Unpacking Linkages Between the Chinese State and Private Firms

Ever since China began integrating into the global economy and shifting away from a planned economy in the late 1970s, domestic and foreign observers have closely tracked the development of the country’s emerging private sector to better understand the relationship between state and business, the country’s progress towards modernization, and the implications for the international system. For decades, China’s private sector consistently grew in scale and scope; however since the early 2010s there have been signs pointing to a resurgence of the state sector, with greater opportunities for state-owned enterprises (SOEs) and in some cases restrictions on private firms. This trend is often referred to as “state advance, private retreat” (guojin mintui). Recent data suggests that there may be an even more fundamental encroachment on the private sector underway, with SOEs acquiring shares in private firms and raising questions over the nature of the Chinese economy.

Why Policymakers Should Care

There are multiple reasons why scholars and policymakers should care about the health of the private sector relative to the state-owned sector in China. The growth of the private sector is a convenient measure of the role of markets in China’s economy and its level of conformity with global economic rules. A sustained retreat of the private sector could mean that China’s economic system may not be compatible with the World Trade Organization (WTO) and other international regimes.

The linkages between the state and the business sector have long been the object of international scrutiny because of the unfair advantage that derives from disproportionate state support for companies. China spent more than twice as much as the United States in dollar terms in 2019, but that quantification did not include the forms of support that are endemic in the Chinese system such as preferential access to public procurement and government guidance of investment.

As Chinese companies internationalize and become increasingly competitive in emerging technologies ranging from semiconductors to batteries, governments worldwide are wary of how state support is distorting markets and potentially leading to overcapacity in certain sectors. In the past, such concerns focused on industries like steel or aluminum but higher value-added sectors – including the automotive and semiconductor industries – are now increasingly in the spotlight. For years, foreign companies have reported increasing competition from local companies within China’s domestic market as indigenization efforts guided by the Chinese government have come to fruition. Now, they are experiencing that competition outside China, including their home market.

A second reason for scrutiny is China’s political trajectory. Many scholars have focused on tracking the advance of the private sector in China, the rise of a private entrepreneurial class, and its role in shaping institutions and policymaking, including through lobbying, to better understand the policy process in the country and document any potential pluralization of Chinese politics. These and other scholars have pointed out that the link between economic liberalization and diffusion of power is not linear, in part because of the co-optation of entrepreneurs by the party. Nonetheless, it represents a significant social transformation in a country that did not legally recognize private corporations until 1988.

A third set of worries, which are of a more recent vintage but now equally if not more prominent, centers around national security, especially given the increasing digitalization of the economy. Concerns are focused on data security, regulation about the type of data that companies must share with the Chinese government, increasingly blurred lines between the civilian and military apparatus in China, and the potential weaponization of trade and technological interdependence. For example, a recent investigation launched by the Department of Commerce on the risks posed by connected vehicles is focused on how these technologies may be used against the United States by foreign governments and particularly China. The investigation, among other things, is exploring how the Chinese government may demand access to data collected by Chinese companies or use backdoors embedded in a connected vehicle’s software to weaponize the technology to its advantage. Identifying the linkages between private Chinese companies, like automaker BYD or Huawei, and the Chinese state, especially in light of recent laws on national security, data, and espionage, are central to evaluations regarding risk. Efforts to enhance civil-military fusion in China have also heightened concerns in Washington and other capitals over dual use technologies and the involvement of nominally private companies in China’s military modernization program.

Delineating the State Sector

In practice, Western policymakers find themselves in the challenging position of trying to understand what the evolving relationship between the state and the business sector mean for U.S. interests, the global trading order, and U.S. bilateral relations with countries that are receiving increasing investment from China. This is complicated because political and economic objectives in China are increasingly interlinked in ways that are reshaping the country’s international commercial footprint, which some have defined as CCP, Inc.

The distinction between companies where the state owns a majority stake, is a minority shareholder, or holds no stakes at all has been a very useful indicator and continues to shape regulation in the United States, as exemplified by ongoing discussions over definitions of foreign entities of concern (FEOC) for laws including the CHIPS and Science Act and the Inflation Reduction Act (IRA). Policymakers would, thus, do well to track ongoing trends in China that blur the lines between the private and state-owned sectors.

Today’s China is less transparent when it comes to economic policymaking and corporate governance compared to a decade ago. However, it is increasingly clear that the current leadership is far less committed to economic liberalization than in the past. Some ambitious commitments early in Xi’s first administration to push forward economic reforms have largely stalled. National security is interpreted in a sweeping way in Xi Jinping’s China and is prioritized in ways that have reshaped the country’s economic trajectory. Anecdotal evidence suggests that despite the significant state support made available to certain industries in China, business sentiment is low due to, among other factors like low consumer sentiment, concerns over state overreach. There are still significant differences between SOEs and private companies, but new rules are threatening the latter’s independence.

Despite the challenges in accessing information on the policy process and, increasingly, reliable data from China, some researchers have pioneered new methodologies to build alternative estimates that take a more comprehensive view of SOEs in China and account for increasing linkages between the state-owned sector and the private sector. This Big Data China feature provides an overview of official estimates and data on the importance of SOEs in the Chinese economy over time. It then presents two alternative estimates of state ownership and linkages between the state-owned and the private sector in China and delves into the data and analysis of Professor Chang-Tai Hsieh and his collaborators. Then, the feature presents some new evidence that suggests firms may not always welcome links to the state sector. It concludes by discussing implications for policymakers and policy suggestions.

What is a state-owned enterprise?

Private entrepreneurs emerged gradually but decisively as an economic force throughout the 1980s and 1990s in China. In the late 1990s the government carried out reforms that restructured the state-owned sector, allowing it to maintain control over larger companies, often carved out of ministries, while “letting go” of smaller ones. China’s experience was deeply different from that of countries in the former Soviet bloc where rapid privatization took place concurrently to political reform in the 1990s. As a result of China’s specific path to a more open economy, the state has remained far more invested in the economy compared to other major economies, even as the number of SOEs declined over time (see Figure 1).

In many cases, SOEs remained more prevalent in sectors that were deemed more strategic or socially important (for example, electric utilities and the petrochemical sector), often with high employment and lower profitability. After the liberalization wave of the 1990s, the governance of SOEs stabilized in the early 2000s with the establishment of an agency responsible for managing state owned assets, the State Asset Supervision and Administrative Commission (SASAC). SASAC, however, is not representative of all SOEs in China. A far larger number of SOEs are affiliated with or controlled by local governments. Prominent examples of local SOEs include the Shanghai Automotive Industry Corporation (SAIC), which is at the forefront of China’s international EV expansion. Overall data on the number of SOEs in China (see Figure 2) shows how dramatically the number of SOEs has declined since the 1990s to today. There may have been an uptick in the number of SOEs in recent years, although, as a share of overall firms, SOEs declined (see Figure 3).

Moreover, a closer look at SOE assets shows that they’re steadily increasing (see Figure 4).

As measured by market capitalization, the share of SOEs amongst China’s top companies kept growing relative to non-state-owned companies in recent years (see Figure 5). Indeed, 71 percent of Chinese companies listed in the Fortune 500 list in 2022 and 84 percent by asset size were state-owned companies. This suggests that just looking at the official data on the number of SOEs in the economy might not be sufficient to understand the importance of the state-owned sector in China.

The National Bureau of Statistics of China releases information collected through the Annual Industry Survey (AIS) which includes a category for company ownership type. Recent academic research suggests that there may be systematic misreporting in the AIS data. This is partly because the level of state ownership is self-reported by firms and in some cases the filing is not updated after they are restructured. Moreover, the state is finding new ways to invest indirectly in firms, making it harder to track through official sources.

Rethinking State Ownership

The official definition and data on SOEs in China are problematic insofar as they are neither completely reliable, because they are not updated or comprehensive, nor are they capturing the changing relationship between SOEs and private firms. Several scholars have been exploring the issue through various qualitative and quantitative tools to better understand the implications for Chinese economic growth, trade, and international relations. The leaders of this new wave of research include scholars based both in the United States and China who have collaborated on various papers exploring the issue.

Professors Chang-Tai Hsieh, Chong-en Bai, Zheng Michael Song, and Xin Wang have proposed an alternative approach to identify the linkages between the state and companies that highlights the growing number of joint ventures and equity investments that tie SOEs and private firms. To do so, they used the registration records of the State Administration for Market Regulation (SAMR), the state organ where all Chinese firms register, and which includes data on each firms’ immediate owners (see the methodology section for more details). The scholars used the data to identify patterns of ownership and uncover hidden connections between the private sector and the state.

Unlike traditional categorizations of SOEs which hinge on ownership stakes, the scholars focus more closely on the role played by joint ventures. The scholars categorize those who own at least 10 percent of a joint venture with state owners as directly connected private owners. Indirect connections are forged when private owners that are directly connected to the state create other joint ventures with private owners that are not otherwise directly linked to the state.

Hsieh and his co-authors’ analysis shows that large private owners (which can include companies or individuals) are highly connected to the state. Take the top 1,000 private owners in China ranked by the sum of the registered capital of all the firms they own. Of those, 78 percent were state-connected, 63 percent directly connected and 14 percent indirectly connected. Instead, smaller firms were far more likely to only be indirectly connected. Unsurprisingly, state-connected private firms are especially visible in sectors with high shares of state ownership. Most importantly, the data reveals that between 2000 and 2019 the number of private owners that were directly connected to the state increased by almost three times (see Figure 6). Indirect connections have grown even more significantly, especially among companies that are more removed from the state.

Indeed, other scholars have also tried to address the challenges with current SOE categorizations, reaching findings that also diverge from the official SOE data. For example, take the work of Franklin Allen and his coauthors, who through a careful analysis of a dataset of 40 million firms traced the ownership structure of companies and their linkages to the state apparatus (see methodology section). Their data indicates that current official estimates largely underestimate the number of SOEs and do not account for the networks created through equity investments between firms (see Figure 7). They also document that this trend is on the rise, as the capital of firms with some state ownership has increased from roughly 61 percent in 1999 to 85 percent in 2017.

Figure 7: Official and Alternative Estimates of SOEs

As an example of this new trend, Hsieh and his coauthors analyze the ownership structure of a conglomerate, the East Hope Group, to illustrate how privately-owned firms are increasingly linked to the state through joint ventures (See Figure 8). In 2019, the family that owns East Hope owned at least a 10 percent equity share in 236 companies, of which 26 are joint ventures. Of those joint ventures, 14 are with state owners, which typically on average are much larger than the East Hope family. These joint ventures directly connect the East Hope family to the state. At the same time, East Hope’s remaining 12 joint ventures link those private owners indirectly to the state.

Figure 8: East Hope Ownership Structure

Hsieh and his co-authors’ findings indicate that the distinction between private and state-owned enterprises in China is becoming blurred and a growing share of China’s economy is neither fully state owned nor fully privately owned. The scholars identify 978,609 firms that have three degrees of separation or less from a state-owned entity and over 3 and a half million that are indirectly connected through joint ventures to the state-owned sector. However, although there are advantages to having links to the state, this indirect connection does not translate to direct control by the party-state over companies. Indeed, Allen et al. suggest that direct management has decreased over time, but it still raises questions concerning the nature of the private sector in China.

U.S. national security-oriented restrictions on exports and investments have shifted from entity-specific to country-wide “countries of concern” in recent years. This is a direct and natural policy response to civil-military fusion policies and increasing party involvement in the private sector, as documented by Curtis Milhaupt and Lauren Yu-Hsin Lin whose work was previously featured on Big Data China. Evidence of greater SOE investment in the broader economy will likely reinforce these kinds of approaches in the U.S. government apparatus despite the existence of complicated challenges in implementation.

The Complex Economic Consequences of Growing State Connections

Over the decades, research has highlighted that SOEs tend to underperform relative to private firms on various metrics including profitability and total factor productivity. However, there may be reason to think that mixed-owned, or connected firms identified by Hsieh and his colleagues and Allen et al. may have an edge thanks to the political and economic support gained through links to the state and the nimbleness of the private sector. Allen et al. find that firms where the state ownership share was over 50 percent tended to perform worse by all metrics but those with 10 to 30 percent central state ownership stakes grew 73 percent faster in size than purely private firms. A stake of up to 10 percent translated to an average 7.6 percent higher profit rate. Indeed, economic advantages may be part of the reason why we are witnessing this increase in linkages between the state and the business sector.

As Hsieh, Bai, and Song point out, through a set of informal institutions, “special deals,” the government in China has long provided support to private firms. This arrangement is especially significant in the case of local governments which have always been more directly invested in the performance of firms, as they can pay higher taxes to local governments and supply benefits to political elites. Thus, the growing investments by state entities into private firms may be a formalization of existing linkages that have fueled China’s growth over the past 30 years. However, those ties are increasingly threatening companies’ international position due to growing trade tensions.

If growing state ownership and connections between the state-owned and private sector is indeed a reflection of existing dynamics, then it calls into question whether there has been a true change in power dynamics between the two parties. China’s domestic politics have changed significantly over the past decade, with the top leadership enacting much more muscular policies to limit the power of large corporations while also deploying extensive measures to support firms, especially in key industries. According to Hsieh, this trend means that companies need to navigate the state’s “two strong hands,” one supportive and the other restrictive which aim to increase the party’s control over the economy even as the private sector continues, in one form or another, to grow. Moreover, political control is likely proving oppressive for companies as the party-state increasingly weights national security over economic growth.

In a recent experiment conducted by a group of scholars based in the U.S. and China, Emanuele Colonnelli, Bo Li, and Ernest Liu provide empirical evidence that some firms may be wary of excessive government involvement. In 2019, the researchers worked with the leading venture capital and private equity industry service provider in China to conduct a survey of firms looking for potential investors (see methodology section for more details). The main finding of the experiment was that firms on average disliked limited partners with government ties, especially to the central government. In fact, the data revealed no significant dislike for local government ties (except for provincial governments) perhaps because firms perceive local governments as more likely to prioritize business development over political goals.

These findings, combined with low business sentiment in China and growing evidence of firms derisking their Chinese operations, suggest that not all government intervention in the economy is welcome by Chinese companies, especially if it comes with national security strings attached. The findings from the experiment suggest that state and party influence on private firms may have evolved to prioritize politics above economic growth, creating new challenges for companies that would naturally seek to maximize political support alongside autonomy. This is fitting given the enhanced level of political control over the economy and local governments that the top leadership has been projecting in recent years. Its effect on the economy is hard to measure, at least for now, but this trend may accelerate the internationalization of certain Chinese firms that are seeking to reduce their exposure to politics.

Conclusion and Policy Relevance

Chinese companies have benefited over the years from the close relationship with the state, especially at the local level. However, those very links could also undermine the growth potential of certain companies moving forward, as foreign governments become more concerned with fair competition and if the party-state leverages its links to companies to achieve national security aims. Evidence that the state-owned sector was expanding its influence in the economy to further political and ideological goals more aggressively could have a chilling effect on investment in the country. It would also fuel concerns among foreign governments that there could be national security as well as economic risks associated with the increasing connections between the Chinese state and companies.

Dynamics that are largely tied to China’s domestic policies and economic strategy are going to continue to have a large-scale impact on trade and, increasingly, the country’s foreign relations. As some scholars have noted, dynamics that are embedded in China’s domestic political economy risk furthering trade and security-related tensions with other countries because of the increased role of the party-state in the economy and in guiding companies.

Concerns over Chinese manufacturing overcapacity fueled by industrial policy are as pronounced as ever in capitals around the world, both in developed and developing countries. Policymakers in the United States and Europe, as well as emerging markets like Brazil and Turkey, are weighing the option to deploy tariffs on Chinese imports. Chinese private companies would in many cases be directly targeted by these policies because many have been benefiting from state support regardless of their ownership structure.

Yet, the distinction between private and state-owned in China remains important for U.S. policymakers. Take the FEOC guidance documents issued by the Department of Treasury and the Department of Energy in December 2023. The threshold of control by a foreign government of a country of concern is set at 25 percent to qualify for battery tax credits. The same 25 percent threshold applies to licensing deals unless significant power in decision-making is conceded to the non-FOEC partners. This decision implicitly acknowledges the deep involvement of Chinese companies with ties to the state in the battery value chain, especially mining and refining.

The guidance on FEOC in the IRA-related regulation is laxer than for the CHIPS and Science for practical reasons. In many cases American and other multinational companies would be just as unlikely to qualify as their Chinese counterparts if they were unable to have any involvement with companies linked in any way with the Chinese state apparatus. The outcome of an even tighter regulation, given the tight timeline set by the law, would mean that so few companies would qualify that it would essentially render tax credits meaningless, especially vis-a-vis Chinese car manufacturers. The guidance is still being finalized, but the proposed approach is wise insofar as it allows production by Chinese private firms outside of China that meets all the requirements laid out by the law to potentially qualify for tax credits.

Significant differences are still observable between the decision process of publicly and privately owned companies in China, which should be reflected in policy. There are still serious issues regarding potential unfair competition, but they should be addressed in ways that clearly target the source of risk and recognize that not all Chinese companies are subject to the same level of political influence. This recognition implies that the national security risk presented by links to the state-owned sector will depend on the industry as well.

To this end, transparency requirements, due diligence and other corporate governance requirements are a powerful tool at the disposal of the U.S. government. Access to the U.S. market remains one of the most important levers available to shape company behavior. The ongoing restructuring and reorganization of international supply chains, including Chinese investment in countries that the United States has free trade agreements with, shows that Chinese firms can be extremely responsive to international regulation. U.S. policymakers should take this into consideration in future regulation to try and reshape Chinese investment decisions in ways that can aide U.S. economic goals.

Finally, even though Chinese companies are internationalizing rapidly, there is no clear framework for how to address any potential threats to economic stability and national security that their increased international presence might bring. The United States would do well to further efforts to discuss the implications of growing linkages between state and private sector in China for derisking efforts and economic security with its partners. The G7 has become more focused on economic security over the past few years, particularly during the Japan presidency. As a result, the G7 could be a good forum to engage with close partners to better think how to reform trade rules to address these issues.

When engaging with partners, the United States will need to acknowledge diverging approaches to Chinese investment and economic vulnerabilities which will shape countries’ position. Ultimately policies in the economic security realm will need to be successful in balancing multiple goals and developing risk management strategies that reduce vulnerabilities without cutting off access to new technologies and positive competition.

Header Image: JADE GAO/AFP/Getty Images

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