China’s State Capitalism: Leviathan Major and Minor

Three of ten largest corporations in the world are owned by the Chinese state–two energy companies, Sinopec and China National Petroleum, and a utility, State Grid. There are four state-owned enterprises in all on Fortune magazine’s list of the 500 largest companies in the world. As recently as 2005 there was none. The sluggish recovery of the developed economies from the 2008 global financial crisis has brought a bout of self-doubt to free-market capitalism. China’s model of state capitalism–dirigisme through state shareholding would be a shorthand description–is touted as the coming alternative.

Though much discussed and surprisingly widely practiced in countries rich and poor, relatively little is known about the functioning and economic implications of state capitalism in its new incarnation. The 20th century model of command economies–state-owned enterprises acting as the agents of government allocation of resources–has evolved into a 21st century one in which the state provides capital to corporations–either via equity or debt–and in the process becomes a controlling shareholder that seeks to optimize economic and political returns on its investment. The political returns manifest themselves as a wide range of public goods from industrial policy to social benefits.

Two academics, Aldo Musacchio and Sergio Lazzarini, take a look at this new state capitalism in a newly published Harvard Business School Working Paper*. First, some definitions. Musacchio an Lazarini identify two flavors of 21st century state capitalism.  One is through state majority control of publicly traded companies. China’s state-owned enterprises, such as the three mentioned above, are a prominent example. The other relies on minority investments in companies by official agencies such as development banks, state-controlled pension funds and sovereign wealth funds as well as national and local government. They summarize the two as,

the widespread influence of the government in the economy, either by owning majority or minority equity positions in companies or through the provision of subsidized credit and/or other privileges to private companies.

In short, Leviathan major and Leviathan minor.

The authors look at state capitalism around the world, not just in China. One point that leaps out of their study is how widespread the model already is, even in what are thought of as free-market economies. We pluck out of their paper this snapshot of it in China, using 2010 data, and by comparison in the other Brics.

Patterns of State Ownership in Brics
Country SOE output to non-financial GDP Listed SOEs SOEs as % of market cap. Number of SOEs with majority control No. of firms with federal govt. minority ownership
Federal State/
Brazil 30 14 34 247 n/a 397
China 30 942 70 17,000 150,000 n/a
India 13 29 4,014 217 837 404
Russia 20 12 40 7,964 250 1,418
S.Africa n/a n/a n/a 270 n/a n/a
Source: Musacchio and Lazzarini

Using Musacchio and Lazarini’s analogy of Leviathan as a majority investor and Leviathan as a minority investor, China falls under the rubric of the former. Government majority holdings in publicly traded companies outstrip minority holdings by a ratio of three to one. The average for the Brics is less than two to one. As a general rule, minority holdings are the result of state investment holding companies investing in a portfolio of firms. China Investment Corporation (CIC), the world’s third largest sovereign wealth fund by assets under management, fits that model. Though not particularly delved into by the authors, China’s state capitalism is also characterized by an upstream oligopoly of large state-owned enterprises in strategic industries, as, again, the three mentioned above illustrate.

Musacchio and Lazarini’s paper is descriptive, not prescriptive, but it does raise questions about some common consequences of 21st state capitalism that are readily applicable to China, where the 121 largest state-owned enterprises own $3 trillion in assets (2010 figures). Does China’s version, as entrenched and widespread as it is within the economy, promote or hinder the development of deeper financial markets and more professional and skilled corporate management and governance? Just as in the political realm, state, government and Party are often interchangeable, so are ownership, governance and management in the world of Chinese state capitalism.

The authors note that Leviathan major state capitalism tends to establish itself in response to market failure, notably where capital markets and corporate governance are weak. In an ideal world, it leads by example to improvements in both. Yet in China’s case, the big state owned banks are so dominant in the financial system and are such an important arm through which the government exercises monetary policy, that that may not happen, regardless of how hard the reformers are now pushing for financial reform. Which leads directly to a bigger question, whether vested interests and cronyism are so entrenched that the system is captive to its agency problem–that those running China’s state capitalism use its as a way to create and distribute public goods in order to legitimize the Party’s monopoly grip on power and to allow the ruling elite rather than the state as a whole to capture the economic rents it generates. John Hempton of Bronte Capital has provocatively described this as  China as a kleptocracy. That may be over-egging the pudding, but to what extent will determine how China continues to ascend the ladder of economic development.

*Leviathan in Business: Varieties of State Capitalism and Their Implications for Economic Performance by Aldo Musacchio, associate professor in the Business, Government and the International Economy unit and a Marvin Bower Fellow at Harvard Business School, and Sérgio G. Lazzarini, Insper Institute of Education and Research, HBS Working Paper Number: 12-101, May 30, 2012

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