State-Owned Enterprises under China's State CapitalismYong WangDepartment of EconomicsApril 22, 2015

Profitability: SOEs vs. Non-SOEs

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5%

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15%

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25%

30%

35%

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45%

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1%

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5%

6%

7%

8%

9%

10%

19931994199519961997 1998199920002001 2002200320042005 2006200720082009 2010

Total Profit to Sales Revenue of Chinese Industrial Enterprises

State Owned & Holding ALL Types Excluding SOHE Export Share of GDP (Right Axis)

Key MessageQuestion: Why SOEs become more profitable than Non-SOEs after around 2001 but the opposite is true in the 1990s?

Three Features:[1] Vertical Structure: After 2001, SOEs monopolize key upstream industries while the downstream industries are largely liberalized and open to private competition[2] Abundant Labor and Structural Change: a huge labor supply in the process of industrialization[3] Trade Liberalization: joining WTO in 2001; export-promoted policies

Explanation: Upstream SOEs extract monopoly rents from the liberalized downstream private sectors, which expand in the process of industrialization and globalization.

Largest Chinese Firms: mostly Upstream SOEs

Decomposition Analysis

Vertical Structure: Upstream State Monopoly+ Downstream Capitalism

Further Discussion on Logic• Without Vertical Structure, expansion of private firms

would hurt the profitability of SOEs in substituting industries (SOE reforms in the 1990s).

• Without Abundant Labor, wage would increase faster, hurting the ability of upstream SOEs to extract rents.

• Without Structural Change, upstream SOEs would not extract that amount of rents from the agriculture sector.

• Without Trade Openness, downstream private sector would not expand that much and hence upstream SOEs could not extract that amount of rents.

Welfare Implications• High profitability of upstream SOEs is a consequence

of China’s growth, not a cause of it.

• Unprecedented prosperity of SOEs is a symptom of the incompleteness of market-oriented reforms.

• Eliminating upstream SOE monopoly could increase GDP, facilitate industrialization, reduce consumption prices, enhance welfare of the public, and ameliorate income distribution (& reduce corruption).

Growth Sustainabilitysufficient industrialization

accelerations in both labor costs and real exchange rate

hurting international competitiveness of downstream firms

downstream firms strangled by upstream monopoly

upstream SOEs unable to milk from downstream

upstream SOEs must reduce markups and improve productivity

Otherwise, China may fall into the middle-income trap

How to Reform SOEs• Natural Monopoly vs. Administrative Monopoly

• Reforms in Strategic Industries

• Capital Accumulation and Industrial Upgrading

• Industrial Policies: Innovation; National Champions

• Complementary Reforms: Financial Reforms; Law Enforcement (esp. anti-trust law, auditing etc.); Safety Network; Anti-Corruption Campaign,…

• Optimal Sequencing and Speed of Reforms: Gradualism; Mixed Ownership; Outward FDI

References[1] Xi Li, Xuewen Liu, and Yong Wang, 2012, " A Model of China's State Capitalism" working paper, HKUST[2] Julan Du and Yong Wang, 2013, "How to Reform SOEs under China's State Capitalism", in Unfinished Reform in China, edited by Jun Zhang, World Scientific Publisher[3] Yong Wang, Jenny Xu, and Xiaodong Zhu, “Structural Change and Dynamics of Real Exchange Rate”, in progress[4]Justin Yifu Lin and Yong Wang, “Structural Change, Industrial Upgrading, and Middle-Income Trap”, in progress[5] Yong Wang and Shang-Jin Wei, “International Trade, Economic Growth, and Middle-Income Trap”, in progress[6] Yong Wang, “Vertical Structure, Income Inequality, and Structural Change”, in progress[7] Yong Wang, 2015, " A Model of Sequential Reforms and Economic Convergence: the Case of China”, China Economic Review.[8] Yong Wang, 2013, “Fiscal Decentralization, Endogenous Policies, and Foreign Direct Investment: Theory and Evidence from China and India”, Journal of Development Economics.[9] Jiandong Ju, Justin Yifu Lin, and Yong Wang, 2013, “Marshallian Externality, Industrial Upgrading and Industrial Policies”, world bank working paper[10]Jiandong Ju, Justin Yifu Lin, and Yong Wang, 2015, “Endowment Structures, Industrial Dynamics and Economic Growth”, Journal of Monetary Economics, forthcoming

Thank You! Email Address: yongwang@ust.hk