A Model of China's Economic Vertical Structure

Abstract

A general equilibrium model is developed to highlight the vertical structure of China's economy, namely that state-owned enterprises (SOEs) monopolize key upstream industries while downstream industries are largely open to private competition. We show how the upstream SOEs extract rents from the liberalized downstream industries in the process of industrialization and globalization, which helps explain why the profitability of SOEs exceeded that of non-SOEs around 2000. Moreover, we show how the vertical structure hinders industrialization, reduces GDP, and harms public welfare. Counterfactual analyses using China's firm-level data from 1998 to 2007 confirm that the upstream SOE monopoly has a significant negative effect on output and welfare, and that this monopoly is more harmful than preferential credit subsidies. We also show how the vertical structure emerges as an equilibrium outcome and how this model framework can be useful for countries beyond China.

Keywords: Structural Change, Growth and Development, Chinese Economy, State-Owned Enterprises, Globalization

JEL Classification: E02, F63, O10, O43, P31