M-RCBG Associate Working Paper No. 153
Reform in Deep Water Zone: How Could China Reform Its State-Dominated Sectors at Commanding Heights
The Chinese government is taking on a significant and burgeoning fiscal burden to invest in commanding heights industries to meet citizen’s growing demand. The government is heavily subsidizing citizen’s healthcare costs, transportation costs, electricity bills, and other infrastructure utilization. But this model is both financially unsustainable and systematically deficient. Investments in commanding heights industries coming dominantly from the state are growingly insufficient to keep up with the rising need for capacity and quality.
Full-scale privatization is precarious given the current market and political circumstances. Partial privatization, namely encouraging the participation of private capital alongside state investment, cannot be fruitful without solving the fundamental problem of market distortion. Social capital is encouraged to invest, but the market mechanism makes it challenging, if not unprofitable, for private capital to enter and shoulder the cost of development with the government.
The fundamental problem in the commanding heights industries is the market distortion as a result of price control and subsidies. Prices are kept artificially low and subsidies make up the losses incurred by state-owned actors. The soft budget constrain solidifies their monopolistic market position because these industries are unprofitable for private capital to enter.
But to relax price control and to lower subsidies are not so straightforward. Here comes the dilemma. Market-based reforms such as price hikes run the risk of affecting the less well-off bodies of the population the most. Market reform 2.0 faces the upmost challenge in striking a balance between market liberalization and social welfare, between unsustainable fiscal burden and unfulfilled promise to citizens, and between economic efficiency and social stability.
This paper proposes new sets of solutions to address the market distortion with dilemma and constraints in mind.