"Managed competition" in China's state firms

China's state-owned enterprises are not the rigid, top-down organizations of the past. In many industries today, they try to combine the benefits of both market competition and state coordination.

Chinese bridge-building machine for high-speed rail. Source: Xinhua

Note: This piece highlights some key points from a research article I published in 2022. The article is open access and free to the public: Inside China’s state-owned enterprises: Managed competition through a multi-level structure.

China’s state-owned enterprises are perhaps the most underrated part of China’s entire political economy. Chinese SOEs are some of the largest companies in the world, making up nearly a fifth of Global Fortune 500 companies (I made a public data set). They dominate China’s strategic industries, including heavy industry, power, infrastructure, telecommunications, and defense. They play a crucial role in China’s industrial policy, including building economies of scale and driving technological upgrading. They are instrumental to China’s Belt and Road Initiative. And they are key players in China’s clean energy push as some of the largest energy consumers and producers in the economy.

Chinese offshore wind farm installed by China Three Gorges Corporation, a Chinese SOE. Source: China Three Gorges Corporation

China’s SOEs are also fundamentally misunderstood. Many outside observers see Chinese SOEs as lumbering giants: inefficient firms supported by the state that hamper productivity growth and innovation. But outside analysts make two mistakes in dismissing Chinese SOEs. First, they tend to have an outdated view of Chinese SOEs as bureaucratic monopolies, going back to their legacies as organizational cogs within the tightly state-controlled economy of the pre-reform era. China’s largest SOEs have actually become incredibly profitable after many rounds of reforms and efforts to rationalize their operations. (This piece focuses on these larger central government SOEs. There are thousands of local government SOEs as well.)

Second, outside observers tend to use the same profit-oriented framework for evaluating Chinese SOEs as they use for private firms. This is a mistake. The point of Chinese SOEs is not to maximize profits like private firms but to support the broader economy as well as China’s national interests. For example, ensuring that the supply of steel and other industrial commodities is cheap, stable, and sufficient helps a wide range of downstream industries from housing to EVs to naval shipbuilding.

To this end, China has been structuring and restructuring its SOEs for years, trying to find a formula that best serves these overarching objectives. At the heart of this process lies a tension between two competing goals. On the one hand, China wants to leverage the power of market competition as a tool for driving improvement and innovation across Chinese firms. The state monopolies of the past are seen as problematic not only because of their stasis and inefficiency (there’s a Chinese expression “large but useless” 大而无当) but also because of the tremendous power they wielded over the economy.

On the other hand, China wants to avoid “excessive competition” (过度竞争) or “vicious competition” (恶性竞争) where firms in a given sector compete in a way that’s economically unsustainable and can damage the entire industry. The classic example is a price war where Chinese firms undercut each other on price, hoping to win market share, but then burn through their capital and go under. This has been happening a lot in China’s tech sector where ride-hailing, food-delivery, and bike-sharing companies poured money into subsidizing consumer prices until they could no longer afford to stay in business. (It’s not just China—this also happens in many consumer tech sectors, like in the US and India.)

So China tries to carry out what Barry Naughton calls a “precarious balancing act” between harnessing the power of competition and trying to ensure that an industry serves the public interest. China tries to get the best of both worlds through what I describe as a system of “managed competition” where SOEs compete for business but operate in a coordinated industry landscape.

Let’s look at the infrastructure construction industry as an example. At first glance, it looks like there are basically two dominant players in this industry: China Railway Group Limited (CREC 中国中铁) and China Railway Construction Corporation (CRCC 中国铁建). These two SOEs are similarly sized Fortune Global 500 companies. Despite their confusing names, they are two of the main firms behind Chinese infrastructure projects both domestically and internationally across not just railway but also highways, bridges, and tunnels.

China’s two main infrastructure firms, CREC and CRCC, are similar in size

But if you take a closer look, you’ll find that these two giant SOEs are actually large conglomerates made up of over a dozen subsidiaries each. These subsidiaries are similar in size, capabilities, and skill sets. Even their names are similar: China Railway No. 1 Group (中铁一局), China Railway No. 2 Group (中铁二局), China Railway No. 3 Group (中铁三局), etc.

Source: Inside China’s state-owned enterprises: Managed competition through a multi-level structure

This is no accident. The industry is structured in a tiered manner. The subsidiaries have a certain degree of autonomy and compete for construction contracts, like building a segment of a high-speed rail line in China. They bid directly on projects across the country and even around the world. Meanwhile, the two parent companies play a coordinating role, moving around resources, technology, equipment, and managerial personnel across the subsidiaries to ensure a relatively balanced set of competitors.

China’s infrastructure SOEs have a tiered structure. Source: Inside China’s state-owned enterprises: Managed competition through a multi-level structure

This has been a key part of China’s success with building large-scale infrastructure. Multiple competent, well-resourced construction firms compete for contracts. If there are any issues, contractors can be swapped out relatively easily. And the parent SOEs help to maintain this balanced set of competitors, making sure that no single subsidiary gets too weak or too dominant.

(Historical sidenote: The bizarre structure of these SOEs and even their oddly generic, number-based names come from their legacy as administrative units within the former Ministry of Railways bureaucracy. In the pre-reform era, these SOEs were actually regional subdivisions of the Ministry of Railways’ construction arm. Before that, they were part of the Railway Corps 铁道兵 of the People’s Liberation Army, which is partly why they retained a closed-off industry culture for many decades. Over time through a series of reforms, they were spun out of the Ministry of Railways and turned into these two groups of infrastructure SOEs.)

The power and accountability structure of these SOEs mirrors that of China’s tiered political system. The parent SOEs do not micromanage the work of the subsidiaries but instead monitor their progress on certain metrics and intervene selectively to keep the competition fairly balanced. The parent SOEs manage the promotion and career trajectories of managers in the subsidiaries. This is similar to the way that Beijing manages the promotions and transfers of provincial and local political leaders using metrics such as economic growth.

China Railway No. 18 Group played a key role in building the high-speed rail line between Mecca and Medina. Source: Rail UK

CREC and CRCC themselves answer to their own “parent company,” which is the State-owned Assets Supervision and Administration Commission (SASAC 国资委). SASAC is a Chinese central government body that oversees 97 of China’s most powerful and strategically important SOEs, such as its energy, telecom, shipbuilding, and defense SOEs (full list here in English). SASAC itself acts like the ultimate parent company, playing a key role in appointing executives and allocating resources across the SOEs under its remit.

While I focused on showing how this system of “managed competition” plays out in China’s infrastructure construction sector, a similarly coordinated SOE structure can be found in other sectors, such as shipbuilding, petrochemicals, defense, industrial goods, etc. At first glance, it may seem as if these industries are dominated by just one or a very small number of massive SOEs. But in reality, these SOEs are often conglomerates that manage an array of subsidiaries with varying degrees of autonomy.

A Chinese shipyard run by CSSC, China’s main shipbuilding SOE. Source: LNG Prime

Finally, zooming out, China has been merging and consolidating SOEs in strategic sectors to build up scale, improve productivity, and create “national champions” that can compete internationally. For example, China merged its two main shipbuilding SOEs into a single giant SOE called China State Shipbuilding Corporation (CSSC 中国船舶集团) in 2019 in a process that took a decade. One of the main reasons for this merger was to create a single Chinese shipbuilding company with the scale to take on South Korea’s own shipbuilding giants. China also combined its two largest train manufacturers after they were found to be competing “viciously” (“恶性竞争”) for a contract in Argentina. The result of that merger is a SASAC-controlled SOE called CRRC (中国中车), which is now the largest train maker in the world. So while it may seem impressive that so many Chinese SOEs appear on the Fortune Global 500, this is really the result of policy efforts to combine smaller firms and deliberately create industry giants.

To sum up, China’s state-owned enterprises matter a lot more than many realize, and it’s important to look a bit deeper at how they’re structured and how they really operate. Their system of “managed competition,” I believe, partly explains why Chinese SOEs are no longer the inefficient organizations of the past and are now remarkably capable—at least at delivering on China’s state goals. In other countries, the state is seen as a tool to make markets work better. In China, markets are seen as a tool to make the state work better.