State Capitalism and the Chinese Firm*
Curtis J. Milhaupt
Ownership is the touchstone of corporate governance analysis. The identity of a corporation’s equity owners has enormous significance for the oversight and incentives of management, the corporate governance challenges it faces, and ultimately, the goals it pursues. The impact of corporate ownership is considered to be particularly acute when a contrast is drawn between privately owned enterprises (POEs) and state-owned enterprises (SOEs). Particularly, in the Chinese context, analysts have devoted considerable attention to SOEs as the “primary vehicles for Chinese state capitalism.” This attention is deserved, but incomplete. We argue in this Chapter that drawing a stark distinction among Chinese firms based on ownership of enterprise (SOEs versus POEs) to frame Chinese state capitalism misperceives the reality of that country’s institutional environment and its impact on the formation and operation of large enterprises of all types. Functionally, SOEs and large POEs in China share many similarities in the areas commonly thought to distinguish state-owned firms from privately owned firms: market access, receipt of state subsidies, proximity to state power, and execution of the government’s policy objectives. A complete account of Chinese state capitalism must explain these similarities.
Simultaneously, recognizing the functional blurriness of corporate ownership categories in the Chinese context calls attention to how the rules of the game for economic activity are shaped in contemporary China. Our central claim is that Chinese state capitalism is largely synonymous with state capture. That is, large firms in China—whether SOEs, POEs or ambiguous state-private blends—survive and prosper precisely because they have fostered connections to state power and have succeeded in obtaining state-generated rents. Large Chinese firms, by definition, have mastered the dynamics of state capture. As a result, large firms in China exhibit substantial similarities in their relationship with the state in ways that distinctions based on corporate ownership simply do not pick up.
This Chapter proceeds in three parts. Part I explores and undermines two parallel, faulty assumptions that are fostered by over-attention to the public or private character of corporate ownership in China: First, that the Chinese state exerts nearly unbridled control over SOEs and has free reign to use these firms as tools of government policy, both domestically and abroad. Second, that large “private” firms in China are autonomous actors operating outside the mechanisms of Chinese state capitalism. Part II explains the dynamics of capture in the Chinese economy, in which firms of all ownership types face a choice: grow and prosper by nestling up to the state and demonstrating the capacity to deliver on key party-state objectives, or seek autonomy from the state and be marginalized. Part III explores the theoretical and policy implications that follow from our analysis.
I. The Ownership Bias
Although ownership of enterprise is a natural starting point for analysis of Chinese corporate governance, focusing on the SOE-POE dichotomy fosters two assumptions that skew analysis of Chinese state capitalism and may lead policymakers astray. In this Part, we explore and unsettle these assumptions. Neither theory nor practice suggests that the Chinese state “controls” SOEs to the degree its equity ownership would indicate. At the same time, however, it is misleading to view “private” firms in China as insulated from the state in ways that set them wholly apart from SOEs. Rather, the human agents managing Chinese SOEs and POEs respond in similar fashion to their institutional environment, fostering close ties to party-state organs, seeking state largesse, and resisting government policies that are not in their interests.
Before elaborating, we begin with a foundational point: even the labels “SOE” and “POE” are misleading, because the boundary between state and private ownership of enterprise is often blurred in contemporary China.
A. Blurred Boundary Between SOEs and POEs
In all economies, the boundary between public and private ownership of enterprise is more porous than conventional analysis assumes, because the state retains control rights over firms even in the absence of ownership interests. These state control rights are typically obtained through taxation, regulation, and subsidization. The causes of and response to the 2008-2009 financial crisis in the United States illustrate that even in countries where private ownership of enterprise has strong ideological and historical roots, the boundary between government control and private control can be blurry and susceptible to change.
The boundary between public and private enterprises is even more blurred in China, a country with a long tradition of state dominance in the economy, underdeveloped legal institutions, and relatively inchoate conceptions of property rights. In practice, the ownership types of many firms in China are ambiguous. For example, one of the main drivers of China’s economic miracle during the 1980s and the early 1990s was the emergence of the so-called “non-state” firms, whose share of national industrial output increased from 22 percent in 1978 to 42 percent in 1993. Many of the non-state firms were “collectively” owned—that is, ostensibly owned by “all residents” in a community, yet with none of the residents possessing the exclusive rights of ownership associated with traditional property rights theories. A scholar has theorized that these collectively owned firms represent an arrangement in which private entrepreneurs choose to have local governments as the owner of the otherwise private firms as a response to a market environment in which business transactions are easily blocked by government regulations. Another scholar has argued that these collectively owned firms were in fact privately owned and operated and were registered as collectively owned only because, at the time, there was no legal framework for the registration of private firms.
With the adoption of the Company Law in 1994, private entrepreneurs gained the ability to register their firms as POEs, but the state also increasingly participated in the ownership of corporate shares. It did so not only through wholly state-owned entities, but also through mixed-ownership entities where the ownership and management of the firms are shared among state and private shareholders. In 1997, China announced a massive program to privatize all but the largest SOEs under the slogan of “grasping the large, letting go of the small” (zhuada fangxiao). In practice, however, the newly privatized SOEs did not become private firms as that term is commonly understood; instead, they became firms with mixed-ownership. It was estimated that as of 2003, mixed-ownership firms accounted for forty percent of China’s GDP. Some of the best-known Chinese firms, such as Haier, TCL, and Lenovo, are mixed-ownership firms. In particular, publicly listed firms in China are typically of the mixed ownership type. Mixed ownership has also become an important ownership form among China’s central SOE groups at the subsidiary level: For example, almost all of the thirty-four subsidiaries of China National Offshore Oil Corporation (CNOOC) are mixed-ownership firms with an average state-share percentage ranging from 40-65%.
Classifying the mixed-ownership firms as SOEs or POEs presents a challenge. When the percentage of state shares in a mixed-ownership firm is relatively large, the firm could, at least in theory, still be classified as an SOE. But the classification gets more difficult as the percentage of state shares decreases. In some cases, the ownership structure of a mixed-ownership firm becomes so fragmented that none of its state or non-state shareholders hold a controlling interest in the firm. An example is Ping An Insurance (Group) Co. of China Ltd. Table 1 shows the top ten shareholders of Ping An, by type, and their respective ownership percentages:
Ping An’s 2012 annual report notes that the “shareholding structure of the Company is relatively scattered. There is no controlling shareholder, nor de facto controller.” Because of its fragmented ownership structure, it is difficult to classify Ping An as an SOE or POE based on equity ownership alone. The inconsistent classification of Ping An by outside observers illustrates the problem. In 2012, Ping An was treated as a POE when it was included in the Fortune Global 500 ranking of the world’s largest firms. Yet in the same year, Ping An did not appear on an influential ranking of China’s top 500 private companies, suggesting that it was not considered a POE by the domestic organization that conducted the ranking.
For some mixed-ownership firms, classifying their ownership type is difficult also because of the way they are managed. A prominent example is ZTE Corporation (ZTE), China’s second largest telecommunication equipment manufacturer and the subject of a U.S. House Committee investigation in 2012. ZTE’s shares are listed on both the Shenzhen and Hong Kong Stock Exchanges. ZTE’s largest shareholder is ZTE Holdings, which owns 30.76% of ZTE’s shares (see Fig. 1). Under both Chinese and Hong Kong law, 30% is the point at which a shareholder is considered to have acquired a large enough stake to trigger a mandatory tender offer requirement. The shares of ZTE Holdings, in turn, are held by Xi’an Microelectronics (34%), Aerospace Guangyu (17%), and Zhongxing WXT (49%). Xi’an Micro Electronics and Aerospace Guangyu are both SOEs. State-owned entities, therefore, control 51% of ZTE Holdings. Perhaps for this reason, ZTE’s 2012 annual report lists the ownership type of ZTE Holdings as “state-owned.” According to the website of ZTE Holdings, it is one of the “national key SOEs” designated by the State Council. The third shareholder of ZTE Holdings, Zhongxing WXT (also known as Zhongxingweixiantong), is a private firm owned by a group of individuals, of whom the founder, Hou Weigui, holds the largest percentage (18%). According to the website of ZTE Holdings, it was the first firm in China to adopt a “state owned, privately managed” model in 1993. Under this so-called “ZTE model,” the majority state shareholders contractually authorize the minority private shareholders to assume sole responsibility for managing the firm, subject only to the requirement that the state shareholders be guaranteed a minimum rate of return. Under the ZTE model, therefore, a firm is an SOE from the standpoint of ownership, but a POE from the standpoint of management.
The preceding discussion suggests that classifying Chinese firms according to ownership is problematic. These problems are greatly compounded by the reality we explore in the next two sections of this Part: equity ownership alone reveals very little about the degree of control the Chinese state exercises over Chinese firms, be they SOEs or POEs.
B. State “Ownership”
By simple syllogism, the state “owns” an SOE. This is literally true in China: the State-Owned Assets Supervision and Administration Commission (SASAC), a government agency that plays the role of both a holding company and a supervisory authority, holds 100% of the shares of the parent companies of each of the approximately 115 central state-owned business groups. While the business groups may contain one or more entities whose shares are listed on a domestic or foreign stock exchange and held by minority private investors, SASAC, which reports to the State Council (China’s cabinet), is the ultimate controlling shareholder atop the business groups. At least formally, this makes SASAC “the world’s largest controlling shareholder.”
Straightforward application of agency analysis, however, points up the problem of assuming that state “ownership” of a corporate enterprise means unbridled state control over the firm. Berle and Means long ago identified the separation of ownership and control in large firms as a threat to “private property,” because it produces a misalignment of incentives between shareholders (owners) and managers. This problem, which carries the economic label “agency costs,” remains the central concern of corporate governance regimes everywhere.
Agency costs, of course, can also jeopardize public property. Majority or even 100 percent ownership of a firm’s equity by the state does not necessarily solve the misalignment of incentives between the SOE’s “owners” and managers. Rather, it may multiply the agency problem. The SOE managers must be monitored by an agent of the state, which in turn must be monitored. In the case of Chinese SOEs, this chain of monitors does not lead to an ultimate principal, because the theoretical “owner” of the SOEs—the citizenry of China—is too dispersed and powerless to play a meaningful monitoring role.
The Chinese state does exert significant political control over senior executives of large SOEs. In particular, the Party and SASAC routinely rotate senior SOE executives among different business groups in the same sector. Top-down political control, however, does not fully eliminate agency costs. To meet its governance goals, the Chinese state has to delegate a significant amount of discretion to its local agents and accommodate their special interests to ensure their participation and cooperation. The frequent rotations of senior SOE executives may be a reflection of the weakness, rather than the strength, of top-down political control, as they suggest that the state has no other effective means of keeping SOE executives in check.
Policy choices made in the transition from communism to market economies compound the agency problem in SOEs. Efforts to revitalize the state-owned sector in many formerly communist countries, including China, included massive delegation of managerial discretion to SOE insiders. In China, the delegation of authority has been a major theme of SOE reforms since the late 1970s. As a result of such policies throughout the transition economies, “irreversible jurisdictional authority” was conferred on managers within their own SOEs. These reforms, together with privatization of SOEs into the hands of entrenched managers, led to rampant “insider control.”
Thus, both theory and the obvious consequences of economic transition policies suggest far greater managerial autonomy from the state in the SOE sector than a focus on ownership alone would suggest. The relatively attenuated nature of the Chinese state’s control over SOEs is evidenced in a variety of ways, discussed below.
1. The state collects little or no dividends from SOEs
Equity owners have a residual claim on the cash flows generated by the corporation. Residual claimant status is a key theoretical reason why equity owners, as opposed to contractual claimants such as bondholders or employees, are legally vested with the right to elect the board of directors. While in theory the state is entitled to all of the SOEs’ after-tax profits, the Chinese government has historically collected little or no dividends from SOEs. In 2007, the State Council required central SOEs (those under SASAC supervision) to begin paying dividends ranging from 0 to 10 percent. In 2011, the SOE dividend rates were increased by 5 percent across the board, to 5 to 15 percent. These rates, however, are still far below the average dividend rates paid by established industrial firms in the United States (50 to 60 percent) and the average dividend rate paid by SOEs in five developed economies (33 percent). Moreover, the dividend rates paid by central SOEs to the government in its capacity as shareholder are lower than those paid to private shareholders by Chinese SOEs listed in Hong Kong. Most importantly, perhaps, virtually all of the dividends paid by SOEs to the government are eventually recycled back to them: More than 92 percent of the dividends paid by central SOEs to the government in 2012 were remitted back to the SOEs in the form of subsidies.
From an agency perspective, these dividend policies have a number of negative implications. First, it is difficult to justify maintaining a large SOE sector on behalf of the citizens—the ultimate principals—if profits from the enterprises are not remitted to the state. Second, low dividend payouts to the government and heavy recycling of profits back to the SOEs in the form of subsidies increase free cash flow, which generates additional agency slack between SOE managers and the government in its role as owner-investor. By increasing the amount of cash at the SOE managers’ disposal, these policies facilitate managerial misbehavior in the form of perk consumption and empire building.
2. Executive compensation practices at SOEs suggest limited state control over managers
Theory and cross country experience suggest that concentrated ownership alleviates agency problems in setting managerial pay. Yet executive compensation practices at Chinese SOEs, with concentrated ownership in the hands of the state, have posed problems throughout the reform era, suggesting limited state control over SOE managers.
During the initial phase of market-oriented reforms of Chinese SOEs, individual state-owned firms were allowed to base executive compensation on firm performance. The practice led to significant disparities in pay levels across SOEs. To address this perceived problem, several ministries of the State Council in 2009 introduced a scheme that capped executive compensation at the central SOEs overseen by SASAC at twenty times of average employee compensation. Putting aside the question of whether this is an optimal compensation formula, such a system ostensibly suggests a significant degree of state control over managerial incentives.
But beneath the surface of state control over executive pay lies a vast domain of managerial autonomy. A common form of private benefit extraction by SOE managers is the practice of “on duty consumption,” a catch-all category of perquisites, expense accounts and side payments that often significantly exceed a manager’s formal compensation, which is regulated by SASAC in cooperation with senior Party organs. The scale and pervasiveness of these practices belie the notion that the Chinese government, as a controlling shareholder, is closely monitoring SOE managers and carefully tailoring incentives to maximize returns on state assets. Rather, these practices suggest a considerable degree of agency slack between SOE managers and the controlling shareholder.
3. The state often fails to implement major operational and policy decisions at SOEs
It is considered good practice for the state to avoid involvement in day-to-day management of SOEs, because government agents generally lack the expertise, information and incentives necessary to run a commercial enterprise effectively. At the same time, however, a principal theoretical justification for the existence of SOEs is to accomplish objectives that, due to market failure, would otherwise be impossible. From this perspective, it would be anomalous if the state were unable to implement major operational decisions at SOEs on issues implicating key state policies. But at times, this is precisely the case in China.
One example can be found in the government’s failure to prevent SOEs from investing in the real estate sector. One of the top priorities of the Chinese government in recent years has been to rein in skyrocketing housing prices. In furtherance of that goal, SASAC in March 2010 ordered 78 central SOEs whose main business was not real estate, but which had entered the real estate sector, to withdraw. Yet almost three years later, as of December 2012, less than one-quarter of the affected SOEs had complied with the SASAC order. Many of the SOEs subject to the order actually expanded their real estate business during this period.
Another example is the recent setback in the Chinese government’s efforts to restructure central SOEs. Over the years, one of the government’s key policies has been to consolidate the SOE sector to address market segmentation, to implement China’s long-term SOE strategy, and to promote China’s national champions. In accordance with these objectives, the number of central SOEs overseen by SASAC has been reduced through mergers to 121 in 2011, down from 196 in 2003. SASAC seeks to reduce the number of central SOEs to below 100. To achieve this goal, SASAC’s original plan was to package the assets of about two dozen smaller central SOEs whose businesses were not complementary into a holding company called Guoxin Assets Management Co. However, the plan reportedly met fierce resistance from the target SOEs, particularly those that had acquired monopoly status in niche industries. The holding company was eventually established in December 2010, but with no initial assets. One year after its establishment, the holding company had acquired only one central SOE, as opposed to the two dozen contemplated by the government’s original plan. Since then it has acquired the state-held shares of Shanghai Bell, a telecommunications equipment manufacturer that has lost out in competition with other telecommunications equipment firms.
4. The state influences SOE behavior principally in its role as a regulator, not as a controlling shareholder
To the extent that the state does successfully intervene in SOE operations to achieve policy objectives, it typically does so as a regulator, not as a controlling shareholder.
For example, the Chinese government has been waging an anti-corruption campaign since Xi Jinping took over the Party leadership in November 2012. One focus of the anti-corruption campaign is to prohibit the consumption of expensive liquors by government officials. Demand for the products of two prestigious Chinese liquor firms, Maotai and Wuliangye, both SOEs, plummeted as a result of the campaign. Starting in December 2012, some distributors of Maotai and Wuliangye offered deep price discounts to win sales. Maotai and Wuliangye responded by setting minimum sales prices for their products and penalizing distributors that sold below the minimum prices. In response, the National Development and Reform Commission (“NDRC”), China’s price regulator, conducted “interviews” with executives of the firms and warned them of their violation of China’s Antimonopoly Law, which prohibits the fixing of resale prices. Following the NDRC interviews, Maotai and Wuliangye publicly announced that they would heed the NDRC warning and terminate their minimum resale price policies.
The important point about this incident is not that the state intervened, but the way in which it intervened. The state did not act as the liquor firms’ controlling shareholder, directing management through the board of directors to change their pricing policies. It intervened as law enforcer, in the same fashion as if the firms had been privately owned. This is not in itself negative. The state should enforce laws neutrally against both SOEs and POEs, and perhaps there were public policy benefits in acting publicly in a case such as this one. But coupled with the other evidence of attenuated government control over SOEs, incidents such as this suggest that the government does not view standard mechanisms of corporate control as its most effective means of influencing SOE behavior.
C. “Private” Ownership
In the context of Chinese state capitalism, “private” ownership does not mean autonomy from the state. In fact, POEs bear striking resemblance to SOEs along the dimensions typically thought to distinguish state-owned firms from the private sector: ready access to state power and largesse, proximity to the regulatory process, and little autonomy from discretionary state intervention in business judgment. We elaborate below.
1. Politically connected entrepreneurs
As one of us has written elsewhere, SOEs are deeply enmeshed in a larger system of party-state organs, a phenomenon we called “institutional bridging.” These bridges consist of dense, stable networks of relationships fostered through rotations of managers, personnel exchanges, and the wearing of multiple hats (on behalf of SOEs, the government and the party) by managerial elites in China.
Institutional bridges are also prevalent between state or party organs and senior executives of large private enterprises in China. We studied the government affiliations of the founders or de facto controllers of China’s one hundred largest POEs (by revenue) as ranked by the China National Association of Industry & Commerce. Based on publicly available information, we identified ninety-five out of the one hundred top executives at these private firms as currently or formerly affiliated with central or local party-state organizations such as the People’s Congresses and the People’s Political Consultative Conferences.
Why do private entrepreneurs join these political organs, whose powers are largely symbolic? One potential explanation is that membership in political organs signals allegiance to and influence within the party-state—creating and reinforcing networks with state-linked actors important to a firm’s success, such as banks, SOEs, and regulators. The signal of influence sent by political participation may also help ward off potential new market entrants and local government officials eager to share in the spoils of a lucrative hometown business. At the same time, widespread membership of successful entrepreneurs in party-state organizations is indicative of the confluence of interests and shared world view of political and economic elites in China—the “integration of wealth and power” in the words of China scholar Bruce Dickson. As the Wall Street Journal reported of the Twitter-like enterprise Tencent Holdings, the “company is politically as well as technologically savvy . . . . Tencent’s chief executive, Pony Ma, joined China’s nearly powerless but symbolically significant parliament, a sign the company had become part of the Chinese establishment.”
2. Government support for private firms
The Chinese state provides extensive support to SOEs—$ 310 billion in nominal terms between 1985 and 2005 according to a recent estimate. But SOEs are not the only firms supported by the state. Subsidies to large, fast growing private firms are widespread and can constitute a significant portion of a company’s net profits. Privately owned Geely Automobile, for example, received subsidies totaling $141 million in 2011, over half of its net profits for the year. When Geely acquired Volvo from Ford in 2010, much of the $1.5 billion purchase price was financed by local governments in northeast China and the Shanghai area. Huawei, China’s largest telecommunications equipment maker, provides another example. Huawei’s shares are held by its employees under an arrangement resembling an Employee Stock Ownership Plan. Yet analysts have suggested that Huawei is viewed by the Chinese government as a “national champion,” and it receives major funding from state banks. As one commentator notes, “[t]he irony that the SOE [ZTE] turned to equity markets while the private company [Huawei] relied on state funds indicates the blurred lines between the public and private sectors in China’s creation of industries considered to be strategic.”
3. Extra-legal control of private firms
The line between state and private ownership of enterprise in China is blurred not only due to ambiguous ownership structures of the kind discussed in Part I.A above, but also because the state exercises significant extra-legal control rights over private firms. To be sure, in every economy corporations are subject to regulations that dilute the control rights of corporate equity owners. State encroachment into private ownership of enterprise is particularly acute, however, when the state does not scrupulously follow clearly delineated and neutrally enforced legal rules in exercising its control rights over private enterprises.
The Chinese state relies on several means to exercise extra-legal control of private firms. One such means is the control of private firms through so-called industrial associations, also known in some sectors as chambers of commerce. Established in industries for which supervising ministries have been disbanded, these ostensibly private organizations are designed to coordinate activities within an industry. Yet the industrial associations are staffed by former government officials from the defunct ministries, and have the same organizational structures and functions as those ministries. The industrial associations actively supervise the operations of firms in their respective industries and have retained much, if not all, of the power exercised by their state predecessors. One such industrial association, China Chamber of Commerce for Import & Export of Medicine and Health Products (“Chamber”), in the early 2000s implemented an export regime for the vitamin C industry under which the export prices of all vitamin C producers were subject to review and approval by the Chamber. Some members of the Chamber were sued in the United States for fixing the prices of vitamin C products in violation of Section 1 of the Sherman Act. Defendants contended that the Chamber is an entity through which the Chinese government exercises its regulatory authority and that the price-fixing agreements at issue were compelled by the Chinese government. The Chinese Ministry of Commerce took the unusual step of submitting an amicus brief in support of the defendants’ motion to dismiss. The federal district court in New York, however, rejected this argument, holding that none of the laws and regulations cited by the defendants and the Ministry of Commerce actually compelled the defendants to fix the prices of vitamin C products. In so doing, the court focused solely on the formal language of the relevant legal rules and directives; it did not consider the Chinese government’s ability and tendency to impose its policies on private firms on an extra-legal basis.
Another means by which the state exercises extra-legal control over private firms is the practice of regulators conducting “interviews” with private firm managers to encourage or compel compliance with policies favored by the government. As indicated above, the NDRC, China’s chief economic planning agency, engages in this practice regularly. By law, the NDRC has the authority to regulate the prices of only a small number of products and services still subject to formal price control. Yet the NDRC routinely conducts interviews with firms that are not subject to these controls, to prod, and at times order, adoption of NDRC-favored pricing policies. For example, in 2010, China’s main cooking oil producers increased or were planning to increase prices due to cost pressures. Concerned about the impact of these price hikes on food price inflation, the NDRC interviewed executives of the cooking oil producers three times to urge them not to increase prices. During one of the interviews, the NDRC straightforwardly ordered the producers to freeze prices for four months, and the producers complied.
Yet another means by which the state exercises extra-legal control over private firms is the practice of prodding or even forcing private firms to participate in state-led industry-restructuring efforts. The right of ownership implies the right to decide whether to relinquish control and be acquired by another firm, but in China, this right often has to yield to the state’s plans for restructuring an industry. In 2009, for example, Shandong Steel Group, a major SOE steel producer in Shandong Province, acquired sixty-seven percent of the ownership of Shandong Rizhao Steel, an emerging privately-owned steel producer in Shandong province, under the auspice of an industry restructuring plan drawn up by the Shandong provincial government a year earlier. The acquisition was completed after the owner of Shandong Rizhao Steel, Mr. Du Shuanghua, had repeatedly stated his strong opposition to the deal and had put up fierce resistance by listing thirty-percent of Shandong Rizhao Steel’s assets in Hong Kong through a reverse merger with a Hong Kong listed company.
The point is not that the government has unbridled control over private firms, any more than it has free reign to impose its will on SOEs. Rather, the point is that where a government routinely chooses to enforce its policies by extra-legal means, the added degree of autonomy from government influence that ordinarily follows from private, as compared to government, ownership of enterprise may be illusory. Of course, this is a principal reason why politically connected entrepreneurs are so prevalent in China: if private entrepreneurship does not bring added autonomy from the state, better to seek the benefits of affiliation with the government. Simply put, if you can’t beat ‘em, join ‘em.
II. State Capitalism and State Capture
To this point, we have painted a rather paradoxical picture of the relationship between the Chinese state and Chinese firms: the state has only attenuated control over state-owned enterprises, yet it exerts significant control rights over private firms in which it holds no ownership interests. The paradox, however, is resolved when the focus of analysis shifts from the “state” versus “private” nature of ownership rights in firms to the dynamics of capture in Chinese state capitalism.
A. Susceptibility to Capture
Every government creates and maintains rents by virtue of its regulatory power. And in every economy where the government imposes restrictions on economic activities, firms devote resources to capturing rents generated by government restrictions. China is obviously not unique in the creation and allocation of rents through government intervention in the economy.
Among the world’s major economies, however, the Chinese state is highly—and perhaps uniquely—susceptible to capture, for two reasons. First, China’s huge economy and massive state interventions therein increase the opportunities for, and payoffs from, capture. The Chinese economy, at $8.2 trillion as of 2012, is now the second largest in the world. Yet the economy is, in the words of the Heritage Foundation’s Economic Freedom report, “mostly unfree.” China ranks near the bottom of the countries surveyed on measures of limited government, regulatory efficiency, and open markets. Despite liberalization efforts in the past three decades that significantly reduced the formal share of the state-owned sector in the economy, the Chinese state still plays a dominant role in the economy, a role far greater than its equity ownership would suggest. In addition to dispensing vast amounts of subsidies, the state intervenes in the economy in significant ways, generating rents that are crucial for firms’ prosperity or even survival.
One primary example of state-generated rents is access to financing. The state imposes a ceiling on bank deposit rates, and channels credit at below market cost to firms favored by the state. As a result, firms in China invest in political connections with the party-state to obtain low-cost financing. An abundance of empirical evidence indicates that the political connections of firms in China are a strong indicator of their access to bank loans. Similarly, firms with political connections are also favored in stock listings. Smaller firms without political connections, by contrast, are forced to obtain financing from China’s vast shadow-banking system at high interest rates.
Another example of state-generated rents is pervasive state-sanctioned monopolies. Many key industries in China, such as electricity, telecommunications, petroleum, railroads, public utilities, and banking, are dominated by firms that are de facto monopolies or oligopolies. These firms acquired their monopoly or dominant status not through market competition, but through market-entry restrictions imposed by the state. China adopted an Antimonopoly Law (“AML”) in 2007, but the AML left intact the monopoly or dominant status of firms in these industries.
The second reason for the susceptibility of the Chinese state to capture is the lack of procedural checks on the process by which rents are generated and allocated. Although China has lawmaking institutions and procedures that outwardly resemble those typically found in a democracy, real lawmaking power in China resides with the Communist Party. The party-state also enjoys broad discretion in setting administrative rules. As the Heritage Foundation’s Economic Freedom report notes, the “legal and regulatory system is vulnerable to political influence and Communist Party directives. The party’s ultimate authority throughout the economic system undermines the rule of law and respect for contracts. Corruption is widespread and cronyism is institutionalized and pervasive.” These weaknesses are partly a reflection of China’s stage of development, but are also traceable to the Communist Party’s monopoly on political power. The monopoly reduces incentives to create neutral market institutions that provide a level playing field for all entrepreneurs, because the Party does not need to account for future states of the world in which it is not in power. The result is an institutional ecology that encourages all firms, whether SOE, POE, or of mixed ownership, to remain close to the party-state as a source of protection and largesse.
B. Mechanisms of Capture
The Chinese economy is distinctive not only in the scale of rents it presents, but also in the mechanisms used to capture those rents. To illuminate the mechanisms of capture in China, we adapt a simple model from Joel Hellman, Geraint Jones, and Daniel Kaufmann, who studied the capture of state power in transition economies in Eastern European and the former Soviet Union. They distinguish two types of powerful firms in an economy with insecure property rights: “influential firms” are incumbents, typically SOEs, that inherited their privileged position from the previous communist system; “captor firms” are de novo private firms that “choose to engage in state capture as a strategy to compete against these influential incumbents”—or, as they put it more colorfully, captor firms “purchase advantages directly from the state.” Because Hellman et al. focused on Eastern Europe, the currency for the purchases in their model consists solely of illicit, nontransparent payments. According to their analysis, the key distinguishing trait between these two types of powerful firms is that captor firms pay bribes to shape the rules of the game, while influential firms can do so simply through the power of incumbency.
Much of this model can be applied directly to China. Because property rights are weak, in order to succeed, firms must either inherit or earn privileges and protections from the state—or more precisely, from the Party in its role as the shadow monitor of state agencies and institutions. And as in their model, it is useful to distinguish between influential firms (SOE incumbents) and captor firms (large, successful POEs) in China as well. Chinese SOEs, like their counterparts everywhere, have natural advantages in capturing state power and state-generated rents. In the Chinese case, many SOEs were literally hived off of government ministries that were eliminated in the transition. Examples are abundant. China National Petroleum Corporation (CNPC), Sinopec, and China National Offshore Oil Corporation (CNOOC), China’s three state-owned petroleum firms, were created from the operating assets of the former Ministry of Petroleum Industry. China’s five state-owned power generating firms and two state-owned power grids were all part of the State Power Corporation, which received the operating assets of the former Ministry of Electricity. China’s three major SOE telecommunications firms, China Telecom, China Unicom, and China Mobile, were converted from the operating assets of the Ministry of Post and Telecommunications through many rounds of industry restructuring. When the Ministry of Railways was eliminated in March 2013, its operating assets were taken over by the newly established China Railway Corporation.
In addition to their provenance traceable directly to the state, Chinese SOEs may also benefit from orthodox socialist ideology, enshrined in the constitution, which emphasizes state ownership of the means of production. Article 7 of the constitution, for example, provides that “[t]he state owned economy, namely, the socialist economy under ownership of the whole people, is the leading force in the national economy.” Within this constitutional framework, the private sector is a “complement” to the socialist public economy.
Despite these natural advantages of SOEs, it is possible for other firms in China to “purchase” the right to compete with incumbent firms—that is, to play the role of captor firms in the Hellman et al model. Corruption of the sort that figures prominently in that model certainly can buy influence in China, as seen in the widespread phenomenon of private firms bribing party-state officials to obtain government contracts and other favors from the state. Family, personal and professional connections also play important roles in capturing the state in China. In particular, firms connected to family members of senior government officials can gain a significant advantage over other firms in securing business deals with the state.
But the mechanisms of capture in China differ from those of Eastern Europe in that the key currency used by captor firms is not bribes, but growth potential. Because the Chinese Communist Party is averse to establishing accountability through the political process, its primary claim to legitimacy in the reform era is the ability to deliver economic development and its hoped-for counterpart, social stability. The overriding primacy placed on sustained economic growth has enabled private firms to capture the state by demonstrating the potential to deliver that growth. For example, Huawei, China’s leading telecommunications equipment company, achieved its initial success by developing a particular digital telephone switch with greater capacity than any other products available on the Chinese market at the time. After Huawei’s technological breakthrough, government support flowed into the firm. Through its advanced technology and ingenious marketing strategies, Huawei was able to overtake other influential firms in the Chinese market, including Shanghai Bell, a joint venture between the business arm of the Ministry of Post and Telecommunications and the French corporation Alcatel, and Julong, which was assembled from eight SOEs supervised by key government ministries and the Chinese military.
The political imperative for growth has been institutionalized in ways that further distinguish the mechanisms of capture in China from those in other transition economies. A unique attribute of state capitalism in China is the large role played by local governments. Contrary to popular perception, China’s model of economic decision making is highly decentralized. This was true even before the commencement of economic reform, but economic decentralization accelerated under transition policies such as “fiscal federalism”—a revenue-sharing regime that grants a significant amount of autonomy to local governments in setting local budgets and expenditures. In particular, a fundamental fiscal reform in 1994 assigned local governments a lower revenue share but higher expenditure responsibilities, leaving them no choice but to seek new tax bases. This reform, combined with the delegation of investment approval authority to local governments, led to competition among local governments for investment projects with high potential to generate tax revenues. Oliver Blanchard and Andrei Shleifer theorized that this competition is made possible by a politically centralized party-state that is ready to reward and punish local officials based on their economic performance. This hypothesis finds support in empirical evidence indicating that the likelihood of promotion of China’s provincial leaders increases with favorable economic performance. Scholars have argued that competition among local governments is a main driver of China’s economic growth in the reform era.
This institutional setting suggests the diminishing relevance of enterprise ownership to the party-state as the economy grows more complex. The growth imperative forces the party to look beyond SOEs in bolstering its claim to legitimacy, and enables private firms to capture state rents by demonstrating growth potential, particularly to local government officials. As a recent report notes, “[l]ocal leaders these days are assessed based on economic growth, and are increasingly agnostic about what type of firm provides that growth.”
The structural dynamics of capture are enhanced by two other factors that provide special privileges to favored firms, without particular regard to public or private ownership. One such factor is industrial policy, which is used extensively to guide and promote economic development. Firms in preferred sectors or industries, such as renewable energy, are in a privileged position whether they are state-owned or privately owned. Another factor is nationalist sentiment, which favors Chinese firms, state-owned or private, over foreign companies.
As a result of these dynamics, successful large firms in China, irrespective of ownership, are likely to be those that have captured state power and rents, either through incumbency, or by demonstrating growth potential to government officials. Industrial policies, nationalist sentiment, and outright corruption reinforce the advantages enjoyed by these firms. Firms that lack politically influential attributes tend to be marginalized in China’s state-centered economy. Even SOEs that rely exclusively on incumbency, without the promise of growth, face the prospect of being absorbed by stronger SOEs.
C. State Capture and Market Dominance
Patterns of market dominance in China are consistent with the claim that state capture is a main determinant of success of Chinese firms. These patterns simultaneously demonstrate how Chinese corporate development has been affected by path dependence and adaptation to the institutional environment. When the state first withdrew from direct participation in commercial activity, SOEs were the default arrangement: They inherited all of the operating assets from the supervising ministries and were the only players in the market. The subsequent path of development would diverge, however, depending on whether the SOE incumbents could capture the state and secure state-generated rents, particularly state-sanctioned monopoly status. When the SOE incumbents fail to do so, they are exposed to the vagaries of market competition and often lose out to emerging firms. The above-mentioned Shanghai Bell, an incumbent telecommunications equipment firm that was marginalized by Huawei, provides an example. But if SOE incumbents could capture the state and erect state-sanctioned entry barriers against emerging firms, their incumbency status could become entrenched, as seen in China’s monopoly industries.
The entrenching of incumbent firms due to state capture could lock China’s industries in a pattern of path dependence. When incumbent firms have captured the state, they become well positioned to resist additional reforms that would threaten their incumbency status. This power of incumbency can be seen from the state’s repeated failures to break up SOE monopolies in key industries. With few exceptions, all such efforts have resulted in the breakup of SOEs along either geographical or product lines, ensuring minimal competition among the successor entities. In the petroleum industry, when the three giant state-owned firms—CNPC, Sinopec, and CNOOC—were initially created in the 1980s, they were assigned mutually exclusive business areas, with CNPC focusing on onshore upstream production, Sinopec focusing on downstream refining, and CNOOC focusing on offshore upstream production. Between 1998 and 2002, the state restructured the petroleum industry and converted CNPC and Sinopec to vertically integrated firms in preparation for China’s entry into the World Trade Organization, but it did so by exchanging assets between CNPC and Sinopec along geographical lines. As a result of the restructuring, CNPC and Sinopec were assigned separate business territories, with CNPC concentrating in the north and Sinopec concentrating in the south. In the telecommunications industry, since 1994 the state has engaged in a continuous process of breaking up SOEs along product or geographical lines, reshuffling industry assets, and merging state enterprises. But all of the activities still have not resulted in nationwide competition among firms across all product lines. A similar pattern of breaking up a massive SOE into smaller units along geographical lines holds in the power-generating industry as well as in public utilities.
The power of incumbency can also be seen in the marginalization of emerging firms that attempt to compete with incumbents but fail due to the lack of state support. An example is the fate of China’s privately owned airlines. Following the issuance of a government guidance document aimed at encouraging private firms to enter SOE-dominated sectors, six privately owned airlines came into operation after 2005. But the new airlines were unable to compete with SOE incumbents, which had been allocated the most lucrative routes. In the wake of the 2008-2009 global financial crisis, SOE incumbent airlines, but not the private carriers, received major government subsidies. Within a short period of time, most of the privately owned airlines were either liquidated, acquired by SOE carriers, or in serious financial difficulty.
This is not to say, however, that new firms cannot compete with entrenched SOEs. Some large, successful private firms have emerged in industries with strong SOE incumbents, but they did so principally in new markets—markets not controlled from the outset by SOE incumbents. Where POEs demonstrate growth potential and technological innovation in markets valued by the state, their rise has not been blocked; indeed, it has been nurtured, particularly at the local level. SOE incumbents, inured to the rents they have captured, generally lack the acumen and incentives to anticipate or create new markets. Private firms have developed to fill the void. Once POEs have become entrenched in a new market with the backing of the state, it is difficult for SOEs to unseat them, despite their natural advantages. Examples of POEs dominating new markets in China are plentiful. Baidu, China’s largest internet search engine, spearheaded the internet search market in China when that market was still in its infancy. AliPay, a third-party online payment platform owned by the e-commerce giant Alibaba Group, became the largest player in China’s emerging online payment market despite the dominance of state-owned banks in the traditional banking market. Private firm ENN Group, China’s largest downstream natural gas supplier, achieved its initial success by distributing natural gas to city residents through pipelines at a time when most city residents in China did not use natural gas at home or had it distributed in tanks. ENN Group acquired its dominant market position after it was able to secure franchise rights from over ninety cities across China. By contrast, CNPC, China’s main upstream natural gas supplier, was late in entering the downstream residential market; it had to use its monopoly on upstream natural gas supply to pressure provinces and cities into granting it franchise rights for downstream distribution.
Large firm development in China, therefore, illustrates a large measure of path dependence, with SOE incumbents dominating certain traditional industries and state-favored POEs controlling newer markets and industries. It also demonstrates adaptation to the institutional environment. In a state-centered ecosystem, successful private firms are the ones that have learned to ingratiate themselves with the state. This suggests a “survivorship bias” at work in the Chinese economy—state capitalism generates considerable institutional isomorphism between SOEs and POEs in regard to their business strategies and relationship with the state. By contrast, firms that have failed to master the capture economy or sought autonomy from the state are disproportionately marginalized.
A. Implications for Theory
The emergence of state capitalism in the global economy has exposed limitations in the standard state-versus-private taxonomy of enterprise ownership. Not only have some SOEs proven to be formidable global competitors, a far cry from the “grotesque failure” of state ownership in the era of central planning, but the theoretical underpinnings of the taxonomy seem increasingly impoverished in light of developments over the past decade. For example, scholars have explored an under-theorized organizational alternative that is prevalent in state capitalist economies: enterprises with mixed state and private ownership structures—that is, private investment in firms controlled by the state. They hypothesize that mixed ownership, under circumstances such as weak regulatory institutions, provides an attractive alternative to the typical pattern in which private ownership of the firm is coupled with government regulation of its activities. Examples of mixed ownership strategies in the Chinese context are explored in Part I.A of this Chapter, and appear to support the contention that these organizational forms are developed at least in part as a response to gradual privatization programs carried out in a weak regulatory environment, in which government backing remains a crucial element of a firm’s success and protection.
Our analysis has highlighted a complementary organizational consequence of state capitalism as practiced in China: Ownership of the firm as such provides relatively little information about the incentives of management, the innovative capacity of the firm (and whether it is directed at generating consumer surplus or capturing state rents), or the degree of autonomy the firm enjoys from the state. In the classic Grossman and Hart formulation, “[o]wnership is the purchase of … residual rights of control.” But because the Chinese party-state retains (relatively undefined) residual control rights in firms of all types, corporate “ownership” is less central to understanding the attributes of the Chinese firm as compared to firms operating under market-neutral institutions and relatively robust constraints on state intervention.
The diluted impact of ownership on the Chinese firm provides an illustration of the by-now familiar point that “institutions matter.” But our analysis has highlighted an under-appreciated way in which the incentive effects generated by the institutions of Chinese state capitalism matter: by blurring the distinction between state and private enterprise. Scholars and policy analysts have widely assumed that private firms by definition have more incentives to be innovative than state-owned firms. And they have often used “corruption” as a sweeping place holder for the incentive effects operating on firms in “low quality” institutional environments. We have provided a much richer perspective, in which the institutions of Chinese state capitalism cause all large successful firms, irrespective of ownership, to share similar incentives and to be positioned nearly identically in relation to the state. Underdeveloped legal and political institutions do lead to corruption as one mechanism of capture, but in China, growth potential, due to its close association with political legitimacy, is the key currency with which to obtain state backing irrespective of ownership.
B. Implications for Policy
Rent seeking, like productive innovation, is ultimately a product of institutions. Thus, as we elaborate below, reform-minded analysts and policymakers would do well to focus less on privatization of SOEs and on shrinking the size of the state sector than on changing the incentives generated by the institutions of Chinese state capitalism.
1. Implications for China
As China’s investment-driven economy matures, economic growth and competitiveness will increasingly depend on the ability of Chinese firms to move up the value chain. Innovation and productivity will be central to this effort, and thus the future dynamism of the Chinese economy will depend in large measure on the country’s capacity to foster entrepreneurship and to nurture enterprises that direct more efforts toward generating consumer surplus than to cozying up to the state. Chicago school economist Gary Becker sums up the situation thus:
China’s new leaders have now made clear that the country needs to rely much more on the creativity and resourcefulness of the private sector if it is to move beyond middle income status, and become a major economic power as measured … by per capita GDP. It remains to be seen whether even the new leaders can overcome the strong opposition of SOEs and other special interest groups to the implementation of a major shift toward the private sector.
As Becker suggests, SOEs are typically seen as the major obstacle to a move toward a private-sector driven economy. Ironically, our analysis suggests that, in China’s current institutional environment, the “private sector” poses equally formidable obstacles to this transformation. Chinese state capitalist institutions do encourage private entrepreneurs to innovate and to explore new markets, and private firm innovation has undoubtedly contributed significantly to China’s economic growth. But once innovative entrepreneurs become acclimated to state largesse and protection, it is to be expected that many will shift focus to maintaining the privileges of incumbency.
Does ownership matter when considering obstacles to China’s institutional development? In other words, does it matter whether SOEs or POEs have captured state power and largesse? Any influential firm—whether SOE, POE or a mixed-ownership enterprise—will resist reforms that threaten its privileged position in the economy. From this perspective, the fact that not only SOEs but also large swaths of the private sector have vested interests in the status quo bodes ill for the development of a truly entrepreneurial economy in China.
Closely related to this question is the so-called guo jin min tui (“the state advances, the private sector retreats”) debate. Critics assert that the Chinese government has failed to deliver on its commitment to the creation of a market economy, made in connection with China’s accession to the WTO in 2001. By some measures and in the perception of many, over the past decade the state’s role in the economy has actually expanded, to the detriment of market-oriented institutions and private enterprise. Defenders of current policy assert that the guo jin min tui concept is “based on a one-sided perspective of the ownership of enterprise” and a “false proposition” because the state and private sectors are complementary.
Our analysis presents a more nuanced perspective on the guo jin min tui phenomenon than the views above. Conceptually, it is true that the guo jin min tui critique may have over-emphasized the ownership of enterprise—precisely the tendency we have argued is to be avoided in analyzing Chinese firms. But our analysis does not support the view that the state and private sectors in China, as currently constituted, are complementary. They are potentially complementary only if the state sector is equated simply with the state-owned sector, as is common among analysts. But our analysis suggests that the size of the state-owned sector is not an accurate measure of the impact of state capitalism on the economy. Considering the incentive effects of the institutional environment, the state and private sectors are anything but complementary; rather, a state-centered ecology creates a vacuum siphoning oxygen out of the private sector, generating large “private” firms that are avatars of state-owned enterprises.
Thus, a shift toward the creation of a true private sector in China will require more than the commonly proffered prescriptions of privatizing SOEs and shrinking the state’s share of the economy. It will require the formation of robust market-neutral institutions: a corporate law that permits entrepreneurs to contract away from state-favored organizational forms, a robust and neutrally enforced antimonopoly law, and elimination of preferential access to bank finance and the capital markets for state-favored firms, to name a few key reforms. As the World Bank’s influential report, China 2030, argues, “[a]s an economy approaches the technology frontier and exhausts the potential for acquiring and applying technology from abroad, the role of government and its relationship to markets and the private sector need to change fundamentally.” Our analysis indicates that the state sector must be curtailed through massive institutional reforms, not through changes in ownership alone.
But here the dynamics of capture again rear their ugly head. China’s incremental economic reforms in the past three decades have led to the entrenchment of interest groups—perhaps an inevitable consequence of any gradualist transition model. Even if the top political leadership is serious about altering the state’s relationship to the economy, a large class of powerful interests—again, comprised not only of SOE incumbents but of private entrepreneurs deeply connected to the party-state as well—is positioned to undermine the impact of market-neutral policies. Worse yet, if gradualism leads to the public perception that market reforms benefit only the well-connected, the state may be prompted to backtrack on reforms in response to popular discontent. Increased state intervention could prompt more rent-seeking, resulting in a political vicious circle. In light of these complexities, our analysis casts doubt on how far China can go in reducing the role of the state in its economy without significant political reforms.
2. Implications for Host Countries Receiving Chinese Investment
Barring a major shift toward a truly private-sector driven economy in China, regulators and policymakers around the world will likely face more conundrums of the sort posed by Huawei and ZTE—commercially oriented, globally active firms that nonetheless have deep connections to the Chinese party-state. As China’s “go global” policy accelerates, other Chinese firms will have to convince skeptical foreign governments that their motives and strategic orientation are purely commercial. This is a collateral cost of state capitalism, borne by all globally active Chinese firms, whether SOE, POE or a mixed-ownership blend. The House Select Committee investigation of Huawei and ZTE underscores this collateral cost. The committee’s findings on the links between these firms and the Chinese government were far from conclusive, but in the absence of more information, doubts were resolved in favor of the committee’s suspicions that “Huawei and ZTE cannot be trusted to be free of foreign state influence and thus pose a security threat to the United States and to our [telecommunications] systems.”
The controversy over a Chinese acquisition of a U.S. meat producer suggests that state capitalism imposes costs on globally active Chinese firms even where sensitive technology or critical infrastructure is not involved. In June 2013, Shuanghui, a privately owned Chinese meat processor, announced a deal to acquire Smithfield, the largest pork producer in the United States. The taint of suspicion over Shuanghui’s motives clouded announcement of the deal and led to a Senate hearing on the transaction. Shuanghui, like many “private” firms in China, emerged out of state ownership, having been publicly listed in 2006. As with Huawei and ZTE, controversy focused on whether Shuanghui was still effectively under the control of the Chinese government and the Communist Party, such that the acquisition was a Trojan horse for any number of possible disasters, such as technology theft, predatory pricing, and contamination of the U.S. food supply. The U.S.-China Economic and Security Review Commission noted that Wan Long, Shuanghui’s chairman and major shareholder of the entity used for the management buyout, is a member of the Communist Party and a delegate to the National People’s Congress. Commenting skeptically on the proposed transaction, the Commission concluded, “[a] final concern is that Shuanghui is an instrument for the Chinese government’s industrial policy.”
Suspicions about foreign investments by Chinese firms, regardless of ownership, are likely to remain as long as the state retains equity interests in ostensibly private enterprises, the government routinely provides subsidies and privileged market access to state-linked firms, and it is common practice for senior executives at major firms, SOE or POE, to be affiliated with the party-state in various capacities. In short, suspicions about foreign investments by Chinese firms will linger as long as the institutional foundations of Chinese state capitalism remain intact.
3. Implications for International Trade and Investment Regimes
The global trade and investment regimes rely heavily on ownership-based distinctions among firms. To list just a few examples, the Model Bilateral Investment Treaty of the United States, published April 2012, attempts to discipline the preferential treatment of SOEs. SOEs have cropped up as an important issue in the negotiation of free trade agreements (FTAs), as the United States and the European Union seek to create special rules to regulate the market distorting activities of state-owned firms that are not adequately addressed by existing trade and investment regimes. And the OECD’s “competitive neutrality” project pivots on ownership. The project’s premise is that
Governments may create an uneven playing field in markets where state-owned enterprises (SOE) compete with private firms, as they have a vested (direct or indirect) interest in ensuring that state-owned firms succeed…. In the current context the ownership issue is limited to the state and is applied to the activities of all types of government-owned bodies that are actually or potentially competing with private operators in any market…”
Similarly, analysis of China’s foreign direct investment is often based on simple ownership taxonomies. A recent, widely cited report highlighted a major increase in investment in the U.S. by private Chinese firms. However, “private” firms were defined in the report as those with less than 20% government ownership.
If, as we have argued, the dichotomy between SOE and POE is a false one in the Chinese institutional context, then ownership-based analyses of, and policy responses to, the rise of Chinese firms in the global economy are likely to be imprecise and possibly misdirected.
This Chapter has offered a new perspective on Chinese firms. Shifting the focus of analysis from corporate ownership to the state-centered institutional ecology in which firms operate exposes major similarities between state-owned enterprises and privately owned enterprises in China. Our perspective suggests less state control over SOEs, and greater state control over POEs, than is commonly assumed. Because the Chinese economy under the institutions of state capitalism is highly susceptible to capture, successful Chinese firms of all ownership types share important traits that distinctions based on corporate ownership simply do not pick up. This insight bears strongly on the necessary scope of China’s economic reforms and has thorny implications for many U.S. and multilateral economic regulatory regimes, which pivot on “state” versus “private” ownership of enterprise.
* This is a short version of an article by the same title which will appear in the Georgetown Law Journal (2015). Milhaupt is the Parker Professor of Comparative Corporate Law and Fuyo Professor of Japanese Law at Columbia Law School. Zheng is Assistant Professor of Law at the University of Florida Levin College of Law.
 Usha C.V. Haley & George T. Haley, Subsidies to Chinese Industry: State Capitalism, Business Strategy, and Trade Policy 24 (2013). See also Li-Wen Lin & Curtis J. Milhaupt, We are the (National) Champions: Understanding the Mechanisms of State Capitalism in China, 65 Stan. L. Rev. 697(2013) (providing analysis of Chinese SOEs as a “networked hierarchy” with deep connections to the party-state).
 Jiahua Che & Yingyi Qian, Insecure Property Rights and Government Ownership of Firms, 113
Q. J. ECON. 467, 467 (1998).
 David Li, A Theory of Ambiguous Property Rights in Transition Economies: The Case of the Chinese Non-State Sector, 23 J. Comp. Econ. 1, 8-15 (1996).
 See Yasheng Huang, How Did China Take Off?, 26 J. Econ. Persp. 147, 154 (2012).
 Lin & Milhaupt, supra note 1, at 700.
 Masahiko Aoki, Controlling Insider Control: Issues of Corporate Governance in Transition Economies, in Corporate Governance in Transitional Economies: Insider Control and the Role of Banks 8 (Masahiko Aoki & Hyung-Ki Kim eds., 1995).
 World Bank, Effective Discipline with Adequate Autonomy: The Direction for Further Reform of China’s SOE Dividend Policy 13, 23-30 (2010), World Bank Policy Note No. 53254.
 Lin & Milhaupt, supra note 1, at 708.
 See Bruce J. Dickson, Integrating Wealth and Power in China: The Communist Party’s Embrace of the Private Sector, 192 China Q. 827, 827 (2007).
 Haley & Haley, supra note 1, at 2-3. A recent study finds that the interest rate subsidies received by China’s SOEs alone are greater than the existing profits of the SOEs. See Giovanni Ferri & Li-Gang Liu, Honor Thy Creditors Beforan Thy Shareholders: Are the Profits of Chinese State-Owned Enterprises Real?, 9 Asian Econ. Papers 50, 50 (2010).
 Fathom China Ltd., Public Funds for Private Firms 10 (2013).
 For example, in 1998, the Beijing headquarters of China Construction Bank lent Huawei 3.9 billion RMB in buyer’s credit, representing 45 percent of the total credit it extended that year. See Nathaniel Ahrens, China’s Competitiveness: Myth, Reality, and Lessons for the United States and Japan; Case Study: Huawei 6 (2013),
 See Wentong Zheng, Transplanting Antitrust in China: Economic Transition, Market Structure, and
State Control, 32 U. Pa. J. Int’l L. 643, 669-70 (2010).
 On the official functions of such industrial associations, a U.S. court noted:
The [industrial associations] were given both governmental functions, which had previously been performed by the [ministries], and private functions. The governmental functions included, inter alia, responding to foreign anti-dumping charges and industry “coordination.” The private functions of the Chambers included organizing trade fairs, conducting market research and “mediating” trade disputes.
In re Vitamin C Antitrust Litigation, 810 F.Supp.2d 522, 526 (E.D.N.Y. 2011).
 In a government catalog published in 2001, the last year for which such catalogs are publicly available, only thirteen categories of products or services were subject to price control by the government, such as electricity, military products, and postal services. See National Development and Planning Commission, Guojia Jiwei He Guowuyuan Youguan Bumen Dingjia Mulu [Pricing Catalog of the State Planning Commission and Related Ministries of the State Council], Jul. 4, 2001, available at http://www.sgpi.gov.cn/laws/wj/gjdjml.htm.
 See Shiyongyou Qiye Jinnian Sanci Bei “Yuetan”; Xiayou Canyinye Zhan Bu Zhui Zhang [Cooking Oil Companies “Interviewed”Three Times in Recent Years; Downstream Restaurants Temporarily Halting Price Hikes], Zhongguo Xinwen Wang [China News Net], Jul. 30, 2012, http://news.xinhuanet.com/fortune/2012-07/30/c_123494170.htm.
 Id. For more backgrounds on the acquisition, see Sheng Hong & Zhao Nong, China’s State-Owned Enterprises: Nature, Performance and Reform 145-48 (2013).
 Heritage Foundation, Index of Economic Freedom 165 (2013). China’s world rank is 136.
 See Tarhan Feyzioglu,et al., Interest Rate Liberalization in China, IMF Working Paper, WP/09/171 (2009), at 3.
 See, e.g., Clement K.W. Chow et al., Investment Opportunity Set, Political Connection and Business Policies of Private Enterprises in China, 38 Rev. Quant. Fin. Acct. 367, 367 (2012) (finding that firms with political connections in China are able to borrow more); Robert Cull et al., Government Connections and Financial Constraints: Evidence from a Large Representative Sample of Chinese Firms, World Bank Policy Research Working Paper No. 6352 (2013) (finding that government connections are associated with substantially less severe financial constraints at private firms in China); Hongbin Li et al., Political Connections, Financing and Firm Performance: Evidence from Chinese Private Firms, 87 J. Development Econ. 283 (2008) (finding that Communist Party membership helps private entrepreneurs in China to obtain loans from banks or other state institutions); Wubiao Zhou, Bank Financing in China’s Private Sector: The Payoffs of Political Capital, 37 World Development 787 (2008) (finding that membership in China’s legislative or semi-legislative organs helps private entrepreneurs obtain access to bank loans).
 More than half of the companies listed on the Shanghai Stock Exchange are formerly state-owned companies. See Shen Hong, Weak Links Mar Investing in China, Wall St. J., Jun. 26, 2013, http://online.wsj.com/article/SB10001424127887323998604578567722934644106.html. A significant percentage of the listed firms have former or current government officials as their CEOs. See Joseph P.H. Fan et al., Politically Connected CEOs, Corporate Governance, and Post-IPO Performance of China’s Newly Partially Privatized Firms, 84 J. Fin. Econ. 330 (2007) (finding that almost 27% of the CEOs in a sample of 790 newly partially privatized firms in China are former or current government bureaucrats). Among the listed firms, firms with politically connected CEOs tend to underperform firms without politically connected CEOs, suggesting that firms with politically connected CEOs may have been unduly favored in the state’s listing decisions. See id. Politically connected firms also reap greater benefits in the process of going public. See Bill B. Francis et al., Political Connections and the Process of Going Public: Evidence from China, 28 J. Int’l Money & Fin. 696 (2009) (finding that politically connected firms, irrespective of their ownership status, have relatively higher offering price, lower underpricing, and lower fixed costs during the going-public process).
 The AML provides that “the state protects the lawful operations of undertakings in SOE-dominated industries concerning the health of national economy and national security, and in industries where state trading is authorized by law.” The Antimonopoly Law of the People’s Republic of China, art. 7.
 Heritage Foundation, supra note 40, at 165. Moreover, China receives low rankings on the World Justice Project’s Rule of Law Index with respect to factors, such as limited government powers and open government and regulatory enforcement, even in regional rankings and within its income group. See World Justice Project, Rule of Law Index 77 (2012-2013).
 See Joel S. Hellman, Geraint Jones & Daniel Kaufmann, Seize the State, Seize the Day: State Capture and Influence in Transition Economies, 31 J. Comp. Econ. 751 (2003).
 See Constitution of the Peoples Republic of China, Art. 7. Ideology, however, may be a pretext for ulterior motives; it is difficult to disentangle influence rooted in ideology from that based on the power of incumbency or corruption.
 See Zheng, supra note 33, at 656-57.
 See Justin Yifu Lin et al., Deregulation, Decentralization, and China’s Growth in Transition, in Law and Economics with Chinese Characteristics: Institutions for Promoting Development in the Twenty-First Century 467, 485 (David Kennedy & Joseph E. Stiglitz eds., 2013).
 Oliver Blanchard & Andrei Shleifer, Federalism With and Without Political Centralization, China versus Russia, NBER Working Paper 7616 (2001).
 See, e.g., Hongbin Li & Li-An Zhou, Political Turnover and Economic Performance: The Incentive Role of Personnel Control in China, 89 J. Pub. Econ. 1743 (2005).
 See, e.g., Jean Oi, Fiscal Reform and the Economic Foundations of Local State Corporatism in China, 45 World Politics 99 (1992); Yingyi Qian & Barry Weingast, Federalism as a Commitment to Preserving Market Incentives, 11 J. Econ. Perspectives 83 (1997).
 Fathom China Ltd., supra note 29, at 18.
 Bo Kong, China’s International Petroleum Policy 14-15 (2010).
 Zheng, supra note 33, at 701-02.
 See OECD, China: Defining the Boundary Between the Market and the State 236 (2009).
 Zheng, supra note 33, at 661-62.
 See Sheng & Zhao, supra note 39, at 152-54.
 Andrei Schleifer, State versus Private Ownership, 12 J. Econ. Persp. 133, 135 (1998).
 See Mariana Pargendler, Aldo Musacchio & Sergio G. Lazzarini, In Strange Company: The Puzzle of Private Investment in State-Controlled Firms, Harvard Business School Working Paper No. 13-071 (Feb. 14, 2013).
 Sanford J. Grossman & Oliver D. Hart, The Costs and Benefits of Ownership: A Theory of
Vertical and Lateral Integration, 94 J. Pol. Econ. 691, 692 (1986).
 According to Douglass North, institutions play an instrumental role in economic development. See Douglas C. North, Economic Performance Through Time, 84 Am. Econ. Rev. 359, 366 (1994) (“It is the mixture of formal rules, informal norms, and enforcement characteristics that shapes economic performance.”).
 See Shleifer, supra note 62, at 143-44.
 See, e.g., Statement of Alan H. Price, in Ten Years in the WTO: Has China Kept Its Promises?, Hearing Before the Congressional-Executive Commission on China 27-28 (2011) (criticizing China’s continued state ownership and control over key segments of its economy as contrary to its WTO commitments).
 See, e.g., Sheng & Zhao, supra note 39, at 154-56 (discussing the dangers of the advances of state-owned enterprises in China).
 World Bank & Development Research Center of the State Council of the People’s Republic of China, China 2030: Building a Modern, Harmonious, and Creative High-Income Society xv (2012)
 Working Party on State Ownership and Privatisation Practices, A Compendium of OECD Recommendations, Guidelines and Best Practices Bearing on Competitive Neutrality 13 (Apr. 26, 2012), DAF/CA/SOPP (2011)10/Final.
 See Thilo Hannemann, Rhodium Group, Chinese FDI in the United States: Q1 2013 Update, April 30, 2013.