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Xi Li
Yong Wang
Xuewen Liu
The weaknesses of many capitalist market economies revealed by
the recent global economic crisis combined with the economic
success of the BRIC countries, especially China, has given rise
to an alternative growth model--state capitalism. As practiced
in China, state capitalism is an economic system in which the
national government provides support to “national champions”
but also lists the champions on the stock market and subjects
them to global competition. Many intellectuals are voicing
opinions on this debate, with the demand for state capitalism as
opposed to liberal capitalism gathering momentum.
During the second phase of the reform of state-owned
enterprises (SOEs), China endorsed the “socialist market
economy” as a goal, and “nurturing the large and letting go
of the small” as a policy to deal with inefficient state owned
enterprises (SOE). Gradually, the inefficient SOEs that were
unable to compete with private, foreign, and other firms were
weeded out of the economy, leaving mainly large SOEs that
consolidated their monopoly positions through mergers and
acquisitions. Today’s SOEs are mainly in upstream, non-tradable
sectors, so they are cushioned against the intense competition
that resulted from agreements China made when it joined
the WTO in 2001. This has led to a vertical structure in which
SOEs dominate the upstream and nontradable sectors such
as petroleum and natural gas, electricity and power, banks,
transport, storage and information transmission, while private
and other firms dominate downstream and tradable sectors,
including most manufacturing. While SOEs maintain market
power in protected upstream sectors, the downstream sectors
are highly competitive.
Interestingly, SOEs outperformed non-SOEs in terms of
profitability during the past decade even though the opposite
was true during the 1990s. Another important trend has been
the declining share of labor income in GDP over the past two
decades.
Recent research by HKUST Business School faculty Xi Li,
Xuewen Liu, and Yong Wang attempt to explain these puzzling
developments by analyzing the emergence of the state
capitalist economy and the impact of trade liberalization on the
opportunistic behavior of SOEs. They argue that the extraordinary
profitability of China’s SOE arose due to a combination of factors.
After China’s entry into the WTO, the demand for downstream
tradable goods increased, and the resulting increase in demand
for intermediate goods monopolized by the SOE’s in upstream
sectors explains the rise in SOE profitability.
This mechanism hinges on three key phenomena: openness
(international trade and export-promoting policies facilitate
industrialization which in turn boosts growth through induced
demand); labor abundance (persistence of low wages even
as exports increase increases monopoly rents and leads to a
declining share of labor income in GDP) ; and strong government
and political favoritism (preferential subsidies and tax treatments
for SOEs, easier access to finance, etc., which enables them to
maintain their monopoly position). Such a strategy presumes that
political elites prefer high profitability in the state sector, either
for ideological reasons or to extract rents.
RESEARCH HIGHLIGHT: A MODEL OF CHINA’S STATE CAPITALISM
An important question is whether this form of state capitalism
can remain viable and successful as the economy continues to
mature. The authors note the following developments that are
now occurring in China. First, China is experiencing a rise in
wages caused by demographic changes that are reducing labor
supply, increasing labor productivity, and robust labor demand.
This is expected to lead to a higher labor income share in GDP
and reduce the profitability of SOEs. Second, under this system,
weak external demand (like we have witnessed in the years
following the global financial crisis) disproportionally impacts
the upstream SOEs’ profits through less induced demand from
exporters in downstream sectors. Third, greater competition
for export markets from countries such as Bangladesh and
Vietnam also reduces monopoly rents of SOEs if they are unable
to improve their productivity. At the same time, maintaining
monopoly power of SOEs in upstream sectors increases input
prices for downstream sectors, reducing their competitiveness
and China’s overall growth potential.
These findings have important policy implications for emerging
market countries. It serves as a warning to countries like Vietnam
that are on the verge of following China’s economic reform path.
It also raises a word of caution for India, which although it is a
labor-abundant economy does not enjoy the magnitude of FDI
and exports that China has benefited from and so relies more
on domestic demand. If Indian upstream industries could be less
politically regulated and more efficient, it would help facilitate its
downstream export. Russia also practices state capitalism where
the important industries like oil and natural gas are controlled by
powerful oligarchs with close relationships to the state. However,
downstream sectors don’t enjoy the comparative advantage of
cheap labor as in China.
The au t ho r s be l i e v e t ha t s i nc e t he SOE ’s e x t r a c t ed
disproportionate profits during the trade liberalization phase due
to unique conditions operating in China, it is unlikely that SOEs
will continue to thrive given the dynamic changes that occurring.
For this reason, it is unlikely that this type of development model
of state capitalism (upstream state monopoly plus downstream
capitalism)will be sustainable in China or appropriate for other
emerging markets.
