A growing network of politically connected businesses has helped power growth.
- May 04, 2021
- CBR - Economics
There’s a narrative about the Chinese economy in which it’s all about the control and the support that the government gives to state-owned companies, plus Chinese industrial policy. If you stop to think a little bit about it, that narrative is basically about the government channeling money to state companies and the government picking industries and companies that will succeed. That approach is the kind of thing that we have lots of reasons to believe will never work. It opens up this puzzle: if what they’re doing is exactly the kind of thing that we say leads to an economic disaster, but in fact it’s not an economic disaster, how can we explain that?
If you want to try to understand the puzzle, you have to look at what’s going on informally—not at what the government is saying, and not at its official policies. My coauthors and I find in previous work that in the 1990s and the 2000s what started to take shape was this informal institution that everybody understood, where in order to get your business up and running, you had to get the support of a local government official. Our more recent research demonstrates that this system has evolved into something more formalized.
In this new form, it’s not about getting some local political leader to support your project; you have to get a politically influential investor to invest in your company, or what the Chinese call a strategic or connected investor. We were able to document that this system has become more pervasive over the past two decades. And it takes two forms: state investors have joint ventures with private owners, and then these private owners turn around and do exactly the same thing with other, smaller private owners.
As a consequence of these two things, there’s been a large increase in this network of companies and owners that have the implicit support of a politically influential individual. And that’s what enables them to navigate the business environment.
The expansion of this network has been one of the important forces behind Chinese growth. As it expands further, I expect it will deliver additional growth. But at some point, this mechanism is going to hit diminishing returns. If everybody is connected, there are no more gains to be had from the system. Then the source of growth has to come from somewhere else.
It also raises the question: What does this imply if you have powerful state actors who are equity investors in a large number of the most powerful companies in the economy? We have an analogous concern in the US about the media: What if the owner of a media outlet cares less about informing the public than about delivering his or her political agenda? Does freedom of the press include that as well? And what does the free market mean in China? What does a free market mean if the owner also has a political agenda?
Chang-Tai Hsieh is Phyllis and Irwin Winkelried Professor of Economics and PCL Faculty Scholar at Chicago Booth.
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