State Capitalism in China

(Individualism vs Collectivism, 31 Oct 2012)

Erica Z. Lin ·

In recent years state capitalism has become an increasingly popular term among political economists. Its rise is a joint effect of sapped confidence in the West due to the lasting global recession, East Asian countries, whose successes are attributed to active government intervention in the economy.

In essence, state capitalism is a system in which profit-seeking economic activities are undertaken by the public sector. The outstanding economic performance of China in the past decades, especially compared to the economic chaos under Mao, has made it one of the most remarkable players of state capitalism, and has given the system a lot of credibility. But, Chinese state capitalism actually has its historical roots in Mao’s state communism. Though, rather than a resurgence of state communism, it is the result of the incomplete economic privatization process of the past reform decades. Moreover, a closer look at Chinese version of state capitalism will reveal that it is not a miracle or a panacea. The tremendous GDP growth doesn’t tell the whole story of China’s state capitalism, as it tends to eclipse the many defects within the system. However, Is state capitalism the real driving force of economic growth? If so, is this type of growth beneficial for the majority or does it serve the interests of the state alone? And is it a sustainable system in the long run?

Under Mao, economic policy gave priority to the heavy industries, capital intensive development path. This conflicted with China’s endowments, as the country was labour abundant, but scarce on capital and natural resources. The chief players in Mao’s economic system were the state- owned enterprises (SOEs), of which was later revealed that one third of them chronically lost money. Another third barely made ends meet, and only the last third managed to break even. Unsurprisingly, Mao’s state communism — and especially the Great Leap Forward — had brought “serious loss to the country and its people”. Post-Mao China had no choice but to reform its economy.

The economic reforms led by Deng Xiaoping started in 1978.  Guiding China onto a more liberalized and privatized path, it witnessed a well-arranged resources reallocation. Driven mainly by market forces, labour and capital shifted from an inefficient state sector to the more productive private sectors, as well as from agriculture to manufacture and services. The more efficient resource allocation, especially the one between the public and private sectors, eventually boosted a period of outstanding economic growth in the subsequent decades, and changed the landscape of economic life in China dramatically. However, this privatization reform has been regarded as incomplete, giving rise to state capitalism in the post-Deng era. Two main causes hindered the completion of the privatization process.

Firstly, the growing private sector took over primarily in small commodity production and the light industries, forcing a number of inefficient SOEs to exit the market. However, policy makers continued viewing the state sector as important as the “pillar of the economy”. Therefore it was allowed to keep its dominance in the “commanding heights” of the economy, in some cases even expanding and strengthening the monopoly position in those sectors.

Secondly, since the 1990s a corporatization of SOEs has been carried out, especially by means of public offerings. Theoretically, this reformed the ownership structure, weakening the control of state in corporations, in exchange for some external investment. In practice though, the government has retained at least 50% of the ownership share — in some industries such as oil and petrochemicals sector even 80% or more. Therefore, the state retains control over an enterprise expanded by private funding. Furthermore, the subsequent growth of these state enterprises, enables the government to generate greater impacts on the whole economy.

So after the economic reforms of Deng we see simultaneously the rise of state capitalism in China and the start of a period of dramatic economic growth. But this doesn’t necessarily mean that state capitalism is the cause of Chinese growth, as its advocates like to suggest.

This figure shows that the profit size of state sector is positively correlated with the market share. It compares the ratio of total assets to the industrial output (RAtP) between the public and private sectors for forty industries, and thus sheds a light on the economic performance of the SOEs in China. Red bubbles represent state sectors and private ones are in blue. The size of each bubble represents the aggregate profits in that individual sector. The horizontal axis shows the industry share, where 100% indicates the sector is completely monopolized. The vertical axis  demonstrates the profitability (RAtP) of both public and private sectors.

These numbers prove that the tremendous profits of few industries come with the monopolized position they have in the market. The actual profitability is variable though, even for monopolists. On the other hand, in the more competitive industries without public sector monopolies, profits disappear for state-owned sectors. There they lose out to the private enterprises, who demonstrate a stronger capacity to adapt the market competition. Even with a smaller market share, they generate satisfying profits. In most cases their profitability is much higher than public industries, including some monopolists. All this suggests that the private sector in China is much more efficient than the public sector. Therefore it is probably the driving force behind China’s impressive economic growth in recent decades.

Impressive but not miraculous, so tell the statistics on labour income share in this second graph. They prove that China is not reaching its goal of enriching the state and fattening its people at the same time (国富民强). A 2010 study by Chong-En Bai and Zhenjie Qian showed that the share of the growing national income that “trickled down” to industrial workers has markedly declined over the last two decades. The main reasons for this are the decline of SOEs and the expansion of monopoly power.

As mentioned above, the partial privatization of the early 1990s forced considerable numbers of inefficient SOEs to exit from competitive industries. At the same time some SOEs in key sectors were allowed to monopolize the market and strengthen themselves through partial privatization during the 2000s. It is the state capitalism that arose from this incomplete privatization that should be blamed for the decline in labour income share. Why? Because the benefits of state capitalism are fundamentally biased. In state-owned companies relatively higher salaries are paid to “insiders” of the system, instead of raising wage levels across the board. With the retreat of SOEs, the total number of “insiders” shrank, and therefore the income labour share dropped.

This does not mean we should reverse the trend of privatization for the sake of improving income distribution. Since the SOEs are proven to be inefficient, reintroducing them would seriously hamper economic growth.  Simply increasing the income level by law or industry rules is not an option either. According to Bai and Qian this would lead to increased unemployment, as overpriced labour could easily be substituted for capital. Thus, enhancing market competition instead of strengthening monopoly power is the only workable policy to turn the falling trend of labour income share. Further privatization is the only way forward.

In terms of welfare, advocates of state capitalism believe that this system does a better job at maintaining social equality than capitalism. In reality, state capitalism does provide a good deal of social welfare, but the welfare generated under the system is biased. It divides its citizens into the “insiders” and the rest. Social housing is an especially striking example. The majority ordinary Chinese who are suffering from high prices on the private market have very limited chances to get social security housing, whereas insiders – some of whom own multiple private houses already – actually are the beneficiaries of the current social housing policy. Some of them are now using that advantage to sell on the social security houses they obtain!

In the same way it separates its citizens, the state treats its public and its private companies rather differently. Especially financing investment has been a long-standing sore point for small and medium-sized private firms. Being incapable to get loans from state banks, they have to turn to underground loans with high interest rates. In the meanwhile, some troubled SOEs can survive and even prosper, thanks to government subsidies and “soft” loans that might not be able to gain under normal commercial criteria. The state-ownd bank, the Industrial and Commercial Bank of China, ranking the 54th on the Fortune 500 in 2012, made the world largest public offering back in 2006, valued at 21.5 billion U.S. dollars. Prior to the offering though, it had been bearing 19.1% of non-performing loans in China. The government spent more than 162 billion dollar to prepare it for the listing, through a series of capital injections and subsidies to dispose bad loans, partly financed from China’s foreign exchange reserves. According to Bank of China Chairman Xiao Gang: “SOEs often enjoy a monopoly in their sectors, favourable conditions in an industry and quasi-government credit ratings.”

Favouritism toward relatively the weak state sector, inherent in state capitalism, is harmful. It prohibits the social resources (capital, human capital and natural resources, etc.) being allocated in more efficient places, and hinders the development of private sectors. This results in a reduction of overall efficiency and economic growth, and further, it will impede future development. Last but not least, state capitalism, as a “creative” combination of state communism and capitalism, tends to privatize the profit but socialize the risks. In the light of the previous discussion, the benefits of the system are biased only to “insiders”, but the state – and in practice the whole society – will bear the losses made by SOEs. No wonder that the decisions making from the state sector tends to be arbitrary and reckless, and its general efficiency is lower than the private enterprises. The public sector is instructed to operate in the “commanding heights” of the economy and carries certain social burdens such as pension and social welfare, however biased. The state in return are responsible for the losses that arise from policy burdens, but as a result, the managers of SOEs are likely to ascribe all their losses to state policy as well. This softens their budget constraints. The state, therefore, will further intervene into the operations of SOEs to constrain this problem, leading to a vicious cycle of policy burdens, soft budgets, agency problems and further political interventions. Thus, a further reform is imperative. Making the SOEs accountable for their own behaviour, relieving them from policy burdens, and increasing market competition would help harden the budget constraints, and that way break state capitalism’s vicious cycle.

On the global stage state capitalism has received a warm welcome in recent years, especially now the free-market system has seemingly failed in a series of financial crises. Many Chinese might also greet state capitalism with applause and cheers, as it seems to have made the country stronger and wealthier. Even though they are at the same time complaining about the “beneficiaries”, they seldom reckoned the link between their personal worse-offs and the rise of state capitalism in China. In a way, they still expect to receive their deserved share from ever the expending national GDP “tomorrow”. Unfortunately, this expected tomorrow will not come under the state capitalist system. Though there is indeed a need for the state playing a role in an industrializing economy, this article showed the downsides of state capitalism based on the Chinese version. The partial reform in China that created state capitalism has raised many new problems, stemming from the historical leftovers of Maoism. All possible solutions to those problems include further privatization, coupled with thorough political and economic reforms in the near future.

But in the end, I should note that the critique of state capitalism in this article doesn’t automatically make other socio-economic models look pretty or promising. As an ancient Chinese statecraft wisdom suggests, the lord of a state should not be afraid of scarcity and poverty, but do worry about uneven distribution and discontent among the people (不患寡患不均, 不患贫患不安). This is not to deny the importance of economic growth, but it emphasises the importance of sharing the fruit of economic growth among its people, and creating a social equilibrium that brings stability and longevity to a society. This ancient wisdom might provide the real long-term path that China should head for.