Prof. Fan Gang on private enterprises vis-a-vis SOEs in China

The Chinese economist warns against "reverse mix-ownership reforms" and calls for fostering big private firms.

Fan Gang is President of China Development Institute, one of the officially-highlighted major thinktanks; Professor at the Graduate School of Chinese Academy of Social Sciences; Director of China's National Economic Research Institute (NERI).

Over a decade ago, Fan wrote a monthly column for Project Syndicate. He was a visiting fellow at the National Bureau of Economic Research (NBER) and Harvard University in the United States between 1985 and 1987, before getting a Ph.D. from the Chinese Academy of Social Sciences in 1988.

Fan made a speech at a December 28, 2022, conference hosted by the 中国企业改革与发展研究会 China Enterprise Reform and Development Society and 中国企业改革50人论坛 China Enterprise Reform 50 Forum, both of which are backed by the State-owned Assets Supervision and Administration Commission (SASAC) of the State Council.

In the speech, he highlighted the importance of private enterprises for the market economy. He argues that private enterprises are more independent in their decision-making and better at responding to market signals. This independence allows private enterprises to take risks with their own money and innovate, leading to a stronger ability to take risks and more flexibility compared to state-owned enterprises that are subject to stricter regulations and bureacracy.

Moreover, private enterprises are more likely to develop into century-old brands, while state-owned enterprises are prone to personnel changes. Fan Gang said China is not short of state-owned enterprises (SOEs), but private companies.

Regarding debt restructuring, Fan Gang suggests formulating policies to maintain the private nature of private enterprises and ensure that they even if SOEs took part in the re-organization of indebted private firms. These policies may include establishing funds and restructuring methods to enable private enterprises to achieve debt restructuring while remaining private. He said China’s “mixed-ownership reform” intended to let SOEs have more private participation, not the other way around.

Fan Gang also highlights the importance of preventing monopolies and blind expansion of capital. At the same time, he recognizes the significant role large enterprises play in modernization, including their innovative strength and their ability to drive small and medium-sized enterprises in forming industrial and innovation chains. Therefore, maintaining a balance between private and state-owned enterprises while preventing monopolies and blind expansion is critical for the sustainable development of China's economy.

Below is a full translation of his speech.

Today, I will be discussing two issues. The first issue is the vigorous development of private enterprises. We have state-owned enterprises (SOEs) and private enterprises, which are complementary. We also have the "Two Unswervingly" policy to develop both SOEs and private enterprises. Here, I want to emphasize that we should pay special attention to developing private enterprises. There are many reasons for this. On the one hand, we are not short of SOEs. Our entire economic reform started in an era where SOEs dominated the economy with very few private enterprises.

From a market economy perspective, the more market entities there are, the more real the price signal is, and the easier it is to achieve market efficiency and give full play to the efficiency of market resource allocation.

Each private enterprise is independent. Because SOEs are state-owned, their relationship with the government and other SOEs is relatively less independent, and sometimes can distort the signal. This is a basic point.

Regarding some specific issues, I want to discuss two aspects. To compare private enterprises and SOEs, let's examine the characteristics of private enterprises. There are many points in all aspects. Here, I will discuss two points.

The first is that private enterprises take risks and innovate with their own money. Now, in the context of the "unseen changes in a century," we still have the advantage of being late-movers to learn and import some of the advanced technologies and knowledge. However, with the United States adopting a containment policy against China and cutting off various channels, we need more independent innovation.

Independent innovation involves great risk, a high probability of failure, and a lot of trial and error costs, not only for the technology itself but also for the business model.

In this process, the characteristic of private enterprises is that they take risks with their own money. In SOEs, the system of using public money and state power is more cautious. Therefore, on this issue, SOEs are relatively less flexible, and their ability to take risks is relatively poor.

Private enterprises can initiate ten projects and accept nine failures. If one project succeeds, it could be a significant success, as they may collect all the rewards.

SOEs may also do this, but if nine out of the ten projects fail, who will bear the consequences of the nine failures? It is not to say that SOEs cannot innovate. Many SOEs have strength and capital and can also innovate through long-term research. However, it is relatively difficult to innovate in completely uncharted waters and with great risk.

Therefore, in the context of "unseen changes in a century," we need more independent innovation, and for that, we need to foster private enterprises, especially in the high-tech field and in the forefront of technology. Objectively speaking, we can see that these high-tech industries and enterprises with leading technology in China's economy are all private enterprises. It is also the result of their daring risk-taking, innovation, and development under the conditions of the market economy in the past. We should cherish such achievements. This is the first aspect of why we should develop private enterprises.

The second reason for developing private enterprises is that they are easier to pass on. Relatively speaking, private enterprises are more likely to become century-old companies, which stems from the continuation of a family and its efforts in a certain field. The blood and sweat of several generations of a family make the enterprises more specialized and sophisticated to produce new and unique products. Such sustained and professional investments are needed by many technologies and industries. SOEs are less suitable for this model because the management is easily shuffled. Executives of SOEs are replaced when they reach retirement age. Such personnel changes make some ideas and styles difficult to pass on, causing difficulties for enterprises to specialize in a particular area in the long run.

Private enterprises, on the other hand, are less likely to face similar problems. Private entrepreneurs can not only persist in a certain business themselves, but can also let their offspring inherit the business. In foreign countries, most of the SRDI (Specialized, Refined, Differential, Innovation) companies and "hidden champions" (SMEs with a large share of a niche domestic or international market due to their unique technology in the niche market but with low visibility) are family enterprises with hundreds of years of inheritance. We should make good use of the characteristics of this so that our specialized and sophisticated enterprises can develop in the long run and enrich the industrial chain. This way, we can gradually make up for the shortcomings and avoid being “choked” on technology. We need to take this matter seriously.

To foster private enterprises, we need to put forward specific policies to solve existing problems. Some private enterprises are facing difficulties and need some sort of bailout. As a result, some financially capable SOEs restructured the private enterprises.

However, after the restructuring, the original private enterprises would probably be included as part of the SOEs because the SOEs are now a significant shareholder of the private enterprise and may want to run the private enterprises as SOEs. We call it reverse-mixed ownership reform.

Originally, the mixed ownership reform was designed to integrate private elements into the system of SOEs. But once that is reversed, the characteristics of private enterprises would disappear. Again, there is no shortage of SOEs in China, but there is a shortage of private enterprises in a certain sense. Therefore, we should maintain the unique nature of private enterprises.

In light of the bailout efforts, we should consider implementing certain policies, such as establishing funds and using restructuring methods to facilitate debt restructuring. Once debt restructuring is achieved, these companies should be reintroduced to the market as private enterprises, maintaining their status as such and continuing to develop in the market.

This approach should be favored over allowing them to become SOEs, as some regions have unfortunately experienced. While some areas have been able to circumvent this issue with local regulations, it is crucial that we take measures to prevent the gradual disappearance of the characteristics of private enterprises in the process of SOE expansion.

To address this issue, it's not just about having a general direction. On specific issues, I only talked about one specific problem. There are still many other specific problems that need to be analyzed in a concrete way, and specific policies need to be formulated to ensure that the “Two Unswervingly” are truly implemented in all aspects.

That was what I want to talk about firstly, namely vigorously developing private enterprises. My second point is to vigorously foster large enterprises. We currently attach great importance to the development of small and medium-sized enterprises, which is appropriate, especially during the pandemic when economic growth is slowing down and there are many livelihood issues. We have adopted some policies to encourage and support the development of small and medium-sized enterprises, which is beneficial for social stability and our innovative development. Among these small and medium-sized enterprises, we are nurturing a large number of competitive enterprises with future potential, which is deserving.

On the other hand, we also need to pay special attention to the development of large enterprises. In some industries, some large enterprises expand blindly after they become big, which is a problem. After large enterprises take shape, it is easy to form a monopoly, which requires supervision to prevent. At the same time, we must recognize that the ultimate strength of an economy depends on how many large enterprises it has. The strength of an industry ultimately depends on how many powerful, large enterprises it has in this industry and in international competition.

It is reasonable that everyone is now striving to be in the top 500. Only by being strong can you continue to develop and stand firm in various industries and have international competitiveness. On this issue, we need to be very clear that we need to oppose monopoly and prevent capital from expanding blindly. At the same time, we also need to see the special role that large enterprises play in the process of development and modernization.

What is the role of large enterprises? First, large enterprises are more likely to have the resources for innovation. As we know, in some developed countries, it's rare for certain industries to have a large number of small enterprises. Instead, there are usually only two or three companies, which is called oligopolistic competition.

What is the difference between oligopolistic competition and competition among millions of small enterprises? That is, the latter leads to the lowest prices. In some industries with millions of small businesses competing, the main way to compete is to cut prices, which can benefit consumers by providing them with the lowest prices.

However, in this situation, because the profit margins of businesses are very low, it is difficult for these companies to have the funds and resources to innovate and conduct research and development. Therefore, in this situation, although consumers may benefit from low prices, they cannot enjoy the benefits of innovation.

Innovation in various products, functional innovation, and other types of innovation can all provide consumers with greater benefits. The advantages of oligopolistic competition are that, on the one hand, it prevents prices from being too high. On the other hand, it does not require prices to be pushed too low, which means that companies can make higher profits and have the ability, funds, and resources to engage in innovation and R&D. Therefore, some economists recently argue that the best internal structure for an industry is not a perfect competition but oligopolistic competition. This is where companies can become larger.

The second point is that large enterprises can drive the formation of industry chains and innovation chains with a large number of small and medium-sized enterprises in their own innovation processes. An invention cannot be completed by a single enterprise alone. Instead, it requires millions of small enterprises to innovate in many small technologies and then cooperate with or purchase from large enterprises to form an innovation chain and industry chain. Only large enterprises that have made progress in these major technological innovation activities and significant investments can drive the development of a large number of small and medium-sized enterprises to achieve the development of an innovation chain. Therefore, from this perspective, we need to develop a good innovation ecosystem, which requires the mutually beneficial development of large and small enterprises.

In these aspects, we also need to implement strategies for fostering large enterprises. Let me address a few specific issues.

The first issue is that we should treat large, medium, and small enterprises equally in terms of rules and regulations. Although large enterprises need to pay special attention to anti-monopoly regulations, overall, we should encourage the development of large enterprises and treat them equally to small enterprises. For example, if small enterprises need financing through an IPO, large enterprises also need to go public for financing.

Secondly, we should view the development of large enterprises as a part of the country's international competitiveness and have an international perspective when looking at these large enterprises. Some large enterprises may appear to be very large domestically, but globally, big companies are still relatively few. For example, some of our current technology companies, in terms of their revenue from outside China, account for only a small fraction of global revenue from consumers. China needs to encourage their growth from the perspective of national competitiveness.

Thirdly, the appropriate proportion of large and small enterprises is an issue that can be found in every industry. As mentioned earlier, from the perspective of the rationality of the internal structure of an industry, the competition among millions of small enterprises may not be good. We need to gradually improve the concentration and have some powerful, large enterprises.

How does this process come about? This process should not be regulated by the government, and the government should not dictate winners. Rather, it should be achieved gradually through cycles of economic fluctuations, various competitions, and mergers and acquisitions.

In this process, on the one hand, we encourage enterprises to view mergers and acquisitions positively. For good enterprises, mergers and acquisitions are a low-cost expansion, and for weaker enterprises, they are a rebirth from which their original investments can be used in the new enterprise after the mergers and acquisitions, which is not simply a matter of bankruptcy and closure.

At the market level, we can actively encourage some equity investment funds to help enterprises carry out mergers and acquisitions. Many equity investment funds in the world are not involved in developing innovative enterprises but rather in mergers and acquisitions, which is a very important link in the development of industries and large enterprises.

Through further reform and opening up, and the development of our market economy, including the development of capital markets and financial markets, we can create a better environment for policy implementation and enterprise development, so that a large number of internationally competitive enterprises can truly develop, further grow, and become stronger. Only then can China's economy become stronger internationally, achieve high-quality development, and realize the Chinese path to modernization. （Enditem）