6. Technology, Classification of Scale and Industrial Organization: Why Can China's “Large Enterprises” Make Higher Profit Margins?

Zhang and Shi (2003) made a systematic and analytical review of the empirical research literatures on the change of efficiency of China's state-owned industry in the post-reform period. Moreover, Keijiro Otsukam, Li Deqiang and Murakami also did a review on these research literatures in their latest work, on the basis of which, they revised many existing research conclusions and conducted an in-depth analysis of the efficiency differences between state-owned and non state-owned enterprises by using more detailed methods and direct survey data.. In addition, recent studies on the performance of state-owned enterprises in China also include Reform of State-Owned Enterprises of China compiled by Jefferson and Xin Ge.

For example, Jefferson (1990)’s research on China's iron and steel industry is probably the earlier literature on economies of scale. The related literature later on include Cao (1994)’s research on iron and steel enterprises, Lo (1999)’s study on the overall state sector, as well as research done by. Murakami and others (1996) and Zhang (1997).

Perkins (1994).

Naughton (1995).

Lin et al. (1994, 1997).

The research in this field is very rich in the literatures of development economics. See the review of literatures provided by Lo (1995). Topic studies on countries are mainly targeted at South Korea, because from the 60s to 80s, economic development strategy in South Korea is typical of the “catching-up strategy”—the government's industrial and trade policies, to a great extent, were aimed at “natural” ratio of twisted factors and changing the given “comparative advantage” so as to achieve “competitive advantage” through creating the scale economy.

In a fairly long period of time, many economists in China have also linked the economies of scale with the ownership system. One version is that in the so-called “natural monopoly” industries with remarkable economies of scale, the state ownership of enterprises should be kept unchanged. However, there is a great deal of disagreements among economists about the fate of state-owned enterprises in competitive industries. Some propose that state-owned enterprises should “withdraw partially”, allowing coexistence of a variety of ownerships while others argue that state-owned enterprises should “completely withdraw” from the competitive industries.

The Third National Industrial Census Office (1997).

National Bureau of Statistics (1992, 1994).

Jun Zhang offered a logically consistent explanation of the changing loss patterns of the state-owned sector in China since the reform, see Zhang (1998, 2000).

Early studies of the changing patterns of the profitability of the state sector can be found in Naughton (1995). Also, Lo (2000) provided a review and comments on the existing research literatures. Zhang (2001) made further revisions to the existing explanations of the decline in the profitability of the state sector and proposed an explanation more consistent with empirical observation, see Zhang (2001).

Otsuka et al. (2000).

Otsuka et al. (1998).

Jiang (1999).

Cao (1994).

In China, this vertically integrated structure is commonly known as “big or small, it is all inclusive”. Of course, in fact, this kind of structure is still typical of state-owned large enterprises. We have carried on a thorough analysis of the shaping logic of this structure of the state-owned enterprises under the planned economy system. See Zhang (1992).

For example, the state-owned iron and steel enterprises not only produce steel, but also iron ore, pig iron and steel. Large state-owned machine tool enterprises not only produce machine tools, but also machine tool parts. The state-owned chemical enterprises not only produce chemical raw materials, but also chemical consumer goods. State-owned TV enterprises not only produce TV sets, but also supporting equipment and intermediate products such as picture tubes. We rarely see highly specialized manufacturers producing only one product among large state-owned enterprises.

Granick (1990) made an in-depth analysis of this structure of property rights, see Granick (1990). Qian and Xu (1993a and b) further treated this structure as a “M-type” structure and believed that the existence of such a structure became a good starting point for the rapid entry and expansion of the non-state sector after the reform.

But, in theory, as shown in Fig. 6.2, one possibility that large enterprises’ profitability will be improved when the structure of industrial organization is “sticky” is the profit margin curve moving upward, rather than moving along the given curve of profit margin. The emergence of this situation is often the result of technological innovation. But it is obvious that China's large enterprises do not have the inherent mechanism of technological innovation. So the movement of the profit margin curve itself will hardly happen in China's large enterprise sector.

If definition 1 for large enterprises changed from the original value of fixed assets of 100 million to 50 million yuan (i.e., definition 2), the number of large enterprises in textile and machinery industries would soar to 471 and 491. See National Bureau of Statistics (1992).

Otsuka et al. (2000).

Byrd (1992).

Sabin (1992).

Firms with too large productivity gaps existing in the same sector without being integrated are typically found in China's steel sector. See Otsuka et al. (2000).

It is obvious that the fact that enterprises with significant differences in productivity can exist in the same sector is the product of the property right system of state-owned enterprises and the centralized capital formation system under the planned economy. Since the 1980s, although the decision-making of investment has been decentralized, the property rights system of enterprises has not changed. Therefore, the basic characteristics of corporate investment and the formation of state-owned capital have not changed as well. The extraordinary growth of demand scale at the beginning of the reform has further encouraged and strengthened this differentiation.

Chen (1999). Chen (1999) provides a detailed analysis of the technological acquisition methods and technical choices of Chinese township enterprises. He pointed out that in the early stage of industrial transition, township enterprises obtained technical input mainly through state-owned enterprises (make use of the obsolete equipment of state-owned enterprises and hire their technical personnel) and achieved growth by producing labor-intensive products. But since the late 80s, due to the change of market demand, township enterprises began to invest in the production of technology or capital intensive products, resulting in a gradual increase in capital/labor ratio of township enterprises. This choice of the technology may not be caused by the rapid rise in labor prices, but may reflect the nature of collective property rights of township enterprises in their mode of investment.

Tan and Tang (1986).

Chow and Fung (1998).

The “double increase project” is a program initiated and implemented by the State Economic and Trade Commission at the end of the 8th “five-year-plan” to increase the technical transformation investment in key enterprises and industries as well as accelerate the pace of enterprise reform.

Jun Zhang provided a comment on the evolution of the reform policy of large and medium enterprises.

With regard to this conclusion, one can see the empirical study on the determinants of the profitability of Chinese state-owned enterprises based on the third national industrial census data done by Jun Zhang and others.

As to the meaning of technical efficiency, see Farrel's distinction method proposed in his classic paper of 1957.

Yao (1998).

Lo (1999).

In calculating the actual labor productivity, we use the price index of industrial net output value provided by Lo (1999).

Nolan (1996).

Murakami et al. (1996).

Jefferson (1990).

Our conclusion is similar to that reached by Zhang (1997) in his earlier studies. His measurement results show that there are different degrees of increasing returns to scale in textile/garment, light industry, petrochemical and chemical industry, building materials industry and other industrial sectors. In his research, the other 4 sectors have different degrees of diminishing returns to scale, but the return of scale of all the enterprises exampled is basically unchanged.

Liang et al. (2000).