Can China's Communists Really Be Good Capitalists?

(Bloomberg View) -- As it heads into a major leadership transition, China is attempting a strange breed of corporate reform. Rather than privatizing state-owned enterprises outright, the government is testing whether selling minority stakes to private investors may improve their performance. Meanwhile, state companies are busy revising their governing laws to give the Communist Party more control over management. The goals of these clauses include ensuring that apparatchiks hold greater sway over key corporate decisions and, according to a recent article in a Communist Party-run newspaper, “creating more returns for shareholders.”

QuickTake China's Market Meddling

Karl Marx must be spinning in his grave. Communist parties were meant to overthrow capitalists, not help them get rich. But China's leaders haven't paid much attention to their supposed spiritual guru for quite some time. Instead, they're hoping to prove that political direction can improve corporate competitiveness as well as the market can.

Most observers, especially those outside of China, would say they're deluding themselves. Fixing China's bloated, inefficient state sector, economists generally believe, requires less officious oversight, not more.

There's an argument for resisting this knee-jerk reaction, however. First, China's Communist Party, which carefully grooms and trains the country's best and brightest for national service, does have a reasonable track record of developing talent. This is the group, after all, that has steered China's economy quite successfully over the past three decades. While one can debate how much credit bureaucrats can claim for that performance, at least we shouldn't be too quick to dismiss the managerial capabilities of Party members.

More importantly, it matters far less who sits in the corner office than the environment that surrounds them. The main problem with China's state sector is the fact that the government spoon-feeds them subsidies, encourages state banks to provide cheap loans and roll over soured debts and protects them from competition. The coddling eliminates most of the incentives that might actually encourage them to prune unprofitable businesses, rationalize their workforces and generally bolster competitiveness. Little wonder that they aren't nearly as profitable as private firms in China.

Party overseers might be able to ferret out some corruption and scare company managers into operating a little more diligently. But unless the government cuts off subsidies and forces these firms to stop using state banks as ATM machines, they'll continue to waste money. Unless exposed to real competition -- both from foreign and private Chinese companies -- and the threat of bankruptcy, they'll never innovate. Forced to stand on their own, by contrast, any managers -- whether from the Party or the private sector -- would be compelled to improve productivity, product and service quality. That's the only way to increase shareholder value.

Other countries provide some evidence that such reforms can work. Singapore, for instance, boasts some highly competitive state-linked firms, such as Singapore Airlines, because their government overlords force them to act as profit-seeking corporations, not job banks.

South Korea also offers a comparison. The giant conglomerates that dominate the economy there, called chaebol, have been run by founding families, not the state. But historically, they were treated much like state-owned companies -- protected from competition and able to tap almost unlimited capital.

When that changed during the 1997 Asian financial crisis, so did the fortunes of the chaebol. As many of them collapsed and, with them, the assumption the chaebol were “too big to fail,” money began flowing more rationally. Though for the most part management didn't change very much, company performance did. The rise of Korea's biggest brands to global prominence can be traced back to the years after the crisis, when the chaebol were finally compelled to compete on their own merits.

In theory, this is the direction in which China plans to head. In a 2013 plenum, the Communist Party pledged to allow the private sector and market forces a larger role in the economy, while maintaining levels of state ownership. The question economists and investors should be asking then is whether or not the party will follow through on its promise. After four years, certainly, the financial system hasn't been opened up sufficiently to break the IV drip that sustains the state sector, nor have markets been pried open.

What matters as well is how the Communists intend on wielding their new corporate influence. If party members and managers at state-owned firms are permitted to run their companies with independence, aiming for greater productivity, transparency and profitability, perhaps they have a chance of successfully reforming them. But if party officials simply become conduits for diktats from the top, aimed at pursuing the goals of policymakers rather than shareholders, these companies will remain stumbling behemoths and a drag on economic progress.

That's a lot of ifs. Perhaps in the end, China's Communists will forge a newfangled type of corporate governance that departs from traditional Western models. To get there, however, they can't ignore the market.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Michael Schuman is a journalist based in Beijing and author of "Confucius: And the World He Created."

To contact the author of this story: Michael Schuman at contactschuman@gmail.com.

To contact the editor responsible for this story: Nisid Hajari at nhajari@bloomberg.net.

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