China’s Reform: Peril, Promise in the Heartland

As China’s President Jiang Zemin visits the United States this week, a lot will be said about his decrees to reform the Chinese economy by selling stock in state enterprises and encouraging the private sector.

In China today, the words “restructuring,” “profitability” and “market value” are heard so often that it sounds like Wall Street East. Managers boast of being able to dismiss workers, and even labor representatives say “fewer workers, more profit.”

But what do such words mean in China, where Jiang’s government says that 50 million to 70 million people will lose their jobs in the next few years and that the state will retain ownership of the 1,000 largest companies--where, indeed, profit hasn’t been a goal of industry for almost 50 years?

In the answers to those questions lie insights into the future of China’s economy and its relations with the United States and the world. And the best way to get answers is to look to specific cases.

Mianyang, a city of 2.5 million in south-central China that was a principal site of the country’s military-industrial complex, illustrates the promise of China’s restructuring but also its harsh realities and perils.

In Mianyang last summer, hundreds of laid-off employees of the Mianyang Silk Printing & Dyeing Mill--which had been declared bankrupt prior to restructuring as a new company--took to the streets to demand back wages and pension compensation.

The protest was quelled by police but resulted in the Mianyang city government coming up with a severance package for the fired workers. That expense, in turn, has cut the working capital of the new Jin Tuoling Silk Printing & Dyeing Co., which is struggling and hoping to bring in capital and new business through a joint venture with Los Angeles garment makers.

But Mianyang is also home to restructuring’s winners. Chang hong Electronics Corp. was a supplier of electrical hardware to the Chinese military until the mid-’80s, when downsizing of Beijing defense budgets pushed it to make civilian products.

Changhong chose to make television sets and has come out on top, with 40% of China’s market. It has ambitions to bring its TV sets into the U.S. market and list its shares on the New York Stock Exchange in 1999.

Changhong is a company owned by the government of Sichuan--China’s largest province, with 113 million people--that started its long march to the Big Board in 1994 when it was allowed to issue shares on the Shanghai Stock Exchange.

Today, at least partial ownership is in the hands of individual Chinese investors, and Changhong is an early example of the shareholding model called for by Jiang at September’s landmark Communist Party Congress.

The idea is “equity formation,” explains Ningning Ding, an economist with the Beijing government’s State Council. The stock issues are a way to tap into the great savings of China’s people, who have put away almost 40% of their earnings as living standards have risen.

Independent share ownership is also a way to separate the wheat from the chaff. With the rise in share ownership, the state has transferred to company management the authority over hiring, firing and pay rates--decisions formerly made by the government.

That reform above all is what’s responsible for the company’s success, according to Changhong Vice Chairman Guang Yin Yu. Most of Changhong’s 25,000 workers are “contract workers; they can be dismissed at any time,” says Yu, who also serves as Changhong’s chief Communist Party representative.

Another benefit of reform, Yu adds, is that “our salaries are according to our job. No more ‘big iron pot’ with equal shares for everybody. Now those who make a greater contribution to the company can be paid 10 times the salary of the lowest earners.”

To be sure, we’re not talking U.S.-style management pay here. The lowest wage Changhong workers earn is about 500 yuan--or $62.50 a month, roughly $3 per workday. So the highest-paid managers and technicians earn $150 to $200 a week, plus fringe benefits in company housing and the use of a company-owned, Chinese-made Volkswagen sedan.

Also, Vice Chairman Yu may talk about management’s right to fire employees, but Changhong is not letting workers go these days. On the contrary, it is expanding, investing almost $300 million to increase its output of television sets to 6.5 million a year and to produce air conditioners and videodisc players.

Its factory complex in Mianyang is a continual construction project, with new buildings going up to house the latest in manufacturing equipment. Changhong had technological assistance from Toshiba and Matsushita of Japan in developing its TV sets, Yu explains.

But that didn’t prevent the company from beating back foreign competition from Japan and Korea in recent years to consolidate its position as China’s TV leader.

“Our low cost of labor is an advantage,” Yu says, and will help the company expand into the U.S. market. The company is working on new products for that effort.

The fact is, however, Changhong will need new and better products to succeed outside of China. The 21- and 34-inch TV sets it now sells for $400 and $900 apiece would be noncompetitive at Circuit City.

In fairness, foreign markets have not been a priority for China’s state companies until now. Rather, the efforts of the last decade have focused on becoming efficient inside China. To earn a profit in the Chinese context means to cease using easy credit from state banks wastefully and to stop employing people and raw materials inefficiently.

The losses of China’s 100,000 state enterprises have grown to more than $10 billion a year. That’s more than 1% of China’s total output of goods and services, according to Joan Zheng, J.P. Morgan Co.’s highly regarded economist in Hong Kong.

And such statistics scarcely capture the waste of underdevelopment--the factories that turn out goods nobody wants, paying a pittance to underemployed people; the infrastructure projects unfinished because the government ran out of money; the smoky haze of industrial pollution that hangs over whole towns because of the inefficient burning of coal.

A new highway between Mianyang and Chengdu, the capital of Sichuan, remains half-finished. If completed, it would allow people and goods to make the 75-mile journey in an hour. As it is, the trip takes three hours and discourages economic activity.

Yet there is progress. A new natural gas field in Sichuan increases fertilizer production for the well-cultivated fields that cover the countryside and promises to bring cleaner energy to expanding cities.

A decade of rapid growth has raised living standards. Farmhouses are improved, apartment balconies sport touches of better living, bicycles are thick on the streets.

The reform of state enterprises, which employ two-thirds of China’s urban work force, is actually the culmination of reforms begun in the 1980s.

“They left the hardest part, the one that will put people out of work, until last,” observes Wilfred Wong, president of China Investment Group, which represents the government of Singapore, Hong Kong business interests and U.S. investors in projects in China.

It is that hardest part of reform that hit Mianyang Silk, a company that employed 4,000 workers and had annual sales of $20 million worth of silk fabric and garments. Unfortunately, the company had bank debt to match and was not profitable. So the local Mianyang government decided to declare it bankrupt--leaving its debt as a bad loan with the state bank--and to form a new company with fewer employees and no debt.

“They lifted our burden,” says Qing-ping Tao, general manager of the new Jin Tuoling silk company, referring to the government’s assumption of the debt.

The Mianyang government set up Jin Tuoling as an employee-owned company and sold $3 million in stock to the 1,600 workers. The shares amounted to a perk for the workers, who didn’t actually pay cash for them.

The plan was that the new, leaner company would operate at one-half to one-third the cost of the former operation and generate new capital for the region or attract it from a joint venture with foreign investors.

But many of the 1,500 or so workers not hired by the new company and 600 other workers eligible for retirement protested in July when they feared loss of back wages and pensions.

So now the Mianyang government has taken back most of its proposed investment in Jin Tuoling and paid out $1,500 severance or pension benefits to most of the former employees.

Meanwhile, much of the silk factory sits idle, since the company lacks working capital and cannot borrow anew from the state bank. The solution, says Yingzhe Xie, chairman of Jin Tuoling’s board and director of the regional silk industry administration, is investment from abroad.

“We can offer a joint partnership with any part of the operation, to make garments or raw silk or semi-finished products,” Yingzhe says.

The specific partner he has in mind is Silk Skyway Ltd., a Los Angeles garment company that has a process for stain-resistant silk. Over the last three years, Silk Skyway and the Mianyang company have been trying to start a venture that would fly silk to South Korea and send finished garments to the United States.

But the U.S. firm has not been able to secure capital for the venture, and the Chinese side has not agreed to intellectual property rights for the stain-resistance process, says A. Marsten Thomason, president of Silk Skyway and a teacher of the yoga-like philosophy of qi gong, which first took him to China.

The outcome is uncertain. Jin Tuoling could be acquired by a larger Chinese company as industrial consolidation continues. Or Silk Skyway could get financing from a Japanese company and do business with Mianyang.

Such disputes and uncertainties over contracts and valuations are common in China, say seasoned negotiators--which only says that developments always take more time than expected.

What do the Mianyang examples and others in Jiang Zemin’s reform process portend? “The next few years will see many experiments, and a variety of ownership forms will emerge,” says Wong, whose overseas Chinese investors see great opportunities in retail stores and other services.

But also, China’s ambition to build big state-related companies on the clannish model of Korean chaebol or Japanese keiretsu promises rough sailing for U.S. and other foreign companies wishing to tap the Chinese market.

We should keep in mind that there are important political contexts to Jiang’s program that outweigh commercial concerns. Taiwan welcomes the program, for one thing.

“We found his speech at the Party Congress very open and welcoming to Taiwan,” says Fuh-Wen Tzeng, head of the department of mainland affairs for Taiwan’s ruling Chung-Kuo (China) Kuomintang party.

And most of all we should understand that China’s people, even though working now for $3 a day, are better educated than the masses of most developing countries. Numbering over 1 billion, China’s men and women make up a country destined to be a major economy of the 21st century. We should pay attention to Jiang Zemin’s visit with that in mind.