More cause for concern
Shang-Jin Wei of Columbia questions the efficiency of the huge amount of capital investment in China that is made by state-owned firms, which account for something less than a third of China’s output, but more than half the corporate lending in China (and how many of their bad loans?).
Is it really possible to invest wisely four out of every ten RMB earned? This concern is especially relevant when it comes to investment by state-owned enterprises. If the investment is not efficient, then the same output could be achieved with less capital, thus freeing resources for other uses, such as raising household consumption or improving profitability and/or the balance sheets of the banks that fund them.
There are a number of a priori reasons for believing that state-owned enterprises may be investing less efficiently than domestic private firms. They are burdened with more administrative interference in terms of restrictions on hiring and firing and on switching product lines in response to changing market conditions. Despite some progress over the years in linking executive pay to performance, managers in these firms often still do not have compensation schemes that encourage efficiency, or discourage overinvestment and “empire building.” Some state-owned enterprises also have weak corporate governance.
The Chinese financial system is dominated by majority or wholly state-owned banks as the figure shows. Such banks may favour lending to state-owned enterprises despite efforts by the authorities to increase the commercial orientation of these banks. For example, while state-owned firms represent a declining share of output (it was about a third in 2005), their borrowing from domestic banks accounts for more than half of the total lending by these banks. Majority state-owned firms also take up the lion’s share of all publicly-traded companies in China’s two stock exchanges…
To see whether state-owned enterprises are systematically less efficient investors, David Dollar and I analysed a data set based on a 2005 survey of 12,400 firms in 120 cities located throughout China. What we found was that ownership did indeed have an impact on the productivity of investments even after more than two decades of corporate reforms. As the chart shows, state-owned firms had the lowest marginal product of capital as measured by the marginal revenue product of capital.
It is perhaps no coincidence that something like 90% of China’s richest people are the children of Communist Party members. As Carsten Holz wrote in the Far East Economic Review and elsewhere: “of the 3,220 Chinese citizens with a personal wealth of 100 million yuan ($13 million) or more, 2,932 are children of high-level cadres. Of the key positions in the five industrial sectors — finance, foreign trade, land development, large-scale engineering and securities — 85% to 90% are held by children of high-level cadres.”