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A comparative study of market structure in the Chinese construction industry

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  CIB W107 Construction in Developing Countries International Symposium “Construction in Developing Economies: New Issues and Challenges” 18-20 January 2006, Santiago, Chile. A Comparative Study of Market Structure in the Chinese Construction Industry D. Wang 1 , R. J. Krizek 2  , and A. Hadavi 3   1 Swinerton Inc., San Francisco, CA, USA. dawang@swinerton.com  2 Department of Civil and Environmental Engineering, Northwestern University, Evanston, IL, USA. 3 Department of Civil and Environmental Engineering, Northwestern University, Evanston, IL, USA. Abstract: The Chinese construction industry has developed over the past two decades within the framework of a socialist market system. Nevertheless, the poor industry performance indicates an inefficient and ineffective market. This study investigates the market structure of the Chinese construction industry in terms of firm size distribution, the Lorenz Curve and the associated Gini coefficient, and the proportion of specialty contractors, and the results for the Chinese construction industry are compared with those for the United States, United Kingdom, and Japan. This comparative analysis indicates that the current market structure in the Chinese construction industry is inappropriate for its further development, and this is an important factor contributing to its poor performance. Chinese firms are generally much larger than firms in developed countries, and they are quite similar among themselves in terms of business volume and services provided. Stated alternately, the Chinese market is not as fragmented as other construction markets. Because of their similarity, many comparable contractors compete with each other in the market, leading to fierce rivalry. The high barriers for firms to exit from the industry make the situation even worse. Several policies are suggested for the government to improve the development of the Chinese construction market.   Keywords Market structure, comparative analysis, chinese construction industry, firm size distribution, specialty contractors  INTRODUCTION Ever since China launched its far-reaching reform of its national economic system in 1978, there has been a process of transformation from a centrally planned economy to a socialist market economy (Flanagan and Li, 1997; Chan et al. 1999; Han and Ofori, 2001). The Chinese construction industry was one of the first industries in the nation to be reformed. The goal of the industry-wide reform was to shift from the old assignment system to a system in which the survival of a construction business is determined by the competitive market. As a result of reduced central control over state-owned enterprises and the introduction of competition and incentives for people   2 to make and share in profits, the Chinese construction industry has been growing rapidly (Flanagan and Li, 1997).  Nevertheless, despite the industry’s great achievements, such as a high annual growth rate and an increasing contribution to the GDP, its development over the past decade or so suggests that it faces serious difficulties during its transition to a market-oriented system. In particular, the profit rate declined during the transformation and has now reached low levels. The percentage of unprofitable firms in the industry has been rising since the early 1990s and remains high today. Furthermore, construction firms compete fiercely in a market that is not fully developed and remains quite different in structure from that seen in well-established market economies. METHODOLOGY Market structure determines the degree of competition and is a major determinant in the behavior and performance of firms (Carlton and Perloff, 1994). Therefore, the analysis of market structure is the first step towards a study of the industry. The structure of the market is defined in terms of the number and size distribution of competing firms (Bain, 1968). In this study, the details of which have been addressed more comprehensively by Wang(2004), the market structure is examined in terms of firm size distribution by employment, the Lorenz Curve, and the associated Gini coefficient, and the results for the Chinese construction industry are compared with those for the US, UK, and Japan. In addition, issues of specialty contractors and subcontracting, as well as conditions of market entry and exit, that affect the market structure in the Chinese construction industry are investigated. China has been switching to a global market economy and the Chinese construction market has been adopting common international practices. China’s entry into the World Trade Organization is accelerating the transformation process. Comparison with the well established American, British, and Japanese construction markets will assist in understanding the  practices that could help the future development of the Chinese construction industry in this transitional period. FIRM SIZE DISTRIBUTION BY EMPLOYMENT The size distributions of contractors by employment size class in the US, UK, and Japan have the following characteristics (see Tables A1 to A4 in the Appendix): (a) The number of contractors is large in these developed countries. In the US, there were 656,448 construction establishments in 1997 (Construction statistics in the US are based on establishments, rather than firms, and one firm may be comprised of multiple establishments. However, the vast majority of US construction firms are small and localized, there were more than half a million construction firms in the United States (Barrie and Paulson, 1992)). In the UK in 2000, there were 163,426 construction firms. The size of the Japanese construction industry is similar to that in the US. In 1996, there were 647,356 construction establishments in Japan. (b)   Most contactors are very small. More than 90% of all contractors in the US had fewer than 20 employees. About 98% of the total construction firms in the UK had fewer than 24 employees. In Japan, about 95% of the total contractors had fewer than 20 employees. (c)   The average size is less than 10 employees per construction establishment or firm.   3 (d)   Large builders have a market share advantage over the small ones. Less than 1% of the total contractors in the US had more than 100 employees, but they represented about 27% of the total output. There were 518 firms that had over 115 employees in the UK; although accounting only for 0.32% of all contractors, these firms accomplished more than one-third of the total output. The largest firm group in Japan made up only 0.06% of all contractors,  but produced 23% of all output. Unlike the three well-developed market economies, the Chinese construction statistics do not categorize construction firms by employment size. Instead, China publishes construction statistics  based on a qualification class system that was established by the Ministry of Construction. Table 1 shows the number of firms, gross output value, employment, and average employees per firm for each qualification class in the Chinese construction industry in 2000. Qualification Class One was the highest class and its holders usually have thousands of employees. The size of the construction firms in the lower qualification classes is smaller to varying degrees, depending on the class. In general, higher qualification class firms employ more people than lower class firms. Therefore, qualification class is used to classify construction firms to analyze the size distribution of firms in the Chinese construction industry, assuming that higher class firms are larger than lower class firms in terms of the number of employees, and Qualification Class Four firms are larger than firms without a qualification class. Table 1. Employment Size Distribution of Contractors by Qualification Class in China, 2000 Contractors Output Qualification class  Number of firms Percentage of total (%) Cumulative  percentage (%) Output (billion RMB) Percentage of total (%) Cumulative  percentage (%) Total employment (1,000) Average employees  per firm Without 49,745 51.14 51.14428.3425.5325.536,434.7 129.4Class 17,562 18.06 69.20104.886.2531.782,870.1 163.4Class 19,228 19.77 88.97249.8914.8946.675,844.1 303.9Class 8,307 8.54 97.51347.2920.7067.366,321.1 760.9Class 2,421 2.49 100 547.6932.641005,939.0 2453.1Total 97,263 100 - 1678.0--27,409.0 281.8Source:   State Statistic Bureau (2001): China Statistical Yearbook  ;   State Statistical Bureau (2001): China Statistical Yearbook on Construction Compared to the three developed countries, there are far fewer construction firms in China, the firm size is much larger, and a big difference exists between the firm size distribution in China and the other countries. In 2000, there were 97,263 Chinese construction firms. The average number of employees per firms was 282, about 30 times that of the US and Japan and 50 times that of the UK. In addition, the larger contractors in China produced a smaller percentage of the total output than their counterparts in the well-developed countries. Class One firms that averaged 2453 employees  per firm accounted for 2.5% of the total firms and one-third of the total output. Since employment size is classified differently for each of the four countries, the average number of employees per firm for each firm size and the measure of this firm size as a percentage of all contractors are used in Figure 1 to compare in one column chart the approximate firm size distributions by employment for the four countries (see Table 1 and Tables A1 to A3 in the Appendix for the source data).   4  Figure 1 demonstrates clearly the characteristics of construction firm size distributions in China and the other three countries. As can be seen, the distributions are similar in the US, UK, and Japan; most of contractors are very small, the range of firm sizes is very wide, and the number of contractors decreases drastically when firm employment size increases. The contractors in the three countries that have more than 20 people account for less than 10% of total. The proportion of the contractors that employ more than 100 people is less than 1%. In contrast, most construction firms in China have more than 100 employees. The range of firm size is narrower, and the distribution is much more even than in the three developed countries. This indicates that Chinese contractors are more similar with a higher proportion of larger firms. Based on the above analysis, the size of Chinese contractors is seen to be much larger than those in developed countries and the overall distribution of the number of firms is much more biased toward medium and large firms, although medium and large firms account for a smaller percentage of the overall construction work. Figure 1. Size Distributions of Construction Firms By Employment (Wang, 2004) 0%10%20%30%40%50%60%         1  ,        9        2  ,        1        2  ,        3        2  ,        9        6  ,        4        6  ,        6        7  ,        0        1        2  ,        0        1        3  ,        3        2        1  ,        2        2        3  ,        6        2        9  ,        6        3        3  ,        5        3        7  ,        2        4        8  ,        4        6        6  ,        4        6        7  ,        6        7        7  ,        2        1        0        7  ,        7        1        2        9  ,        4        1        3        2  ,        6        1        4        5  ,        9        1        6        3  ,        4        2        0        1  ,        8        2        4        0  ,        0        3        0        3  ,        9        3        3        4  ,        8        4        8        2  ,        4        6        1        4  ,        4        6        6        1  ,        7        7        6        0  ,        9        9        8        8  ,        2        1        9        6        7        2        1        7        1        2        4        5        3 Average employees per firm    P  e  r  c  e  n   t  a  g  e  o   f   t  o   t  a   l   f   i  r  m ChinaUSUK Japan   LORENZ CURVE AND GINI COEFFICIENT The Lorenz curve and its associated Gini coefficient indicate the degree of competition in a market  by measuring inequality in the size distribution of firms (Hart and Prais, 1956). The Gini coefficient is a statistical measure derived from the Lorenz curve, which relates the cumulative share of the total value of any variable (output, revenue, number of employees, etc.) to the number or percentage of firms in the industry arranged in increasing size. If the “curve” is a straight line, all firms are of equal size. A diagonal would suggest that all the firms are of equal size and the industry may be viewed as completely unconcentrated, indicating fierce competition in the market. In general, however, firms are not of equal size in any given industry and the greater the deviation of the Lorenz curve from the diagonal, the greater the inequality in firm sizes and the higher the market
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