Tread carefully with privatization

Reforming coal and steel through sell-offs might not be the best solution for the country or the environment

It came as no surprise that this year's Government Work Report, by Premier Li Keqiang recently unveiled, highlighted the strategic importance of reform inside and across the state-owned enterprise sector - and the steel and coal industries in particular.

But it will probably surprise many outside China and across Europe if a more accurate picture is portrayed of the challenges facing the steel and coal industries in China. It will also surprise many across Europe if rapid privatization is proposed.

In fact, it may well be the case that coal consumption in China, a major source of carbon dioxide emissions, has already peaked and this downward trend over the past few years is set to continue and even accelerate.

These coal burning figures, therefore, establish clearly that any wholesale sell-off from public to private sector of the Chinese coal industry should be scrutinized very carefully.

Privatization of large parts of the Chinese coal industry could even reverse the successes achieved in recent years. Driven almost entirely by the need for higher and higher profits, privately-owned coal plants will not share the government's concern for environmental protection and a long-term reduction in the current over-reliance on fossil fuels generally.

The private sector, when faced by any continued decline in demand, will also have no hesitation in cutting its workforce amid other draconian cost-saving measures.

Some sort of government control and hands-on involvement would lead to far less painful shedding of staff, coupled with extensive efforts at, and investment in, retraining of redundant workers.

Turning to the Chinese steel industry, long plagued by overcapacity, it is also necessary to establish a clear, accurate picture of this industry's supply and demand position and the challenges faced.

According to a recent report by BMI Research, China's overall steel consumption is set to increase to just over 87 percent of production. Clearly, overcapacity remains an issue but, with increasing domestic demand, this challenge is far from insurmountable.

Western fears, frequently fueled by the media, of ever-increasing steel production and steel dumping are not based on an accurate account of supply and domestic demand. Rather than a flood of Chinese steel dumped on international markets this year and going forward, it is increased domestic steel consumption that will snap up industry production.

It is the steel industry, perhaps more than any other, that is often cited as ripe for consolidation and privatization due to the popular belief that overcapacity is rife and out of control. But the facts far from support this view. It is increased demand due to the growing real estate and construction industries in China that has primarily contributed to a trend in a rebalancing of supply and demand for Chinese steel.

As a result, Chinese steel inventories as a proportion of total production fell to an all-time low of just 8.2 percent at the end of last year. The recent BMI report also finds that average exports of domestically produced steel fell by 17.5 percent last year.

While China's coal and steel industries no doubt face challenges and require reform, it is clear from the reports cited above that tangible progress is being made, with even a positive trend taking shape in recent years.

But continued reform of these strategic industries should not only build on the significant progress achieved in recent years. It should learn from the mistakes made by many Western governments with their rushed and often botched privatization programs.

Creating and maintaining competition is essential for consumer choice and corporate competitiveness in most industries but not in strategic industries such as steel and coal. Such industries, of course, need to avoid overcapacity and strive to minimize inefficiency while fostering a modern business culture built on teamwork, creativity and innovation, as well as product and service quality.

But it is one of the biggest myths that this cannot be achieved and maintained with public ownership. Unfortunately, Western governments and their privatization plans for both steel and coal have sought to remove virtually all government ownership and control with immediate effect.

Western governments appear to have assumed that some sort of private-sector panacea acts like a magnificent magic wand which in one fell swoop returns bloated, inefficient and loss-making public utilities to lean, market-oriented and profit-making private sector companies. It does not. Not at all.

What Western governments have found is that wholesale privatization has led to dominance in these industries by one or maybe only two bigger and bigger privately owned companies. Steel and coal are industries where economies of scale and little or no room for substantial product differentiation dominate. As a result, it is almost inevitable that the larger corporate players grow and grow, either driving smaller, less financially muscular rivals to extinction or simply gobbling them up with aggressive or even hostile takeover maneuvers.

Market share concentrated in a few very powerful players soon emerges where barriers to entry are raised to insurmountable levels.

Soon after, prices rise and investment falls, especially in health and safety, as these mega-sized industry bullies are driven entirely by rapacious shareholding investors and greedy senior managers.

If we take the United Kingdom as an example, although there are countless more examples, we see nothing but higher and higher prices and poorer and poorer service and safety levels.

China's central government should learn from the West and guard against wholesale privatization.

This is not to say that further reform should not include a move toward privatization with more input and influence from the private sector.

An immediate move to appoint private-sector professionals, possibly with a proven track record of turning around ailing companies, could be considered as part of some sort of partial privatization.

China's central government could also reduce its total ownership of the largest steel and coal producers, but such a reduction should be gradual, with partial but suitably significant government ownership ensured. There should be no salami-like slicing and erosion of any government stake in the coal and steel sector. It is only government ownership and decision-making authority that will guarantee continued progress and ensure accountability.

Private-sector profit-making objectives of course play an important part in improved efficiency and overall competitiveness, but increasingly dominant privately owned players will lead (and has led across large parts of Western Europe) to excessive profiteering and an almost total neglect of any contribution to broader societal goals, such as reduced pollution.

Finally, it is perhaps Western governments, many of them European, that can learn from China's central government and the real progress made in reforming both coal and steel sectors. Government influence and involvement in coal and steel, in the case of China's central government, should pave the way for some sort of partial renationalization by many European governments.

The author is a visiting professor at the University of International Business and Economics in Beijing and a senior lecturer at Southampton University. The views do not necessarily reflect those of China Daily.