from state socialism relies not only on evolutionary bottom-up
processes but also on sustained intervention by the state to build a new in-
stitutional framework. e state must simultaneously dismantle the institu-
tions of central planning and put in place the requisite rules of competition
and cooperation of a capitalist economy. e shi of control rights is oen
retarded, however, by mutually reinforcing interests that perpetuate a close
relationship between the state and the rm. On the one hand, state actors are
rarely willing to institute a new economic system that completely deprives
them of direct control rights at the rm level. On the other hand, managers
oen prefer the continuation of direct state-rm linkages to gain access to
resources in a highly insecure and rapidly changing business environment.
As a result, “there is still a much dierent atmosphere of interaction between
government and individual economic agents in ex-socialist countries than in
countries with a long tradition of free markets” (Murrell :).
We call this type of institutional order politicized capitalism, where state
actors set the regulatory framework and remain directly involved in guiding
transactions at the rm level. In transitions from state socialism, politicized
capitalism is a hybrid order comprising recombinant institutional elements,
preexisting and emergent organizational forms, and networks oriented to es-
tablishing a market economy (Stark ; Nee ). It is a mixed economy in
which market liberalization and ownership reform are unnished, preserving
partial control rights by the state as both a redistributive allocator and an
owner of productive assets. Although the new rules of a market economy im-
pose formal limits on state interventions in the rm, the dening feature of
politicized capitalism is the overlap of political and economic markets and the
absence of clearly dened state-rm boundaries. e central dilemma faced
by reformers is to promote market-driven economic growth within the con-
straints imposed by competing demands of political and economic actors.
Politicized capitalism emerged in China in the s in the course of mar-
ket transition (Zhou ). is chapter examines the structural tensions be-
tween state intervention and marketization in the emergence of China’s new
capitalist economy. Apart from occasional rural markets, the market as a co-
ordinating mechanism of production and distribution was virtually nonex-
istent before the start of economic reform in . Under Mao, markets and
private ownership of productive assets were eliminated and replaced by a vast,
multitiered national system of nonmarket bureaucratic allocation. e char-
acteristic feature of the Maoist-era institutional order was a pervasive reliance
on political controls in a redistributive economy where the communist party
and government managed all dimensions of production and distribution
(Schurmann ; Whyte and Parish ; Walder ). Market transition is
a dynamic transformative process characterized by a diminishing role of cen-
tral planning and increasing signicance of market institutions in economic
life. Figure - provides a conceptual map, with ideal-type institutional or-
ders arrayed by the extent to which market versus planning and private versus
state ownership of productive assets enable, motivate, and guide economic ac-
tivity. Politicized capitalism is a hybrid institutional order in which recombi-
nant elements of central planning and state control combine and interact with
emergent markets and private ownership forms. It comprises institutional ar-
rangements patched together in ad hoc improvisations to address the needs
and demands arising from rapid market-oriented economic growth.
e question we explore here is whether politicized capitalism embodies
a Nash-like equilibrium, the stable institutional order at the culmination of
departures from central planning. In this case, the dening feature of politi-
cized capitalism persists in the close overlap of political and economic mar-
kets wherein the state is actively involved at the rm level. Alternatively, if
politicized capitalism is itself an embodiment of the organizational dynamics
of market transition, constructed from recombinant institutional elements
to facilitate the rise of a capitalist economy, as Greif () has detailed for
Europe, we predict that political interference in economic life declines in in-
dustrial sectors and regions to the extent that an emergent market economy
replaces the centrally planned economy (Nee , ). If this alternative
scenario holds, it would be conrmed by evidence of decline in the politi-
cized nature of economic decisions in state-rm relations as the role of the
state shis to greater emphasis on building market institutions, i.e., property
rights, legal system, market structures.
China’s politicized capitalism bears a strong family resemblance to other
developmental states in East Asia in its reliance on state intervention to pro-
mote transformative economic growth. e goal of the state is to wield state
power at the national and local levels to enable, motivate, and guide economic
development in order to “catch up” with the advanced industrial economies.
In China even more than in the other East Asian developmental states, growth
and economic modernization are the basis of state power, providing legiti-
macy for the continuation of the Chinese Communist Party (CCP) leadership.
A strategy of transition has evolved that addresses the interest of reformers in
safeguarding the power and privileges of the political elite even while imple-
menting wide-ranging economic reforms that both reduce the scope of state
managerial controls over production and distribution and expand the role of
the market as a mechanism to motivate and guide economic growth.
Politicized capitalism as a hybrid order permeates the transition economy,
but its role in guiding economic action is a variable feature of economic life
subject to empirical analysis. e remainder of the chapter is organized as fol-
lows: In the following sections we discuss core features of China’s politicized
Figu re 4 -1 Politicized Capitalism as a Transformative Economic Order
Capitalist planned economy Centrally planned economy
capitalism as a distinct type of developmental state and then give an overview
of China’s growth promoting macro-policies. We then explore state interven-
tionism at the rm level as a core feature of China’s hybrid capitalist system.
We focus on discrete empirical studies exploring two types of state interven-
tions: () state assistance in the rm’s external transactions, such as govern-
ment assistance in securing loans and () state interventionism in corporate
governance inside the rm. In conclusion, we oer an outlook on the expected
development of China’s institutional order of politicized capitalism.
Overall, we report evidence on the persistence of state involvement at the
rm level. Our evidence reveals a rather complex situation: On the one hand,
direct state involvement in decision making at the rm level has a negative
eect on performance; on the other hand, rms will not openly reject state
involvement because they still rely on state actors to ease resource constraints
of China’s regulated markets. Because market transition creates conditions of
decreasing resource dependence on the state, politicized capitalism is inher-
ently in disequilibrium (Nee ; Nee and Lian ). Where private rms
compete in open markets, entrepreneurs prefer to be free of the communist
party. A tipping point is reached when a critical mass of entrepreneurs no lon-
ger depends on state-controlled resources, and growing reliance on tax rev-
enues contributed by private enterprises reinforces incentives for government
to make resource allocation decisions based on assessment of their eects on
local economic performance and on their prospects for career mobility.
China’s economic miracle has riveted attention on the positive role of the state
in promoting transformative economic development. As Stiglitz observes,
“e contrast between Russia’s transition, as engineered by the international
economic institutions, and that of China, designed by itself, could not be
greater: While in China’s gross domestic product (GDP) was per-
cent that of Russia, by the end of the decade the numbers had been reversed.
While Russia saw an unprecedented increase in poverty China saw an unprec-
edented decrease” (:). Per capita GDP grew from to (constant
prices ) between and . e market capitalization of rms listed
on China’s stock exchanges increased from percent of the GDP in to
percent by . Exports increased from billion in to billion
per annum in (constant prices ). Annual net foreign direct invest-
ments grew from million in to . billion in (World Bank
). China thus becomes the latest entry in the pantheon of successful de-
velopmental states, along with South Korea, Taiwan, and Japan (Stiglitz ).
In its core features, China’s current economic system of politicized capi-
talism resembles that in other East Asian societies in the early stages of eco-
nomic takeo. Direct state intervention at the rm level is widespread, and
the state’s guiding hand in promoting national growth remains visible. Two
mutually reinforcing institutional changes frame the interactions between the
local state bureaucracy and rm-level economic actors: a) modernization of
the party and government bureaucracy and b) scal decentralization.
Strengthening Bureaucratic Capacity after Mao
Modernization of the state bureaucracy has been the government’s priority
throughout the reform period. Mao’s decade-long Cultural Revolution crip-
pled China’s state apparatus. It politicized the structure of bureaucratic career
mobility, severely undermining rules and norms of merit-based recruitment
and promotion. e predominance of “red” cadres recruited and promoted on
the basis of their political activism reduced the state’s capability to perform
routine administrative tasks. Demoralization and the accompanying break-
down of rational-legal norms and procedures resulted in reliance on personal
connections (guanxi) in the functioning of public administration. Given
widespread local cadre opposition at the outset of economic reform, reform
leaders soon realized that restoring the ecacy of the state bureaucracy was
essential to success in their ambitious reforms (Nee ).
Administrative reforms in the s introduced strict retirement ages for
government ocials and a one-time buyout strategy to retire old veterans as a
means to push out Maoist bureaucrats who were impeding progress in market-
oriented economic reforms. Early retirement was aimed at reducing bureau-
cratic inertia and commitment to the old planning mentality of state social-
ism (Lipton and Sachs ; Murrell ). Reformers also sought to build a
modernized bureaucracy by implementing merit-based entrance exams and
promotion schemes to reinforce incentives to improve local economic devel-
opment (Li ; Li and Lian ). College education and technical qualica-
tions became general entrance criteria. Many elite bureaucrats are recruited
with engineering and public administration degrees, reecting the emphasis
on technical training and expertise.
As a result of these administrative reforms, government regulations and
procedural guidelines have become more and more precise and transparent
(Yao ). is has increased the predictability of bureaucratic decisions
and reduced uncertainty with respect to government policy and regulatory
practices. e passage in of a comprehensive legal code governing civil
service culminated this two-decade-long concerted eort by reform leaders
to modernize China’s state bureaucracy. e new civil service law sets forth
strict, rule-governed performance guidelines with respect to appropriate con-
duct. Public announcement of openings, reliance on scores in civil service
examinations to recruit candidates, annual performance reviews, competitive
examinations in routine promotions, and monitoring by the personnel de-
partment have been institutionalized at all levels of the national bureaucracy.
Notwithstanding national reform measures, the quality of the state bu-
reaucracy varies considerably across regions and localities in China. Progress
in building a modern bureaucracy has been uneven and inconsistent. In poor,
rural hinterland regions, corruption is an incorrigible feature of local public
administration. Predatory behavior on the part of government ocials is re-
ected in the routine use of local state administration to extract surplus from
peasants through local levies and taxes, hosting of banquets at the expense of
entrepreneurs, requisition of farmland for use by developers without adequate
compensation to the farmers, and ocial tolerance of environmental degra-
dation. Moreover, local bureaucrats routinely intervene as predatory agents
under the cover of promoting economic development. Widespread public per-
ception of abuse of power and corruption has contributed to a sharp increase
in the frequency and contentiousness of local protests and rebellions. e an-
nual number of mass incidents is on the rise, with around , registered
protests and petitions in (Li ). Despite the national guidelines up-
holding merit-based recruitment and promotions of government and party
bureaucrats, the poor hinterland regions lag far behind the coastal provinces
in the formal training and technical competence of civil servants.
Max Weber ( ) observed that the rise of market capitalism and
the development of modern bureaucracy are closely coupled institutional pro-
cesses. As in the rise of capitalism in the West, modernization of the civil
service in China has made the most rapid progress in the prosperous private
enterprise economy of the coastal regions. In the course of two decades of
reform, the Yangzi Delta region, an epicenter of Chinese capitalism, has at-
tained a level of bureaucratic eciency comparable with Western industrial-
ized countries. According to the World Competitiveness Yearbook, covering
countries and economic regions worldwide, Zhejiang province was ranked
in terms of bureaucratic eciency1 (score .) in , ahead of the United
States (.) and Australia (.). Although China’s overall score is much
lower, ranking , it ranks higher than some European industrialized coun-
tries including Germany, the United Kingdom, Belgium, and Italy. Corrup-
tion and bribe taking are also far less pronounced in Zhejiang province (rank
; scoring higher than the Czech Republic and Hungary, Europe’s success-
ful transition economies) than in China as a whole (rank ). Recruitment of
elite bureaucrats relies on open competitive national searches. Recruiters are
even sent to North America to interview Chinese students with postgraduate
degrees from U.S. and Canadian universities for specic key positions. Short-
term training workshops in the West are increasingly popular and involve the
major elite universities.
ough traditional China was the rst to institute national civil service
examinations in recruiting scholar-ocials for the imperial bureaucracy,
the spirit of the imperial bureaucracy was shaped by generalists, the elite
literati committed to Confucian moral and ethical teaching. It was not until
the contemporary era that rational-legal norms and approach to public ad-
ministration have gained legitimacy as the dening spirit for the government
bureaucracy. Rather than generalists, as in the “red” cadres of the Cultural
Revolution era, today’s elite bureaucrats are recruited for their technical ex-
pertise and promoted for their performance as technocrats. Competition in
internal bureaucratic promotion is intense and the standards of annual per-
formance reviews are high but transparent, allowing fair evaluations and pre-
dictable career paths. rough strict implementation of national rules and
standards, the provincial government of Zhejiang province has successfully
reestablished the high social status government ocials traditionally held in
China. With its emphasis on merit-based recruitment and promotion, Hang-
zhou municipal government has built a modern bureaucracy that uses state-
of-the-art knowledge in public administration and related elds, typically
favoring indirect means of governance—tax policy, regulatory action—over
direct interventions in the rm.
e building blocks of Zhejiang’s bureaucratic modernization are promul-
gated in China’s civil service laws and preceding regulations. e particular
success may lie in a specic esprit de corps that Zhejiang’s government suc-
ceeded in establishing. Notwithstanding, Zhejiang’s success in building an
eective state bureaucracy should not diverge much from other areas of China
where private enterprise and markets have gained a critical mass. Overall, the
state bureaucracy is undergoing a process of dynamic transformation from
a Maoist-era politicized state apparatus to a technocratic bureaucracy that
emphasizes higher education and technical expertise in the recruitment and
promotion of bureaucrats. Secure government employment coupled with high
social status and attractive benets serve as incentive to avoid malfeasance.
As this transformation progresses, politicized capitalism is in disequilibrium
as the rise of a private-enterprise economy and competitive markets rapidly
diminishes the relative industrial output of state-owned enterprises (SOEs)
and drives the Chinese state inexorably toward less direct interventions at the
rm-level, and indirect instruments such as taxation and credit policies.
e theory of state and local nance has long stressed the disciplining eect
of scal decentralization on government activities and the provision of pub-
lic goods. Qian and Roland () oer a model to analyze the relationships
among the organization of the state, economic policies, and the tightness of
scal budget constraints. ey identify two main mechanisms that may con-
strain predatory political interference in the economy. First, under the as-
sumption of factor mobility, a federalist system introduces competition among
local governments, which increases opportunity costs of bailouts and any ac-
tivities leading to inferior enterprise performance (Weingast ). If local
government jurisdictions fail to provide a hospitable business environment,
they face poor chances of attracting resources needed to enhance economic
prosperity. Competition in a federalist system eventually limits discretionary
authority, predatory behavior, and rent-seeking. Second, in federal systems,
scal decentralization may harden budget constraints of jurisdictions and
provide incentives for eciency-oriented local activities. Local governments
compete to build a business environment favorable to private capital.
Indeed, China’s policy of scal decentralization has constituted a key in-
stitutional innovation aimed at strengthening economic incentives of munici-
pal and provincial governments to support market-oriented economic reform.
According to the scal revenue-sharing system, lower-level governments have
the obligation to submit a xed proportion of scal revenues to their superior
government unit, while retaining the residual for their own budget. Given that
tax revenues are positively correlated with rm performance, local bureau-
crats have an incentive to do what they can to assure that local rms prosper
(Montinola et al. ; Li ). Fiscal federalism has thus developed into a
major driving force of economic reforms in China. With increasing nancial
independence of local governments, revenue-generating reforms have gained
in importance, whereas the incentive for local governments to maintain ele-
ments of the old socialist command economy has declined.
Increasing nancial responsibilities and hardening budget constraints im-
posed strong pressure on government to privatize the local economies, given
low protability, weak tax revenues, and increasing state subsidies needed to
maintain loss-making state industries, and the superior economic perfor-
mance of private rms over state-owned rms. Local governments developed
a strong interest in divesting loss-making state-owned rms. Figure - de-
picts the close negative bivariate relation between state-owned production
and local revenues and more specically between state-owned industrial pro-
duction and corporate tax income at the provincial level between and
. It shows that provinces that have declining industrial production from
state-owned enterprises relative to nonstate rms also have higher corporate
Provincial and municipal governments responded to increasing economic
pressure by accelerating privatization and divestiture of state-owned assets.
Following China’s ocial policy, “zhua da, fangxiao” (grasp the big ones and
let the small ones free), the s saw an unprecedented increase in the pace
of privatization of these enterprises. Small- and medium-size rms were sold
in the form of manager or employee buyouts or auctioned o, whereas big
state corporations of the so-called sensible key sectors were partially priva-
tized and corporatized, with many of them being listed at one of China’s
two stock exchanges. As a consequence, the number of state-owned enter-
prises was reduced by more than percent from , to , and total
national employment in them was reduced from million to million
between and , while their total production value was stabilized at
around percent of gross industrial output. Within the nonstate economy,
private sector development emerged as the most dynamic growth engine
of China’s economy. By the end of , registered employment in the pri-
vate sector already reached million with an annual production growth of
percent, out-competing all other ownership forms (China State Statistical
Figure - illustrates the close parallel development of waning state-owned
industrial production and increasing market liberalization based on pooled
provincial-level data covering the period between and . It conrms
that as the market economy expands, the gross industrial output contributed
Figu re 4 - 2 State-Owned Production and Provincial Revenues,
source: National Bureau of Statistics of China.
Corporate Tax (billion RMB) Local revenue (billion RMB)
State owned production / Total Gross Industrial Output
State owned production / Total Gross Industrial Output
.2 .4 .6 .8 1
.2 .4 .6 .8 1
by state-owned enterprises declines. In other words, as predicted, in market
transitions the greater the size of the market economy, the less state-owned
productive assets can compete with private-ownership forms in the produc-
tion of industrial output (Nee ; Naughton ). We infer from Figure -
that the state-owned sector is strongest in regions of the transition economy
where competitive markets are still subordinate to the state in the allocation
of scarce resources.
It is obvious that the changing relative contribution by state-owned enterprise
and private enterprise drives a dynamic transition in the role of the state to-
wards the custodial and midwife role of the East Asian developmental state.
Like Taiwan, South Korea, and Singapore, China has instituted an overall
growth strategy of modernization and technological innovation that provides
Figu re 4 - 3 Bivariate Relation Between Provincial State-Owned
Enterprise-Production/Gross Industrial Output and Marketization
source: Data from National Bureau of Statistics of China; Fan and Wang ().
State owned production / Total Gross Industrial Output
.2 .4 .6 .8 1
an institutional and political framework for intense collaboration and coop-
eration between the political and the business elites. e rst so-called indus-
trial policy (chanye zhengce) guidelines were implemented in ,2 when the
government perceived that the old planning apparatus was no longer suitable
to steer economic priorities—particularly industrial development—in China’s
economic development. Since then, the government has frequently revised
and reformulated industrial priorities in an eort to single out future win-
ners and losers in the ongoing structural transformation of the economy. e
government seeks to create an environment conducive to the growth of large-
scale rms that can eventually turn into big, multinational players who estab-
lish global brand names. Common instruments such as market entry regula-
tion, taxation, and loan decisions are part of the state’s tool kit to inuence
the direction of structural transformation (Lu ). In this sense, China’s
industrial policy is also actively involved in shaping market structures.
In parallel, the Chinese government developed a science and technology
program that relies on the mechanism of central planning and resource al-
location. Major institutions in charge of formulating the national science
and technology (S&T) plans are the State Science and Technology Commis-
sion and the State Economic and Trade Commission. A set of four mutually
complementary S&T programs builds the framework of China’s national
technology policy.3 Each program supports a close science-business interface
to secure innovation activities with good prospects for productivity growth
and to maximize the commercialization of research and development (R&D)
output. While the individual programs follow a set of distinct core objectives,
with specic tools to promote technological development, the planning in-
stitutions gradually adjust national priorities and targeted research goals in
response to the changing overall state development goals. Concurrent to the
structural changes within China’s research landscape, the central government
has gradually increased the relative role of R&D policies. In , the “Deci-
sion on accelerating scientic and technological progress” formulated a target
value of . percent of GDP for national S&T expenditures. Although China
has not yet reached its target value, the recent increase of R&D expenditures
over the last few years is indeed impressive. Between and the an-
nual R&D expenditures increased from . percent to . percent, meanwhile
surpassing even the average value of the EU- countries. e majority of
R&D expenditures accrue in the business sector, followed by R&D institutes
and universities. In parallel, the proportion of scientists and engineers in the
overall S&T population increased signicantly from percent to percent
between and (National Bureau of Statistics of China ).
e state’s modernization eorts are supported by massive investments
in China’s system of higher education. Overall educational funds increased
from . percent of GDP in to . percent in . Government funding
equaled . percent of GDP in , and the remaining educational funds
were generated by tuition fees and nongovernment funding organizations
(State Statistical Bureau ). In terms of public expenditure of GDP on
education, China is comparable with Singapore and ranks only slightly lower
than Japan and Korea. Institutions of higher education enjoy special attention
and received percent of government appropriations for education in .
e annual number of university graduates increased from only . million
in at the start of the reform period to . million in . Due to China’s
centralized system of university entry exams, the structural composition of
university graduates is closely aligned with the specic needs of China’s eco-
nomic development. About percent of China’s university graduates hold
a degree in engineering, percent in business administration, and another
percent in natural sciences (National Bureau of Statistics of China ).
is makes China the biggest producer of engineers worldwide (with about
, graduates in ).
In contrast to Japan’s technological catching-up process, which basically
relied on the country’s own development strength, China’s reformers have
embraced foreign technology to jump-start national economic development.
Foreign direct investment (FDIs) emerged as a core element of the national
reform agenda from the outset of economic reforms in the late s. e state
promoted FDI to serve two complementary purposes: First, foreign invest-
ments obviously alleviated China’s capital constraint; second, the new FDI pol-
icies were designed specically to speed the country’s technological catching-
up process through channels such as reverse engineering, skilled labor turn-
overs, and demonstration eects. Special economic zones with generous tax
and scal incentives not only facilitated the inow of scarce capital, but also
served as entry ports for advanced technologies, Western-style management
techniques, and organizational blueprints. Country wide development of
technology parks and development zones facilitated an immense inow of
FDIs across China. Meanwhile, China ranks number one worldwide among
FDI recipient countries with an FDI inow of billion USD in (State
Statistical Bureau ). Steered by specic investment incentive schemes,
FDIs gradually shied from labor-intensive technologies toward capital- and
knowledge-intensive technologies. Local content regulations guaranteed that
national rms beneted from the growing FDI inow as suppliers of input
factors and machinery. More recently, local content regulations even included
R&D activities in order to deepen the technological exchange between multi-
national companies and local rms.
While the aforementioned programs represent many of the standard features
of national policies of developmental states (Evans ), state activities in
China’s politicized capitalism typically go beyond the provision of growth-
promoting strategies that indirectly encourage rm development. Due to
the overlap of political and economic markets in politicized capitalism, state
actors also enjoy opportunities to directly interfere at the rm level. Fig-
ure - highlights the dual role of the party-state and its representatives, as the
rule-setting body and as actively involved in rm transactions. In politicized
capitalism, the rm not only responds to market signals, but its performance
and economic success are also aected by its relations with state representa-
tives and the extent and quality of government involvement within the rm.
Due to weak legal and political checks and balances, legal limits to political
interference are largely absent. Although China has invested tremendous ef-
forts to bring its business laws and regulations into accordance with Western
practices, legal institutions are still weak and provide little protection against
state interference. A core feature of China’s legal reforms is to build legitimacy
for economic reforms and sustain transformative economic growth without
aecting the CCP’s monopoly on political power. Hence, the legal system is
still not independent from the Communist Party, and local courts remain in a
subordinate position in relation to the local party committees (Findlay ).
One can dierentiate between two distinct types of direct state interven-
tions at the rm level:
a) State involvement in market transactions of the rm, particularly to as-
sist and support business deals in state-controlled markets, and b) Direct state
involvement in the rm’s corporate governance.
State Involvement in Market Transactions
State involvement as a third party in economic transactions is widespread
when rms operate in partially liberalized or state-controlled markets. In such
cases, resource dependence theory predicts a voluntary construction of clien-
telist ties between rms and government in an eort to alleviate and mitigate
resource constraints. Political capital becomes an important asset and may
aect a rm’s success in securing business deals. Examples of state-controlled
or highly regulated markets are those for land-use rights, for public construc-
tion projects, for credit and for capital, as well as specic state production
monopolies such as tobacco and energy. Outcomes in these markets are not
fully determined through market mechanisms bringing supply and demand
into equilibrium; instead, business transactions are still heavily regulated and
controlled by the state. Hence, political capital embodied in personal relation-
ships between political and economic actors may provide crucial informa-
tion advantages or provide legitimacy and credibility for entrepreneurs that
eventually help to secure a business deal. By contrast, in competitive mar-
kets, market outcomes are determined by the price mechanism; hence, the
economic benets of political ties decrease. Market transition theory predicts
that the importance of political connections for business success is negatively
correlated with the degree of economic liberalization and marketization (Nee
; Bian and Logan ). Hence, in heavily state-regulated industrial sec-
tors and regions, entrepreneurs must cultivate personal connections with
Figu re 4 - 4 e Firm in Politicized Capitalism
powerful government bureaucrats to gain reliable access to resources and pro-
tect their rms from predatory interventions (Wank ; Xin and Pearce
; Peng and Luo ).
In our eld research involving interviews with private entrepreneurs in
the Yangzi Delta in the summer and fall of , we found rich evidence sup-
porting the close connection between the extent of state control and the value
of political capital. Many entrepreneurs whose businesses competed in free
markets told us they do not invest in political capital. e general manager
of a computer company, for instance, clearly rejected the idea of playing the
“game of politics,” and explained, “In my sector, the government cannot give
me much, not much tax breaks, and not much government contracts.” By con-
trast, entrepreneurs in state-controlled and highly regulated markets, such as
the construction business, told us they invest considerable eorts to establish
close personal ties with the political elite. Especially for entrepreneurs who
depend on government contracts for their business, having strong political
ties with government is oen the decisive factor in business success. One en-
trepreneur in the water purication business in the Yangzi Delta remarked:
“Competitive bidding is just a form. It doesn’t involve the entire process in
terms of results . . . Political connections are still as important as before . . . If
some senior government ocial gives a signal we will get the project. Some-
times we lose bids, because someone else gets the nod from a senior ocial.”4
Government interference and inuence in regulated markets oen goes well
beyond the legal limits and involves corruption and bribery. A Chinese study
conducted in reveals that about percent of illegal land-use cases can
be attributed to local government malfeasance (Li ).
Resource constraints and the need to secure the “helping hand” of govern-
ment are particularly important for rms beyond a certain critical size. With
size, rm vulnerability increases, due both to increasing rent-seeking activi-
ties of government ocials and to resource dependence, so that good govern-
ment relations become a crucial factor in doing business. As one interviewee
pointed out, “Once you are big, you are in trouble. You must have good rela-
tionships with the government then . . . If the party wants you to die, you have
no way to live.”5 Managers and entrepreneurs develop and cultivate political
capital through the informal pursuit of old friendships with government of-
cials in social gatherings and family visits (particularly managers who held
previous positions in the government), and through nancial donations to
support government projects. ere is also the formal inclusion of govern-
ment ocials on so-called expert committees formed as a consulting body
to provide guidance in important rm decisions. Entrepreneurs in regulated
markets tend to make signicant nancial investments in maintaining politi-
cal connections. Our interviewees indicated that “social expenditures” of up
to percent of the contract value are expected; the investment might be a
higher percentage in smaller deals.6
Our anecdotal evidence from interviews with entrepreneurs in the Yangzi
Delta region is supported by data from the World Bank’s Investment Climate
Survey of , rms conducted in in cities in China. e survey was
conducted in two parts: one to be answered by the rm’s CEO and the other by
the CFO or accountant. Using this World Bank dataset, we compare the state’s
role in assisting business transactions in both types of market structures. As
an example of a state-controlled market, we focus on China’s credit market,
which represents one of the least-reformed sectors of China’s transition econ-
omy. For a case study of competitive markets, we chose China’s product mar-
ket, which (with few exceptions, i.e., state monopolies in tobacco and energy)
was the rst market to be liberalized in China’s economic reforms.
To assess the eect of political connections in both market structures we
chose to compare the eect of political capital as measured by direct govern-
ment assistance to the rm and the involvement of a party ocial in the rm’s
management. e party and government can best be described as a multi-
plex principal-agent relationship, with the party being the principal and the
government agencies representing diverse agents (Shirk , ). e local
party committees can therefore oer access to most administrative bureaus at
the local level. For instance, the party can provide an indispensable network
outside of which bank credit is much more dicult to access. Membership in
the CCP is oen regarded as a minimum requirement for a career as a profes-
sional manager—particularly in state-owned enterprises and in private rms
that exceed a certain size and inuence. A CEO with active involvement as
a party secretary, vice party secretary, or party committee member signals
a closer and stronger party aliation. According to the Investment Climate
Survey, more than percent of the surveyed rms actually have a CEO who
holds an oce in the CCP. Some regional variation can be observed, with
more liberalized and reformed areas showing a smaller proportion of politi-
cally active CEOs and less-liberalized, economically backward regions show-
ing a higher proportion.
e banking sector is still dominated by four state-owned commercial
banks and three political banks. Although the state banks have been joined by
joint-equity banks, about regional city banks and private banks like the
Minsheng Bank (founded in ), the oligopolist structure of the Chinese
banking sector persists. e People’s Bank of China controls interest rates for
dierent kinds of deposits, state-owned banks still benet considerably from
their established branch network, and the state commercial banks are still
the central provider of nancial control. e Chinese government has imple-
mented only partial reform of the commercial banking sector. Recent reforms
show a surprising degree of inconsistency. For example, the Commercial Bank
Law (eective in ) guarantees the formal-legal independence of commer-
cial banks, but the law still emphasizes that loan decisions should be taken
under the “guidance of state economic policies” (art. ). Abundant evidence
conrms that China’s commercial banks are not independent in their loan
decisions (Zhu ; Leung and Mok ; Lin ). Political intervention is
still rife despite legal reform of banking to foster formal autonomy in lending
decisions. In , private rms and individuals received only about percent
of short-term loans of China’s state commercial banks, including the four state
commercial banks, policy banks, and agencies of postal savings (China State
Statistical Yearbook : ). Even the newly founded joint-equity banks are
not completely immune from political interventions (Wong ).
e importance of political capital for a rm’s success in getting a bank
loan can be readily inferred from Figure -, which compares credit access
across cities for rms that do not receive government assistance (le-hand
side) with those that do (right-hand side). Figure - shows that where the
CEO is politically well-connected and active as party secretary, rms have
greater success in securing bank loans.
at political ties play an essential role independently of the rm’s owner-
ship status is conrmed by Table -. With only two exceptions (listed rms
and collective rms with CEOs holding a party oce), both government as-
sistance and active party participation of CEOs are associated with greatly
improved chances to secure a bank loan. Although bivariate relations are of
course technically and methodically not appropriate to establish causal rela-
tionships, market transition theory and resource dependence theory both pro-
vide strong arguments supporting underlying causalities hinting at a strong in-
terventionism of political capital in China’s state-controlled nancial market.
Our ndings are also consistent with an analysis by Li et al. (), of a sample
of more than , private rms showing that political connections are helpful
in obtaining bank loans and tend to reduce discrimination by state banks.
A closer look at the sectoral distribution of government assistance con-
rms that political ties are used instrumentally to steer scarce capital into
Figu re 4 - 5 Eect of Government Assistance on Access to Bank Finance,
source: Data from World Bank Investment Climate Survey, .
Graphs by availability of government assistance to secure bank loans
Figu re 4 - 6 Eect of Politically Active CEOs on Access to Bank Finance,
source: Data from World Bank Investment Climate Survey, .
Graphs by party office of CEO
preferred industrial endeavors. Figure - provides evidence that government
assistance in loan applications is particularly common in China’s high-tech
sectors such as biotechnology and electronics, which enjoy priority in China’s
current industrial policy and technology programs. In the high-technology
Ta b l e 4 -1 Political Capital and credit access by ownership form
18.30% 12.29% 47.62% 15.33% 15.94%
government 44.32% 46.43% 62.96% 42.37% 42.24%
part y oce 15.97% 14.88% 66.66% 16.99% 16.72%
part y oce 24.83% 14.02% 40.00% 32.17% 32.17%
source: World Bank Investment Climate Survey .
Figu re 4 -7 Sectoral Distribution of Government Assistance
source: World Bank Investment Climate Survey, .
Metallu rgical products (manuf. & tools)
Food proce ssing
Chemical products & medicine
Transportat ion equip.
(incl. telec om & ship bui lding)
Biotech products & chi nese med icine
Infor mation t echnolog y
Accountin g & non-bank ing
fina ncial se rv.
Advert isement & m arketi ng
Auto & auto pa rts
Household ele ctron ics
Electronic par ts mak ing
Garm ent & leath er
Figu re 4 - 8 Government Assistance and Sales Performance
source: World Bank Investment Climate Survey, .
annual sales growth in 2003 (%)
Graphs by by availability of govern ment support to identify clients
sector, China’s policy is similar to that of other Asian developmental states
(Whitley ; Kang ).
Our analysis of the eect of political capital in product markets—our
counterexample of a liberalized market—reveals a completely dierent pic-
ture. Figure - shows that political ties do not in general improve sales perfor-
mance, as indicated in the comparison of rms without government assistance
in securing clients (le-hand side) and those that enjoy government sponsor-
ship (right-hand side). Only in Benxi and Xian does government assistance
appear to be associated with slightly improved performance. In general, gov-
ernment assistance in securing either domestic or international clients does
not aect the rm’s sales growth. Specically, as shown in Figure -, political
capital embodied in politically active CEOs does not result in stronger perfor-
mance in the rm’s sales.
Table - conrms our ndings for most ownership forms. With the ex-
ception of collectively owned rms, political ties and government support are
not linked to advantages on the product market. To the contrary, rms gener-
ally exhibit stronger growth in sales if they lack political ties in the form of
government assistance and politically active CEOs.
us, it is clear that economic benets generated by political capital de-
pend crucially on the extent of market liberalization. Consistent with market
transition theory (Nee ), positive payos of political capital are conned
to regulated and state-controlled markets, whereas political capital does not
yield any additional benets in competitive markets. Our results match well
with recent work by Li, Meng, and Zhang (), who analyzed determinants
of party membership of entrepreneurs. eir ndings show that the less de-
veloped the local market-supporting institutions and the less liberalized the
local markets, the more likely entrepreneurs are to enter politics.
State Involvement in Firm Decisions
e implementation of the Company Law promulgated in has altered
both the quality and intensity of state intervention in the rm, depriving the
government of its former unchallenged monopoly rights and control over
former state-owned enterprises [Ed: restore]. In the s, state-craed in-
stitutional change established the framework for converting them into public
corporations. e objective was to transform loss-making state enterprises
into prot-making rms through corporatization and listing on stock ex-
changes. With the Company Law, the government sought to bring organi-
zational standards in line with Western-style corporate governance (Guthrie
Figu re 4 - 9 Politically Active CEOs and Sales Performance
source: World Bank Investment Climate Survey, .
annual sales growth in 2002 (%)
Graphs by party office of CEO
), shiing power from the party and government to the board of directors
and the CEO as major decision makers within the rm (Wong, Opper, and
Hu ). State involvement in rm decision making, however, was not com-
pletely abolished. In an eort to not lose all control rights over China’s indus-
trial key sectors, specic aspects of established political governance structures
were maintained. Not surprisingly, this provided politicians and bureaucrats
with opportunities for direct intervention in the rm. e state is particularly
interested in maintaining involvement in large-scale modern corporations,
business groups, and conglomerates in core industries, either listed or un-
listed. Certain giant former state-owned enterprises, such as China National
Oshore Oil Corporation (CNOCC) listed on the Shanghai Stock Exchange,
are regarded as crucial in leading China’s bid as a global economic power.
Whether as a private rm that has grown into a major player in its niche or as
a former state-owned enterprise, the larger the enterprise, the more the state
becomes interested in guiding its future development. Two major channels
for direct interference can be identied: state ownership of shares and gover-
nance structures within the rm.
State Intervention via the Ownership Channel
Although China has witnessed a major privatization move, reducing the size of
the state sector by over percent between and , the government has
oen retained partial control rights in large-scale rms. Corporatization and
stock exchange listing have reduced the average state shareholding in rms
listed on the Shanghai Stock Exchange to about one-third of the rms’ total
shares. However, another third is held by corporatized state-owned companies.
Ta b l e 4 - 2 Political Capital and Sales Growth by Ownership Form
27.35% 23.08% 30.09% 76.85% 97.06%
government 23.21% 38.17% 33.33% 27.66% 30.43%
part y oce 39.07% 20.25% 50.42% 75.54% 99.89%
part y oce 22.49% 29.73% 13.30% 23.21% 17.89%
source: World Bank Investment Climate Survey .
us, on average, percent of company shares are still under either direct or
indirect state inuence.
Bureaucrats maintain direct ties to such rms through their participa-
tion as members of the board of directors representing state-owned shares. As
such, they are entitled to represent the state’s interests in the rm’s strategic
decisions, albeit within the framework of an advisory capacity as stipulated
by the rules of corporate governance of the Company Law (Gensler and Yang
). us, while the rm’s top executive, the CEO, has full control over its
management, the state has a voice—the more so the larger its ownership share
in the rm—and votes on strategic decisions.
Such state participation in corporate governance, however, turns out to be
problematic. State asset administration is carried out by an institution that
serves as a representative of the central government. ese so-called state as-
set management companies usually have weak incentives to perform moni-
toring activities. First of all, their ocials usually do not receive any personal
benets from eective monitoring. Second, state shareholders do not operate
under hard budget constraints; even if budgets are admittedly hardened, state
shareholders can almost be sure to be bailed out by the state treasury if com-
panies suer nancial distress. Not surprisingly, corporate performance of
China’s listed companies is negatively related to the proportion of a company’s
state shares (Xu and Wang ; Qi, Wu, and Hua ).
Government ownership of course also invites intervention in corporate
governance beyond the regular board meetings and shareholder meetings.
e continuation of close rm-business relations and informal networks
among actors allow for ready interference in almost all types of rm deci-
sions. Government involvement in corporate governance of rms listed on
the Shanghai Stock Exchange is particularly pronounced when it comes to
decisions aecting nancial issues, that is, decisions on mergers, change in
shareholding structure, and on share placements and new issues. Overall per-
formance eects of this direct government intervention are negative, however,
showing the state’s inability to overcome the inherent incentive and informa-
tion problems of state ownership even aer a shi toward greater reliance on
market mechanisms (Nee, Opper, and Wong ).
State Intervention Through Politicized Governance Structures
State involvement is further exacerbated through the persistence of politicized
vertical command structures within the rm. Although the ocial policy line
was to encourage a complete separation of government and business func-
tions (zhengqi fenkai) to support a rationalization of the economic sphere,7
the reforms in actuality revealed a high degree of ambivalence and inconsis-
tency. In spite of the ocial propaganda, which claims to constrain the state’s
role to that of a normal shareholder without any priority rights to interfere
into the rm’s organization and governance, China’s new company legislation
reveals a more ambivalent position toward depoliticizing the former state-
To begin with, Article , Company Law, still calls for a supervision of
enterprises by the government and social masses. Inevitably, this claim may
create conicts with the intended enterprise independence. Even more seri-
ous decits of the ocial depoliticization strategy result from the continu-
ing inuence of the “three old political committees”—party committee, labor
committee, and trade union—placed within the rm. Despite the creation of
new organizational and governance structures, such as shareholders’ meet-
ing, board of directors, and supervisory committee alongside the position of
the CEO, the old political organs were not abolished. Instead, the Company
Law guarantees and regulates their future involvement and responsibilities.
Although the “old three” lost a large amount of their inherited coordination
and control rights, their survival invites a continuation of political involve-
ment in the rm’s decisions. Particularly their long tradition as central politi-
cal bodies within the rm provides fertile grounds for continuing informal
involvement (Wu and Du :). Figure - sketches the internal structure
and persisting links between the three old committees [lao san hui, i.e., party
committees, trade union, and workers congress] and new decision-making
bodies [board of directors, manager, and board of supervisors].
Article of the Company Law species “the activities of the local branch
units of the CCP in a company shall be carried out in accordance with the
Constitution of the CCP,” but this constitution provides little additional clari-
cation of the party’s scope of involvement. It simply delegates the implemen-
tation of higher party decisions to local party committees and grants them
the right to “supervise party cadres and any other personnel.” More specic
was former General Secretary Jiang Zemin’s detailed sketch of the party’s ac-
tivities at the enterprise level. According to his guidelines, the party should
focus on four functions: () implementation of the party line, () fulllment
of party-related tasks with special attention to production and management,
() participation in the most important business decisions, and () support for
the board of directors, the supervisory committee, and management (Foreign
Broadcasting Information Service ).
Survey evidence conrms the active role of party committees. An in-depth
study of state involvement in listed corporations nds persisting party inter-
ference in almost all domains of the rm’s activity, with party committees
exercising an even stronger inuence in the rm than government bureaus
(Nee, Opper and Wong ). Local party committees exert the most control
in personnel decisions, especially the selection of managers of departments,
branches, and subsidiaries, and the selection and dismissal of vice chief ex-
ecutive ocers. In essence, party involvement concentrates on personnel is-
sues, which have been a central focus of the nomenklatura system for decades
of socialist planning (Shirk :). e fact that local party units tend to
have a high level of involvement in decisions assigned de jure to the enterprise
manager suggests that they may use the manager’s oce as their venue for
Party inuence within the rm may be even stronger if the CEO is actively
involved in the party and holds a party oce. Particularly in large- and medium-
size rms, management positions are oen lled by politically active mem-
bers of the CCP. e previously mentioned Investment Climate Survey of
, rms found that more than percent of CEOs concurrently hold party
positions. Although politically active CEOs are naturally most common in
Figu re 4 -10 Corporate Governance of China’s Listed Firms (According to
source: Opper ().
• Shareholder representatives
• Employee representatives
has a voice in
delegates rights to
elects employee representatives supervises
Board of Supervisors
elects and appoints
state-owned enterprises (with more than percent of CEOs holding a party
position), political participation of management personnel is also widespread
in non-state-owned rms. Fiy-seven percent of CEOs in the surveyed listed
rms and percent of CEOs in ocially registered private rms held party
oces. Recruitments of politically active CEOs are oen motivated by an ef-
fort to gain information advantages and utilize political capital to mitigate
resource constraints, that is, in access to credit markets and markets for land
and construction permits.
Conicts of interests arise easily, as the Company Law lacks mechanisms
to align the party committee’s interests with the rm’s performance. e party
committee has neither residual claims nor benets from local tax revenues.
Party members, moreover, are insuciently insulated from patron-client ties
and may easily be “captured” by interest groups or be tempted to maximize
their own self-interests. In sum, the party committee presides over a politi-
cal network in the rm that can be used to mobilize informal opposition to
reform policies that threaten vested interests in the rm. Our own interviews
revealed conicts of interests over labor issues as well as in strategic decisions,
such as investments beyond the borders of the local locality.
Party intervention in rm decisions can have negative eects on perfor-
mance. Based on data from listed rms at Shanghai Stock Exchange speci-
fying the extent of party intervention in distinct rm decisions overall,
Nee, Opper and Wong () found evidence for such negative eects (on “re-
turn on assets” and “return on equity”) for party interference, particularly,
in nancial decisions. is contributes to explaining why SOEs are unable
to compete eectively with private enterprise. Interventions by the state in
listed rms in which the state is a major shareholder have a negative eect on
the rms’ economic performance at a time when they face increasing market
competition from private enterprise.
Our analysis has sought to highlight the structural and organizational
features of politicized capitalism as a hybrid institutional order. e focal
question is whether China’s politicized capitalism is a new type of capital-
ism that will endure and complement the landscape of capitalist systems.
e construction of politicized capitalism by means of ad hoc improvisa-
tions responding to the demands of rapid market-driven economic growth
is a source of institutional continuity. Given the central role of the state at
the outset of reform, path dependence alone would dictate a strong state
component in the constitution of the new Chinese capitalism. Aer all, the
same state that managed production and distribution under central planning
guides the transition to capitalism.
e dilemma of state involvement in guiding economic life, is that, on the
one hand, state intervention is associated with negative eects on the rm’s
performance when state bureaucrats directly inuence decision making in the
rm. On the other hand, in spite of negative performance eects, rms are
not able to completely distance themselves from state actors as long as they
depend on access to scarce resources controlled by the state in regulated mar-
kets such as the credit market or the market for land-use rights. Hence, po-
liticized capitalism currently rests on lock-in eects in sectors where political
and economic markets interact to blur the boundaries between the state and
the rm. Large-scale, capital intensive rms dependent on state-controlled
resources and rms in sectors characterized by a high dependence on gov-
ernment contracts such as the construction and the real estate business have
strong economic reasons to accept and cultivate close state-rm relations.
Moreover, partial state ownership in recently privatized state-owned enter-
prises provides ample opportunities for direct state intervention in corporate
governance. If politicized capitalism persists in Nash-like equilibrium, then
the structural and organizational interpenetration of political and economic
markets will remain as incorrigible features of Chinese capitalism.
Notwithstanding lock-in eects of path dependence, politicized capitalism
as a hybrid order itself embodies organizational dynamics of market transi-
tion. As evident from the contrast in utility of political capital in product and
credit markets, the benets from close state-rm relations mainly stem from
the governments’ ability to provide access to scarce resources and on state-
owned enterprise. We infer from this that politicized capitalism is to an extent
largely bounded within the state regulated and controlled sectors and con-
strained by the extent and size of the market economy. Small- and medium-
scale rms, for example, operating in close-knit local business networks and
in competitive markets are oen able to distance themselves from the state in
securing nancial capital. It is estimated that about – percent of China’s
total capital investment is allocated outside the banking system (Tsai ).
Friends, families, private founders and even business partners establish a reli-
able lending network that provides mutual loan opportunities. Several of our
interviewees pointed out that they prefer private lending to bank lending as
an ecient and exible way of getting short-term capital. Moreover, a deepen-
ing market transition is under way, partly enforced by commitments to liber-
alization specied in China’s World Trade Organization accession contract.
In addition to the growing share of domestic nonstate nancial institutions,
increasing competition by foreign nancial institutions will help to liberalize
China’s credit market, though progress is expected to be slow and gradual
due to the extended branch networks China’s state-owned banks can rely on.
Hence even in the banking sector, currently the most regulated sector, the
trend is clearly in the direction of liberalization.
Overall, we show that China’s politicized capitalism is still in dynamic
transition. Fiscal decentralization and the continued rapid growth of the in-
dustrial output contributed by the private enterprise sector encourage interest
in shiing to the custodial and midwife roles characteristic of mature East
Asian developmental states (Johnson ; Amsden ; Wade ; Evans
). Following the privatization of small- and middle-sized state-owned en-
terprises in the early s, local governments are less involved in inuencing
economic decisions within the rm as they attempt to improve the business
environment to attract entrepreneurs and investments to their region. It is not
too far of a stretch to imagine that reformers might eventually want to include
in their ambitious reform agenda a national commitment to constructing a
modern polity wherein open electoral politics moves China beyond an out-
dated Communist Party dictatorship. It would take such a reform for China
to move decisively beyond politicized capitalism to emerge as a mature East
Asian developmental state, where the state and its bureaucrats operate within
the framework of an independent legal system, which guarantees clear and
distinct state-rm boundaries where private actors are shielded against arbi-
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. Respondents are asked to assess whether the bureaucracy hinders business
. e rst industria l policy guideline was the “Guowuyuan guanyu dangqian
chanye zhengce yaodian de jueding,” released by the State Council on March , .
. e so-called Spark program (since ) supports rural development; Pro-
gram (since ) currently emphasizes education in the elds of automatization,
computer-aided design, and computer integrated manufacturing systems—technolo-
gies, medical apparatus, biotechnology, and material sciences; the Torch Program
(since ) focuses on the provision of research infrastructure; and the Key Tech-
nologies R&D Program provides support for R&D in key industrial sectors.
. Inter view conducted November , , in the Yangzi Delta.
. Interview conducted on November , , with the founder of a rm produc-
ing building material in the Yangzi Delta.
. Interview conducted with a supplier of construction material on November ,
, in the Yangzi Delta.
. is context was mentioned in “Gufenzhi qiye shidian banfa” (//),
Chapter , line , in Zhongguo Renmin Daxue Jinrong yu Zhengquan Yanjiusuo (Eds.),
. A statement by Wang Zhongyu, Secretary General of the State Council, fur-
ther details: “e rst (aim) is to accelerate the separation of government functions
from enterprise management, make further eorts to change government functions,
reform the relationship of administrative subordination between the government and
enterprises, comprehensively realize the decision-making power of enterprises, relieve
the competent government departments of their relationship of administrative subor-
dination with the economic entities run by them or the enterprise directly managed
by them, and thoroughly cut their ties in terms of manpower and nancial resources”
(Xinhua, February , ). In this spirit, the tenth -year plan species, “to complete
the establishment of a modern enterprise system under which there will be clearly es-
tablished ownership, well dened power and responsibility, a separation of enterprise
management from government administration, and scientic management” (Xinhua,
March , ).