China’s State Firms Caught Between Old Ways, New Ideas

In 1976, as the Cultural Revolution was winding down, Zhang Jingming was ordered to join the Shanghai Petrochemical Co. as a machine operator.

In those days, the state dictated your future, and workers had no say. But Zhang remembers being proud of his new company, which was expanding like crazy and often received kudos from Beijing for its role in nation-building.

Twenty-four years later, both Zhang and his company have come a long way. Shanghai Petrochemical was honored as the first Chinese company listed on a foreign stock exchange, and Zhang has risen to company secretary. SPC has separated much of its onerous welfare burden--such as company-supported hospitals, schools and soccer fields--from its profit-making activities and cut its work force by more than 30,000.

But it is still no General Electric.

The gap between one of China’s best state-owned enterprises and foreign competitors remains huge. Even with the cuts, Shanghai Petrochemical employs several times as many workers as its Western counterparts. It often must consider politics as much as economics when making key business decisions, isn’t allowed to compete too aggressively against inefficient state competitors and struggles daily to overcome supply and distribution problems.

“In China, SPC is one of the best,” Zhang says. “But compared to well-managed foreign companies, it’s still a beginner.”

Two decades after “paramount leader” Deng Xiaoping launched major economic reforms of state-owned enterprises, this cancerous legacy of communism tops China’s list of dire economic problems.

So far, Communist Party leaders have tiptoed through this minefield. They have accepted a destabilized banking system, lower living standards and diminished national vitality rather than enact more aggressive reforms that could send millions of workers into the street.

But as the interrelated social and economic problems get worse, the party has become more embattled and hard-line, China watchers say. That can be seen in a range of harsh responses to the Falun Gong meditation movement, the Catholic Church, striking local workers, Internet discussion groups and even a Western cartoon channel.

“Is the party in danger of falling?” asks Timothy Weston, a China expert at the University of Colorado. “I think the party thinks it’s in danger from all sides.”

That said, leaders recently agreed to join the World Trade Organization--a step likely to hammer inefficient state-owned enterprises--and outlined plans in September to loosen their ownership grip on the bloated state sector, even as they maintain majority control. Often policy seems to move slowly and in different, even contradictory, directions.

“We’re still seeing what’s possible,” says Han Hua Liu, director of enterprise development with the Shanghai Academy of Social Science.

To be sure, China’s gradualist course has arguably been vindicated by the nation’s economic successes and the emergence of a middle class during the last two decades. At the opposite extreme is Russia, whose abrupt abandonment of a planned economy has been followed by chaos, instability and failure.

Yet some experts wonder how long China can keep up this balancing act. “There’s a lot to be said for an incremental approach,” says Harry Broadman, a World Bank economist and author of a landmark study on China’s state sector. “The question is whether they should accelerate [reform] while they still have the luxury of quite strong growth.”

Where Zhang and Shanghai Petrochemical will end up is impossible to chart. But their journey so far provides a road map of China’s erratic course to date.

Today, SPC’s five dozen factories, spread over 5.4 square miles, churn out everything from gasoline and jet fuel to ethylene, polyester fiber and plastics, many of which end up as toys, auto parts, computer casings and leisure suits. The complex is so extensive that even employees get lost in the massive tangle of pipes, tubes, vents and ducts that spread across the landscape like a black and silver octopus.

Zhang’s personal exposure to Western thinking accelerated a few years after joining the company, when he was tapped to study English.

The 18-month course was a bit impractical, and much of the grammar a bit stiff. But he supplemented the curriculum by listening to English radio programs. He started working with some of the company’s joint venture partners, following foreigners around on the job site and listening in on negotiations and licensee discussions.

China was pretty suspicious of foreigners in those days, he recalls. The country had only recently opened a tiny door to the West and still hoped to gain its technology and know-how without being infected by its values.

Inevitably, however, new ideas crept in, gradually introducing Chinese managers to Western concepts such as efficiency, time management and creative problem- solving--ideas once denounced as exploitative by the Communist Party.

“We as Chinese have learned a lot of good things from foreign companies,” Zhang says.

As SPC started to internalize these new tools, however, strains developed, particularly when the approach conflicted with the weaknesses of central planning.

As central budgets tightened in the late 1980s, SPC became one of the first Chinese companies allowed to borrow money directly from foreign banks, many of which were tripping over themselves to enter the market. Local banks were also willing to lend large sums as long as they got blessings from above, with little thought to repayment.

“The [local] bank would just lend because the government said it was approved,” Zhang says.

Faced with a flood of easy money, SPC went on an $875-million borrowing spree that quickly drove its debt-to-equity ratio up to 76%, far above that of well-run Western companies. Although years of hard work have reduced the ratio to 36%, other state firms that followed were soon overwhelmed by debt, which in turn has left the banking system shaky.

SPC’s newfound capital allowed it to finance an ambitious expansion. But that created another problem. Government shareholders continued to demand huge tax payments and dividends based on the company’s sales, not its profit. By the early 1990s, SPC was left with only a few million dollars annually after interest and expenses to run a 67,000-worker complex.

That led to a second experiment, under which SPC in 1993 became the first Chinese company to list on the Hong Kong and New York stock exchanges.

The glare of foreign investor attention soon spotlighted SPC’s many social obligations, a holdover from the Mao legacy of a communist society built around the work unit. Those obligations included a hospital, a college, thousands of apartments and even seafood restaurants. Unwinding them led to another wrenching change, as many once-integral functions were spun off onto the local government.

For many in the company, these demands didn’t make sense. But Zhang began to better understand it all when he was tapped as one of only 19 people nationwide for a pilot project to send Chinese state-owned company managers to Britain for an MBA.

The curriculum highlighted many concepts widely accepted in the West but new to China, including productivity, time management and return on capital. “It really changed my way of thinking,” he says.

Zhang says his new skills were put to almost immediate use . China has tended to rely on engineers in negotiations, while Westerners use lawyers--two professions that might as well be from different planets. As a result, talks often bogged down. With a better understanding of Western thinking, Zhang was able to help bridge the gap. “At least when you have someone who understands both sides, it becomes easier,” he says.

Foreign shareholders and market pressure have forced other changes on SPC over the years. It is paying more attention to market demand--a relatively new concept in China--after operating for years under the assumption that customers would take whatever it produced.

As a long-term investment, SPC has been a dud. The company went public in 1993 in Hong Kong at the equivalent of 20 U.S. cents a share. Last summer the price fell as low as 5 cents before recovering recently to around 16 cents. That reflects in part eroded earnings, fear of growing foreign competition and doubts about the health of China’s state sector in general.

Still, one Hong Kong-based analyst says the company is profitable, and Beijing sees petrochemicals as strategic, so official support should continue.

While China’s controlled market protects the company--the vast majority of SPC’s market is in China--it also creates huge dislocations. Company revenue in 1998 tumbled 75% when smugglers took advantage of the difference between high fixed prices in China and low prices elsewhere in Asia.

SPC also must keep more workers than it needs--10 times as many as a U.S. competitor, by one estimate--to avoid competing too aggressively against other state firms. And it must endure micro-managing by its government shareholders.

“If we could lay off people as we wished, purchase materials anywhere and enjoyed greater autonomy and fewer social costs, we could expand quickly,” Zhang says. “Since our plant is located in China, our development and growth has to fit in with the government’s macro plan.”

Still, for all its problems, SPC looks good against the nationwide picture, in which bloated state companies monopolize bank capital to the detriment of more vital private companies. Although China’s 98,600 state-owned enterprises account for just 25% of industrial output--down from 78% in 1978--they still control 63% of the nation’s assets and employ 65% of its work force. Nearly half of them are losing money, and the share is rising as the number of efficient, private competitors has grown.

“If the government continues to support failing enterprises, overcapacity just gets worse,” says Hu Biliang, senior economist with SG Securities.

Chinese planners are hoping the private sector will expand to replace jobs lost at state companies, even though the government’s own policies often stand in the way. The danger for companies such as SPC is that they will suffer further brain drain as managers leave for higher-paying jobs with foreign-controlled joint ventures.

Zhang admits that he could have left to work for a private company years ago, as did most of his classmates in the MBA program. But he remains proud, even after 24 years, of what SPC has accomplished.

“Personally, I have affection for the company,” he says. “Money is important, but it’s not the only thing.”