1995, p. 6; Hu, 1994, pp. 74–76).12

In a Chinese theorist’s view, strictly speaking, what the CSI case involvedis only formation of joint ventures, not M&A (JS, 23 August 1994). However,as a foreign investment consultant observed,


joint venture is the Chinese approach to M&A. … In the West, M&As are generallyundertaken through the issuance and sales of new shares. In China, however, sincemost of the enterprises belong to the state, the M&A has to be structured as a jointventure. The Chinese enterprise would then inject its state assets as its portion of thepaid-up capital, while the foreign party would put up the cash. (Hernandez, 1995,p. 6)

Having been legalized since 1979, establishment of joint ventures is polit-ically and ideologically much less controversial than M&A. Many foreigninvestors have thus chosen to conduct M&A in China under the banner of jointventure (XB, 19 April 1996). Hence, in the Chinese context, M&A can beregarded as a specific form of joint venture. However, there is the differencethat, whereas joint venture usually refers to formation of new enterprises and‘creation of new economic composition’, M&A involves injection of foreigncapital into existing SOEs (Hu, 1994, p. 75).13 Since only M&A but not jointventure would result in transfer of state ownership to foreign hands, we regardM&A in particular but not joint venture in general as a form of foreign partic-ipation in China’s privatization.14

CSI’s activities in China have caused a serious debate among Chinese theo-rists. Supporters of the case argue that through ‘grafting into foreign capital’,CSI has successfully retooled its Chinese subsidiaries, turning them intoprofit-making enterprises. Apart from capital, the Hong Kong company hasalso brought in advanced management. This would produce a demonstrationeffect for the overall restructuring of Chinese SOEs (Hu, 1994). Moreover,CSI’s takeovers were said to be consistent with global M&A practice andtrends, and are compatible with Chinese law. They would promote develop-ment and standardization of China’s property rights exchange market (Li S.G.,1994). It was argued that although the CSI case is not perfect, it is a ‘feasiblechoice for the utilization of foreign capital by Chinese SOEs’ (GS, 6 August1994).

The more cautious view is that China still lacks the theory and practice todraw conclusions about CSI’s activities. Any immature judgment may lead towrong policy decisions (Qin, 1994). Chinese SOEs gained only CSI’s initiallimited investment, but lost their own chance to raise funds overseas (JS, 7December 1994). An editorial in Jingji ribao (Economic Daily) warned thatexaggeration of the positive impact of the case had led to the ‘unhealthytendency’ of choosing the best enterprises for ‘grafting into foreign capital’.Too much attention had been paid to the amount of foreign capital absorbed,without any concern for enterprise performance, expropriation of state assets,the motives of foreign investors, and loss of state ownership (JR, 1 November1995). High-profile reports have been made on a serious labour dispute in aCSI subsidiary in China, leading to further challenge against M&A by foreigninvestors (MB, 16 November 1995). In March 1996 a front-page article in the


authoritative Jinrong shibao (Securities Daily) made a severe attack on CSI,criticizing the company for ‘reaping profit without actual investment’ (kong-shou taoli) (JS, 18 May 1996).

Chinese leaders were also divided over the CSI issue. Many senior centralgovernment officials took the CSI-model as a feasible way to revitalizeChinese SOEs (MB, 16 November 1995). On the other hand, the then Vice-Premier Zhu Rongji, the country’s economic tsar, allegedly condemned thespeculative nature of CSI’s maneuvering in China, and ordered regulation ofsales of stakes in SOEs. Despite disagreement among the top leadership, thepractice of ‘grafting into foreign capital’ has become increasingly common inChina. According to one estimate, in 1994 foreign firms invested US$19.7billion in 490 M&A transactions, up from $15.2 billion in 1993. In fact, asurvey conducted by an international consultancy and accounting firm indi-cates that China has emerged as the most popular target country in the worldfor M&A activity (Hernandez, 1995, pp. 4 and 6).

M&A by foreign investors in China have shown six major trends. First,foreign buyers have shifted their targets from small and loss-making SOEs tomedium-size and more efficient key enterprises. Second, foreign investorshave asked for a bigger stake in the enterprises. Third, while earlier M&Awere rather dispersed and random, foreign investors have shown particularinterest in a few selected sectors such as tyre-making and pharmaceuticalindustries. Fourth, after M&A, some enterprises have been listed abroad. Fifth,through installments, foreign investors have used a small amount of capital toacquire a controlling stake in Chinese companies. Sixth, after M&A, individ-ual enterprises have been grouped into conglomerates (ZSZ, 22 April 1995).The central government regarded the third and fourth trends, and the tendencyto underprice state assets, as ‘chaos’ that should be corrected (CEN, 18December 1995).

In view of the above, the central government’s policy was to regulateforeign M&A activity, in order to make it an official means to retool SOEs.In mid-1995, the State Economic and Trade Commission issued a noticerequiring ‘grafting into foreign capital’ projects to be approved by it (CEN,31 July 1995). In early 1996 a spokesperson for the Commission said thatrules were being drafted to attract foreign investment in loss-making SOEs.According to him, the government was hoping to encourage foreigners toinvest ‘more in existing state enterprises than in establishing new compa-nies’ (SCMP, 29 March 1996; my own emphasis). As mentioned, in theChinese context investment in existing SOEs distinguishes M&A fromformation of joint ventures. The statement just quoted thus suggests thatM&A was replacing joint ventures as the major form of China’s utilizationof foreign capital.


THE CHINESE CASE IN COMPARATIVE PERSPECTIVE

We have now identified the major forms of foreign participation in China’sprivatization. Although there has been no official privatization programme inChina, the country’s shareholding economic reform has enabled foreigninvestors to acquire ownership of Chinese state assets. At the end of April1995 foreign shares represented over 10 per cent of all Chinese shareholdingenterprises’ capital stock (JS, 7 June 1995).15 However, measured in terms ofthe share of foreign exchange in total privatization revenue, in 1993 foreigninvolvement accounted for almost 60 per cent of China’s privatization,compared to merely 5 per cent in 1991.16 Despite the rapid increase during theperiod, the extent of foreign participation in China’s privatization remainedsmaller than in other transitional economies in Europe and Central Asia(TEECA) (Table 5.3).

TEECA are eager to attract foreign participation in their privatizationprojects because foreign investors are believed to be ‘active and “responsible”owners’, who can bring in immediate economic benefits to the host countries


Table 5.3 Share of foreign exchange in total privatization revenue in thedeveloping world (%)

1988 1989 1990 1991 1992 1993 1988–93 1994

Developing World 9 14 32 38 31 44 34 65East Asia and the Pacific 6 0 0 11 30 46 31 69Europe and Central Asia 70 67 26 56 60 67 57 51Latin America and theCaribbean 8 13 35 37 24 33 30 21Middle East and NorthAfrica 0 7 0 19 28 48 44 25South Asia 0 3 36 0 3 2 2 37Sub-Saharan Africa 0 1 51 20 28 88 28 83

China 0 0 0 5 9 59 23 N.A.

Note: Data on the developing world include various forms of privatization, such as direct salesof public assets to private investors in the form of public offerings or private placement, andcontracting out of government services through concessions or licensing agreements (Sader, 1995,p. 2). Data on China, however, cover only privatization through issuance of A-shares, B-shares,and H-shares. The two sets of data are therefore not perfectly comparable. Moreover, the actualshare of foreign participation in China’s privatization should be more than is indicated in the table,because the Chinese data do not include purchase of A-shares by foreigners, conversion of stateshares and corporate shares into foreign shares, issue of N-shares, and mergers and acquisitionsby foreigners.

Source: 1988–93 data on the developing world are from Sader (1995, p. 34), and 1994 data fromthe World Bank (I am indebted to Andrea Anayiotos, consultant, IECIF, the World Bank, forproviding me with the 1994 data). Data on China are from Liu (ed.) (1993, p. 806).

through raising efficiency, internationalization, and integration in the worldeconomy (Artisien-Maksimenko and Rojec, 2001, p. 3). Specifically, assupply of domestic capital in TEECA has been scarcer than in China, there hasbeen a heavier reliance on foreign participation in TEECA’s privatization thanin China. Privatization in TEECA took place before formation of wealth in theprivate sector. With a ratio of domestic money stock of 30 per cent to 50 percent of the national output, and given the low savings rate of 2 per cent to 7per cent of disposable income, people in TEECA generally lack the necessaryfunds to buy state assets. As a result, the privatization deals have mostly beenconcluded with foreign companies (Welfens, 1994, p. 36; Frydman andRapaczynski, 1994, pp. 60 and 157). In comparison, when privatization inChina began, earlier economic reform had significantly augmented people’sconsumption and investment power. From 1980 to 1992 the money stock inproportion to China’s gross domestic product rose rapidly, from 26 per cent to67 per cent, and the domestic saving ratio from 30 per cent to 37 per cent(World Bank, 1994, p. 184; 1995c, p. 172).

With only a few exceptions, such as Poland17 and Russia18, foreign partic-ipation was generally regarded by TEECA governments as a major highway toprivatization. The keyword was ‘sell everything’. But in reality, foreigninvestors were often frustrated by a range of problems, including restrictionson foreign owners’ personnel policy, inheritance of liabilities, and unforeseenenvironmental costs (Major, 1993, pp. 91–92). Among TEECA, Hungary hasbeen the most receptive to foreign participation in privatization: equal treat-ment between foreign investors and Hungarian citizens, and between jointventures and domestic enterprises; no specific limit on the objective and shareof foreign investment; complete legal protection to every foreign investment;free redemption and repatriation of profits; and no restriction on appointmentof foreign directors. Between 70 per cent and 80 per cent of Hungarian stockswere transacted in Vienna rather than the domestic Budapest Stock Exchange.In mid-1992 foreign investment accounted for 70 per cent of the Hungariangovernment’s receipts from privatization (Faur, 1993, pp. 204–6; Meszaros,1993, pp. 199–202; Simoneti, 1993, p. 100; Torok, 1993, pp. 379–80).

Initially, China, like Hungary, did not set any specific limit on the share offoreign ownership.19 No restriction was mentioned in a set of provisionalregulations published in January 1995.20 The concern for loss of control ofChinese enterprises to foreign investors led to voices arguing that a ceiling of50 per cent should be imposed on foreign ownership (CEN, 5 June 1995; JS,20 October 1995). Then, in June 1995, the Chinese government published adocument21 specifying in which sectors foreign investment was encouraged,restricted or prohibited. It stipulated that the state had to hold a majority (over51 per cent) share in some types of transportation, energy, and machine-build-ing projects. Strategic sectors such as media and military production would be


completely closed to foreign participation (CEN, 24 and 31 July, 30 October1995). In addition to this direct ownership restriction, foreign investors havebeen discouraged from the Chinese market by factors such as corruption,absence of legal framework, foreign exchange control, and political uncer-tainties (Karmel, 1996, pp. 533–43). According to one study, these indirectbarriers are even more important than direct ownership restrictions in prevent-ing global equity market integration (Bekaert, 1993).

Nevertheless, China, as a late participant of the global privatization trend,has achieved impressive results in the competition for international capital.The wave of worldwide privatization has led to the situation where ‘there aretoo many assets (enterprises) searching for too few buyers’ (Lieberman, 1993,p. 15). Although the Chinese environment for foreign involvement in privati-zation has not been particularly attractive compared with other developingcountries, it has managed to capture a significant proportion of internationalcapital, thanks to the country’s rapid economic growth and the huge potentialof its domestic market.22 According to World Bank records, from 1992 to 1995over US$2 billion international capital was raised in the form of closed-endfunds earmarked for China’s securities market. The amount accounts for about22 per cent of the total for all developing countries (Table 5.4).

In short, as part of the global trend, there has been growing foreign partic-ipation in China’s privatization. While the country has not had any officialprivatization programme for foreign investors, significant amounts of stateassets have been transferred to the hands of foreign investors through theshareholding economic reform. The securities market has served as an impor-tant channel for this process, and foreign participation tends to promoteChina’s integration into the world economy (Karmel, 1996).

The creation of domestic wealth by earlier economic reform has reducedChina’s desperation for foreign capital. In fact, while privatization to foreignowners has improved enterprise performance in TEECA, China has benefitedmainly from privatization to domestic owners (Estrin et al., 2009). However,foreign involvement has the unique advantages of supply of convertible funds,introduction of advanced technology and management and marketing skills,establishment of links with the world economy, provision of impetus todomestic enterprise reform and restructuring, and speeding up capital marketdevelopment. On the other hand, China shares some general concerns aboutsales of SOEs to foreign investors: loss of national patrimony to foreign hands;exposure of ‘basic’ or ‘strategic’ sectors to foreign control; and foreign‘exploitation’ of the national economy (Bornstein, 1994a, p. 242; JS, 21September and 26 October 1995; ZZB, 23 August 1995 and 16 January 1996).The increasing share of foreign involvement in China’s privatization suggeststhat the pro side has gradually won over the con side. However, given that aclear legal framework is still absent and the issue remains politically sensitive,


foreign participation in China’s privatization has remained a matter that ‘canbe practised, but not said’ (nenggan bu nengshuo), a distinct feature that char-acterizes China’s reform.

THE STATE, FOREIGN CAPITAL, AND DEPENDENTDEVELOPMENT

The Chinese case has theoretical significance. Since the 1970s, political sciencehas undergone a shift of interest from a society-centred to a state-centredperspective. The role of the state as a key conceptual variable in political


Table 5.4 Closed-end country funds for China

Launch Name of fund Initialyear capitalization

(US$ million)

1992 Cathay Clemente (Holdings) Ltd. 59.4China Fund (HKSE) 50.0China Fund Inc. 120.0China Investment Company 27.0China Investment and Development Fund 31.4Credit Lyonnais China Growth Fund 20.0Greater China Fund 94.2Jardine Fleming China Region Fund 96.0Lloyd George-Standard Charter China Fund Ltd. 49.0Shanghai Fund (Cayman) Ltd. 17.7Shanghai Fund (Cayman) Ltd. 8.8Wardley China Fund Ltd. 89.9

1993 China Investment Trust Plc. 18.5Templeton China World Fund Inc. 298.9Jardine Fleming China Region Ltd. 46.2Fleming Chinese Investment Trust Plc. 90.8CH China Investments Ltd. 23.7

1994 Shanghai Growth Investment Ltd. 104.0Guangdong Development Fund Ltd. 97.0Templeton Dragon Fund Ltd. 795.0

1995 AusChina corp Ltd. 5.2Total 2142.6

Source: World Bank (1995d; 1996).

analyses has been restored.23 A major impact of this on development studieshas been the revision of classical dependency theory into dependent develop-ment theory. According to classical dependency theory, such as that of AndreFrank (1969), the world economy consists of chains of dependency extendingfrom the ‘centre’ to the ‘periphery’. The centre expropriates and appropriatesa large part, if not all, of the economic surplus of the periphery. Such depen-dency makes development of the periphery impossible. In this model, ThirdWorld states are mere agents of the centre, and thus are not expected to playany positive role in development.

However, on the basis of the case of Brazil, Peter Evans (1979) arguedagainst the rather deterministic view of classical dependency theory.According to him, development can be achieved despite dependency if a‘triple alliance’ of foreign capital, the state and the national bourgeoisie can beformed. In this model, although the state is constrained by the centre’s inter-ests, it also has its own interests in local capital accumulation. By playing anactive role, the state can be ‘one of the keys to the movement from a situationof classical dependence to one of dependent development’ (Evans, 1987, pp.211–12).

While the dependent development analysis was originally developed in thecontext of Latin America, York Bradshaw and his associates applied it toAfrican and East Asian countries (Bradshaw and Tshandu, 1990; Bradshaw,Kim, and London, 1993). In their view, a distinction should be made betweenthe effects of international trade and foreign direct investment. Whereas traderelationships are likely to be mutually beneficial, foreign direct investment isconducive to development only if the host government maintains effectivecontrol over multinational corporations. The implication is that dependentdevelopment is available only to countries with relatively strong states. Thedependent development thesis’s emphasis on the state’s control over foreigncapital has led many to suggest socialism as the prescription for classicaldependency.24 It is expected that the characteristically strong state apparatusesof socialist countries will make rational use of foreign capital for nationaleconomic development, without subordinating the domestic economy to thecapitalist centre. In reality, however, most socialist countries chose to avoidclassical dependency by breaking ties with the capitalist world economy,rather than to achieve dependent development by commissioning the state toregulate foreign capital. The effectiveness of the socialist state in convertingclassical dependency into dependent development is thus largely untested.

The opening of China to foreign trade and investment since the late 1970shas made the country a good case for the examination of the role of the social-ist state in dependent development. Unlike most post-communist countries,where the original socialist state structures had collapsed before they wereintegrated into the global capitalist market, the Chinese communist party-state


has remained to be the chief initiator and designer of the country’s reform.Among other surviving socialist states, China is the largest economy that hasadopted an open economic policy. It is thus important to investigate the role ofthe Chinese state in the governance of foreign capital in the country. The find-ings will have implications not only for surviving socialist states, but also forpost-communist countries searching for a new role of the state in the economy.25

There have been three studies on China’s control over foreign direct invest-ment in the country, conducted by Kleinberg (1990), Pearson (1991), and LeeC. (1997). These scholars all found that the Chinese state has played a positiverole in directing foreign capital towards national economic development, andhas been able to prevent multinationals from repatriating surplus out of thecountry. The Chinese state thus seems to be strong enough to save the countryfrom the fate of classical dependency.26 This may be true as far as foreigndirect investment – the focus of all these three studies – is concerned.

As noted, compared with trade, foreign direct investment requires a higherdegree of control by the host government if such investment is to producepositive effects in the host country. Unlike the three studies mentioned above,in this chapter we have examined how foreign capital has participated inChina’s privatization mainly through portfolio equity flows. Compared withtrade and foreign direct investment, portfolio equity flows tend to exhibit amuch higher degree of volatility, and should thus be subject to even closerstate scrutiny. Is the Chinese state strong enough to carry out this task, so thatclassical dependency can be turned into dependent development? We tacklethis question by focusing on the role of the Chinese state in governing theacquisition of state assets by foreign capital. We begin by examining differentapproaches to conceptualizing the Chinese state.

China as a Developmental State

The search for new approaches to conceptualize the Chinese state began in the1980s, as the traditional Leninist-totalitarian model failed to capture theincreasingly complex political, economic, and social dynamics in post-MaoChina. The first major alternative that emerged was the developmental stateapproach. Developmental states, as defined by Leftwich, are those states‘whose politics have concentrated sufficient power, autonomy and capacity atthe centre to shape, pursue and encourage the achievement of explicit devel-opmental objectives, whether by establishing and promoting the conditionsand direction of economic growth, or by organizing it directly, or a varyingcombination of both.’ Such states can be found in Asia, Africa, and, histori-cally, Europe, according to Leftwich (1995, pp. 401 and 420). Yet most of thediscussions on developmental states have been based on East Asian experience(Douglass, 1994; Onis, 1991; Thompson, 1996).


It is also in the East Asian context that the concept of developmental statewas applied to China. According to White and Wade (1988), East Asian coun-tries such as Taiwan and South Korea are exemplars of ‘capitalist guidedeconomies’. By guiding the development of the capitalist market, theTaiwanese and South Korean governments perform the important functions ofdevelopmental states. In China, White and Wade argue, the major theme of thereform has been to shift the balance between the state and market in favour ofthe latter. The direction of change is towards a ‘socialist guided market’. Whilebasic-level units of production have been granted greater power to make deci-sions according to market considerations, the state has continued to be inter-ventionist by defining the goals, priorities, and paths of development. In thisprocess the socialist state structures play the positive role of the developmen-tal state. Hence, according to White and Wade, the ‘capitalist guidedeconomies’ in Taiwan and South Korea and the ‘socialist guided market’ inChina can be grouped under the same conceptual category of ‘developmentalstate’.

However, Breslin (1996) argued that the Chinese state is not developmen-tal. Rather, it has been suffering from ‘dysfunctional development’ in threeaspects. In the first place, political demands from within the party-state andother societal groups have undermined the relative autonomy of the Chinesestate, making it unable to formulate a coherent and effective national develop-ment strategy. Second, the decentralization of decision-making power to locallevel has weakened the central state’s ability to coordinate national develop-ment. Finally, as a result of the open door policy, China’s national develop-ment strategy has been subject to the influence of external economic factors.Hence, in Breslin’s view it would be a mistake to apply the concept of devel-opmental state to the case of China.

China as a Corporatist State

The concept of ‘developmental state’ seeks to define a balance between thestate and market, but it says nothing about how interests in the state andmarket are organized, and how they interact with each other. It is here that weneed to turn to corporatism. There have been a number of definitions of corpo-ratism. The most widely used one, put forward by Schmitter, says that corpo-ratism is:

a system of interest representation in which the constituent units are organized intoa limited number of singular, compulsory, noncompetitive, hierarchically orderedand functionally differentiated categories, recognized or licensed (if not created) bythe state and granted a deliberate representational monopoly within their respectivecategories in exchange for observing certain controls on their selection of leadersand articulation of demands and supports. (Schmitter, 1974, pp. 93–94)


While most corporatist cases are found in Europe (Schmitter, 1993, p. 197),Lee, Peter Nan-Shong (1991) applied the concept to synthesize two conflict-ing images of the Chinese state: on the one hand, the Chinese state is seen asdominant in defining industrial policy, but on the other hand it seems power-less in improving industrial performance in the post-Mao era. According toLee, as the Chinese state realized the institutional and functional constraintson its domination, it has had to ‘license’ industrial power to enterprises, inexchange for their cooperation in extracting resources from the economy.27 Insuch a way, the formerly totalitarian Chinese state has ‘metamorphosed’ into acorporatist state.

From a different angle, Unger and Chan (1996) discuss China’s corpo-ratism in an ‘East Asian context’.28 Their starting point is that corporatismstresses consensus, cooperation, and goal-oriented harmony. As such, it isfavoured by East Asian countries such as Taiwan, South Korea and China,because corporatism tends to bring about political and social stability that isfavourable to rapid economic growth. In the case of China, when the statedecided to relax its control over the economy and society, it needed a mecha-nism through which power could be decentralized in an orderly manner. Usingcorporatist measures, the Chinese state gradually changed from a directcommand system to one that rules indirectly through authorized agencies,which are the numerous state-created and state-led associations and organiza-tions. In each sector, only one surrogate is recognized as the valid representa-tive. As the state plays a leading role in such institutionalization of sectoralinterests, Unger and Chan’s analysis synthesizes the usual ‘state versus soci-etal corporatism’ division into state-led societal corporatism.29

Unger and Chan noted that the hierarchy of Chinese corporatism consistsof three levels. At the national level, there is ‘peak corporatism’ that empha-sizes firm though indirect state control of the designated organizations. Ateach lower layer of regional government – province, city, county, townshipand village – there is ‘regional corporatism’ by which the regional governmentorganizes power among associations operating at that level. Finally, a form of‘micro-corporatism’ is emerging in some state enterprises to mediate betweenmanagement and workers. It is through this three-tier corporatism that sectoralinterests are organized to provide a politically and socially stable environmentfor economic development (Unger and Chan, 1996, pp. 107–28).

For Oi (1992 and 1995), it is regional corporatism that has been the drivingforce of China’s economic growth. According to Oi, a major characteristic ofChina’s fiscal reform has been the assignment to local governments of prop-erty rights over increased income. Induced by this, local officials have enteredinto a wide range of business activity. While local officials may reap personalbenefits from this, an objective result has been the speeding up of localeconomic development. Oi called this phenomenon ‘local state corporatism’,


which refers to ‘the workings of a local government that coordinates economicenterprises in its territory as if it were a diversified business corporation’(Oi,1992, pp. 100–101; original italics).

A different assessment of the effect of China’s fiscal reform is that the changehas caused a significant decline of central state capacity (Wang S.G., 1995). Onemay derive from this the view that the rise of ‘local state corporatism’ has weak-ened the Chinese state’s ability to perform the role of a developmental state. Oiagreed that ‘there is a need for strong state capacity, but this capacity shouldexist at both the local and the central levels’ (Oi, 1995, p. 1147). The essence ofthe developmental state is an appropriate balance between state intervention andthe market. For Oi, that effective state intervention need not come from thecentre; the Chinese case proves the success of ‘strong local state intervention’(Oi, 1992, p. 124). In this sense, ‘local state corporatism … is a qualitatively newvariety of developmental state’ (Oi, 1995, p. 1133).

Despite Oi’s use of the term ‘corporatism’, in her analysis one finds littleuse of the standard corporatist framework as summarized by Schmitter. In fact,Oi admitted that her use of the term ‘corporatism’ differs from the commonusage. By corporatism Oi referred mainly to the ‘merger of state and econ-omy’ (1992, p. 100). Such a feature, however, may better be conceptualized asstate entrepreneurialism, to which we now turn.

China as an Entrepreneurial State

A common weakness of the concepts of ‘developmental state’ and ‘corporatiststate’ is that they fail to differentiate the Chinese state from other East Asianstates. It is true that China shares many developmental and corporatist charac-teristics with Taiwan and South Korea. But it is only the Chinese state thatitself runs profit-seeking, risk-taking business. This unique feature of theChinese state is captured by Blecher (1991) and Duckett (1996) in their ideaof the entrepreneurial state.

According to Blecher, ‘what is distinctive about the entrepreneurial state isthe establishment and operation by state agencies of enterprises not merely toassist the agency in carrying out its assigned task, but in order to earn profits’(1991, p. 268). He found that state agencies in Guanghan County in SichuanProvince have been engaged in a wide range of entrepreneurial activity,including construction, banking, and manufacturing. Likewise, Duckettobserved that state bureaux in Tianjin had adapted to marketization by settingup large numbers of new enterprises that operate on the newly emergentmarkets. These new enterprises were established for the purpose of generatingprofits for their bureaux. This helps state bureaux to reduce their financialburden and streamline state administration. State entrepreneurialism has thusbecome a survival strategy of state bureaux.


Both Blecher and Duckett see the concept of entrepreneurial state as auseful supplement to that of the developmental state. Blecher noted that thereis a ‘tendency to exclude entrepreneurship from the developmental role of thestate’ (1991, p. 266). In the developmental state approach, the role of the stateis restricted to the creation, promotion and administration of an environmentthat is favourable to development. But the state itself refrains from beingengaged in entrepreneurial activity. An entrepreneurial state exceeds this limit.In this model, state agencies ‘are directly and feverishly involved in startingnew enterprises, procuring finance, scrambling for inputs and competing foroutput markets’ (1991, p. 287). In Blecher’s view, both the developmentalstate and entrepreneurial state perspectives are useful for the understanding ofpolitical and economic changes in China. He found that the developmentalstate model tends to be applicable to places where the socialist planning legacyis strong, geographical location is remote, and links to the larger economy areweak; whereas state entrepreneurialism is likely to be found in localities wherethe planning structure was devastated during the Cultural Revolution period,the emphasis of reform is on retooling state enterprises rather than promotingprivate businesses, connections with major economic centres are available,and the economic base is relatively strong and balanced (1991, pp. 283–85).

From another angle, Duckett also noted the complementarity of theconcepts of developmental state and entrepreneurial state. According to her,

the term ‘entrepreneurial state’ refers collectively to the independent activities ofstate bureaux, but it is not a comprehensive model of the state. While business hasbecome an important focus of bureaux’ work, they still carry out their other admin-istrative functions. For this reason, the entrepreneurial state does not necessarilychallenge the ‘developmental state’ model. (Duckett, 1996, p. 189)

Whereas Blecher held that locational conditions determine the applicability ofeach model, Duckett argued that the developmental state perspective is moresuitable for national analyses, and the entrepreneurial state model for regionalstudies. In her view, the developmental state model focuses ‘on the develop-mental capacity of the central leadership or government and higher echelonsof the national bureaucracy. … The concept of state entrepreneurialism helpsrefine the notion of the developmental state by disaggregating it and examin-ing its constituent parts’ (Duckett, 1996, p. 189).

In short, Blecher and Duckett agreed that both developmentalism and entre-preneurialism can be found in the Chinese state, depending on which localityor level of analysis the focus of study is concerned with. Whereas develop-mentalism hypothesizes autonomous state intervention in the form of creating,promoting and administering a favourable market environment at the nationaland macro level, entrepreneurialism predicts direct involvement of the state inbusiness activity at the local and microeconomic level.


China as a Market-Facilitating State

While developmentalism and entrepreneurialism complement each other,Howell (1993) combines the two perspectives into the idea of the market-facilitating state. Contrary to the liberal view, Howell argued that China’sreform and opening has not led to a retreat of the state. Rather, to adapt to thenew environment and to meet new requirements, the state has undergone aprocess of major restructuring, resulting in a market-facilitating state thatpossesses the following four key features:

first, it is entrepreneurial, that is, it both promotes entrepreneurship and engagesitself in risk-taking, profit-seeking economic pursuits; second, it is legalistic, that is,it legally defines relations between economic actors in the market-place and settleseconomic disputes through the law; third, it is technocratic, that is, the state is runby technically and professionally qualified people; and finally it is regulatory, thatis, it seeks to regulate the market at the macro-economic level whilst withdrawingthrough deregulation from the tangle of the microlevel. (Howell, 1993, p. 181)

Among the four features, entrepreneurialism is captured by the entrepreneur-ial state perspective, whereas the legalistic, technocratic, and regulatory func-tions are the key elements of a typical developmental state. Hence, the‘market-facilitating state’ perspective can be seen as a combination of theentrepreneurial state and developmental state models. The hypotheses ofdevelopmentalism and entrepreneurialism mentioned above thus apply also tothe market-facilitating state perspective.

Howell observed that a larger number of ‘quasi-state institutions’ haveemerged in China. ‘They are quasi-state in that they are set up and owned by thestate but are supposed to behave like business enterprises’ (Howell, 1993, pp.193–94). These quasi-state institutions are responsible for their own profits andlosses, and display greater economic initiative and innovation than other stateenterprises. As such, they constitute what Blecher and Duckett called entrepre-neurial state. But more than entrepreneurialism, Howell noted, these quasi-stateinstitutions also performed the function of mediation between the state andforeign capital. For example, the China International Trade and InvestmentCorporation is a government entity directly under the State Council. It is run asa business corporation to deal with foreign traders and investors. This conflictswith Evans’s ‘triple alliance’ model (see above), in which the state acts only asa neutral mediator between national bourgeoisie and foreign capital.

The open policy has also made the Chinese state more legalistic, Howellnoted. In order to create a legal environment that is more favourable to foreigntrade and investment, China has devised a number of laws and regulations onjoint ventures, taxation, patents, foreign exchange management, accounting,customs, and entry and exit procedures. Another consequence of the opening


up of China has been the cultivation of, in Howell’s word, ‘a layer of techni-cal and professional cadres’. To equip the state with the manpower that iscapable of handling technical matters related to foreign trade, investment, andtechnology transfer, a large number of more educated, younger, and better-trained professionals have been recruited into state or quasi-state institutions.This has made the Chinese state increasingly technocratic. Finally, as foreigneconomic activity demands greater flexibility and initiative at the lower level,the open policy has transformed the role of the state from being commandingto regulatory. Economic decision-making power has been decentralized fromthe centre to provincial, municipal, and even enterprise level. Instead of amicroeconomic planner, the state has become a macroeconomic regulator ofthe country’s market-oriented foreign trade and investment framework(Howell, 1993, pp. 186–200).

In short, according to the market-facilitating state perspective, the Chinesestate has responded positively to the new external political-economic environ-ment brought about by the open policy. It has become both entrepreneurial anddevelopmental (legalistic, technocratic and regulatory). This contrasts sharplywith the classical dependency perspective, which hypothesizes that enteringinto economic relations with the capitalist centre will reduce the peripheralstate to a mere agent of the capitalist centre.

CONCLUSION

As has been shown, there has been growing foreign participation in China’sprivatization. While the country has not had any official privatizationprogramme for foreign investors, significant amounts of state assets have beentransferred to the hands of foreign investors through the shareholdingeconomic reform. As of the mid-1990s, there were over 700 listed SHEs inChina. Total capitalization, at about 1600 billion yuan, represents 24 per centof gross domestic product (GN, 1997, No. 20, p. 10). Measured in terms of theshare of foreign exchange in total capital raised through share issue, in 1995foreign involvement accounted for 74 per cent of China’s privatization,compared with 46 per cent in 1992 (ZZQTN, 1996, p. 35).30

The Chinese state does exhibit some features of the developmental state ininviting foreign participation in the country’s privatization. The expansion ofthe B-share market and the gradual opening of the A-share market to foreigninvestors were deliberate policies defined explicitly and autonomously by thecentral state in order to obtain external equity financing and internationalfinancial techniques. When signs of illiquidity emerged, the state acted to acti-vate the market by enlarging its scale. The form of state intervention has beenat the macro- but not microeconomic level.


However, there have also been signs of ‘dysfunctional development’ in theflow of foreign capital to the Chinese state sector. Bureaucrats in general lackthe professional knowledge required for the construction and operation of afinancial market. More importantly, the central state has not been able to steerlocal authorities to remain on the intended locus of reform. As a result, thecarefully designed separation between the A-share and B-share markets wasweakened; large amounts of state shares and corporate shares were convertedinto foreign shares; state assets were transferred out of the country through‘backdoor listings’ on foreign exchanges; and mergers and acquisitions ofChinese SOEs by foreign investors remained unregulated. In these respects,the Chinese state has not been an active designer or an effective executor of anational development strategy; rather, it has been a passive respondent tounexpected situations and local initiatives. In general, the expansion of foreignparticipation in China’s privatization owes at least as much to the dysfunc-tional activity of local authorities as it does to the plans and strategies of thedevelopmental state.

With regard to the corporatist state perspective, we see limited relevance ofit to our case. We do not find any attempt on the part of the state to corpora-tize the interests of foreign buyers of Chinese state assets. Although the stronglocal initiatives which played an important role in the sales of state assets toforeign hands can be comprehended in terms of ‘local state corporatism’, assuggested by Oi, such activities can better be captured by the developmentalstate and entrepreneurial state perspectives. To the extent that no corporatistmeasure has been employed to manage different interests arising from foreignparticipation in privatization, the corporatist state perspective is of little use.

In comparison, the market-facilitating state perspective, which combinesthe ideas of developmental state and entrepreneurial state, provides the bestdescription of the role of the Chinese state in the sales of state assets to foreigninvestors. Developmentalism is reflected in the state’s effort to develop a legalframework for the settlement of disputes (that is, legalistic), to invite bothdomestic and foreign experts to give advice (that is, technocratic), and to limitits intervention to the macro- but not micro-level (that is, regulatory). But suchdevelopmentalism has been limited by the dysfunctionalism mentioned above.On the other hand, state entrepreneurialism is reflected in the state’s role as ashareholder; that is, the state itself is engaged in entrepreneurial activity.31 Indealing with foreign investors, state officials were primarily motivated byconsiderations of profit and efficiency. These entrepreneurial and develop-mental activities can be embraced by the market-facilitating perspective.

The growth of foreign participation in China’s privatization can thus beseen as made possible by the market-facilitating state. As regards the role offoreign capital, although some foreign (in particular Hong Kong) investorshave attempted to make use of China’s legal loopholes to increase their hold-


ings of Chinese shares and to make abnormal profits (as in the Zhongce case),in general there is little lobbying from foreign investors for the relaxation ofrestrictions on sales of state assets to them. The pressure for change has comemainly from domestic (in particular local) rather than international sources.Hence, contrary to the classical dependency analysis, there is no indicationthat the Chinese state has become a mere agent of the capitalist centre. It islargely local authorities, rather than foreign capital, that bring about signs of‘dysfunctional development’. This alerts us to the tendency of ‘dependencyanalysis’ to place too much emphasis on the role of national-level state actors,neglecting the influence of local authorities. In any event, to the extent that theChinese state, central or local, is market-facilitating, it seems to be capable ofavoiding classical dependence, and of bringing about dependent development.

NOTES

1. The World Bank maintains a global privatization database recording privatization projectsthat have taken place in developing countries since 1988 (Sader, 1995, p. 2). The databasecovers transactions involving domestic and foreign investors. However, according to infor-mation obtained from the author’s personal correspondence with the World Bank, in the caseof China only those with foreign participation are included. A list of China’s privatizationtransactions involving foreign participation can be found in World Bank (1995d, Vol. 1, pp.131–32; 1996, pp. 130–31).

2. The Chinese figure is derived from data in CSY, and the developing economies’ figure isobtained from World Bank (1995a, pp. 268–69).

3. ‘Regulations of the State Council on domestically listed shares for overseas investors.’ Fulltext in CEN (29 April 1996).

4. This does not apply to joint venture investment companies formed by foreign investors andChinese non-bank and non-financial institutions (CD, 19 September 1995).

5. The other market ‘rescue’ measures included temporary suspension of new listings and newissues of A-shares, development of Chinese mutual funds, and provision of financing tohigh-quality securities firms (ZZB, 30 July 1994; CEN, 22 August 1994).

6. By the end of 1995 private foreign exchange savings at the Bank of China, which accountedfor about 60 per cent of the country’s total, had reached US$13.7 billion (CD, 28 January1996).

7. Such high-profile moves to allow domestic investors to trade B-shares have upset the centralgovernment, prompting the People’s Bank of China to persuade Shenzhen securities author-ities to enforce the official ban on the practice. While there has been a warning that a crack-down on the trading of B-shares by domestic Chinese ‘could be imminent’, Shenzhen-basedanalysts believed that the chances of a complete ban were not high because it would seri-ously damage the market (SCMP, 25 and 26 June 1996).

8. Rather than direct defiance, some foreign investors have found alternatives to bypass therestriction. For example, the St. Gobain Group of France acquired stakes in the White DoveShenzhen United Company and the White Dove Kaifeng Abrasives Factory by injectingcapital into the holding company of the Chinese enterprises, the Henen White Dove Group(CEN, 29 January 1996).

9. Apart from Hong Kong, ‘backdoor listing’ activities of Chinese enterprises can also befound in other places, such as Canada (MC, 1 November 1993, pp. 42–44).

10. In February 1995 problems of ‘red chip’ companies drew international attention as the chair-man of two Hong Kong-listed subsidiaries of China’s Capital Iron and Steel Corporation, orShougang, was arrested in Beijing on charges of corruption. After purchase of a listed shell


company in Hong Kong in 1992, Shougang injected a pile of state assets into four othersubsequent acquisitions. Shares of the ‘Shougang empire’, which had been worth US$1.4billion prior to the arrest, slumped by a fifth, and shares of other ‘red chip’ companies werealso dumped (EC, 25 February 1995, pp. 68–70; FEER, 2 March 1995, p. 16).

11. A Hong Kong-based expert in Chinese securities called all Chinese shares listed on interna-tional exchanges other than Hong Kong ‘I-shares’ (Wu P., 1994, p. 46). But this is not acommon term.

12. For more cases of ‘grafting into foreign capital’, see Tung (1995, pp. 13–15), and Ji, Y.(1995, pp. 35–36).

13. According to incomplete statistics, among the 260 000 foreign-invested enterprises inChina, 70–80 per cent were formed in conjunction with existing Chinese enterprises (CEN,3 June 1996).

14. On this point, we differ from a World Bank study, which includes joint venture in general asa privatization technique (Sader, 1995, pp. 19–20).

15. According to another source, at the end of 1994 foreign shares represented less than 2per cent of all Chinese shareholding enterprises’ capital stock (JS, 10 January 1995). Itis not clear whether this figure is comparable with the 10 per cent mentioned in the maintext.

16. The actual share of foreign exchange in China’s privatization revenue should be more thanthe quoted per centage. See note to Table 5.3.

17. In Poland, foreign investors may not buy more than 10 per cent of an enterprise (Frydmanand Rapaczynski, 1994, p. 23).

18. In Russia, there are many indirect restrictions against foreign participation in privatization(Fedorov, 1993; Bornstein, 1994b, pp. 445–46; Radygin, 1995, p. 12; Schrader, 1994, p.263).

19. In the case of Hungary, even 100 per cent foreign ownership is allowed (except in the bank-ing sector). But this has not resulted in foreign domination of Hungarian enterprises. Instead,foreign investors have largely remained minority stakeholders in Hungarian companieslisted on the Budapest exchange. Two possible reasons have been suggested for this. Firstly,Hungarian managers may be regarded as competent enough so that external control byforeign investors is not deemed necessary. Secondly, special deals involving underpricing ofstate assets may have been offered by Hungarian insiders, in exchange for an assurance ofmaintaining their managerial control (Earle, Frydman, and Rapaczynski, 1993, p. 11;Frydman and Rapaczynski, 1994, p. 113).

20. Namely, ‘Provisional regulations on the establishment of foreign-funded joint stock compa-nies Ltd’.

21. Namely, ‘Guiding directory on industries open to foreign investment’.22. According to Chinese analysts, foreign investors are attracted to China’s privatization

mainly by the country’s growth potential, and the access to China’s market and land (ZZB,23 and 30 August 1995).

23. See Skocpol (1985). Although statist theorists have been successful in ‘bringing the stateback in’, they have received criticisms from Almond (1988), Cammack (1989), Colburn(1988), Migdal, Kohli, and Shue (eds) (1994), and Mitchell (1991).

24. See, for example, Cardoso and Faletto (1978).25. In fact, there have been views that for post-communist transition to be successful, there is a

need to re-build effective state intervention mechanisms in post-Leninist states. SeeCirtautas (1995) and Ellman (1995).

26. In Kleinberg’s own words, ‘The effectiveness of state intervention into China’s economicrelations invalidates the “dependent development” model as a description of multinationalcorporate investment in Communist countries’ (Kleinberg, 1990, p. 256). What Kleinbergactually meant by ‘dependent development’ was ‘classical dependency’. He did not makeany distinction between the two concepts.

27. Such a ‘licensing’ aspect of Chinese corporatism, according to Kerr and MacKay (1997),leads to endemic corruption, poorly defined property rights, and high transaction cost.

28. For a note on the different uses of the term corporatism by Lee and Chan, see Chan (1993,p. 36, fn. 17).


29. According to Pearson (1994, p. 33), such ‘state-led societal corporatism’ allows the social-ist regime to pre-empt the emergence of autonomous groups.

30. The actual extent of foreign involvement in China’s privatization should be larger than thefigures here suggest, because they cover only privatization through issue of B-shares and H-shares, and do not include purchase of A-shares by foreigners, conversion of state shares andcorporate shares into foreign shares, issue of N-shares, and mergers and acquisitions byforeigners.

31. For a detailed analysis of the Chinese state as a shareholder, see World Bank (1997).


6. China’s privatization through listingstate enterprises in Hong Kong

H-SHARE COMPANIES AND RED CHIPS IN HONG KONG

When China launched its economic reform in the late 1970s, foreign capitalshortage was a major constraint to the country’s development.1 To cope withthe problem, a number of channels have been opened to absorb foreign capi-tal, namely foreign loans, direct foreign investment, and other means.

Initially, most foreign capital was obtained in the form of foreign loans.From 1979 to 1991, China utilized US$52.7 billion foreign loans, representing66 per cent of the total amount of foreign capital utilized during this period.Since 1992, direct foreign investment has emerged to be the largest source offoreign capital. From 1992 to 2000, China absorbed $320 billion direct foreigninvestment, accounting for 73 per cent of all the foreign capital utilized duringthis period. Other means include processing and assembly, compensationtrade, international lease, and portfolio equity flows (PEFs). Their share intotal foreign capital utilized has been negligible most of the time, with theexceptions of 11 per cent in 1997 and 15 per cent in 2000 (CSY, 2001, p. 602).

What happened in 1997 and 2000 was a dramatic increase in the issue offoreign shares. Officially, there are two major types of Chinese foreign shares,B-shares and H-shares. They are both Chinese shares traded in a foreigncurrency (US dollar or Hong Kong dollar), with the difference that B-shares arelisted on the Shanghai and Shenzhen Stock Exchanges, and H-shares on theHong Kong Stock Exchange (SEHK).2 Before 1997, the average annual amountof PEFs absorbed through B-shares was only $0.6 billion, and that through H-shares $1.2 billion. But the amount raised through B-shares soared to $1 billionin 1997, and that through H-shares to $4.3 billion and $6.8 billion respectivelyin 1997 and 2000 (CSRCW, 6 December 2001; CSY, 2001, pp. 586 and 642).

At the very beginning, Chinese securities officials regarded B-shares onlyas a transitional device to solve the dilemma between the need to acquire PEFson the one hand, and the intention to shelter the domestic stock market fromexternal shock on the other (Liu (ed.), 1998, p. 2). The plan was that when thedomestic stock market had become mature enough, B-shares would be mergedwith domestic shares, or A-shares.3 On the other hand, the infrastructural infe-riority of China’s embryonic stock market relative to the established one in

92

Hong Kong has made B-shares less attractive to foreign investors than H-shares.4 Owing to these reasons, the task of absorbing PEFs has fallen largelyon H-shares. In fact, during 1993–97 total PEFs obtained through H-sharesamounted to $9 billion, almost triple the amount absorbed through B-shares.Although the subsequent Asian financial crisis produced a heavier blow toHong Kong than to China, due to the greater financial opening of the formerthan the latter, from 1998 to 2000 the amount of PEFs obtained through H-shares was thirty times that through B-shares (CSRCW, 6 December 2001;CSY, 1998, pp. 578 and 628).

Officially, H-share companies refer to those ‘incorporated in the People’sRepublic of China and approved by the China Securities RegulatoryCommission for a listing in Hong Kong. … The letter H stands for HongKong’ (SEHKW). While only a handful of central agents were involved in thenomination of H-share companies, other authorities may obtain PEFs by estab-lishing the so-called red chips. Red chips are ‘Hong Kong-listed companieswhich are at least 35 per cent owned, directly or indirectly, by state institu-tions, provincial or municipal organizations in the mainland’ (SEHKW). Assuch, they ‘typically represent the interests of China’s leading ministries, theState Council, and provincial and municipal authorities’ and thus can beregarded as ‘extensions of governmental organizations operating withininvestment and cash-raising guidelines laid down by a holding company and acontrolling government body’ (De Trenck et al., 1998, pp. 26 and 44).

There are three major ways to form a red chip. First, a Chinese enterpriseoperating in Hong Kong lists its Hong Kong assets in the SEHK. Second, aChinese enterprise operating in Hong Kong moves its mainland assets to HongKong, and then lists them in the SEHK. Third, a Chinese enterprise purchasescontrolling stakes in an inactive listed company in Hong Kong (Huang andGao, 1999, pp. 390–91). The last method, known as ‘backdoor listing’, hasbeen the most common one, adopted by about half of all existing red chips(McGuinness, 1999, p. 245). In a typical ‘backdoor listing’, a red chip usesstate capital to purchase a shell company in Hong Kong, and subsequentlyraises funds through new rights issues. This contrasts with the case of H-sharecompanies, which are listed mainly through an initial public offering (IPO),where new and/or existing shares are offered to local and internationalinvestors (see Table 6.1) (McGuinness, 1999, p. 9).

In short, H-share companies and red chips are two different types ofChinese vehicles for the acquisition of PEFs, the former being official and thelatter unofficial. ‘Red chips differ from H-share companies in that they are notmainland-incorporated companies but may be incorporated in Hong Kong orelsewhere overseas’ (SEHKW). In terms of scope of business, most H-sharecompanies are engaged in infrastructure industries, while red chips have verydiversified business interests (McGuinness, 1999, p. 10). 5

Listing state enterprises in Hong Kong 93

THE DEBATE

The debate about the merits and demerits of H-share listing can be traced backto December 1991, when a Chinese study group led by a deputy director of theState Commission for Economic System Reform (SCESR) visited Hong Kongupon SEHK’s invitation. After the study, the group concluded that listingChinese state-owned enterprises (SOEs) in Hong Kong had the advantages ofhelping to maintain Hong Kong’s stability and prosperity, especially duringthe political handover of Hong Kong in 1997; raising foreign capital forChinese SOEs; and promoting the international presence of Chinese SOEs. Onthe other hand, the study group identified a list of disadvantages: less technol-ogy spillover effect than direct foreign investment; need to share profit withforeign shareholders; and competition with China’s domestic stock exchanges.On balance, the study group advised the State Council that the gains from list-ing Chinese SOEs in Hong Kong were ‘large’, while the losses were ‘small’.The State Council responded by giving a cautious green light to the plan (Liu(ed.), 1998, pp. 2–5).

On 15 July 1993, Tsingtao Brewery began listing on the SEHK, making itthe first H-share company (Liu (ed.), 1998, pp. 11–12). But as early as themid-1980s, some Chinese SOEs were already absorbing PEFs in Hong Kongthrough the ‘back door’, thereby forming the so-called red chips. Examplesinclude the Beijing-backed CITIC Beijing’s acquisition of the Ka Wah Bankin 1986, and the Fujian Provincial Government’s acquisition of Min Xin in1987 (Morgan, 1998, p. 8).

The practice of ‘backdoor listing’ allowed Chinese institutions to bypass


Table 6.1 H-share and red-chip enterprises compared

H-share enterprises Red-chip enterprises

Incorporated in China Incorporated in Hong Kong

Mainland enterprises restructured Hong Kong listed company with at for listing in Hong Kong least 35% mainland Chinese interest

Creation monitored by central Established through local government government initiative

Funds raised through IPO Funds raised through shell companies

Examples: Guangzhou Shipyard Example: Guangdong InvestmentInternational Company Northeast Electrical Company

both China’s restrictions on sales of equity abroad, and Hong Kong’s regula-tions on new listings. By this means, a red chip could raise financing throughnew rights issues, reduce its effective tax rate by establishing a joint venturewith the overseas-registered company that it controlled, and obtain foreignloans at a much lower cost. Officially speaking, formation of a red chiprequires approval of the State Council, if the project involves assets that areheld at the national level and above $30 million. In practice, however, this rulecan be avoided by breaking a large acquisition into a number of smaller trans-actions over a period of time (De Trenck et al., 1998, pp. 52–53, 56; Goldsteinand Folkerts-Landau, 1994, p. 99).

Initially, neither the Chinese nor Hong Kong authorities discouraged these‘backdoor listing’ activities. However, as the practice went on, some compa-nies were found to have muddled accounts, sub-standard disclosure andinflated assets. In many cases it was not clear whether the funds raised fromrights issues were actually used for the intended purpose. There were also indi-cations that some red chips used ‘backdoor listings’ as a way to transfer stateassets out of China. To maintain the reputation of the SEHK, from May toSeptember 1993 the Hong Kong authorities took a series of actions to tightenrules on ‘backdoor listings’ and rights issues. On the other hand, Chinese secu-rities officials urged enterprises seeking foreign listing to apply for centralapproval, rather than to look for ‘roundabout ways’. In May 1994, the Chinesegovernment officially banned the practice of ‘backdoor listings’ on overseasstock markets (Goldstein and Folkerts-Landau, 1994, p. 99; Ko, 1993; ZZSN,1994, p. 61; ZSZ, 2 July 1994).

The above moves, however, turned out to be ineffective. For example, in1996 the China Ocean Shipping Company managed to make Shun Shing a redchip through ‘backdoor listing’. In June 1997, the Chinese government issuedanother ban against such practices, and set a series of guidelines for assetinjection by red chips (De Trenck et al., 1998, pp. 79–80; He et al. (eds), 1999,p. 1361; Yau, 1998, p. 10). On 1 July 1999, the Securities Law of China cameinto effect. According to Article 29 of this first comprehensive Chinese law onsecurities, domestic enterprises intending to issue securities overseas directlyor indirectly, or to list and trade their securities overseas, must obtain priorapproval from the securities regulatory authority of the State Council. In late1999, the central government tightened its grip on red chips by requiring themto seek approval for large-scale asset restructuring and capital deployment.Moreover, priority was given to the listing of H-shares over red chips (MB, 10December 1999; SCMP, 4 November 1999).

Hence, in the Chinese debate about listing shares in Hong Kong, the focushas been on whether the process is under the control of the central securitiesregulatory agents. Predictably, the ‘official’ view is that the advantages of list-ing H-share companies in Hong Kong outweigh the disadvantages, as long as


the process is centrally administered. In contrast, red chips’ uncontrolled‘backdoor listing’ activities should be outlawed. Implicit in such a line ofthought is that state control is desirable. Such a view, however, is inconsistentwith the neoclassical economic belief in the merit of privatization, which holdsthat withdrawal of state interest in business enterprises is a necessary, thoughnot sufficient, condition for market efficiency. As Steven Cheung, a strongadvocate of privatization in China, advised Chinese leaders, ‘for state-ownedresources that are salable, sell’ (Cheung, 1989, p. 8). Similarly, the World Bankcontended that ‘the [Chinese] government should completely withdraw frominherently competitively structured industries where small and medium sizedfirms predominate’ (World Bank, 1997, p. xiii, italics in original).

Listing of Chinese SOEs in Hong Kong, whether through the formation ofH-share companies or red chips, is a major form of foreign participation inChina’s privatization, or what one scholar called ‘informal privatizationthrough internationalization’ (Ding, 2000a). Such a move, according to theabove neoclassical logic, should lead to improvement in economic efficiency.As noted by some scholars, an SOE situated in the international market maybe expected to behave like a competitive private firm (Ding, 2000a, p. 127).However, while listing enterprises in Hong Kong has helped China to raise asignificant amount of PEFs, it has contributed little to the enhancement ofeconomic efficiency. This is due mainly to the residual role of the state. Theexperience of privatization in the Czech Republic, Hungary, and Russiashowed that, due to the specific economic, social, and political objectives ofthe government, residual state holdings would lead to conflicts of interest thatwould hinder efficient operation of enterprises (Pistor and Turkewitz, 1996,pp. 217–42). A World Bank economist also noted that ‘[i]f the state is to main-tain a stake in firms after privatization, its share should be small and tempo-rary, and its stance relatively passive, although it should continue to monitorthe firm to prevent fraud and asset-stripping’ (Gray, 1996, pp. 194–95). Wepresent three cases below – the Guangzhou Shipyard (an H-share company),Guangdong Investment (a red chip), and Northeast Electrical (another H-sharecompany) – to show that the residual role of the state in Chinese enterpriseslisted in Hong Kong has resulted in a similar set of problems, namely asset-stripping, and submission to non-economic (social and political) factors.

CASE STUDY 1: GUANGZHOU SHIPYARDINTERNATIONAL COMPANY

Background

Producing eight ships of total tonnage of 188 000 dwt in 2000, Guangzhou


Shipyard International Company (GSIC) is China’s fifth largest shipbuilder.The company was established in 1993 on the basis of Guangzhou Shipyard,an SOE founded in the 1950s to build barges for military and civilian use.During China’s first Five-Year Plan period (1953–57), very limitedresources were earmarked for Guangdong’s heavy industrial development,due to the province’s strategically vulnerable location. Nevertheless, the fewinfrastructure projects designated to Guangdong included the construction oftwo new shipyards, namely the Guangzhou First Shipbuilding Factory andthe Guangzhou Ship-repairing and Shipbuilding Factory. The reason forprioritization of the shipbuilding industry in Guangdong was to utilize theadvantage of the province’s long coastline, and to enhance the country’s seatransportation as well as coastal defence capability in the south. In 1958, thetwo shipyards were merged to form Guangzhou Shipyard. In 1960,Guangzhou Shipyard was placed under the direct administration of theMinistry of the Third Machinery Industry. Constrained by the central plan,the shipyard had little incentive to grow. It took 17 years (1958–74) for thenet value of Guangzhou Shipyard’s fixed assets to double (Liu (ed.), 1998,pp. 179–80; Lu and Xu, 1999, pp. 40–43; Tang, 1989, pp. 24–28 and149–51; WGSIC).

Originally a large part of the Guangzhou Shipyard’s products were formilitary use, such as guided-missile destroyers, escorts, and supply ships (Liu(ed.), 1998, p. 180; Tang, 1989, p. 151). When China launched its economicreform in the late 1970s, the company began to shift more resources to theproduction of ships for civilian use, and to explore the overseas market. In1982, the enterprise was put under the administration of the China StateShipbuilding Corporation (CSSC), a new entity established under the directleadership of the State Council. Guangzhou Shipyard’s business then beganto expand and diversify. Nevertheless, as an SOE, the company had to submita large part of its revenue to the state, and to provide costly social welfare toits workers. Consequently, only limited capital was left for technologicalrenovation. Although in 1990 Guangzhou Shipyard was included in thenational Eighth Five-Year Plan as one of the key SOEs for renovation, stillinsufficient capital was allocated to the enterprise (Liu (ed.), 1998, pp.180–81; WGSIC).

In January 1992, paramount leader Deng Xiaoping called for furtherreform during his high profile ‘southern tour’. The move gave politicalmomentum to the then emerging shareholding system reform. Taking thisopportunity, Guangzhou Shipyard applied for conversion into a shareholdingenterprise. After reviewing the company’s track record, CSSC recommendedthe State Commission for Economic System Reform (SCESR) to includeGuangzhou Shipyard in the first batch of enterprises to experiment with‘standardization of shareholding enterprises’ (Liu (ed.), 1998, p. 182).


Listing in Hong Kong

In June 1993, GSIC was established as a new shareholding company to takeover the production and business operations of the old Guangzhou Shipyard,while workers’ welfare responsibilities were left to Guangzhou Shipyard (seebelow for the reason for such an arrangement). In August, GSIC began listingin Hong Kong. Through the issuance of 145 million H-shares, the companyraised over $42 million. The IPO was over-subscribed by 77 times. In October,GSIC issued over 126 million A-shares, listed on the Shanghai StockExchange. After these changes, CSSC (as the state representative) retains a42.6 per cent stake in the company, while overseas and Hong Kong investorshold 31.8 per cent, and Chinese domestic public investors 25.6 per cent. Withsuch ‘foreign’ participation, in October 1994 GSIC became a Sino–foreignlimited joint stock company, thereby entitling it to a series of preferential treat-ments. In July 1999, the original CSSC split into two corporations, the newCSSC and China Shipbuilding Industry Corporation. The new CSSC has sinceinherited the original CSSC’s controlling stake of GSIC. Both the original andthe new CSSC are under the direct control and administration of the StateCouncil (CSFSY; CSRCW; GSICBI, 6 December 2001; WGSIC). The owner-ship structure of GSIC is shown in Figure 6.1.

GSIC was among the first batch of the nine Chinese SOEs that wereapproved to list H-shares. Two central authorities, the People’s Bank of China(PBC) and SCESR, were responsible for the selection of these earliest H-sharecompanies. During the selection period (mid-1992), all securities matters inChina were under the supervision of PBC. But in October 1992, when the first


Source: WGSIC.

Figure 6.1 Ownership structure of Guangzhou Shipyard InternationalCompany

China State Shipbuilding Domestic Overseas andCorporation Chinese Hong Kong investors(State-share holder) (A-share holders) (H-share holders)

42.6% 25.6% 31.8%

Guangzhou Shipyard International Company

nine H-share companies had been selected and were preparing for the IPOs,the State Council Securities Commission (SCSC) was established to replacePBC as the national regulator of securities affairs. The new agent was respon-sible for macro policy issues relating to the securities markets, with an inde-pendent entity, the China Securities Regulatory Commission (CSRC), as itsexecutive arm (Wang J.X., 1997, p. 233; World Bank, 1995b, Vol. 2, p. 22).

It is important to note that all the above agents – SCESR, PBC, andSCSC/CSRC – were central authorities. The role of local governments wassmall. In fact, early in China’s first major regulations on the securities market– Circular of the State Council on Strengthening the Macro Regulation of theSecurities Market (17 December 1992) – it was clearly stated that all mattersrelated to the issue and listing of foreign shares by Chinese enterprises mustbe centrally arranged and approved by SCSC/CSRC. ‘Local authorities anddepartments should not go their own way.’ This rule was further emphasizedin a subsequent State Council circular (Xiao (ed.), 1995; 1993–95, pp.2049–50).

As mentioned, GSIC was established to take over the production and busi-ness operations of the old Guangzhou Shipyard, while workers’ welfareresponsibilities were left to Guangzhou Shipyard. Through a series of contrac-tual relations, Guangzhou Shipyard provided housing, catering, health, child-care, education, and retiree management services to GSIC. GuangzhouShipyard continued to pay pensions to the 1500 workers who retired from theenterprise before 1990, whereas GSIC was responsible only for the pension ofthe 500 workers who retired after that year. Such arrangements significantlyreduced the welfare burden of GSIC and thus enhanced its profit potential,thereby facilitating the listing of the company (Liu (ed.), 1998, pp. 179 and185). In fact, this kind of financial costuming is a common practice of H-sharecompanies (De Trenck et al., 1998, p. 25; Steinfield, 1998, pp. 146–49).

Company Performance after Listing

Once listed, an H-share company is regulated by a number of laws and regu-lations. As a Chinese shareholding enterprise, it is subject to China’s CompanyLaw, and as a Hong Kong listed company, it is required to observe applicableHong Kong laws and codes. In addition, it has to satisfy a series of require-ments jointly stipulated by securities authorities in China and Hong Kong.That is to say, H-share enterprises are subject to double supervision (SEHK,1998, p. 6).

On the first trading day of GSIC’s H-shares (6 August 1993), the shareprice closed at HK$2.4, which was 15 per cent above the IPO price. In 1993,the company made an annual after-tax profit of 106 million yuan, 24 per centhigher than the amount predicted in the prospectus. In 1994, the profit jumped


by 74 per cent, reaching 183 million yuan. Although there was a gradualdecline in profit after that year, the company did not suffer any loss until 2000.Throughout the period from 1994 to 1999, there was positive return on equity.The net asset value per share even rose from 2.62 to 2.73 yuan. Yet, thecompany’s H-share price dived from the 1994 high of HK$5.6 to the 1999 lowof HK$0.3 (Table 6.2; Xiao (ed.), 1995, p. 1710; ZJ, June 1994, p. 28).

In fact, since 1993 the general trend of all H-share prices has been a down-ward one, as investors’ confidence has been weakened by problems includingsubstandard disclosure of company information and lack of transparency inoperations.6 In the case of GSIC, the first annual report of the company indi-cated that the profit attributable to shareholders included a ‘public welfarefund’ of 11 million yuan. Some financial analysts charged that such account-ing practice was inappropriate and ‘misleading’, as the fund was not distrib-utable to shareholders. GSIC counter-argued that ‘the public welfare fundconstituted a part of shareholder equity.’ Foreign investors were forced toaccept this as part of ‘the costs of doing business in China for [H-share])companies’ (FT, 6 May 1994; Liu (ed.), 1998, p. 187; SCMP, 14 April 1994).

Another instance was that GSIC used the yuan’s official exchange rate forforeign currency conversion in its 1993 annual report, while all the other H-share companies of the time had used a swap market rate. GSIC’s conversionmethod resulted in a favourable exchange difference of 86 million yuan whenChina unified the official and swap market rates on 1 January 1994. The casedrew the concern of accounting experts in Hong Kong, as GSIC’s practice wasagainst the territory’s accounting standards that required the adoption of a


Table 6.2 Financial indicators of Guangzhou Shipyard

1994 1995 1996 1997 1998 1999 2000

Turnover 1530 1834 2061 1682 1865 2281 2222(million yuan)Profit after tax 183 102 33 36 22 6 –728(million yuan)Profit attributable to 183 101 33 40 19 1.0 –729shareholders(million yuan)Return on equity (%) 14.15 7.69 2.51 2.96 1.41 0.07 NilNet asset value per share 2.62 2.66 2.68 2.71 2.73 2.73 1.26(yuan)Earnings per share (yuan) 0.370 0.205 0.067 0.080 0.038 0.002 –1.473H-share price(high–low) (HK$) 5.60– 3.80– 2.43– 4.25– 1.16– 0.87– 0.67–

2.10 1.74 1.40 1.14 0.35 0.30 0.32

Sources: GSICAR; WGSIC.

market rate, which ‘made it difficult to obtain a full picture of the operationalprofitability of the group’ (SCMP, 6 and 25 August 1994).

In 1998, as a consequence of the Asian financial crisis, some Chinese non-bank financial institutions were unable to repay overdue deposits to many oftheir clients, including H-share companies. Taking the case very seriously,CSRC summoned the senior managements of all the H-share companies toreport their financial conditions. In October, CSRC sent investigation teams toselected H-share companies, including GSIC. It was later disclosed that, as ofend of 1998, GSIC’s deposit in the troubled non-bank financial institutionsamounted to 519 million yuan, of which 378 million yuan was overdue. In1999, the company wrote off 10 per cent of the overdue deposits as bad debts,resulting in the decline in profit in that year and the loss in 2000 (GSICAR;MB, 12 November and 31 December 1998; 26 April 1999; SCMP, 26 and 27April 1999; WGSIC).

CASE STUDY 2: GUANGDONG INVESTMENT

The Parent (Guangdong Enterprises Holding) and its Listed Flagship(Guangdong Investment)

The Guangdong Enterprises Holdings (GEH) Limited was established in 1980(under the name of Guangdong Enterprises Limited until 1986) as a product ofChina’s economic decentralization. By a series of ‘special policies’ promul-gated during 1979–1981, Guangdong province obtained a high degree of auton-omy over its investment priorities. In return, it was required to raise its owncapital to finance development projects, without relying on resources allocatedby the central government. One major strategy adopted by Guangdong leaderswas to maximize the province’s strength in absorbing foreign capital arisingfrom its proximity with Hong Kong. To do so, they convinced the centralgovernment to grant them the power to establish three Special EconomicZones, to approve foreign investment projects that did not affect nationalbalances, and to utilize foreign investment in infrastructure. Moreover, to createa separate entity to conduct business, the Ministry of Foreign Trade and theGuangdong Foreign Trade Bureau co-founded the Guangdong ProvinceForeign Trade Corporation, with GEH as its subsidiary in Hong Kong. Apartfrom being Guangdong’s ‘window company’, GEH also served as the umbrellaof a number of prefectural companies looking for international business oppor-tunities through Hong Kong (Cheung, 1998, pp. 125–30; De Trenck et al.,1998, p. 153; Vogel, 1989, pp. 80–87, 248, 354–55, 443).

The original nature of GEH, however, was not favourable to the company’seffort of raising PEFs. As a provincial government-owned trading company, it


did not have the profit potential to attract public investors. To solve the prob-lem, GEH resorted to ‘backdoor listing’. In 1987, GEH acquired the control-ling stake of Union Globe Development Limited, turning this Hong Konglisted-company (incorporated in 1973) into a red chip. In 1988, Union Globewas re-named Guangdong Investment (GI), which has since then been thelisted flagship of GEH (CH, 1987, p. 497; WGIL).

The basic structure of GI is similar to that of GEH, with the major differ-ence that many of the lucrative businesses of GEH were injected into GI.Through a series of complex asset shuffling, earnings were transferred fromthe parent to the listed company, while debts went from the listed company tothe parent. The whole purpose was to produce a high–yield image of GI, at theexpense of lower profitability of GEH (De Trenck et al., 1998, pp. 158–62).

Between 1988 and 1991, GI was engaged mainly in property development.In 1992, after Deng’s southern tour, the company began to expand by acquir-ing subsidiaries, many of which were from the parent, GEH. These included atour company, a malt plant, a brewery, a curtain wall specialist, and somehotels and properties (see Table 6.3). As income-generating businesses, theycontributed positively to GI’s earnings growth, and thus sustained the shareprices. Between 1994 and 1997, the return on equity ranged from 7.4 per centto 10.3 per cent, and share price soared from the 1994 low of HK$3.6 to the1997 high of HK$12.3 (Table 6.4; see also De Trenck et al., 1998, pp. 168–71;WGIL).

Hence, GI continued to be attractive to public investors, at least on paper,by receiving favourable injections from GEH. Such a high-yield image of GIenabled the group to raise more funds. From 1994 to 1997, the group received$183 million net through issue of share capital. Moreover, it managed to spinoff four of its subsidiaries: Guangnan Holdings in 1994,7 Guangdong Tanneryin 1996, and Guangdong Brewery and Guangdong Building Industries in1997. During 1994–97, the net proceeds from the shares issued on the IPOs ofGI’s subsidiaries amounted to $103 million (WGHL; WGIL).

The fund so raised enabled GI to make more acquisitions. Through suchrolling of acquisitions and fund raisings, the group built up an empire that, asof end of 1998, consisted of twenty-four subsidiaries in Hong Kong, eight inBritish Virgin Islands, thirty-one in mainland China, and one each in Bermuda,Cayman Islands, and Singapore. They covered a wide business scope thatincluded hotels and tours, transportation, property, building materials, timberand furniture, brewing, leather, energy, finance, and wholesale and retailing(WGIL).

Failure and Government Bailout

GI, however, suffered a drastic decline in business in 1998. The recession in



Table 6.3 Selected acquisitions by Guangdong Investment

Date Name of company (and stake) acquired Fund spent(approximate

amount inUS$ million)

1987 New Cathay Hotel (from GEH; stake unknown) N.A.Jun 91 Cameron Centre (stake unknown) 20Nov 91 Citybus (20%) 6.4Dec 91 Guangdong Tour (stake unknown), Guangzhou Malt 64

(44.2%); Panyu site (4.1m sq ft) (fromGEH; stake unknown)

Jun 92 Shenzhen Brewery (24.5%); Guangdong Hotel and 100Irving Court, Cao Yang Village, and a Guangzhou property (70%); Full Arts (80%) (from GEH)

Dec 92 Weili Washing Machines (60.8%) 38Jul 93 CIL (5%) 1.9Sept 93 Zhongshan Power’s 50 MW plant (95%) 28Dec 93 Shenzhen Brewery (additional 40%) 17Apr 94 Wharney and Guangdong hotels (from GEH) 105May 94 Full Arts (additional 10%) 2.4Jun 94 300 MW Shaoguan Power (45.9%) 71Aug 94 Nanhai Tannery (75.6%) 24Nov 94 Guangnan Hang (34.7%; from GEH) 14Jun 95 Nanfang Dept Store (56%) 22Apr 96 2x125 MW Meixian generators (12.5%) 14Jun 96 Nanhai Tannery (additional 24.4%) 36Sept 96 Guangzhou-Zhuhai expressway (20%) 14Mar 97 50 000 KW generator in Zhongshan Power plan (95%) 30May 97 Guangdong Transport (51%) 192May 97 Guangdong Yingde Highway (70%) 20July 97 Maxfitter (100%) 50July 97 Shenzhen Brewery (additional 10.5%) 18July 97 A car park lot in Hong Kong (60%) 29Aug 97 12 residential units and car parks in Hong Kong (100%) 42Sept 97 Paul Y-ITC Construction (3.2%) 17Sept 97 Nam Fong (10%) 45Nov 97 Guangdong Regency Hotel, Zhuhai (100%) 83Nov 97 Guangdong Finance (100%) 58Apr 98 Guangdong Fur (100%) 1.4Dec 99 Shenzhen Guangdong Hotel (additional 29% from GEH) N.A.

Sources: 1987 and 1999 data from WGIL; 1991–96 data from De Trenck et al. (1998, pp.169–70); 1997–98 data from CPY (1998).

Hong Kong, slowdown of growth in China, negative sentiment among thebanking community towards lending in Asia, renminbi devaluation, and majorflooding in China made operating conditions difficult in every industry inwhich GI had interests. Reflecting this situation, the group’s share price divedby 85 per cent from August 1997 to June 1998. Nevertheless, some financialanalysts still counted on support from GEH, believing that the favourable assetinjections from the parent would give ultimate support to the business shapeof GI. For example, in June 1998 the investment firm Core Pacific-Yamaichiadvised its clients to buy GI’s shares, on the ground that ‘[t]he relationshipwith its parent company gives [GI] a major competitive edge when identify-ing and acquiring high growth investment projects’ (CPY, 1998:1, 6;GIAR1998).

The parent itself, however, was soon found to be in trouble. In October1998, one of Guangdong’s largest financial institutions – GuangdongInternational Trust and Investment Corporation (GITIC) – was closed downdue to severe liquidity problems. The news immediately alerted investors tothe financial situation of other ‘window companies’ of Guangdong, includingGEH, leading to the downgrading of GEH’s international credit rating. InJanuary 1999, GEH announced that it had outstanding debts of $2.9 billion.Being unable to meet the debt obligations, the group was technically bankrupt(MB, 13 January 1999; SCMP, 8, 23, 25 and 29 October 1998; 13, 19 and 20January 1999).

Yet, GEH survived by receiving support from the Guangdong provincialgovernment. In January 1999, it was revealed that the provincial government


Table 6.4 Financial indicators of Guangdong Investment

1994 1995 1996 1997 1998 1999 2000

Turnover 3528 4309 6472 7145 6281 5359 4948(HK$ million)Profit after tax 597 841 764 897 –1982 –2453 –1272(HK$ million)Profit attributable to 437 579 604 750 –2072 –2377 –1356shareholders(HK$ million)Return on equity (%) 8.64 10.28 7.38 8.80 Nil Nil NilNet asset value per 2.55 2.82 3.51 3.51 2.43 1.77 3.24share (HK$) Earnings per share 0.269 0.290 0.280 0.391 –0.833 –0.957 –0.544(basic; HK$)Share price 6.15– 4.88– 7.50– 12.30– 5.15– 2.05– 0.73–(high–low) (HK$) 3.58 2.85 4.38 3.50 1.05 0.82 1.50

Sources: GI2000ARA; TDW; WGIL.

would inject up to 30 billion yuan into GEH. In May, the provincial govern-ment proposed a bailout plan under which the provincial government andcreditors would share the responsibility of restructuring GEH. According tothis plan, the provincial government would inject the Dongshen Water Project– which supplies more than 70 per cent of Hong Kong’s water – into GI. Onthe other hand, total debts worth about $5.9 billion in GEH would be restruc-tured through the issue of new debts, notes and preference shares. After morethan a year of negotiation with creditor banks, the plan was finally confirmedin December 2000. In addition, GI disposed of two of its subsidiaries to GEHand issued 2.3 billion new shares to GEH, while GEH would inject a cash sumof $20 million into GI. Such a debt-restructuring plan has helped GI return tothe black after three years (1998–2000) of losses. In the first half of 2001, thecompany registered a net profit of $16.5 million (Table 6.4; XB, 27 January1999; MB, 30 January 1999; SCMP, 26 May 1999; 23 and 28 December, 2000;22 September 2001; WGIL).

The above moves – to close down GITIC but save GEH – were carried outby the Guangdong provincial government, but under direct instruction of thecentral government. GITIC was liquidated under an order from DaiXianglong, the then governor of China’s central bank, in a bid to give a clearsignal that the central government would not pay for the debts of local finan-cial institutions. The case of GEH was handled by Wang Qishan, a seniorcentral official appointed in early 1998 by the then Premier Zhu Rongji asdeputy governor of Guangdong to strengthen the central government’s grip onthe province. It was with Zhu’s support that Wang designed the rescue plan.8

Though it was the central government’s decision to bail out GEH, it was up tothe Guangdong provincial government to pay for the cost. The DongshenWater Project, which was injected into GI to keep the company afloat, is aprovincial asset (MB, 30 January 1999; SCMP, 7 January and 8 October 1998,4 April 2000).

The reason why the central government saved GEH but not GITIC was thatGEH had five listed companies in Hong Kong. Liquidation of the group wouldcause a severe blow to the Hong Kong economy, a situation that the centralgovernment wanted to avoid. Hence, in the restructure plan, GI – GEH’s listedflagship in Hong Kong and a constituent stock of the Hang Seng Index9 – wasgiven the first priority to use the injected assets to repay its debts (CD, 8March 1999; MB, 26 May 1999; SCMP, 26 May 1999; XB, 26 May and 17December 1999).

Ambiguous Role of the State

Many reasons have been cited for the failure of GEH: sudden reversal ofmarket conditions; wrong assessment of risk and return when making


investment decisions; and improper debt management (MB, 13 January 1999;XB, 13 January 1999). To be sure, GEH was just another victim of the Asianfinancial crisis, which caused financial trouble to a vast number of companiesin the region. Substandard financial supervision that invited embezzlementwas also a factor.10 However, a more fundamental problem is the ambiguousrole of the state in GEH.

Commenting on the case of GEH, an unspecified source said that, ‘the keyto the problem is the availability of easy money’ (SCMP, 17 December 1999).Similarly, an investment company’s research reported that the failure of GEH‘highlights the fact that many China companies mismanaged financialresources and made poor investment decisions during the days of easy credit’(AACR, 1999). The question is, why was so much ‘easy money’ and ‘easycredit’ made available to GEH? The answer lies in the ambiguous relationbetween GEH and the state. On the one hand, GEH emphasized that it is anindependent business entity that bears its own risk, despite the state-ownednature of the group. For example, in GEH’s prospectuses for $250 million and$500 million note issues in 1997, it was stated that

[w]hile the company is owned and supported by the [Guangdong] government, it isnot a sub-division of that government, or the central government. [GEH’s] obliga-tions, including its obligations under the notes, must be satisfied out of its ownassets, and are not guaranteed or otherwise supported by the Guangdong govern-ment or the central government. (SCMP, 11 March 1999)

However, like most other Chinese enterprises, GEH had few financialrecords of its own to meet foreign bankers’ lending requirements. Senior exec-utives of the group, who were at the same time provincial officials, thusresorted to government backing by issuing letters of comfort. This was also thecase in the two GEH note issues mentioned above, which carried letters ofcomfort from the Guangdong government. In the foreign bankers’ view,although such documents were legally non-binding, they did imply moralobligation (SCMP, 11 March 1999). More importantly, the state-owned natureof GEH and the previous injections of high-yield provincial assets to itssubsidiaries created an expectation that loans to the group had low sovereignrisk. While the central government attempted to make it clear that such expec-tations were not always valid by closing down GITIC, its rescue of GEH gavea conflicting signal. The irony is that not only had the public listing of GEH’ssubsidiaries in Hong Kong failed to enhance corporate governance of thegroup, it was this status that necessitated government bailout.

In fact, the financial conditions of both GSIC and GI were distorted by therole of the state. GSIC was made profitable on paper by leaving most of thewelfare expenditures to the state-owned Guangzhou Shipyard. This was neces-sary in order to make the company attractive to foreign investors. As a World


Bank economist observed, China’s enterprise reform has focused on ‘de-link-ing social services from enterprises’ and ‘discharging State shareholder func-tions in SOEs’ (Broadman, 2001, p. 864). The problem is that non-stateshareholders may exploit this policy to their advantage by taking all the valu-able assets while leaving the liabilities to the state. The financial strength ofthe company is artificial in the sense that a major part of the costs of ineffi-ciency have been absorbed by the state. As long as China’s social safety net isweak, achievement of real economic efficiency through laying off redundantresources (in particular labour) remains difficult (World Bank, 1999, p. 30).

In the case of GI, the company’s high-yield image was created by receiv-ing favourable asset injections from its parent GEH. More importantly, thevalue of the state assets tends to dissipate after the transfer, not due to anybusiness pattern, but as a result of stripping of state assets.11 This is particu-larly likely when local governments are involved, as the central government’scontrol becomes less effective (Ding, 1999, pp. 33–34; 2000a, pp. 128–33;2000b, pp. 3–10 and 14–20; Smyth, 2000, pp. 5–6). Moreover, the bailout ofGI by the central government shows that listing Chinese enterprises in HongKong does not necessarily imply improvement of corporate financial disci-pline. The political consideration of the economic stability of Hong Kong,which heads the list of ‘special motives’ of Chinese state investment abroad(Ding 2000a, p. 130), has softened the budget constraint.

In short, while listing enterprises in Hong Kong has helped China to raisesignificant amount of PEFs, it has contributed little to the improvement of thecompanies’ economic performance. Rather, the residual role of the state inthese enterprises has resulted in problems such as asset-stripping and submis-sion to non-economic (social and political) factors. Contrary to neoclassicaleconomic belief, privatization and internationalization of SOEs do not neces-sarily lead to enhancement of economic efficiency.

CASE STUDY 3: NORTHEAST ELECTRICAL COMPANY

Background

The above two case studies may prompt one to the view that while both H-share enterprises and red-chip firms exhibited distorted corporate financialconditions, the former type of companies tended to be better regulated than thelatter type because H-share enterprises were officially formed under directscrutiny of the central government, whereas most of the red chips were estab-lished through ‘backdoor listing’ under local initiative. Such a conclusion,however, is not entirely accurate, as it does not take into consideration theimportance of the fiscal relationship between the central government and the


concerned local governments. Our third case study, which is on an H-shareenterprise that nearly became the first case of bankruptcy and delisting of itskind, will show that under China’s decentralized fiscal system, an H-shareenterprise owned by a local government may behave like a red chip.

Northeast Electrical Transmission and Transformation MachineryManufacturing Company (referred to here as ‘Northeast Electrical’) is an H-share enterprise. There are two major reasons for the selection of this companyas a case study. First, it is a large, heavy-industrial SOE, and heavy industry isone of the major sectors where Chinese intergovernmental fiscal relations areleast defined. Moreover, because of the number of interested parties and theamount of resources that must be allocated, restructuring heavy-industrialenterprises has been much more complicated than reconfiguring light-indus-trial enterprises. As a result, the state’s role in reforming heavy-industrialenterprises is quite sensitive. In fact, in Liaoning Province, the home ofNortheast Electrical and a centre of China’s heavy-industrial sector, many ofthe reforming enterprises are still heavily dependent on preferential govern-ment contracts (Smyth and Zhai, 2003). Second, in December 2001 CCICFinance filed a petition in Hong Kong to liquidate Northeast Electrical. Thesubsequent public interest in the case and Beijing’s reaction revealed that thelong arm of the state could still reach into a ‘foreign’-listed enterprise. In short,the case of Northeast Electrical illustrates the conflict between residual stateintervention and foreign privatization.

Restructuring and Conversion into an H-Share Enterprise

Northeast Electrical is located in Shenyang, the capital of Liaoning province.It manufactures, exports, and develops new technologies for electrical trans-mission and transformation machinery. Its predecessor, the NortheastElectrical Transmission and Transformation Equipment Group Corporation(NET), was established in 1985 to coordinate a loose association of 26 enter-prises involved in manufacturing electrical equipment in northeast China(WNETTMMC).

In 1992, NET was restructured into a private placement company by issu-ing shares to carefully selected employees and legal-persons. In the spring ofthat year, reform of China’s shareholding system gained momentum whenparamount leader Deng Xiaoping called for further changes during his high-profile southern tour. That triggered a dramatic increase in the number of listedcompanies in China. To control the pace of expansion, the state established aquota for public placements. Many of the enterprises not granted public place-ment thus resorted to private placement, giving rise to a large number ofprivate placement enterprises, including NET (Liu (ed.), 1998, p. 386).

When NET went private, shares were issued to three categories of legal-


persons: NET itself, six of the SOEs that comprised NET, and a number ofNET’s subsidiaries. Such a large transfer of state assets had not been officiallyendorsed, and the group’s property holdings and organizational structure werenot clearly defined (Liu (ed.), 1998, p. 336). In fact, this was a common prob-lem among privately listed Chinese companies. The Chinese Company Lawhad not yet been published, and shareholding enterprises were regulated onlyby an unofficial document, ‘Opinions on the Standardization of ShareholdingLimited Enterprises’ (gufen youxian gongsi guifan yijian). According to the‘Opinions’, since only the interests of individual employees and legal-persons,but not the general public, would be involved in the formation of privatelylisted companies, the rules governing this type of company could be less strictthan those for publicly listed companies (Xiao (ed.), 1995, pp. 299–300).

Northeast Electrical also faced the inherent problem that while its majorsponsor, NET, was a ‘specifically itemized group enterprise’ (dan lie qiyejituan) in the 1990 national plan, the groups’ institutional and property rela-tions remained ambiguous. Administratively, Northeast Electrical wasassigned to the Shenyang Municipal Machine-Industry Administration, but atthe same time its constituent enterprises reported to the machine-buildingindustry bureaus of different cities, such as Shenyang, Jinzhou, and Fuxin,leading to unclear institutional affiliations and leadership (Liu (ed.), 1998, pp.336–37).

In late 1993, when Northeast Electrical was still experimenting with share-holding reform, the Liaoning provincial government and the State Machine-Building Industry Bureau nominated Northeast Electrical as a candidate forH-share listing. In March 1994, the State Council Securities Commissionendorsed the recommendation and included Northeast Electrical in the secondwave of Chinese enterprises listed in Hong Kong. Northeast Electrical alsobecame the first H-share company from Liaoning province (Liu (ed.), 1998, p.337). The confusion surrounding Northeast Electrical’s financial backgrounddid not prevent the company from being approved for listing by the HongKong Stock Exchange, because such problems were considered typical forChinese state enterprises at the early stage of reform. In addition, investorswere already advised that Northeast Electrical, like other H-share enterprises,was a ‘high-risk’ company.12

Northeast Electrical underwent restructuring yet again to prepare for itsconversion from a private-placement company to an H-share enterprise. Twoof NET’s six constituent SOEs withdrew from Northeast Electrical because oftheir unfavourable financial history. Moreover, separate entities were estab-lished to take over Northeast Electrical’s non-revenue-generating facilitiessuch as schools, childcare centres, hospitals, canteens, housing, and sanatori-ums. Some of the unprofitable components, as well as the social-service oblig-ations, remained with NET (Liu (ed.), 1998, pp. 337–38; WNETTMMC). The


whole purpose of these moves was to enhance the Northeast Electrical’s profitpotential, thereby facilitating the listing of the company. This kind of financialwindow-dressing is a common practice among H-share enterprises (De Trencket al., 1998, p. 25; Steinfield, 1998, pp. 146–49).

At the same time, the Liaoning provincial government and the agencies thatmanage state assets officially confirmed NET’s right to hold and manage stateassets. Subsequently NET injected assets into Northeast Electrical, which inturn issued shares to the state (state shares), legal-persons (legal-personshares), employees (internal-employee shares), overseas and Hong Konginvestors (H-shares), and domestic Chinese investors (A-shares). NortheastElectrical went public on the Hong Kong Stock Exchange in July 1995. Byoffering some 258 million H-shares, the company raised $60 million. Later inthe year, Northeast Electrical listed 30 million A-shares in the domesticShenzhen Stock Exchange, raising 150 million yuan (approximately $18million) (Liu (ed.), 1998, p. 140, pp. 338–39; WNETTMMC).

In the first three years that it was listed in Hong Kong (1996–98), NortheastElectrical made a profit of 174 million yuan ($21 million). However, it subse-quently lost nearly 1.3 billion yuan ($157 million) from 1999 to 2001 (seeTable 6.5). In June 2001, the company was served with a writ from the HighCourt of Hong Kong regarding a past due note against its assets held by abanking consortium led by CCIC Finance. The judgment ordered repaymentof the $40 million principal and $1.6 million interest. In December, CCIC fileda liquidation petition, making Northeast Electrical the first H-share companyto face possible liquidation and delisting (XB, 10 November 2001; SCMP andXB, 29 December 2001; WNETTMMC).


Table 6.5 Financial indicators of Northeast Electrical

1996 1997 1998 1999 2000 2001

Turnover 1353 1563 1541 1398 1312 1279(million yuan)Profit after tax 83.8 83.8 6.8 –168.4 –366.8 –785.6(million yuan)Profit attributable to shareholders 83.8 84.0 6.4 –168.3 –364.7 –780.1(million yuan)Return on equity (%) 5.15 4.91 0.37 N.A. N.A N.ANet asset value per share (yuan) 1.86 1.96 1.96 1.77 1.29 N.A.Earnings per share (yuan) 0.096 0.096 0.007 –0.193 –0.418 –0.893H-share price 1.67– 3.65– 1.26– 0.83– 0.56– N.A.(high–low) (HK$) 0.86 0.80 0.26 0.33 0.27

Source: WNETTMMC.

In May and June 2002, Northeast Electrical and its creditors concluded a 65per cent loan-repayment agreement, and the liquidation petition was with-drawn. This was made possible mainly by the sale of Shenyang Transformer,a subsidiary of Northeast Electrical, to the Shenyang municipal governmentfor 150 million yuan ($18 million). Most of the cash raised would be used tosettle part of Northeast Electrical’s debts (JR, 31 May and 12 June 2002; XB,12 June 2002). In fact, Northeast Electrical, through its parent, NET, is ulti-mately controlled by the Shenyang municipal government.13 Although localofficials had insisted that the municipal government would not rescueNortheast Electrical, observers expected that the state would eventually stepin, since it would not allow an H-share company to collapse (PR, 11 March2002; SCMP, 25 January 2002; STD, 28 November 2001; XB, 25 and 26January 2002).

Indeed, the government bailout of Northeast Electrical agrees with ourearlier observation that the budgetary constraints of Chinese companies listedin Hong Kong are not strong enough to ensure economic efficiency because ofthe residual role of the state in these enterprises. Although partially privatizedwith foreign participation, H-share companies are still managed in accordancewith the state’s non-economic objectives, such as maintaining Hong Kong’sprosperity and the reputation of state firms.

Government Bailout and Intergovernmental Fiscal Relations

Our earlier analysis of GSIC and GI might lead one to the view that H-shareenterprises are better managed than red chips, because H-share companieswere organized under direct central government scrutiny, whereas most redchips were established through informal local channels. The case study ofNortheast Electrical, however, does not support this generalization. NortheastElectrical is an H-share enterprise, but like the red chip GI, it survived onlywith a government bailout. Northeast Electrical and GI are both owned bylocal governments, while GSIC is under the direct control and administrationof the central government. This raises the issue of intergovernmental fiscalrelations in China.

Since the 1980s, intergovernmental fiscal relations in China have under-gone several reforms. Before 1980, all taxes and profits were remitted to thecentral government in Beijing, which redistributed the revenue among localgovernments based on whether it approved their spending plans. In 1980, togive local governments an incentive to collect and explore new sources ofrevenue, a contract-responsibility system was introduced under which centraland local governments shared agreed proportions of revenue. The contractsturned out to be too negotiable and often unenforceable, however, resulting ina significant haemorrhage of revenue from the centre to local governments. In


1994, alarmed by the political and economic implications of its weakenedfiscal power and declining state capacity, the central government replaced therevenue-sharing scheme with a tax-assignment system that has effectively re-centralized revenues (Bahl, 1999, pp. 88–129; Ma, 1997, pp. 6–9; Wang S.G.and Hu, 2001).

On the expenditure side, before the reforms, sub-national governmentswere simply local cashiers for the central budget. Since 1980, under the fiscaldecentralization, the central government sets general guidelines on the accept-able level of local expenditures but leaves the details to local officials. In prin-ciple, the state budget defines the division of expenditure responsibilitiesbetween the central and local governments. The centre pays for services thatbenefit the nation as a whole, while local governments finance functions ofregional or local concern. In practice, however, this division is not alwaysclear, particularly in heavy industry, transportation, telecommunications,education, science, and health care. Sub-national governments frequentlylobby to have local projects financed by the central budget (Bahl, 1999, pp.70–75; Ma, 1997, pp. 10–11; Zhang L.Y., 1999, p. 131)

In sum, since 1980 fiscal decentralization has complicated intergovern-mental relations in China. Each level of governments strives to maximize itsrevenue share but minimize its expenditure responsibilities. While the 1994fiscal reform institutionalized the revenue side of the fiscal relations, there hasbeen strong resistance to change on the expenditure side. As a result, there aremany grey areas of fiscal responsibility, leaving such decisions to politicalconsiderations (Bahl, 1999, p. 71; Wang and Hu, 2001, p. 213; Zhang L.Y.,1999, p. 131).

This situation is key to understanding the problems faced by Chineseenterprises listed in Hong Kong. GSIC, the H-share enterprise, is controlledand run by the central government through a centrally owned parentcompany CSSC; GI, the red-chip firm, is owned by the Guangdong provin-cial government through a provincial parent company GEH. NortheastElectrical, the H-share company, is owned by the Shenyang municipalgovernment through a municipal enterprise group (NET) (see Table 6.6).Northeast Electrical and GSIC are both H-share enterprises but are owned bydifferent levels of government. While Northeast Electrical is an H-shareenterprise and GI is a red chip, they are both owned by local governments.Moreover, the Shenyang municipal government, which owns NortheastElectrical, is one of the nine designated ‘line-item cities’. In 1984 ninemunicipal governments were awarded direct fiscal relations with the centralgovernment, making their budgetary status equivalent to that of a province(Bahl, 1999, pp. 138–39). In other words, Northeast Electrical and GI aresimilar in that they are both Hong Kong-listed branches of parent companiesowned by a provincial government.


113

Table 6.6 Level of state ownership of Guangzhou Shipyard, Guangdong Investment and Northeast Electrical

Guangzhou Shipyard Guangdong Investment Northeast Electrical

State owner Central Government Guangdong Provincial Shenyang Municipal Government Government

Parent company China State Shipbuilding Guangdong EnterpriseCorporation (CSSC) Holding (GEH) Northeast Electrical

Transmission and Transformation Equipment Group Corporation (NET)

Listed branch in H-share enterprise: Red chip: H-share enterprise:Hong Kong Guangzhou Shipyard Guangdong Investment (GI) Northeast Electrical

International Company(GSIC)

When Northeast Electrical and GI were making profits, their parent compa-nies received incomes from them. Any resulting tax went to the respectivelocal government according to the 1994 fiscal reforms (Bahl, 1999, p. 107).However, when the financial state of the two companies deteriorated so seri-ously that they were on the brink of bankruptcy, the role of the respective localgovernments was ambiguous. As an H-share company, Northeast Electricalwas supposed to have satisfied the state’s financial and managerial require-ments. Its collapse would damage foreign investors’ confidence and China’splan to list state enterprises on overseas markets. In the case of GI, although itis a red chip not included in the official listing plan, Chinese leaders did notwant to see the company going into bankruptcy, because this would have beena severe blow to a Hong Kong economy already in deep recession. Thereforebailing out Northeast Electrical and GI was necessary to maintain the credi-bility of China’s shareholding-system reform and the prosperity of HongKong. The Shenyang municipal government and Guangdong provincialgovernment would unquestionably subscribe, in principle, to these policyobjectives of the central government, but who would provide the financing,Beijing or the relevant local government? This fiscal division of authorityremains unclear.

As mentioned, bailing out Northeast Electrical and GI would help maintainthe confidence of foreign investors in Chinese H-share enterprises and wouldalleviate Hong Kong’s economic difficulties. However, any benefits from theachievement of these policy objectives would be available to China as awhole, including Shenyang city and Guangdong province, even if the respec-tive local governments did not contribute a single yuan to the bailout. In polit-ical economy jargon, the benefits of rescuing Northeast Electrical and GI are‘public goods’ that tend to invite free riders. Given that local governmentshave been assigned definite income rights over local enterprises, while expen-diture responsibilities have not been clearly defined, it would be rational forthe Shenyang municipal government and Guangdong provincial governmentto maximize their revenues from Northeast Electrical and GI, respectively, butavoid paying for the mismanagement of these companies. It is exactly suchlogic that led to the failure of the two companies.

According to Northeast Electrical’s annual report, the company sufferedlosses due to increasing market competition and sluggish technological andmanagerial restructuring (WNETTMMC). The more fundamental problem,though, was a tremendous flow of cash to its municipally owned parent, NET.In August 1996, NET had issued bonds worth about $2 million to NortheastElectrical. When the bonds matured in October 1999, NET did not redeemthem. Instead, Northeast Electrical provided an unsecured $2 million loan toNET. Northeast Electrical’s shareholders were not informed of this arrange-ment until the Hong Kong Stock Exchange made it public. The backroom deal


was rejected in a subsequent special meeting of shareholders. No informationwas given about whether the loan has ever been repaid (JR, 26 July 2000). Infact, by 1999 NET had received loans of about $60 million from NortheastElectrical. Instead of repaying the accumulated debt, NET deeded a hotel toNortheast Electrical to offset the debt. But the hotel, located in Shenyang, wasitself losing money (MB, 8 February 2001). Such sweetheart loans from listedcompanies to their unlisted parents for undisclosed purposes are quitecommon in China’s domestic stock market (FEER, 11 July 2002). The case ofNortheast Electrical shows that it can also occur with a Chinese companylisted in Hong Kong.

On the other hand, when Northeast Electrical received the liquidation peti-tion, the Shenyang Municipal Government was quite firm that it would notrescue the company, as the estimated cost, 500–600 million yuan ($60–72million), was deemed too high. A municipal official even said that ‘losing anH-share listing status is no big deal. It costs just 50 to 60 million yuan [$6–7.2million] to buy a shell company’. However, the central government inter-vened, forcing the Shenyang municipal government as well as the Liaoningprovincial government to draw funds from their budgets to save NortheastElectrical (PR, 11 and 27 March 2002; SCMP, 25 January 2002; XB, 15 and26 January 2002). This is much like the case of GI, where the local govern-ment (Guangdong province) agreed to bail out the financially troubled parentcompany, Guangdong Enterprises Holding, only under strong pressure fromthe central government.

Thus the cases of Northeast Electrical and GI are similar in that both enter-prises served as a source of income for locally owned parent companies.However, in the face of financial crisis, the local governments were unwillingto draw funds from their respective budgets to rescue the companies. Thebailout was possible only because the central government intervened. Thisfinding is consistent with Huang’s (1996 and 2001) contention that fiscaldecentralization induces Chinese local governments to free-ride on publicgoods provided by the central government, but they have sometimes beenprevented from doing so because of the presence of a highly centralized polit-ical system. Our study also lends support to Steinfeld’s (1998) argument thatthe presence of a strong state with the legitimate authority to create and main-tain regulatory institutions is important for achieving economic efficiency. Incontrast, the emphasis by Oi (1999) on property-rights reform seems insuffi-cient to explain the case of Northeast Electrical, where budget constraintsremained soft despite the fact that the company had been partially privatizedwith international participation.

A consideration of intergovernmental fiscal relations helps explain why theH-share enterprise Northeast Electrical has behaved like the red chip GI. Thisleads to the conclusion that, due to the residual presence of the state, privatized


and internationalized enterprises are often managed in accordance with polit-ical rather than economic considerations, and this keeps them from achievingeconomic efficiency. It makes no difference whether the company is an H-share enterprise or a red chip. What is important is the level of the governmentthat owns the company. Under China’s decentralized fiscal system, the finan-cial management of a locally owned listed branch tends to be less regulatedthan that of a centrally owned one, because the local government has induce-ments to maximize income from the listed branch but not clearly definedeconomic responsibility for proper management of the company. In the eventof company failure, the local government is reluctant to provide financialassistance. However, if the failure threatens to interfere with the centralgovernment’s policy objectives, it will likely force the local government to uselocal funds to bail out the company. Ironically, then, it is the political strengthof the central government that softens the budget constraints of Chinese enter-prises listed in Hong Kong.

CHALLENGES FOR HONG KONG AND THE INVISIBLEHAND OF BEIJING

In light of all this, it is not surprising that political factors influence themanagement of Chinese SOEs. However, this is not the norm in Hong Kong.Will the growing number of listed Chinese enterprises conflict with the freemarket principle of the Hong Kong Stock Exchange? The case of NortheastElectrical shows that the state-owned – and thus state-backed – nature of H-share companies does, to some extent, politicize the Hong Kong stock market.

According to one report, the Chinese central government considered theattempt to force Northeast Electrical into bankruptcy as an ‘ill-intended move’by a ‘hostile power’. CCIC Finance, the major creditor that filed the liquida-tion petition, consists of the First Chicago Bank of USA (30 per cent), theIndustrial Bank of Japan (30 per cent), the Bank of China Hong Kong Branch(30 per cent), and the China Resources group (10 per cent). Although the lasttwo were China-related enterprises, CCIC Finance was essentially under USmanagement. It is not clear whether the epithet ‘hostile power’ referred to theUS business interest. In any case, after Northeast Electrical received the liqui-dation petition, the Chinese central government, through its Hong Kong repre-sentative, urged CCIC Finance to accept a 60 per cent loan-repaymentproposal and mobilize other creditors to opposite the petition (PR, 27November 2001; 11 March 2002).

The intervention of the Chinese central government politicized the opera-tions of Northeast Electrical and challenged Hong Kong’s judicial indepen-dence. The company, claiming a legal privilege similar to diplomatic


immunity, declared that because it was incorporated in China and its parent(NET) was a state-owned enterprise, the liquidation proceedings could only beheard in mainland China, not in Hong Kong. Creditors and local experts inHong Kong countered that the liquidation petition was within Hong Kong’sjurisdiction. The dispute became a test of Hong Kong’s rule of law. In January2002, trading of Northeast Electrical’s H-shares was suspended, and for thefirst time the company admitted that the lawsuit in Hong Kong would affectits operations. Nevertheless, it did not make an appearance at all the courthearings (JR, 27 November 2001; SCMP, 28 November and 29 December2001; XB, 3 and 26 January, 30 April, 14 May 2002).

While Northeast Electrical was saved by the government bailout, the chal-lenges that Chinese SOEs pose to Hong Kong’s financial status remain. By theend of 2001, Chinese companies accounted for 23 per cent of total marketcapitalization in Hong Kong, compared to less than 1 per cent in 1991. By themid-2000s, about 70 per cent of the new funding raised in the Hong Kongstock market has come from mainland Chinese enterprises. The Hong KongStock Exchange wants to maintain its unique role as the largest ‘foreign’ venuefor listing Chinese enterprise, but the generally poor performance of H-sharecompanies has hurt its reputation. As of mid-2002, about 80 per cent of the redchips and H-share enterprises were trading below their IPO prices (SCMP, 16July 2002; PI). More importantly, the political rules behind Chinese SOEshave challenged the long-established free-market principle of the Hong Kongstock market. As one scholar noted, the state’s involvement in Chinese enter-prises listed in Hong Kong ‘represents not only the deviation from the inter-nationally accepted practice, but also the exposure of domestic hazards of aplanned economy to a market economy.’ Such interference from the Chinesegovernment ‘may go beyond the control of the securities regulations in HongKong and even the Government of the Special Administration Region’ (ZhangX.C., 1999, p. 75). The case of Northeast Electrical shows that this concern isnot unfounded.

With the transfer of Hong Kong’s sovereignty to China in 1997 and thefurther economic integration of Hong Kong with the mainland, the Hong Kongstock market has become even more subject to the influence of China’sdomestic economic policy. One example is the Chinese government’s use ofthe Hong Kong stock market as an outlet for state shares. In the early 1990s,when ideology was still hindering reform of China’s shareholding systemreform, the Chinese government was, by law, the largest shareholder in thecountry’s shareholding enterprises. The proportion of state shares in listedcompanies ranged from 51 per cent to more than 80 per cent. This changed in1994, when the newly implemented Company Law reduced the minimumlevel of state ownership to 35 per cent. As of mid-2000, however, the state stillheld some 60 per cent of the total shares of listed state enterprises, and the


market value of the state shares amounted to about 3 trillion yuan ($360billion). Finding an outlet for the huge portfolio of state shares has long beena major obstacle to reform of the shareholding system, yet the government isbadly in need of funds to support its national social-security system. Thisissue is becoming more and more important as China’s population ages. Theamount required is estimated at one trillion yuan ($120 billion) for the urbansector alone. One plan for addressing this growing need is for the governmentto cash in part of its state shares (FEER, 11 July 2002; MB, 9 and 27 October2000).

The state-share sale plan, however, faced strong resistance from China’sdomestic securities sector. Their primary concern was the impact on stockprices. From May to October 2001, although just a fraction of state holdingswas actually released to the market, share prices in the Shanghai StockExchange plunged by 35 per cent. Since then, any indication of further salesof state shares has caused similar market panic. In June 2002, the governmentgave in by suspending the state-share sale plan, resulting in an immediate 9per cent jump in Chinese stock prices (FEER, 11 July 2002; MB, 25 June2002).

Hong Kong, however, is excluded from the policy freeze. According toChina’s provisional rules on the sale of state shares promulgated in June2001, whenever a state enterprise issues new shares, it must simultaneouslysell off an amount of state shares equal to 10 per cent of the value of the fundraised by the IPO. This rule, while suspended for new issuance of domesticshares, remains in effect for H-shares. The exception is justified by the claimthat the Hong Kong stock market is ‘mature’ enough to absorb the state shares(MB, 9 July 2001 and 24 June 2002; XB, 16 July 2002). There has been noserious consideration on the Chinese side about the impact of the state-sharesale plan on Hong Kong’s stock market, however, nor has the Hong KongStock Exchange ever been consulted.14 In other words, Hong Kong appar-ently has no say in deciding whether to serve as an outlet for Chinese stateshares.

The Northeast Electrical case shows that state involvement in Chineseenterprises listed in Hong Kong has made these enterprises less efficient andhas threatened the free-market foundation of the Hong Kong economy. Theexclusion of Hong Kong from the national ban on the state-share sale plansuggests that the Chinese government might use the Hong Kong stock marketas a venue for state fund-raising rather than as a stage to improve corporategovernance. Both cases would have serious implications for Hong Kong’sfinancial autonomy. This, perhaps, should not be surprising, given theunequal power relationship between China and Hong Kong.


RECENT DEVELOPMENTS15

General

Within about 20 years, the influence of Chinese enterprises in the Hong Kongstock market became dominant. As of March 2009, 470 Chinese enterprises(including red chips, H-share companies, and non-H-share private enterprises)were listed in the SEHK. They accounted for 37 per cent of the market in termsof total number of companies listed, 61 per cent in terms of market capitaliza-tion, and 70 per cent in terms of equity turnover (SEHKW).

While red chips were more popular from the mid-1980s through the 1990s,H-share enterprises have become more common since 2000, especially afterthe IPOs of some gigantic enterprises such as Industrial and Commercial Bankof China Limited, Bank of China, and China Construction Bank (Guo, 2009,pp. 59–60). On the other hand, the Chinese government has continued itspolicy of tightening regulation of red chips. For example, in 2006 a new set ofrules was announced such that red chips that plan to launch IPOs are requiredto report to the State Administration of Foreign Exchange 30 days in advanceabout how the capital raised would be transmitted to the mainland (SCMP, 18July 2006).

In 2007, Chinese enterprises raised over US$47 billion in the SEHK, repre-senting 65 per cent of the total. During the year, 85 per cent of the total valueof IPOs, or US$32 billion, was raised by Chinese enterprises; and the tenlargest IPOs were all launched by Chinese enterprises. Due largely to theactivities of Chinese enterprises, the SEHK emerged to be the seventh largestin the world in terms of market capitalization, fifth in terms of total equityfunds raised, and fourth in terms of IPOs (HKSAR Government, 2007, pp.66–68 and 84). To strengthen its position, the SEHK has continued its effort toattract Chinese enterprises to list shares in Hong Kong. Measures in this regardinclude setting up offices in major Chinese cities, organizing workshops andseminars to introduce listing requirements in Hong Kong, and developing H-share-related products such as H-shares Index Futures, H-shares IndexOptions, and Mini H-shares Index Futures. As stated in its 2007–2009Strategic Plan, it is the mission of SEHK to make Hong Kong into ‘a leadinginternational marketplace for securities and derivatives products focused onHong Kong, Mainland China and the rest of Asia’ (SEHKW).

On the other hand, however, there were signs that with the growth of Chinainto one of the world’s largest foreign exchange owners, the Chinese govern-ment has attached less importance to listing H-shares in Hong Kong as asource to raise foreign capital. In 2006, an informal ‘A before H’ policy wasintroduced, by which Chinese enterprises were encouraged to list A-sharesbefore listing H-shares (WSJ, 18 April 2007). It was not until September 2008,


when new issuance of A-shares was suspended in the wake of a slump in thedomestic stock market, that the restriction on H-share listing was relaxed (RN,12 March 2009; SCMP, 11 September 2008). That is to say, the domestic A-share market seems to have gained a higher priority than the H-share marketin the Chinese government’s overall financial policy consideration.

In the following, we update the developments of the three case companiesexamined above. This shows that, after more than one or two decades of list-ing of these H-share or red-chip enterprises in the international financial centreHong Kong, the state is still playing a residual yet influential role in the casesof Guangzhou Shipyard and Guangdong Investment, and corporate gover-nance is still not up to standard in the case of Northeast Electrical.

Guangzhou Shipyard International Company

As mentioned above, following the Asian financial crisis, GuangzhouShipyard International Company (GSIC) wrote off 10 per cent of its overduedeposits as bad debts in 1999, resulting in the decline in profit in that year andthe loss in 2000. From then on to 2005, the company’s shares were traded ataround HK$1 to 2. But business began to pick up in the next year, due to risingdemand and the state’s support for the shipbuilding industry. In 2007, GSICreceived orders that would keep the company busy for at least four years.Moreover, it gained a significant amount of non-operating income frominvestment and financial derivative instruments. The company’s net profitmore than tripled, and the share price rocketed to about $68 by the end of theyear (Table 6.7; XB, 18 December 2007). To meet soaring demand, GSICattempted to enhance its production capacity through developing new produc-tion sites and acquiring Wenchong Shipyard from its parent CSSC (MB, 1 July2008; SCMP, 2 September 2008).

However, a major turnaround occurred in 2008. Demand for shipbuildingdeclined on the one hand, while cost rose on the other, resulting in cancella-tions and delays from ailing shipowners. The situation was made worse by theinternational financial tsunami. GSIC’s net profit fell by about 13 per cent inthat year, and share price dived to about $3 in October. In light of this, the stateintervened by providing subsidies to domestic vessel buyers and relaxing cred-its for ship exporters (SCMP, 13 February and 11 March 2009).

Guangdong Investment

Guangdong Investment enjoyed steady growth of turnovers and profits in theearly 2000s (Table 6.7), thanks largely to the Dongshen Water Project injectedinto the company in the government bailout of 1999. By this project,Guangdong Investment acquired the exclusive right to supply water from



Table 6.7 Financial indicators of the three case companies, 2003–2008

2003 2004 2005 2006 2007 2008

Guangzhou ShipyardTurnover 2840 2363 2729 3322 5907 6984(million yuan)Profit after tax 24 58 140 277 960 840(million yuan)Profit attributable to 24 61 135 267 939 820shareholders (million yuan)Return on equity (%) 3.73 8.48 15.29 21.13 38.28 29.86Net asset value per share (yuan) 1.33 1.45 1.78 2.55 4.96 5.55Earnings per share (yuan) 0.050 0.123 0.273 0.539 1.897 1.66H-share price 1.95– 1.98– 2.275–14.70– 68.50– 44.40–(high–low) (HK$) 0.62 1.08 1.420 1.45 12.50 3.30

Guangdong InvestmentTurnover 5164 5109 549 656 6689 7590(HK$ million)Profit after tax 1449 1079 1510 179 1998 1995(HK$ million)Profit attributable to 1107 896 1303 1507 197 1877shareholders (HK$ million)Return on equity (%) 12.39 8.92 11.36 11.94 12.74 12.76Net asset value per share (HK$) 1.70 1.81 1.91 2.07 2.30 2.50Earnings per share (HK$) 0.201 0.160 0.227 0.250 0.278 0.305Share price 1.77– 2.75– 3.025– 3.800– 5.63– 4.54–(high–low) (HK$) 0.97 1.13 2.050 2.625 3.51 1.66

Northeast ElectricalTurnover 623 342 546 466 640 518(million yuan)Profit after tax 31 22 42 23 –319 –71(million yuan)Profit attributable to 28 21 27 30 –311 –69shareholders (million yuan)Return on equity (%) 4.93 2.71 3.34 3.56 –60.72 –22.18Net asset value per share (yuan) 0.65 0.88 0.92 0.95 0.59 0.36Earnings per share (yuan) 0.032 0.024 0.031 0.034 –0.36 –0.08H-share price 1.160– 1.410– 0.860– 1.020– 3.79– 1.95–(high–low) (HK$) 0.510 0.540 0.410 0.610 0.90 0.27

Sources: NTC; annual reports of individualcompanies; Datastream.

Guangdong Province to Hong Kong, and the non-exclusive right to supplywater to some other Chinese cities in the Pearl River Delta (includingShenzhen and Dongguan) (NTC). In 2008, water supply accounted for 45 percent of the company’s revenue, while major department store (28 per cent),electricity (12 per cent), real estate (10 per cent), hotel and highway (5 percent) businesses accounted for the rest (XB, 24 April 2009).

In fact, Guangdong Investment benefits from the state’s political attentionto the stable supply of water to Hong Kong at a stable price. For example, in2009 the company received from the Guangdong provincial government agrant of 652 million yuan as a subsidy for freezing the price of water supplyto Hong Kong from 2006 to 2008, and for infrastructure modification works.According to a new agreement, the price of water supply to Hong Kongwould increase by 18.6 per cent in 2009, and 6.3 per cent each year in2010–2011, resulting in a water bill of about HK9.4 billion to Hong Kongover this three-year period (MB, 11 March 2009; XB, 24 April 2009). That isto say, Guangdong Investment can be expected to continue to receive astable income through providing water supply with the provincial govern-ment’s backup.

Northeast Electrical

With the government bailout in 2002, Northeast Electrical’s losses were turnedinto profits. However, a loss of 319 million yuan emerged in 2007 (Table 6.7).This was due mainly to the failure of a former holding subsidiary of thecompany, Jinzhou Power Capacitor, to repay a loan of 22.9 million yuan guar-anteed by Northeast Electrical. The news shocked the market, as it was not thefirst time that shareholders of Northeast Electrical had had to pay the cost forthe company’s debt litigation (ETN, 18 March 2008; XB, 15 January 2008).This is reminiscent of Northeast Electrical’s loss in the late 1990s due to itssweetheart loans to its parent company, as mentioned above.

There have been other cases of corporate misgovernance of NortheastElectrical. For example, in 2003 the company was found to have over-statedits net profit by one million yuan (XB, 19 August 2003). And then in December2008, the Hong Kong Stock Exchange, after a long investigation, censured 17former and current directors of Northeast Electrical for failing to disclose fiveconnected transactions. Again, this was not the first time that this companywas reprimanded for disclosure problems (SCMP, 9 December 2008). Allthese incidents lead to doubts about whether privatization of Chinese SOEsthrough listing in Hong Kong would ensure improvement of corporate gover-nance.16


NOTES

1. After three decades of opening, China’s foreign capital constraint has been very much relaxed.By the end of 2008, the country had accumulated a foreign exchange reserve of close to US$2trillion, or about 40 per cent of the world’s total (CD, 20 May 2009).

2. There are also Chinese shares listed in New York, Singapore, London, and Tokyo, knownrespectively as N-, S-, L-, and T-shares (McGuinness, 1999, p. 10). Being of a small amount,they will not be covered in our analysis. As of November 2001, there was only one Chineseenterprise solely listed in New York, and one in Singapore (CSRCW, 6 December 2001).

3. China’s B-share market reform in February 2001 seems to suggest that the government haschanged the plan (Ma, 2001, pp. 153–54).

4. Similarly, due to the infrastructural deficiencies of the Budapest Stock Exchange, 70–80 percent of trade in Hungarian stocks has been transacted in the Austrian stock market, whereHungarian companies were also quoted (Meszaros, 1993). It has been the idea of some‘Austrian equity visionaries’ that Vienna could be made into ‘a Hong Kong for eastern Europe’(EM, January 1997, pp. 83–88).

5. The differences between H-share companies and red chips have often caused confusion (DeTrenck et al., 1998, p. 44). For example, Edward Steinfeld (1998, p. 124) mistakenly called theMa’anshan Iron and Steel Company ‘king of the red chips’. In fact the company is an H-sharecompany.

6. Other factors leading to the poor performance of H-share prices include over-packaging of H-share companies for listing purposes, the withdrawal of investment funds from Asia, competi-tion from red chips, China’s economic retrenchment, unsatisfactory management of H-sharecompanies, inefficient utilization of capital raised, and inadequate understanding of the inter-national capital market (Huang and Gao, 1999, p. 407; Liu (ed.), 1998, pp. 126–36; Niu, 1997,p. 496).

7. The company was sold back to GEH in 1995 (see Table 6.3).8. The appointment of Wang Qishan to handle the GEH crisis has been interpreted as a move of

the central government to assert its authority in Guangdong (STD, 28 October 1999).9. Guangdong Investment was a Hang Seng Index constituent from November 1994 to December

1999 (De Trenck et al., 1998, p. 154; SCMP, 7 December 1999).10. The sudden deterioration of the financial conditions of Guangnan, a subsidiary of GEH, in

1998 was believed to be a result of bribery and fraud. Several former senior executives of thecompany were arrested for alleged corruption (SCMP, 30 January and 9 September 1999; 17January 2000).

11. But advocates of ‘backdoor listing’ counter-argue that such an approach will not lead to strip-ping of state assets because: (1) the value of the shell companies will increase since the priceof the shares tends to rise after acquisition by Chinese enterprises; (2) Chinese state enterprisesmaintain effective control by holding the controlling stake of the shell companies; (3) the valueof the state assets injected into shell companies is assessed in accordance with Chinese andinternational standards; (4) capital can be more efficiently utilized by issuing shares (Wu Z.Y.,1995, pp. 103–104). These arguments, however, do not stand empirical testing, at least not inour case study.

12. Author interview with a senior executive of the Hong Kong Stock Exchange (12 August 2002).13. According to standard property-rights theory, ownership refers to a bundle of rights that an

agent is empowered to exercise over an asset. These include utilization rights (the right toutilize an asset), residual control rights (the rights to appropriate the returns from an asset), andalienation rights (the rights to transfer rights over an asset to others through gift or sale). SeePutterman, 1995, pp. 1049–50.

14. Author interview with a senior executive of the Hong Kong Stock Exchange (12 August 2002).15. The author is indebted to Fung Kin Hang for his assistance in the updating work of this section.16. Such a finding challenges Tobin and Sun’s (2009) view that Chinese SOEs, through list-

ing on the Hong Kong Stock Exchange and other foreign venues, gain ‘collateral benefits’such as transfer of better governance practices to China.


7. Completing privatization through‘share conversion’1

BACKGROUND

As mentioned, for political, economic, and ideological reasons, ‘privatization’(siyouhua) has been taboo in China. But de facto privatization has been under-way since the mid-1980s, under the name of ‘shareholding system reform’(gufenzhi gaige). Under this reform, various types of shares have emerged,including state shares (guojia gu), legal-person shares (faren gu), individualshares (geren gu), and foreign shares (waizi gu), defined according to the typeof owner (see Table 7.1).

Initially, only individual shares and foreign shares could be traded on theShanghai and Shenzhen Stock Exchanges. As a safeguard against loss of statecontrol over enterprises, state shares were made nontradable and legal-personshares could only be transferred among ‘legal-persons’ (that is, enterprises orinstitutions) (Walter and Howie, 2003, pp. 80–81). Since most legal-personsare actually state entities, legal-person shares and state shares are collectivelyknown as state-owned shares (guoyougu). The nontradability of state-ownedshares led to many problems. First, state assets were made ‘dead’ (that is,obsolete) and thus less valuable. Second, property rights of enterprises could

124

Table 7.1 Types of Chinese shares

Type of share Official holders

State-owned shares, of which:State shares State Council authorized representativesLegal-person shares Enterprises, institutions, or authorized social

groups

Individual shares Public retail investors, or employees of the companies that issue the shares

Foreign shares Foreign investors

Source: Based on Walter and Howie, 2003, p. 77.

not be clearly defined among individual investors. Third, capital mobility andeconomic restructuring were hindered. Finally, the development of asecondary stock market was obstructed (Cheng, Liu, and Wang, 2000, pp.51–52, 317–23; ZJS, 22 January 2003).

Although public trading of state-owned shares in the two stock exchangesin China was officially disallowed, transactions of this type of share actuallytook place over the counter or through direct negotiations, at discounts of upto 80 per cent of market prices. This resulted in what is known as ‘reductionof holding of state-owned shares’ (RHSOS, or guoyougu jianchi). In 1994, aprivate enterprise in the southern city of Zhuhai purchased from the state 35.5per cent of the shares of a listed state-owned enterprise (SOE), the first case ofspontaneous RHSOS in China (NR, 25 June 2002). Similar activities in subse-quent years led to a decline in the proportion of state-owned shares in the capi-tal structure of China’s listed companies from 69 per cent in 1993, to 61 percent in 1997 (see Table 7.2). Such a sale of state assets in parallel markets maybe called ‘privatization with Chinese characteristics’ (Walter and Howie, 2003,pp. 16, 203–206).

At the 15th Chinese Communist Party Congress, held in 1997, the share-holding system reform, after more than a decade of evolution, was finallyendorsed as the ‘mainstream reform’ for SOEs. It might then have beenexpected that the proportion of state ownership in Chinese enterprises wouldfall further. However, this has not been the case. From 1997 to 2004, there wereonly minor changes in the relative size of the state sector. As explained below,hidden under such stability were some fluctuations in China’s privatizationprocess during this period. A breakthrough finally occurred in May 2005, whena ‘share conversion’ pilot reform programme was introduced. The pace ofchange since then has become much speedier than before, leading some schol-ars to interpret the latest reform as ‘shock therapy’ (see next chapter).

Completing privatization through ‘share conversion’ 125

Table 7.2 Proportion of state-owned shares in the capital structure ofChinese listed companies (year-end figure)

Year 1992 1993 1994 1995 1996 1997 1998 1999

% 65 69 65 62 61 61 61 61

Year 2000 2001 2002 2003 2004 2005 2006 2007

% 61 64 64 63 62 55 35 30

Source: CSFSY, 2008, p. 181.

This chapter analyses the share conversion reform within the perspective ofChina’s two-decade-long privatization attempt, and argues that the latestchange represents a major, and probably final, step along this line. Thisspecific form of privatization through the share system has been largely over-looked in many major studies of changes in China’s state ownership, such asthe one published by the World Bank (Yusuf, Nabeshima and Perkins, 2006).The fact is that the share system has provided an important channel throughwhich assets have been transferred from the state to private hands. Throughoutthe past decade, despite some ebbs and flows, the reform has been in basiccontinuity, providing yet another indication of China’s incrementalist reformapproach. The following discussion will trace the policy’s evolution from theofficial endorsement of the shareholding system reform in 1997 to completionof the share conversion reform in late 2006.

1997–2000: IMPLICIT PRIVATIZATION

As mentioned above, the 15th Chinese Communist Party Congress held in1997 marked the formal endorsement of the shareholding system as the ‘main-stream reform’ for SOEs. A three-year target was set to eliminate the deficitsof most large- and medium-sized SOEs through ‘strategic restructuring’; thestock market was expected ‘to serve the function of relieving SOEs’ difficultconditions’. This was followed by a wave of RHSOS through backdoor listing(that is, SOEs used state shares to purchase inactive listed companies). From1997 to 1998, there were over 100 such cases of transfer of state-owned sharesto private enterprises. In 1999, a Central Committee meeting of the ChineseCommunist Party decided that ‘under the premise that the state maintainscontrolling interest, the holding of state-owned shares could be appropriatelyreduced’. The originally unofficial and spontaneous RHSOS was thus made anofficial policy. In the same year, the Ministry of Finance announced a two-stepRHSOS programme: in the first stage, to reduce the proportion of state-ownedshares in total capital from 62 per cent to 51 per cent, and then further downto about 30 per cent in the second stage (JR, 25 June 2002; Lan and Wang,2001, pp. 28 and 42).

To facilitate RHSOS, SOEs were given higher priority for listing shares onthe stock market (Zhang, 2004, p. 2035). Once a firm was listed, the rightsissues, stock dividends, and listing of employee shares tended to dilute stateownership. According to a survey of over 1000 Chinese listed companies, theproportion of state ownership decreased from the pre-listing average of 45 percent, to the post-listing level of 31 per cent (Wang, Xu and Zhu, 2004, pp.472–76). But the newly listed companies, being SOEs, came to the marketwith a high proportion of state-owned shares. For example, in the year 2000


PetroChina offered more than 17 million H-shares (Chinese shares listed inHong Kong) to raise about US$3.1 billion. While this was the largest H-sharesfloat by China, the offer represented only 10 per cent of PetroChina’s enlargedshare capital, and parent China National Petroleum Corp still retained a 90 percent stake after the offer (RN, 27 March 2000).

Put together, the above two contradictory trends largely offset each other,explaining why the relative size of state ownership in China’s listed compa-nies remained unchanged at 61 per cent from 1997 to 2000 (see Table 7.2; andWalter and Howie, 2003, pp. 135, 201–203). That is to say, the lack of furtherdecline in the relative size of state ownership during this period did not suggestany stalemate in China’s privatization; just the contrary, it was because moreSOEs embarked for privatization by converting themselves into listed compa-nies. In absolute terms, however, this resulted in the further accumulation ofnontradable state-owned shares.

2001–2002: PENSION-DRIVEN PRIVATIZATION

The situation outlined above produced a great threat to the stock marketbecause the growing amount of nontradable state-owned shares meant that anyRHSOS would cause a sudden increase in the supply of shares on the stockmarket. According to one estimate, to reduce the proportion of state-ownedshares by each percentage point requires the sale of 36 billion yuan (aboutUS$5 billion) worth of state assets at market price. This had a tremendousbearish implication for share prices. During August–September 2000, whenthere was news that a formal RHSOS programme would be introduced, theShanghai Stock Exchange Index plummeted by about 11 per cent in a month.On the other hand, some state-owned share offers were under-subscribed. Asa result, the first-round RHSOS was laid aside by the end of the year.However, the plan was revived in June 2001, when a set of provisionalmeasures for raising money for the National Social Security Fund (describedbelow) through RHSOS was announced (Fu, 2006, pp. 13–14; NR, 25 June2002; ZX, 17 August 2000).

The original purpose of RHSOS was to solve the economic inefficiencyproblems arising from the nontradability of state-owned shares. But by 2000,a more imperative factor – raising money for a newly established nationalpension fund – had emerged as the major driving force for selling state assets.The background of this was that China’s pension system, run on a pay-as-you-go basis, was unable to sustain its rapidly aging population. A computer simu-lation exercise estimated that in 2000 China was suffering from an implicitpension debt of around 46 to 64 per cent of the country’s gross domestic prod-uct (Wang, Xu, Wang, and Zhai, 2004).


In view of the problem, since the early 1990s the Chinese government hasworked to establish a new pension system in line with World Bank recom-mendations. Under this new system, workers are required to contribute part oftheir current income to finance their future retirement. But to collect theserevenues, the central government has to delegate some administrative powerto local authorities, leading to the standard principal/agent problem, wherebythe agent (local authorities) may not act in the interest of the principal (centralgovernment). By making use of their advantage in the asymmetry of informa-tion, local authorities have used contributions from current workers to coverpension payments to current retirees. In effect, contributions from over 100million workers have been stolen, and the size of their ‘empty accounts’ is esti-mated to range from two trillion to seven trillion yuan (about $0.28 trillion to$1 trillion) (Frazier, 2004, pp. 48–56).

To form a ‘fund of last resort’ in case of financial default by local author-ities, a National Social Security Fund was established in September 2000under the direct administration of the central government. According to a setof ‘provisional measures’ announced in June 2001, regular initial publicofferings and rights issues would be subject to a 10 per cent ‘tax’ by tyingthem to sales of state-owned shares, in order to raise revenue for the newpension scheme. The revenues obtained from such RHSOS would be trans-ferred to the National Social Security Fund. This policy immediately trig-gered a slump in share prices, with the Shanghai Stock Exchange Indexfalling by 32 per cent in four months. The market finally rebounded inOctober when the China Securities Regulatory Commission cancelled partof the provisional measures (Leckie, 2003, p. 149; Naughton, 2007, p. 474;NR, 25 June 2002).

Apparently it was the concern for social stability that led to the suspen-sion of the RHSOS programme. According to official statistics, the numberof stock market investors in China soared from 2.2 million in 1992 to 68.8million in 2002 (see Table 7.3). Collapse of the stock market would meanserious loss of wealth of this growing sector of the country’s population,leading to potential social unrest. These official figures, however, aremisleading. According to Walter and Howie, after adjusting for doublecounting, inactive accounts, and other factors, the number of actual holdersof shares might range only from 5 million to 10 million, with less than 1million active traders. More important, institutional investors (securitiesfirms) accounted for the majority of secondary market trading. These dahu(‘big shots’) and market manipulators formed the ‘rich minority (which)successfully duped the government into protecting their positions’ (Walterand Howie, 2003, pp. 139–58). Another source reported that it was the‘concerted effort’ of some 20 securities firms that led to the suspension ofthe RHSOS programme (Naughton, 2002).


While the threat of social unrest because of the stock market slump mightbe a fake one, China’s social order will be in real danger if the new pensionsystem collapses. This is because failure to honour pension payments means abreach of social contract; unpaid pensioners thus would have a high degree oflegitimacy to protest (Frazier, 2004, pp. 56–60). Therefore, it was imperativefor the central government to look for alternative ways of RHSOS, in order toraise capital for the National Social Security Fund. In view of this, shortly aftersuspension of the provisional measures, the government invited public sugges-tions on how to achieve RHSOS. Within a month, over 4000 proposals werereceived (NR, 25 June 2002; ZHB, 4 January 2002).

In December 2001, then-Premier Zhu Rongji urged the China SecuritiesRegulatory Commission to ‘introduce new measures for re-launchingRHSOS’ so as to provide financing for the pension fund. He noted that thiswas premised on the stability of the stock market, and he set no timetable forthe plan. Nevertheless, this could not prevent another round of market anxiety.As a result, share prices, after a strong but short recovery, dived again in early2002 (WB, 23 January 2002; XR, 19 December 2001). Moreover, the stockmarket rejected the RHSOS plan by reducing initial public offerings and rightsissues. As can be seen in Table 7.4, the amount of funds raised through thesetwo means in 2002 was only about half of that of the previous year.

By the middle of 2002, it became politically necessary for the governmentto intervene, as the new leadership of the Chinese Communist Party was dueto assume power in the 16th National Congress of the Party to be held later


Table 7.3 Number of stock market investors in China (year-end figure)

Year 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Million 2.2 7.8 10.6 12.4 23.1 33.3 39.1 44.8 58.0 66.5 68.8

Source: CSFSY, 1999 and 2003.

Table 7.4 Amount of funds raised by China’s listed companies (billion yuan)

Year Initial public offerings Rights issues Total

2000 85.2 51.0 136.22001 61.4 42.3 103.72002 50.0 5.7 55.72003 47.2 7.0 54.2

Source: Fu, 2006, p. 17.

that year and stability has always been the overriding concern during suchpower transitions. Consequently, in June 2002 the RHSOS programme washalted again. In contrast to the similar announcement made a few monthsearlier by the China Securities Regulatory Commission, this time the decisionwas made at the State Council level. More importantly, the governmentpromised that ‘no further concrete implementation measures would be intro-duced.’ As a result, the relative size of state ownership in China’s listedcompanies re-expanded from 61 per cent in 2000, to 64 per cent in 2001 and2002. The situation was back to square one, but the stock market reacted witha 10 per cent upsurge on the day after the announcement of the decision (seeTable 7.2; CZ, 22 February 2002; LB, 25 June 2002; SZB, 24 June 2002; ZJS,2 July 2002).

The fundamental reason for the failure of pension-driven privatization wasthat two conflicting programmes – RHSOS and the social security reform –were linked together. The essence of RHSOS was to transfer assets from thestate to the market. As such, it had to yield to ‘market’ forces, in the sense thatthere should be a price differential between state-owned shares and individualshares, in order to reflect their difference in tradability. That is to say, from theRHSOS perspective, nontradable state-owned shares were sellable only at adiscount to market prices. In contrast, the new pension fund called for a maxi-mum return from the sale of state assets; any sale of state-owned shares atprices lower than those of individual shares was regarded as ‘depletion of stateassets’. It is under such a mind-set that the June 2001 ‘provisional measures’required the sale of state-owned shares at the same ‘market’ price of initialpublic offerings of individual shares and rights issues. The slump of shareprices was simply a ‘market’ rejection of the over-pricing of state-ownedshares. Critics of the pension-driven privatization therefore argued that therewas nothing wrong with RHSOS; the problem was just with the price set (DB,2 July 2002; GS, 22 January 2002; YW, 4 February 2002; ZGJCD, 28 June2002; ZW, 6 March 2002).

Ironically, even the National Social Security Fund, which was supposed tobe a chief beneficiary of RHSOS, also favoured cancellation of theprogramme. While RHSOS was intended to raise capital for the pension fund,its negative impact on share prices would reduce the value of the equities heldby the fund. Hence, after RHSOS was halted in June 2002, the National SocialSecurity Fund responded by injecting capital into the stock market, leading toa sharp rise in share prices (SDB, 27 June 2002). That is to say, the stockmarket has co-opted the pension fund into being a supporter of market reform.In a few years’ time, the pension fund even emerged as the largest institutionalinvestor in Hong Kong and became a sophisticated and influential player inthe Hong Kong stock market (XB, 15 October 2006).


2003–2004: DEADLOCK

The end of the pension-driven privatization programme meant that RHSOSthrough the stock market was no longer feasible. However, this did not actuallyend the sale of state assets. Rather, the old practices of privatization throughover-the-counter transactions and direct negotiations between SOEs and privateenterprises resumed (XC, 12 February and 13 June 2003; ZGJCD, 28 June and15 August 2002). This resulted in rampant management buyouts, or insiderprivatizations, by which former managers of SOEs seized control of the enter-prises. To prevent depletion of state assets in these unregulated exchanges, ahigh-powered central agency, the State-Owned Assets Supervision andAdministration Commission (hereafter, State Asset Commission), was estab-lished at the 10th National People’s Congress in March 2003. Charged with‘unified authority, duty, and responsibilities’ over 196 SOEs directly under theState Council, the State Asset Commission absorbed power of control over theseenterprises from various state bureaucracies, including the Ministry of Finance,the State Economics and Trade Commission, and other specialized bodies underthe State Council and the Party (Naughton, 2003 and 2005a).

Immediately after its inception, the State Asset Commission suspended allmanagement buyouts and began to explore ways to establish a ‘unified, stan-dardized national market’ for transactions of state assets. As a central govern-ment agent representing the state’s interest, its primary concern was to defendthe value of state assets. The objective was to sell nontradable state-ownedshares ‘at good prices’ with reference to the market prices of tradable shareslisted in the secondary market. On the other hand, the China SecuritiesRegulatory Commission was more concerned with the interest of shareinvestors. As such, it was very sensitive to any sale of state-owned shares bythe State Asset Commission, because of the bearish implication of the increasein share supply. The tension between the two commissions resulted in a dead-lock in China’s privatization process through 2003–04, with the relative sizeof state ownership in China’s listed companies remaining almost unchanged at62–63 per cent during this period (see Table 7.2; DB, 21 February 2004; GJB,9 February 2004; Naughton, 2005a; Naughton, 2007, pp. 316–19, 323–25;SZB, 4 February 2004; XB, 11 April 2003; ZW, 21 July 2003).

2005–2006: FURTHER PRIVATIZATION UNDER THESHARE CONVERSION REFORM

A breakthrough occurred in late April 2005, when a share conversion pilotreform programme was launched. The official Chinese name of this reform,guquan fenzhi, suggests that its purpose was to solve the ‘division’ (fenzhi)


between ‘equities’ (gu) and ‘rights’ (quan). This division is a historical prob-lem arising from the coexistence of nontradable state-owned shares and trad-able individual shares, which has resulted in a ‘dualistic’ market consisting of‘different types of equities, different prices, and different rights’ (Fu, 2006, p.3). The term has thus been translated into English as ‘equity division reform’(CD, 20 November 2006; CIICN, 1 May 2005; GNW, 9 January 2006; XFNN,7 November 2005). This, however, is misleading, because what the reformaimed at was exactly to eliminate the ‘division’. This article thus followsNaughton (2005b) to name this reform ‘share conversion’.

Under the share conversion pilot reform, from May to June 2005 altogether45 listed companies were asked to initiate their own plans to convert nontrad-able state-owned shares into tradable shares. Apart from approval by the ChinaSecurities Regulatory Commission, each plan also had to be acceptable to thecompany’s board of directors and at least two-thirds of the individual share-holders. To secure such support, more than 90 per cent of the companiesproposed to offer bonus shares to existing individual shareholders. The ChinaSecurities Regulatory Commission explained that the primary purpose of thereform was to solve the problem of nontradability of the large amount of state-owned shares, instead of cashing them in (Fu, 2006, pp. 15 and 24–25; HKS,2 May 2005; Naughton, 2005a; XJR, 21 June 2005; ZX, 15 May 2005).

The plans initiated by the pilot companies proposed that, on average, everyten tradable individual shares would receive three bonus shares from the state.The reform programme thus meant a concession of state interest to individualshareholders, which was against the original position of the State AssetCommission. But with the agency’s organization extended from central tolocal levels, it became holder of an increasing amount of industrial assets, anda more flexible approach to the problem of nontradability of state-ownedshares would be to its advantage.2 The State Asset Commission thus becameless resistant to the share conversion plan, making the share conversion reformpolitically feasible. As the reform proceeded, not only the State AssetCommission and the China Securities Regulatory Commission but also theMinistry of Finance, the People’s Bank of China, the Ministry of Commerce,and the State Administration of Taxation supported the change (Naughton2005b; 2007, p. 475; SJB, 21 July 2005; SZB, 27 June 2005; ZS, 26 April 2006;ZZB, 8 January 2006).

The pilot programme was completed within four months after its introduc-tion, and in early September 2005, the share conversion reform was officiallylaunched nationwide. By late April 2006, a year after the introduction of thepilot programme, 868 listed companies accounting for about 70 per cent oftotal market capitalization had already completed conversion of nontradableshares into tradable shares, or were in the process of doing so. The rest weremainly those firms consistently posting losses, or whose market capitalization


was too small, or those facing disciplinary actions. They were pressured by theChina Securities Regulatory Commission to join the reform by the end of theyear, otherwise they would be merged, acquired, or delisted. In May 2006,initial public offerings, which had been suspended since the introduction of thereform, resumed. All the shares of the newly listed companies were tradable.That is to say, new listings would no longer increase the accumulation ofnontradable shares (SCMP, 19 June 2006; ZGB, 30 December 2005; ZXQB, 13June 2006; ZZB, 29 April 2006).

According to the State Asset Commission, the share conversion reform, incontrast with the RHSOS programme, did not necessarily mean diminishedstate ownership because state-owned shares, after they are made tradable, maystill be retained by the state. It was stipulated that within the first three yearsof the reform no more than 15 per cent of the state-owned shares could be sold.Moreover, the state may even choose to increase its shareholding (MB, 23September 2005; SJB, 21 July 2005; XJR, 21 June 2005). However, this doesnot seem likely to happen, given that the state lacks the capital as well as theincentive to do so. On the other hand, by making state-owned shares tradable,it has become easier for Chinese ‘legal persons’ to cash in the state-ownedshares they hold. Hence, the share conversion reform, though in itself a shareconversion rather than an RHSOS programme, has significantly speeded upthe process of privatization in China. As indicated in Table 7.2, in 2005 therelative size of state ownership in China’s listed companies fell sharply, from62 per cent to 55 per cent. A year later, it was reported that over 95 per cent ofChina’s listed companies had completed, or were undergoing, the shareconversion reform (GR, 19 January 2007). On the other hand, on the basis ofthe success of the share conversion reform, the RHSOS programme wasresumed in July 2007, for the purpose of raising money for the nationalpension fund. This time, the stock market did not react with panic, as there isthe restriction that a state-share-holder could not sell more than 5 per cent ofits holdings within three financial years, unless approved by the State AssetCommission (MB, 8 July 2007; XB, 7 July and 13 October 2007).Nevertheless, this has opened up another channel for the transfer of state assetsto private hands, thereby intensifying the trend of privatization in China. Bythe end of 2007, the proportion of state ownership had already plummeted to30 per cent (Table 7.2).

NOTES

1. The author is indebted to Charlotte Chan, Jester Chan, and Elton Ma for their research assis-tance in the work on this chapter.

2. This is in line with the observation that local governments are the major promoters of priva-tization in China. See Liu, Sun and Woo (2006).


8. Conclusion: privatizing throughgroping for stones

SHARE CONVERSION AS ‘SHOCK THERAPY’?

The ‘share conversion’ reform discussed in the last chapter represents animportant breakthrough in China’s privatization. By issuing bonus shares toindividual shareholders, it has diluted state ownership in China’s listed compa-nies; and by making state-owned shares tradable, it has facilitated further saleof state assets in the stock market. In late 2006, Shang Fulin, chairperson ofthe China Securities Regulatory Commission and a proposer of the shareconversion reform, announced that the reform ‘had basically been accom-plished’. That is to say, it took only about 20 months (from May 2005 to endof 2006) to complete the whole share conversion reform. The stock marketwelcomed the change with a 167 per cent rise in total capitalization during thisperiod, and it was widely expected that a ‘golden decade’ for China’s stockmarket would ensue. As asserted by a Chinese commentator, the share conver-sion reform was the ‘fastest and smoothest’ change in China’s economicsystem reforms (NR, 10 January 2007; SZB, 15 January 2007; ZS, 22 January2007).

This dramatic change has led some Chinese scholars to interpret the shareconversion reform as ‘shock therapy’. The announcement of the reform on 30April 2005 (the day before the stock exchanges closed for the weeklong MayDay holiday) without any major hints in advance was described as a ‘suddenattack’ of the stock market and ‘an arrow that has no return’ (SZB, 8 May2006). When the list of the first batch of pilot companies for the reform wasannounced, trading of the shares of these companies was suspended immedi-ately. Hua Sheng of Yanjing Overseas Chinese University explained this as a‘shock therapy’ approach to prevent market speculation. Guo Shiping ofShenzhen University noted that at such a critical moment, ‘[S]hock therapymight as well be used to search for a solution for the market’ (CW, 10 May2005; GJB, 7 June 2005). Another scholar, Xie Maoshi of Hunan BusinessSchool, complained that giving bonus shares to individual shareholders was‘unreasonable’ and that the share conversion reform was not much differentfrom making all shares tradable all of a sudden, through ‘shock therapy’ (DR,26 November 2005).

134

The above brings us to the debate over shock therapy and gradualism. Thegradual reform of China since the early 1980s on the one hand, and the suddenswitch to the market economy of many former Soviet bloc countries in the1990s on the other, has resulted in a hot discussion about which approach ismore desirable. As China’s reform continues to produce higher economicgrowth than that of most former Soviet bloc countries, this debate about shocktherapy and gradualism has in general concluded in favour of the latter.1 Manyformer advocates of rapid switch from plan to market have given up theirearlier belief in the big bang approach, and a supporter of China’s gradual tran-sition even claimed that ‘We Are All Gradualists Now’ (Rawski, 1999, p. 153;original italics).

But in what sense is China’s reform gradual? If we follow the so-called‘slow-fast characterization’ of the debate between shock therapy and gradual-ism (Sachs and Woo, 2000, pp. 6),2 the answer to this question would be thatthe Chinese reform is a gradual one because it has been taking place at aslower pace than those in most of the former Soviet bloc countries. However,there are many cases in the Chinese reform – such as the introduction of theagricultural household responsibility system, and the restructuring of propertyrights of small state-owned enterprises – in which speed of introduction wasby no means slow (Wang X., 1998, p. 145; Wang D., 2005, p. 15). Moreover,while shock therapists favoured ‘the faster the better’, and gradualistscautioned to wait till ‘conditions are appropriate’, both failed to spell out anappropriate speed of change (Brada, 1995, p. 186). Hence, it is problematic todistinguish between shock therapy and gradualism simply with a slow-fastschema. As will be elaborated below, a more meaningful criterion would bewhether the transition is characterized by the coexistence of new and oldsystems, that is, a dual-track one.

SHOCK THERAPY, GRADUALISM, AND DUAL-TRACKTRANSITION

The debate between shock therapy and gradualism appeared in the 1990s,when former socialist regimes were confronted with choices of post-commu-nist transition strategies. Shock therapy is originally a psychiatric measuresometimes used as a last resort to treat mental patients. The theory is that bystimulating nerve cells through electrical shocks, mental conditions of patientscan be expected to return to ‘normal’ (Brabant, 1995, p. 158). Applied to post-communist transition, normalcy is defined in terms of Western capitalisteconomies, and shock therapy is the reform package (typically consisting ofprivatization, liberalization, and internationalization of economic activities)that aims at creating instantaneously such a ‘normal’ system in former

Conclusion 135

centrally planned economies (Aslund, 2002, p. 70; Sachs and Woo, 2000, p.8). To achieve this, any unfavourable institutions are to be destroyed first,followed by immediate construction of new ones (Murrell, 1993, pp.112–19).

In contrast, gradualism does not pre-assume any normal destination.Rather, it holds that goals of reform are contingent upon available knowledgeand institutional settings, which cannot be changed overnight (Murrell, 1993,pp. 119–22). Even if market is accepted as the presumed goal of transition,market itself is ‘a source of information’ from which actors learn to becomeentrepreneurial, and is an ‘evolving institution’ that needs to adapt to circum-stantial conditions (Brabant, 1995, pp. 160–70). Since contingency is impor-tant, the role of blueprint in reform must be limited. In the case of Chinesegradualism, the reform is regarded as ‘one without-a-theory, rather than adeliberate approach’. Instead of consciously adhering to any guiding theory,China’s reform strategy is ‘informed by an intensely pragmatic mindscape andfacilitated by a set of historically situated structural factors’ (Zhu, 2007, p.1504). It is therefore not a revolution with a clear vision at the onset, but anevolution characterized by learning-by-doing (Jin and Haynes, 1997, pp.80–84).

If gradualism was so defined, then China’s gradual reform would best beunderstood in terms of ‘groping for stones to cross the river’, a well-knownmetaphor often attested to Deng Xiaoping (Tao and Xu, 2006, p. 178; Zhu,2007, p. 1504). It refers to the situation that, since the reform has no masterplan, it can only proceed on a trial-and-error basis, leading to ‘a succession ofapproved small steps towards the far riverbank’ (Hope, Yang and Li, 2003, p.2). Under this approach, throughout the Chinese reform ‘No ultimate goal wasannounced, nor any timetable for the transition’ (McMillan and Naughton,1992, p. 130). It is a gradual reform strategy, not because it is slower thanshock therapy, but because its goal – the other side of the river – is not pre-defined.

Without any pre-defined normalcy, gradualists are sceptical of the worka-bility of ‘utopian social engineering’, or reforms based on target blueprints(Murrell, 1992, pp. 3–11). Consequently, they tend to attach less significance‘to the details of the imagined endpoint for the immediate tasks to be under-taken’, and prefer a ‘dual economy’ than ‘an immediate economy-wide liber-alization’ (Murrell, 1993, p. 122). In the case of China, as Naughton (2007)noted, the adoption of a dual-track system could be regarded as ‘the most char-acteristic feature of China’s initial departure from the planned economy’ (p.91).

As mentioned at the beginning of this chapter, the fact that it took onlyabout 20 months to complete the share conversion reform has led someChinese scholars to interpret the change as a kind of shock therapy. However,


it should be noted that these Chinese scholars were using the term ‘shock ther-apy’ only in a very general sense, and this should not lead to the view thatChina has switched from its long-followed gradualism to shock therapy.Although it is true that the share conversion reform was introduced muchfaster than China’s other reform programmes, this alone does not amount to afundamental change in approach to reform. Apart from speed, how a newsystem replaces an old one is another important criterion to distinguish the twomajor approaches of reform. Gradualism involves dual-track transition,whereby new and old systems coexist until the former is ready to completelytake over the latter. In contrast, under shock therapy the old system isdestroyed before the new system is established and there is thus no overlap(Murrell, 1993, pp. 113 and 122).

According to such a definition, share conversion reform falls clearly underthe gradualist category. When the shareholding system reform began toemerge in China in the mid-1980s, existing political, economic, and ideologi-cal constraints allowed tradability only for individual shares, but not for state-owned shares. This resulted in the ‘equity division’ into two separate markets:an official stock market for tradable individual shares and a parallel market fornontradable state-owned shares. Through the share conversion reform, allshares were made tradable, thereby merging the two markets into one, afterthey had been in coexistence for about two decades. For China, this is justanother case of ‘dual-track transition’, following the unification of dual pricesand multiple currencies.3

Put in such broad perspective, the share conversion reform is part of thetwo-decade-long evolution of China’s shareholding system. The problem thatthe share conversion reform intends to solve – the coexistence of tradable andnontradable shares – was born with the establishment of the first shareholdingcompany in 1984. It took 13 years for the shareholding system reform toevolve from a spontaneous experiment into an official reform programme in1997. Then after three years (1997–2000) of implicit privatization, the imper-ative need to raise capital for the National Social Security Fund spurred anattempt at speedier sale of state assets from 2001 to 2002. But in face of strongmarket rejection, the ‘reduction of holding of state-owned shares’ programmewas scrapped, followed by a deadlock from 2003 to 2004. As a compromise,in 2005 the state agreed to issue bonus shares to individual shareholders, underthe name of the share conversion reform. It was a Chinese-style ‘managementby exception’, a plan introduced at the time when Chinese top leaders found itimperative to solve the market distortion and official corruption due to thedual-track system in the stock market (Bell and Feng, 2009). The wholeprocess was consistent with the gradual, incremental, trial-and-error approachdescribed by Chinese leaders as mo zhe shitou guo he (to cross a river by grop-ing for stones).

Conclusion 137

ENTERING THE POST-SHARE-CONVERSION ERA

In short, China’s two-decade-long privatization attempt has finally beenaccomplished through the share conversion reform. From 2002 to 2007, thenumber of state-owned enterprises declined by about 10 000 per year, whileprofits rose by an average of 250 billion yuan per year (ZJN, 2008, p. 833). In2005, only 188 billion yuan were raised through shares and rights issues. Butin 2006 and 2007, after the implementation of the share conversion reform, theamount soared to 559 billion yuan and 843 billion yuan respectively (ZJN,2007, p. 821; 2008, p. 831). The capital market has thus served as an impor-tant channel for Chinese state enterprises to privatize through initial publicofferings. In fact, a comparative study on post-communist privatization notedthat ‘no country utilized the capital markets to the extent the Chinese did’(Lieberman, Kessides and Gobbo, 2008, p. 21).

Then what next? According to a 2007 report of the China SecuritiesRegulatory Commission, there are three major challenges for the country’scapital market in the post-share-conversion era. First, resources will be furtherallocated according to market principle; the less efficient elements of themarket will be sloughed off through competition. Second, there will be greaterdemand for regulation and institutionalization of the market. Finally, interna-tionalization and the increasing competition that follows will require furtherreform and development of the capital market. Looking into the future, thereport predicts that more capital market products will appear, the size of thecapital markets will expand, the prosperity of the market will become moresustainable, the Chinese economy as a whole will become more efficient, andmore wealth will be created (SZB, 16 February 2007). Such an optimisticoutlook for the post-share-conversion era lasted throughout 2007. During theyear, the Shanghai Composite Index jumped by 97 per cent, and the ShenzhenComponent Index even by 166 per cent.

However, market sentiment began to turn around towards the end of 2007,and further worsened along with the worldwide financial tsunami in thefollowing year. In 2008, both the Shanghai Composite Index and the ShenzhenComponent Index plummeted by about 65 per cent. Some leftists argued thatthe crisis in the western financial market showed the superiority of the social-ist economy over the capitalist market (PR, 20 February 2009). Moreover, crit-ics of the share conversion reform attributed the downturn to this reform. ButShang Fulin, chairperson of the China Securities Regulatory Commission,argued that share conversion is an indispensable reform but not a panacea. Thereform continued amid criticisms. In 2008, share conversion was completed orbeing implemented in 46 listed companies, leaving only about 50, out of thetotal of over 1600 Chinese listed companies, unreformed (ESJB, 7 January2009; ZR, 15 January 2009). Chinese reformers, however, have become


increasingly aware that further reform must be guided by ‘more detailed’policy design and vision, instead of relying on ‘groping for stones’ (SS, 12January 2009). ‘If the initial stage of the Chinese reform that began in 1978could be metaphored as one crossing a river, now thirty years after, theChinese reform is like a ship sailing in the sea’ (Ibid.).

Finally, as the Chinese economy enters the post-share-conversion era, ourstudy of China’s corporate governance reform has to move accordingly to apost-privatization perspective. Studies on post-privatization in other formersocialist countries find that accomplishment of privatization does not auto-matically lead to economic success. For example, data collected by Broadman(2000) from Russia’s industrial firms suggest that ownership changes did notnecessarily result in restructuring. Similarly, Prasnikar, Svejnar, andDomadenik’s (2000) study of Slovenian firms finds that the pace of restruc-turing depends more on the power dynamic among interest groups than onownership structure. Moreover, according to Kogut and Spicer’s (2002)comparative case analysis of post-privatization market formation in Russiaand the Czech Republic, without effective state regulation and trust, ‘markets’are used for political contests rather than for economic competition. Yet thereare also studies that support post-privatization optimism. For example, Earleand Estrin (2003) found evidence about the positive impact of privatization onRussian labour productivity; and Earle and Telegdy (2002) obtained similareconometric results from Romanian industrial corporations. Now that Chinahas entered into the post-share-conversion era, continuing studies of Chineseenterprise performance will contribute to this literature by providing new dataand perspectives for the comparative analysis of post-privatization in formersocialist economies.

NOTES

1. For reviews of the Western debate about shock therapy and gradualism, see Aslund (2002, pp.70–112) and Brabant (1998, pp. 102–108).

2. Sachs and Woo referred to that debate as one between ‘experimentalist school’ and ‘conver-gence school’. These two schools correspond more or less to gradualism and shock therapyrespectively in our context.

3. For other discussions on China’s ‘dual-track transition’, see Jin and Haynes (1997), Lau, Qianand Roland (2000), and Opper (2001).

Conclusion 139

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References 159

A-sharesand B-shares 66, 67–9, 87Guangzhou Shipyard International

Company (GSIC) 98listings 119–20nature of 62–3Northeast Electrical Company 110

acquisitions 73–5agency problem 15Anheuser-Busch 71–2Asea Brown Boveri 72Atlantic Richfield 72

B-sharesand A-shares 66, 67–9, 87expansion of market 64–7growth of 92–3listings 65nature of 62–3

backdoor listingGuangdong Investment (GI) 102,

112–16process of 93reduction of holding of state-owned

shares (RHSOS) 126state control of 95–6

Beijing Light Bus 69–70Beijing Tianqiao Department Store

Company 10, 29Bersani, Matthew 17Blecher, M. 84–5Bornstein, Morris 8, 62Bowles, Paul 17Brabant, Jozef M. van 14Bradshaw, York 80Breslin, Shaun G. 45, 82Broadman, Harry G. 26, 139

Capital Iron and Steel Corporation89–90

CCIC Finance 110–11, 116Chan, Anita 44, 83

Chen Aimin 58Chen Feng 18Cheung, Steven 96China

closed-end country funds 79as corporatist state 82–4, 88dependent development theory

79–81as developmental state 81–2, 85, 86,

87–8economic growth 5, 46–7, 61as entrepreneurial state 84–5, 86, 88foreign capital in 61, 76–9and the Hong Kong Stock Exchange

(SEHK) 116–20ideological debate 10, 17, 18–22as market-facilitating state 86–7,

88–9privatization in 1, 2–3, 4–6, 7, 8,

138–9state enterprise losses 9–10state ownership, decline in 33–7

China International Trade andInvestment Corporation 86

China Ocean Shipping Company 95China Securities Regulatory Commission

(CSRC)approval of share listings 99, 131B-shares 66conversion of corporate shares 35–6,

69establishment of 32Guangzhou Shipyard International

Company (GSIC) 101reduction of holding of state-owned

shares (RHSOS) 129share conversion reform 132, 133,

138China State Shipbuilding Corporation

(CSSC) 97–8, 112, 113China Strategic Investment (CSI) 73–5classical dependency theory 79–81

Index

161

closed-end country funds 79commodification 9, 18Company Law

regulation of shareholding enterprises(SHEs) 32, 34, 35, 58

state ownership 117supervisory mechanism 39

corporate governance 106–7corporate shares 33, 34–7, 62–4, 69–71corporatism 44, 83–4corporatist state 82–4, 88corporatization 13–14, 27–8Czech Republic 96, 139

Dai Xianglong 105Deng Xiaoping 11, 31, 48, 97, 136dependency theory 79–81dependent development theory 79–81developing countries 61, 76–9developmental state 43–4, 45–6, 81–2,

85, 86, 87–8Domadenik, Polona 139domestically listed foreign shares see B-

sharesDongshen Water Project 105dual-track transition 39, 135–7Duckett, Jane 84–5Duncan, Ron 26

Earle, John S. 139Eastern Europe 2–3, 7, 69, 135Engels, Friedrich 19enterprise (collective) shares 12, 13,

51–2entrepreneurial state 84–5, 86, 88equity division reform see share

conversion reformEstrin, Saul 139Europe 76, 81Evans, Peter 80

fiscal decentralization 111–16Ford Motor Company 66foreign capital 61, 76–9, 92foreign direct investment (FDI) 92foreign investors

capital flows 61, 76–9, 92Foshan Tongbao Shareholding

Limited Company 54increasing participation 64–75

privatization in other developing countries 61, 76–9

shareholding system reform 59state role 79–89

foreign loans 92foreign shares 33, 63, 64, 69–71, 124foreign stock exchange listing 71–3Foshan Electrical and Lighting Company

Limited 55–7, 58Foshan First Radio Factory 51–3, 57, 58Foshan, shareholding system reform in

46–57, 58Foshan Tongbao Shareholding Limited

Company 53–5, 58Frank, Andre 80Fujian 31Fushan First Radio Factory 29

Gelb, Alan 14gradualism 135–7grafting into foreign capital 73–5Guangdong 31, 97Guangdong Enterprises Holdings (GEH)

Limited 101–7, 113Guangdong International Trust and

Investment Corporation (GITIC)104, 105

Guangdong Investment (GI) 94, 101–7,112–16, 120–22

Guangzhou 29Guangzhou Shipyard International

Company (GSIC) 94, 96–101,112–13, 120, 121

Guo Shiping 134

H-share companiesGuangzhou Shipyard International

Company (GSIC) 94, 96–101,112–13, 120, 121

nature of 93–4Northeast Electrical Company

107–17, 118, 121, 122H-shares

effects of 94–6growth of 92–3Guangzhou Shipyard International

Company (GSIC) 98–101listings 65, 71–2, 92–6, 119–20nature of 62, 63, 64PetroChina 127


Hainan 31Hainan Air Company 35Harbin Power Equipment 72Hong Kong Stock Exchange (SEHK)

Chinese share listings 116–20Guangdong Investment (GI) 101–7,

112–16Guangzhou Shipyard International

Company (GSIC) 98–101H-share listings 65, 71–2, 92–6,

119–20National Social Security Fund 130Northeast Electrical Company

107–17, 118, 122Howell, Jude 86Howie, Fraser J.T. 128Hua Sheng 134Huang, Yasheng 115Huang, Yiping 26Hungary 77, 96

incrementalismshareholding system reform 137shareholding system reform in

Foshan 46–57and state reform influence 42–3,

57–60individual shares 33, 34–7, 62–4, 124individual workers shares 12, 13institutional investors 128intergovernmental fiscal relations

111–16internal-employee shares 110internal shareholding system 53, 59Isuzu Motor 69–70Itochu 69–70

Jefferson, Gary 14Jiang Zemin 19, 20, 32–3Jiangling Auto Company 66joint ventures 73–5

Kleinberg, R. 81Kogut, Bruce 139

Lee Chyungly 81Lee Kuen 14–16Lee, Peter N.S. 83Leftwich, Adrian 43, 81legal-entity shares 54, 55, 56

legal-person shares 33, 62–4, 110,124–5

Li, David D. 37Li Peng 70Li Yining 21–2limited liability companies (LLCs) 27local government see regional

government

management buyouts 131Mark, Shelley 15market-facilitating state 86–7, 88–9marketization 9, 18Marx, Karl 19, 22mass ownership transformation 23McCormick, B.L. 45mergers 73–5Min Xin 94

N-shares 62, 63, 64, 65, 72National Electronic Trading System

(NETS) 35National Social Security Fund 127–31Naughton, Barry 26, 132, 136new public ownership 21–2New York Stock Exchange (NYSE) 72Nimrod 70Northeast Electrical Company 94,

107–17, 118, 121, 122Northeast Electrical Transmission and

Transformation Equipment GroupCorporation (NET) 108–11, 113,114–15, 117

Nottle, Robert 17

Oi, Jean 44, 83–4, 115

Pan, Weihwa 26Parker, David 26Pearson, M.M. 81pension fund 127–31People’s Bank of China (PBC) 28, 52,

98–9PetroChina 127Poland 77political objections 10, 17, 18–22portfolio equity flows (PEFs)

acquisition of 92–3Guangdong Investment (GI) 94,

101–7, 112–16, 120–22

Index 163

Guangzhou Shipyard International Company (GSIC) 94, 96–101,112–13, 120, 121

Hong Kong Stock Exchange (SEHK) listings 92–6

Northeast Electrical Company 94, 107–17, 118, 121, 122

Prasnikar, Janez 139private individual shares 12, 13private placement enterprises 29–30privatization

advantages 1, 4channels of 22–3, 124–6corporatist state 82–4, 88vs. corporatization 13–14, 27–8definition 8, 62dependent development theory

79–81developmental state 81–2, 85, 86,

87–8disadvantages 1, 4dual-track transition 39, 135–7entrepreneurial state 84–5, 86, 88foreign investors 61, 76–9foreign participation, sources of

64–75future of 138–9gradualism 135–7ideological debate 10, 17, 18–22,

94–6market-facilitating state 86–7, 88–9origins of 7, 8pattern of 4–6proceeds from 1, 2–3reduction of holding of state-owned

shares (RHSOS) 125, 126–31,133

regional government role 88–9share conversion reform 125, 131–3,

134, 137, 138share types 62–4shareholding enterprises (SHEs),

performance of 39shock therapy 134–7spread of 8state ownership, decline in 33–7terminology 9worldwide trends in 1–3, 7, 61

profit contract system 9public-owned enterprise shares 13

public placement enterprises 30public shareholding system 55, 59

Rana, P.B. 14Rawski, T. 14red chip companies

effects of 94–6Guangdong Investment (GI) 94,

101–7, 112–16, 120–22Hong Kong Stock Exchange (SEHK)

117nature of 93–4

reduction of holding of state-ownedshares (RHSOS) 125, 126–31,133

regional governmentcorporatism 83–4Foshan, reform in 46–57, 58Guangdong Investment (GI) 101–7,

112–16intergovernmental fiscal relations

111–16Northeast Electrical Company

107–17, 118pension reform 128privatization role 88–9reform role 59

regulationmarket-facilitating state 86–7of mergers and acquisitions 75of securities listings 95–6of shareholding system reform 32,

58residual claims 14–15rural sector 28–9Russia 59–60, 77, 96, 139

Schmitter, Philippe C. 82Securities Commission 32, 58Securities Law 40, 95Securities Trading Automated Quotations

System (STAQS) 35Shang Fulin 134, 138Shanghai 12, 31, 37Shanghai Dazhong Taxi Company 69Shanghai Diesel Engine Company 69Shanghai Lighting Apparatus Factory

22Shanghai Stock Exchange

fluctuations in 138


Guangzhou Shipyard International Company (GSIC) 98

reduction of holding of state-owned shares (RHSOS) 127, 128

share listings 31, 62, 64, 67state share sales 118

share conversion reform 125, 131–3,134, 137, 138

share issues 17, 36share types 62–4shareholding conglomerates 13shareholding cooperative enterprises 30,

33shareholding enterprises (SHEs)

companies, number of 11, 29, 30, 31,32, 40

corporatization 27–8enterprise models 12–13, 51evolution of 29–33, 39–40foreign investors 87in Foshan 46–57, 58performance of 37–9regulation of 10, 32, 34, 35, 58shareholders, number of 23and state-owned enterprises (SOEs)

25, 28–33, 39–40state ownership, reduction in 33–7

shareholding system reformdevelopment of 10–11, 124–6effects of 37–40enterprise models 12–13, 51evolution of 5–6, 28–33, 39–40, 137in Foshan 46–57, 58Guangzhou Shipyard International

Company (GSIC) 97ideological debate 10, 17, 18–22literature review 14–18origins of 7privatization, future of 138–9regulation of 32, 58share issues 17, 36share types 62–4spontaneity in 42–3, 57–60state role 10, 43–6, 57–60

Shengping Departmental Store 47Shenyany 12Shenzhen 12, 31, 37, 46Shenzhen Development Bank 36Shenzhen Stock Exchange 31, 62, 64,

67, 138

Shenzhen Wanke Company 36shock therapy 134–7Shougang 89–90Shun Shing 95Sichuan 12Sichuan Guanghua Chemical Fibre 70Singh, Ajit 16–17Singh, Inderjit 14social security 99, 106–7, 109, 118,

127–31socialist guided markets 82socialist states 80–81socialization 9, 19South Korea 43, 45, 82, 83Spicer, Andrew 139spontaneity

shareholding system reform in Foshan 46–57

and state reform influence 42–3, 57–60

statebailout by 110–16enterprise models, role in 12–13expropriation of state assets 14–15foreign investors 79–89Foshan, reform in 46–57, 58Guangdong Investment (GI) 105,

106–7, 112–16, 120–22and the Hong Kong Stock Exchange

(SEHK) 116–18intergovernmental fiscal relations

111–16ownership, decline in 33–7securities listing controls 95–6share of shareholding companies 14shareholding system reform 10,

28–33, 43–6, 57–60and spontaneous reform 42–3, 57–60

State Commission for Economic SystemReform (SCESR) 97, 98

State Council Securities Commission(SCSC) 99

state enterprises 9–10, 22–3State-Owned Assets Supervision and

Administration Commission (StateAsset Commission) 131, 132

state-owned enterprises (SOEs)conversion to shareholding

enterprises (SHEs) 25, 28–33, 39–40

Index 165

corporatization of 27–8decline in 33–7foreign participation 64–75, 87Guangzhou Shipyard International

Company (GSIC) 94, 96–101,112–13, 120, 121

Hong Kong Stock Exchange (SEHK) listings 94–6, 119–20

losses 28Northeast Electrical Company 94,

107–17, 118, 121, 122reduction of holding of state-owned

shares (RHSOS) 125, 126–31,133

reforms 26–8share conversion reform 125, 131–3size of 61

state-owned shares 124–5state shares

conversion of 34–7, 69–71Foshan Electrical and Lighting

Company Limited 55–6Foshan First Radio Factory 51Foshan Tongbao Shareholding

Limited Company 54, 55Guangzhou Shipyard International

Company (GSIC) 98Hong Kong Stock Exchange (SEHK)

listings 117–18nature of 33, 124–5Northeast Electrical Company 110,

118reduction of holding of state-owned

shares (RHSOS) 125, 126–31,133

share conversion reform 125, 131–3

shareholding enterprises, models of 12, 13

shareholding system reform 62–4Steinfeld, Edward 115Sun, Yan 18Svejnar, Jan 139

Taiwan 43, 45, 82, 83Tam, On Kit 16tax-for-profit system 9Telegdy, Álmos 139transitional economies in Europe and

Central Asia (TEECA) 76–9Tsingtao Brewery 71–2, 94

Unger, Jonathan 44, 83Union Globe Development Limited 102unit shares 12, 13

Wade, Robert 43, 82Walter, Carl E. 128Wang Qishan 105welfare benefits 99, 106–7, 109, 118,

127–31White, Gordon 17, 43, 82worker shares 51, 52, 54, 55, 56World Bank 29, 96

Xie Maoshi 134

You, Ji 18

Zhao Ziyang 11, 20, 29, 31, 33, 47–8Zhenhai Refinery 72Zhongce phenomenon 73Zhu Rongji 28, 52, 75, 129


Shareholding System Reform in China - Shu-Yun Ma

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