Why China’s SOE reform would always disappoint

An elderly man walks past the People's Bank of China in Beijing on August 12, 2015. China cut the yuan's value against the US dollar for the second consecutive day on August 12, roiling global financial markets and driving expectations the currency could be set for further falls. AFP PHOTO / WANG ZHAO (Photo credit should read WANG ZHAO/AFP/Getty Images)
Photograph by Wang Zhao — AFP/Getty Images

The news that China is pursuing tepid reforms for its massive state-owned companies is deflating to anyone who believed the proclamations from two years ago that China was taking big steps toward economic liberalization under then-new president Xi Jinping.

On Sunday, the government announced reforms allowing SOEs to accept private investors. That was it. There was no talk about replacing managements run by politicians; no discussion about making SOEs accountable to anyone besides the Communist Party, only two years after the Xi government said markets would take a “decisive function in resource allocation.”

The state-controlled press of course spun the weak reforms positively, writing that SOEs would become more robust and move towards fully independent market entities. But that appears unlikely.

While private investors may improve the 115 or so massive conglomerates that comprise China’s state-owned businesses—there are another 80,000 small SOEs scattered around the country that own newspapers and other vestiges of a Soviet-style economy— the core problem facing China’s state sector remains that they always defer to the desires of the Communist Party before market considerations. That remains unresolved and may always be so as long as the Party is in charge.

“In the process of deepening reforms of state-owned enterprises, the leadership of the party can only be strengthened, not weakened,” said Zhang Yi, who runs the commission that oversees Chinese SOEs, the State-Owned Assets Supervision and Administration Commission of the ruling State Council, in a statement.

The Chinese government has never had any intention to give up control of its state-owned sector because they believe that industries important to China’s economic and national security will improve only if they remain completely or largely under government control, according to Michael Pillsbury, author of The Hundred-Year Marathon: China’s Secret Strategy to Replace America as the Global Superpower.

The Defense Department consultant has had a close relationship with China for decades. He worked with the CIA and FBI when Chinese defectors arrived in the U.S. He writes in his book that when Congress voted in the late 1990s to grant permanent normal trade relations with China, which set the stage for its ascension to the World Trade Organization in 2001, the Chinese suppressed their intentions to influence state companies. Part of WTO’s provisions require that governments not influence, directly or indirectly, commercial decisions of their companies, Pillsbury says. “ However, China has not kept this commitment,” he writes. The Party’s influence over SOEs is one example. “They reasoned that if Congress knew that a free market was off the table for the foreseeable future—if not forever—the vote would not pass,” he writes.

Last year I met with an SOE expert named Xuan Xiaowei who works at one of China’s government think tanks close to the country’s ruling cabinet. He explained why Westerners have a difficult time understanding the state-owned businesses. In doing so, he made it clear why Westerners who believe in sweeping SOE reform are far too optimistic. He said three theories have always guided Chinese SOEs: market theory, which we understand in the West; Confucianism, which we don’t and which emphasizes social hierarchy; and Marxism, which we don’t believe in. “An SOE is a tool of government to achieve different goals,” Xuan told me. He said SOEs were setup to function as a big brother to the Chinese working class. They provided safety in their guaranteed lifetime employment. That efficiency suffered as a result was of small consequence.

What Xuan described was what many officials in China believe. To think the companies should function as market-based businesses, as some in the West have, isn’t consistent with Chinese thinking.

It appeared to many back in 2013 that China’s announced economic reforms were primed to really change the country. But following a massive stock market bailout, only incremental loosening of the country’s tightly-controlled currency, and now disappointing SOE reform, that optimism appears to have been misplaced.

Subscribe to Well Adjusted, our newsletter full of simple strategies to work smarter and live better, from the Fortune Well team. Sign up today.