The Boundary Between State and Enterprise: The Real Question for China's Economy
Updated: Sep 30
1.
Ask ten Chinese economists to define the "China model" and you will get eleven answers. That is the view from inside. From outside, there is only one. Set aside the hollow ideological readings, and the "China model" that has come to dominate thinking among politicians, academics, think tanks and the media in Europe and America in recent years is a single idea: the increasingly blurred line between the state and the enterprise. More precisely, it is the encroachment of state capacity on the enterprise.
Competition between companies is supposed to turn on products, services and prices. Yet when foreign companies compete with a Chinese one, what increasingly unsettles and alarms them is not knowing whether their rival is merely a company, or an agent of a state that runs through it and empowers it.
News reports suggest from time to time that China is preparing to unveil "major economic reforms." Any such reform will have to confront this outside view of the China model, a real question that cannot be avoided. Only by easing, and ultimately dispelling, this deepening suspicion and fear can China's economy truly stabilize and resume its climb.
2.
Chinese scholars' versions of the China model fall, broadly, into three camps.
The first holds that there is no such thing as a China model. Freedom, even a fairly minimal degree of it, acting on an economy of China's immense scale, naturally produces remarkable growth. Sustained growth of this kind has appeared not only in China's own history but in other countries as well, and there is nothing extraordinary about it.
The second is "political meritocracy." It is a modern, GDP-driven version of imperial China's civil-service examinations: officials compete for promotion on the strength of economic growth in their jurisdictions. Some scholars call it "performance-based democracy," as opposed to "vote-based democracy." Local governments locked in this competition are more inclined to direct resources to their most productive groups, entrepreneurs among them, and so reap faster growth.
The third is "disinterested government." In this account, a disinterested government is less easily captured by narrow interest groups than an elected one and more likely to pursue the country's long-term goals, which allows it to catch up with more advanced economies. Its proponents also argue that the distinctive history and culture of East Asia played an important part in producing such governments, making the China model one case of an "East Asian model." Once the goal of catching up has been reached, however, the disinterested government needs to make "major adjustments."
In short, the inside view of the China model tends to emphasize the features and capacities of the state system, and to explore where they came from.
China's economic performance over the past decade and more has resembled a large-scale cognitive experiment. As external relationships and foreign markets that were once pliable have gradually hardened, it has tested how much pressure China's economy can really bear, and how reliable the inside view of the China model really is. That inside view overlooks, or at least greatly underestimates, the importance of foreign markets to China.
External markets and relationships amount to more than a given year's import and export figures or their share of GDP. The exchange of goods, services, capital, technology, talent, knowledge and values on a vast scale created a stable expectation that China would keep integrating with the world. Considering that China had been cut off from the world for a long stretch not so long ago, that expectation was among the most important reasons for confidence in its economy.
3.
The outside view of the China model scrutinizes precisely these "features and capacities of the state system," primarily through the framework of market fairness in international competition. Its critique rests on two core dynamics.
The first is the sheer scale of China's market, and the way that market is used. A market of vast scale confers advantages that smaller economies can hardly match. When access to that market is allotted, through licensing and approvals, to one or a handful of domestic companies, those companies inevitably gain enormous advantages of scale and cost. When they then enter international markets, few foreign competitors can match them on either count.
Elon Musk told analysts on Tesla's earnings call in January 2024 that Chinese carmakers were the most competitive in the world, and that without trade barriers they would "pretty much demolish" most other car companies. This is not alarmism. It is where the logic naturally leads.
A large economy enjoys another visible advantage in the practice of "trading market access for technology." When a market is alluring enough, access to it can more readily be exchanged for technology.
The second is the government's formidable capacity to intervene, above all its control over factor markets: land, capital and labor. A company's costs can be broken down, roughly, into the costs of land, capital and labor. If the government controls and distorts factor prices in order to intervene in the market, companies' costs no longer reflect reality, and competition among them is no longer fair competition in any real sense.
Ownership is the fundamental lens through which to view an enterprise. Ownership reform was once at the heart of China's reforms, and the decisive measure that brought its economy back to life. From the standpoint of international competition, however, the legal form of a Chinese company's ownership may no longer matter so much.
Seen from outside, state-owned and private enterprises alike look like branches of the state as a "super-corporation," its wholly owned or majority-controlled subsidiaries.
By any definition, the board of directors should be a company's highest decision-making body. In China's state-owned enterprises, however, major matters must first be discussed and decided by the Party committee.
Data offer another example. Under certain conditions, Chinese and foreign companies alike are obliged to cooperate when the state demands access to data. Yet the two systems differ markedly in their governing principles, in who directs the process, and in the channels available for challenging it.
From the outside, this means that Chinese companies, even private ones such as TikTok and Huawei, lack avenues of judicial redress independent of administrative power. As a matter of legal logic, they can hardly refuse the compulsory demands of state security agencies.
Shaomin Li, a Chinese-American economist, has defined the China model, simply and succinctly, as "China, Inc."
4.
Several related arguments current within China deserve closer examination.
The first is the "internal affairs" argument: where exactly the line between state and enterprise falls is a country's own business, and no one else's. Its error is obvious. If competition between companies can always be reduced to competition between states, companies from small countries would have no room to survive. What fairness could such competition claim?
The second is the "victim" argument: China, too, is a victim of deglobalization rather than its perpetrator. Deglobalization has indeed been a trend of recent years, and admittedly every country is its victim. Yet the trend has arrived almost in lockstep with "de-Sinicization," the push to reduce dependence on China, which is in other words one of deglobalization's defining features. De-Sinicization certainly has domestic causes in the West, such as the rise of populism. But the China model is without doubt a key external factor that has catalyzed and intensified it.
The third is the "double standard" argument. Take industrial policy. Europe, America, Japan and South Korea all have industrial policies, some with a longer history than China's, so why single China out? This argument is stronger than the first two, and it deserves more careful scrutiny.
The difference lies in the scale and the instruments of industrial policy.
The Center for Strategic and International Studies (CSIS), a Washington think tank, has made an international comparison on a consistent basis, combining direct subsidies, tax incentives, below-market credit and state investment funds to estimate industrial-policy spending as a share of GDP. (To exclude the anomalous effects of the pandemic, CSIS chose 2019 as its base year.)
China's industrial-policy spending came to at least 1.73% of GDP, more than its defense budget that year. The figures were 0.67% for South Korea, 0.55% for France, 0.50% for Japan, 0.41% for Germany, 0.39% for the United States and 0.33% for Brazil. China's share was 2.6 times South Korea's and 4.4 times America's, and the report states explicitly that its estimate is conservative.
The instruments may matter even more than the scale.
Europe, America, Japan and South Korea lean toward tax incentives and direct funding for research in frontier technologies. Their support clusters at the very front of the industrial chain, in basic research, or at the consumer end, in the form of purchase subsidies. It operates largely through the market and interferes relatively little in the production and operations of particular companies.
China's toolkit is more varied, and it is combined with opaque, non-fiscal instruments. These include straightforward fiscal subsidies, below-market credit and syndicated loans, government guidance funds, industrial land allocated at low prices, and preferential electricity rates.
China's industrial policy also reaches an unusually wide range of companies. Data from Germany's Kiel Institute for the World Economy show that as of 2022, more than 99% of China's A-share listed companies received direct government subsidies. In addition, China supports selected priority industries, such as electric vehicles, wind power, rail transport and semiconductors, with a coordinated "combination punch" that spans the entire industrial chain.
Naturally, Chinese government bodies and scholars have disputed these estimates, arguing that the concepts are "poorly defined," the statistical scope "arbitrary" and the methodology "detached from WTO standards." Some Chinese scholars argue in particular that when late-developing countries use industrial policy to provide "coordinated guidance in line with comparative advantage" in areas of market failure, they are exercising a legitimate right to development. They add that measures adopted in recent years by America and Europe, such as the CHIPS and Science Act and the Inflation Reduction Act (IRA), likewise contain hundreds of billions of dollars in direct subsidies, along with extremely stringent localization requirements that shut others out.
The dispute over industrial policy is not the subject of this essay. The point here is that deglobalization and barriers to international trade tend to reinforce each other in a cycle. Moreover, in a society where information is controlled, the outside view matters all the more. Without it, information and perception will also reinforce each other, and the gap between the inside and outside views will only keep widening.
5.
The real question is whether this China model actually serves China's interests.
Before 1978, every Chinese enterprise was merely a "production workshop," an executing arm of state or collective strategy, and the Chinese economy of that time lay stagnant.
Reform of enterprise property rights was the key step in bringing China's economy back to life. Its essence was to establish that an enterprise, or at least the great majority of enterprises, is an instrument through which individual citizens, that is, entrepreneurs, pursue their own goals and realize their own worth. By clarifying the boundary between state and enterprise and introducing incentives, China's economy was able to climb out of the mire.
Joining the WTO was the most important step in China's integration with the world. Before that, the central theme of China's economy was internal revitalization, pursued mainly through market-oriented reform, and the line between state and enterprise moved toward the enterprise. After accession, China's economy acquired a second theme, external competition, and the line began moving back toward the state.
Abroad, the consequence of this reversal has been to crowd out other countries' production capacity and jobs, and resentment is no doubt still building. And at home?
The bill for the China model will ultimately settle on the balance sheet of every household. Take "financial repression," in which deposit rates are held for long periods below true market rates. In effect, ordinary savers are quietly subsidizing the state-owned enterprises and leading companies that obtain cheap loans. Weak household consumption has, unsurprisingly, become a chronic ailment of China's economy over the past 20 years, and it shows every sign of growing worse.
To win a competitive edge in international circulation, China has in effect sacrificed domestic circulation, and in particular the spending power of its households. Whether viewed from the international side or the domestic one, this is unsustainable.
Take the "second China shock" now widely debated abroad: a new round of structural upheaval in global markets, driven this time not by shirts and toys but by Chinese electric vehicles, green-energy equipment and other new manufactured goods. On the surface it is a problem of international circulation. In essence, it is the spillover of an imbalance in domestic circulation.
The only solution is to shift the direction of policy from "supply-side subsidies" to a "demand-side restart," so that domestic circulation becomes genuinely able to absorb the output of domestic industry, rather than pushing surplus capacity out into international circulation.
Render unto the state what is the state's, and unto the market what is the market's. Charting the boundary between state and enterprise cannot remain a slogan. It needs a yardstick that can be checked.
At least three are already at hand. The first is competitive-neutrality review: before any government action is taken, it must answer whether it alters the relative costs of competitors in the same industry. The second is measurable factor prices: how far land, capital and labor are priced by the market should be open to public monitoring by third parties. The third is disclosure of subsidies: who received them, how much, and on what grounds should be as easy to look up as a listed company's financial statements.
All three answer a single question: where the state stops, and where the enterprise begins.
I once discussed this subject at length with Liu Xiaoguang, founder of Beijing Capital Group. Mr. Liu passed away some years ago, but one thing he said has stayed with me ever since.
"A clear boundary between enterprise and state," he told me, "makes the national interest compatible with the interests of the world." Having moved abroad in recent years, I appreciate all the more how far ahead of his time he was. A new survey of the boundary between state and enterprise is what I am calling for. It is the necessary path to benefiting China and the world alike.
References:
International comparison of industrial-policy spending: CSIS, Red Ink: Estimating Chinese Industrial Policy Spending in Comparative Perspective, May 2022
Kiel Institute for the World Economy: Kiel Policy Brief No. 173, Foul Play? On the Scale and Scope of Industrial Subsidies in China, April 2024
Justin Yifu Lin, “New Structural Economics”, World Bank Publications, 2012
Shaomin Li, "The Rise of China, Inc.,“ Cambridge University Press, 2022
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