Rise of ‘Red Zaibatsu’ in China: entrenchment and expansion of large state-owned enterprises, 1990-2016

Ever since Deng Xiaoping’s reforms commencing in the 1980s, how to improve efficiency of state-owned enterprises has been on the government agenda. Progress has been made but more slowly than one expects in the decade. Even worse, against all the odds, China’s large state-owned firms, mega-SOEs, the backbone of Maoist economy previously, have gained exponential growth in the past decade. Reforms of that part of the economy have stalled. Why? To reveal the rationale and mechanisms of the rise of mega-SOEs, this study establishes a two-stage game model for an ‘authoritarian market economy’ (or a ‘market-Leninist economy’) where market monopoly and rent-seeking by state-owned conglomerates is firmly entrenched. Our findings confirm a ‘subgame perfect Nash equilibrium’ in China’s authoritarian market economy that has led the state (the owner or ‘principal’) and the large state-owned firms (the manager or the ‘agent’) to a paradox which prevents continuous reforms towards a Pareto solution for efficiency improvement.