China need to loosen up control on defense industry and allow private company to get involve in defense related industry But it is not easy
Privatizing China’s Defense Industry
China hopes to create its own military-industrial complex, but it won’t be easy.
By Zi Yang
June 07, 2017
The Chinese defense industry has once again become the focus of world media after a string of attention-grabbing headlines this year. On April 25, the Thai government approved a $393 million
with China. The day after, China’s first domestically built
was launched at Dalian port. The following week, China’s first civilian airliner, the
took its maiden flight, another feat for the defense corporations involved.
Now the world’s second-largest spender on national defense, China is advancing reforms in its defense state-owned enterprises (SOEs). Xi Jinping, as commander-in-chief, has long been vocal about
, a sentiment shared by his colleagues on the Central Military Commission (CMC). In 2015, General
, vice chairman of the CMC, “called for China to develop a military-industrial complex like the one in the U.S.”—where the private sector and the invisible hand assume the leading role.
Hungai (混改), or mixed-ownership reform (MOR), is the vehicle for reaching this goal. Why is MOR needed? How does the state intend to implement MOR? What are the obstacles facing MOR? Will MOR succeed in helping China catch-up with the U.S. defense industry? I propose that MOR will have limited success because of the structural restrictions of the Chinese defense industry.
Why MOR
In 2016, China had a
of $146.6 billion, and the
of its defense industry was estimated to be around $362 billion. Yet despite the astronomical figures, the Chinese state-owned defense industry has many underlying challenges common to corporations of its type. (Wholly or partially state-owned
share strikingly similar problems.) With soft budget constraints and shielded from competition, it is not a surprise that inefficiency, lack of innovation in certain areas, and mounting debt are prevalent among defense SOEs.
MOR hopes to remedy these problems by drawing in funds, expertise, and methods of operation from the non-public sector. One of MOR’s twin goals is to relieve the state’s financial burden by broadening access to capital market financing — from 2010 to June 2016, the defense industry raised
from issuing bonds and equity. The other, perhaps more important long-term objective is to introduce market forces into the industry and pressure company executives toward reform along market lines — hence the emphasis on mixed-ownership.
How to MOR
There are three main methods for implementing MOR. Securitization, a critical mean of fundraising by transforming assets into securities, is one leg of the tripod. The current Chinese defense industry securitization rate is comparatively low, at
, when U.S. counterparts stand at 70 percent. Although the state would like to have more defense assets go public, national security remains a concern because the most productive assets (i.e. research institutes) generally hold classified state secrets. For years there have been talks of injecting research institute assets into publicly traded companies.
surfaced in January 2017 about plans to reorganize secret and non-secret research institute assets, and a March article confirmed that research institute reform plans have been
.
An employee stock ownership plan is another method. Designed to raise employees’ enthusiasm for their work, the
caps employee company ownership at 30 percent, “with each individual employee owning no more than one percent of the total.” The state stakeholder, however, will still hold at least 34 percent of a company’s total equity. The plan is currently being tested in pilot programs.
Public-private partnerships manifested through civil-military integration constitute the third pillar of MOR. Encompassing both defense conversion (
junzhuanmin; 军转民) and civilian contracting (
mincanjun; 民参军), civil-military integration seeks to reduce technological redundancy and accelerate the exchange of dual-use technology. Currently, civilian goods constitute
of China’s two largest shipbuilding conglomerates’
.
In March 2017, the People’s Liberation Army (PLA), for the first time in its history,
more than 3,000 dual-use technology patents and
2,346 to the public in an effort to increase transparency, incentivize innovation, and facilitate defense conversion. The patents included a synthetic aperture imaging system, a high power pulse modulator for a medical linear accelerator, a lateral drift control method for unmanned helicopters, and a blast energy absorbing honeycomb structure, to name a few. In addition, the military opened more of its current projects to civilian contractors. However, the
between the state-owned and non-public sectors remains, as the former still mistrusts the latter, and the latter wishes for more leverage in dealing with the former.
MOR Outlook
There are a few challenges facing MOR in China. Although eroding under the anti-corruption campaign, entrenched interests in the defense industry can always make an argument against market-oriented reforms in the name of national security. The chasm between the state-owned and non-public sectors is deep, and it will take time before defense executives are willing to share power with new owners based on fairness and mutual respect.
Chronic underperformance makes some defense assets a tough sell. Companies related to military informatization are performing well. Five out of eight subsidiaries of the
, specializing in informatization, witnessed year-on-year net income growth in 2016. Seven out of eight have debt to asset ratio above 33 percent, while five out of eight enjoyed over ten percent ROE in 2016.
However, high debt-to-asset ratios and unsatisfactory return on equity (ROE) are common among other firms. China Shipbuilding Industry Corporation (CSIC) and Aviation Industry Corporation of China (AVIC), two of the
defense companies behind China’s first aircraft carrier and civilian airliner, respectively, are not performing well. CSIC’s two listed arms are experiencing net income growth, but their ROEs are below satisfactory. The ROE for China Shipbuilding Industry Co. Ltd. (SHA:
) in 2016 was 1.23 percent and 1.73 percent in 2017. China Shipbuilding Industry Group Power Co. Ltd. (SHA:
) had a ROE of 4.22 percent in 2016 and 6.05 percent for 2017. Only one out of AVIC’s 14 defense subsidiaries has a satisfactory ROE of above ten percent. Nine are more than 50 percent in debt.
