State Ownership and Regulatory Costs: A Law and Economic Explanation for the Prevalence of State-Owned Enterprises in China

Abstract

Despite China’s effort to privatize many state-owned enterprises (SOEs) after 1978, SOEs remain a prevalent type of enterprise in contemporary China. There is a widespread belief that they are inefficient and only exist because they have captured the government. This belief, however, does not fully explain why SOEs have been privatized in some sectors but not in others. This Article provides an efficiency explanation of SOEs in China. Applying the law and economic theory on the ownership of enterprise to state ownership, this Article conceptualizes the efficiency of SOEs as a tradeoff between two social costs: ownership costs and regulatory costs. SOEs generally have high ownership costs and thus are not common in many developed countries. However, in developing countries with weak regulatory capacity and legal institutions, they may help reduce regulatory costs, including the social costs associated with the enactment, alteration, and enforcement of regulatory rules, and those costs resulting from the failure to regulate enterprises adequately. The magnitude of regulatory costs in a specific country and industry, in turn, is significantly influenced by the regulatory institutions within which the enterprises operate. An important implication is that refining regulatory regimes may reduce regulatory costs and – in part by facilitating privatization of SOEs – enhance social efficiency.