The Shrinking Chinese State

The Shrinking Chinese State

In many ways, U.S. President Joe Biden’s administration marks an about-face from his predecessor’s. But on China, their positions are remarkably similar. Both see the country as a strategic threat and a great-power rival. The public broadly agrees, believing that the rise of Chinese leader Xi Jinping and his ultra-nationalistic ambitions represent a major danger.

The image of an increasingly powerful China was underscored during recent China Communist Party gatherings, commonly referred to as the “two sessions.” During the events, which Xi used to launch China’s 14th Five-Year Plan and kick off celebrations of the party’s centenary, the message was clear, namely that China’s success in controlling the pandemic and reviving growth exemplifies the superiority of its system over the chaos of liberal democracy.

The scene hit home that, although the U.S.-Chinese conflict has thus far been largely limited to the economic arena—trade war and skirmishes over Big Tech—the underlying problem is still that of a very politically powerful state. And it is that same state’s influential role in the economy, a perceived reversal of China’s recent experiments with market-based economics, that the United States has chafed against.

But this unease over the role the Chinese state and its proxies play in the economy may not be justified. If the state’s role in a society is measured in terms of government expenditures relative to GDP, then China actually pales in comparison to other major economies. In fact, government expenditures as a share of China’s GDP average a bit more than 30 percent in recent years, much lower than one might expect for an ostensibly socialist economy. The Organisation for Economic Cooperation and Development average is closer to 50 percent for its economies. Much, though not all of the difference, is due to the smaller role that social programs play in China’s government expenditures and that state-owned enterprises provide some public services that do not appear on government accounts.

A recent analysis by Gavekal, a research firm, on the composition of China’s economy found that since the late 1990s, combined expenditures and investments by the government and state-owned enterprises have been remarkably stable—within a narrow range of 42 to 46 percent of its GDP. If one looks only at central government spending, meanwhile, the state’s share in the economy is actually declining.

After Chinese leader Deng Xiaoping opened up China in 1979, the story of the state’s role in the economy has been one of unquestionable decline. In turn, thanks to marketization of land, liberalization of banking and finance, opening to international trade, and encouragement of entrepreneurship in everything from manufacturing to high-tech, China’s economy is on track to overtake the United States as the biggest in the world.

In some quarters, the real role of the state is well understood. Market optimists often invoke the phrase “60/70/80/90” to explain how the economy functions. In broad strokes, since the 2008 global financial crisis, private firms have accounted for 60 percent of GDP, 70 precent of innovation, 80 percent of urban employment, and 90 percent of new jobs. In 2014, economist Nicholas Lardy summed it up in a book aptly titled Markets Over Mao: The Rise of Private Business in China, in which he trumpeted the many successes of market reforms and the rise of private sector activities. For him, a key indicator is the relative shares of fixed-asset investments (investments in machinery, land, buildings, and the like) by state-owned enterprises and private firms. In 2010, each accounted for around 42.5 percent of China’s total fixed-asset investment. By 2015, according to the National Bureau of Statistics, the private share had surged to 50 percent and the state had plummeted to 32 percent.

To the alarm of market watchers, the state’s share has recently ticked back up to more than 35 percent, and the private sector has seen a decline. Some observers worry this means China’s state champions are becoming dominant forces in the national—and, in turn, global—economy. Others are anxious about a potential financial crisis sparked by outmoded and unwieldy state-owned enterprises collapsing under the mountains of debt they accumulated while borrowing to build new fixed assets.

But the recent uptick in state-owned enterprise investments is more nuanced. Most of the increase is due to infrastructure projects like water treatment plants and highways, not commercial endeavors like expanding capacity for manufactured exports. According to the World Bank, moreover, much of that infrastructure is being developed in China’s poorer far western provinces, such as Tibet and Xinjiang. Such spending is in line with Xi’s high-profile campaign to have eliminated poverty by 2020 and the state’s desire to ramp up security in those areas.

If Gavekal’s analysts have correctly concluded the state’s role in the economy has been stable in recent years and state-owned enterprise investments in infrastructure have surged, it must follow that the state’s commercial investment is falling. This too is borne out of the data. National Bureau of Statistics surveys report that state-owned enterprise investments in manufacturing assets have collapsed from some 20 percent in 2008 to a mere 8 percent in 2017.

Furthermore, investments are increasingly being managed by local authorities, not Beijing. In 2000, fixed-asset investments undertaken locally and by the central government were roughly the same. By 2017, local state-owned enterprises were investing six times as much as central ones. This reflects China’s peculiar fiscal structure. Provincial and municipal governments cannot levy broad taxes nor can they borrow directly from banks. Thus, many establish “local government financing vehicles,” which are classified as state-owned enterprises, to raise funds and manage infrastructure investments.

Security hawks can thus rest a bit easier. Although public goods, by definition, have positive spillover effects for the broader economy, it is hard to imagine this kind of local government investment having much relevance to the issue of China becoming a threatening global technological power.

Ultimately, however, economic aggregates may not matter as much as the increasing political influence of the state. During his tenure, Xi has increased Chinese Communist Party influence over corporations, state-owned and private alike. An analysis of company charters by the Economist found that more than 40 precent included “party building” as a mission.

For years, meanwhile, the state has encouraged domestic tech titans to explore fields like e-commerce to compete with dominant U.S. incumbents. But even they are subject to increasing scrutiny in Beijing, as evidenced by Chinese regulators’ recently nixing the public offering of Ant Group, a financial services spinoff from Alibaba.

Beijing might see state intervention as necessary to mitigate financial risks or encourage the activities that will make China an innovative superpower. But good regulation needs to be predictable and transparent. Reports that Xi gave the go-ahead to scrub Ant Group’s initial public offering cast this kind of state intervention as arbitrary and personalistic. But they will not find safe harbor in Western markets, so Chinese firms will be the ones to suffer the capricious whims of government regulators.

Beijing’s authoritarianism might make some nervous about any kind of state influence in the economy. But risk assessments should not conflate state influence with economic reality. Xi does have an ambition to make China a tech superpower, and he may well use the might of the state to achieve that end. If that is what motivates Washington’s anxieties, then economic arguments aren’t the basis for challenging China—security ones are.

By Staff Writer