How Uncompetitive is the State-Owned Industrial Sector in China

The profitability gap between state-owned enterprises and the non-state industrial sector in China is significant. Using a highly-disaggregated database of China’s industry in 2003, we estimate an average return to capital in state-owned enterprises about 9% that of foreign-invested firms, and about 59% of the return to capital in all non-state-owned industrial enterprises. Capital return differences are mainly driven by productivity differences, but the negative impact on SOEs’ rental rates of a relatively integrated labor market is not negligible. The rental rate gap is much higher in sectors that represent a small share in SOEs’ output and assets, meaning that the capital subsidies granted by the government have not biased SOEs’ production structure toward industries with greatest profitability gap. The inefficiency cost of distortions in relative factor prices is estimated between 5% and 8% of total industrial output.