Can SOEs Sustain Long-term Economic Growth?

WeChat Image_20190509170926.jpg

With the aid of unfavorable banking and anti-competition policies that hinder private firms, SOEs have displaced private Chinese companies in the market. However, SOEs remain relatively inefficient, unproductive, and stagnant.

In a highly publicized move on March 15th, 2019, The National People’s Congress approved the New Foreign Investment Law. While this action is considered an effort to reform aspects of the Chinese finance and business economy, China’s fundamental decision to promote state-owned enterprises as the primary market players in the Chinese economy must not be overlooked or disregarded.

A recent presentation made by Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics, draws attention to China’s shift from the market economy towards a more state-controlled economy. Within a broader context, China’s increased reliance on SOEs as the main market players indicates that the central government is no longer prioritizing market economy reform and market liberalization. 


China’s economy has turned away from promoting economic development through a market economy, instead adopting a more heavily state-controlled approach to guide the market. Therefore, central government market policy has embraced SOEs as key drivers of economic growth. However, despite the state’s promotion of SOEs, the SOEs under the State-owned Asset Supervision and Administration Commission (hereby referred to as SASAC) have proven to be less profitable and less efficient in capital utilization when compared to private companies.

The full scope of long-term impacts on the economy remains unclear, but an in-depth data analysis reveals that the efficiency and profitability of SOEs is decreasing, while private companies simultaneously face destruction by state-led anti-competitive economic policies designed to favor SOEs. As a result, private Chinese companies must endure unfavorable state-run banking policies, thus putting them at a disadvantage. The long-term sustainability of the market has become a concern for analysts, academics, and policymakers alike.

Ultimately, SOEs have struggled to sufficiently capitalize on favorable policies and contribute proportionally to enhancing the economy. This situation places China’s robust market and long-term economic sustainability at risk.

Market Policy Trends From 2000-2013

The combination of banking policies and market policies from 2000-2013 indicated China’s greater dedication towards shaping a market economy and carrying out market-oriented reforms. These years were characterized by vibrant lending of credit from Chinese commercial and industrial banks to private firms. Between 2010 and 2013, the average percentage share of bank loans provided to private firms was 52.7%. This percentage figure is important because it belies the general misconception that private firms suffered from credit disadvantages in China during this time.  On the contrary, banks actually favored the extension of credit to private businesses because they:

  • Demonstrated higher tendencies to pay back loans
  • Made more total investments in the industrial sector
  • Exhibited higher likelihood to afford market interest rates
  • Indicated lower likelihood to default on payments

These characteristics resulted from the firm structure and competitive business environment pushing each other to improve, innovate, and earn more profit than their competitors. SOEs could not meet the same levels of growth and profitability.

The high degree of competition during this period also benefited SOEs, even though these firms demonstrated weaknesses in competition, innovation, and profitability. The relatively stronger market economy during this period with high levels of competition increased SOE productivity as well. As a result, the productivity gap between private firms and state-controlled firms narrowed nearly to the point of convergence under these market economy conditions. Unfortunately, a shift in market policy since then has curbed growth and momentum.

The investment environment in the industrial sector from 2006 to 2013 also reflected vibrant private firm growth due to positive lending policies. According to the data provided by Dr. Lardy, private firms accounted for 48% of the total share of investments in the industrial sector in 2013, up from 36% in 2006.

Market Policy Trends From 2013-2019

In the current market policy trend, China emphasizes SOE dominance in the Chinese market rather than its previous market economy approach. This shift is evident through three red flags in the economy:

  1. A sharp decline in the number of bank loans provided to private Chinese firms
  2. A downturn in the amount of investment by private firms in the industrial sector
  3. An increase in M&A activity across SOEs under SASAC

Sharp Decline in Bank Loans

52.75% of total bank loans were used to fund private firms during this period. By contrast, only 32.75% were granted to SOEs between 2010 and 2013. According to figures provided by Lardy, this category was flipped upside-down in 2014 when 34% of the total available loans were made to private companies while SOEs received 60%. This gap further widened in 2016 to 11% for private firms and a whopping 80% for SOEs.

Another important fact provided by Lardy that should be kept in mind is that the total quantity of loans provided to private firms decreased as well. In 2013, private firms received about 2.6 trillion RMB in loans to use as capital. In 2016, private firms received only about 600 billion RMB.

A Downturn in The Amount of Investment By Private Firms

The impacts of increasingly unfavorable market policies targeting private firms can be identified in the amount of investments undertaken in the industrial sector. Between 2015 and 2016 the share of private investments decreased from about 50% to nearly 47%, a trend expected to continue. The adverse market policies against Chinese private firms have also alarmed US companies doing business in China.

According to our 2019 Business Climate Survey Report, the number of companies that believed the quality of China’s investment environment was deteriorating between 2015-2016 increased from 26% of respondents to 31%. Private Chinese firms and foreign firms alike have been more wary about the Chinese investment environment since 2014.


Figure 1: Perceived Quality of China’s Investment Environment

Source –2019 Business Climate Survey Report, The American Chamber of Commerce

An Increase in M&A Activity Across SOEs Under SASAC

M&A activity increased during 2014-2017 parallel to the decline in bank loans made to private Chinese firms. This spike in M&A activity is important because President Xi had explicitly called for the expansion of SOEs in the areas of balance sheet and industries, but the growth in size of balance sheet does note equate to increase in efficiency. According to Lardy’s data, the number of SOEs under SASAC shrank from 196 SOEs before the global financial crisis to 97 SOES in 2017. This is the result of many mergers that have cut the total number of SASAC members by nearly half.

The merger activity has decreased competition in the market, and it is argued that the combination of nearly unlimited access to bank credit in addition to a sharp decline in competition has caused SOEs to utilize credit inefficiently. For example, in 2010 an SOE would only need 10 RMB to generate 20RMB in revenue, while in 2017 this SOE would require 18 RMB to generate the same 20RMB in revenue. This phenomenon is evident across most, if not all SASAC firms, and the liability-to-assets ratio has experienced consistent growth on a y-o-y basis as well.


The change in attitude and approach of the central government toward the market economy has had an extremely negative impact on private Chinese firms and on the degree of competition in the business environment. The four main negative effects are:

  1. Massive displacement of private firms
  2. Decrease in competition, productivity, and efficiency between SOEs
  3. Inability by SOEs to maintain high levels of competition and innovation
  4. Slowed economic growth

China’s shift away from market economy reform and promotion has eliminated roughly 200,000 LLC entities in the country. In 2016, there were about 2 million of these organizations, but by 2017 the number of existing LLCs had fallen to 1.8 million. This was a direct result of the unfavorable and extremely stringent loan policies banks implemented towards private Chinese firms. LLCs were forced into a disastrous situation. Their options were limited to bringing on an SOE as a shareholder, accepting acquisition by an SOE, or risking bankruptcy. SOEs were supposed to absorb more efficient private companies and increase the overall average productivity, but they have experienced the opposite effect. This is revealed through an evaluation of the profits generated by SASAC firms and an analysis of the increase in the share of assets due to retained earnings. The ratio between liabilities and assets, also known as the debt ratio, has increased by 0.71% y-o-y for SASAC entities. One of the key reasons behind this increase is SOEs’ heavy reliance on external financing to fund business operations, typically from banks. The amount of retained-earnings only helps generate about 20% of the total returns on assets.

The decline in capital utilization efficiency of SOEs, in addition to their lack of productivity, inhibited the Chinese economy’s ability to realize its growth potential. Lardy estimates that China’s economy could potentially grow at a rate of about 8% per year if economic policies returned to the market-oriented path. SOE acquisition of more efficient private companies caused productivity and innovation to dwindle, and remaining on the current course will lead to greater economic slowdown. The long-term economy is likely to be sluggish as the central government turns to favor greater state control of the market through SOEs at the expense of higher efficiency and growth.

In Closing

China is going through a period of change, one that is characterized by greater consolidation of state power in the markets and bias in favor of SOEs. Numerous foreign experts predict that the central government decision is a conscious one that prioritizes centralization and consolidation of Party strength over economic growth and development.

Although the economy will continue to grow, the rate of growth during this period will drop in comparison to previous years, when policies favored market economy policies. According to Lardy, China will only be able to return to high levels of growth when its market and banking policies once again promote the market economy, market reform, and an equal playing field for private Chinese firms and SOEs.