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Can China Really Reform Crony Communism?

NEW YORK (TheStreet) -- When China's new leaders take power in the coming months, they will face a Herculean task: Reforming the nation's bloated state-owned or controlled enterprises (SOEs). Or so vowed Wang Yong, head of China's State-Owned Assets Supervision and Administration Commission (SASAC), in an Oct. 24 address to China's bi-monthly legislative session.

China had 144,700 SOEs as of 2011, excluding state-run banks. Many have restructured over the years, adopting corporate-management principles and floating the strongest subsidiaries on public exchanges, as part of the government's "grasping the big, letting go of the small" initiative. But reforms have largely stalled since 2008, and tens of thousands still lack basic corporate governance. Those enterprises also have clunky balance sheets, inefficient cost structures and low productivity -- but because they're wards of the state, and often run by the Communist Party's inner circle, they can't officially fail. Welcome to crony communism, folks.

Looking ahead, this presents something of a problem for China's economy: The sheer number of SOEs prevents private firms from entering key industries. And China's private firms tend to be more efficient, productive and profitable -- 9.9% more profitable, according to the World Bank and China's own State Council. Private firms could arguably boost China's economic output far more than SOEs over time. If they have the chance.

And giving them the chance is the SASAC's aim. In addition to accelerating corporate-governance reforms, Wang vowed to expand "market entry" into power supply, telecommunications, oil exploration and production, and petrochemicals. Premier Wen Jiabao has also pledged to bring the private sector into China's railway operations.

Needless to say, the SOEs won't make way quietly. Because of SOE leaders' tight relationship with party leadership, corruption runs rampant and bribery is an everyday practice. No doubt, SOE chiefs try to grease more than a few palms in Beijing in order to keep their precious monopolies.

For all of China's sake, though, here's hoping they're unsuccessful and Wang's planned reforms take hold. Certainly, travelers would benefit from a rail system built and managed by private firms, which are far less likely to use the slap-dash construction methods that have led to tragic crashes. After all, when state-run firms work on projects with state-imposed deadlines and state-set budgets, there's a degree of state-sanctioned corner-cutting. Private firms, with more autonomy and skin-in-the-game accountability, tend deliver safer products. And one can extend that same logic to construction in general.

Private firms would also potentially bring vast improvement to Chinese power, telecom and oil, not only increasing output, but likely finding ways to increase efficiency and lower prices for end users (assuming, of course, the government ever does away with subsidies). They'd also likely be more profitable, giving them more money to reinvest in new software, technology, facilities, innovation and labor, all of which supports higher Chinese growth.

Sure, if SOEs restructure as SASAC intends, and if private firms are allowed to compete, not all SOEs would survive the transition. Nor should they, if officials eventually want the economy to stand on its own two feet. But the strongest firms would grow, profit and find ways to compete within China and globally. Over time, that's a far greater source of economic opportunity than 144,700 bloated, corrupt SOEs.

This article constitutes the opinions and analyses of Fisher Investments as of October 2012 and shouldn't be regarded as investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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