1.1 The Chinese State and Economic Growth
Over a century after its eclipse, China has arrived again at global center stage,1 drawing increasing attention from economists, political scientists, international relations experts, other scholars, and observers. This attention derives in large measure from the fact that not only has China achieved impressive economic growth hitherto unmatched in magnitude and duration but also it has done so under a political system and using strategies which are quite different from those adopted by most other countries. Chinese economic growth is built on a political system that has collapsed in many other countries including the Soviet Union. Its economic policies also differ from what most other countries implement. The dominant institutional framework is what the Chinese leadership calls “socialism with Chinese characteristics” which keeps the Chinese Communist Party in the central role. But the reality is that China has a mixed economy in which the state has a major guiding role but with detailed economic decisions being to a large extent decentralized to lower level government.
China’s emergence as an economic power has brought increased scrutiny of the manner of its rise. That this rise has relied on state power and is at variance with the approach favored and followed by advanced countries has led to criticism of the state and its institutions over which it exercises authority through ownership or control. Criticism leveled at the Chinese state takes two forms. The first is that its political order of authoritarian rule is unsustainable and will ultimately be overtaken by forces for democratization. Because the dominant political system in the world is democratic government in its various forms, many believe China must converge to this norm . Thus, Pei (2006) notes:
The second is that authoritarianism cannot coexist with a true market economy. Hence, efforts to graft Western institutions onto an authoritarian structure also will not succeed. So commentators think that the Chinese political system must collapse, and even market reform under this system cannot work. For instance , Chang (2010) concluded that “China cannot make much progress toward (the rule of law), at least as long as the Communist Party is around.” The second criticism, by extension, challenges the efficacy of China’s numerous state enterprises, which have historically played a major role in the economy, and they need to be reformed through privatization or liquidation (Lal, 2006).2if current trends continue, China’s political system is more likely to experience decay than democracy … the very policies that the party adopted … are compounding the political and social ills that threaten its long-term survival.
Yet China’s experience since the late 1970s has defied these predictions. It has achieved rapid economic growth for over three decades, through a model of growth that, though not quite approaching that of the developmental state, can nevertheless be described as state-led, or, at a minimum, state-guided. Unlike the rest of the world, China follows state-led growth, not private sector growth. State enterprises are at the heart of this model.
Given China’s strategy, state enterprises remain major players in the economy. Already the largest enterprises in their respective sectors, they are growing larger. Szamosszegi and Kyle (2011) noted that “the observable state sector, which consists of state enterprises and the enterprises they directly control, accounts for approximately 40 percent of the Chinese output under reasonable assumptions.”
For the above reasons, China’s state enterprises have continued to occupy a central position in discussions of the role of the state. Despite their declining numbers and shares of industrial output and exports, these enterprises have remained major players in the economy. They are central to China’s state-led growth strategy, but they have also been accused of holding the economy back. In reality, China’s state enterprises have been going through many changes, and the state enterprise of today bears little resemblance to that in the 1990s.
1.2 State Enterprises as Central Institutions
Ever since the foundation of the People’s Republic of China, state enterprises have been key instruments of the state’s control of economic activities. Also, for as long as they have existed, these enterprises have been criticized as producing lower levels of output than non-state enterprises, and at lower levels of productivity. Allegations of waste and corruption have also been leveled at state enterprises, whose managers, many political appointees, have been found to have diverted enterprise funds for personal gain.3 A wealth of empirical studies, to be detailed in Chap. 2, confirms the negative economic impact of Chinese state enterprise operations. This raises the question of why the Chinese state continues to allocate to these enterprises such a major role.
Before this question is answered, critics of China’s state enterprises need to deal with one uncomfortable fact. As Table 1.1 shows, despite the perverse impact of these enterprises and the commanding heights they occupy in the economy , China’s spectacular economic growth has remained unabated until after 2010. If these impacts were indeed material, is it then expected that growth rates would be even higher had these enterprises been privatized or closed? There is also scant correlation between economic growth and state enterprise reforms instituted. At least at the aggregate level, therefore, the perverse impact of state enterprises cannot be detected.
Table 1.1
China’s economic growth and major state enterprise reform measures
Year | GDP growth rate (%) | State enterprise reform |
|---|---|---|
1978 | 11.7 | Enlarging operational autonomies; Linking profits of SEs to employees’ benefits |
1984 | 15.2 | Separation of ownership rights and control rights; Manager/contract responsibility system |
1993 | 13.9 | Setting up modern enterprise system |
1995 | 10.9 | Grasping the large (state enterprises), letting go the small |
1997 | 9.2 | Helping loss-making ones get out of the difficulties |
1999 | 7.7 | Mixed ownership reform |
2002 | 9.1 | Supervision system for state-owned assets |
2013 | 7.8 | Putting forward overall objectives of state enterprise reform |
Sources: GDP growth from World Bank database; reform details from Chap. 3
Coming to the question of China’s state enterprise role, both Western theory and China-specific factors can be adduced as supporting arguments. As will be elaborated in Chap. 2, a number of Western theories argue for a sizable role of the state in mixed and market economies. And in the Western theory of public enterprises itself, state enterprises have to play both an economic and social role for which the trade-off is efficiency. Thus noted Baumol (1984: 14): “where circumstances are such that the profit motive drives firms to behave in a manner that conflicts with the social interest, inefficiency and indolence may become a virtue.”
In the specific context of China, it must be remembered that prior to economic liberalization in 1978, these state enterprises were vital to the Chinese economy, accounting for about 80% of national gross domestic product (GDP), but also providing employment and a social safety net (“the iron rice bowl”)4 for the workforce, and hence ensuring social stability (Wang & Li, 2010: 5). Thus, China began reforms with a pervasive state enterprise sector performing both economic and social functions. With its gradualist approach, China’s reforms of the state sector, even if aimed at shrinking this sector, would take time to unfold.
In addition , Li (2008), drawing from Minsky’s (1986: Chapter 4) argument that a large government sector was vital for a capitalist market economy to maintain macroeconomic stability and avoid deep recessions, argued that the Chinese state-owned enterprise sector must be sufficiently large to be able to manage and implement very substantial public sector investment projects that accounted for about 50% of the total capital formation.
If we move away from purely economic arguments, an explanation can be found from political economy. Economics has never been the only reason for these enterprises’ existence. As Hsu (2014) noted, the enterprises have also been central to the government’s political economy: control over essential economic institutions is part and parcel of Communist Party control over the state apparatus. While economic liberalization was part of this political economy, it was motivated as much by the conferment of legitimacy to the Party leadership after the decade of the disastrous Cultural Revolution (1966–1976) (Lin, 1999) as by the (as yet unknown) perceived benefits of liberalization. This is why these enterprises have continued to exist despite the national leadership’s strategy of moving toward a “socialist market economy”. The caution with which reforms were enacted, exemplified by the gradualist approach, can then be explained by the fact that the same leaders who espoused liberalization were also those who participated in the design of the planning system, with socialism the dominant philosophy.
Finally, state enterprise r...