SOE Megamergers Signal New Direction in China’s Economic Policy



Sean O'Connor

Under Chinese President and General Secretary of the Chinese Communist Party (CCP) Xi Jinping, the Chinese government is revamping its state sector via a series of “megamergers” (the joining of two or more firms worth billions of dollars) as it seeks to consolidate state control in strategic sectors of the economy. To evaluate the impact of large-scale state-owned enterprise (SOE) mergers for both China’s economic growth and the international competitive landscape, this report seeks to address three questions:

1) How do megamergers fit into the context of China’s previous SOE reform efforts?

2) Why is China merging its largest central SOEs?

3) What are the implications of Chinese SOE megamergers (and, more broadly, Chinese government control over the economy) for the global competitive landscape?

How do megamergers fit into the context of China’s previous SOE reform efforts?

China’s restructuring of SOEs began in 1978 with Deng Xiaoping’s initiation of market-oriented economic reforms. SOE reforms in the 1980s were characterized by changes to management and profit sharing systems, followed by consolidation and privatization in the 1990s when many small and inefficient SOEs were closed, merged, or sold. At the same time, the government began building a group of large industrial SOEs concentrated in critical sectors of the economy which it saw as essential for national security and economic development. In the 1990s and 2000s, these reforms gave way to a series of measures aimed at promoting competition among SOEs. However, these measures largely failed to produce more efficient state-owned businesses and led to increased state control.

Why is China merging its largest central SOEs?

For the Chinese government, the economic aims of megamergers are twofold: first, they seek to improve firms’ performance by cutting excess industrial capacity, minimizing competition among SOEs in China, and increasing economies of scale (thereby lowering prices); and second, they attempt to create larger, more competitive “national champions,” which can compete internationally due to increased size and market share. Through these efforts, the Chinese government seeks to reduce debt and improve the efficiency of its state sector.

However, efforts to incentivize more efficient SOE operations have not been sufficient for reducing debt levels. Chinese banking officials and foreign economists alike warn that high debt levels may pose a systemic risk to the country’s banks and to the health of the broader economy. Over the past five years, SOEs’ returns and profit margins have steadily declined, forcing them to become increasingly reliant on government loans and subsidies to remain viable. SOE mergers have failed to address these challenges, offering only temporary debt relief through the consolidation of SOE assets and elimination of intra-state competition.

Beijing’s pursuit of SOE consolidation is in line with efforts to enhance its control over state firms operating in strategic sectors of the economy. As China’s General Office of the Communist Party stated in September 2015, SOE reform has reached a critical juncture where “Communist Party leadership can only be strengthened, it cannot be weakened.” 1 Despite recent policies—including the promotion of a “mixed-ownership” SOE model—that policymakers in Beijing claim will reduce the role of the state in the economy, it is unlikely the Chinese government will take any meaningful steps to relinquish control over economic decision making.

What are the implications of Chinese SOE megamergers for the global competitive landscape?

SOE megamergers threaten to undermine the global competitiveness of U.S. businesses and other foreign firms operating in accordance with market principles. The Chinese government’s efforts to merge large SOEs in critical sectors are increasing SOEs’ share of the domestic economy, enhancing their international competitiveness, and deepening concerns about unfair competition in China and overseas. Government support enables Chinese SOEs to offer products far below market prices, shutting out foreign firms—particularly small- and medium-sized foreign firms—from designated sectors. As a result, the global competitive landscape could quickly become dominated by a shrinking number of firms. Global economic governance is at a crossroads to determine how massive mergers and acquisitions (M&As), particularly involving state-owned corporations, should be regulated to maintain free and fair economic growth and development.

SOE Megamergers

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The staff research report was originally posted here.