# Box 1: SOE Reform in China

China launched a major economic reform and liberalization program in the late 1970s that transformed the productivity of the Chinese economy. China's approach to ownership change in industrial firms has evolved slowly and in a piecemeal fashion over the past twenty years; but its reform of ownership in agriculture took place early in the reform process, and was more widespread and swifter in pace. Starting in 1978, government allowed the previously collectivized farmers to retain and sell more and more of their production in increasingly free markets. By the early 1980s, all farmland was "de-collectivized," and allocated to family units, a massive privatization, or re-privatization, process affecting 800- million people. Not all prices were immediately fully freed, the state retained a role in marketing and credit at least until the early 1990s, and one could not freely buy and sell the land allocated. These reforms were revolutionary, affecting the lives of a populous sector, still-in 1978-accounting for 71 percent of employment in China.

SOE productivity in the industrial sector was increased by gradually freeing prices and decentralizing economic decision-making. At the same time, government created forms of industrial ownership, particularly at the subnational level, that successfully combined elements of collective and private property. Latterly, new private entry and foreign direct investment were permitted. All of this proved efficacious and changed China's economic landscape. In 1998, the non-state sector (including private agriculture) accounted for 62 percent of GDP, while the share of SOEs in industrial output declined from 78 percent in 1978 to 28 percent in 1999.

Since 1987, there have been numerous privatizations of small collectively owned township and village enterprises, and further experimentation with ownership forms at the local level. Small privatizations created managementemployee buyouts, known as "joint stock cooperatives": Many of the resulting entities were saddled with heavy debt burdens, excessive employment, and social obligations, and were thus non-viable; in 1995, 72 percent of such firms were in the red. In the mid-1990s, government tried to improve their performance by creating limited liability companies giving managers a larger stake (so as to hold them accountable) and through sales, mergers, and takeovers of SOEs by private firms. Implementation of the Bankruptcy Law also led to some 3,400 SOE bankruptcies since 1996. But few outright sales of medium or large SOEs were allowed.

In the last few years, as long-simmering pressures on the banking system have grown acute, the government has announced its intent to clean up and privatize large SOEs. Many such firms carved out their better assets to set up new companies for initial public offerings on the stock market in which they became the largest controlling shareholder. There has been some dilution of shares over time, but mostly to other state entities with the majority of shares still remaining in state hands. While less concentrated ownership has led to private takeovers in some cases, full privatization continues to, move at a slow pace. Most Chinese SOEs being overstaffed and heavily burdened with social welfare responsibilities, authorities are reluctant to take steps that would result in large layoffs, add to unemployment, and perhaps provoke social tension. They do not wish to move in the absence of severance and retirement packages, unemployment insurance schemes and training programs. These take time to build. In the interim, for the largest firms-both in terms of turnover and employees-the Chinese continue to search for mid-way mechanisms that will raise profitability and efficiency without full privatization. Their own experience to date, and the experience of many other countries that followed a similar path, suggests that it will not reap the full benefits from SQE reform unless it limits the state's role in their operations. Economic reforms coupled with privatization would lead to even-greater-performance improvements.

While China's SOE problems grow increasingly acute (badloans of'SOEs are, crippling the commercial banks), many countries in transition or elsewhere" would welcome themz-if'they could.be.assured that they would-be accompanied by the country's impressive growth and,production record. The Chinese experience shows the importance and utility of policy pragmatism, and the maintenance of a capacity within the state-to formulate and enforce the policies chosen.

Source: Nolan, 1995; International Finance Corporation, 2000; Zhang, 2001.