[1] After 2001, state-owned enterprises (SOEs) in China became more profitable than non-SOEs due to China's vertical industrial structure, with SOEs monopolizing key upstream industries while downstream industries were liberalized and open to private competition. [2] Abundant low-cost labor and China's structural economic change from agriculture to industry also contributed to higher SOE profits. [3] China's joining of the WTO and export-promoting policies after 2001 further drove this trend by expanding downstream private sectors, from which upstream SOEs could extract monopoly rents.

1. State-Owned Enterprises under
China's State Capitalism
Yong Wang
Department of Economics
April 22, 2015

4. Profitability: SOEs vs. Non-SOEs
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
1993 1994199519961997 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)

6. Key Message
Question: 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.

7. Largest Chinese Firms: mostly Upstream SOEs

8. Decomposition Analysis

9. Vertical Structure: Upstream State Monopoly+
Downstream Capitalism

10. 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.

11. 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).

12. Growth Sustainability
sufficient 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

13. 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

14. 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

15. Thank You!
Email Address: yongwang@ust.hk