Chinese State-Owned Companies, Misallocation and the Reform Policy

This paper attempts to quantify the resource misallocation arising from firm ownership and to evaluate the SOE reform policy in China. State-owned enterprises (SOEs) in China typically enjoy preferred policies such as better access to financial system, reflecting the connections between these firms and various levels of government. This, however, leads to potential important distortions, with implications for resource allocation, productivity, and thus long-term growth. The SOE reform policy that seeks to Grasp the Large, Let Go of the Small could further exacerbate the distortions. By investigating a large firm-level data set with the methodology of Foster et al. (Am Econ Rev 98(1): 394-425, 2008) and Olley and Pakes (Econometrica 64(6):1263-1297, 1996), we show that SOEs are significantly less likely to have efficient resource allocation than firms not controlled by the various levels of China's government. Industries with dominant state-owned firms likewise have less efficiency, suggesting the impact China's SOE policy that has especially favored the largest of the state-owned firms. The results have important policy implications in suggesting that reforms that allow for greater market forces among firms would lead to potential economic growth in China.