Grasp the Large , Let Go of the Small : The Transformation of the State Sector in China

In the late 1990s, China’s industrial sector was dominated by state-owned firms. We document how this changed after 1998. More than 80 percent of the state-owned firms in 1998 were shut down or privatized by 2007. Among firms we classify as state-controlled in 2007, many were restructured and registered as private firms with a controlling share held by a stateowned conglomerate or were new firms established after 1998. In 2007, almost half of the state-controlled firms were registered as private firms, and about 40 percent were new firms established after 1998. The privatization and convergence in labor productivity decelerated after 2007, but the establishment of new state-owned firms continued at roughly the same rate. When we interpret these facts through the lens of an equilibrium model of heterogeneous firms, we find that the transformation of firms that remained under state control and the creation of new state-controlled firms together account for 21 percent of China’s growth from 1998 to 2007 and 18 percent of its growth from 2007 to 2012. However, the exit and privatization of state-owned firms had a negligible effect on aggregate growth. A central feature of the industrial revolution in China over the last two decades is the decline of the state-owned sector. Figure 1 illustrates that the share of state-owned firms in industrial output declined from 50 percent in 1998 to 30 percent by 2005, and has continued to fall since then, albeit at a slower rate. This fact naturally suggests that China’s growth was driven by the growth of the private sector and the reallocation of resources away from state-owned firms. According to a popular view, the growth of the private sector was only possible when, starting in the late 296 Brookings Papers on Economic Activity, Spring 2015 1990s, state-owned firms were shut down or privatized. The shutdown of loss-making state-owned firms released resources that were more profitably employed by private firms. Privatizing state-owned firms may have raised their productivity by more closely aligning control and cash-flow rights. The industrial revolution in China is thus nothing more than the triumph of “Markets over Mao,” to quote the title of a recent book by Nicholas Lardy (2014). Another view is that China’s growth was driven by “state capitalism.” Advocates of the role of state capitalism point out that although many state-owned firms were closed or privatized, the remaining state-owned firms are among the largest firms in China today. For example, 67 of the Figure 1. Revenue Share of State-Owned Firms, 1998–2013 200