A dynamic analysis of overstaff in China's state-owned enterprises

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Abstract

Overstaff in state-owned enterprises (SOEs) is a key and difficult issue in the Chinese economic reform. This paper models the transition process in the reform that SOE overstaff is gradually absorbed by private enterprises and the economy grows through converting redundant SOE workers into active labor force. It characterizes the steady equilibrium, where all overstaff has been completely absorbed, and the dynamic path from current state to the steady equilibrium. The optimal transition strategy maximizing household utility is also discussed.

Introduction

Overstaff was a prevailing phenomenon in central planning economies like China because output target instead of efficiency or profits was given the highest priority by planning authorities. The ignorance of production efficiency encouraged enterprises to employ as many resources, including human resources, as possible to fulfil the planning target. The economic reforms in China, dating back to 1978, have been aiming to improve productivity and efficiency of the economy. After two decades of reforms, previous overstaff or disguised unemployment in China's state-owned enterprises (SOEs) ultimately resulted in massive laying off. Before further discussion, it is worthwhile to have a short review of reform process and to find out the reasons for overstaffing, which can serve as a background of our analysis.

Reforms in China focus on efficiency and productivity improvements and economic growth. The major measures to fulfill these goals include the introduction of contract responsibility system in rural areas, the introduction of incentive mechanism and management autonomy in SOEs and the introduction of market mechanism economy-wide. In the early years, the incentive mechanism was represented by profit retaining, i.e., SOEs could claim part or all of above-quota profits if they realized the planed quotas of output and/or profits. The retained profits were an economic resource for SOEs to increase employees' bonus and welfare expenditure or to update production equipment and capacity under the government supervision Fan, 1994, McMillan and Naughton, 1996. This mechanism has been enhanced since 1984 by the gradual implementation of contract management responsibility system in SOEs. In this system, the management of a SOE contracts with their supervising agents on profits and other targets. The managers can share the above-target profits if they fulfil targets, or pay penalty otherwise, according to the scheme stipulated in the contracts.1 These reforms strongly stimulate the management of SOEs to pursue profit maximization as indicated by Perkins (1994) and Yin (1998), bringing in the managers' motivation to lay off overstaff to reduce costs.

The gradual reduction in planning allocation of resources and in government interference in the management of SOEs also made rent seeking feasible. In pre-reform period, the government plans set input/output quotas and prices for SOEs and firms had no authority in production and price decisions. In order to reduce price distortion and allow markets to allocate resources, the Chinese government adopted a dual-price system in 1985, which permitted SOEs to sell/buy the above-quota outputs/non-labor inputs at market prices Wu and Zhao, 1987, Byrd, 1989. By the early 1990s, the dual-price system was actually ineffective because the government had gradually but steadily reduced price controls. In 1992, the government-determined mandatory pricing as a percentage of total retail sales, retail sales of agricultural and sideline products, and sales of production materials was 10%, 15%, and 20%, respectively (Harrold and Lall, 1993). The Fifteenth Congress of Chinese Communist Party held in 1997 formally defined the Chinese economy as a “socialist market economy” and market mechanism in resource allocation was further enhanced. It is safe to say that at the end of 1990s except for very limited number of products with strategic importance, basic utility services, interest rates and wages in SOEs, almost all prices of goods and services are market determined. Moreover, managerial contracts between the management of SOEs and government supervising agencies have no quantitative output targets or quotas since late 1980s (Chen, 1995). Therefore, the managers of SOEs can independently decide prices and output levels of their products.

Unlike conventional private enterprises, SOEs, however, cannot operate without any constraints imposed by the government. One of such constraints is that they are not allowed to simply lay off redundant workers to increase profits if the workers refuse to be sacked. Instead, the management of SOEs is allowed to let redundant workers “wait at home” by paying them a very low wage which can barely cover their living costs.2 So, actual production in SOEs is undertaken by the remaining active employees, who go to enterprises everyday. This institutional change converted disguised unemployment into a massive waiting labor force. Although no official statistics on the number of waiting workers are available, World Bank (1996) reports 84.6% of SOEs are over staffed and Niu (1994) estimates that 30% of SOE employees are redundant. It is true that waiting workers receive a much lower wage rate than their active counterpart, but massive movement of waiting workers to the private sector had not been observed before 1998. There are two possible reasons contributed the formation of large volume of waiting workers within SOEs. First, SOE workers themselves refuse to move the private sector because they are used to the government's iron-rice-bowl policy (i.e., life time employment), because jobs in private enterprises are uncertain and harder, and because the private sector does not supply employees with welfare services such as medical care, housing, child care. Second, the majority of waiting workers are unskilled labor without the skills required by private firms.

An ambitious initiative by the new Chinese Premier Zhu Rongji in 1998 is a move to completely reform SOEs and solve their problems within 3 years when he came into the office. The move includes that SOEs abolish the iron-rice-bowl policy and no longer insure employees everything from cradle to grave, SOE employees have to use their income to buy houses, medical care and pension, and the implementation of “reemployment engineering” to help waiting workers to acquire new skills and jobs. It is believed that if these measures are successful the massive overstaff in SOEs will be eliminated and the Chinese economy will be reshaped and enter a new era.

This paper focuses on the analysis of this new economic transition. It intends to investigate the effects of the Chinese government's initiative, to trace the economic development process resulted from the initiative and to predict the characteristics of the long-run equilibrium using a dynamic model embodying the features of the Chinese economy discussed above. Particularly, it develops a simple macro model to illustrate the operation of the reemployment engineering and its policy implications. In this macro analysis, technology progress and population growth are abstracted so that the sole resource of economic growth in the transition process is waiting workers in SOEs. When all of them are absorbed by new work opportunities, the economy will reach a new long-run steady equilibrium.

In a related work, Yin (1998) analyzes the macroeconomic effects of SOE waiting workers with a static model and does not consider the reemployment issue of redundant SOE workers. However, this paper pays more attention to the dynamic transition process and the economic growth through absorbing redundant SOE workers. The model in this paper bears some features of dual labor market models in the sense of segmented labor market (Saint-Paul, 1996). However, dual labor market models focus on the reasons for wage differentials and unemployment accompanied with above-market-clearing wages. The dualism in these models often exists within an individual firm. In contrast, this paper models the employment division between the private and state sectors in the Chinese economy and studies the unemployment issue inherited from the previous planning system.

Section snippets

A dynamical model

The preferences of a representative Chinese household for consumption over time t are represented by the utility integral,uh=0u[ch(t)]exp(−θt)dt,where u[ch(t)] is household h's instantaneous utility of consumption, ch(t), and θ is the rate of time preferences. The family has nonhuman wealth, ah(t)≡kh(t)+bh(t), which is equal to the holdings of private firms' capital, kh(t), plus family debt claims, bh(t). In this model, bh(t) can be either positive or negative and a positive bh(t) should be

Steady equilibrium

The steady equilibrium is defined as the time-invariant equilibrium of the economy so that all waiting workers in the state sector have been transferred into private enterprises, i.e., dLp(t)dt=E(t)=0.

Given wage rates and capital stock at government controlled constant levels, wa, wi and Ks, the first-order condition (8) determines the steady employment in SOEs, Ls. Three observations can be obtained from (8). (i) Although there is no inactive SOE worker in steady equilibrium, the wage rate of

The dynamics toward the steady equilibrium

The steady equilibrium depicts the situation where the waiting workers have been completely absorbed by private firms. It may be more interesting to illustrate how the modeled Chinese economy approaches to this steady equilibrium from current state. To find out an explicit dynamic path, we specify the utility and production functions in this section. First, the production functions are assumed to be Cobb–Douglas, i.e.,Fp[Lp(t),Kp(t)]=PLp(t)αKp(t)1−α,Fs[Ls(t),Ks(t)]=SLs(t)βKs(t)1−β.

Since we

Concluding remarks

A simple dynamic model focusing on the problem of overstaff in China's SOEs is developed. The model mimics the undergoing operation of reemployment engineering in China and describes the possible transition process of the Chinese economy in which SOEs gradually step out from the swelling of waiting workers and achieve lean and efficient production. As waiting workers are employed by new enterprises and effectively produce output, the whole economy grows. The model depicts out the dynamic tracts

Acknowledgements

The author would like to acknowledge an anonymous referee for her/his constructive comments.

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