Economics Update (January-March 1996)

China Moves Toward Market Economy
With Business Mergers, Acquisitions

hina has chosen a new economic path.

Compared with economic reforms attempted in Russia and some Eastern European countries, China's approach to privatizing and consolidating businesses has a few apparent advantages—it provides for more experienced management and infusions of capital and allows for a slower transition, which gives the government finer control.

In an article in the November/ December 1995 issue of Economic Review, Jie Lin Dong, president of E-W Communications Inc. and publisher of China Finance, and Jie Hu, an economist in the financial section of the Federal Reserve Bank of Atlanta, examine the use of business mergers and acquisitions as a way of privatizing the Chinese economy, documenting the history and development of these activities and addressing some of the challenges the government faces in this attempt.

As China pushes its market-oriented economic reform forward, there seem to be three reasons behind the emergence of its mergers and acquisitions market—reasons that are likely to continue driving the market's development.

First, the government is essentially being forced to restructure and revitalize state-owned enterprises, especially the unprofitable ones.

Second, the new enterprises have growing needs, such as increasing capacity, upgrading technology, diversifying or divesting, and expanding into broader geographic areas. Mergers and acquisitions help enterprises meet these needs.

Third, the mergers and acquisitions policy helps attract foreign investment, which certainly is preferred over government bailouts.

Economic Reform

China's economic reforms started in the agriculture sector in 1978 when farming was on the verge of collapsing. The shift from the commune system to family farming improved productivity dramatically.

Rising inflation and political up-heaval delayed the spread of economic reforms to the industrial sector until 1992.

But then the government began allowing—in fact, encouraging—inefficient state-owned enterprises to merge with better-run state-owned enterprises, collective enterprises, private enterprises, or foreign business interests.

The goal is to convert state-owned and collective enterprises into joint-stock companies, which distribute shares of stock among individuals, institutions, and the government or into private businesses.

For example, the Vantone Company, one of the largest private enterprises that has prospered from the booming real estate business in Hainan Island, has made inroads into the retail and pharmaceutical businesses by acquiring state-owned enterprises.

China's approach is to move slowly with this reform. The advantage of moving slowly is that the government has more time to establish rules and solve problems as they arise. But the disadvantage is that economic growth may not come quickly enough to offset the problems associated with the rapidly deteriorating state-owned enterprises.

Rules are being drafted as the new market evolves, but often the rules are vague or redundant.

Among the rules, however, are restrictions that mergers and acquisitions must be compatible with the government's industrial strategy; state-owned enterprises related to national security, military defense, advanced proprietary technologies, scarce minerals, and other sensitive enterprises cannot be sold to private or foreign investors; the government must retain a majority interest in industries such as energy, transportation, or communications; and the merger or acquisition of a large state-owned enterprise that is the backbone of an industry must be reviewed separately.

The Results

Jie Lin Dong and Jie Hu note that too little research has been done on the mergers and acquisitions to evaluate effectively the virtues and vices of China's approach.

But so far, they said, the mergers and acquisitions appear to have had several positive results. Revitalized state-owned enterprises have relieved some government burden, international investors are reacting positively, and privatization has allowed more opportunities for individuals to start or expand businesses.

Still, the authors noted several concerns and issues that must be resolved. For example, mergers can result in worker layoffs. Also, information about Chinese businesses is not properly dispersed, so buyers and investors aren't confident of the opportunities. Many policies, procedures, and systems need to be established or developed—such as a judicial system, a tax collection system, a social welfare plan, revisions in the role of China's central bank, and a system of checks and balances.

In conclusion, the authors said that more research is needed on mergers and acquisitions in China and more time is needed for the impacts of reform to appear as the nation's rapid growth and immense potential position it to be a more and more significant element in the international market.
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