70: Nicholas Lardy on the Chinese Economy

Episode Summary

Executive Summary: The episode examines why China’s growth has slowed and why the state remains central despite decades of market reform. Nick Lardy argues that private firms are far more productive than state-owned enterprises, but state dominance in finance, industry, and political control is dragging on productivity. He says Xi Jinping has reversed market-oriented reforms, deepened industrial policy, and made reform harder.

Main Topics: China’s transformation since 1978 (Priority: 5/5): Lardy contrasts the late-Mao planned economy—characterized by state-set prices, lifetime jobs, and near-total state ownership—with today’s mixed economy featuring skyscrapers, private enterprise, and market prices. State-owned enterprises vs. private firms (Priority: 5/5): The discussion centers on the large productivity gap between state and private firms, with SOEs still dominant in key sectors such as energy, transport, and banking despite representing a shrinking share of output. Xi Jinping and the reversal of market reform (Priority: 5/5): Lardy explains how the reformist expectations of 2013-14 gave way to stronger party control, anti-corruption consolidation, and a more interventionist state role in both state and private companies. Sources of China’s growth slowdown (Priority: 4/5): The slowdown is attributed mainly to falling SOE productivity and reduced investment share by private firms, with demographics and U.S.-China trade friction as additional but secondary headwinds. Trade, exchange rates, and global distortions (Priority: 4/5): The episode revisits China’s pre-2008 export-led model, arguing that an undervalued currency distorted the domestic economy by favoring manufacturing over services and fueling foreign backlash. Industrial policy and Made in China 2025 (Priority: 4/5): Lardy discusses China’s effort to build strategic industries like semiconductors through state-led investment, while noting uncertainty over whether this policy will ultimately succeed or waste resources. Why reform is difficult (Priority: 4/5): The final segment considers whether resistance comes from vested interests, limited political capacity, or Xi’s preference for a large state sector as a tool of party control.

Key Arguments: China has shifted from an almost fully planned economy in 1978 to a far more market-oriented system, but the state still controls strategic sectors and finance. Private firms are about three times as productive as state firms in manufacturing and industrial activity, making the state sector a major drag on growth. SOE performance improved after WTO accession and increased competition, but has deteriorated sharply since the global financial crisis. Consolidating SOEs into larger conglomerates has reduced competition, innovation, and cost discipline, lowering returns on assets. Xi Jinping’s approach has prioritized party control and political consolidation over deep market reform. Demographics are a headwind, but education gains and labor-quality improvements have mattered more to growth than labor-force expansion. China’s pre-2008 export model was not sustainable because an undervalued currency harmed services and intensified trade tensions. Made in China 2025 may help strategic upgrading, but it could also misallocate resources; its success remains uncertain. Most Chinese exports are now produced by foreign or private firms rather than subsidized SOEs, so global distortion claims are harder to prove than domestic inefficiency. Reform is difficult because local governments, SOE managers, and possibly Xi himself benefit from the current state-centered system.

Data Points: China population relative to U.S.: More than 4 Chinese people for every 1 American - Used to emphasize China’s scale China population relative to Britain: 21 Chinese people for every 1 Briton - Used to emphasize China’s scale U.S. GDP per capita: About $60,000 per year - Comparative income level China GDP per capita: About $17,000 per year (adjusted for prices) - Comparative income level China growth in 2018: More than 6% - Overall economic growth rate U.S. growth in prior year: Around 3% - Comparison point for growth China growth in the decade before 2008: More than 10% per year on average - Historical high-growth period Private sector share of total output today: About 70% - Current structure of the Chinese economy SOE share of output today: Roughly one-third - Residual share after private sector dominance Oil and natural gas production concentration: Over 90% controlled by three big state companies - Example of SOE dominance in upstream energy Private vs. state productivity in manufacturing/industry: Private companies are roughly 3 times more efficient - Key argument about productivity gap SOE return on assets decline: About two-thirds decline since 2008 - Evidence of worsening efficiency after the financial crisis Party membership: About 85 million members - Illustrates the breadth of CCP presence in business and government Labor-force contribution to growth since reform: About 10% - Lardy’s estimate of demographic/labor-force contribution to long-run growth Chinese exports in 2018: Around 10% growth overall, then shrinking in final months - Trade slowdown and tariff effects Share of all Chinese companies that lose money: A little more than two-fifths - Evidence of inefficiency and reliance on credit Share of exports produced by state companies: About 10% in recent years - Shows exports are mostly not state-produced anymore Number of centrally administered SOEs: 98 companies - Result of merger drive under Xi Subsidiaries under those SOEs: About 25,000 subsidiary companies - Scale of SOE conglomerates Return on assets of centrally administered SOEs: From about 6%-7% down to around 2.5% - Evidence that mergers hurt performance

Pivotal Quotes: "the market must be the decisive force in the allocation of resources" — Nick Lardy: Describing the reformist 2013 Third Plenum language that raised hopes for market liberalization "the productivity of state companies has declined dramatically" — Nick Lardy: Explaining the post-2008 slowdown and the drag from SOEs "the party must be control of everything, everywhere, all the time" — Nick Lardy: Summarizing Xi Jinping’s broader approach to state power and political control

Implications: China’s slowdown appears structural, not temporary: state dominance, weaker SOE productivity, and politicized reform are reducing growth potential. For global firms and policymakers, this means persistent state intervention, uneven market access, and continued trade tensions are likely to remain features of China’s economy.