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Toe-to-toe with SOEs

Competitive neutrality is expected to stimulate China’s SOE reforms and build confidence among Chinese private businesses

By NewsChina Updated Jan.1

To address structural problems in its economy, China will accelerate internal reforms and is considering adopting the “competitive neutrality” principle, said Yi Gang, governor of the People’s Bank of China, at the G30 International Banking Seminar 2018 in Indonesia on October 14. It was the first time a Chinese ministerial official had expressed a positive attitude toward competitive neutrality, which aims to provide a level playing field for State-owned enterprises (SOEs) and private enterprises. This principle of equal treatment was reiterated by top officials from the State-owned Assets Supervision and Administration Commission of the State Council and China’s National Bureau of Statistics.  

Adopting the principles of competitive neutrality will give impetus to China’s stagnant domestic reform and boost confidence among private enterprises, according to Professor Lu Feng with the National School of Development of Peking University, who has conducted thorough research on competitive neutrality. In an exclusive interview with NewsChina, he said he hoped this would stimulate the endogenous dynamics of China’s economy which is facing downward pressure.  

NewsChina: What does ‘competitive neutrality’ mean? 

Lu Feng: Competitive neutrality, as defined by the OECD [Organization for Economic Cooperation and Development, a group of industrialized economies], means that “no business entity is advantaged (or disadvantaged) solely because of its ownership.” In an economy where SOEs are regarded as necessary in some areas, competitive neutrality policy aims to avoid situations in which SOEs gain special competitive advantages over private businesses. This is the way toward a level playing field for all enterprises, so market resources are distributed effectively in a market-oriented way and innovation is encouraged.  

Competitive neutrality was initiated in Australia during the 1990s to improve the country’s competitive environment. The Commonwealth Competitive Neutrality Policy Statement in Australia of 1996 states that competitive neutrality “requires that government business activities should not enjoy net competitive advantage over their private sector competitors simply by virtue of public sector ownership.” The framework mainly included tax neutrality, regulatory neutrality, debt and subsidy neutrality.  

Competitive neutrality was then promoted by the OECD to improve competition policy among its member states. It was not directed at China or any other emerging economies. However, in recent years, Western countries, particularly the US, used the concept to question China’s economic system and indicate their position in negotiations on new regional free trade agreements and World Trade Organization reforms.  

NC: Why was the policy first launched and implemented in developed countries?  

LF: Because they have SOEs, which means they needed to deal with the relationship between public and private sectors. Second, these countries have deep understandings about how a good market economy works and how to maintain national economic competitiveness.  

As the first country to adopt competitive neutrality, Australia later stressed the concept in its bilateral free trade agreement with the US, Singapore, South Korea and Japan. Gradually, the US also emphasized competitive neutrality in its free trade agreements with other countries, such as Israel, Chile, Canada, Mexico, Peru, South Korea and Singapore.  

These actions are in recognition of the fact that SOEs, existing in nearly every country, must participate in international competition on an equal basis with no competitive advantages from government subsidies or preferences. The proposed TPP [Trans-Pacific Partnership, an 11-country free trade agreement] also adopted the principle.  

NC: What’s your take on Yi Gang’s statement regarding competitive neutrality, particularly during the Sino-US trade row? 

LF: Sino-US trade friction was directly triggered by the US. The Trump administration systematically questioned China’s SOEs, subsidies and policies in its second report in 2017 on China’s status as a non-market economy. Its 301 Section report on March 23, 2018 accused China’s innovation policy of damaging US companies’ interests. Its announcement of punitive tariffs on imports from China caused China’s retaliation. The first round of punitive tariffs was enforced by both sides in early July. 

Bilateral trade tension has escalated since then. The US threatened to impose higher or more punitive tariffs on Chinese products. Moreover, some bilateral issues between China and the US are becoming internationalized and multilateral. China has to pay special attention to this new change. 

On October 24 and 25, top trade officials from 12 WTO members, including the EU, Japan and Australia, met in Ottawa with the goal of modernizing WTO rules. The communique of the meeting says that they realized ‘the need to address market distortions caused by subsidies and other instruments.’ There is no detailed explanation about what ‘market distortions’ referred to and what was causing market distortions. But we cannot ignore it just because it is not detailed enough.  
Instead, given the positions expressed by major parties of the meeting on other occasions, their intention for targeting China is clear [For example, top trade officials from the US, EU and Japan declared in a joint statement in September that the they would strengthen rules for SOEs in  
‘third parties’].  

The Ottawa meeting is not an isolated case. The questions the US has over certain features of China’s economic system are evolving into real divergence between China and major developed countries. The divergence may expand to multilateral organizations such as the WTO, B20 and G20. It’s a possibility that China has to take seriously. 

In this sense, I believe that Yi Gang’s remarks on competitive neutrality provide new ideas for China to deal with the external changes and trade conflict between China and the US. Competitive neutrality could give China an opportunity to navigate toward in China’s interests.  
NC: What do you mean by this?  

LF: In 2018, China made a series of moves to expand its opening-up to counter US unilateralism, including those announced by Chinese President Xi Jinping at the first China International Import Expo in Shanghai in November. Compared with substantial steps in further opening up, little breakthroughs have been made in domestic reforms due to various factors. It is urgent for China to take the initiative to launch a new round of necessary reforms to serve China’s long-term development and turn things around in the external environment.  

Competitive neutrality, a concept commonly used in developed market economies, was originally designed not to target any country. But in recent years it has become an excuse for some developed countries to question China’s economic system.  

For example, since 2010, the US repeatedly used it to make demands and bargain for its interest in dialogues with China, and to bring relevant changes to international trade rules. In 2011,  
Robert Hormats, then US under secretary of state, proposed that the US use policies including competitive neutrality to counter ‘state capitalism.’ In 2012, Hilary Clinton, then US secretary of state, stressed at a G20 conference [G20 Ministerial Meetings, Mexico] that G20 members should abide by competitive neutrality principles.  

The TPP reached in 2015 after rounds of negotiations led by the US, required TPP countries to ensure that their SOEs do not discriminate against the enterprises of other TPP parties and that  
non-commercial assistance to SOEs is not allowed to cause adverse effects to the interests of other TPP parties. These cases show that the US is prone to turning competitive neutrality into binding international rules.  

In this context, if China uses competitive neutrality principles as a reference to push domestic reforms forward, it will reduce misunderstandings and divergences with other countries, enhance mutual trust and meet China’s domestic demand to deepen SOE reforms and modernize its national governance system and governance capacity.  

NC: Will adopting competitive neutrality principles collide with China’s current policies? 

LF: The path of China’s economic system reform in the past several decades is in line with the principles of competitive neutrality. Forty years ago, China abandoned a planned economy and introduced a market economy based on competition. In the 1990s, it made the establishment of a socialist market economy system the goal of its economic reform. A social consensus has been gradually reached in Chinese society to encourage fair competition to  
promote economic development since then, which has also become the guideline for top decision-makers. The resolution of the Third Plenary Session of the 18th Communist Party of China Central Committee [in November 2013] pledges equal access of all enterprises with different ownership to production resources, as well as equal legal protection and regulation as they compete with each other. 

So even though China did not write competitive neutrality into its policies, the core of this policy is compatible with China’s basic experience in developing an open market economy, and consistent with China’s policies of promoting [State-owned] enterprise reform and fair competition.  

Therefore, if China could learn something from the concept and make breakthroughs in areas where deeper reforms prove difficult, it will help China enhance the degree of competition in the Chinese economy and improve the open market economy system. 

Starting necessary reforms now based on competitive neutrality principles will help boost investor confidence and market expectations, and reinvigorate innovation and investment in the private sector

NC: Will competitive neutrality principles help drive the development of Chinese private enterprises? 

LF: Competitive neutrality principles mainly target SOEs. But SOEs and private enterprises are two aspects of the same issue. In the past four decades, China has made significant progress in establishing market competition mechanisms. In reality, however, State-owned and private enterprises are still treated differently.  

For example, private enterprises still face discrimination in terms of market access and investment in many competitive sectors. SOEs and private enterprises are commonly treated differently in terms of financing, M&A and bankruptcy risk, as well as penalties for misconducts and bailouts in cases of liquidity and debt crisis.  

Therefore, starting the necessary reforms now based on competitive neutrality principles will help boost investors confidence and market expectations, reinvigorate innovation and investment among private sectors, thus bringing China’s economy out from its economic downturn and generating another round of robust growth. 

In recent years, China has been facing downward pressure despite the medium-to-high rate of growth. The long adjustment period has many reasons, including lower growth potential and an unfavorable external environment. But the lack of breakthroughs in China’s reforms in key fields, as well as voiced uncertainties [in the roles of private businesses], have weakened confidence among private enterprises and hindered the dynamics of private enterprises. It is one of the main reasons behind China’s current economic difficulties. 

At the same time, adopting competitive neutrality will help China’s SOEs to grow. There are good examples to learn from in Europe, like the Netherlands, Germany and France, where a large number of SOEs have established balanced structures of corporate governance and developed strong international competitiveness under the framework of competitive neutrality in spite of their public ownership.  

It is neither rational nor possible for China to totally copy their experiences in adopting competitive neutrality. However, China could gradually carry forward the principle with vigorous but prudent and practical efforts. For the moment, a sense of urgency is needed to push the necessary reforms in China forward.