Chinas capitalist state needs its just reward

Updated: Apr 30 2006, 05:30am hrs
Chinas state-owned enterprises had a combined profit of 628 billion yuan ($78 billion) last year, slightly more than General Electric Co has earned in all of the past five years combined.

While GE shareholders received about $40 billion, or 52% of the companys total earnings, as dividends, the Chinese government got a big zero.

Last year was no fluke. Since 1994, state-owned enterprises affiliated with the federal government havent paid any dividends even though many of them have benefited handsomely from Chinas emergence as a manufacturing powerhouse.

This no-dividend strategy is being pursued not only by the 169 federally-controlled companies, whose profit rose almost 28% last year, but also by most of the 138,000 enterprises administered by provincial and municipal governments.

In a nutshell, the state in China isnt getting a return on the capital that it has deployed to provide jobs for some 43 million people. This is damping Chinas aspiration to realign the focus of economic growth from exports and investments to domestic consumption.

When the majority shareholder doesnt have to be paid a share of the profit, it becomes a lot easier for managers to reward themselves with excessive corporate perks.

Within-firm allocation of capital does not receive the same scrutiny as channeling it via the financial sector, the World Banks China office noted in its recent quarterly update on the economy.

A captive source of money also leads to serious macroeconomic distortions. Take, for example, the governments plan to discourage the building of another wholly-nnecessary steel plant amid a nationwide glut. A government diktat to banks asking them not to finance such a project wont have the intended effect as long as managers in state-controlled firms decide to build the plant anyway with internal accruals.

As Raghuram Rajan, the chief economist at the International Monetary Fund in Washington, pointed out in a speech in November, it is unlikely the chairman of a state-owned corporation will prefer to return cash to the state via dividends rather than retaining it in the firm, particularly when banks are under orders to restrain credit growth.

State-owned company profits represented 3.3% of Chinas gross domestic product and 20% of the governments fiscal revenue last year, according to the World Bank. Getting some of the money out of corporate treasuries and into the governments coffers will be a key plank of what economists have identified as the most-populous countrys biggest challenge -- a rebalancing of its growth model.

For the past 27 years, Chinas remarkable growth story has been built largely on a foundation of resource mobilization -- powered by the recycling of a huge reservoir of domestic saving into exports and investment-led growth, Morgan Stanley Chief Economist Stephen Roach said in an April 24 report. This strategy has now outlived its usefulness.

Investment threatens to exceed 50% of Chinas GDP, from about 45% in 2005, he said. In their earlier heydays of economic development, this ratio never got much above the low-40% range in either Japan or South Korea, Roach said.

Chinas recently enacted 11th Five-Year Plan aims to improve the quality of economic growth by paying more attention to the environment, which has been severely damaged by reckless exploitation, and to the inequitable distribution of income.

A clear dividend policy would go a long way toward bringing about the desired rebalancing of the economy.

Probably the most effective way to change the composition of demand towards consumption is to move ahead on a dividend policy for state-owned enterprises and to ensure that the revenues go through the overall budgeting process, so that they can finance reforms in education, health and social security, the World Bank said in its quarterly report.