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Margaret Cornish explains why Canada has nothing to fear from the state in Chinese SOEs.

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23 February, 2012
By: Margaret Cornish

In the wake of Prime Minister Stephen Harper’s trip to China and recent talk about the growing economic importance of state capitalism (including our own series on the topic), OpenCanada talked to Margaret Cornish, author of the new report Behaviour of Chinese SOEs, about this perceived clash between unfettered and fettered capitalism and what Canada should do about it.

Is the trend toward “state capitalism” tightly linked to the rise of emerging economies?

Once they get big enough to compete internationally, firms from G20 emerging markets face an intensely competitive international trading and investment environment dominated by global giants. States do seek to give leading domestic companies a boost during this globalization process. This is generally true whether or not the firms are state-owned. Two thirds of the Fortune 500 companies from emerging economies have some level of state ownership. In my comments, I am going to address Chinese state-owned enterprises (SOEs).

In the Jan. 21 issue of The Economist, Adrian Wooldridge refers to “state capitalism” as economies in which corporations are partly owned, and fully controlled, by the state. These state-owned enterprises are alleged to be captured by the elites and serve the purposes of the elite or the party, depending on the country. Due to the pervasive influence of politicians, these firms are characterized by micro-management, cronyism, loss-making, low productivity, corruption, and an inability to innovate.

To begin with, we need to recognize that the economic diversity and scale of institutions and companies in China is difficult to grasp. At any given moment across a range of situations, statements can be both true and not true. These sweeping generalizations are not completely inaccurate, but they are missing the detail and context necessary to make sense of what is going on. While it is certainly possible to find instances of the above features of “state capitalism,” in my view, the converse is closer to reality. If micromanagement, cronyism, etc. were the defining features of Chinese SOEs, it would be difficult to account for their success.

The 121 nationally supervised SOEs are profit-driven to their core, and widely understood in China to be the most competitive and best-managed of China’s companies. If the state has a goal, it is for SOEs (and entrepreneurial firms) to globalize rapidly and compete head-to-head with global competitors in international markets. SASAC evaluation criteria are overwhelmingly financial, and financial performance drives executive compensation. The executive suite is made up of a party-appointed chairman and other executives drawn from within the SOE. These party-appointed leaders move from one SOE to another, with the majority of them carrying the rank of minister. Their career mobility lies in the corporate vision and leadership qualities they bring to bear at a succession of SOEs.

Allowing the market to decide [has been] the fundamental principle driving growth in China over the past three decades. The power of the market to decide winners is so internalized that Chinese executives express a certain bafflement that the government or party would have the time or inclination to direct SOE decision-making and strategy. SOEs are pushed to compete [against each other, domestically, and] internationally against the major rivals in their field. Neither the bureaucracy nor the party seeks to micromanage how that is done in detail.

Deng Xiaoping’s advice at the beginning of reform was, “study what the West has to teach us.”  For the past 40 years, Chinese students, government officials, and business people have consciously set out to learn from the West – in many sectors, there is now a sense that China has achieved international standards and may be improving on that. The pattern has been to study many sources, synthesize them, and adapt [the ideas] to their own system. Innovation is now identified as a key requirement for a sustainable society. We will see whether a generation of learning, synthesizing, and adapting is an effective foundation for innovation. Chinese strengths include a long decision horizon, planning, and effective co-ordination of resources. China educates more engineers each year than we have in total. Although the emphasis on innovation is recent and there is thus little to go on, it would be overconfident, to say the least, to assume that SOEs won’t be contributors to innovation. Entrepreneurial firms will no doubt be innovative as well.  

SOEs are starting to invest globally – including in Canada. Should Canada treat these companies differently than it does typical foreign investors? What threat do they pose to Canada?

Like many other countries, Canada has laws governing major foreign investment by foreign companies. The Investment Canada Act focuses on acquisitions for control of an existing Canadian company in its effort to ensure that foreign investment brings net benefit to Canada.  The SOE Guidelines include more detailed provisions to deal with applications by companies owned by foreign states. As I note in my paper, the publicly listed arms of these SOEs are subject to the rigorous financial reporting, transparency, and governance requirements of the New York, London, and Hong Kong stock exchanges. As I understand it, proposed investments in Canada by these listed arms are not generally subject to additional governance requirements. When the non-listed arms seek to invest, I think undertakings on these points are apt to ensure an appropriate level of transparency and Canadian governance is maintained.

There is an ongoing undercurrent in the debate on Chinese investment suggesting that China is a potential rival to the supremacy of the United States and the West in general, and that its SOEs may therefore behave in hostile ways. Let us take the concern that in a period of global scarcity of a commodity, the Chinese state might order SOEs to ship produce from Canada to China at prices below the prevailing price in Canada. Canadian transfer pricing rules and administration are designed specifically to prevent exports at below-market prices. Another fear expressed is that the Chinese state might push an SOE to somehow disadvantage a Canadian market or a Canadian company for whatever reason. Again, Canadian competition and other laws are in place to discipline any such move. In short, Canada has the necessary laws and enforcement capability to protect our interests.

It is worth noting that such behaviour would be contrary to the SOE corporate interest. It would put at risk corporate and financial integrity by undermining the good name and relationships that take decades to establish. These companies are contending for global position and leadership. Such a move would directly damage the entire web of commercial relationships, to say nothing of lawsuits, security investigations, etc.
There are parallels between the suspicion and resistance that Chinese firms sometimes meet in OECD countries and the reaction to overseas investment by Japanese manufacturers in the 1980s.  The Japanese focused on establishing strong relationships with local communities, spreading the economic benefits of their businesses. This is the best means to dispel cultural misunderstandings.

Collaborating with Chinese firms, accessing their supply chains, and connecting with their management networks are all sources of potential advantage to Canadian firms in dealing with Chinese SOEs and other investors in Canada. Canada is short on capital to develop not just its natural resources, but also its technologies and human resources. Our great strength is the diversified nature of investment from overseas.  
China may well be moving from high growth (GDP growth of 10 per cent over 30 years) to something somewhat slower. Society and government are in rapid transition. The Investment Canada Bureau within Industry Canada (which implements the Investment Canada Act) has the tools to achieve net benefit for Canada. In recent years, the Investment Canada Bureau has demonstrated its intention to challenge foreign companies that do not fulfill agreed undertakings.

The economic rise of East Asia carries both threats and opportunities for Canada. The economic shift has already occurred – the issue is how we adapt to it. Trade and investment with China is just one element. The principal insight of liberal capitalism is that markets will allocate resources more efficiently than governments. China’s admittedly unique development model doesn’t challenge that core thesis. Theirs is an intensely competitive economy and society. 

There can be little doubt about the rise in Asian energy consumption with its attendant purchasing and investment power. The International Energy Agency, which has been closely following Chinese energy SOEs for over a decade, notes that they were both substantially independent of the state and driven by the imperative to compete successfully with their global rivals.

How do you evaluate Prime Minister Stephen Harper’s trip to China, and the deals he signed there?

Prime Minister Harper did sign many deals – the uranium [deal], FIPA, the renewal of the energy framework, various agricultural commodity agreements – all very helpful both to Canada and the Canadian business community. Harper also witnessed the signing of many private-sector deals. These occasions assist companies to bring negotiations to a conclusion and get needed coverage in China and Canada for their deals. There was considerable press coverage in China. Strong relationships at the top leadership and ministerial level are important to all bilateral relationships, but especially in China. To make the most of the business, social, and cultural relationships, these have to be cultivated and developed over time. To gain credibility in China, Canadian government and business both need to work on concrete initiatives that carry through with the intent of [establishing] broad government-to-government agreements.

Does the rise of state capitalism necessarily mean the decline of countries that relied on liberal capitalism to triumph? 

My research suggests that behaviours described as typical of “state capitalism” are far from characteristic of Chinese SOEs. If Chinese SOEs did suffer from rampant micro-management by the state (or party), non-commercial orientation, loss-making, poor productivity, and corruption, then western companies wouldn’t have much to worry about. Unfortunately, that is not the case.

We are in the midst of a change in global economic power with the states of East Asia (not just China) and other G20 emerging markets taking a greater role. Changes in relative power are unsettling, but it is hard to see what is gained by mischaracterization of the competitors. A response based on clear-sighted understanding rather than half-truths will take us further in the long run.

China spent the last 30 years learning and adapting to western technology and management.  Other emerging-market economies have done the same with varying forms of support from the state. They all have legitimate global economic interests to pursue. The “state capitalism” mindset seems to assume that the status quo prior to their rise is somehow superior to what might evolve as the interests of a wider range of countries are brought to bear. Multilateral institutions are likely to be the best defence of the international trading and investment system created by liberal capitalism. China is generally regarded as an active and compliant participant. 

With respect to energy and the global shift in supply and demand, Canada needs to consider a global energy strategy – not a continental one. We need to recognize the rise of Asian energy consumption (China, Japan, South Korea, etc.) and diversify our customer base. Prime Minister Harper’s recent trip to China, and the parallel initiatives of Natural Resources Minister Joe Oliver, suggests a growing grasp of the momentous global changes of which Canada and China are a part.

The development of Canada’s natural resources represents the lion’s share of our recurring exports and hence an important source, not the scourge, of our standard of living in an intensely competitive world.

Photo courtesy of Reuters

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