Beijing needs to be bolder with SOE reform

The government wants to merge state companies in sectors with overcapacity, yet doesn’t want them to cut jobs. It's asking for trouble.

Wholesale industrial reform often leaves blue-collar workers as its biggest victims. Just look at the empty factories and houses across the rust belt US states of Michigan, Illinois, and Ohio. Their decline is a consequence of cross-border trade deals that gave countries that could build better and cheaper cars access to the world’s largest economy.  

China’s government is facing similar problems with its own increasingly redundant heavy industries. Many state-owned enterprises in the iron and steel, coal, cement, and shipbuilding sectors are loss-making and debt-ridden, wallowing in overcapacity after years of government-encouraged, super-charged investment.

Theoretically, Beijing should cut its poorly performing industries back via bankruptcies and consolidation, sacking millions of workers and redirecting them and the bank capital that is freed up into more productive areas.

The government knows this. Yin Weimin, the minister for human resources and social security, told a news conference on February 29 that 1.8 million workers in the coal and steel sectors out of 12 million would likely lose their jobs and that the government will allocate Rmb100 billion ($15.4 billion) over two years to help relocate these workers.

But saying what’s necessary and doing it are two very different things.

China’s communist government has long worried that job losses could cause widespread anger that ends up being directed at the Party itself. These fears have been embodied in a multi-day protest by thousands of Chinese miners at one of the mines of Longmay Coal, an SOE in Heilongjiang province in the northeast of the country. The workers there claim not to have been paid for months, despite provincial governor Lu Hao claiming at the National People’s Congress meeting in early March that Longmay had made all salary payments.

Concerns over such social disharmony appear to be stymieing Beijing’s SOE reform efforts. Xiao Yaqing, the head of the State-owned Assets Supervisory Advisory Commission that oversees many SOEs, told reporters on March 12 that “more mergers mean less bankruptcies and can help us peacefully resolve any disputes”.

That’s not the language of a man poised to smash underperforming companies together and force them to shed unnecessary jobs.

Bad debt boom

The paucity of China's SOE reform to date is already evident.

The largest change to date was the consolidation of China Southern and China Northern Railways -- effectively turning two large monopolies into one huge one. Beijing also intends to squeeze Cosco and China Shipping into one massive, loss-making shipbuilder. Neither reform has involved much discussion of slimming down workforces. 

Without real SOE reform bad loans will continue to pile up. Standard & Poor’s analyst Qiang Lao noted on Wednesday that "it's not clear how SOE reform may improve the operational efficiency of the companies involved."

He believes the banking sector’s non-performing loan ratio will only worsen in the meantime, potentially hitting 3% by year-end versus 1.67% at the end of 2015. Defunct SOE debts are adding to this tally. Add into that the fact so-called special mention loans - or overdue loans that are not yet considered by the banks to be in default - may spiral to 4% or more, and Lao said China's lenders could end up sitting on troubled loans of 7% to 8% by the end of the year. 

Beijing seems resigned to this outcome -- hence the government’s decision to let banks sell portfolios of non-performing loans to investors in asset-backed securities and to allow lenders to take equity positions in indebted companies in exchange for debt relief.

Time for retraining

Sacking millions of workers is no way to make friends. But Beijing needs to conduct such steps to avoid a bad debt explosion among its SOEs and to reorientate its economy from investment and low-end manufacturing and towards services and consumption.

A good start would be for the government to double down on its own admission that workers need to move industries. Instead of propping up zombie SOEs while it seeks to gradually trim workforces, the government should prioritise the creation of state-supported vocational training facilities as soon as possible. It could then shift redundant steelworkers, miners, and shipbuilders to them so they can learn more relevant skills.

Using its capital to create such centres would offer a much more positive return on investment, as workers gain necessary skills in higher-end manufacturing, services, and tourism. China’s budding educational sector could play a vital role too. These companies would likely gain strong investor support were they to need private funding to support them in such efforts.

Additionally, retraining these workers would create more labour supply in parts of the economy that most need it. Doing so would also help to moderate workers’ soaring salary demands, which could reportedly reach an average of 8% this year. That in turn would help to ensure the growth and efficiency of healthier parts of the economy, and underpin China’s efforts to travel up the manufacturing food chain.

Beijing’s willingness to admit that mass redundancies are necessary is a positive step. But it has to conduct them. Rather than drag its feet over such reform, the government could create institutions to offer workers new opportunities. Its people are less likely to riot if they see new jobs opening up, and a way to get them.

For the future of its own people and China's economic health, Beijing should be bolder in its reforms. 

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