Bureaucratic Mergers

What foreign businesses can expect from China's recent government restructuring.

Julie Reinganum and Thomas Pixley

Reports are in on the long-anticipated restructuring of China's ministries and commissions. In March, State Council Secretary General Luo Gan presented, and the Ninth National People's Congress (NPC) adopted, the blueprint for ministerial reforms. Some of the developments, including the preservation of the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) and the Ministry of Railroads in their present forms, proved wrong the forecasts of China watchers. Other speculations, such as that several industrial ministries would be scrapped, were closer to the mark. A review of previous ministerial restructuring campaigns provides a context in which to analyze the recent changes, including their possible impact on foreign trade and investment. Since the 1980s, ministerial restructurings have reflected China's transition from a planned to a market-oriented economy, sometimes catching up with the process and sometimes anticipating future developments.

Redefining Beijing's role

As stated by Luo Gan, the goals of the recent ministerial restructuring, the largest since the PRC's founding, are to separate ministries' administrative functions from their commercial activities; strengthen macroeconomic guidance and reduce the number of specialized economic departments; clearly define the responsibilities of economic bureaucracies and eliminate redundant management; and replace administrative management of economic affairs with a legal system of management. How PRC leaders ultimately implement this latest round of reforms remains unclear, and will determine whether the goals of the restructuring can be achieved. Among the greatest challenges to implementation will be the massive layoffs of government officials and the redefinition of many agencies' authority, which will begin with an in-depth assessment of each ministry's activities and staffing. According to sources at the State Development Planning Commission (SDPC), formerly the State Planning Commission, the assessment process alone will take at least until the end of 1998.

Who's up, who's down

Among the highlights of the March ministerial changes are the transformations of the ministries of coal, machine-building, metallurgy, and internal trade, and the textile and light industry associations, into State "bureaus" that report to the State Economic and Trade Commission (SETC) (see Table). This move significantly strengthens the position of SETC, since these industrial organizations previously reported directly to the State Council. SETC essentially has been transformed into a "super ministry" responsible for supervising all industrial production, except that of industries subsumed under the new Ministry of Information Industry (MII). MII has been formed by the merging of the Ministry of Posts and Telecommunications (MPT), the Ministry of Electronics Industry (MEI), and the data transmission sections of the State Aerospace Bureau, the General Administration of Civil Aviation, and the Ministry of Radio, Film, and Television. Traditional postal services will be relegated to a new State Postal Services Bureau under MII.

Another important reform is the merging of the administrative divisions of China National Petroleum and Gas Corp. (CNPC), the China National Petrochemical Corp. (SINOPEC), and the Ministry of Chemical Industry to form a new State Bureau for Chemical and Oil Industry. On the commercial side, SINOPEC reportedly will control operations in coastal southern China, where downstream activities will be concentrated, and CNPC will control firms, primarily upstream-related, in northeastern China. If this in fact occurs, SINOPEC would be left with a less substantial asset base.

The State Council, for its part, has announced that it will retain authority over 17 bureaus and roughly 20 ad hoc committees and groups. Among the bureaus that will remain intact are customs, religious affairs, statistics, and taxation. The National Environmental Protection Agency, which will also remain under the State Council, has been renamed the State Environmental Protection Administration. In addition to the name change, the bureau has acquired the environmental regulatory functions of several ministries, and thus will assume greater authority over environmental protection issues.

The State Council will run six of its own offices, and will directly administer nine institutions, including Xinhua News Agency, the Chinese academies of sciences and social sciences, and the China Securities Regulatory Commission. Two of the six offices are new--the Legal Affairs Office and the Office for Restructuring the Economy. The Special Economic Zone Office and the ad hoc National Leading Group for Work Concerning Foreign Capital have been abolished.

As a consequence of these various name and organizational changes, as much as half of the government's 8 million civil servants will be laid off by the end of 1998. Reports suggest that 10 times as many local and provincial officials as central government officials will lose their posts. Beijing has justified the layoffs by citing the need for a more pragmatic and technocratic bureaucracy in the face of China's expanding involvement in the global economy.

A historical perspective

Over the years, organizational reforms have been driven both by changes in Beijing's approach to the marketplace and by the degree of independence that market players have been able to assert. As far back as the late 1970s, China was taking its first steps to move from a planned economy, run by ideological industrial ministries focused on economic micromanagement, to a market economy supervised by a development-oriented government engaged more in macromanagement of economic activity.

The current restructuring has its roots in the government's efforts, beginning in the early 1980s, to initiate specific administrative reforms. The first stage, launched in 1982, was designed to simplify the government organizational structure and eliminate the lifelong employment system to allow for the promotion of younger staff. During this period, the ministerial changes most visible to foreign businesses were those implemented in the foreign trade sector. In 1982, Beijing increased the number of Chinese companies authorized to engage in foreign trade ("foreign trade corporations"), and permitted their local branches to conduct business with foreigners. This period also saw the formation under government ministries of new entities to direct foreign business, and the establishment of large corporations to interact with foreign investors in China, most notably China International Trust and Investment Corp. and China Huayang Trading Corp.

The second stage of administrative reform focused on, among other things, allowing enterprises greater independence. SINOPEC and China State Shipbuilding Corp. were formed in 1983 and 1988, respectively, as the first "Chinese-type" holding companies, accountable to the State Council and characterized by State ownership, management, and regulation of all aspects of the industry. CNPC was formed when the more broadly conceived Ministry of Resources replaced the Ministry of Petroleum Industry. CNPC shared with the Ministry of Resources responsibility for overseeing oil and gas exploration and extraction, and issuing permits for such work--duties previously carried out by the Ministry of Petroleum Industry. State oil companies' autonomy remained limited under CNPC, however, since this corporation shared permit-granting authority over exploration and drilling with the Ministry of Resources.

During the 1980s, these central-level reorganizations were consistent with the devolution of government control from the center to provinces and municipalities (see The CBR, January-February 1998, p.16). Though the changes enhanced only marginally the formal autonomy of enterprises in relation to Beijing, in practice they bolstered the independence of the enterprises in the marketplace, which eventually tipped the balance of control over industry away from the government.

Divorcing manufacturers from regulators

Restructuring of government ministries has continued into the 1990s. In essence, Beijing's goal in this third stage has been to allow greater allocation of resources by the market than by the government. Since 1988, Beijing has attempted to separate the commercial functions of the government, as owner of State assets, from its regulatory functions. For example, when the Ministry of Resources was dissolved in 1993, the State Planning Commission took over the oil and gas exploration permit process, while CNPC retained control over the actual projects. The staff and facilities of the permit office formerly operated by CNPC and the Ministry of Resources were transformed into an information clearinghouse under CNPC.

SETC, a product of extensive restructuring, is another prime example of Beijing's ongoing administrative reform. Its predecessor, the State Economic Commission (SEC), was formed as a supraministerial organization in the early 1980s through a merger of several State commissions, ministries, and other economic organizations, to coordinate the ministries' economic planning functions. As China moved away from economic planning, SEC's work was redirected, and the organization was ultimately disbanded in 1989. While some of its functions were folded into the State Planning Commission, others were assumed by a group of six investment corporations. (These corporations directed central government-funded investments until 1995, when they, too, were dismantled and restructured under the new policy-oriented China State Development Bank.) SETC was then established in 1993 to modernize the technology and management of State-owned industrial enterprises.

SETC shares many characteristics with SEC. For instance, SETC appears to have been formed to re-centralize decisionmaking. The body has carried out this mandate, in part, through its role in approving large investments in and technical upgrades of existing State-owned facilities. SETC has worked in tandem with the State Planning Commission, which has had approval power over new large capital investments.

SETC's new role as overseer of industrial production, together with the renaming of the State Planning Commission, have fueled debate over which body wields authority over various sectors. Hong Kong press reports have suggested that SDPC will focus on macroeconomic planning and relinquish some of its project-approval powers. Though SDPC officials deny this, the enlargement of SETC's authority over project recommendation and approval perhaps could come at SDPC's expense. According to sources in the State Council, the smoke surrounding the divisive issue will not clear before June, at the earliest.

This third stage of bureaucratic reform has also seen the transformation of several ministries into industry associations. In 1993, the ministries of textiles and light industry became the General Association of Textiles and the General Association of Light Industry, respectively. The official duties of these general associations, which continued to report to the State Council, were to reduce excessive competition and wasteful investment through "coordination" and "promotion" of firms' activities. The associations were also directed to delegate as many of their functions as possible to industry units or private-sector entities.

Both Chinese and foreign observers note, however, that the 1993 changes in form did not result in significant substantive changes. Though downgraded, the general associations continued to have considerable influence over approval of foreign investment projects. In the recent restructuring, the associations have been subsumed under SETC. Whether reporting to SETC will alter their authority will become apparent only once SETC's broader role has been defined. Some analysts are skeptical that the change will be substantial.

Local changes drive central reforms

As Beijing has instituted various types of restructuring at the central level, provinces and municipalities have also introduced reforms aimed at increasing enterprise efficiency. For example, to streamline production, sales, and distribution of raw materials and finished drugs, the manufacturing arms of the Shanghai Pharmaceutical Bureau and the Shanghai Bureau of Chemical Industries have merged over the past two years to form the Huayi Group. All business decisions relating to production issues in Shanghai are now made by the Shanghai Pharmaceutical Group Co., an independent entity under Huayi. The Shanghai Pharmaceutical Bureau still exists, but today performs only administrative functions, including issuing production licenses. Though it is difficult to determine whether the merger has mitigated the effect of the downturn in recent years in Shanghai's pharmaceutical sector, the head of Huayi still tends to defer to the bureau chief on certain matters, likely for political reasons.

Driving many of these lower-level changes has been Beijing's recognition that it can no longer micromanage business entities, though it maintains some control over the project-approval process. Factors undermining effective central control include overstaffed central-level ministries, with bulging payrolls; reduced macroeconomic planning responsibilities of the ministries, as Beijing pays greater attention to market mechanisms; and the diminished role of the ministries in approving foreign investment.

But these facts are pitted against the central government's desire to direct investment funds to avoid "irrational" and inefficient use of resources. And Beijing will have to deal with any social or political instability that results from the imminent rise in unemployment levels caused by the reforms. Beijing thus must balance increasing pressure from local governments and industry to use a lighter hand in regulating competition, with its desire to maintain stability and direct China's economic development.

Business implications

As for how the reforms will affect trade and investment, it is safe to expect the central government to continue to exert considerable influence over foreign investment, principally through government approval requirements. And SDPC will still use its Guiding Catalogue on Foreign Investment in Industry as a means of shaping economic trends at the macro level.

Indeed, despite the organizational changes of the 1980s and early 1990s, Beijing has continued to dominate key industry sectors by controlling assets. And although some personnel and office titles may have changed, the same individuals tend to remain in positions with control over the investment process. As many foreign investors can no doubt attest, a project backed by an influential official moves more smoothly through the approval process than a project without such a sponsor.

To ensure the attainment of industrial policy goals and to shape the overall direction of Chinese industrial development, planners in Beijing most likely intend to preserve their authority in certain key industries: automotives, energy, steel, and telecommunications. Baoshan Iron and Steel Corp. and the First Automobile Works (Group) Corp. are two large entities in such industries that have been targeted for direct control through subsidies and "planning independence," under which an entity reports directly to Beijing and is independent from provincial-level guidance. The government also continues to arrange mergers of firms in such industries. Most recently, in midst of the NPC, Wuhan Iron and Steel Corp. proposed a merger with Baoshan Iron and Steel Corp. Even in non-key sectors such as pharmaceuticals, Beijing retains--and is unlikely to relinquish--a certain amount of authority. Approval of foreign project proposals for manufacturing new drugs, as well as agricultural chemicals, shifted back to Beijing from local bureaus in 1995 and 1997, respectively.

In many sectors, however, Beijing is no longer a major player. For example, the market for molded-case circuit breakers, an indispensable industrial item, has been liberalized. MEI's most recent utterance on these circuit breakers was in 1990, and more recent attempts to license manufacturers have been completely ineffective. Thus, the impact of the restructuring of ministries and the shift of authority to the local level will depend on the degree of central government control over each industry.

If the outcome of the recent restructuring in fact matches Beijing's articulated goals--to extricate itself from enterprise functions and relinquish control of assets--regulators and planners may take a more market-based view of foreign involvement in such highly regulated industries as telecommunications and automotives. This would no doubt stimulate new business opportunities. And some foreign press reports since the March NPC suggest that foreign investors will be able to take stakes in newly corporatized entities, including the State Power Corp. Such investment would presumably take the form of share purchases in China or Hong Kong. Mergers of ministries and State corporations into new organizations, including those in aviation and petrochemicals, also may force these entities to put their financial houses in order and meet lagging financial obligations to foreign parties.

Bureaucratic efficiency thus may improve, as approval authority is consolidated into fewer agencies. In other cases, competition among ministries for control over certain types of foreign investment may diminish, as ministries with competing interests are conflated into a single large umbrella organization. In the cellular phone market, for example, the transfer of authority over Unicom and China Telecom, which were competitors under MEI and MPT, respectively, to the new MII may quash bureaucratic competition.

Some analysts believe the ministerial changes could also be a way for Beijing to re-assert its control over the direction of foreign investment. But indications so far from authoritative PRC sources suggest that central-level leaders, concerned about declining inflows, are intent on attracting more foreign investment. These leaders recognize that heavy-handedness is not the way to accomplish this goal. Only after Zhu Rongji has settled into his new position as premier, and implementation of government restructuring is well under way, will Beijing's intentions become clear.

Though sources at many foreign companies with longstanding China operations believe that the announced changes mean little, external events may yet force substantive administrative change. Recent events in South Korea have sparked a debate within the leadership over the applicability of the South Korean chaebol model to China. PRC leaders such as Zhu Rongji had begun to view the South Korean chaebol--large, diversified industrial conglomerates such as Samsung Group and Daewoo Group that are funded by government loans and pushed to develop exports--as a model for restructuring and developing China's industries. But South Korea's financial downturn may encourage Beijing to implement a true restructuring, not just in form, but also in substance. This would include reforming the banking sector, allowing banks to lend on the basis of economic viability as opposed to policy goals, and not resorting to chaebol-style conglomerates.

While the rhetoric of the reforms points to praiseworthy goals, severe impediments remain. The vested interests of many bureaucrats, both central and local, will work against plans that cut into their turf. The State Physical Culture and Sports Commission, upon being marked for elimination, protested so strenuously that the government actually reversed plans for dismantling the organization and simply renamed it the State Sports Administration. Whether the government will bow to an industrial ministry's resistance to restructuring is another question, but the threat of resistance remains.

The ambitious goals of the recent ministerial reforms--to aid China's market-style economic development, relax the government's grip on business, reduce bureaucratic bloat, and promote central macro-guidance--echo past themes. Because a simple change in name does not always entail a change in function, foreign businesses should carefully monitor the central-level administrative reshuffling and attempt to gauge how the changes will affect the local bureaus with which they interact. In the past, many local industrial bureaus continued to exert authority over foreign investments in their jurisdictions, despite the transformations of parent organizations at the center. If history is any guide, true administrative reform in China does not happen overnight. To work within this fluid and often politically charged environment, it remains important for foreign firms to keep a hand on the pulse of the ministries in Beijing, and rely on local-level entities to help execute business plans.

Julie Reinganum is president and chief executive officer of Pacific Rim Resources, Inc., a San Francisco-based consulting firm. Thomas Pixley is senior analyst at Pacific Rim Resources.

---

Copyright 1998 by the US-China Business Council
All rights reserved.