A Model of China's State Capitalism

This paper documents a hallmark feature of China's state capitalism as the state controlling the economy in a vertical economic structure: State-owned enterprises (SOEs) monopolize key industries and markets in the upstream, whereas the downstream industries are largely open to private competition. We develop a general-equilibrium model to show that this unique vertical structure, when combined with openness and labor abundance, is critical in explaining a puzzling fact about China's economy: SOEs outperformed non-SOEs in the past decade while the opposite was true in the 1990s. We show how the upstream SOEs extract rents from the liberalized downstream sectors in the process of industrialization and globalization. It implies that the unusual prosperity of SOEs in China can be merely a growth-undermining symptom of the incompleteness of market-oriented reforms rather than a proof of their efficiency dominance over non-SOEs. Emergence, sustainability, and other macroeconomic implications of this model are also discussed