Is state ownership turning into a core interest for China?

Since the breakdown of the US-China trade talks earlier this month, it has often seemed as if Chinese officialdom and state-controlled media have been speaking off of a single script of pure nationalist outrage. But in fact the trade tensions have exposed some interesting differences in views across the system. Consider this part of a Xinhua commentary published on Saturday (you can read the Chinese text or an English summary):

At the negotiating table, the US government made many outrageous demands of China, including restricting the operation and development of state-owned enterprises. Obviously, this goes beyond the scope of trade negotiations and touches on China’s basic economic system. This shows that behind the US trade war with China is an attempt to violate China’s economic sovereignty and force China to harm its own core interests.

Some commentators have noted how the expression “core interests,” previously only attached to territorial issues, has now been applied to state-owned enterprises. But those who track such minutiae will notice that this commentary is signed by two journalists; Xinhua commentaries used to articulate official views are typically written by committee and do not carry a real person’s byline. The more official series of People’s Daily commentaries on the trade war has, as best I can tell, not mentioned state-owned enterprises at all. So my interpretation of this Xinhua piece would be that there are definitely people in the Chinese system who share these views, but the government has probably not (yet) decided to adopt this as its official position.

Now compare this “China has a state-owned economy and we’re proud of it” take with a recent speech from Guo Shuqing, who as Party secretary of the People’s Bank of China and head of the China Banking & Insurance Regulatory Commission is the government’s top-ranking financial official. Guo’s talk on the trade war (Chinese text and English summary) covered a lot of ground, but he also addressed the issue of state ownership:

In recent years, there has been an opinion expressed abroad that China’s rapid economic development is the result of “state monopoly capitalism.” But this kind of talk has no basis. In fact, the composition of China’s economy has become increasingly diversified, and the market share of state-owned enterprises has continuously declined. Including the economic activity of government, the state-owned economy accounts for less than 40% of GDP. Many state-owned enterprises are listed on foreign or domestic stock exchanges, and in fact are joint-stock enterprises; 100% purely state-owned enterprises are rare. Large state-owned enterprises have a large number of subsidiaries whose controlling shareholders are private enterprises. And even the central state-owned enterprises compete with each other. Today, private and foreign investors can enter almost all industries and sectors without any restrictions or barriers.

The tone here is quite different: yes, we have state enterprises, but they are a small and declining part of the economy, and it is more important that there is market competition among all companies. These defensive statements probably are not really completely, objectively true (though I think Guo’s estimate of the state-owned share of GDP is probably not too far off). Guo is what foreigners usually call a “reformer” in the Chinese system, and in a different context I’m sure he would frankly discuss the fact that both foreign and domestic private companies face many barriers. Indeed, at the moment Guo is spearheading a political campaign to increase private-sector firms’ access to bank credit, a campaign whose very existence makes it clear that there is not at all a level playing field.

But I think Guo is here engaging in a strategy that is common for those who want to nudge the Chinese system in a more market-oriented direction: they tend to describe things are being more competitive and market-driven than they actually are, so that marginal change in that direction seems unremarkable and logical. If you pound the table and call China’s state-owned enterprises a core interest of the nation, it becomes quite difficult to change them. If you say, China is mostly a market economy already, then gradually reducing the role of SOEs over time seems pretty unthreatening.

One of the dangers I see in the US-China trade war is that it could become politically more and more difficult for people like Guo to both defend China’s system against foreign attacks, and continue to nudge it in a different direction. “The Americans want us to get rid of state enterprises, and by gosh they’re right” is a much less likely response to US pressure than “How dare those Americans tell us to get rid of our state enterprises?” And that’s true even among people who might not otherwise be disposed to cheer on SOEs.

As is so often the case, Sheng Hong of the Unirule Institute (a libertarian-leaning think tank now mostly banned in China) sees the fundamental political issue quite clearly. Here are a few lines from his recent blog post (I have retranslated the Chinese, since the English version is a bit clunky):

State-owned enterprises account for 10% of exports, so the remaining 90% are made by private and foreign-invested enterprises. Therefore the vast majority of Trump’s tariffs are being imposed on private and foreign enterprises who do not receive government subsidies. This does not correct a market distortion, but actually punishes companies that follow market rules, which makes the market more distorted. …

In order to punish the unfair trade of a small group of companies, Trump has harmed all Chinese companies, and especially private companies. This has caused their feelings to run high and united them in their hatred [of the US], so that in a nationalist fervor they are now supporting their own country’s state-owned enterprises.

In other words, the trade war seems very likely to increase popular support for state-owned enterprises, and push more Chinese people into the view that they do actually represent a core interest of the Chinese nation. And that is probably not in the longer-term interests of the US.

I expect a US trade hawk would likely respond to this by saying that waiting around for China to decide on its own to slim down state-owned enterprises has not worked out for the last decade or so, and the harm this has done justifies putting pressure on China to change more quickly. And they would have a pretty good point. Which is unfortunately why it is now seems hard to be optimistic about the politics on either side.

William James on the value of doctorates and diplomas

Greg Ip at the WSJ has a nice piece responding to the ruckus over the nominations of Stephen Moore and Herman Cain to serve on the Federal Reserve Board. It’s obvious from the Fed’s own history that the mockery of Moore for not having published peer-reviewed journal articles, or not having a Ph.D. in economics, quite misses the point. As Greg nicely puts it, the real question to ask about someone who is may need to make economic policy decisions is whether they are a disciplined thinker, not whether they have a certain credential.

By coincidence, I also recently read an essay by William James entitled “The Ph.D. Octopus,” originally published in the Harvard Monthly in March 1903 (it was reprinted in his essay collection Memories and Studies which is out of copyright and freely available). Some of James’ sentiments still ring quite true:

America is thus as a nation rapidly drifting towards a state of things in which no man of science or letters will be accounted respectable unless some kind of badge or diploma is stamped upon him, and in which bare personality will be a mark of outcast estate. It seems to me high time to rouse ourselves to consciousness, and to cast a critical eye upon this decidedly grotesque tendency.

James worried that the institutionalization of graduate degrees, and in particular their use by employers to screen potential hires, would cause all kinds of negative consequences:

To interfere with the free development of talent, to obstruct the natural play of supply and demand in the teaching profession, to foster academic snobbery by the prestige of certain privileged institutions, to transfer accredited value from essential manhood to an outward badge, to blight hopes and promote invidious sentiments, to divert the attention of aspiring youth from direct dealings with truth to the passing of examinations…

James was deeply aware of the tension between universities’ avowed mission of free intellectual inquiry and their economic function as producers of credentials, and hoped that the former would discipline the latter:

Our universities at least should never cease to regard themselves as the jealous custodians of personal and spiritual spontaneity. They are indeed its only organized and recognized custodians in America today. They ought to guard against contributing to the increase of officialism and snobbery and insincerity as against a pestilence; they ought to keep truth and disinterested labor always in the foreground, treat degrees as secondary incidents, and in season and out of season make it plain that what they live for is to help men’s souls, and not to decorate their persons with diplomas.

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Rediscovering the importance of export discipline

The new IMF working paper on industrial policy, by Reda Cherif and Fuad Hasanov, has gotten a lot of notice, and indeed it is very clear, comprehensive, and useful. But for anyone who has already done some reading on the history of successful Asian economies, particularly Taiwan and South Korea, it is not exactly surprising stuff. Here for instance is their quick summary of the key characteristics of these economies’ successful industrial policies:

  • Intervene to create new capabilities in sophisticated industries: Pursue policies to steer the factors of production into technologically sophisticated tradable industries beyond the current capabilities to swiftly catch up with the technological frontier.
  • Export, export, export: A focus on export orientation as any new industrial product was expected to be exported right away with the use of market signals from the export market as a feedback for accountability. As conditions changed, both the state and the firms adapted fast.
  • Cutthroat competition (at home and abroad) and strict accountability: No support was given unconditionally although performance assessment was not necessarily based on short term profits. While specific industries may get support, intense competition among domestic firms was highly encouraged in domestic and international markets.

The combination of a focus on exports with tough competition sounds a lot like what Joe Studwell, in his 2013 book How Asia Works (which is not cited in the IMF paper’s bibliography), called “export discipline.” His explanation is clearer and punchier:

Governments in all the major economies of east Asia tried at some stage to nurture domestic manufacturers. That those in north-east Asia succeeded, while those in south-east Asia failed miserably, turned on a small number of policy differences. By far the most important of these was the presence – or absence – of what I call ‘export discipline’.

This term refers to a policy of continually testing and benchmarking domestic manufacturers that are given subsidies and market protection by forcing them to export their goods and hence face global competition. It is their level of exports that reveals whether they merit state support or not. …

Where export discipline has not been present, development policy has become a game of charades, with local firms able to pretend that they have been achieving world-class standards without having to prove it in the global market place. In south-east Asia, the energies of entrepreneurs were directed towards fooling politicians rather than exporting.

I would still recommend Chapter 2 of How Asia Works as the definitive comparison of successful and unsuccessful industrial policies in Asia.

The point of such a comparison is to move beyond sterile debates over whether industrial policy can ever work, since in fact basically all countries have some kind of policy for promoting particular industries. As Cherif and Hasanov put it, “The key question is, if many countries have been conducting industrial policy anyway, what should the right way to do this be.” The presence or absence of export discipline should be a useful way to evaluate whether industrial policy is likely to be successful.

Even within Asia this lesson is not as widely appreciated as it perhaps could be. For instance, former Chinese finance minister Lou Jiwei recently made a surprisingly harsh public criticism of Made In China 2025 (for which he has apparently been forced into early retirement). He called it a waste of taxpayers’ money and an unwarranted intrusion of government: “those industries are not predictable and the government should not have thought it had the ability to predict what is not foreseeable.”

While I have a lot of respect for Lou, I’m not sure this is the strongest criticism of Made in China 2025. It’s not clear that “the market” would necessarily pick different industries as being desirable to invest in now: the ideas that people have about what technologies are going to be important in the future don’t seem to be that different across the public and private sectors. The Chinese government have have a plan to promote artificial intelligence, but private venture capital firms are also throwing plenty of money at that sector as well. Semiconductors are one of the key sectors targeted by The Made In China 2025, and I don’t think many people are seriously arguing that semiconductors won’t be important in the future.

This is not to say that venture capital investors are necessarily going to be right about the future either, just that both government officials and venture investors can read the same things and are influenced by the same conventional wisdom. This point is not original to me: I picked it up from Brad DeLong’s 2010 book with Stephen Cohen, The End of Influence:

Americans like to say scornfully that industrial policy is about “governments picking winners.” Picking winner industries is not that hard—even for governments. Most countries trying to climb the ladder of quality and industrial sophistication through selective promotion compiled pretty much the same lists at the same time. Even at the leading edge of the technological frontier, the industries that governments are tempted to promote are largely the same ones picked by the analysts and brokers at investment firms such as Merrill Lynch, Nomura, or Rothschild’s.  …

Picking “winner industries” is not the hard part; winning is. It is difficult to create actual winners, companies that develop into successful competitors.

And that, of course, is where export discipline comes in.

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Oliver Sacks on the nineteenth century’s love of facts

Oliver Sacks’ posthumously published essay collection The River of Consciousness is a surprise and a delight. While it has some pieces in his familiar style of reflections on neurological casework, the highlights are the truly wonderful essays on the history of science. Who knew that Darwin discovered the pollination of flowers by insects? Or that Freud did foundational research on the structure and role of nerve cells?

Informing these essays is Sacks’ deep affection for and engagement with the work of nineteenth-century scientists, particularly Darwin and Freud, but also many more obscure toilers. At one point, when investigating some of the peculiar visual hallucinations experienced by his migraine patients, he can find no help in twentieth-century psychiatric literature, so he looks further back:

When I searched the current literature, I could find no mention of these [phenomena]. Puzzled, I decided to look at nineteenth-century accounts, which tend to be much fuller, much more vivid, much richer in description, than modern ones.

Sacks found that those nineteenth-century writers, while often lacking a theoretical framework to interpret their observations, were meticulous recorders of what they observed. Twentieth-century psychiatry had a more developed theoretical system, but had little time for phenomena that did not easily fit into that system, and so ignored them. There is perhaps a parallel for this in anthropology, where the extremely detailed accounts of early fieldworkers can still be usefully mined for insights for decades afterward–something it is difficult to imagine happening with many contemporary works with a much more elaborate theoretical apparatus. A mindset that places value on facts is itself something of value.

In the nineteenth century, an era of naturalistic description and phenomenological passion for detail, a concrete habit of mind seemed highly appropriate, and an abstract or ratiocinating one was suspect—an attitude beautifully brought out by William James in his famous essay on Louis Agassiz, the eminent biologist and natural historian: “The only man he really loved and had use for was the man who could bring him facts.”

The nineteenth-century genius for, or mania for, the collection and description of facts is definitely one of the most distinctive traits of the epoch. Jürgen Osterhammel’s The Transformation of the World: A Global History of the Nineteenth Century, one of my favorite history books, describes this very well, though with more attention to the social than the natural sciences:

The novelty in nineteenth-century Europe was that, over and above a normative political and social theory, branches of knowledge arose with the aim of describing the contemporary world and grasping the patterns and regularities beneath the surface of phenomena. …

“Factual investigation”—which Joseph A. Schumpeter contrasted to “theory” in his great history of economic thought—acquired new scope and significance in the nineteenth century, when Europeans produced incomparably more self-observational and self-descriptive material than they had in previous centuries.

For the most important analysts of political and social reality—one thinks of Thomas Robert Malthus, Georg Wilhelm Friedrich Hegel, Alexis de Tocqueville, John Stuart Mill, Karl Marx, Alfred Marshall, and the chief figures in the German “Historical School” of economics, including the early Max Weber—factual investigation was closely bound up with the theoretical quest for connections and correlations.

Indeed, Schumpeter’s History of Economic Analysis has a lot of praise for “factual investigation,” and he particularly liked works that defied the stereotype of economics being excessively theoretical:

Of particular interest to us is the type of analysis that combines presentation and explanation of facts in such a way that the two cease to be distinct tasks and mutually condition one another at every step: the type of analysis that arrives at its results by means of discussing individual situations. … It is hardly possible to overlook the factual complement in the Wealth of Nations—though some critics seem to have accomplished even this feat.

A lot of those massive, fact-filled nineteenth-century tomes are certainly impossible to read today, but the greats of the era were able to integrate voluminous facts with theorizing and strong arguments. Such a style of analysis was precisely what Sacks enjoyed about Darwin’s later botanical works. These are little known compared to the Origin of Species, and yet Darwin spent decades of his life on them.

Darwin spoke of the Origin as “one long argument.” His botanical books, by contrast, were more personal and lyrical, less systematic in form, and they secured their effects by demonstration, not argument. …

Botany was not a mere avocation or hobby for Darwin, as it was for so many in the Victorian age; the study of plants was always infused for him with theoretical purpose, and the theoretical purpose had to do with evolution and natural selection. It was, as his son Francis wrote, “as though he were charged with theorising power ready to flow into any channel on the slightest disturbance, so that no fact, however small, could avoid releasing a stream of theory.”

Sachs accepts that the twentieth-century transformation of botany and zoology from sciences founded in descriptive natural history to more theoretical enterprises led to tremendous progress, but “it was clear that something was being lost, too.” With economics also having taken an empirical turn over the past couple of decades, perhaps there will be a swing back to appreciating some of those nineteenth-century virtues.

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How much did outside advice really change things in Russia and China?

Recent polemics against neoliberalism have revived an old debate over the role of the economic advice given to developing countries by the World Bank and IMF. A crude but nonetheless influential interpretation of the relevant economic history holds that Russia’s failed “shock therapy” privatization of SOEs in the 1990s was the result of uncritical acceptance of free-market dogma pushed by the international financial institutions, while China’s successful “gradualist” approach to SOE reform was the result of wise officials ignoring those same institutions and carefully designing policy according to local conditions.

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Chart from Novokmet et al. “From Communism to Capitalism: Private Versus Public Property and Inequality in China and Russia”

This interpretation may accord too much importance to the advice given by the international financial institutions, and too little to the domestic politics of the countries actually making the decisions.

John Nellis, a participant in the World Bank’s first mission to the USSR in 1990, has published an account of that period based on his notes taken at the time. It makes for fascinating reading. It’s particularly interesting that the famous Soviet State Planning Committee, or Gosplan, seemed committed early on to a “gradualist” approach to reforming state ownership:

Even here, in the principal basilica of socialist planning, no one questioned that the old system had failed and that a transition to the market, or something approximating a market, was urgently required. But those we met in Gosplan, and many of those we met in other Soviet ministries and central units, thought that the transition would be a gradual, lengthy affair, and that the outcome would be some sort of mixed approach. In this evolutionary process they thought (or hoped) that Gosplan would retain authority to forecast, analyze, assist, guide and even lead reform. …

As for the future of the real sector, the officials’ evolutionary vision was that the massive, multi-divisional state enterprise/ministerial complexes would be broken down into “correctly sized” units. These would then go through a process of “corporatization” and would become joint stock companies, with all shares initially held by the state. These would then undertake a process of finding private partners, Soviet or foreign, who would bring in capital, technology, management expertise, and access to markets. Some percentage of shares would have to be turned over to these partners, but it would at first be a minority share, particularly for foreigners. These processes had just begun to start and, in their view, years would pass before substantial results were seen. Central organs such as Gosplan would guide and assist this evolution. Majority private ownership was a long-term prospect.

This aspiration is not so different from the course that was actually followed by China. (Nellis also notes that a 1988 Soviet law had allowed for the creation of cooperatives, which, much like China’s township and village enterprises in the 1980s, often functioned as de-facto private companies.) The joint World Bank-IMF report that was published after the mission acknowledged that large-scale privatization was effectively impossible, and focused more on how to manage state enterprises effectively.

All this suggests that China’s “gradualist” approach to overhauling state ownership was less a strategy adapted to uniquely Chinese conditions, but more the approach most likely to be favored by a socialist government that wanted to maintain political continuity and control over the reform process. Yet by 1992, the Soviet Union had been dissolved, and the Russian government launched a program of rapid mass privatization using vouchers–a much more radical approach than anything that had been considered in 1990. Nellis asks the obvious question:

The overwhelming majority of persons we spoke to in 1990 were gradualists. They wanted to effect as painlessly and politically acceptable as possible a transition to the market. …

Why did the 1990 joint IFI mission not get a glimpse of the coming emphasis on mass privatization? How did it — we — miss the fact that the government of the Russian Federation would opt for audacity?

The answer, clearly, is the radical change in domestic politics after the vote to dissolve the Soviet Union in 1991. In particular, the failed coup against Gorbachev, which was led by representatives of the same conservative interest groups that had tried to stymie economic reforms. After the failed coup, the reform and privatization of state enterprises was no longer a technocratic matter of economic management, but an urgent political task to dismantle the strength of the interest groups that had led the coup. The new Russian government was driven by an “overriding fear that the communists might try again to regain power,” Nellis writes. And the reshuffle of domestic politics had elevated to decision-making positions people who were not that important in 1990, and had not previously had well-formed views. 

A more recent, if less detailed, summary of the World Bank’s involvement in Chinese SOE reform by Zhang Chunlin serves as something of a companion piece to Nellis. Zhang is currently the lead private sector development specialist at the Bank, and previously worked on Chinese SOE reform both at the Chinese government and the World Bank. He writes that

The Bank’s work in the 1980s focused on the reform of the traditional SOE model itself while maintaining state ownership. Recognizing the need for state direct control over some “important enterprises” such as public utilities, the [1985] report argued that once a suitable economic environment is created through price reform and competition, pursuit of profit should lead most state enterprises in economically appropriate direction. The fundamental problem remains of the proper relationship between the state and the enterprise.

The central theme of the World Bank’s recommendations for China was not the necessity of privatization, but of corporatization: giving state-owned enterprises the legal form of modern corporations. That promised to improve management and decision-making within SOEs. But it also posed the problem of how the state was to exercise its ownership rights to control these firms. Much of the Bank’s work since the 1990s has focused on finding the right institutional structures for effective state ownership, and it has advocated for reducing state ownership in many sectors.

But the radical downsizing and privatization of SOEs that started around 1995 and continued through about 2002 was a domestic decision driven by the dire financial situation at many firms. A World Bank report in 1997 did call for state ownership to “completely withdraw from inherently competitively structured industries where small and medium sized firms predominate,” but it noted that this recommendation “would formalize a process that is already underway.” (And, of course, China did not actually follow this recommendation.)

Zhang also notes that in later years the World Bank contributed to the debate over the creation and structuring of an agency to represent the government’s interests in SOEs, the body now known as Sasac. It’s less clear if this is a contribution the Bank should be proud of: Sasac is widely regarded as a conservative interest group that has worked to strengthen the position of large SOEs, rather than to further their effective reform. But Zhang mainly wants to emphasize the “productive partnership” that the Bank has had with China. “In retrospective, a clear reason why the Bank managed to stay relevant has been its willingness to adapt to China’s own reform strategy,” he writes.

Yet that is perhaps not so different from how the World Bank worked with Russia in the 1990s: it was willing to adapt to both the gradualist preferences of the Soviet leadership in 1990, and the radical program of the new Russian government in 1992. In the case of both Russia and China, the World Bank seems to have mainly tried to help their governments find the best way to implement decisions that had already been reached by domestic political leaders. It’s not clear that the advice of international financial institutions really played a decisive role in making those decisions.

 

 

Does the state still love state-owned enterprises even after they’re not state-owned anymore?

That is the question raised in an interesting new NBER paper on the aftereffects of China’s privatization of SOEs in the late 1990s: “Can a Tiger Change Its Stripes? Reform of Chinese State-Owned Enterprises in the Penumbra of the State,” by Ann Harrison and four coauthors.

They report that in 2013, 45% of industrial SOEs received government subsidies, but only 15% of private industrial firms received them. Privatized SOEs, however, are different: 25-35% receive subsidies, much more than firms that were always private. Similar results show up in access to finance: privatized SOEs pay higher interest rates than current SOEs firms but lower interest rates than firms that had always been private.

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Their hypothesis is that “allocation of government support in the form of subsidies, tax breaks or low interest loans favors both SOEs and former SOEs.” They conclude that while SOEs do change their behavior after being privatized, the government does not change its behavior toward those companies: “former SOEs retain ready access to large loans, concessionary interest rates, and outright subsidies.”

But why should this be the case? The paper is curiously silent on this.

The whole point of the SOE privatization over 1998-2003 (after that, privatization basically stopped) was so that the government would not have to keep giving free money to money-losing SOEs. Privatizing the SOEs, and then continuing to give them lots of free money, rather seems like the worst of both worlds. So it seems rather unlikely that this pattern is the result of a deliberate, centralized policy choice.

My hypothesis would be: it’s about people. Let me propose that the managers of SOEs understand the government pretty well and are pretty good at extracting benefits from the system. Since, after all, that is a good part of their job.

Furthermore, the managers of privatized SOEs are often going to be the same people who managed the firm when it was state-owned. One survey of SOE privatizations found that sales to insiders (aka management buyouts) were by far the most common type of deal, accounting for 47% of their sample.

Therefore, privatized SOEs are often going to be run by people who have established relationships with government officials and managers of state banks. It stands to reason that they are going to be better at working those relationships than the executive of a run-of-the-mill private company. And that companies that have been able to obtain subsidies in the past would know best how to continue obtaining those subsidies in the future.

On the financial front, this behavior by state banks is not irrational. If a state bank has an established relationship with an SOE, that relationship doesn’t just evaporate once the SOE is privatized. The bank will still have a lot of knowledge about its customer, and have a history that makes it more comfortable continuing to lend on favorable terms.

So the persistence of favorable treatments for SOEs after privatization is probably mostly about the persistence of relationships–and firms’ understandable unwillingness to relinquish established sources of commercial advantage.

A preview of Nick Lardy’s new book *The State Strikes Back*

A new Nick Lardy book comes along regularly every few years, and each one is an event for the China-watching community. Anyone who cares about the Chinese economy will find The State Strikes Back: The End of Economic Reform in China? interesting and provocative. This is a preview, not a review, since the book is not officially out until next week and so my Kindle pre-order hasn’t downloaded yet. But I saw his book talk in Seattle last night, where he gave a characteristically clear and concise summary of the argument (he also has an op-ed in the FT.)

The new book has to be understood in the context of Lardy’s previous book from 2014, Markets Over Mao: The Rise of Private Business in China. In that book he argued that it was the rise of increasingly efficient and productive private-sector companies that has driven China’s economic growth over the last four decades, not state-owned enterprises, government planning and industrial policy. In contrast to the view in some quarters that China remains a fundamentally state-controlled economy, he laid out all the ways in which markets have been liberalized and competition increased since 1978.

A lot of the key changes in the relationship between the state and private sector happened in the 1980s and 1990s, and are well explained in that book. But Lardy also engaged with the argument that, as he put it, “state-owned firms returned to prominence of the decade of leadership of President Hu Jintao and Premier Wen Jiabao (2003-12)”.

While acknowledging that the Hu-Wen government wanted to make state enterprises and industrial planning play a a bigger role in the economy, he argued that the data showed they had not succeeded. In fact, the private sector’s share of economic aggregates had continued to increase, not because of continued privatization but because private firms are more efficient and grow faster than SOEs. This process was aided by a substantial increase in private firms’ access to bank credit.

The main point of Lardy’s new book, based on his slides and talk, is that the positive trends he had emphasized in his last book are now going in reverse. The data now show that private firms’ access to bank credit has sharply declined, and that their share of various economic aggregates is also falling. He puts particular emphasis on the drop in lending to private firms:

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(Note: Lardy has a chart like this in his slides, but this is my chart not his. It is based on the same underlying data but my estimates come out slightly different.)

The big decline in bank lending to the private sector (the absolute volume of new loans to private companies shrank, not just the share) had major consequences. It forced private firms to rely even more on shadow finance. But in 2016 the government also decided (correctly) that the rapid expansion of shadow finance posed systemic risks. The tightening of regulation led to an outright decline of shadow financing in 2018, putting many private firms into dire financial straits. The financial pressure on private firms has allowed their state competitors to expand at their expense: SOEs in industry are growing faster than their private competitors. Lardy said this is the first time this has happened since 1978.

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(Again, this is a re-creation of one of Lardy’s charts using public data.)

Lardy thinks all this is bad for China. He is right! He also puts most of the blame on the policies of Xi Jinping–tolerating SOE inefficiency, encouraging the creation of larger SOEs, tightening Party control over private firms–since these trends in the data did not show up until a few years into his administration.

Essentially, both of Lardy’s recent books are about the use of economic data to support a narrative about the direction of reform in China. In Markets Over Mao, he argued that the data did not support a narrative of the resurgence of the state sector, and in fact supported a narrative of the rise of the private sector to new heights. I think it is fair to say that a number of people felt that Lardy in that book was too forceful in downplaying trends that were in fact important, but perhaps were difficult to tease out in the aggregate economic data. Now, Lardy is arguing that the data support a narrative that the state is resurgent and the private sector is losing out. Since this is a recent reversal of a positive long-term trend, he thinks that if China changes course it could significantly boost its economic growth rate, by as much as 2 percentage points.

My own view is more that economic policy under Xi Jinping represents an intensification of trends that were already playing out under Hu Jintao. I think this is pretty clear if you pay attention to China’s official rhetoric and try to understand the underlying political economy. Since I think the problems go back further than 2015, I am less optimistic than Lardy about China’s longer-term growth prospects (thanks to Greg Ip of the WSJ for including a summary of my views in his latest piece).

I also think that it is tricky to tell a clear story about the rise or fall of the state sector using the official economic data–having spent a lot of time and effort trying to do that myself. As someone who very much appreciates Lardy’s careful work with Chinese data, let me offer a couple of caveats to the charts above, in the spirit of seeking truth from facts.

First, on the bank lending data. Lardy is right to highlight the sharp downturn in lending to private companies in 2015-16. But it is not clear to me that this is a result of government policy to favor SOEs. Recall that there was a pretty serious economic downturn in 2014-15. It would make sense for banks to respond to that by trying to reduce the risk in their loan books, and one obvious way to do that would be to curtail lending to smaller and riskier companies, i.e. private ones. (The fact that SOEs are seen as less risky than private companies is a structural problem, but it’s nonetheless true that banks are correct to make this judgment given the realities of China’s political economy.) In other words, the change may have been more cyclical than structural.

There is some preliminary evidence that supports this interpretation. The data that Lardy and I use to calculate lending to state and private firms is released with a long lag, and recent figures aren’t out yet. But banking officials disclosed last year that lending to private firms totaled 30.4 trillion renminbi as of September 2018. This is equivalent to 38% of outstanding corporate loans–which is roughly the same level as in 2013, and a big increase from the 32% in 2016 (again, this is the share of outstanding loans; the chart above is the share of new loans made each year). This suggests that new loans to private firms rebounded in 2017-18 (probably more in 2017) as the economy recovered.

Second, on the industrial data. The fact that industrial SOEs are increasing their value-added faster than private companies is certainly notable. But SOEs and private companies tend to operate in different industries, so it can be hard to tease out the difference between sector effects and ownership effects. Industrial SOEs are concentrated in upstream, commodity-producing sectors, while private firms are more in downstream manufacturing sectors. It seems quite likely to me that the big decline in SOE value-added in 2015-16, and its rebound in 2017-18, have the same source: swings in commodity prices that had big effects on their profitability (value-added is basically profits plus labor compensation). The chart below uses monthly rather than year-to-date data, and we can see that the growth in SOE value-added has recently fallen back below that of private firms as steel and oil prices have come down.

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Lardy is right that the fact that in these charts the red line (SOEs) is above the blue line (private firms) is significant and concerning. But if this year or next the blue line moves back above the red line, will that mean China’s private sector is out of the woods, and all is fine? I suspect not.

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