Confronting the Challenge of Chinese State Capitalism

This commentary is part of CSIS's Global Forecast 2021 essay series.

One of the most pressing challenges the Biden administration will face is how to compete with, and push back against, China’s increasingly powerful and disruptive state capitalist system, which not only threatens U.S. economic and strategic interests, but also undermines the regulatory and legal architecture that underpins the global economy.

The problem is daunting. China now has more companies on the Fortune Global 500 list than does the United States (124 versus 121), with nearly 75 percent of these being state-owned enterprises (SOEs). Three of the world’s five largest companies are Chinese (Sinopec Group, State Grid, and China National Petroleum). China’s largest SOEs hold dominant market positions in many of the most critical and strategic industries, from energy to shipping to rare earths. According to Freeman Chair calculations, the combined assets for China’s 96 largest SOEs total more than $63 trillion, an amount equivalent to nearly 80 percent of global GDP. The size and scale of these entities is partly a function of China’s massive domestic market, but more important is the fact that SOEs operating in strategic sectors (e.g., banking, infrastructure, telecommunications, energy) are shielded from domestic and foreign competition and are immune from any antitrust scrutiny by the Chinese government.

While SOEs are not unique to China, the level of political control wielded over them is. As Xi Jinping declared in 2016, SOEs should become “stronger, better, and bigger." In 2017, the Chinese Communist Party (CCP) amended its constitution to assert that the Party “plays a leadership role” in firm decisionmaking. That same year, Ministry of Industry and Information Technology head Xiao Yaqing, then the head of the central SOE regulator, said: “To give full play of the Party's leadership and its core political role, SOEs should stick to the political principle that all SOEs must be under the Party's leadership.”

The problem is not limited to SOEs nor to the traditional sectors that comprise the “commanding heights” of the global economy. Backed by a thicket of subsidies and industrial policies, a domestic market that restricts foreign competition in strategic sectors, and aided by generous state lending, China’s private firms have been propelled into the global market and now vie with U.S. and European firms for leadership in cutting-edge technologies, including robotics, artificial intelligence, biotechnology, and telecommunications.

While many of these companies are truly innovative, lose business opportunities to SOE cousins, and in an ideal world prefer to operate in a market free from heavy-handed state involvement, it is also undeniable that they often benefit from a domestic political-economic order that has invested significant sources to ensure that they become major international players. As one senior Chinese official put it bluntly in an interview earlier this year, “Regardless of whether state-owned or private enterprises, they are all Chinese enterprises.”

Rather than operating as a collection of individual, profit-first firms (as is the case in most developed Western economies), the CCP has created a robust set of formal and informal mechanisms that induce connectivity (of varying intensity) between state-owned and nominally private Chinse firms. Companies competing in non-strategic sectors can largely operate on more or less market terms, but for any sector or industry that Beijing has deemed strategic, foreign companies must expect that the Chinese government has placed its fingers on the scales to benefit domestic firms. Thus, when a U.S. or European firms compete against, say, COSCO Shipping or Huawei, it is the entirety of the Chinese government’s balance sheet that it must contend with, not just an individual firm. U.S. companies have long tried to prosper within this system by partnering with local firms and keeping ahead of their local rivals, but as Beijing sets it sights much higher up the value-added chain, the space for foreign companies in China is shrinking.

Looking beyond China, what gives this state capitalist system such immense global force are the synergies and interconnectivity between and among Chinese firms, state-owned banks and investors, and the Chinese Party-state. This commercial-strategic ecosystem, which I have dubbed “CCP Inc.,” possesses an unrivaled ability to deliver the complete value package when entering overseas investment deals: it can buy, build, and finance on a scale and speed that is unmatched.

Yet China’s state capitalist system is not without significant weaknesses—some of which are already known; some of which are only beginning to emerge as China’s international investment environment faces geopolitical headwinds; and some of which, including the long-recognized demographic and productivity challenges; are beginning to bite. While Beijing can leverage its super-sized and super-scaled SOEs to consolidate dominant market positions in strategic global industries, this comes at a price, not least of which is the squeeze placed on China’s more efficient and productive private sector. As the Peterson Institute’s Nick Lardy persuasively argues, “The resumption of state-led growth, in which a growing share of resources is flowing into investment by relatively low productivity state firms, and an increasingly omnipresent party are contributing to China’s growth slowdown.” While the Xi administration has taken recent steps to boost the performance of SOEs, there will inevitably remain a critical tension between the size of the state sector and China’s positive growth trajectory.

Yet regardless of the long-term viability of Chinese state capitalism, the near-term implications for the United States are significant, from the inherent propensity to unleash waves of industrial and technological overcapacity that undercut U.S. firms, to the crucial role SOEs and state-backed firms play in supporting the Chinese military’s modernization and overseas expansion. Waiting for China’s political or economic system to grind to a halt is an unwise strategy given Beijing’s four-decade long streak of seemingly defying the laws of economic gravity.

How, then, should Washington respond?

Despite concerted efforts by the outgoing Trump administration to put significant economic pressure on Beijing in the hopes that it would abandon or adjust its statist approach to industrial policy, the Biden administration will confront a China more statist and more determined to ensure its companies occupy dominant positions over key technologies and resources both at home and abroad. Now projected to grow at an astounding 7.9 percent this coming year (per IMF forecasts), and arguably having confronted the pandemic more ably than most other large countries, China also will likely behave with a confidence the United States has not yet encountered.

This means that the United States must first recognize the limits of its ability to shake the Xi administration, and the CCP more generally, from its current techno-statist approach to industrial planning, economic development, and global integration. Indeed, there is a good argument to be made that many of the Trump administration’s efforts to cut China off from global supply chains and constrain investment in key companies only further convinced the Xi that state capitalism is the best—and only—viable path forward.

Yet Chinese firms—both private and state-owned—do not have an inherent right to market economies if they are not willing to operate transparently and according to the rules of the game. On this, several of the initiatives started under the Trump administration to demand more transparency into the ownership structure and political connections of Chinese firms seeking to invest in the United States should be continued yet refined. New legislation and increased efforts by the Securities and Exchange Commission and the U.S. Public Company Accounting Oversight Board’s (PCAOB) to bring Chinese companies listed on U.S. exchanges into auditing compliance is one notable example.

Related to this, the Biden administration should task relevant agencies with drafting summaries of existing legal and regulatory tools that might be employed to better protect U.S. interests from market-distorting actions of state-owned or state-backed Chinese firms. The United States already has a robust toolkit for combating behavior that is market distorting and threatens national security, but too often, existing regulations that might pertain to problematic Chinese firms just are not enforced, as in the case of long-ignored flouting of auditing standards.

The Biden administration should continue to build and expand the capacity of government agencies and the intelligence community to monitor and track the sprawling network of Chinese firms. This includes both increased funding for developing better tools and technologies to capture open-source information, but equally as important, resources to train and hire subject matter experts to interpret and analyze the incoming data flows. There is a treasure trove of open-source material available, including bond prospectuses, annual reports, ownership and financial databases, niche industry publications, as well as company government websites that can help answer key questions, including:

  • How and where do Chinese firms raise capital?

  • How are they state-supported and subsidized, and how have these types of support evolved to evade international scrutiny?

  • How are they leveraging joint-ventures and other forms of formal partnerships with foreign firms to gain access to technology and talent?

  • How might increased transparency requirements impact their ability to raise funds, engage in mergers and acquisitions, and operate globally?

  • What do procurement documents tell us about the Chinese government’s technological and domestic security priorities?

One important area of focus should be creating new tools to map ownership structures. Indeed, one of the single biggest factors aiding the expansion of SOEs and private companies globally is their ability to mask ownership through a labyrinthine network of obscured ownership and a proliferating network of subsidiaries. This helps mask their connections to the Chinese government and circumvent competition regulation, commercial and investment law, and sanctions. Consider one astounding statistic: “The average number of firms of the largest 100 [Chinese] conglomerates increased from 500 to more than 15 thousand from 1995 to 2015.” This translates into 1.5 million total companies, and that’s just for the top 100 business groups.

There’s also important work to be done to bridge the information divide between corporate America and the U.S government. With obvious exceptions, the majority of U.S. companies do not want to willingly support China’s expansionist and illiberal activities, yet individual firms are ill-equipped to track and trace complex ownership structures, investments, and global supply chains that might be problematic. More robust and readily available tools and information must be made available to U.S. and companies from partner countries to help them decrease their knowing exposure to firms linked to the CCP or People's Liberation Army (PLA).

Now the hard part.

There is no long-term strategy for successfully competing against Chinese state capitalism that does not include significant investments in the United States’ own domestic infrastructure, educational system, health care, and governance capacity. Absent a deep and enduring commitment to rebuilding internal competitiveness, as well as creating an economic system that is vastly more inclusive, the United States can only tread water while China continues to march toward the future.

Frustration with China’s brand of industrial policy stems from its opacity and its deeply mercantilist objectives, not from the mere fact that it the Chinese government seeks to boost the competitiveness of Chinese firms. While still considered a four-letter word to some, the United States should begin a conversation on creating its own market-friendly industrial policy. Indeed, as my colleagues Matt Goodman and Dylan Gerstel have pointed out, the United States has already seen a number of important technological successes as a result of industrial policy initiatives. “Since World War II, Washington has used military procurement and large research and development (R&D) budgets to accelerate the development of cutting-edge technologies that serve as the foundation of the modern economy, ranging from the Internet, satellites, GPS, aircraft, vaccines, supercomputing, and the components of smartphones.” Obviously, given the deep political divisions and the long-standing inability to prioritize domestic “nation building,” the challenge is immense. Yet there is no other path.

Next, it is imperative the United States find overlap and synergies with like-minded countries that share apprehensions about the statist elements of China’s economic rise. Adopting a unilateral approach to deterring problematic Chinese investments is unavoidably inadequate, given the highly integrated nature of global technology, human capital, and financial markets. While the European Union’s recent agreement to move forward with the Comprehensive Agreement on Investment (CAI) with China might feel like a gut punch to the incoming administration, there remains significant underlying concern in many European capitals about the economic and national security risks that China’s SOEs and state-backed firms pose to their own national interests.

The United States should start by finding ways to accumulate small, ad hoc partnerships where they can be forged. One concrete example: the creation of a coalition of like-minded market economies to share intelligence that tracks the transactions, ownership, and financing of firms (SOE or otherwise) suspected of working to further the interests of CCP and PLA geostrategic goals. To start with, the core of this group should be a “Five Eyes Plus,” with the addition of the European Union and Japan. Of course, the grouping can be expanded, assuming applicants can ensure they are capable of protecting sensitive intelligence. Related to this, my colleague Bonnie Glaser has also recently outlined several smart steps the United States can take to work with partners and allies in order to blunt Chinese economic coercion, which is often implemented through Chinese commercial firms.

Last, the United States should lead a global conversation about creating new sets of rules and institutions that can facilitate and sustain cross-border trade, investment, and technology given the extraordinary changes in just the past few decades. As others have argued, the existing array of institutions created in the twentieth century that did so much to promote global integration, the World Trade Organization most prominently, were not designed to deal with the size and complexity of China’s sui generis “socialist market economy.” Building an economic order for this century is, of course, a vast undertaking, but as the recent splintering of ties between the United States and China demonstrates, in the absence of effective mediating institutions, economic and financial frictions can metastasize to become geopolitical tensions.

Jude Blanchette holds the Freeman Chair in China Studies at the Center for Strategic and International Studies in Washington, D.C.

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