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The State Strikes Back: The End of Economic Reform in China?
China’s extraordinarily rapid economic growth since 1978, driven by market-oriented reforms, has set world records and continued unabated, despite predictions of an inevitable slowdown. In The State Strikes The End of Economic Reform in China? , the renowned China scholar Nicholas R. Lardy argues that China’s future growth prospects could be equally bright but are shadowed by the specter of resurgent state dominance, which has begun to diminish the vital role of the market and private firms in China’s economy.
Lardy’s book is a timely sequel to his path-breaking Markets Over The Rise of Private Business in China (Peterson Institute for International Economics, 2014). This book mobilizes new data to trace how President Xi Jinping has consistently championed state-owned or controlled enterprises, encouraging local political leaders and financial institutions to prop up ailing, underperforming companies that are a drag on China’s potential. As with his previous book, Lardy’s perspective departs from conventional wisdom, especially in its contention that China could achieve a high growth rate for the next two decades―if it reverses course and returns to the path of market-oriented reforms.
Lardy’s book is a timely sequel to his path-breaking Markets Over The Rise of Private Business in China (Peterson Institute for International Economics, 2014). This book mobilizes new data to trace how President Xi Jinping has consistently championed state-owned or controlled enterprises, encouraging local political leaders and financial institutions to prop up ailing, underperforming companies that are a drag on China’s potential. As with his previous book, Lardy’s perspective departs from conventional wisdom, especially in its contention that China could achieve a high growth rate for the next two decades―if it reverses course and returns to the path of market-oriented reforms.
200 pages, Paperback
Published January 29, 2019
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Displaying 1 - 5 of 5 reviews
June 3, 2019
Fascinating as an economics text, with a deep knowledge of China. A call for more competition in the state-owned sector in order to preserve a high growth rate
May 13, 2020
There are relatively few revelations in this book, and the writing leaves much to be desired, but the author does prove his case that one of the main reasons for China's economic slowdown since the global financial crisis is the resurgence of the state.
First, though, the author shows that China's necessary economic "rebalancing" contributed to the slowdown as well. From about 2002 to 2008, China undervalued its yuan (with purchases of foreign currencies totaling 14% of GDP at its peak), encouraged exports (its trade surplus topped 7% of GDP), and increased domestic savings (which went from about 31% of GDP to 41%). Yet since then the trade surplus has fallen to about 2% of GDP, and domestic savings to 37%, while private consumption and the proportion of GDP devoted to the service industry have gone up substantially.
All of this probably does slow growth a bit, but the author explains the unfortunate policy reasons for the slowdown as well. Since the 18th Party Congress of 2013, President Xi Jingping has encouraged more state investment, especially after 2015 when the State Council endorsed his "Made in China 2025" program, as well as the following year's "Five Year Plan." Investment in state-owned enterprises has started to climb, to about 35% of all investment, after a long fall. And, after rapid restructuring of state-owned enterprises under Zhu Rongji after 1997, and a peak return on assets for them of about 5% before the crisis (when they almost returned as much as purely private firms), their returns have dropped to 3%, while private returns jumped above 10%. State-firms leverage ratio jumped to 160%, and the flow of loans from banks to the state sector increased from 28% to 83% of all lending (!). These state companies are getting bigger, more indebted, and less profitable. Finally, he shows that the State-Owned Assets Supervision and Administration Council (SASAC), created in March 2003, has not performed as expected. It's attempts to merge 200 big state firms down to 100 didn't bring gains, and the few examples of "mixed ownership" haven't brought in private sector management. SASAC has continued shifting subsidies from high-performing to low-performing companies. On the whole, China's state-owned assets are over 220% of GDP, while in most countries it's still a few percentage points. Socialism looks like its coming back
So Lardy shows that China's slow performance is at least partially due to the slowing pace of reforms, and the gradual return of increasingly inefficient state-owned companies. But much of the book is taken up with side-debates or disproving counterfactuals. A pithier book, or even a long article, might have done the job better.
First, though, the author shows that China's necessary economic "rebalancing" contributed to the slowdown as well. From about 2002 to 2008, China undervalued its yuan (with purchases of foreign currencies totaling 14% of GDP at its peak), encouraged exports (its trade surplus topped 7% of GDP), and increased domestic savings (which went from about 31% of GDP to 41%). Yet since then the trade surplus has fallen to about 2% of GDP, and domestic savings to 37%, while private consumption and the proportion of GDP devoted to the service industry have gone up substantially.
All of this probably does slow growth a bit, but the author explains the unfortunate policy reasons for the slowdown as well. Since the 18th Party Congress of 2013, President Xi Jingping has encouraged more state investment, especially after 2015 when the State Council endorsed his "Made in China 2025" program, as well as the following year's "Five Year Plan." Investment in state-owned enterprises has started to climb, to about 35% of all investment, after a long fall. And, after rapid restructuring of state-owned enterprises under Zhu Rongji after 1997, and a peak return on assets for them of about 5% before the crisis (when they almost returned as much as purely private firms), their returns have dropped to 3%, while private returns jumped above 10%. State-firms leverage ratio jumped to 160%, and the flow of loans from banks to the state sector increased from 28% to 83% of all lending (!). These state companies are getting bigger, more indebted, and less profitable. Finally, he shows that the State-Owned Assets Supervision and Administration Council (SASAC), created in March 2003, has not performed as expected. It's attempts to merge 200 big state firms down to 100 didn't bring gains, and the few examples of "mixed ownership" haven't brought in private sector management. SASAC has continued shifting subsidies from high-performing to low-performing companies. On the whole, China's state-owned assets are over 220% of GDP, while in most countries it's still a few percentage points. Socialism looks like its coming back
So Lardy shows that China's slow performance is at least partially due to the slowing pace of reforms, and the gradual return of increasingly inefficient state-owned companies. But much of the book is taken up with side-debates or disproving counterfactuals. A pithier book, or even a long article, might have done the job better.
March 6, 2021
Lardy begins by examining the reasons for China’s economic slowdown. He attributes slowing growth to over-investment, weakened global demand and government policy. Lardy believes, however, the Chinese economy has much greater potential. He shows (using official statistics) that investment, income and production have trended towards advanced economies' composition since 2010. In investment, private consumption has outpaced GDP, government consumption has increased while government investment and net exports have fallen. Production has seen China’s services sector (entertainment, finance, business services, IT and R&D) expand faster than GDP while industry's share has fallen. Disposable income has increased as a share of GDP.
Lardy terms these trends a 'rebalancing process'. On the demand side, policy changes resulting in reduced financial repression and social safety net strengthening (pensions and medical insurance) have combined with structural factors that increased the dependency ratio and raised income. These factors will all increase consumption as a portion of GDP. Supply factors like tax reform, 'gradual opening' of the services sector to investment and a fair value currency have also driven Lardy's rebalancing.
China’s economic capacity has been hampered by inefficient SOEs. Lardy shows that in 2016 state industrial firms were 2.5 times more likely to be unprofitable compared with private firms and aggregate losses were 10 times greater. Forty per cent of SOEs are effectively insolvent, being unable to cover interest payments (at 5.54 per cent). China’s huge corporate leverage increase over a shorter period and at an earlier development stage than comparable economies was overwhelmingly siphoned to SOEs, which account for three quarters of the borrowing. SOE internal expenditure analysis shows that opportunistic corruption and employment imperatives rather than profit maximisation drive investment decisions.
Lardy goes on to outline then challenge hypotheses explaining SOE and private enterprise profit divergence. Prevailing arguments include: differing borrowing rates, industry concentration and input price fluctuations (SOEs in commodites vs private in consumer goods), social provisions and sector barriers to entry.
SOE reform is then examined. Lardy traces the various reform approaches taken to increase productivity. These are: mergers, debt-to-equity swaps, mixed ownership, corporate governance and financial reform. None have been fully successful in catalysing widespread profitability. The Party dictates key corporate decisions, political rather than market driven mergers have decreased competition, swaps have been too small scale to reduce leverage, and financial reforms, at the time of publication (2019), are yet to yield results. Market reform can only be achieved in this space if the Party steps away as the determinant for resource allocation. This is a difficult proposition when city and rural banks have substantial local SOE debts on their balance sheets which are inaccurately classified as solvent and senior provincial SOE Party members outrank commercial lenders. The problem is further compounded by local SOE product sales which are funding large portions of provincial value-added tax revenue.
As Lardy's final chapter makes clear SOEs are a foundational pillar of China's political system. While SOEs continue to occupy this fundamental role, China's economic policy settings will constrain the nation's growth capacity.
An informative though very dry little book. Finally, Lardy's concluding 'reasons for [market reform] optimism' are short and thoroughly unconvincing.
Lardy terms these trends a 'rebalancing process'. On the demand side, policy changes resulting in reduced financial repression and social safety net strengthening (pensions and medical insurance) have combined with structural factors that increased the dependency ratio and raised income. These factors will all increase consumption as a portion of GDP. Supply factors like tax reform, 'gradual opening' of the services sector to investment and a fair value currency have also driven Lardy's rebalancing.
China’s economic capacity has been hampered by inefficient SOEs. Lardy shows that in 2016 state industrial firms were 2.5 times more likely to be unprofitable compared with private firms and aggregate losses were 10 times greater. Forty per cent of SOEs are effectively insolvent, being unable to cover interest payments (at 5.54 per cent). China’s huge corporate leverage increase over a shorter period and at an earlier development stage than comparable economies was overwhelmingly siphoned to SOEs, which account for three quarters of the borrowing. SOE internal expenditure analysis shows that opportunistic corruption and employment imperatives rather than profit maximisation drive investment decisions.
Lardy goes on to outline then challenge hypotheses explaining SOE and private enterprise profit divergence. Prevailing arguments include: differing borrowing rates, industry concentration and input price fluctuations (SOEs in commodites vs private in consumer goods), social provisions and sector barriers to entry.
SOE reform is then examined. Lardy traces the various reform approaches taken to increase productivity. These are: mergers, debt-to-equity swaps, mixed ownership, corporate governance and financial reform. None have been fully successful in catalysing widespread profitability. The Party dictates key corporate decisions, political rather than market driven mergers have decreased competition, swaps have been too small scale to reduce leverage, and financial reforms, at the time of publication (2019), are yet to yield results. Market reform can only be achieved in this space if the Party steps away as the determinant for resource allocation. This is a difficult proposition when city and rural banks have substantial local SOE debts on their balance sheets which are inaccurately classified as solvent and senior provincial SOE Party members outrank commercial lenders. The problem is further compounded by local SOE product sales which are funding large portions of provincial value-added tax revenue.
As Lardy's final chapter makes clear SOEs are a foundational pillar of China's political system. While SOEs continue to occupy this fundamental role, China's economic policy settings will constrain the nation's growth capacity.
An informative though very dry little book. Finally, Lardy's concluding 'reasons for [market reform] optimism' are short and thoroughly unconvincing.
December 14, 2019
Over the past decade China’s growing financing of money-losing state companies has followed lock-step with its slowing economy and slowing economic reforms.
These trends go against Chinese President Xi’s stated objectives to continue improving the economic well-being of the average Chinese, over greater integration and leadership in the global economy.
As powerful as China appears to outsiders, it’s leadership is concerned that winding up more state companies at this point could adversely affect Labour and financial stability in the country, and threaten the Communist Party’s control.
Mere decades ago China had 118,000 state-owned firms. Today that number has dwindled to 14,000 albeit mostly large companies.
But many are “zombie” companies steadily losing money year after year but staying in business with ever increasing loans, and mostly local loans at that.
The incentives in the system are built to support the inertia of local government to sustain local sales tax revenues, local employment figures, and GNP output figures.
And trade irritants from abroad are certainly not helping the situation. Nor is corruption in regional and local governments.
Even while China’s annual growth at 6-8% still outpaces developed countries, some analysts say that China’s slowdown is inevitable and why not now.
But the slowdown comes far too soon for China to realize its domestic and global ambitions.
These trends go against Chinese President Xi’s stated objectives to continue improving the economic well-being of the average Chinese, over greater integration and leadership in the global economy.
As powerful as China appears to outsiders, it’s leadership is concerned that winding up more state companies at this point could adversely affect Labour and financial stability in the country, and threaten the Communist Party’s control.
Mere decades ago China had 118,000 state-owned firms. Today that number has dwindled to 14,000 albeit mostly large companies.
But many are “zombie” companies steadily losing money year after year but staying in business with ever increasing loans, and mostly local loans at that.
The incentives in the system are built to support the inertia of local government to sustain local sales tax revenues, local employment figures, and GNP output figures.
And trade irritants from abroad are certainly not helping the situation. Nor is corruption in regional and local governments.
Even while China’s annual growth at 6-8% still outpaces developed countries, some analysts say that China’s slowdown is inevitable and why not now.
But the slowdown comes far too soon for China to realize its domestic and global ambitions.
March 2, 2022
Very interesting, perhaps somewhat dated
A very interesting book about economic trends in China. However, developments on now so rapid that even though this book is barely four years old, it is probably already somewhat dated. Nevertheless, well worth reading.
A very interesting book about economic trends in China. However, developments on now so rapid that even though this book is barely four years old, it is probably already somewhat dated. Nevertheless, well worth reading.
Displaying 1 - 5 of 5 reviews