Monday, January 12, 2009

The Central Govt's Power to Consolidate, or Not

The South China Morning Post is reporting that the State Council is considering measures "such as tax cuts and incentives, to promote consolidation in the slumping steel industry". ("Beijing to Discuss Steel Industry Incentives and Consolidation", 13 Jan 2009.) These measures are apparently separate from the previously announced four trillion RMB stimulus package.

Consolidation among steel industry firms is certainly desirable; China's steel industry currently suffers from over-capacity among dozens of firms. This news, however, is probably not anything new. China's government has been talking about consolidation for years -- among both the steel and auto industries. So why has nothing happened until now? Is it due to the central government's unwillingness or inability to force consolidation?

The evidence would seem to argue for the former.

There are plenty of examples in which the central government was able to force consolidation and/or reorganization. Recent moves with the telecom industry come to mind. Also, several years ago, the central government was successful in consolidating the civil aviation industry. Local governments all over China had their own airlines, and in one fell swoop, these local airlines (with the exception of Hainan Airlines) were divvied up among China's current Big Three SOE airlines. Regardless of the reason, it can be assumed that the central government simply decided it was time for consolidation and took steps to make it happen.

If they could force this kind of consolidation on the airline industry, then why not the steel industry, or the auto industry? Why only use incentives and suggestions? Are the reasons political or institutional?

I had a conversation this afternoon with a visiting scholar from Beijing who took a stab at a hypothesis: Not surprisingly, it has to do with the staying power of the Communist Party. The logic here (at the risk of oversimplifying) is that, planes falling out of the sky run a much greater risk of causing widespread social instability than do problems with the quality of mainland steel or autos.

Poor oversight of a fragmented airline industry could potentially lead to maintenance problems, and ultimately, to plane crashes. Such news would cause people to question the viability of the Party which has staked its legitimacy on social stability, not to mention economic growth and more nationalistic themes such as technological prowess (which could be called into question should planes start to fall).

The perceived potential for social instability necessitated actions to force the consolidation of the airline industry. The lack of such potential in the steel or auto industries means that the central government is only willing to spend enough political capital to give really strong suggestions to the local government owners of firms in these industries. Suggestions that, until now, most have chosen to ignore.

At least that's my friend's theory. Does it sound plausible? Is there any evidence that would confirm or refute this theory?


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  1. I meant, C-Dell here....

  2. While a desire to limit planes falling out of the sky is a plausible explanation for the concerted push for consolidation in the airline industry, I think connecting this to fears of social instability is far fetched. It is much more likely explained by a desire to protect the reputation of Chinese aviation as it entered a rapid expansion (including international routes) phase. If Air Gansu and Ningxia Airline planes were constantly returning to earth at inappropriate times, the average air consumer in the US (and quite possibly in China as well) would simply think Chinese Airlines = Bad, and would not exempt a much safer China Southern from this equation. As I recall Aeroflot planes were constantly crashing, but has anyone ever suggested this was a reason for the collapse of the Soviet Union? Not to my knowledge. On the other hand, I still won’t fly Russian airlines.

  3. @Charlie...

    Thanks for the comment!

    So commercial reasons also seem to be a plausible explanation for wanting to consolidate...a desire to improve their reputation. I'll buy that.

    (Which reminds me that back in the '90s, we expats had a joke that the SOE that owned/regulated the airline industry, CAAC, stood for China's Airlines Always Crash. I think they've pretty well recovered from that poor reputation since then.)

    Anyway, whether the reason for pushing consolidation is related to commercial concerns or social stability concerns, it's hard to understand why, after the big consolidation push, they allowed a few private airlines to spring up. I'm still scratching my head over that one.

    Speaking of Russian airlines, I also remember always having to ask what kind of plane I would be flying before I bought a ticket. Back then, Chinese airlines still flew some leftover Tupelovs which were to be avoided.

  4. Hi G.E.

    Thanks for all your extremely enlightening & stimulating posts!

    I'm not sure I'm so convinced by your Beijing scholar friend's explanation, at least if it is assumed that the remarkable level of fragmentation in much of Chinese industry (steel, autos, electronics, solar, batteries, etc., etc.) is increasingly detrimental to China developing the kind of nat'l-champion firms its leaders apparently desire (fragmentation + local protectionism = extreme price competition And high barriers to exit/consolidation = severe difficulty growing to scale and/or techno. sophistication). Your friend's explanation would in effect seem to imply that in the government's preference-ranking the bad PR involved in dying air passengers (or coal miners, for that matter) comes before truly building the nat'l champions. That would then appear to explain why we see consolidation in airlines and, currently, coal mines, but not in, say, autos or steel.

    The problem, for me, in this argument is that I find it hard to believe that the government gives 'safety/avoiding negative PR' a higher preference ranking than building strong firms. Even if one believes that the gov. is quite genuinely concerned about crashing airplanes and dying miners (which I generally do), it would seem very likely that 'building strong, internat'l-competitive firms' has at least equal preference ranking. And then that just reaffirms the puzzle of why we see consolidation in some industries but apparently not in others. One hypothesis could be that the "scandal value" of horrific mining & airline disasters helps those parts of the government committed to consolidation win fights that are much harder to win where such a scandal is absent.

    I'd love to pick your brains a bit more about consolidation & fragmentation in Chinese industry - Skype sometime? (I think you know who I am...:)

  5. Thanks, NM.

    What if we inject another factor into the mix?

    The government wants to see consolidation happen because it thinks bigger firms = stronger firms = national champions. But maybe there is also support for the notion of allowing the market to have a significant impact on choosing who the ultimate winners are.

    That factor, the market, would affect the degree to which the government decides to step in and take its own measures to force consolidation.

    I think my friend's point here was that maybe a factor that trumps the market is safety and the potential impact on social stability of a perception of unsafe airlines. Therefore, the government was more willing to take steps to have its will carried out in airlines than in other industries.

    Anyway, that's one possible way of viewing it.

    In terms of trying to figure out preference rankings, I generally don't find that to be a very useful tool for understanding entities that aren't entirely monolithic.

    In China's case, you would need to figure out the preference rankings of individual politburo members and State Councilors. Then you would also need to consider interaction terms in which one may trade his preferences on one issue for the support of another.

    In one of the most opaque regimes on earth, we could only really guess about such things. :)

    Feel free to email me and we can chat over Skype.


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