Challenges Ahead in China's Reform of State-Owned Enterprises

EXECUTIVE SUMMARY

MAIN ARGUMENT

The Xi Jinping administration has identified the reform of state-owned enterprises (SOE) as an essential step in the structural transformation of China’s economy. In September 2015, Beijing released long-delayed guiding opinions for reforming state firms, to be followed by a series of policy documents. Three key challenges, however, block the path ahead: deciding when and how to grant market forces a greater role, especially after stock market turmoil; aligning managerial incentives with firm performance and corporate governance priorities; and overcoming company-level obstacles. Continuing to restrict competition in protected sectors while merging centrally owned firms will increase their market share at the risk of long-term competitiveness and efficiency gains. Yet such performance concerns are a lesser priority for SOEs in strategic industries, where political rather than market logic remains paramount. Second, while the Chinese Communist Party under Xi is actively exercising its authority to appoint and remove the top leaders of yangqi, shuffling executives cannot eliminate their multiple and often conflicting incentives. Finally, the size, complexity, and organizational culture of centrally owned firms will complicate reform implementation.

POLICY IMPLICATIONS

• To establish realistic expectations for the next phase of China’s reform of SOEs, policymakers and business leaders must understand the major challenges ahead in carrying out new reforms.
• The Chinese government has long maintained protected industries and reformed yangqi by merging underperforming and smaller state firms into other centrally owned companies. Yet boosting competition and enabling market exit for the worst performers, particularly in nonstrategic sectors, may be the best approach to improve efficiency and service quality in the long term.
• New reforms will not succeed without targeted policies at the firm level to align executive incentives, strengthen internal oversight, and overhaul enduring cadre culture.