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China’s Heavy Economic Legacy of State Ownership and Central Planning

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China’s Heavy Economic Legacy of State Ownership and Central Planning

Waning productivity and declining growth in China cannot be explained by the pandemic or even demographic shifts. It is also the consequence of an unfinished reform agenda. 

China’s Heavy Economic Legacy of State Ownership and Central Planning
Credit: Depositphotos

The ongoing tensions between China and the United States underscore the importance of delving deeply into the causes of the former’s stagnating economic growth. Yet the literature concerning China’s economic growth frequently draws comparisons with Japan and other market economies in East Asia, neglecting China’s history as a centrally planned economy with widespread state ownership. 

A different comparative approach is worth considering: drawing parallels with the transition from communism to capitalism in Eastern Europe and the former Soviet Union. 

As someone whose career at the World Bank revolved around the transition of ex-communist economies, I have seen how difficult it is to advance the restructuring of large state-owned enterprises, and how the state-owned sector’s legacy in ex-communist countries hinders sustained economic growth. 

Admittedly, there are stark differences in context: In China, the emergence of new private enterprises and substantial foreign direct investment brought about spectacular growth between 1978 and 2008. In Russia, the concentration of ownership by the state, and particularly at the hands of oligarchs, is an “important cause of Russia’s economy having been nearly stagnant since 2009 and completely stagnant since 2014.” Notwithstanding the dissimilarities, a comparison between China and post-communist countries is instructive, particularly when exploring state ownership.

State Ownership Reform in China

The waning productivity and subsequent growth decline in China since 2008 should not be attributed solely to transient factors, such as the aftermath of the global financial crisis and the COVID-19 pandemic, or even to demographic shifts. It is also the consequence of an unfinished reform agenda. 

The share of state-owned enterprises (SOEs) in China’s GDP is about 25 percent. Since 2008, the flagging economic performance of SOEs has weighed down China’s growth trajectory. Unlike the significant reforms of the 1980s and 1990s, the last two decades have been marked by a “reform fatigue” that hindered Chinese leaders from pursuing much-needed policy measures – perhaps due to a concern that privatizing or dissolving state institutions might trigger a collapse akin to that of the formerly Communist countries in the 1990s.

The results of Chinese policy measures aimed at reforming state enterprises have varied significantly since the 1980s, due to the state’s fluctuating and gradually diminishing prioritization of the issue. Results range from the relatively successful reforms championed by Zhu Rongji between 1998 and 2003 to  the near-complete failures of the past decade. 

China’s SOE restructuring strategy employs instruments that have proven to be ineffective in Eastern Europe and the former Soviet Union: (1) corporatization (transformation of SOEs into Joint-Stock Companies (JSCs); (2) top-down mergers of SOEs, orchestrated by public officials rather than business executives; (3) debt-to-equity swaps involving state equity infusion to offset company debts; and (4) the establishment of mixed ownership arrangements with private partners assuming minority stakes. 

These measures have faltered whenever attempted in former Communist nations. Such policies serve as a fig leaf and cover up opposition to privatization. 

By point of illustration, as a World Bank representative during the 1990s, I interacted with the general director of a failing Russian SOE targeted for restructuring. His proposed alternative was to merge with a profitable SOE, and, when faced with the World Bank team’s argument that the merger wouldn’t enhance incentives for efficiency for either company, his compromise was to transform the SOE into a JSC. He was eager to sell only a small stake, no more than 25 percent, and maintain full control of the company. It remained unclear who would be willing to buy a minority stake in a failing company that could not be restructured by a minority stake investor. Ultimately, the effective remedies were the sale of controlling stakes in enterprises to private investors, bankruptcy liquidation, and the divestiture of assets.

What are the current prospects then for Chinese reform or restructuring? One solution would be selling a controlling stake in large enterprises. Since this solution runs the risk of domination by oligarchs, the Chinese leadership would probably insist on selecting bidders who are acceptable to the Communist Party.

Another solution for companies would be divestiture: splitting the companies between profitable parts, which could be sold, and loss-making parts that the state would continue to subsidize until their eventual closure. The profitable parts could be offered to domestic or foreign investors, to the extent they are not technologically sensitive. Sale to foreign investors is problematic in view of the indigenous orientation of the current authorities. 

The remaining option is liquidation of these enterprises, similarly to what was done in China in the 1980s and ‘90s. In today’s political context, the party is not willing to take this risk. 

Central Planning, Industrial Policy, and Subsidies

A growing system of subsidies stemming from the legacy of central planning is yet another factor contributing to the slowdown in China’s growth. Under President Xi Jinping’s leadership, state-driven industrial policy has increasingly replaced market-oriented economic reforms. In May 2015, for example, China’s State Council launched the “Made in China 2025 Program,” outlining desired breakthroughs in 10 priority sectors, including advanced information technology. 

State subsidies have fostered an uneven playing field, not only between private and state-owned enterprises but also between entities aligned with local, provincial, and national government and those that are not. Local banks are often reluctant to approve loans to private firms, unless these entities possess personal affiliations with relevant government officials. Decisions regarding subsidy allocation typically rest with individual government officials, rather than being subjected to review by peer assessors and expert panels, as is common in industrialized nations. 

Remarkably, over 90 percent of listed companies in China have received government subsidies. Analyzing Chinese firm-level data spanning 2001 to 2011, Philipp Boeing and Bettina Peters reveal that ill-utilized research and development subsidies, diverted for non-research purposes, accounted for 53 percent of the total R&D subsidy volume. Another recent study showed that China’s “progressively prescriptive industrial policies may have yielded limited results in promoting productivity.” 

In a 2016 address to the European Economic Association, Fabrizio Zilibotti emphasized that China had exhausted the benefits of growth driven by investment and must transition toward growth led by innovation. However, significant R&D subsidies go to waste, failing to reach the most capable and innovative firms. “Simply allocating funds to firms for R&D endeavors… falls short of fostering innovation-led growth,” Zilibotti concluded.


The ongoing growth stagnation is poised to persist due to the Chinese leadership’s hesitancy in implementing substantial reforms within the state sector. Their insistence on a prescriptive industrial policy further stifles innovation. 

As this stagnation persists, Chinese leaders, concerned about domestic instability and potential unrest, might increasingly adopt a confrontational stance toward the United States, potentially heightening the prospects of a “Cold War” scenario between the two nations. One bellwether is the recent actions taken by U.S. President Joe Biden to curtail sensitive exports to China, which, in response, prompted China to impose bans on rare mineral exports.

The legacy of central planning consequently evokes a sense of déjà vu, resembling the Cold War dynamic between a communist and a capitalist bloc. However, this scenario diverges from the historical Soviet-U.S. Cold War due to the existing economic interdependence between the United States and China. The intensification of the new cold war could disrupt this interdependence through trade conflicts and superpower struggles. 

With both sides endeavoring to forge their distinct blocs by pressuring allies to pick sides, today’s economic interdependence will be challenged, carrying substantial cost for all.