• State-owned companies claimed over two-thirds of the nearly $850 billion in total profits produced by listed Chinese companies in 2023.
• Control of corporate profits enables consolidation among state firms, indicates key industries are protected from private competition, and reveals the heavy role of state banks in credit allocation.
• Getting the Chinese economy back on track requires the government to allow, and perhaps even encourage, underperforming state companies to be displaced by the private sector.

Prevailing Winds is a China-focused blog written by Nicholas Borst, Director of China Research at Seafarer. The blog tracks the economic and financial developments shaping the world’s largest emerging market.

Amid China’s ongoing economic woes, Xi Jinping recently met with a group of China’s top private firms, including Huawei, BYD, Tencent, and Alibaba. During the meeting, Xi declared that the Communist Party was committed to improving legal protection for private firms and allowing them to compete fairly with state firms. The speech echoed remarks from a similar event in 2018, when Xi had previously promised better treatment for private firms. Six years later, private firms still face numerous disadvantages compared to state firms.

The barriers and limitations that private firms encounter are among the deepest and most enduring structural problems in the Chinese economy. Economists have long argued that China needs to reform state-owned enterprises (SOEs) and create opportunities for the private sector. Although this argument is old, it remains true. Unfortunately, this point often gets lost amid economic commentary focused on short-term developments.

The paradox of the Chinese economy is that while the private sector has expanded over the decades and become the leading driver of economic growth, state influence over the economy remains pervasive. One indicator of state power is corporate profits. Despite the private sector’s tremendous growth, state firms still control a disproportionate share of profits. Understanding how and why the state has managed to retain control over profits will shed light on the factors that continue to perpetuate state influence and limit the growth of the Chinese economy.

Assembling the Data

Obtaining comprehensive data on profits in China is challenging. While the National Bureau of Statistics provides relatively comprehensive data on industrial firms, both listed and unlisted, there is less data available for the service sector. This is a significant issue because the service sector now accounts for more than half of China’s gross domestic product (GDP).

One way to overcome this data problem is to focus on listed companies, which are required to regularly report their financial statements to investors. Through these disclosures, the stock market serves as an important window into China’s economy. However, it's important to remember that the stock market is not a perfect reflection of the economy, as many significant companies in China – such as the gargantuan central state companies directly under Beijing's control – are not publicly listed. Additionally, many private companies in China would like to list publicly but have not received permission from regulators, who jealously guard their control over initial public offering (IPO) approvals. Despite these limitations, listed company data still provides insights into the Chinese economy due to the large number of listed firms and the depth of financial reporting they provide.

Assembling the data, however, is easier said than done. China’s landscape of publicly listed firms is complex because many firms are listed in overseas markets such as Hong Kong and New York. There is also a definitional problem of determining what constitutes a Chinese firm. Many of China’s largest private firms are structured as variable interest entities, complex legal structures that bypass foreign ownership restrictions through the use of overseas holding companies. Therefore, compiling a comprehensive picture of China’s listed firms requires gathering data from both domestic and overseas stock markets, examining holding companies, and adjusting for multiple reporting currencies.

Fortunately, much of the work to address these issues has been done by index providers who create comprehensive lists of China's listed companies. One of the most extensive indexes is the Bloomberg China Large, Mid, and Small Cap USD Index, which features over 1,000 of China’s largest companies, regardless of listing location. This index covers an estimated 99% of China’s total market capitalization.

Classifying State versus Private

The next challenge in assessing control over profits is separating companies into state-owned and private categories. Corporate classification in China is a messy process, but China’s corporate registration data provides some help. Chinese companies are required to declare their controlling shareholder based on several criteria, including total ownership, share of voting rights, and ability to appoint the board of directors. As shown in Figure 1, Wind Information, a Chinese financial data provider, classifies companies into different ownership categories based on their controlling shareholder. I have further streamlined these classifications into three categories: state, private, and mixed.

Some of these categorizations are straightforward, such as state-owned enterprises (central and local) and private enterprises. However, a fair number of companies fall into other categories, such as the “public enterprise” category where no controlling shareholder is reported. I classify most of these companies as “mixed” since they frequently have both state and private shareholders.¹ Collective enterprises, a holdover from China’s socialist system, are also classified as mixed. Additionally, some overseas-listed companies are classified as “other” or have no categorization and require manual research and classification. After some research and adjustments, I have categorized Chinese companies into three primary ownership groups: state owned, privately owned, or mixed ownership.

These classifications indicate whether state or private investors are the controlling shareholders in a company. Yet, they do not provide a definitive analysis of state influence over a company. As I discussed in the market commentary State-owned Enterprises and Investing in China, the corporate landscape in China is full of examples of private companies acting on behalf of the state, such as investing to support state policy priorities like the development of a domestic semiconductor industry. No large-scale analysis of Chinese companies can fully cover these issues of state influence, as it requires company-by-company analysis. Nevertheless, classification by shareholder ownership still provides important insights into the Chinese economy.

Follow the Money

After completing all the steps above, we can chart the distribution of profits between state and private firms. Figure 2 illustrates the shares of corporate profits across these three ownership categories for more than 1,000 of China's largest listed companies as of the most recent year available (2023). The chart is quite revealing. The figure shows that state companies claimed over two-thirds of the nearly $850 billion in total profits produced by listed Chinese companies in 2023.²

Sources: Bloomberg; Wind Information; Seafarer.

Industry Stranglehold

What’s driving the state share of profits? A deeper look at the distribution of profits across various industries helps shed light. Figure 3 shows that in 2023, the financial sector accounted for around 43% of total listed company profits. For comparison, this is substantially higher than the U.S. figure of 24%.³

Sources: Bloomberg; Wind Information; Seafarer.

Within the financial sector, profits are overwhelmingly dominated by state companies. As shown in Figure 4, profits of privately-owned financial firms are essentially non-existent.

Sources: Bloomberg; Wind Information; Seafarer.

While the financial sector is the most significant, there are other large swathes of China’s economy where state companies dominate profits, notably the Consumer Staples, Industrials, Energy, Real Estate, and Utility sectors. Concentrated state profits in these industries all contribute to the state capturing the lion’s share of profits across the economy.

An analysis of this trend over time is harder to perform due to the issue of survivorship bias. The historical data from firms that have delisted from stock exchanges (due to mergers or bankruptcy) are not reflected in the data set. Even with these limitations, a look back over the past decade is instructive. The private sector made slow but meaningful progress, capturing a greater share of profits up until around 2020, as shown in Figure 5. Coinciding with Xi Jinping’s crackdown on private firms and the property market collapse, the progress of private firms has stalled.

Sources: Bloomberg; Wind Information; Seafarer.

Profits and Power

Why are corporate profits such an important indicator of state power in China? First, profits are a crucial financial resource. The control over a significant portion of corporate profits provides state firms with substantial funds that can be directed toward reinforcing state control. The most direct way this occurs is through consolidation among state companies. The Chinese government directs profitable state companies to use their resources to consolidate with weaker state companies, ensuring that struggling state firms do not go bankrupt. In other situations, Beijing will recycle the dividends it receives from profitable state firms towards other political priorities.

Second, the concentration of state profits reveals where competition is most restricted. On a level playing field, private companies will outcompete state companies and capture profit from them. There is a wealth of studies that confirm that private companies are substantially more efficient than their state competitors.⁴ Therefore, large, persistent profits by state firms occur when private firms are prevented from competing. Competition can be restricted through monopolies, unfair regulatory treatment, or subsidies to state firms. From the profit data, we can infer that large swathes of China’s key industries remain protected from private competition.

Third, the profit data unmasks the continued domination of state financial institutions over the allocation of capital. While China has gradually liberalized its financial system and state banks have become more efficient, the profit data cast doubt on how significant these reforms have been. How market-oriented can a financial system be when private financial institutions are largely non-existent? The heavy role of state banks in controlling the allocation of credit has led to a large-scale misallocation of capital in the Chinese economy. State banks perform “national service” by lending according to Beijing’s directives, including bailing out struggling industries and financing political priorities such as the Belt and Road Initiative. All these activities distort the flow of capital from going to the most productive areas of the economy.

State Takeover of the Property Market

It is revealing to examine how these dynamics of state control play out in a specific industry, and the turmoil that has engulfed property developers is a good example. In late 2020, Chinese regulators announced a policy for property developers called the Three Red Lines. Property developers’ access to financing would be conditional upon meeting prudential guidelines related to their liabilities to assets, net debt to equity, and cash to short-term debt.

In theory, the Three Red Lines did not discriminate between private and state developers. In practice, however, they revealed the not-so-hidden contours of state control. After the policy was implemented, the real estate sector entered a dramatic slowdown that persists to this day. Most of China’s large private developers have gone bankrupt, while most state developers remain standing. Many private developers went bust for good reasons, such as Evergrande and Country Garden, which were notorious for their highly leveraged balance sheets and dubious business practices.

However, the data reveals something broader. It was not just the “bad egg” private developers that went bankrupt. The Three Red Lines had a severe impact on almost all private developers, even those in healthy financial condition. Figure 6 shows how 46 listed property developers with public bonds outstanding in 2020 have fared, and how many of the Three Red Lines they violated at the time.

Sources: UBS; Seafarer.

Unsurprisingly, private developers with multiple violations went bankrupt. However, many private developers, even those with only one violation or none, also went bankrupt. In fact, only three out of a total of 32 private developers in this group escaped default. In contrast, none of the state developers went bankrupt, even those with multiple violations. Mixed ownership developers, those with large state investors, have also generally fared better. One recent example is Vanke, whose largest shareholder is the Shenzhen government, which recently received a substantial bailout that has thus far prevented it from defaulting.

The real estate development industry is now in the midst of a slow-motion takeover by the state. Private developers are shutting down or being acquired. State developers, bolstered by policy support and better access to credit, are consolidating the industry. The profits, severely diminished compared to several years ago, now overwhelming go to the state.

Conclusion

The core problem in the Chinese economy is the unfair treatment of the private sector. Xi Jinping and other Chinese officials are right to pledge greater support for private companies. In fact, the Chinese government is currently drafting the Law of the People’s Republic of China on Promoting the Private Economy. The law contains many of the same promises that have been made for years, including equal legal treatment, opening more industries to private investment, better access to credit for private companies, and a crackdown on unfair behavior like SOEs delaying payments to private firms.

What should a careful observer look for to see if China has truly changed its approach to the private sector? If these reforms are successful, it may take years for the effect to be fully reflected in the profit data. Instead, the early indicators will be industry-by-industry developments that indicate space being made for private companies.

A necessary first step will be for the government to stop bailing out poorly performing SOEs. Much of the private sector’s progress over the past several decades has been through displacing inefficient SOEs. Since 2015, it has been much harder for this process to occur as the Chinese government has been set on saving weak SOEs by merging them into ever-larger state conglomerates. If failing SOEs are not forced out of the market, the space for the private sector to grow and expand will be severely constrained.

An even more meaningful indication of change would be signs of private competition in areas of the economy that have been previously walled off from private firms. These industries are predominantly, but not exclusively, in the service sector. For example, will private firms be allowed to challenge China UnionPay’s de facto monopoly on bank cards? Will the restrictions that limit the growth of China’s small private banks be removed? Will China permit a privately-owned airline to take market share from the state airlines? Will Beijing allow the enormous state energy firms to face private competition? Will a private telecom provider be allowed to compete with China Mobile, China Telecom, and China Unicom?

Until these signs of change are apparent, China’s private sector problem will remain unresolved. The distortions in favor of state companies are deeply embedded within the structure of the Chinese economy and cannot be solved with a speech or even a new law full of incremental changes. The real solution requires the Chinese government to allow, and perhaps even encourage, underperforming state companies to be displaced by the private sector. Such a change would be a dramatic, albeit unlikely, step towards getting the Chinese economy back on track.

The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect Seafarer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.

As of December 31, 2024, securities mentioned in this commentary comprised the following weights in the Seafarer Overseas Growth and Income Fund: Alibaba Group Holding, Ltd. (2.3%). As of December 31, 2024, the Seafarer Funds did not own shares in the other securities mentioned in this commentary. View the Top 10 Holdings for the Seafarer Overseas Growth and Income Fund and the Seafarer Overseas Value Fund. Holdings are subject to change.

1. Some public enterprises have been manually reclassified by the author when it is clear that there is a de facto state or private controlling shareholder.
2. Based on the author’s calculation of the member companies of the Bloomberg China Large, Mid, and Small Cap USD Index. Profit data is from Wind Information.
3. Based on the author’s calculation of the member companies of the Bloomberg China Large, Mid, and Small Cap USD Index and the Bloomberg U.S. 3000 Index. Profit data is from Wind Information and Bloomberg.
4. For example, see Jurzyk, Emilia, and Cian Ruane. “Resource Misallocation Among Listed Firms in China: The Evolving Role of State-Owned Enterprises” International Monetary Fund, March 12, 2021.