China's State Capitalism Trap

To the rest of the world, China looks unstoppable. Since 1990 its growth rate has rarely dropped below 8 percent, and output has tripled in the last decade. But at a breakfast meeting during the World Economic Forum, several experts on China said one of the country’s greatest assets in its sprint to power—state capitalism—could soon sap its strength.

China’s most powerful companies, including China Mobile, with 600 million customers, and energy giants Sinopec and PetroChina, have substantial government ownership. Advocates of state capitalism say it combines the best of both worlds: the entrepreneurial spirit of the private sector along with the stability that comes from government backing. Critics at the Davos breakfast, sponsored by Hong Kong-based Caixin Media, countered that state capitalism is inefficient, unfair, and can eventually breed the volatility it’s intended to suppress.

Deng Xiaoping launched China’s growth beginning in 1978 by allowing private enterprise and freeing up foreign trade and investment. Deng, however, never entirely surrendered power to the private sector, and after decades of gradual privatization that put about two-thirds of economic activity in private hands the government has begun to reassert its authority. The theme in Chinese business is “state in, private out,” said the first of the speakers at the Hotel Europe breakfast, Weiying Zhang, a professor at the Guanghua School of Management at Peking University. Zhang received his economics doctorate from Oxford University and has been involved in liberalizing China’s economy since the 1980s. He said some Chinese entrepreneurs, unable to compete with state-supported giants at home, have taken their skills abroad, costing China a vital source of energy and innovation.

The Chinese government’s continued control of critical companies stems from its obsession with maintaining order. While the movement of hundreds of millions of people into cities has fueled growth, the next stage of urbanization will be harder, said John Zhao, chief executive officer of Hony Capital, a private equity firm in Beijing. “A big issue is the risk of social unrest,” Zhao said at the breakfast. Chinese leaders view a pure market economy as excessively volatile—and point to the 2008 financial crisis in the U.S. and Europe as evidence.

China’s state companies aren’t necessarily the powerhouses they appear to be, said Xiaonian Xu, a professor of economics and finance at the China Europe International Business School in Shanghai. He said the return on invested capital at state-owned enterprises lags the level at private companies and would be lower still if not for government subsidies. And because state-owned entities face little competition, they tend to overcharge: “Nobody can get in,” Xu said. He reached back to the 1870s for a parallel to China’s economy today: German unification under Otto von Bismarck. The “Iron Chancellor” advocated a strong bureaucracy and a private sector tightly linked to the government. That economic nationalism, Xu argued, laid the groundwork for World War I.

China’s state capitalism was once seen by the West as a transition between communism and capitalism. That shift could still happen, Xu said, pointing to the way South Korea reined in its chaebol—favored conglomerates—after the Asian financial crisis of the late 1990s. But the Chinese leadership shows no sign of relinquishing control. That will cause continued stress both inside China and with its Western trading partners, who feel their companies are playing on a tilted field. As China’s strength grows, said Timothy Garton Ash, professor of European studies at Oxford, “These tensions hyperventilate.”

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