China Economic Update: July 2016

Despite decades of change, China’s State-Owned Enterprises (SOEs) are a specific segment of the economy that still requires substantial reform.

Taming the beast – the challenges of reforming China’s state-owned enterprises

Last month, we highlighted our concerns around the slow pace of China’s broad reform agenda since 2013’s Third Plenum. Despite decades of change, China’s State-Owned Enterprises (SOEs) are a specific segment of the economy that still requires substantial reform. While the role of SOEs has generally declined across recent decades, they still control a significant share of the economy – varying by sector – and have considerable financial and political influence, which poses challenges to the reform process.

The actual contribution of SOEs to China’s economy is somewhat unclear – with estimates that SOEs share of GDP ranging anywhere from 20% to 40% – however it is generally accepted that SOEs are a drag on economic growth, given institutionalised inefficiencies and the negative effects of barriers to entry for private firms.

Reforms to state-owned enterprises announced at the 2013 Third Plenum were relatively modest and somewhat inconsistent – with policy statements that noting that markets should have a decisive role in allocating resources, but that SOEs should continue to have the leading role in the economy.

As seen with a range of reforms and policy responses over the past two years, short term volatility and slowing economic trends can lead to backtracking on reforms in the interests of immediate growth.

From a purely economic perspective, further reform to SOEs is an obvious course of action to improve the performance of China’s economy – reflecting the inefficiencies, excess capacity and negative competitive impacts from their preferential arrangements with government and banks. However, this overlooks the social importance of SOEs – as major employers – and their political influence – being able to directly influence economic activity at the government’s behest, as well as a growing role in foreign political measures, such as ‘One Belt, One Road’. These factors increase the likelihood that SOE reform will remain at best a slow and limited process.

For further details, please see the attached document: