Dec 05, 2017 03:43 PM

Editorial: SOE Reform Must Face Up to Industrial Monopolies

Monopolies lead to poor quality, high prices and short supplies.

Recently, local governments in North China have been pushing for a switch from coal to natural gas as fuel for industries and households in a bid to reduce air pollution. However, the process has not been smooth in some ways. Some residents have been left in the cold as the installation of gas facilities has failed to take place in a timely manner. Other people don’t have enough gas to heat their homes because of shortages. The price of gas has also gone up in some places, causing a widespread public outcry.

The reasons for the ongoing heating crisis may vary, but their roots all lie in the structure of the gas and oil market. Like electricity, oil, railways, aviation and telecom, the gas sector has long been dominated by state-owned companies. The reform of monopolized industries is one of the hardest obstacles in the broader project of state-owned enterprise reform. But this obstacle has to be overcome as soon as possible, because it concerns the livelihood of the general public, as well as the sustainable growth of China’s economy.

The reform of monopolized industries started in the mid-1990s. State-owned companies that dominated the electricity, telecom and aviation industries have been broken apart, with competition introduced. Some monopolized industries also started price-setting reforms. However, there remains little competition. State-owned companies can still make excessive profits through their dominance of certain sectors. Anti-monopoly reform has slowed or ground to a halt in some areas.

Since the 18th National Congress of the Communist Party of China in late 2012, anti-monopoly measures have been back on the agenda. The central government issued a guideline in 2015 to deepen state-owned enterprise reform, laying out detailed measures for monopolized industries. When party leader Xi Jinping addressed the 19th National Congress in October, breaking state-owned enterprise monopolies was emphasized as a basic measure.

The reform of monopolized industries is very important, because state-owned companies often control the lifelines of the economy, especially the energy sector. The prices of raw materials, energy and transport in industries often dominated by state-owned enterprises can directly affect other companies’ operation costs and the public’s quality of life. The lack of competition in these industries may distort prices and prevent the efficient allocation of resources. Repeated reports of soaring electricity prices coexisting with under-utilized power generation capabilities are one example. In other scenarios, monopolies tend to become a bullying force in the market, constituting unfair competition.

After years of development, state-owned companies have entangled roots in multiple industries. If the authorities want to push ahead with anti-monopoly reform, they will have no choice, but to face down these ossified interest groups.

The central government has planned to separate governing from business, with the government only playing a supervisory role. State-owned companies have also been asked to separate their infrastructure maintenance and operation businesses. But the reforms have run into obstacles.

Even the electricity industry, which has introduced competition, has seen companies trying to hold on to their monopoly. The industrial association in Shanxi province has recently been fined 73.38 million yuan ($11 million) for organizing 23 power companies to reach an electricity supply price deal. The involved companies complained that they were just following “industry norms.” It only shows their lack of a sense of rule of law. Breaking the monopoly on energy, raw materials and infrastructure will be the key of anti-monopoly reform.

To shake up monopolies, entry barriers must be lowered in order to introduce more market competition. Competition can boost efficiency, and force state-owned enterprises to reform and to realize that they can no longer rely on so-called “monopoly dividends.” Now, it has become clear which monopolies are natural in nature; the introduction of competition to industries that were previously seen as not ready for opening-up has in fact raised efficiency significantly. The next step should be studying which subsectors of natural monopolies can be further opened up, and drafting rules to encourage and oversee the participation of private capital to push ahead mixed-ownership reform. Hopefully, it will then create a “catfish effect” to boost the vitality of more companies and help upgrade the sectors and promote innovation.

Price is the most important signal in the market. Deeper reform of monopolies cannot go without pricing reform. In August, the National Development and Reform Commission issued guidelines on strengthening oversight on monopoly pricing. And the recent guidelines on deepening pricing reform focus on monopoly industries, urging the opening of competitive sectors and their pricing, as well as increasing the role of the market steadily. This will strengthen supervision over the naturally monopolized industrial network. For sectors that will require the government to act as price-setter, there should be a comprehensive regulatory and pricing framework put in place. Over the coming three years, monopoly pricing is set to take center stage. However, questions remain whether the “visible hand” will stay on the sidelines, and if reforms will continue even in turbulent economic times. Also, while “cost appraisal plus a reasonable return” are international practices among governments elsewhere, in China, people are justifiably concerned whether monopoly pricing can actually be fundamentally changed.

As supply-side structural reforms deepen, the transformation of state-owned monopolies has become a tough spot — as well as a focus. The government must take a hard line on forging reforms, in order to build its credibility and mobilize private capital to join the cause. Meanwhile, we should spare no efforts to create a fair and competitive environment, and to strictly enforce the Anti-Monopoly Law. We must adhere to the law, get rid of anti-competitive behavior such as collusion among state-owned enterprises, and do not let them think that illicit gains will be greater than penalties. This way, the Anti-Monopoly Law can grow teeth, smoothing the path toward state reform.

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