Thursday, August 10, 2017

the "Final Solution" of Chinese Debt Problem: a Grand Sell-off of State-Owned Assets

In the recent years, business news outlets and analyses websites have been keen to present the rapidly increases Chinese debt pile as one of the biggest risks facing the global economy today.  The numbers are certainly scary.  The debt levels, less than 80% of the GDP less than a decade ago, recently surpassed 300% on official estimates.  The numbers would be much higher if grassroots level "shadow banking" of informal community loans are accounted for.  Given the size of the Chinese economy, the amount China owes as a collective is definitely not a small number.

The greatest risk of the massive debt pile is structural.  Increasing debt levels shows that the returns on loans have not kept up with the loans themselves; borrowed money are not being spent in productive enough ways to make the loans economically worthwhile in the long-term.  The continuing losses from low-return loans serve to cancel out the strong financial base, including large domestic savings and large trade surplus generated from net exports, from which China can draw resources for continued provision of loans.  Continued long enough, the suspicions that borrowing will become more difficult will jilt the economy.

Within the framework of the increasingly unproductive provision of loans, the importance of state-owned enterprises (SOEs) loom large.  As a collective, the SOEs provide much lower returns than their private counterparts in the same industry, at home, and more importantly, abroad.  The lower returns have much to do with the political role of SOEs.  As the economic arms of the state, SOEs are often prodded into making investments that are economically not viable but politically helpful.  Critics argue that many of the projects on the "Belt and Road Initiative" are likely to lead to low returns on capital, if not outright default on loans.

Aside from being compelled to make questionable investment decisions based on political needs, SOEs are often also put in positions where they need to keep losing money for the sake of social stability.  SOEs in heavy industry, like steel-making and shipbuilding, are often compelled to overproduce products that have no comparable demand, just to keep millions employed.  Many of these middle-age employees are leftovers from an earlier, pre-economic reform age when employment is guaranteed for life.  If laid off, they have neither the resources or the skills to survive in the country's competitive market economy.

So for the sake of ensuring millions are employed and do not cause problems, SOEs stay bloated, costly to run, and produce products that no one wants.  In return, governments pump more and more into them, ensuring that their nonsensical business models continue to survive.  Of course, this practice is, as noted above, not sustainable.  No matter how much China earns, it will ultimately not be enough to cover increasing amounts of losses deliberately racked up by SOEs for sociopolitical reasons.  At some point, the unproductive loans have to be stopped no matter what.

But thankfully, if there is anything that the SOEs still have at hand, it is tons of assets.  Many are industrial firms with factories and skilled engineers still somewhat useful to private firms.  Their locations often occupy prime lands that can be sold off to be redeveloped by real estate companies.  Many of the larger SOEs also have recognizable (at least in China) brand names that can fetch good prices should they be transferred to more profitable private firms in the same industry.  If these assets can be sold off, at least part of the SOE debt pile can be paid off.

What's more, if SOEs can be sold off to private companies piecemeal, they are likely to positively impact private firms in terms of economy of scale, making them just as profitable as (if not more than) they were before acquisitions.  The resulting Chinese economy that is more centered on competitive private firms can quickly reverse the issue of low-return loans, as private companies would not heed political needs, only borrowing and investing when it makes business sense.  The government will be also to wield less political power through business deals, but it would be made up by much healthier financial positions.

However, if the grand sell-off of SOE assets is to take place, it is better to happen earlier than later.  The value of SOE assets are bound to decline over time as the less competitive ones have less incentive than private firms to update their production technologies and implement real industry-changing innovations.  In decades time, their production assets (and brand names) will be devalued to a point where selling off the assets will lead to returns much lower as a portion of still-increasing debt pile than if the sell-off is to happen now.  Perhaps the government can come to realize the urgency of the matter and execute before the whole plan no longer leads to much benefit.  

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