China's Private Airlines Still Face Unfriendly Skies

It had all the elements of a classic case study in the successes of China's economic miracle — a poster child for the virtues of purging the old socialist, state-controlled model for a new and more open one. When China flung the doors of its airline industry open to private investors in January 2004, the country stood on the cusp of an air-travel revolution, and it was a revolution that private-sector entrepreneurs were supposed to lead.

But something strange happened along the way. Instead of spearheading the new future of air travel, private companies have been trounced by their state-owned rivals. For a number of reasons — some blame lousy management skills, others point to blatant government favoritism — the private companies have fallen spectacularly back to earth while the state-owned airlines have been flying high on the winds of China's air-travel boom.

Six years ago, with rising incomes and red-hot growth, passenger numbers in China were soaring and airports were springing up all over the country. The sleek, well-managed privately owned airlines that analysts expected to spring up nationwide would, the thinking went, radically transform the industry, destroying their bloated and inefficient state-owned competitors who couldn't adapt to the frenetic pace of industry change.

China's air-travel industry has, indeed, lived up to the hype. Passenger numbers have nearly doubled since 2004, to half a billion a year. Thirty new airports have been built and the government has plans for nearly 100 more over the next 10 years. But while the country's state-owned air giants — Air China, China Southern and China Eastern — are soaring, their private rivals have been left bruised, broken or bankrupt. Of the 14 private airlines established since 2004, only four are still in business. Some never got off the ground, while others have gone bust or been acquired by more powerful state-owned rivals.

Such was the fate of southern China's Shenzhen Airlines, which was taken over earlier this year by Air China. Its major shareholder, Li Zeyuan, had been jailed numerous times for "economic crimes" while his son served as chairman of the company. Safety standards were questionable at best; its struggling subsidiary Henan Airlines, based in central-eastern China's Henan province, suffered a tragic accident in August when one of its planes crashed on approach to the airport in the city of Yichun, killing 42. The parent company has not fared much better: an independent investigation launched after the Henan crash discovered that more than 100 of Shenzhen's pilots had faked their flying qualifications.

One of the few players to have successfully made it through the turbulence is China's only low-cost carrier, Spring Airlines, which has survived by slashing overheads and offering low-cost fares on less popular routes. "We don't compete with the state-owned airlines, we complement them," says Spring Airlines spokesman Zhang Wu'an. "We're offering a different level of service to a different target customer." It keeps overheads down by focusing with near religious fervor on a no-frills approach, charging extra for baggage and meals.

That frugal business model has helped it deal with the fact that it has been shut out of some of the most lucrative routes in the nation. The company now flies out of Shanghai to almost 40 destinations — but still can't get permission to fly the big-money route between China's two most influential cities. "To this day, Spring, the best-run private airline in the country, isn't allowed to fly the Shanghai-Beijing route," says Zhang Qihuai, a researcher at the Institute of Air and Space Law at China University of Political Science and Law and one of the leading lawyers in the aviation industry. "All the best routes are dominated by the state-owned airlines. None of the private airlines can get a piece of that pie."

That kind of market-access problem has stoked the ire of foreign business leaders in recent months, with the European and American chambers of commerce among the many complaining vocally that they have been denied a piece of China's thriving economic action. But their complaints are all too familiar to leaders of other domestic private businesses, many of whom are finding that the odds are often stacked against them in favor of their state-owned competitors.

The State-Owned Assets Supervision and Administration Commission (SASAC), the government ministry charged with managing the vast array of companies under government ownership, now controls a business empire worth close to $1 trillion. Its dominion includes China Mobile, the world's biggest mobile-phone carrier; PetroChina, the world's second biggest company by market cap; and ICBC, the world's largest bank. By some estimates, profits from the two biggest state-owned companies, China Mobile and PetroChina, are greater than the profits from China's top 500 private companies combined.

Their vast scale means that the state-owned players wield enormous influence on China's economy and in turn on China's politics, an influence that private companies could never hope to match. For a start, they have a direct line to the highest levels of government through their parent company at the government ministry SASAC. The CEOs of the 100 or so most powerful companies, known as central state-owned enterprises, literally have a direct line — a special red phone on their desks that they can use to connect with the most senior figures in the Chinese government. Such unbeatable guanxi, or contacts, ensures businesses will get preferential bank loans, government subsidies, public procurement contracts — and a friendly ear from policymakers.

In public, at least, the government has repeatedly pledged to help the growth of the private sector. When the government announced its 11th Five-Year Plan in 2007, Premier Wen Jiabao lauded government support for private entrepreneurs as one of the key policy initiatives. But if anything, China's state-owned enterprises have grown even more powerful in the interim as many private companies have struggled to stay in business in the aftermath of the financial crisis.

For more than two years, private business leaders have grumbled that they have been completely bypassed by China's turbocharged stimulus package, which has seen the government shell out some $586 billion to prop up the postcrisis economy. A huge proportion of that money was spent on infrastructure projects, and most of it flowed straight into the pockets of state-owned construction giants and suppliers of raw materials.

Meanwhile, in some industries, state-owned companies have made deliberate pushes into services dominated by private players. Last month, China Mobile and the state mouthpiece People's Daily announced plans to launch a search engine to compete directly with the dominant — and privately held — Baidu. In other sectors such as car manufacturing and telecommunications, regarded by Beijing as pillar industries, successful private companies have been forced by government edict to merge with their state-owned competitors for the greater good of the industry. Earlier this year, the thriving private carmaker Zhejiang Gonow Auto was folded into the state behemoth Guangzhou Auto in an uncomfortable "arranged marriage." As the state-owned sector has grown in scope and scale, a new phrase has even been coined to describe its creeping influence: guo jin min tui, or "as the state advances, the private sector retreats."

Still, some analysts argue that at least in the airline business, private-sector companies didn't need government interference to spoil their business plans. Fueled by greed and hobbled by shoddy management, they were retreating in disarray all by themselves long before their state-owned competitors began advancing. "The private airlines had their own internal management problems," says Li Xiaojin, a professor at the Civil Aviation University of China. "Some operators were using the airline business as a way to get land from the local government and get into the real estate business," he says. "Shenzhen Airlines, for example, requested land from local governments in Henan and Kunming, then built houses on the land and kept that profit separate from the airline itself. "

Regardless of the shortcomings of some of the airline entrepreneurs, for aviation lawyer Zhang, the ultimate logic is stark and clear: private players are only welcome as long as they linger quietly in the background and don't get in the way of the earning power of the state-owned cash cows. Never was that more obvious than during the economic crisis of 2008, he says, when SASAC pumped over $2 billion into the three largest state-owned airlines to help them survive after a year of horrific losses.

"It might not be immediately obvious how the government is supporting the state-owned sector," says Zhang. "But the fact is, if you give a heap of money to the state-owned airlines and you give nothing to the private airlines, which one do you think will have the fuel to fly farther?"