The Trans-Pacific Partnership offers enormous opportunities. These flow from its comprehensiveness, both in terms of issues and the (potential) parties to the agreement. The Trans-Pacific Partnership (TPP) embraces some of the world’s most important trading states and its provisions will guide future negotiations, including with additional TPP members.
With the opportunities come risks. The TPP’s sweep makes a dangerous misstep more likely and the probability of expansion means negotiators must consider countries not yet at the table. These challenges help explain why the TPP has taken so long to conclude.
An especially tricky area is state-owned enterprises (SOEs). The first problem is defining what an SOE is. The second is global divergence in SOEs. There are economies with few and economies with many. There are governments that make sincere and effective efforts to limit the competitive advantages offered to SOEs.[1]
There are other governments which take only superficial action. Several TPP member states remain convinced that SOEs offer irreplaceable gains. Of these, Singapore has the most sophisticated approach, centered on state-owned investment company, Temasek. While TPP talks are secret, there are indications Singapore seeks to exempt Temasek from restrictions on SOEs.[2] This would be an unreasonable position and should be rejected.
Because the TPP is so broad, Singapore and others may view sheltering Temasek as a small price for the agreement. Unfortunately, the ultimate price is far higher than implied by even a blanket Temasek exemption. Some countries not party to the TPP have very damaging SOE policies. There are scattered examples in Europe, which could affect the Trans-Atlantic Trade and Investment Partnership. But the major offender is China.
SOEs dominate two dozen sectors of China’s economy. Present “reform” efforts make SOEs larger without curbing advantages granted to them. There is also growing evidence that China may explicitly imitate Temasek, but on a far grander scale. Protecting Temasek and the entities it controls from TPP obligations is unjustified on its own but disastrous with regard to China. It could leave the U.S. with a choice of granting Beijing the means to continue to undermine competitive markets, or excluding China from the TPP permanently.
Identifying SOEs
There is dispute about what constitutes an SOE. If the state is the sole or majority share-holder, the answer is clear. Failing that, the state as controlling share-holder qualifies but the definition of “controlling” must neither be too expansive nor easily gamed by interventionist governments.
Consider:
X is a wholly state-owned holding company that presently undertakes few transactions of its own. Its listed subsidiary, Y is very active and itself controls a huge number of subsidiaries, several of which have also sold stock. One subsidiary, Z, is a limited liability corporation that operates globally, with a single outlet in X’s home country.
X is easy. Y includes private investment but is majority state-owned and sensibly classified only as an SOE. Z is not majority state-owned and appears to act on commercial principles. Further, since most operations are outside X’s home country, it is difficult to see Z as controlled by the government that controls X. However, Y is Z’s single largest share-holder and claims it as a controlled subsidiary (a variant of this has management from X dominating Z’s board).
The obvious question is whether Z is an SOE. A second follows immediately: should Y’s investment and control of Z be evaluated under the TPP’s chapter on SOEs? Or should Y’s role in Z be viewed as purely commercial? One aspect is plain: a stock market listing (Y) and having private share-holders (Z) are insufficient by themselves to qualify as a private company or be otherwise exempt from TPP requirements.
Neither the example nor the concern about SOEs being misclassified is hypothetical.[3] In late 2013, China acknowledged the need for pro-market reform, following a decade of statist policy. But prior to any reform, centrally-controlled SOEs absorbed $100 billion in what Beijing termed private investment. Some was permitted where the state was mandated to be absolutely dominant, such as power generation and the military.
The 2009 stimulus, where SOEs received enormous sums from state banks despite a far weaker business environment, makes clear SOEs were privileged.[4] The funds not only gave SOEs unfair advantages but emboldened them to act in predatory, anti-competitive fashion. Partnership with private investors did not change SOEs’ status or alter the advantages they were granted.
More ambiguous but more important is the possibility of commercial failure, the single best criterion for evaluating a firm’s status. The biggest possible advantage an SOE can have over a private company is if it cannot go bankrupt. Does Z face the same prospect of failing as its peers? If not, it is an SOE. If Z can fail commercially but the vast majority of Y’s subsidiaries cannot, then Y is not only an SOE but its operations are anti-competitive and must be restricted.
Temasek’s Status
If Singapore has in fact made unreasonable proposals regarding Temasek, it is incumbent upon the U.S. to ensure these do not undermine the TPP’s immediate and ongoing value. Temasek is an SOE and failing to treat it accordingly would invite substantive and political mockery.
It would hand U.S. Congressional opponents of the TPP an effective and accurate soundbite. An extreme demand from Singapore would be not even to list Temasek as an SOE exempted under non-conforming measures (NCM’s, what countries are permitted to do in violation of a treaty’s general obligations). This omission would undermine the credibility of the TPP in the eyes of major supporters, as well.[5]
Exempting Temasek would also be a substantive step back when the TPP is touted as a major step forward. Temasek’s own operations as merely a holding company are not a threat to competitive markets. But the many companies it owns and operates are plainly a threat. These subsidiaries were properly subject to the terms of the Singapore-U.S. Free Trade Agreement.[6] The TPP must enhance the market’s role in trans-Pacific commerce. Granting Temasek greater protections than Singapore previously agreed to would do the opposite.
That Temasek and its subsidiaries must be addressed in the TPP, as in the Singapore-US bilateral agreement, should be incontrovertible. The issue is how to evaluate its investments.[7] Singapore may claim that Temasek isa passive investor and does not alter the status of its subsidiaries. Such a claim can be investigated. If it is found that Temasek does not alter the competitive status of the firms it invests in, there should be TPP provisions to ensure this remains true. In this case, there is no apparent reason for Singapore to oppose application of TPP rules to Temasek.
Alternately, it could be found, for example, that Temasek’s subsidiaries never fail for commercial reasons or do so much less frequently than their competitors. If so or if there is other evidence of market distortion, Temasek and the firms it invests in should be subject to TPP disciplines. Granting that, it may be reasonable for some Temasek subsidiaries to be covered in the NCM section. Rather than treating all Temasek partners as SOEs, especially sensitive investments could be exempt from specific TPP rules while others must meet all obligations.
As negotiators are painfully aware, other TPP parties have SOEs to shield. An unsound approach to Temasek will weaken treatment of SOEs in Vietnam and elsewhere. It may encourage governments such as Japan to imitate the protected Temasek model. While the SOE chapter will not be perfect, it must set the right precedent. A key appeal of the TPP is the start of the long process subjecting SOEs to competition requirements in the international trade regime. The door cannot be left open to ongoing abuse.
The Chinese Gorilla
Singapore, Malaysia and other TPP partners are the minor leagues for SOE abuses. Most TPP countries want China to eventually join the agreement. If Temasek sets a precedent where SOEs can operate freely, China will drive dozens of huge firms in most major sectors through this loophole. Shielding Temasek would allow Chinese entities to receive regulatory and financial support and engage in predatory behavior that skews competition globally. It will make including China in the TPP very difficult politically and perhaps a mistake economically.
The first leap from the frying pan is size. Temasek last reported a portfolio worth $177 billion. China Investment Corporation’s (CIC) portfolio is more than three times that. And this understates the matter. The closest Chinese counterpart to Temasek is known as Central Huijin. Central Huijin is designated a subsidiary of CIC but, among other assets, owns the largest stake in each of China’s four biggest banks. The reported sizes of these banks alone would give Central Huijin assets in the trillions of dollars.[8]
CIC, Central Huijin, or whatever organization(s) Beijing designates as holding companies for state assets could easily get bigger. China has over 100,000 SOEs, where the top 300 report combined gross assets of $20 trillion.[9] Singapore is trying to sneak a knife past the metal detector while China is waiting in line with a howitzer.
Announced Chinese “reform” of the state sector does not entail shrinking that howitzer, and may use Temasek as a model. SOEs are being merged explicitly for the purpose of gaining an advantage in global competition. The sectors involved include agriculture, consumer electronics, nuclear power, rail, rare earths, and shipping.[10] This is a U.S. and global trade nightmare.
Other steps may be scarier. Chinese investment firm CITIC Pacific has some similarities to Temasek and, as a headline reform, was made much larger while seeing state ownership increase.[11] Pilot programs create “state-owned asset investment companies,” where the two models are, remarkably, Temasek and Central Huijin.[12] Consciously or not, Beijing is preparing to take full advantage of any exemption granted Temasek, at 100 times the size.
Competition would be severely undermined if Chinese SOEs can escape strong international disciplines. They received roughly $5 trillion in non-commercial loans from 2009 through 2013.[13] More subtle, Chinese regulators and the domestic firms they are supposed to oversee are both responsible to the Communist Party. Nor can foreign companies expect impartiality from a captured judiciary. None of this has been altered by WTO membership or any other agreements Beijing has made.
Most dramatic are a range of SOEs that are not allowed to fail in commercial competition within China. The protected sectors are those “vital to national security” but also that “serve as the lifeblood of the economy” and, most vague, “pillar industries and high technology industries.” From aviation to telecom, SOEs never lose.[14] If the TPP permits Temasek to be (largely) exempt, it will have very little capacity to limit the sweep of advantages China offers its firms.
Finally, it is worth nothing that exempting Temasek would not just affect China’s TPP status. The U.S. and China are negotiating a bilateral investment treaty (BIT). Beijing will immediately seize any exceptions granted to Temasek’s in its BIT proposal on SOEs. A BIT that does not tightly limit benefits for Chinese SOEs has no chance to pass the Congress, nor should it. An easy deal with Singapore now will plague the U.S. for years to come.
Think of the Children
Temasek is an SOE and its operations and, especially, investments should be examined for their competitive impact, both now and prospectively. Negotiators may understandably be caught up in the scope of the TPP and fail to address Temasek properly. This would be costly going forward – if extreme demands from Singapore are accepted, Europe and others may follow suit. Worse, extending the TPP itself will become dubious. China’s enormous state sector is already a major concern and it would be a very serious error for TPP to give Beijing a green light to continue to warp the market.
Derek Scissors is a resident scholar at the American Enterprise Institute.
Footnotes
[1] Trying to check SOEs has become known as “competitive neutrality.” However, competitive neutrality may also refer to a particular approach to SOEs, such as Australia’s, which is not ideal for the TPP.
Derek Scissors, Why the Trans-Pacific Partnership Must Enhance Competitive Neutrality (Washington, DC: The Heritage Foundation, 2013).
[2] Temasek, “Temasek Investor Factsheet,” July 8, 2014, http://ift.tt/1OkABwA and Victoria Guida, “Singapore’s demands complicate TPP – U.S.-India statement wide-ranging – EU nods to TTIP secrecy concerns,” Politico, November 26, 2014.
[3] X is China’s China Petrochemical Group Corporation (Sinopec Group), Y is listed Sinopec Corp. Ltd, and Z is Rain CII Carbon LLC, a petroleum coke producer. There are many other candidates.
[4]“China Focus: SOE reform essential to a stable and sustainable economy,” Xinhua, November 9, 2013, and Austin Ramzy, “Why China’s State-owned Companies Are Making a Comeback,” Time, April 29, 2009.
[5] United States Senate Committee on Finance, “Hearing on Trans-Pacific Partnership: Opportunities and Challenges,” April 24, 2013.
[6] Bureau of Economic and Business Affairs, 2014 Investment Climate Statement – Singapore (Washington, DC: United States Department of State, 2014).
[8] “Central Huijin raises stake in State banks,” China Daily USA, December 17, 2013, and Maria Tor and Saad Sarfraz, “Largest 100 banks in the world,” SNL, December 23, 2013.
[9] Zhiyong Wang, “China’s top 500 slows down,” China.org.cn, August 31, 2013.
[10] Jiamei Wang, “SOE mergers needed to compete on global stage,” Global Times, March 24, 2015; “China’s Huafu Group swallowed by COFCO Corp,” Xinhua, November 26, 2014; “China flat panel display makers align against global rivals,” Xinhua, October 11, 2014; Pete Swenney and Charlie Zhu, “Update 3-China nuclear power firms to merge in bid to boost global clout,” Reuters, February 4, 2015; Carlos Tejada and William Kazer, “China’s Two State-owned Railcar Makers to Merge,” The Wall Street Journal, December 30, 2014; “China rare earth producers merge,” Xinhua, December 13, 2014, and Alison Leung, “China’s top two shippers join forces in domestic container trade,” Reuters, October 12, 2012.
[11]“Cabinet approves China Everbright Corporation restructure,” Xinhua, August 2, 2014, and Yvonne Lee and Ned Levin, “Citic Pacific to Sell Shares to Strategic Investor,” The Wall Street Journal, May 14, 2014.
[12] “China names 6 SOEs for pilot reforms,” Xinhua, July 15, 2014.
[13]Derek Scissors, Testimony before the Senate Committee on Banking, Housing, and Urban Affairs Subcommittee on Economic Policy, “The Importance of Chinese subsidies,” December 11, 2013.
[14] Song Shengxia, “SOE ownership to reform,” Global Times, December 20, 2013, and Zhao Huanxin, “China names key industries for absolute state control,” China Daily, December 19, 2012.
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