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 theoretical model to show that this unique vertical structure, when combined with openness and labor abundance, is critical in explaining two puzzling facts about China’s economy: (1) the SOEs have outperformed the private …rms in the past decade while the opposite was true in the 1990s; (2) the labor income share in total GDP is persistently low and declining, contradicting the predictions in the standard growth and trade models. Our paper highlights how the vertical structure leads to the upstream SOEs bene…ting disproportionally more than the downstream private …rms from the international trade by taking advantage of the abundant domestic labor. Sustainability of such a growth model and the SOE reforms are discussed.

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Xi Li