Li Minqi: The Actual Efficiency of State-Owned Enterprises is Far Higher Than That of Private Enterprises — A Discussion with Mr. Zhang Wenkui
Mr. Zhang Wenkui, Deputy Director of the Enterprise Research Institute at the Development Research Center of the State Council, recently proposed in an interview with the China Business Times to "resolutely push forward the privatization of State-Owned Enterprises (SOEs)" so that the vast majority of SOEs complete privatization by 2030 (see the relevant report in the China Business Times, August 12, 2012). This proposition warrants a serious critical discussion.
The Profit Rates of Chinese SOEs Have Surpassed Those of American Firms
In this interview, Mr. Zhang Wenkui argued that SOEs are inefficient and corrupt, distort resource allocation, and act as a drag on the Chinese economy: "Our analysis shows that the efficiency of SOEs is significantly lower than that of private enterprises, yet they occupy a large volume of factors [of production] at lower prices that are disproportionate to their efficiency and scale. Two recognized indicators for measuring efficiency are Return on Equity (ROE) and Total Factor Productivity (TFP). In 2003, the ROE for private enterprises was 13% while for SOEs it was 12%; by 2007, the ROE for SOEs reached 15% while for private enterprises it was 23%. Now, the gap between SOEs and private enterprises on this indicator is growing wider." Mr. Zhang further contended that only by privatizing the vast majority of SOEs can the obstacles to China's economic growth be removed and a foundation for sustainable growth be laid.
The "Total Factor Productivity" mentioned by Mr. Zhang is based on the theory of the value of production factors in neoclassical economics—that is, the theory that various factors of production such as labor, capital, and land will receive remuneration according to their respective marginal productivity in a free market economy. This theory possesses major logical flaws and was overturned as early as the 1960s during the famous "Cambridge Capital Controversy" [1]. This article will set that issue aside for now.
Return on Equity is easier to understand; it is essentially the ratio of a company's profit to its net assets (also known as shareholders' equity).
Mr. Zhang compared the performance of SOEs and private enterprises in 2003 and 2007. This article utilizes data for industrial enterprises above designated size [2] for the year 2010 as published in the 2011 volume of the China Statistical Yearbook. In 2010, the total shareholders' equity of all state-owned and state-controlled industrial enterprises was 9.8 trillion yuan, with total profits (pre-tax profits) of 1.4 trillion yuan, resulting in an ROE of 15.0%.
In the same year, the total net value of fixed capital of all corporate enterprises in the United States (roughly equivalent to net assets) was 12.9 trillion dollars, total pre-tax corporate profits were 1.4 trillion dollars, and the average pre-tax profit rate for all corporate enterprises was 11.0%. I believe Mr. Zhang would agree that the United States is the global model for a market economy, with the most complete market regulations and the most standardized and fair competitive environment. The World Bank report China 2030, which Mr. Zhang participated in drafting, undoubtedly takes the United States as its ideal model, either explicitly or implicitly. The profit rate of China's state-owned industrial enterprises has exceeded the average level of American enterprises, which proves that the efficiency of China's SOEs is by no means inferior even on a global scale.
The Excessively High Profit Rates of Private Enterprises Stem from Low Social Costs
To fairly evaluate the efficiency of an enterprise, one must comprehensively examine whether the enterprise, in addition to paying various direct financial costs, has also fully paid the various social costs it ought to have paid, and use this as a basis to judge whether competition between enterprises is fair.
Let us analyze in depth whether private and foreign-funded enterprises (FFEs) have fully paid the various social costs they should. In 2010, all state-owned and state-controlled industrial enterprises paid a total of 1.6 trillion yuan in Value Added Tax (VAT) and taxes and surcharges on principal operations, equivalent to 111% of their total profits. All private industrial enterprises paid 7700 billion yuan in the same categories, equivalent to 51% of their total profits. All industrial FFEs (including those from Hong Kong, Macau, and Taiwan) paid 6600 billion yuan, equivalent to only 44% of their total profits.
It is evident that the profits obtained by private and foreign enterprises are more than double those of SOEs, yet their combined tax payments are less than those of the SOEs. This indicates that a significant portion of the ultra-high profits of private and foreign firms likely stems from underpayment of taxes caused by "super-national treatment" [3] and arbitrary tax exemptions granted by local governments, as well as potential tax evasion.
If private industrial enterprises had paid taxes at the same rate as SOEs, they should have paid 1.7 trillion yuan in VAT and surcharges. Compared to the actual amount paid, they underpaid by 910 billion yuan—an amount equivalent to 60% of the total profits of private industrial enterprises that year. After deducting these owed-but-unpaid taxes, the rightful profit of private industrial enterprises would be approximately 600 billion yuan, with an adjusted ROE of 11.5%.
If industrial FFEs (including Hong Kong, Macau, and Taiwan investment) had paid taxes at the same rate as SOEs, they should have paid 1.7 trillion yuan. Compared to the actual amount, they underpaid by approximately 1 trillion yuan, equivalent to 67% of their total profits that year. After deducting these taxes, the rightful profit for FFEs would be approximately 500 billion yuan, with an adjusted ROE of 7.5%.
Because SOEs still retain a portion of the socialist tradition, worker benefits are relatively better and labor laws are executed with relative rigor. Conversely, as is widely known, sweatshops, the brutal exploitation of cheap labor, and the flouting of national labor regulations are widespread among private and foreign enterprises.
In 2010, private industrial enterprises employed 33.12 million people. If private enterprises had paid wages according to the same standards as SOEs, they should have paid 1.2 trillion yuan in total wages; in reality, they paid only 670 billion yuan—an underpayment of 540 billion yuan. This underpayment is equivalent to 36% of the total profits of private industrial enterprises that year.
In 2010, industrial FFEs employed 26.46 million people. If they had paid wages according to SOE standards, they should have paid 960 billion yuan. Assuming FFEs paid the average wage for other units in the manufacturing sector (which likely overestimates the actual wage level in FFEs), they paid only 810 billion yuan—an underpayment of 150 billion yuan, equivalent to 10% of their total profits.
If private and foreign enterprises were to pay taxes and wages according to SOE standards, then in 2010, the total rightful profit of all private industrial enterprises would have been 63 billion yuan, with a rightful ROE of 1.2%. The total rightful profit of all industrial FFEs would have been 340 billion yuan, with a rightful ROE of 5.2%.
Evidently, a significant portion of the ultra-high profits of China's private and foreign enterprises comes from tax underpayment and the brutal exploitation of cheap labor. After deducting the various social costs that private and foreign enterprises ought to have paid, their real rate of return on capital is only 1% to 5%, substantially lower than that of SOEs.
SOEs Are the Real Backbone of China
While creating relatively high economic efficiency on a global scale, China's SOEs have also shouldered a massive amount of social costs that ought to have been borne by private and foreign enterprises. If Mr. Zhang Wenkui and China's mainstream economists persist in their course and mislead the Chinese government into pursuing total "privatization," dismantling and selling off all remaining SOEs—let me ask: at that time, who will bear the various social costs currently carried by the SOEs? Can private and foreign firms afford them?
Facts prove that even a relatively standardized market economy like the United States cannot avoid major economic crises because private enterprises occupy a completely dominant position. If China undergoes total privatization, how can it avoid a major economic crisis? Given that China's various social contradictions are intensifying and its political future is in a delicate state, how can political stability be guaranteed once a major economic crisis erupts?
At that point, private and foreign enterprises will not only fail to pay full taxes to the government but will also continuously pressure the government for tax cuts. The government, having lost the backing of SOEs, will completely lose its economic bargaining power against private and foreign firms. Furthermore, without the shield of the SOEs, the basic rights of a vast number of workers will go unprotected, leaving them to be exploited at will by private and foreign capital. This will lead to widespread social discontent among the laboring masses, resulting in the deterioration of public security in normal times and an uncontrollable situation during extraordinary periods.
If things truly reach that stage, not only will the current political system be impossible to maintain, but even ordinary private and foreign firms will likely find that "when the nest is overturned, no egg stays unbroken" [4]. At that moment, how will Mr. Zhang Wenkui justify his theories?