As outlined earlier, China's strategy in developing its mergers and acquisitions market is driven by the government's desire to reform low-efficiency state-owned enterprises, adjust the industrial structure, and attract foreign investments. Those goals are likely to remain strong ones, guiding the country's economic development, and the mergers and acquisitions market is likely to move forward, albeit along a bumpy path. Several issues will be relevant to its development.

Economic Issues.

Currently, the mergers and acquisitions market is a buyers' market and subject to imbalance. For example, in the Enterprise Owner-ship Exchange Fair sponsored by Hunan province in 1993, only 4 out of 161 enterprises were sold on the spot. One factor contributing to this situation may be that it will take some time for the idea of mergers and acquisitions to become fully appreciated and exploited by the industrial circle in China, as was true for the stock markets. It is important to remember that China was a central planning economy only sixteen years ago. A second important factor is that the mergers and acquisitions market is still in the experimental stage according to the government's strategic plan, as discussed earlier, and a lot of policy uncertainties will not be fully resolved until the government has gained more confidence from the experiments. It also makes a difference that the business norm, including intermediation agencies and operational protocol, has not been established yet. As a result, deals often fall through because of miscommunication or unreasonable expectations. A fourth factor shaping the current imbalance in the market is that information is not properly dispersed, and neither domestic nor international investors are fully aware and confident of the opportunities. As these problems are resolved over time, the demand-supply imbalance may change.

China has applied to reenter the World Trade Organization, and if the application is accepted development of the mergers and acquisitions market is likely to accelerate. China will have less domestic market protection, and its businesses will face more international competition. One consequence is likely to be an increase in bankruptcy for money-losing enterprises, some of which may become acquisition targets. Even currently profitable enterprises may benefit from being merged to reposition themselves for the more intense competition.

For the Chinese government foreign capital and management skills are vitally important in the mergers and acquisitions market if the country is to achieve its economic goal.

The potential benefits to China from foreign investments are enormous, and it would be a rational choice for the government to maintain a policy of welcome for international investors. Given the country's population of 1.2 billion, the consumer market along with the investment market is practically impossible to saturate if the economy stays on a reasonably healthy and stable path. The government has planned that in the next ten years China will invest $500 billion in its infrastructure alone, and a sizable portion of that amount needs to come from international capital markets. The energy industry, for example, will need to raise $20 billion in foreign capital before 2000. The mergers and acquisitions market provides a valuable channel for attracting foreign capital, and against this general backdrop it is likely to become more open to international investors, with adjustments in policy details occurring from time to time.

Institutional Issues.

For a healthy mergers and acquisitions market to develop, the institutional environment needs to resolve vide information services, policy uncertainties, provide information services, and establish a compatible financing system. The first of these areas concerns, in particular, China's policy toward ownership reform--specifically, how fast state and collective enterprises are allowed to be converted to joint-stock companies. As discussed, a joint-stock company may be easier to deal with in a transaction than a state or collective enterprise. At another level, the policy to encourage or discourage such conversions is closely related to the government's attitude toward privatization, which significantly dictates the depth of the mergers and acquisitions market. Privatization is still a politically sensitive word at this point, but the government is liberal enough to list ownership reform as a priority in its economic agenda, and the "Corporate Law" passed in 1994 has provided a legal ground for such reforms.6 While more state and collective enterprises are expected to be converted and some to be privatized, privatization does not seem to be keeping pace with ownership reform.

Asset-Evaluation Agencies.

The asset-evaluation agencies are set up by the government to address potential underpricing of state assets in mergers and acquisitions transactions. Given that the spirit of free markets is to let buyer and seller determine a fair price through free negotiations, one may question the necessity of such evaluation agencies. A partial reply is that in China a state-owned enterprise often suffers severe "agency problems," which is to say that the interest of the state may not be always properly rep-resented by the designated managers or the local government officials. In fact, it is not uncommon for either managers or local governments to underprice state assets in order to advance personal or local gains. On the other hand, as part of the government the asset-evaluation agencies may have the problem of conflict of interest when a state-owned enterprise is involved in a merger and acquisition deal. It has been suggested that the evaluation agencies should be severed from the government to enhance their independence.

Securities Market.

The development of China's securities market may have a positive impact on mergers and acquisitions activities in that it provides a better investment atmosphere. In particular, it may provide information and liquidity for acquiring a listed company, and it is also a possible exit for cashing out of an acquisition. In the last three or four years, the institutional framework has been established for the primary and secondary stock markets, which are expanding with amazing speed. But it is not known if or when foreign investors will be allowed to acquire more than 5 percent of a company through the stock market.

Financial System.

China's banking system, under tight control of the government, still operates on the Soviet model, which provides little service and support to the mergers and acquisitions transactions unless so directed by the government as in some rare cases in the past. In recent years, gradual reform has begun to separate the functions of the central bank, the policy banks (banks that carry out the government's industrial policy instead of pursuing profits), and the commercial banks. Banks have a long way to go, however, before they become competitive and efficient and able to provide financing for mergers and acquisitions activities.

Related to financing of mergers and acquisitions activities is the issue of credit rating, which is an unfamiliar concept to most Chinese people. Without a system to evaluate the creditworthiness of business entities as well as individuals, a crucial link in the chain of finance is missing. Bad debts among state-owned enterprises have caused periodic systemic crises in recent years. A few cases of credit disputes involving Chinese companies in international activities have also been reported. Such an environment is not only hazardous to the development of the mergers and acquisitions market but also inhibits foreign investment and stunts the growth of the domestic financial markets in general. Establishing independent credit rating agencies will be only the first step in solving the problem. More importantly, cultivating a civilization pillared by the idea of individual responsibilities will be a long-term project--and no easy job in a country where people were deprived of individual decisions for thirty years before they were unfettered but also lost in the collapse of communist ideology.

Political and Social Issues.

Several political and social issues will influence the development of the mergers and acquisitions market. The first is unemployment. Some background will shed light on the seriousness of this problem. According to government statistics, the total population in China is 1.2 billion, with 14 million babies born each year. There are 768 million people currently aged between 15 and 59. The labor force is about 600 million (see Table 3), and more than 10 million people enter the job market each year, Among the 168 million in the urban work force, 2.7 percent are unemployed and 10 percent are on welfare while nominally employed by a state-owned enterprise. Among the 446 million in the rural labor force, 13 to 25 percent are estimated to be oversupplied and 50 million-100 million of them are migrating among the cities looking for a job. By 2000, there will be 500 million in the rural labor force while only 200 million will be needed in agriculture and 100 million in the township enterprises. The remaining 200 million will look for jobs to the cities, which at the current pace of development will be able to absorb only 20 million of them by then. With such dire long-term prospects for the labor market, the immediate unemployment pressure is no comfort at all. Half the state-owned enterprises, even though (under the direction of the government) they are eating away 60 to 70 percent of the fixed-assets investments from banks, are still losing money. This unsustainable fiscal policy not only fuels the rising inflation but also strands the government in a difficult dilemma: if it keeps subsidizing the low-efficiency state-owned enterprises, desperately needed fast economic growth and job creation will remain seriously hindered; if it lets the state-owned enterprises go on their own, many of them will face bankruptcy and the result will be immediate massive unemployment.

The mergers and acquisitions activities are a double-edged sword to cut through the unemployment problem. On one side, an acquisition may save many jobs by revitalizing a potentially bankrupt enterprise and may help the economy create more jobs and lessen inflation pressures by relieving the government of a financial burden. On the other hand, an acquisition often results in immediate downsizing of the bloated work force, which transforms a latent economic inefficiency into a conspicuous social problem. The government is therefore likely to maintain a cautious policy toward any work-force cuts following an acquisition or a merger at the same time that it is encouraging the development of the mergers and acquisitions market. In other words, the government may prefer to have big/strong fish eat small/weak fish without spitting out the bad parts; and contracts in a mergers and acquisitions deal may often preclude shutting down factories and laying off workers. Some other measures promulgated by the government, such as the establishment of a social safety network, may also help. According to the Labor Ministry, about 95 million, or two-thirds, of urban workers now have unemployment insurance, up 20 percent from 1993. Under the plan, a worker who loses a job receives 70 to 80 percent of his or her salary for two years as unemployment compensation, then 20 to 50 percent thereafter as welfare, or the worker can choose a lump sum compensation with which to start a small business (Knight-Ridder 1995).

A second issue is the political resistance by several groups against mergers and acquisitions (Jia Lu 1995). One such group consists of the old guard, who believe that the privatization of state-owned enterprises and the development of private enterprises are ideologically unacceptable. Without convincing alternative proposals, however, they are losing their audience. Another group is made up of economists and sociologists disturbed by the fact that some mergers and acquisitions deals have generated egregiously unequal wealth distribution. Their argument is best appreciated in those cases in which people have exploited legal loopholes to get rich quick. Workers who have lost their jobs and others whose interest has been hurt may very well join forces with this opposition group, and the matter could be further complicated by concerns about strategic national interests in some cases involving foreign investors. Given these realities, people who support the idea of mergers and acquisitions have cautioned against possible slips if the market develops too fast without an adequate legal environment in place. However, they believe that as long as tactical prudence is exercised in the process, the opposition will not be strong enough to stunt the market's development.

Table 3: Employment of Civil Work Force, 1994 (Thousands)

* Includes employment in nonprofit organizations such as government agencies, hospitals, and schools.

Source: SAS (1995a)

The third issue is the possible loss of state assets. In mergers and acquisitions activities, many state assets are transferred, at a price, to private ownership. Given the market's immaturity and the deficiency of the regulatory and legal systems, the government has a concern that some transactions may be or may appear to be carried out to the state's disadvantage and result in a loss of its assets. One complaint is that intangible assets, such as business and technology know-how, trade secrets, and brand name recognition, tend to be undervalued the most. Although the potential problem of state asset losses may not be enough to justify wiping out the mergers and acquisitions market, it is important that the transfer of state assets to private owners be accomplished in an orderly manner and at a fair price. Establishment of business protocol and the maturing of the market may help to eliminate the loss or the appearance of loss of state assets.

It has been observed that local governments tend to weigh the potential problem of state asset losses less than the added value brought by mergers and acquisitions activities, a position that adds to the contention between the central and local governments. The 1994 tax law stipulating that state-owned enterprises belong to and must submit their profits to the central government has prompted local governments to sell state-owned enterprises whose current control is in the gray area. The bank law passed in 1994 has rightly reduced local-government say on the control of bank credit allocation, and the problems of many local state-owned enterprises are likely to be aggravated. The local governments may in turn have an incentive to adopt more lenient policies toward mergers and acquisitions.

Whether China's general economic development, which is the backdrop for the mergers and acquisitions market, can follow a steady path is also an important question. One major risk lies in the lack of an efficient system of social institutions – the lack of an effective judicial system fully compatible with the market economy, a sustainable social welfare system, an independent central bank and a market-oriented banking system, a credit-rating system, and the like. Progress in these areas has been made but not as quickly as one might have hoped. Among other reasons, rampant corruption throughout the society, resulting from the lack of efficient checks and balances of power as the country is undergoing dramatic social change, may serve as an indicator for how quickly the system can be in place.