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factory September 9, 2010 (Chinavestor) Transforming from planned economy to market economy was by no means an easy task. In fact, when China decided to be politically communist and economically capitalist in 1979, it could hardly find in history examples to follow or models to copy. Therefore, China had to find ways to accomplish its goals through repeated trials and failures, which, of course, could be extremely costly.

The issues were abundant and the one on top of the list had to be state-owned enterprises (SOEs), which were the nightmare for the policymakers. Prior to 1979, all businesses in China were SOEs, numbered in hundreds of thousands by rough estimates without any accurate statistics. As the name indicates, they were owned, operated and financed by the government.


At a time when the government was preoccupied with political stability and policy reform, business management was neither their expertise nor their priority. Businesses were left unmanaged or poorly managed; factories were equipped with decades-old machinery; and the workforce was full of excessive and aged workers. Came 1979, all needed to be changed, and that required unprecedented trials and frequently resulted in devastating failures.

In that year, the policy of separating government and business was put into force. Under the policy, the government ceased financing the SOEs, and they had to turn to government-owned banks for loans. When the SOEs received financing from the government, they did not have to pay back. Therefore, when they received bank loans, they conveniently “forgot” to pay back the loans, causing the banks to pile up bad debts, which almost destroyed the banks. This phenomenon was then described as ‘three dares”: “dare to borrow, dare to spend, and dare not to repay.”

In addition to the financing mess, management was another critical issue. Prior to and in the early stage of the reform, factory managers were in charge of SOEs with no responsibility and little knowledge of financing and marketing. Therefore, most of them were not qualified to run “independent” enterprises. As the reform moved forward, especially when the Corporate Law was put into effect, factory managers’ titles were changed to those of chairman, president or CEO. Despite the title change, their functions were basically unchanged. Lack of qualified and effective corporate management threatened the mere survival of the SOEs.

The toughest issue, however, was neither financing nor management but the excessive workforce. Under communism, workers were employed for life. Now the government was confronted with a dilemma: whether or not to shrink the workforce, providing a business solution but, at the same time, creating a social uneasiness of unemployment (xiagang). That dilemma had troubled the policymakers for years to come. However, in order to rescue the SOEs, xiagang became a necessity.

Realizing that drastic measures had to be taken to deal with the overall problems, the government categorized the SOEs into three groups: the worst, the weak but salvageable, and the best. The worst were to be eliminated through bankruptcy; the weak enterprises would be merged into the strong ones; and the best would be given the priority to expand. Unfortunately, those measures did not work well. First of all, although one of the first laws published in China was the Bankruptcy Law, it created more confusion than solution. Secondly, merger of incompatible businesses would frequently produce opposite results, i.e., mutually destructive instead of mutually beneficial.

What was left was privatization. Thus, the era of private enterprises has begun.

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