Alex Benedict World

When it Comes to EXIM, SOEs Could Cost China

The reauthorization of the U.S. import-export bank could be critical to U.S. companies who in the wake of the trade war with China.

By Alex Benedict

The reauthorization of the U.S. import-export bank could be critical to U.S. companies who  in the wake of the trade war with China.

A recent piece of legislation sponsored by the House Financial Services committee Chairwoman, Rep. Maxine Waters (CA-43), and cosponsored by Vice Chairman Rep. Patrick McHenry (NC-10), would restrict certain transactions with Chinese state-owned enterprises (SOEs). This bill, H.R. 3407, the United States Export Finance Agency Act of 2019, would reauthorize‒or allow the continued subsidization of American exports. The Export-Import Bank of the United States (EXIM), which currently subsidizes the foreign transactions, could potentially be affected by the current state of the bill, which restricts EXIM’s ability to interact with Chinese SOEs. EXIM is the official export credit agency of the U.S. federal government and operates as a wholly owned federal government corporation that helps assist in financing and facilitating the export of U.S. goods and services.

While Republicans are generally more against EXIM than Democrats, the reauthorization of the bill is a bipartisan issue, with members of both parties on both sides of the debate. Many representatives are against EXIM to begin with, arguing that the Bank’s ability to subsidize foreign purchases of American-made products‒but not subsidizing American purchases of American-made products‒is harmful to American businesses.

This debate is particularly salient when it comes to China, whose SOEs have historically utilized EXIM subsidies. Given the recent economic and political tensions between the U.S. and China, reauthorization of EXIM‒with new specific restrictions in regard to China‒will face an uphill battle in Congress.

The Rise of Non-State-Owned Enterprises (NSEs) in Modern-Day China

The role of state-owned enterprises (SOEs) in the Chinese economy has changed substantially in the past forty years. SOEs had previously been at the core of Chinese economic reform, but recently have been surrounded by rapid and widespread privatization of enterprises throughout China as a result of the growing demand for global, and private, economic presence (Song 345). However, since the global financial crisis of 2007-2008, the majority of Chinese SOEs are not completely state-owned, but rather state-controlled shareholding corporations––corporations in which the state has majority stake, but there are privately owned shares––or fully privately owned corporations. This shift to privatization, which allows China to remain competitive in the ever-changing global economy, has been the main driver of China’s economic growth.

A research paper published by the National Bureau of Economic Research emphasizes the importance of distinguishing between non-state-owned entities (NSEs) that were previously SOEs, and those that were not. Former SOEs “enjoy lower interest rates, larger loan facilities, and more subsidies while suffering poorer performance than never-SOEs” (Harrison 4). In other words, former SOEs do not do as well as private enterprises who have no history of state-ownership, regardless of the state resources that were used for their upkeep.

Current and former SOEs still play an important role in the country’s heavy industries‒(oil, metals, and chemicals). NSEs have become more prevalent because of their flexibility in responding to market demands, something that classic and former SOEs have difficulty doing. This could be a result of how SOEs had been propped up by the Chinese government, allowing for extensive corruption and little efficiency when SOEs enter a global market that demands efficiency. As a result, in 2015, NSEs were responsible for upward of 70 percent of Chinese GDP, 78 percent of total employment, and over 70 percent of investment in research and development (“State-Owned Enterprises” 3).

As the Chinese government is encouraged to open its markets, the opportunity for expansion of these NSEs increases. SOEs have retreated from labor-focused industries, and now focus heavily on industries that are more crucial to the state itself (national security, business competitiveness). This shift of SOE focus and expansion of NSE territory is important for a number of reasons, primarily in terms of bolstering overall economic growth. Yet there’s pushback from the Chinese government, who sees itself as the sole controller of industries it deems of strategic importance‒ like electric and coal, aerospace, and military‒because a firm grip of these industries maintains a firm grip on the political economy of China as a whole. However NSEs have the potential to take over industries the state considers less critical.

How “Private” Are NSEs? True Levels of State-Ownership in NSEs

The decentralization of the economy gave rise to NSEs, which are primarily industrial collectives, principally township/village enterprises (TVEs)––market-oriented public enterprises under the purview of local governments based in townships and villages in China––and foreign-funded firms that satisfying labor-intensive industries like construction and retail (Song 349). There are still state-induced barriers preventing NSEs from entering critical sectors like petroleum and telecommunications, as well as other various industrial sectors. These barriers limit NSEs to industries the state does not monopolize. In addition to sector hurdles, NSEs still often face monetary barriers in competing with SOEs; government banks give preferential treatment to SOEs, making up an estimated 85% of all bank loans given out in 2009. SOEs oftentimes do not repay their loans, negatively affecting the economy that NSEs were initially permitted to help repair (“China’s Economic Rise” 27). As a result, SOEs contribute much more heavily to Chinese debt than do NSEs.

As NSEs began to enter the Chinese economy in the 1980s, they relied heavily on local governments to avoid interference from the federal government. This relationship proved symbiotic, with local bureaucrats, entrepreneurs, and natives benefitting jointly with the success of the NSEs. The majority of NSEs still maintain close working relationships with the state, but there has been a movement in recent years to separate the two. Regardless of company ties to the Chinese state, which comes with inherent political and personal advantages, increasing competition from the private sector has made it more difficult for state companies to function more efficiently than those that are privately-owned. However, SOEs and NSEs alike can find success internationally.

Enterprises in China can be categorized in three ways: 1) private enterprises, or NSEs; 2) SOEs; or 3) mixed enterprises with the state as the minority shareholder. In China, the effectiveness of complete privatization is unlikely, and the government often turns to a process of faux-corporatization to retain greater control of the economy. Mixed enterprises still have some state control, but the government holds far less than the majority of the firm’s shares and has no legal rights in regard to firm operations; however, mixed enterprises have the ability to promote government reforms in the corporate sector, as government interests can more readily align with private investors (Pargendler 2691-2).

Overall, a 2006 study conducted by the McKinsey Global Institute concluded that enterprises with majority-state ownership are 46 percent more productive than SOEs with no private ownership, and enterprises with minority-state ownership are 70 percent more productive (“Putting China’s Capital To Work”). Evident from the drop in percentage share of profits and much lower return on assets, the following graphic illustrates the ineffectiveness of SOEs as compared to private companies. The numbers are telling of the impact that maintaining control of these enterprises will have on productivity in the Chinese domestic and international economies.

Picture2
Source: The Economist

EXIM and H.R. 3407

H.R. 3407 is part of a trade war perpetuated by the Trump administration’s own concern regarding Chinese economic strength and tries to address the struggles that the WTO has with economic regulation of Chinese enterprise. In a report on the U.S.-China Economic Relationship, the Brookings Institute writes that “state control over public and private businesses makes it difficult to distinguish between what is a public body and what is private, thereby making unclear whether…there is a rule or regulation issued by a public entity that is subject to WTO rules” (Meltzer).

The way to remedy the trade war is not to impose greater restrictions on business with Chinese SOEs, but to enact WTO guidelines. China is notorious for disregarding WTO rules, and the WTO is unequipped to reprimand China for its noncompliance. The trade war is already detrimental to American workers, especially farmers and manufacturers, whom the tariffs imposed by China affect most.

The reauthorization bill stipulates that any transaction that EXIM finances over $25 million relating to a Chinese SOE cannot be used to “provide material or financial support to the following policies and operations of China: 1) military or intelligence; 2) ‘One Belt, One Road’ initiative, a program started by Chinese President Xi Jinping. The initiative is to create “a vast network of railways, energy pipelines, highways, and streamlined border crossings” westward, southward, and throughout the rest of Asia, subsequently increasing the use of Chinese currency, the renminbi; 3) abuse of human rights, including freedom of speech” (FSC Majority Staff) [Chatzky]. Additionally, any SOE-related transactions greater than $25 million require the consultation of an appropriate federal agency, as well as a US Trade Representative’s certification within 60 days. H.R. 3407 will reauthorize EXIM if passed, but has a way to go before that happens.

While the presence of NSEs in China is increasing, the Chinese Communist Party (CCP) still retains control of China’s economy, hurting China if this bill is passed. But the passage of the bill with such heavy restrictions will also have severe implications on U.S. companies and businesses, many of which benefit from trading with China and its SOEs.

A Bipartisan Bill

The bill is contentious with Republicans and Democrats alike, many of whom have their qualms with the bank. Representatives on both sides of the aisle are worried about its impact on U.S. companies who do business with China. They see certain U.S. trade, especially that H.R. 3407 restricts with Chinese SOEs, as of economic importance and not detrimental U.S. foreign policy. Many business deals between U.S. companies and Chinese SOEs are thought to be simply transactional and not related at all to foreign policy.

While opposition is a bipartisan front, there is a core group of fiscal conservatives who vehemently oppose EXIM. They oppose because of instances like the following: American company Boeing was able to sell their jets to AirIndia through EXIM subsidies, even though AirIndia is in direct competition for trade routes with American airline Delta. EXIM’s role allowed for AirIndia to offer lower fares for certain flights, beating out Delta and hurting American enterprise.

Just as opposition to EXIM is a bipartisan issue, so is its reauthorization without restriction. Members who represent districts with high levels of manufacturing or those that contain large American corporations (i.e. Boeing) will be more invested in the bank’s reauthorization without restriction since it is in the best interest of their district (and reelection).

While there are a multitude of problems with EXIM–especially that of promoting corporate welfare at the expense of the American people–shutting down EXIM likely will only further hurt U.S. companies. There are over 100 export credit agencies globally today, all of which will remain intact if EXIM is not reauthorized, putting foreign countries and companies at an inherent advantage over U.S. companies.

With the reauthorization of EXIM and the ongoing trade war, tensions are running high. The implications of H.R. 3407 on American businesses are real, but so are concerns of American business contributing to Chinese state-owned enterprises. While it may be true that China is a threat to U.S. global hegemony, restricting American enterprise, especially when other foreign EXIM-like banks go unaffected, is not the way to tackle this economic threat.

Works Cited:

Image: https://www.gtreview.com/news/global/expert-analysis-how-trading-companies-can-circumvent-protectionist-policies/

Chatzky, Andrew et. al. “China’s Massive Belt and Road Initiative.” Council on Foreign Relations. https://www.cfr.org/backgrounder/chinas-massive-belt-and-road-initiative

“China’s Economic Rise: History, Trends, Challenges, and Implications for the United States.”Congressional Research Service.

FSC Majority Staff. “Memorandum: June 26, 2019 Full Committee Markup.” The House Financial Services Committee.

Harrison, Ann et. al. “CAN A TIGER CHANGE ITS STRIPES? REFORM OF CHINESE STATE-OWNED ENTERPRISES IN THE PENUMBRA OF THE STATE.” The National Bureau of Economic Research.

Meltzer, Joshua, et. al. “The US-China economic relationship: A comprehensive approach” The Brookings Institute.

Pargendler, Mariana. “State Ownership and Corporate Governance” The Fordham Law Review. “Putting China’s Capital to Work: The Value of Financial System Reform.” McKinsey Global Institute.

Song, Ligang. “State-owned enterprise reform in China: Past, present and prospects.” China’s 40 Years of Reform and Development.

“State-Owned Enterprises in the Chinese Economy Today: Role, Reform, and Evolution.” University of Alberta China Institute.

 

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