What has China done to promote big business groups? Are they paragons or parasites?

There has been significant change within Chinas large enterprises and groups, but until quite
recently these changes have remained poorly understood. Divergent views on this subject have
emerged. These competing views broadly correspond to the competing paradigms found in the
development literature. This split has emerged at least in part owing to the fact that among studies
related to Chinas economic development, because of a priori assumptions regarding key variables
determining enterprise performance, there has been a tendency to categorize and study enterprises
mainly from the perspective of different ownership types. Ownership and the distribution of
property rights have conventionally been considered one of the main determinants of economic
performance, particularly in economies undertaking the transition from plan to market. As a result
of this mindset there have been many studies looking at state owned enterprises (SOEs) as a whole
and also studies making comparisons between the state sector and the newer private sector.
Comparatively fewer studies, by contrast, have looked directly and exclusively at Chinas large-scale
sector or large enterprise groups. The important contribution and growing presence of large
enterprises, particularly large groups within key industries supported by specific state policies, has
therefore at times also been largely overlooked. Only a small (though growing) body of specialized
literature in Western academia investigating large enterprises and groups has emerged in the past
few years (Keister 1998; Lo 1997; Lo 1999; Lo and Chan 1998; Nolan 1996; Nolan and Wang 1998;
Smyth 2000). These studies have already strongly challenged some of the conventional insights on
Chinas industrial development. In particular, the generally negative assessment made of the overall
performance and importance of large-scale state industry, and the tendency to regard small
enterprises as engines or the foundation for recent economic growth, has been brought into
question (World Bank 1997: 21). Instead, an alternative and competing viewpoint, namely that
Chinas LMEs are now actually coming to represent the 'core' of Chinas transformed economy, is
gaining ground.
[3] By 1997 there were 468,000 enterprises in the industrial independent accounting category. The
number of LMEs increased in this period markedly, from approximately 5,000 to 24,000, up from 1.3
per cent to 3.9 per cent of the total number of all independent accounting industrial enterprises.

. The report shows that to succeed the encouragement strategy needs to be accompanied by a
strategy of discipline; that is, policies that impose hard budget constraints on the old-large
enterprises that remain from pretransition days. Soft budget constraints that allow these enterprises
to not pay their taxes, social security contributions, and bank debts undermine the level playing field
between different kinds of enterprises and have also been at the root of explosive fiscal and banking
crises. The decentralization of management decisions boosted the productivity of firms. 25 But
relative to the rest of the economy, state industrial enterprises languished, with slow growth and
declining profits. In part this was because state enterprises, unlike their nonstate competitors, were
required to provide job security and a range of social services, such as housing, education, and
health care. Yet slackening performance also reflected a deeper malaise rooted in the poor
investment decisions of the past and in an "iron rice bowl" system that did not penalize low
productivity.
Policies promoting institutional change in the trial business groups
The previous sections have examined some of the features of the national team, including the
industries and provinces from which they developed, their origins and the origins of policies aimed
at promoting their development, the size of the groups and their strategic importance to the Chinese
economy. The next sections go on to look in more detail at policies introduced to the national team
trial groups in two important policy directives, central to understanding the current grasp the large,
let go of the small policy, issued in 1991 and 1997.27 Although the emergence of trials with groups
can be dated back to 1986, these two influential State Council policy directives, in which formal
selection of the trial groups was made, are still regarded as a a great leap forward in the
development of business groups (Chen Qiaosheng, 1998: 704). As already described, even before the
first batch of trial groups was officially chosen in 1991 five years of experimentation, consideration
and preparation concerned with the direction of business group policy had taken place. Dongfeng,
one of the very first trial enterprise groups, after several months was expanded to include two more
auto producers. Shortly after this, by April 1987 the number of trial groups had unofficially expanded
to 13 and the preferential planning policy was complemented with the promotion of internal group
finance companies. Over the years a number of new policies were introduced and spread to the trial
business groups, including foreign trade rights, standardization of the mother/son company system,
clarification of property rights within the core enterprises and promotion of technology centres.
Table 3.4 illustrates the various measures, the timing of their introduction to the trial groups and the
way in which they gradually broadened their coverage. By 1999 the three trial groups had increased
to 120 and at least seven major policy measures had been introduced .
The first State Council directive, December 1991
The first directive laid out the objectives, principles of experimentation with groups and necessary
conditions for choosing the trial groups. Broadly speaking the policies introduced attempted to free
the enterprise groups from some of the constraints of the old planning system. This was partly
achieved by using the market mechanism to exploit their full potential but also by the introduction
of new rules and laws to promote necessary institutions and greater cohesion within the groups. In
total five interrelated goals for the national team enterprise groups are listed in this directive.
Firstly, and unsurprisingly, a priority was to encourage specialization and redress the historical legacy
of geographically dispersed small-scale industry and the inability of achieving economies of scale.
Secondly, the groups were seen as a means of breaking through the existing regional and
departmental barriers which constrained the natural growth of large-scale enterprise groups. This
remains a problem today: enterprise mergers are still hindered by regional and departmental
barriers. The government should guide the development of large enterprises by industrial policy but
not administrative intervention (CDBW, 8 December 1998). Thirdly, they were to give play to the
leading role of large enterprises in concentrating and directing investment funds in the hope of
reducing replication. Fourthly, even by 1991 it was hoped that international competitiveness could
be improved so the groups could become major forces in international markets.
The fifth and final objective was related to the domestic economy.This was to improve what are
referred to as macro-economic adjustment capabilities. This objective highlights the official
endorsement groups were given in absorbing enterprises in the small-scale state sector and loss
makers in general, a role they have assumed from early on in reforms. This policy clearly states that
by reforming a set of large enterprises as the core of the business groups it will be possible to more
efficiently lead the economic activities of a large number of medium and small sized enterprises. In
the 1994-97 period alone it is reported, for example, that profitable large groups saved about 2,000
loss-making enterprises (China Business Review, May-June 1999). The history of enterprise groups,
as already noted, is closely associated with that of merger and take-over, a process which in China
has usually involved loss-making enterprises. The groups, therefore, have explicitly been given a dual
role, one with inherent contradictions. They have been earmarked to lead the large-scale sector into
international markets but also to absorb large numbers of poorly performing small enterprises. This
dual function of enterprise groups continues to make them an appealing and natural policy for the
reform of state industry though it also brings into question whether they will be able to succeed in
achieving international levels of competitiveness.
The State Council envisaged several criteria the groups would need to fulfil in order to achieve the
foreseen goals. Firstly, a strong core member was needed, hence usually the agglomeration of the
groups around successful large state-owned enterprises. Secondly, a multi-layered structure was a
prerequisite for a large group company with the ability to lead smaller enterprises, increase scale
and become trans-regional. Thirdly, an integrated management system was needed, based around
capital ties between enterprises. Furthermore, the selection of groups was to correspond to
national economic development strategies and industrial policies. Trans-regional and departmental
groups were also encouraged as was their separation from governmental responsibilities. A key
feature of this policy were efforts to force the often disparate members of the enterprise groups
together into a cohesive organic whole by advocating the unification of the group led by the mother
company. To this end the policy of six unifications within the close layer of enterprises of the group
was promoted. This foresaw unifying the planning departments of the core members and developing
greater contractual relations within core enterprises. Unification of loans needed for large
infrastructure and technology projects, of imports and exports, integration of the main management
teams (giving responsibility of hiring and firing to the mother company) were other elements of the
six unifications policy. Eventual unification in the ownership of core members, to be supervised by
the State Capital Management Bureau, was also put forward and this led to the creation of a policy
which empowered groups with rights to manage state capital. The 1991 directive also gave details
of the single track which were expanded and clarified. To an extent this measure also contributed to
unification within the groups. Preferential planning only included the core enterprise and the close
layer of members but not semi-close and dispersed members. This created an incentive for
enterprises to enter the close layer of the groups. The development of finance companies promoting
the internal circulation of funds, and export and import rights allowing independent export and
import management, were also included in this directive.
The first State Council directive in 1991 outlined the reasons for forming business groups and some
of the policies that were to be used. It also chose the groups to be included in the trials. It marked an
important step in the development of an industrial strategy which had not yet fully crystallized. This
involved adopting measures to promote the institutional transformation of large-scale industry in
key industries while at the same time giving up control of the small-scale state industry.

The second State Council directive, 1997
After a gap of about five years on 29 April 1997 the second state directive was published and the
additional batch of 63 trial groups was added to the initial 57 groups. It deemed that the initial batch
had basically achieved the stated goals but stressed that a new phase had been entered. The new
policy, although pushing forward and recognizing many of the reforms initiated in the earlier
document, noted that two important changes had taken place. Firstly, the growth pattern had
transformed from extensive growth to concentrated growth, referring to the need to further focus
development in certain key areas of the economy. Secondly, it also stressed the implications of
further integration with the international economy: as opening to the outside continues enterprises
will face more severe domestic and international competition. Accordingly it was argued that a
crucial stage in reform had been entered in which two basic transformations, from extensive
development to intensive concentrated development within key industries, and from national to
international markets, were to be made. To achieve this, it concludes, deepening the trial work with
large enterprise groups is a vital necessity.
The five goals laid out in the later document are in many ways quite similar to those given in the
1991 document, though there are two noticeable differences. Firstly, an important position is given
to the establishment of the modern corporate system so that the groups and their members could
become defined legal entities. To this end it is noted that the direction of state enterprise reform is
the establishment of the modern corporate system, based upon Chinas company law, newly
established in 1994. Greater emphasis is also placed upon the separation of enterprise and
governmental activities and the transformation of government departments, making the groups
responsible for their debts as well as granting them rights to retain profits. Secondly, although the
role of groups in promoting macroeconomic stability and directing a large number of small
enterprises is not omitted entirely as a goal in this later document, it is only briefly mentioned in
passing. This signified the intention to move away from direct state intervention in the creation of
forced marriages. The second policy continued to attempt to concentrate greater powers within
the mother company. This was so they could formulate strategies for the groups and become the
leading providers of capital and technology, as well as co-ordinators of foreign investment and
technological exchanges within the groups. To this end the investment function of the mother
company was expanded, giving it greater freedom in co-ordinating new investment projects as well
as utilizing foreign capital for new projects below $30 million dollars. Domestic and international
stock market listings were also to be encouraged among the mother companies, as well as corporate
bond issues. Trade rights were also expanded to other members of the enterprise groups, creating
incentives for them to join. The creation of technology and research centres within the groups to
help promote their product development capabilities and hopes of being successful in the
international market place were also advanced.
The second State Council directive issued in 1997 recognized Chinas increasing international
economic integration and the need to further develop the framework within which large enterprises
operated. It recognized the need to further concentrate industry in certain sectors by creating larger
economic units more akin to large modern industrial corporations in developed nations. It expanded
the number of enterprises and the industries and regions they covered, it recognized also that large
enterprises could also be privately run, by including three TVEs. There were, therefore, a number of
important changes in the focus of policy in the second directive as well as the means by which the
goals could be achieved.
A number of trials were introduced in the groups: have these had an impact on performance?
Preferential planning status
The single track preferential planning policy was the first and perhaps single most important
measure introduced within the trial business groups. It enabled the emergence of the groups from
within the planning system and the beginning of their evolution into units more akin to enterprises.
For the first time it gave enterprises real autonomy in the most basic of decisions concerning areas
such as product output volume, basic construction and investment, foreign technology use, science
and education, salary and financial decisions. First introduced in 1986 at Dongfeng and two other
auto producers, the system was quickly expanded to other groups, reaching 13 by 1989 (Table 3.4).
By the end of 1991 all of the trial groups were using the single track system. Of all the policies
directed at the trial groups this one appears to have spread very quickly and at the time was also
highly influential. Symbolically this policy elevated the core enterprise to the same level as the
planning authorities. Instead of receiving planning orders, the groups were able to make requests
directly to the state planning department and other necessary organs, informing them directly of
their plans and requirements. By 1991 the right to participate in relevant meetings with the Planning
Commission and other related departments was granted. The Planning Commissions role evolved to
providing macroeconomic information to the groups to help them better adjust in unpredictable
market conditions. The policy also raised the status of managing directors to vice-ministerial level,
though significantly their salaries were not raised in line with their new political status. The elevation
of the status of the business leaders reflected the growing importance attached to the trial groups in
political circles as well as the evolving and emerging ties between business and state leaders.
Although preferential planning was basically phased out as the plans importance diminished, it had
played an important role in stimulating the early development of the enterprise groups. As early as
1986 it recognized the need to clear away the restraints of the planning system and represented the
first coherent measure aimed at promoting business groups by empowering enterprises with the
most basic of production decisions. It was also the first step in the movement towards a more co-
ordinated business group strategy.
Internal finance companies
In July 1987 the first internal finance company was established, again at Dongfeng. This
corresponded to a time when relations between close members of the groups, concerning both
production and management, were growing ever closer. Exchanges of products and services had
increased quickly. At Dongfeng, for example, by 1987 a third of the groups total sales were made
between member enterprises (Chen, 1998). This in turn helped break down not only the regional
and departmental ownership structures between close members of the group, it also led to the
question of how better internal channels for distributing funds could be developed. A logical step
was to establish an organ that could productively harness funds, moving them from enterprises
making excess profits to those short of capital. The policy caught on and by 1994 there were 33 such
finance companies (Table 3.4). Recent empirical work, among the few studies in Western academia
on Chinese business groups, has found strong evidence to show that finance companies have
improved the financial and productivity performance among some of Chinas largest business groups
(Keister, 1998). The example of the finance company, therefore, stands out as an innovative
measure which, via the development of internal markets for credit, helped stimulate the
development of the groups.
The finance companies were restricted to activity within their groups. They tended also to be
established using group personnel. As a result this gave the finance companies unique insights into
their groups capabilities and longer term development strategies but sometimes financial expertise
was lacking. The problem with the traditional banking system was that it was not capable of
undertaking loans of sufficient size nor could it allocate them across the various provincial and
departmental boundaries that the business groups often spanned. Finance companies therefore
provided indispensable services. Among these were the provision of timely short-term credits to tide
over member enterprises in emergency situations and innovative measures, such as the introduction
of hire-purchase schemes. The banking system did not offer the kind of flexibility, dedication or
innovation needed to promote the interests of the trial groups. Among the problems with the
finance companies, however, has been their uneven distribution and lack of standardization. By July
1995 the Bank of China had approved the creation of a total of 53 finance companies, of which 35
belonged to the trial business groups. The 53 finance companies had total assets of 6.6 billion yuan
which at this time was equivalent to about one per cent of the entire financial sectors assets (Chen,
1998: 21). By 1997 this had increased to 1.6 per cent, and a further 16 finance companies had been
created, increasing the number to 69. However, within the trial groups some finance companies
remained very small with less than 100 million yuan in assets while others exceeded 7-8 times this
amount. The size disparities of the finance companies was in practice greatly dependent upon the
actual size of the group. Another problem with the finance companies in some cases has been that
the groups have been unaware of the potential roles such finance companies could play. As a result
they have not had a great impact on the groups. Nonetheless, the development of internal finance
companies has been an innovative and beneficial measure overall, with very strong evidence to
suggest that they have improved the financial and productivity performance of the groups.
Empowering business groups with the rights to manage state capital
This policy was introduced more slowly, but by 1997 renewed commitment was shown in efforts to
reform the rights to manage state property, a key element in clarifying the ownership relations
between the large numbers of group members. Again, Dongfeng was the first group to introduce this
policy under the guidance of the newly established State Capital Management Office in 1990. Later
in 1990, a small trial among three groups was run, including Dongfeng, Heavy Vehicle Group and
Dongfang Group. By 1992 official policy expanded the number undergoing the trial to 7 groups. From
February 1993 onwards more of the trial groups were given these rights. Provincial and city level
governments also started to introduce the policy, quickly widening its impact.
In the five years from 1982 to 1987 Dongfeng had grown from a group of just eight enterprises
spanning eight provinces to 118 enterprises spanning 21 provinces. However, as a leading group
representative commented, this amounted in reality to the linking of industrial departments, not
enterprises (Chen, 1992: 64). It became very difficult for Dongfeng to control group members, which,
though nominally linked to Dongfeng, were still in large part under local government control. In
extreme cases, for example, local authorities simply repossessed enterprises that Dongfeng had
turned back into profit. Closely related to this problem was the policy of the three no changes (san
bu bian) which during the 1980s stated that departmental relations, financial relations and
ownership rights within enterprises should not change. Under these conditions the expansion of
groups became seriously threatened. To combat this in September 1992 the State Capital
Management Office published On how to implement the empowerment of trial business groups
with state capital management rights clarifying issues related to the new policy. This specified that it
gave the rights to run the close members of the group to the core enterprise . . . . Establishing
between the core enterprise and its close members ownership ties, concentrating the groups power,
making the close members of the group become the cores wholly invested son companies or stock
controlled companies and giving play to the overall advantages of the group (emphasis added)
(SCMB, ZGZN, 1993:334). This measure, therefore, was designed to give the mother company
ownership and hence management control over the close members of the group. The mother
company came to supersede the previous regional and provincial controllers in place under the
policy of three no changes. By passing the rights to manage the close members of the group on to
the core of the group the policy of six unifications put forward in 1991, attempting to promote
cohesion, was logically extended. It delineated the responsibility for the management of state
capital, placing a firm responsibility with the groups core. This policy therefore stood out as another
strong endorsement of the positive function of the enterprise group.
Technology centres
Introduced in the 1997 directive, this has involved the annexation of existing scientific research
institutions to the business groups as well as the creation of new centres. By 1997 within the 120
business groups 71 state level research institutes had been created or annexed. Measures had also
been taken to force all large and medium enterprises to create their own research institutions or
face disciplinary measures, such as losing bank loans and also preferential access to material
supplies (CDBW, 3 April 1999). The central government has been busy in promoting ties between
research institutions and state enterprises, keenly aware that if Chinese enterprises are to be
successful, especially in the longer term, they must develop research capabilities. By the end of 1998
there were 203 state level and 500 provincial and city level R&D centres and 120,000 reported co-
operative efforts between universities, research institutions and state enterprises. Of the 203 state
level institutes 100 were affiliated to the national team players and 512 preferred enterprises
(CDBW, 3 April 1999). This reflected the wish of the State Council to push the groups from
technology-acquiring late-industrializing enterprises to modern corporations capable of innovating
themselves. Under the centrally planned system research was carried out in institutes well removed
from the activities of the plant, and much of the scientific progress was based upon imports from the
Soviet Union. It is unsurprising, therefore, that many enterprises still lack adequate research
capabilities. Even in 1997 about 80 per cent of all research was undertaken by the state research
bodies and 20 per cent by enterprises. In the US enterprises were responsible for half national R&D
expenditure and in Japan and Germany over 60 per cent (Li, 1999: 141). It is estimated that the top
500 global companies investment in R&D is about five to ten per cent of their total sales whereas in
China LMEs have invested no more than 1.5 per cent of sales in technical innovation since 1990
(CDBW, 17 January 2000). Given the great disparities in the average sales of Chinas largest
enterprises and her global competitors, already noted to be less than 2 per cent of the global
Fortune 500 enterprises for Chinas top 500 enterprises, it is evident that annual research
expenditures of global corporations vastly exceed those of Chinas largest groups.
By the eve of the reforms not only was China still quite technologically backward, there were also
relatively few resources contributed to research and development within enterprises. The
incorporation of research institutions into the trial groups represents another strategic step in
pushing forward the development of modern corporations in China and reflects the long-term vision
and hope of creating
If a country has several large companies or groups it will be assured of maintaining a certain
market share and a position in the international economic order. America, for example,
relies on General Motors, Boeing, Du Pont and a batch of other multinational companies.
Japan relies on six large business groups and Korea relies on 10 large commercial groupings.
In the same way now and in the next century our nations position in the international
economic order will be to a large extent determined by the position of our nations large
businesses and groups
Vice-premier Wu Bangguo, reported in the Jingji Ribao, in early 1997
By all accounts China has made outstanding economic progress in the past two decades. If
Chinas provinces were each considered individual nations, the twenty fastest growing nations
in the world from1978-95 would all be Chinese (World Bank, 1997: 2). It is sometimes argued
that Chinas rapid industrial development, the motor behind growth in this period, has been
primarily as a result of the speedy proliferation of small enterprises. The powerful imagery of
the healthy young shoots of small private enterprises pushing their way upwards in response to
sprinklings of market reform is an image that many observers hold dear. This interpretation
considers Chinas small enterprises the foundation for recent growth (World Bank, 1997: 21).
More recently, however, this view has been challenged by those who point out that although
small enterprises have played a very important role in Chinas recent industrial development,
the large-scale sector, predominantly state-owned, has also been critical (Lo, 1997; Lo, 1999;
Nolan, 1996; Nolan and Wang, 1998). Among other things they show that the number of large
and medium enterprises (LMEs) and their share of industrial output has increased significantly
during the reforms. Furthermore, LMEs are found predominantly in key upstream pillar
industries, often supplying smaller scale enterprises with basic producer goods, or in industries
with significant linkages. As well as this, despite being parched by years of planning, empirical
evidence now also suggests LME productivity and financial performance has bettered that of the
small-scale sector (Lo, 1999). In short, there is a growing weight of evidence suggesting the role
of the large-scale state sector has been of far greater importance in Chinas reform than has
previously been recognized.
Yet not unlike Japan in the 1950s and 1960s, and South Korea in the 1970s and 1980s, policy
makers and business leaders in China have made great efforts to nurture the saplings of big
business, particularly large enterprise groups.
One of the slogans state enterprise reform has now adopted is grasp the large, let go of the
small. The latter element, letting go of the small, is itself an important and interesting subject.
By the end of 1996 up to 70 per cent of small state-owned enterprises (SOEs) had already been
privatized in pioneering provinces and about a half in many other provinces. This was referred
to as a quiet revolution from below (Cao, Qian, and Weingast, 1999: 105). Equally
revolutionary measures, however, have also been undertaken in the large-scale sector. Of in
which successively 55 and 63 enterprise groups were selected to undergo influential trial
reforms.
8
Among the reform measures introduced were the development of internal group finance
companies, the systematic introduction of stock market listings, the promotion of preferential
planning within the groups giving them greater autonomy in basic decision making, granting of
import and export rights, the empowerment of the groups core with special rights to incorporate
state assets into the group and the creation of research and technology centres. Extensive financial
support from the banking sector and shelter from international competition by a wall of protective
tariffs, not mentioned in these directives, have also been provided. By the end of 1996 the 120
groups had swelled: alone they were accountable for more than 50 per cent of profits and
approximately 25 per cent of tax, total assets and total sales of state-owned industrial enterprises
in the independent accounting sector (SCDRC, ZJN, 1997: 677). Thousands of member
enterprises had been incorporated within the business groups of the national team players, as well
as many thousands more in preferred province level teams of business groups. Many of Chinas
LMEs, the large-scale sector, are now incorporated in the 2,302 enterprise groups registered at the
national or provincial level (Yin, Yuan, and Zang, 1999: 132).
9
In 1997 these groups accounted
for just 1.27 per cent of the total number of independent accounting enterprises but 51.1 per cent
of all assets and 45.5 per cent of all sales (Yin, Yuan, and Zang, 1999). An approximate
calculation suggests that these groups produced over 10 per cent of Chinas GDP (SSB, ZTN,
1998: 56; 431; 444).
10
The significance of policies instituted in the national team lies not only in
the impact on the 120 team players but also, perhaps even more importantly, the great influence
they have had and continue to exert as role models on the development of provincial and lower
level enterprise groups. Most provincial as well as hundreds more city and lower level
governments are nurturing their own teams of preferred enterprise groups.
11
As a result it is
probable that the scale and reach of central and local government industrial policy, if not its
effectiveness, far exceeds that which nations such as South Korea or Japan exercised during their
most impressive growth periods.
To a great extent the development of the national team of business groups has adopted the
traditional Chinese method of reform, using incremental steps, the groping for stones approach
as opposed to shock therapy. However, unlike many of the previous incremental reform
measures, those related to the trial business groups have over time developed explicitly stated
objectives as well as implicitly accepted time horizons. With WTO entry approaching, it is
considered imperative to develop a number of large enterprise groups to make up the backbone
of the national economy and the countrys main force to participate in international
competition.
12
Although by the mid 1990s most accounts agreed that China had already
succeeded in growing out of the plan there was still a great gulf between Chinese and foreign
multinationals. By 1999 there were still only 6 Chinese enterprises in the Global Fortune 500
listings, of which one was from Hong Kong, one a bank and two trade companies (Fortune, 2
August 1999).
13
Tariff barriers remained high, sheltering a number of strategic industries.
President Jiang Zemin at the 15
th
Party Conference in late 1997 summarized how efforts were to
be made to distil the state sector into key pillar or life blood industries of the national
economy using strategic adjustments to create highly competitive large enterprise groups:
particular relevance to this debate are two policy directives, officially issued in December 1991
and April 1997
Even as early as 1987 policy makers were issuing directives claiming the development of
business groups is of profound long-term importance to the development of production
capabilities and deepening the reform of the economic system (CRES, ZJTGN, 1988: IX-17). The
goal of grasping a batch of large enterprise groups, using capital ties to link and promote
enterprise restructuring, creating economies of scale and thoroughly giving play to their
backbone role more recently has also been included as part of long-term development plans up
to the year 2010 (CRES, ZJTGN, 1997: 243). This sentiment, even in the wake of the Asian
financial crisis, appears to have remained unchanged.
There is a strong consensus in China that large groups are vitally needed if it is to attain a
cherished goal of becoming a leading nation in the international economic order.
Insider lending appears to substitute for a formal financial system and to give firms access to
otherwise scarce capital where markets are inade- quate a t allocating funds (Goto 1982; Lamoreaux
1986). Informal financing arrangements allow funds to be allocated to their highest return uses
within a particular group, provides opportunities for diversification, and allows firms to engage in
otherwise unaffordable activities. Insider lending can mitigate certain informational asymmetries
and reduce transaction costs, allowing firms to gain control over their environments. During de-
velopment, for example, if banks exist, they are likely to be skeptical about unfamiliar potential
borrowers. Jnformal finance arrangements, that are often based on trust among well-acquainted
parties, reduce such risks by reducing the amount of information unknown to each party and the
costs associated with investigating potential borrowers (Williamson 1981). These arrangements
might also provide a vehicle for co-opting resources and thus further reducing environmental
uncertainties (Pfeffer and Salan- cik 1978). In China in the late 1980s, financial markets were unable
to distribute funds efficiently, which left many firms without necessary capital. Firms that were
members of some business groups had access to additional financing through the group's finance
company (caiwu gongsi), a specialized firm that collected and redistributed funds within the group
and also obtained funds through state banks on behalf of member firms (Shi 1995). Reformers
originally experimented with finance companies in the central industries and later in most other
industries (Li 1995). Initially the activities of the finance companies were not monitored, but as their
activity expanded regulations were implemented to control lending practices. The finance company
enabled the member firms to engage in research and development, to better manage investments
both within the group (i.e., investments in other firms that are members of the same group) and
out- side the group, and, if necessary, to meet short term operating expenses (for a description of
the emergence and functioning of finance companies in Chinese business groups see [Keister 1998).
The informational and market-substitute advantages of the group- specific bank suggest that firms in
Chinese business groups with finance companies should be advantaged over firms in groups that do
not have finance companies, and the more extensive the operations of the finance company, the
greater the advantages of this specialized firm.
Interlocking directorates are not new to China; they existed in government ministries before reform
when a single state representative was assigned to the boards of more than one firm (Schurmann
1965; Xie 1996).8 In the business groups, interlocks occur when member firms acquire shares in each
other and place representatives on each others' boards. The interlocks have the same functional
form as interlocks in other contexts (i.e., an individual occupies a seat on more than one board of
directors); however, unlike in the United States, where interlocks are both a source of information
(Davis 1992; Haunschild 1993; Mizruchi 1992) and a form of co-optation or monitoring (Aldrich 1979;
Dooley 1969; Mizruchi and Stearns 1988), interlocks in China primarily function as an information
source for the interlocked firms (Li 1995; SASBG 1995; Xie 1996).' The interlocks allow information
about technological advances, market oppor- tunities, innovative strategies, and so on, to pass
among firms in the group. Interlocks are not the only source on information available to firms, but
they are a central and predominant source. Because interlocks in China are not a form of co-optation,
they were viewed differently by Chinese managers during the 1980s than they are generally viewed
by Western managers. Chinese managers generally saw them as positive, as they tended to see most
forms of social connection among firms in the groups. (Keister, 1998).