Tag Archives: sovereign wealth funds

China’s State Capitalism: Leviathan Major and Minor

Three of ten largest corporations in the world are owned by the Chinese state–two energy companies, Sinopec and China National Petroleum, and a utility, State Grid. There are four state-owned enterprises in all on Fortune magazine’s list of the 500 largest companies in the world. As recently as 2005 there was none. The sluggish recovery of the developed economies from the 2008 global financial crisis has brought a bout of self-doubt to free-market capitalism. China’s model of state capitalism–dirigisme through state shareholding would be a shorthand description–is touted as the coming alternative.

Though much discussed and surprisingly widely practiced in countries rich and poor, relatively little is known about the functioning and economic implications of state capitalism in its new incarnation. The 20th century model of command economies–state-owned enterprises acting as the agents of government allocation of resources–has evolved into a 21st century one in which the state provides capital to corporations–either via equity or debt–and in the process becomes a controlling shareholder that seeks to optimize economic and political returns on its investment. The political returns manifest themselves as a wide range of public goods from industrial policy to social benefits.

Two academics, Aldo Musacchio and Sergio Lazzarini, take a look at this new state capitalism in a newly published Harvard Business School Working Paper*. First, some definitions. Musacchio an Lazarini identify two flavors of 21st century state capitalism.  One is through state majority control of publicly traded companies. China’s state-owned enterprises, such as the three mentioned above, are a prominent example. The other relies on minority investments in companies by official agencies such as development banks, state-controlled pension funds and sovereign wealth funds as well as national and local government. They summarize the two as,

the widespread influence of the government in the economy, either by owning majority or minority equity positions in companies or through the provision of subsidized credit and/or other privileges to private companies.

In short, Leviathan major and Leviathan minor.

The authors look at state capitalism around the world, not just in China. One point that leaps out of their study is how widespread the model already is, even in what are thought of as free-market economies. We pluck out of their paper this snapshot of it in China, using 2010 data, and by comparison in the other Brics.

Patterns of State Ownership in Brics
Country SOE output to non-financial GDP Listed SOEs SOEs as % of market cap. Number of SOEs with majority control No. of firms with federal govt. minority ownership
Federal State/
Brazil 30 14 34 247 n/a 397
China 30 942 70 17,000 150,000 n/a
India 13 29 4,014 217 837 404
Russia 20 12 40 7,964 250 1,418
S.Africa n/a n/a n/a 270 n/a n/a
Source: Musacchio and Lazzarini

Using Musacchio and Lazarini’s analogy of Leviathan as a majority investor and Leviathan as a minority investor, China falls under the rubric of the former. Government majority holdings in publicly traded companies outstrip minority holdings by a ratio of three to one. The average for the Brics is less than two to one. As a general rule, minority holdings are the result of state investment holding companies investing in a portfolio of firms. China Investment Corporation (CIC), the world’s third largest sovereign wealth fund by assets under management, fits that model. Though not particularly delved into by the authors, China’s state capitalism is also characterized by an upstream oligopoly of large state-owned enterprises in strategic industries, as, again, the three mentioned above illustrate.

Musacchio and Lazarini’s paper is descriptive, not prescriptive, but it does raise questions about some common consequences of 21st state capitalism that are readily applicable to China, where the 121 largest state-owned enterprises own $3 trillion in assets (2010 figures). Does China’s version, as entrenched and widespread as it is within the economy, promote or hinder the development of deeper financial markets and more professional and skilled corporate management and governance? Just as in the political realm, state, government and Party are often interchangeable, so are ownership, governance and management in the world of Chinese state capitalism.

The authors note that Leviathan major state capitalism tends to establish itself in response to market failure, notably where capital markets and corporate governance are weak. In an ideal world, it leads by example to improvements in both. Yet in China’s case, the big state owned banks are so dominant in the financial system and are such an important arm through which the government exercises monetary policy, that that may not happen, regardless of how hard the reformers are now pushing for financial reform. Which leads directly to a bigger question, whether vested interests and cronyism are so entrenched that the system is captive to its agency problem–that those running China’s state capitalism use its as a way to create and distribute public goods in order to legitimize the Party’s monopoly grip on power and to allow the ruling elite rather than the state as a whole to capture the economic rents it generates. John Hempton of Bronte Capital has provocatively described this as  China as a kleptocracy. That may be over-egging the pudding, but to what extent will determine how China continues to ascend the ladder of economic development.

*Leviathan in Business: Varieties of State Capitalism and Their Implications for Economic Performance by Aldo Musacchio, associate professor in the Business, Government and the International Economy unit and a Marvin Bower Fellow at Harvard Business School, and Sérgio G. Lazzarini, Insper Institute of Education and Research, HBS Working Paper Number: 12-101, May 30, 2012

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CIC’s Gao Shines A Little Light On China’s Sovereign Wealth Fund

In January, Stephen A. Schwarzman, chairman of the Blackstone Group, confided in our man at the World Economic Forum in Davos his surprise at the hullaballoo over sovereign wealth funds, and China’s in particular. He had seen Chinese investors at close quarters for years and known them as passive investors.

Now Gao Xiqing, president and chief investment officer of the China Investment Corp., the sovereign wealth fund that attracts the most attention, has said the same thing. Speaking at an OECD forum in Paris he said that when the $300 billion CIC takes a stake in a foreign company, it wants “to be viewed as just one of the investors” and is not looking to take control of any foreign industries.

Gao acknowledged that many foreign governments feel uncomfortable about CIC’s investments, because of the fact that it is wholly owned by the Chinese government and because of China’s rapid economic expansion, which gives it a swelling trade surplus to recycle. But he said it is not much different from other sovereign wealth funds. Which may not reassure anyone very much.

“Our government has never been transparent for about the past 5,000 years and all of a sudden we are told we need to be transparent. We are trying…”  Gao said. And he offered a couple of insights: CIC had lost around 10% of its value in recent months due to the appreciation of the yuan against the dollar; CIC has ploughed $3.2 billion into a private equity fund run by former Goldman Sachs executive Christopher Flowers that is looking to buy into financial institutions weakened by the global credit crunch.

Which also may not reassure anyone very much either.

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Steeling For A Takeover Fight

The unsourced report in China Business, here via AFX, that China’s newly launched sovereign wealth fund, China Investment Co., and a number of steel firms, including China’s biggest, Shanghai-based Baosteel, will bid $200 billion for U.K.-based Rio Tinto hits two themes.

The first is China’s concern that a combination of two of the world’s largest natural resources companies (Australia’s BHP Billiton has a $142 billion offer out that Rio Tinto has rejected as too cheap) would put near monopolistic pricing power over raw materials — iron ore for steelmaking in this case — that China needs to grow its economy in the hands of a private non-Chinese entity.

China is the world’s largest iron ore importer. World ore prices have tripled since since 2002, largely on demand from China. Similar concerns over the pricing power of a combined BHP and Rio have been expressed by the Japanese and European steelmakers’ industry associations. Brazil’s Cia. Vale do Rio Doce would be the only other iron ore supplier of similar size.

The second theme highlighted by the report is that Beijing is ready to redeploy its foreign exchange reserves for strategic economic ends via its sovereign wealth fund. That will send xenophobic jitters through the west, though it is what sovereign wealth funds do.

As I noted earlier, a Chinese-backed bid for Rio Tinto isn’t out of the question. I still think a stand ’em up, knock ’em down takeover fight for control is unlikely. That would not be the way one would expect China Investment Co. would want to announce itself to the world, but it does have Blackstone at its side should it so choose to do. (Update: China Investment Co, has denied China Business’s report.)

BHP will likely raise its offer. Rio Tinto has yet to lay out its defense (that may come as soon as Monday), and there are plenty of private equity companies that might be interested in getting in on the action. Still all to play for and the stakes remain high.

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