It takes a China

In this FT article, Geoff Dyer and  Richard McGregor writes about “an experiment in capitalism that could challenge much of the conventional wisdom about state ownership” (what convention???)

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China’s champions: Why state ownership is no longer proving a dead hand
By Geoff Dyer and Richard McGregorPublished: March 16 2008 17:58 | Last updated: March 16 2008 17:58When the Aluminium Corporation of China acquired a 9 per cent stake in Rio Tinto last month, the Chinese state-owned company pulled off a number of firsts. Not only was it the biggest ever overseas investment by a Chinese group, it was also the largest ever dawn raid on the London stock market.

Yet while most of the attention focused on what the share purchase meant for BHP Billiton’s efforts to acquire Rio Tinto, the acquisition heralded another important trend – the quiet revolution under way in the Chinese state sector, which has produced a new generation of confident companies with global ambitions.

A decade ago, China’s state-owned sector looked like an economic disaster waiting to happen. In the aftermath of the 1997 Asian financial crisis, average profit margins in Chinese state companies fell to close to zero, and many reported huge losses. The government felt it had no option but to embark on a brutal programme of closures that left tens of millions without jobs.

Fast-forward 10 years and the situation is almost unrecognisable. In 2007, the combined profit of the 150 or so companies controlled by the central government is expected to have reached Rmb1,000bn (£70bn, $140bn, €90bn). In the five years to 2008, this figure rose by 223 per cent. At the end of last year, the list of the world’s 10 most valuable companies contained four groups controlled by the Chinese state – even if this partly reflected the relatively high valuation of the Shanghai stock market.

What we are witnessing, in other words, is an experiment in capitalism that could challenge much of the conventional wisdom about state ownership. Plenty of countries have strong state-owned companies in semi-monopolies such as telecommunications or heavily regulated sectors such as energy and mining. Yet China is trying to create a series of leading public companies in industries exposed to cut-throat competition, where technology, design and marketing are crucial features – just the sort in which state-owned companies have typically suffered at the hands of private rivals.

At a time of growing discussion about whether there is a genuine “China model” for economic development that involves a much bigger role for the state, the fate of China’s public companies could help change the terms of the debate.

One of the most interesting tests will be in the car industry. Chinese companies have startled the auto industry over the past three years by grabbing a 26 per cent share of one of the most competitive markets in the world – which is also now the second-largest. The company with the fifth-biggest brand in the local market – ahead of Nissan, Ford and Hyundai – is the state-owned Chery Automobile.

Based in Anhui, a poor province inland from Shanghai, Chery has benefited greatly from local government assistance in terms of access to financing and land purchases. Critics also claim that the company cut a few corners in its earlier years – its highly successful QQ micro-car was very similar to General Motors’ Chevrolet Spark.

But Chery has also proved skilful at marketing, for example using the internet to create buzz among young car-buyers, and has displayed a ruthless control of costs – neither of which are traditional attributes of state companies. Industry executives have also been impressed by the heavy investment the company has made to boost its engineering capabilities, which will be vital if it is to compete overseas. “Chery looks, feels and has the DNA of a private company,” says Michael Dunne, managing director of consultants JD Power in Shanghai.

State-owned enterprises – often known by the initials SOE – are making their mark in a string of other industries where there is plenty of competition and companies need both capital and a technological edge.

China is awash with private investment in steel, but the industry leader and most technologically advanced steelmaker in the country is the state-owned Baosteel. Chinalco, another SOE, has rapidly become one of the world’s leading producers of aluminium and alumina and is developing plans to become a diversified metals multinational.

Shanghai Electric, meanwhile, is increasingly taking on Japan’s Mitsubishi and Marubeni in bidding to build new coal-fired power plants around Asia. China’s two state-owned shipbuilding giants, China Shipbuilding Industry Corporation and China State Shipbuilding Corporation, are expanding rapidly and beginning to catch up with their Korean and Japanese competitors in terms of technology.

Some of the sector’s improvements reflect reforms the government has pushed on the state sector. Many SOEs have listed at least part of their shares, exposing them to at least some shareholder influence. Executives’ compensation is linked ever more to performance rather than bureaucratic formulas.

“SOEs are increasingly competitive in attracting top executive talent,” says David Michael, head of Boston Consulting Group’s China office. “There are a number of local Chinese managers of multinationals or private sector companies who have gone to work in the state sector.”

Several SOEs have taken on foreign strategic investors in recent years and some have multinational executives on their boards. These relationships have not been without tensions, but they have helped to sharpen performance.

The government has attempted to ensure that those state-owned companies competing globally are competitive at home. Chinalco’s acquisition of shares in Rio was approved by a government agency only after it had pitched its case against other SOEs, including Baosteel and Shenhua, China’s biggest coal company and the world’s second-largest.

There also have been increasing signs that China’s SOEs are learning the skills of corporate finance. Chinalco’s snap purchase of Rio Tinto stock was one example; another has been the ongoing tussle between China’s two biggest airlines, Air China and China Eastern, which could turn out to be the first public takeover battle between SOEs.

Last year, Singapore Airlines agreed to buy a 15.7 per cent stake in China Eastern, which is still controlled by the government but has listed minority stakes in both Shanghai and Hong Kong. The Chinese government gave its approval.

Yet Air China had other ideas, because it wanted to join forces itself with China Eastern to create a national champion. The company started to criticise the deal in public and lobby China Eastern’s shareholders to vote against it. “Everywhere we went, it seemed as if Air China had been there the day before,” says Li Fenghua, chairman of China Eastern. Sure enough, investors rejected the deal after Air China promised to make a higher bid. China Eastern has so far rebuffed Air China’s offer.
Large SOEs in China have always fought tough battles over strategy. But what has been different about the China Eastern situation is that a lot of the debate has been in public – and that Air China has gained an upper hand by offering more money to investors rather than winning a backroom political deal.

Such reforms only explain part of the success of some SOEs. According to Andrew Grant, head of McKinsey’s China practice, many of the successful companies in China have what he calls a “hybrid” structure, mixing features of private and state companies. The best SOEs gain financial firepower from their state parents but have sufficient independence to be managed like private companies. Likewise, some of the most successful privately run groups, such as telecommunications equipment maker Huawei and PC manufacturer Lenovo, have been helped by their close ties to government. “You are starting to see the development of a really interesting dynamic in the state sector,” says Mr Grant. “It is not the case that SOEs are going to dominate the entire economy, but I am very optimistic about some of them.”

The idea of such “hybrid” companies also helps explain the winners in other capital-intensive sectors, including China’s auto industry. “To develop a car company in China, you need to be able to play both sides, running the business with private sector-type discipline but also getting close to local governments for the land and bank contacts that this brings,” says Mr Dunne.

However, the record of SOE reform has not been a uniform success. While there are some outstanding state-owned companies, there are also plenty that demonstrate the well documented pitfalls of political interference and heavy-handed bureaucracy.

Top managers in SOEs are political appointees who can be forced to move jobs regularly between different companies and government departments. In a notorious case in the telecoms sector in late 2004, the government shifted the heads of China Telecom, China Mobile and China Unicom overnight, without giving them any notice.

Older SOEs are often still grappling with outmoded equipment and might be obliged to purchase components and other supplies from affiliated companies, regardless of quality or cost. SOEs can also face more restrictions than other companies when hiring and firing workers.

Although corporate governance has improved, investors regularly complain about lack of transparency in SOE finances, particularly over the transfer of assets between listed companies and their state-owned parent groups.

Moreover, there are several economic downsides to the increasing power of the large SOEs for the Chinese authorities. Although China’s private sector has grown sharply in recent years, the state sector still manages to command the lion’s share of formal financing. The commercial banking market is still dominated by the large state-owned banks and analysts say that these banks still prefer to lend to other large SOEs. Indeed, this close relationship is one reason that the Chinese economy is still vulnerable to periods of over-investment.

The massive boom in the local stock market, which saw companies raise more money in mainland China last year than in any other market, has also largely benefited SOEs. The 12 biggest initial public offerings last year in Shanghai were all by SOEs and accounted for 85 per cent of the capital raised.

Shen Minggao, an economist at Citigroup in Beijing, argues that the recent boom has affected the economy in other ways, by delivering most of the benefits of economic growth to state-owned companies in the form of higher profits, with relatively little going into the pockets of ordinary wage-earners. The massive reorganisation of the state sector in the late 1990s pushed responsibility for a lot of health and education spending on to families.

Meanwhile, the state has been the main beneficiary of the recent surge in SOE share prices, given that in most of these companies only a small proportion of the shares are actually traded – 4 per cent in the case of Industrial and Commercial Bank of China. “It is the state and not households that became wealthier during the blossoming of the SOEs,” says Mr Shen. “Households actually enjoyed only a small portion of the expanding wealth cake.”

Greater independence is good for corporate performance, but there are also signs that China’s more powerful SOEs are outstretching the ability of the country’s regulators to control them. The most remarkable incident occurred last summer, when the large state-owned oil companies forced the authorities to raise fuel prices by helping to create an artificial shortage.

The Chinese government sets prices for oil sold domestically, which puts pressure on the large oil companies – PetroChina, Sinopec and CNOOC – when international prices rise. The response from the large oil companies was a high-stakes game of bluff with the authorities: the amount of oil sold in China was reduced and several large refineries were put on “scheduled maintenance”. When many smaller, private refineries also refused to sell oil at the government-set price, creating an even bigger shortage, the authorities had no option but to increase prices.
The SOEs are also facing a backlash in some Beijing policy circles over their overseas investments. PetroChina has been operating in Sudan for over a decade, during which time Beijing has forged a close relationship with Khartoum. While these ties have prompted criticism that China has weakened international efforts to halt the violence in Darfur, PetroChina has at times sold more of the oil from Sudan to Japan than it has at home – prompting some experts to ask if the controversial Sudan policy actually brings real benefits.

Zhu Feng, of Peking University, says that the oil companies have “hijacked” the country’s foreign policy on Sudan. “Chinese oil companies and a lot of other oil companies in Sudan have made the money. It is not the people or the country [that have made money],” he says.

According to Zhang Yunling, at the Chinese Academy of Social Sciences: “It is not the government deciding to go to Sudan. It is the oil company. They have gradually developed their business and asked the government for support.”

Erica Downs, of the Brookings Institution in Washington, says Sudan is the “crown jewel” of PetroChina’s international business, but that “the company’s domination of the Sudanese oil industry arguably has done more damage to China’s reputation abroad than the activities of any other Chinese SOE”.

“The case demonstrates how the overseas activities of a Chinese SOE can simultaneously harm one Chinese foreign policy objective – to be and be perceived as a responsible rising power – and help another – to enhance energy security,” she says.

The Chinese government has attempted to improve its public relations in recent years, ordering ministries, with varying success, to explain decisions to the foreign and local media. Petro-China, however, one of the country’s most powerful companies, has shown no inclination to fashion a public message.

Elsewhere, in countries as diverse as the Philippines, Zambia and Peru, Chinese investments have provoked a political backlash. “In the future, this issue will become more and more serious,” says Mr Zhang.

For the ruling communist party the political benefits of the SOEs’ new wealth far outweighs any financial costs incurred in keeping them at the “commanding heights” of the economy. To maintain its grip, the party needs a strong state sector with the power to balance a rising entrepreneurial class. The risk for the authorities, however, is that over-mighty companies end up dictating policy themselves.

Copyright The Financial Times Limited 2008

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Ko So-young S-line?

Ko So-young (she looks like this) S-line, would in Korean parlance refer to Ko So-young the actress, and her S-shaped, or slim, figure. S.K.Y. would normally refer to that which falls down at the end of the world, or a trio of the top Korean elite schools, being Seoul National, Korea, and Yonsei (their graduates combine to make up about 2/3 of the political and bureaucratic elite). But not for the ever inventive Korean netizens (here).

Ko(rea University), So(mang Church), and Young(nam voting disctricts) become short hand for the powerbase of newly inagurated President Lee Myung-bak. S-line, or its looks, refers to his time as a S(eoul) mayor. S(omang), K(orea University), Young(nam) does the same. As JoongAng Daily put it: “The SKY is the limit for minister nominees” and its not difficult to make a similar sentence that includes line either.

President Lee Myung-bak is a graduate from Korea University and has brought with him a darling amount of alumni to serve as ministers and at other top positions. As a churchgoer at the 70,000 man strong Somang Presbyterian Church, he is in company with 60 former ministers (not including pickings of his own), 10 university presidents, and 150 popular entertainers (here). Then there is Youngnam, the two Gyeongsang provinces that is the political homeland for Lee Myung-bak’s Grand National Party (although the homeland would probably liked to have seen someone born there as its candidate, such as daughter of former military general-cum-dictator-or-president, Park Geun-hye).

Unfortunately I am skipping the part that should read, “note, the above is not uncommon in South Korea”. And although your company present believes a president should be judged by more, it would be somewhat unfair to let Lee Myung-bak be judged on other than his (economic) performance (if the voters remember that’s why they elected him). To bad then, that he will be judged in April, at the National Assembly election. For references Ko So-young is spelled 고소영 S-라인 in Korean.

More on elites, see: Ahn, Byong-Man (2003). Elites and Political Power in South Korea. Cheltenham: Edgar Elgar

The March First Independence Movement (Samil Undong)

“The widespspread demonstrations that ensued on this day drew people from all walks of life into a celebration of Korean national will, as demonstrators paraded through the streets shouting “Taehan tongnip manse” (”long live an independent Korea”) [대한독립만세]. The peaceful demonstrations on March 1 [1919] sparked a nation-wide movement in the following months. Over a million people participated in demonstrations, with the Japanese police reporting “disturbances” in all but seven of Korea’s 218 counties“

Read the full March First Proclamation of Korean Independence
(English, 己未獨立宣言書 宣言 書, 독립선언서 원문, 독립선언서 번역문)

Carter J. Eckert, Ki-baik Lee, Young Ick Lew, Michael Robinson & Edward W. Wagner, Korea Old and New: A History. 1990, p278. Seoul, Korea: Ilchokak, Publishers

No strings attached as the New York Philharmonic plays in Pyongyang

The New York Phiharmonic held a concert in Pyongyang in  26 Feb 2008 to the hopes of better relations between the U.S. and the DPRK. At least that’s how the American side - whose memories of Ping Pong diplomacy probably resonate in the background - saw it as the largest contingent of United States citizens since the Korean War appeared north of the 38th parallel (here).

Then how might the North Koreans have seen it? Evidently, among those present “There were those who sobbed and wiped off their tears” (here), but most Koreans could not even access a transmission (here). Kim Jong-il did not attend, but is likely to profit in one way or the other (here). The concert was only possible due to the “Dear Leader”, and furthermore he managed to draw positive - or at worst non-negative - attention to his regime (just guess who made it to the TIME Asia edition cover page).

Below is the NY Phil playing the Korean folk song Arirang (but also see this Youtube link for Jang Sa-ik’s version). As conductor Mr. Loring Maazel put it: “There’s no sides - there’s no North and South in ‘Arirang” (here). The NY Times has a good review of the first time an American cultural organization appeared in the North (here).

(Video courtesy sangdoo2)
 

As prices rise in China food aid to North Korea falls

World food prices has risen dramatically over the last period and moves on to affect even reclusive North Korea. Globally, China may hold the key to world food prices (Jing Ulrich, here), but biofuels (IMF, here) and poor harvests also play significant roles (see also this great FT site on food prices). As China takes the world on a ride of agflation (the Economist, here), or simply stops exporting deflation, this also shows how North Korea is in it with the rest of us - or at least the less well off parts of the world.

A Hankyoreh article (here) says up until now an average of 1,200 tons of food has crossed the border at Dandung, Liaoning Province, daily! As of 2008 the Chinese government has not issued any new export permissions. The article says 80 to 90 per cent of Chinese food aid, which has now completely stopped, used to pass through Dandung.

For food aid in general, the World Food Programme fears cut in assistance, and the Food and Agriculture Organisation estimates poor countries will have to pay 35 per cent more for their cereals imports (here). The only benefactors of the rising food prices must be the protected South Korean farmers whose products will seem a little bit less expensive as consumers lately (2004-06) have paid more than two and a half times the prices on world markets (OECD, here).

Lee Myung-bak’s nominees faces tough criticism

Lee Myung Bak’s reorganisation of the government bill passed in the National Assembly on Friday (here) and was approved by the Cabinet Saturday. After he is sworn in as the 10th President of the Republic of Korea, his 15 minister nominees will face fierce questioning in Parliament on Wednesday and Thursday. Lee Myung-bak is probably chief violater of public norms, but as he is to be sworn in as President he should have the decency to back those whom he has nominated, faulty or not.

Top of the list of criticism is the riches enjoyed by the group of 15, with average assets of nearly 4 bill. won (US$4.2 mill.) or 58.7 bill. won between them (here). Real estate, tax evation, academic plagiarism is at the hear of the matter - at least on the surface. The real issue is the upcoming election for the national assemby in April. 

Criticism has already demanded its first victory/prey as Lee Choon-ho, nominated as minister for gender equality and family, has withdrawn her nomination as it became known that she owns 40 (or 36) properties in 12 different cities (here and here).

Nominated as the unification minister, Nam Joo-hong is targeted because of his hardline old-school views on North Korea, and having a son with a U.S. citizenship, a wife and daughter with residency status greatly eases the job for the critics. That his son has chosen to enlist next month, and his wife has given up her residency rights, will do no good.

Park Mi-seok, senior presidential secretary for social policy, is accused of plagiarism while being a professor at the Sookmyung Women’s University (here).

Han Seung-soo, prime minister to be, is also criticised for various speculative real estate deals, tax evations, and for one time having claimed to be a Cambridge faculty member (while actually having been a research fellow, here).

Lee Myung-bak is even receiving criticism from his own party as GNP chairman Kang Jae-sup (rightly) believes negative public opinion may hurt in the April 9. parliamentary election. So far military evasion by family members and academic plagiarism have been sure disqualifiers, but Lee Myung-bak has himself proved that real estate speculation and tax evasion may not necessarily be. Luckily no one questions his 39 appointed secretaries (here) or support staff (here) … yet…

Power shakeup in North Korea as investigations continue

The top echelon of power in the DPRK is under investigation (also Feb 11. post). Investigations of the party, cabinet, and the military, are being undertaken and overseen by the Guidance Department under the direct control of Kim Jong-il. It has the authority to investigate any organisation, and is known to have been involved in leading an investigation only twice before. In February 1984 the National Security Agency came under investigation, and its first director Kim Byung Ha committed suicide, while key officials were sent to prison camps. In 1997 several of Kim Il-sung’s close associates and thousands of high officials who followed Kim Il-sung were targeted and punished North-Korean style (Daily NK).

Also involved in inspections are the Defense Security Command of the People’s Army and the National Security Agency. They cannot, as the Guidance Department, extend into wideranging inspections as they are limited to the types of organizations and cadres they may investigate.

It has been discovered US$ 20 million at the house of the head of the National Economic Cooperation Committee (NECC) and the National Economic Cooperation Federation (NECF), Mr. Jung Un Up. He is currently under questioning, and so is staff in China and Russia. The money may have been intended as funding for the DPRKs legitimate overseas business, or could simply be accumulated bribes or otherwise “re-directed” funds (here). The amount proximates that of the registered capital of a conglomerate such as Pugang, and is a US$ 5 million short of the funds involved in the Banco Delta case (here).

The Minister of Obstruction

In an editorial by The Hankyoreh (Feb. 19, 2008), the new Minister for Foreign Affairs and Unification, Prof. Nam Joo-hong, is referred to as the Unification Ministry’s Minister of Obstruction” on account of his school-of-collapse and regime-change views.

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Looking at what Nam Joo-hong, the Kyonggi University professor who has been chosen to head the Unification Ministry, has said about North Korea until now, you can see how wrong the new government is about the issue of relations with North Korea. When President-elect Lee Myung-bak appoints a scholar so ultra-right that it would have had a hard time putting him to use even in the Cold War era, it’s enough to make you wonder whether the motive is to heighten tensions. There has never been anything like this in the history of the Unification Ministry.

Nam is your typical member of the “school of collapse.” He has consistently claimed that there are signs that a sudden situation could arise in the North, saying that it has problems in five major areas, including food, energy and succession. Immediately after the February 13 agreement was made, he said that the crisis management ability of the leadership in Pyongyang was reaching a breaking point. Naturally this leads to the position that Seoul should participate in the Proliferation Security Initiative, or PSI, and put pressure on Pyongyang in the form of economic sanctions. His thinking is the same as that of the neocons who led the North Korea policy of the Bush administration before it turned out to be a failure.

Nam sees the solution to the North Korean nuclear issue to be regime change, instead of multilateral dialogue like the six-party talks. His reason is that it is too late for the North to give up its nuclear cards, so it is inevitable that the issue becomes a prolonged one. He reduces the February 13 agreement to a political deal between Pyongyang and Washington to earn time. Put simply, he thinks the collapse of the system in North Korea is what has to happen for the nuclear issue to be resolved. He cites a stronger U.S.-Korea alliance as the only alternative, so as to be prepared for such a sudden change of events.

Similarly, Nam argues that developing inter-Korean relations is something that should happen only after the nuclear issue is out of the way. This is the same as saying that relations can improve if the North collapses. He does not even hesitate to say that the June 15 summit declaration is a “North Korean document used for controlling the South” and that the engagement policy needs to be completely reconsidered. It is easy to see what will happen to inter-Korean relations, difficult as it has been to make them what they are today, if someone such as this becomes the minister of unification.

Even before settling on Nam, President-elect Lee was being criticized for only looking after the alliance with the United States while neglecting inter-Korean relations and the question of the Korean Peninsula. Having a “minister of obstruction of unification” like Nam be around in such a situation will cause Lee’s administration to be criticized for having an anti-reunification stance. Neglecting to work for peace and reunification goes against the constitution and smothers the Korean people’s desire for unification. We hope to see the new administration get started on the right foot. As the saying goes, “Choosing the right people is everything” (insaga mansa).

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Fidel Castro announces retirement

Mr. Fidel Castro, ruler of Cuba since 1959, announces his retirement as president. He will temporarily be succeeded by his brother Raul Castro. (It is always tempting, but never advisable to draw parallells to North Korea, but surely the “Dear Leader” is watching - and who knows what he makes of it…)

Published on the Granma website: “It would betray my conscience to take up a responsibility that requires mobility and total devotion, that I am not in a physical condition to offer,” referring to the intestinal operation he had in 2006 (here)

A married Ewhaian graduates!

Ewha Womans University (its not a spelling mistake), founded in 1886, used to deny the right of education to married women. It is a novel thing then, that the university that stands at the forefront of advocating the capabilities and advancement of women should have its first married graduate (here). Congratulations both to Ewha and to Mrs. Ki Sung-hwa (who is also a mother ~ a double taboo!).