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 structure: State-owned enterprises (SOEs) monopolize key industries 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 the puzzling fact that China’s 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 industries in the process of industrialization and globalization. The unprecedented prosperity of SOEs is shown to be an efficiency-undermining symptom of the incompleteness of market-oriented reforms rather than a proof of SOE superiority. Emergence, sustainability, redistributive effects, and general implications for other countries of this state capitalism are also discussed.