Kellee S. Tsai is Division Head and Chair Professor of Social Science at Hong Kong University of Science and Technology, and Professor of Political Science at Johns Hopkins University. Her most recent book is State Capitalism, Institutional Adaptation, and the Chinese Miracle (co-edited with Barry Naughton, 2015).
This is one of six essays in the book review roundtable on Nicholas R. Lardy’s Markets over Mao: The Rise of Private Business in China.
What are the sources of China’s breathtaking economic growth since the late 1970s? The answer is encapsulated in the title of Nicholas Lardy’s most recent book, Markets over Mao: The Rise of Private Business in China. It’s the private sector. In 1978, state-owned enterprises generated three quarters of China’s industrial output. Today they account for only one quarter. Besides displacing state firms in terms of industrial output, private firms now produce nearly 90% of the country’s exports, are far more profitable than state firms, and employ a growing share of the urban workforce. Markets over Mao methodically combs through over three decades of government statistics to demonstrate, with empirical confidence, the remarkable expansion of China’s private economy.
Lardy provides a valuable service to those daunted by how to triangulate among internally inconsistent sets of official Chinese data, with their shifting categories of firm ownership and reporting practices. The third chapter of Markets over Mao is especially instructive in delineating the seven major types of firms, including explanations of the five subcategories of private firms. Of particular interest, Lardy alerts us to enterprise lending data released by the People’s Bank of China starting in 2011, which identifies the majority or dominant ownership stakes in limited liability companies and shareholding limited companies. Some are primarily owned by state entities, while private shareholders have majority or dominant stakes in others. Yet private shareholder-dominant companies are not typically included in calculating the size, economic contributions, and financial indicators of the private sector. Hence, a recurring cautionary message in Markets over Mao is that relying on official registration status in statistical yearbooks underestimates the true scope of China’s private economy.
Markets over Mao goes beyond serving as a statistical roadmap for number crunchers, however. The book boldly argues that China should not be regarded as state capitalist. This claim rests on three main observations. First, the private sector is growing and outstrips state firms in multiple performance indicators, including return on assets. Second, China’s private sector is not as credit-constrained as most people think. Third, and relatedly, the bulk of the government’s 2008–9 stimulus funds were not disproportionately invested in the state sector. The first observation is uncontroversial. Economists and other dedicated observers of China’s political economy agree that the private sector is more dynamic and profitable than the state sector, even as state-owned giants grab news headlines. The second and third claims, however, warrant further reflection.
Readers may be surprised by the book’s argument that most accounts of China’s private sector exaggerate its financing challenges. Lardy points out that the preponderance of investment in reform-era China has been financed by retained earnings rather than by bank credit or equity markets. During the 1990s, about 40% to 50% of investment in nonfinancial corporations came from retained earnings; and the ratio reached an average of 71% during 2002–8. The private sector has been particularly reliant on retained earnings due to its higher rates of productivity and “more limited access to bank credit” (p. 97). However, Lardy quickly discounts the latter issue by contending that the private sector receives more bank loans than normally recognized—and actually received a growing share of bank loans during the stimulus years. He estimates that in 2012, 44% of all loans outstanding went to the private sector, an increase from 35% in 2009. As detailed in “Appendix A: Alternative Measures of Private Sector Credit,” this calculation includes not only loans to private firms and individual businesses but also business loans to rural households, consumption loans to households (including mortgages), and firms where the dominant shareholder is private. Including these additional loans shows that between 2010 and 2012 private firms accounted for 52% of new lending, whereas state firms received only 32% (p. 104). Markets over Mao states decisively, “Chinese private firms now enjoy better access to credit than in any previous period in the reform era” (p. 108).
Why, then, does the conventional wisdom persist that private businesses in China face a structural financing gap relative to state firms? Lardy notes that observers typically (myopically) focus on the percentage of short-term loans going to officially registered private and individual businesses.  As of 2009, private firms received only 1.78% of total short-term loans (p. 158, Table A.1). Another basic reason is because private firms—especially the small and medium-sized enterprises (SME) that constitute 97% of registered businesses—indeed face barriers in accessing credit from state banks. The reasons for these credit constraints are well-known: collateral requirements, smaller loan sizes, risk aversion by state-employed credit officers, and prioritization of lending to state firms in key industries. Throughout the reform era, downstream private firms have thus depended primarily on retained earnings and a variety of informal financing mechanisms. A 2012 survey of SMEs in fifteen provinces, for example, found that 57.5% of respondents had participated in informal credit markets.  Moreover, in China’s biannual surveys of private entrepreneurs, “access to credit” remains a leading self-reported constraint facing private-sector development.  Indeed, after presenting novel indicators of increased bank lending to private firms, Lardy concedes that “it is still accurate to say that relative to their contribution to GDP state firms have greater access to bank credit than private firms” (p. 109).
The foregoing observations raise the broader analytic question of how to characterize the nature of China’s contemporary political economy. Lardy is adamant that state capitalism is not an appropriate descriptor. China has made a transition to market capitalism, Lardy contends, because the state no longer dominates the allocation of resources in product markets. Arguably, however, the “market economy” label is too broad to capture important features that distinguish China from other market economies. The “varieties of capitalism” framework, for example, identifies major institutional differences between liberal market economies (e.g., the United States) and command market economies (e.g., Germany) in industrial relations, education and training, corporate finance, inter-firm relations, and corporate governance.  Varieties of capitalism within Asia have also been recognized, ranging from the postwar developmental states of Japan, South Korea, and Taiwan, which pursued industrial policy and strategic allocation of credit, to the entrepôt city-states of Hong Kong and Singapore that have flourished as regional centers for trade and finance. All are regarded as market economies, but their de facto one-party states played important strategic and variegated roles during their high-growth decades.
The role of the state in China’s reform-era growth shares some similarities with East Asian varieties of capitalism but also diverges in key aspects. On the one hand, China has been quite open to foreign direct investment—as were Singapore and Hong Kong but not Japan, South Korea, and Taiwan during their high-growth periods. On the other hand, Markets over Mao acknowledges that a number of state-defined strategic sectors are closed to both private and foreign investment. These include the military, telecommunications, power generation and distribution, petroleum and petrochemicals, civil aviation, and shipping. Meanwhile, the 2010 Strategic Emerging Industries initiative selected seven next-generation technologies and products for preferential policies (e.g., tax rebates and financial incentives). Such targeted policy measures are well-known to students of East Asian political economy.
Yet the scope of state intervention in China goes beyond familiar levers of the East Asian developmental state. Senior leadership and managers of state-held firms are appointed by the Organization Department of the Chinese Communist Party (CCP). The party-state “completely dominates” the financial sector, including banking, insurance, securities, and asset management (p. 20). Furthermore, a number of successful “private firms” originated out of close ties to the party-state (e.g., Lenovo and the Chinese Academy of Sciences, Huawei and the People’s Liberation Army). No one seriously contests that private firms are more profitable than state firms, or that market forces are vibrant in retail, exports, and nonstrategic industrial sectors. But other institutional characteristics suggest that China’s party-state plays a more significant role in the economy than would be expected in an average Organisation for Economic Co-operation and Development (OECD) market economy. China’s market is being mediated, even thwarted, by a host of competing political priorities—namely, social stability and the continuation of CCP rule.
In contesting the depiction of China as state capitalist, Markets over Mao draws on various popular and political sources that use the term in a critical manner. As evidence, the book cites declining state profits, the ineffectiveness of industrial policy, and increased bank lending to the private sector. However, state capitalism is not a theory about economic performance. In studies of comparative capitalism, state capitalism is an analytical category that describes the hybrid organization of an economy by delineating the political motives, institutional scope, and intended effects of state intervention. Economic outcomes may vary. Ultimately, Markets over Mao is more convincing in making the case for how state capitalism is constraining growth opportunities in China than in dispelling the empirical existence of state capitalism itself.
In the end, Lardy’s sanguine assessment of China’s Third Plenum reform agenda implies that China is gradually making a teleological transition toward a liberal market economy. He acknowledges that implementing those reforms will entail “significant transition costs, and will be opposed by the interest groups that have benefited disproportionately from the imbalanced growth of the past” (p. 153). Political barriers indeed exist, but they extend beyond vested interests and corrupt officials. The party-state itself is reluctant to relinquish control over strategic sectors. Regime durability and regional leadership may be more important to China’s rulers than return on assets. With $3.7 trillion in foreign exchange reserves, China possesses the resources for “evergreening” unprofitable state firms in the interest of national economic security, with plenty to spare for initiatives such as the Silk Road Fund and the Asian Infrastructure Investment Bank. China’s state sector may be shrinking, but the party-state’s aspirations for what remains is not.
 Another empirical study finds, however, that prior to the global financial crisis, China’s state firms had lower levels of leverage than private firms, but following the crisis, state firms became much more highly leveraged than private ones. Mali Chivakul and W. Raphael Lam, “Assessing China’s Corporate Sector Vulnerabilities,” International Monetary Fund, IMF Working Paper, no. 15/72, March 2015, 10.
 Jianjun Li and Fengyun Hu, “Zhongguo zhongxiao qiye jinrong jiegou rongzi chengben yu xinzi xindai shichang fazhan” [Financing Structure and Cost of China’s Small and Medium-Sized Enterprises and Development of the Shadow Credit Market], Hongguan jingji yanjiu 5 (2013): 7–11.
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