Endnotes

¹ The market economy is an opposing concept to the command or planned economy in the PRC. The market economy is one where resource allocation is adjusted through the market mechanism (Chen Zhongsheng, 1999 [6]). Realizing a market economy is the objective of the PRC economic reform. Though there are great differences among different types of market economies, such as the UK, USA and Japan, in Chinese eyes there is a common character to all market economies, i.e. people acknowledge the scarcity of various resources, and both individuals and firms are basically free to make decisions about what is produced, how much to produce, for whom to produce and how to produce, based on supply and demand. Thus, it is clear that in all market economies (whether the UK, USA or Japan) resource allocation is mainly dependent on the market rather than on administrative fiat, laws, etc. Compared to the traditional Chinese socialist economy, they all have great advantages and are worthwhile for the PRC to follow.

² Privatization usually refers to the process of selling or giving away the existing stock of government production assets. In reality, there is another type of privatization, called privatization at the margin, in which the state maintains ownership of existing assets but allows non-state owned investors to make new investments and therefore obtain partial ownership of total assets (David D. Li and Changqi Wu and Tao Li, Feb 2004 [16]). In the PRC, both types of privatization existed during the reform process, leading the state-owned asset share in total assets to continue to decline.

³ In the PRC, economic overheating and high inflation are seen as outcomes of social aggregate demand exceeding supply (excessive demand). Since aggregate demand is composed of aggregate investment, consumption and net exports, and consumption is stable and net exports are small or nearly zero in the long run, excessive demand is mainly caused by excessive investment (investment demand exceeding supply). At the micro level, this means investment beyond the point at which the marginal return exceeds the relevant opportunity cost of capital. Under the assumption of profit maximization, if a firm’s objective function deviates from profit maximization, the marginal return to capital will be lower than the level of profit maximization. This case is allowed to exist in the PRC because of soft budget constraints (see Chapter 5).

⁴ "Soft budget constraints" are a widespread phenomenon in the socialist system, meaning that since financial resources (banking loans, fiscal revenue stock market quotas, etc) are mostly controlled by the government (even in market economy countries there are light soft constraints), the supply of funds is softly constrained and the excessive demand for loans is easy to satisfy.

⁵ In 1997 the 500 largest state owned enterprises held 37% of all the assets of state industrial firms, and contributed 46% of the tax revenues collected from all state firms and 63% of total profits in the state sector. By contrast, smaller firms owned by local governments were performing poorly: in 1995, 72% of firms owned by local governments were in the red, compared with only 24% of the centrally owned firms. (International Finance Corporation, 2000)

⁶ Table 3.1, 3.4 and 3.5 are not consistent because they come from different sources, which adopt different statistical standard. For example, a parent company headed by one boss may include several subsidiary companies, which are allowed to register as different enterprises. However, China Second National Census regards them as one company. So the number of enterprises in Table 3.5 is less than the number shown in Table 3.4.

⁷ It is reported that after the B share market was opened to domestic investors, many B shares came to be owned or traded by very small mainland retailers, that is not what the CSRC originally planned for this market (SCMP, April 14, 2004 [27]). Furthermore, since July 2003, major foreign investors can buy Chinese stocks under the Qualified Foreign Institutional Investor (QFII) scheme without going through the B share market and its raison d’etre may diminish.

⁸Under the ST (special treatment) and PT (particular transfer) system, companies with poor performance become ST or PT instead of being de-listed, and price fluctuation ranges are limited to some extent. Because of this, the shares of these companies became the target for speculation with adverse effects on the market.

⁹ Marketization is a concept especially referring to transitional economies or non-market economies. In short, it is a process through which an economy transforms itself from a planned economy to a market economy. Since 1979, the PRC has been in a process of marketization. Marketization is also defined as an evolutionary process where the market mechanism starts, develops and becomes mature, where the market mechanism plays a more and more important role in resource allocation, and where the economy relies more and more on the market mechanism (Chen Zhongsheng, 1999 [6]). In neoclassical economics, there is no room for marketization, because it is assumed that the economy is under perfect competition or is already marketized. The process of economic marketization is one where the individual’s rights to economic freedom are established, enforced effectively and protected. In a command economy, these rights are incomplete and even illusionary. Marketization aims to make them complete and tradable with each other (Zhang Shuguang and Zhao Nong, 2000 [40]).

¹⁰ In the case of Japan, it is widely argued that many companies may try to maximize market share rather than shortterm profits. Their view seems to be that maximizing market share and establishing the status of the company in the market ultimately paves the way for maximizing profits in the long run. It should be noted that, from this long-term perspective, two goals, i.e. market share maximization and profit maximization, are not necessarily trade-off relationships, but are rather compatible.

¹¹ Without doubt, most standard economic models are based on the assumption of profit maximization, despite the fact that authors cast doubt on the relevance of this assumption. When one is not certain whether an enterprise is a profit maximization entity, as a secondary optimal choice one can regard profit maximization as a theoretical benchmark, so that the difference between reality and the theoretical benchmark can be identified (Zhao Zhijun, 2002 [43]).

¹² Though the work of Gathmann on the Internet is unpublished, it is worthy of reference and draws our attention.

¹³ The model form of decreasing return to scale can be deduced from constant or increasing return to scale. For example, for constant return to scale technology Y = AH^αK^βL^{1 - α - β} (see Barro, Robert J., Sala-i-Martin, Xavier, 1995 [4]), where H: human capital, K: material capital, L: ordinary labor, managerial ability can be regarded as a function of human capital B = AH^α. Thus, the production function can be rewritten as Y = BK^βL^{1 - α - β} which is decreasing return to scale with respect to K and L (for &beta + (1 - α - β) = 1 - α < 0). This assumption allows managers to share “a residual profit” (οy/οH)H = y - (KR + LW).

¹⁴ In a competitive framework, the marginal return on capital is determined by the capital cost R. However, in the PRC, the money market price is almost completely controlled by the central bank, which represents the central government rather than the market. The interest rate as a benchmark of capital cost R is not determined by the market, but by the government. For this reason, in a relatively short run, R can be regarded as an exogenous variable individual that firms are not able to control.

¹⁵ Multi-objective function of the firms may also take the Cobb-Douglas form: O(π,Y) = Bπ.Y^{1 - λ}. However, our conclusions may not be changed, because the logarithm of Cobb-Douglas function is an increasing linear function of logarithms of profit and output.

¹⁶ Michael K. Y. Fang, Wai-Ming Ho and Lijing Zhu 1999 [22] directly assume that interest rate on loans is set so low that there is an excess demand for bank loans. This means that excessive demand is caused by low interest rate and with no relation to the behavior of firms. Here, we can conclude that excessive demand is caused by deviation of firm objectives from profit maximization, and excessive demand is satisfied with soft constraint supply.

¹⁷ It is difficult for an enterprise to survive with a negative residual profit. A negative profit means nothing can be paid for the manager's ability and no one with that ability would wish to become a manager.

¹⁸ In the case of λ < (α + β)/[1 - (1 - α - β)τ], there will not be any residual profit paid for manager’s ability. This type of firm has no reason to exist in the long run. This may explain why SOEs eventually go bankrupt: they pay too much attention to nonprofit objectives.

¹⁹ Following modern firm contract theory, if control rights are separated from ownership, residual income is related to the ability of managers. Thus, it should be indicated in the contract of a firm with managers that the residual income should be at least partly owned by the managers, in order to encourage managers to work hard for the firm. For the sake of easy explanation, we assume here that the residual income (profit) totally belongs to managers.

²⁰ From an accountant's view, the profit is divided into two parts, the normal profit KR and the residual profit π_λ. The contribution of capital is normal profit KR, which is gained from ownership.

²¹ Precise distribution of A should be a discrete distribution due to the assumption of limited number of people.

²² Looking at registration status, there are more than ten types of enterprises (Appendix 1. Definition and Classification of Enterprises by Registered Status). The socialist PRC implemented a public ownership system in the past. Usually SOEs and collective enterprises are called public enterprises, and others are called non-public enterprises. Non-public enterprises usually have lower equity assets owned by the state or collective, and have higher privatization exposure. Broadly speaking, non-public enterprises are also called private enterprises by some scholars. It should be noted that private enterprises are included in non-public enterprises. In addition, since only few private enterprises were surveyed, and also some indicator data were not available, we compare SOEs, collectives and nonpublic firms. Of course, we make a separate investigation of private enterprises.

²³ Further evidence for the efficiency of non-public enterprises:

Download the tables [PDF 73KB | 1 page]

²⁴ For the limit of relatively small number of sample, conclusion for private enterprises may not be generalized.

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