Layoffs and the limits of state-enterprise reform

I recently came across an interesting paper by Daniel Berkowitz et al. entitled “Recasting the Iron Rice Bowl: The Reform of China’s State Owned Enterprises” (here’s a working paper version). They come up with a fresh interpretation of the peak period of SOE reform (roughly 1997-2007), arguing that the main effect of reform was to greatly lessen the political pressure on SOEs to hire lots of employees. Once that pressure was released, SOEs could become more profitable by laying off workers and spending on new capital rather than new employees; as a bonus, the remaining SOE employees got much higher wages.

We find that SOEs profitability increased primarily for two reasons: first, because the elasticity of substitution between capital and labor exceeds unity and SOEs had preferential access to capital, SOEs could become profitable by increasing their capital intensity: And, second, the state placed its SOEs under less political pressure to hire excess labor. We also find that, with the exception of the top central SOEs, in general SOEs became profitable without having impressive productivity gains. …

It is striking that overall employment in SOEs during 1998-2007 fell by 62.9%, while employment within private and foreign firms grew by 644% and 202%, respectively. It is also striking that SOEs increased the capital intensity of their production processes more aggressively than private and foreign firms. During 1998-2007, the aggregate capital intensity grew by 34%; however, the 127% growth within SOEs was much more rapid than the 68% growth within private firms and the negligible (-6.7%) growth within foreign firms. While the capital intensity for SOEs in 1998 was 0.89 and comparable to the foreign firms (0.99) and higher than private firms (0.48), by 2007 the SOEs’ aggregate capital intensity of 2.03 was roughly 2.5 times and 2.2 times higher than in the private and foreign sectors.

There are two other noteworthy patterns for labor and wages. First, the overall real wage in manufacturing grew by 162%, and these gains were most pronounced within SOEs (228%), then within private firms (136%) and, lastly, within foreign firms (114%). State-sector real wages in 1998 were close to private-sector real wages and roughly one-third lower than foreign-sector wages. By 2007, state-sector wages were roughly equivalent to foreign-sector wages and almost 50% higher than private-sector wages. Second, labor’s share of value added fell by 7.9 percentage points. This change was most pronounced for SOEs (a 14.1 percentage point decline) and then private firms (a 6.7 percentage point drop), and negligible within the foreign sector. Thus, labor’s share within SOEs fell because the declining rate of employment exceeded the increasing rate of wage growth.

Ending the state sector’s historic role as an absorber of excess labor was an important achievement. But having too many workers was not the only thing dragging down SOE performance. The important corollary of these findings is therefore that the internal restructuring of SOEs was rather limited despite apparently impressive improvements in profitability.

On the authors’ analysis (which is confined to the industrial sector) SOEs became more profitable but not much more productive. SOEs that were privatized did become more productive than SOEs that were not privatized. Since privatization largely stopped after 2007, this channel for improving productivity went away.

I have previously argued that calling a halt to SOE privatization was a policy mistake that should be reversed, and this paper supports that line of argument. The deterioration in both SOE profitability and productivity since 2008 by themselves make a strong case that the achievements of the 1997-2007 reform period were less substantial than widely perceived at the time. In hindsight the cyclical boom in the economy was probably much more important.

The paper’s data on the decline of SOE jobs and rise of SOE wages also help shed light on other questions. In more recent years there has been a fair amount of public resentment of the high salaries of SOE employees. It seems plausible this was aggravated not just by SOE wages moving higher, but also by SOE jobs becoming much fewer and harder to get. The pattern of keeping discipline on employment and focusing on capital-intensive expansion strategies has, at least in my impression, continued since 2007. There has been some increase in total SOE employment since 2010, but a very modest one.


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