Shareholder rights stand for little when it comes to the reform of state owned enterprises in China and the issue of national stability.

More and more quasi-Government entities, many with private backers, are stepping in to take over inefficiently run and poorly managed state-owned assets and manufacturers – in many cases resulting in huge job losses.

These necessary but painful structural shifts are often borne by poor communities where there is little opportunity for other forms of employment.

Such events are one of the main causes of social unrest inside China, along with demonstrations related to Government land displacement of people and villages.

dragondata spoke to some individuals involved in a recent example of such a practice.

A subsidiary of the Ministry of Commerce of People’s Republic of China acquired a state owned clothing manufactory in the relatively poor province of Shan Xi.

In the old days, when everything was planned, the factory was managed and supported by the central government. The government provided production orders and funds to support its daily operation.

The members of the management team were appointed by local government officials, employees received flat pay regardless of the factory’s profitability and both the management team and employees lacked the knowledge or incentive to make the factory a more profitable operation – Marxism in action.

With economic reform, the factory, just like many state owned enterprises, was unable to compete in a market driven environment.

It had been operating at loss for a long time until the subsidiary of the Ministry of Commerce of PRC showed interests in acquiring the facility.

Although this latter company is also primarily owned by the government, it runs much more like a privative business corporation.

The company was looking to utilize the factory to produce clothing for their overseas clients and for its private brand.

In addition, the management team had much more in depth knowledge about the industry and the market.

They were looking to bring the old factory back to life with its resources and management expertise.

If the acquisition can successfully turn the factory operation from loss to profit, it will also help the local economy to grow – the only catch was the massive layoff.

After closing the acquisition deal, the acquiring company laid off many workers from the factory.

In general, laid off workers from state owned enterprises receive some government pension, however, the monthly pay was insufficient to support their living even in Shan Xi.

In remote areas like Shan Xi, the workers had little hope in finding new jobs partly due to lack of skills and the limited number of employment opportunities available in the region.

A demonstration happened.

dragondata was told one of the lead managers in the acquisition team was beaten badly, and other members of the acquisition team had to take refuge in their hotel.

The situation was out of control and Beijing had to step in to resolve the conflict.

Since the acquiring company is largely owned by the government, a mandatory ruling came down more like an “order” rather than something the acquiring company can negotiate.

The central government made a mandatory ruling that the acquiring company had to make a one time payment to the laid off workers.

Acquiring companies now have to provide some form of compensation to laid-off workers.

In this story, three government arms – the central government, the acquired company and the acquired company got into a fight.

The government, acting like a parent reprimanding two unruly siblings had the final say and settled the fight.

This story implies a much bigger problem the Chinese economy is facing.

How can the Chinese government formulate new policy and reform its political structure to better support transitioning from a planned economy to market economy?

Most of these large government owned companies are also traded on major stock exchanges domestically and overseas.

However if these companies place the government’s interests before shareholders, then how market orientated can these firms really become?

This has a number of implications for the many foreign investors that are approached by such quasi-Government entities, looking for foreign capital to help fund local initiatives.