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Angela Huyue Zhang -- The China Inc. illusion

Investments by Chinese state-owned enterprises in Europe have run into muddy waters recently.

During its scrutiny of a proposed joint venture involving a French energy group and a Chinese nuclear power company, the European Commission held that all Chinese SOEs in the energy sector should be treated as a single entity in analyzing market competition. This decision has investors concerned that future deals involving Chinese SOEs could be delayed or held up by Brussels.

Several European antitrust experts however have expressly endorsed the commission's decision and called on it to take a more stringent approach in scrutinizing future Chinese investments. One scholar went as far as suggesting that all companies with a link to the Chinese Communist Party should be treated as a single entity, regardless of their ownership status.

Given the government's omnipresent involvement in the Chinese economy and the party's pervasive control over SOEs, it is tempting to view all Chinese SOEs under the broad umbrella of "China Inc." But such a view misreads the political and economic reality in China today.

While much media attention has been fixated on the large, powerful state-owned monopolies occupying the top slots in the Fortune 500, most Chinese SOEs operate in competitive sectors. According to research by Andrew Batson of GaveKal Dragonomics, non-strategic industries represented a 49% share of SOE assets in 2011, up from 38% in 2006. SOEs operating in these sectors are highly profit-driven and engage in fierce competition among themselves and with private enterprises and foreign backed-rivals.

The assets held by the government of Shanghai provide a good illustration. The city government not only owns the ports, tunnels and airports, but also the makers of several well-known brands of soap, shoes and clothes, leading department stores, supermarket chains and book stores, a slew of luxury hotels, and a large portfolio of residential and commercial buildings at home and abroad.

Shanghai Brightfood, a multinational food and beverages conglomerate, is one city asset. Fans of Mickey Mouse may also be surprised to learn that the city holds a majority stake in Shanghai Disney Resort, the world's largest Disney theme park.

Decentralized economy

The Chinese state is by no means a unitary entity. While political power is concentrated in Beijing, most of the rights of economic governance have been delegated to local governments, including the management of state assets. Two-thirds of SOEs and a little more than a half of state assets were within the control of local governments in 2013, according to finance ministry data.

For both political and economic reasons, local governments have incentives to prop up local companies, providing them with cheap land, preferential tax treatment and financial subsidies. This in effect brings thousands of local governments into fierce competition with each other. Thus, local SOEs, though in theory all owned by the state, in fact belong to different owners with diverse interests.

For instance, Gree Electric Appliances, a leading maker of air-conditioning units, is controlled by the Zhuhai city government in Guangdong Province. Sichuan Changhong Electric, a well-known television manufacturer, is controlled by the Sichuan provincial government. These SOEs are local champions that are vital competitive assets for area governments.

Moreover, the Chinese state, despite its significant political clout, is not omnipotent. Although the central government has repeatedly tried to orchestrate competition among SOEs in strategic sectors, it has often failed to do so.

A prime example can be found in the Chinese steel industry. Despite Beijing's numerous attempts to reduce competition among steelmakers, overcapacity remains a severe problem.

As a consequence, the central government recently encouraged a tie-up between Baosteel and Wuhan Iron and Steel, two of the largest state-owned producers. To the extent that these two SOEs do compete with each other, it would be problematic to treat them as a single entity for the purpose of antitrust assessment. True, competition among such SOEs may have been fiercer absent government intervention, but there is no doubt that a merger between them reduces competition.

Legal risks

Importantly, treating Chinese SOEs as units of China Inc. would carry significant legal risk. Such an approach would jeopardize the commission's jurisdiction in many future cases involving Chinese SOEs.

For instance, the Chinese leadership is currently mulling consolidation in the oil industry, with one option being a merger between China National Petroleum and China Petroleum & Chemical (Sinopec), two large state-owned producers each with a substantial global presence, including in Europe.

The European Commission would have an important interest in intervening in such a transaction to ensure that the merger would not pose a threat to European consumers. But now that the commission has created a precedent for all Chinese SOEs in the energy sector to be treated as one entity, then presumably it no longer has a basis to intervene in such a deal, as its decision in effect means the two groups should already be considered as one.

Thus far the commission has focused on analyzing the possibility of the Chinese state influencing its SOEs. This misses the point. As long as the state retains voting power in the SOEs, it will always have power to influence their commercial decisions. This is true for all SOEs, whether Chinese, French or German. The real question to ask is not whether the state can control SOEs, but whether it actually does.

After decades of market reform, the Chinese government has neither the incentive nor the ability to coordinate competition in liberalized economic sectors. To the extent it might want to intervene in regulated or strategic sectors, the key antitrust analysis should center upon analyzing the effects of any such coordination, bearing in mind that there may not necessarily be a unity of interest among involved SOEs and that the transaction costs of coordination could be prohibitively high.

This is an empirical issue that requires not only a careful assessment of the economic landscape in the particular industry, but also a close examination of the incentives of the various governing actors involved, including the central government, local governments and the top management within the SOEs. As such, any bright-line approach is ill-suited to answer the fundamental question of the anticompetitive effects of state ownership.

Indeed, the Chinese state, due to its sheer size, its vast and intricate bureaucracy, and its highly decentralized economic system, has a different utility function than what is commonly assumed about a commercial entity and there is a limit to what the Chinese state can do.

Too often, Western policymakers and academics fail to appreciate such complexity. To act in the best interest of European consumers, the European Commission would be wise to adopt an effects-based approach to scrutinize Chinese SOEs.

Angela Huyue Zhang is a senior lecturer in competition law and trade at King's College London and author of the forthcoming book "Antitrust and the Rise of China: A Mutual Challenge" (Oxford University Press).

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