Competitive Neutrality of State-owned Enterprises in China's Steel Industry: A Causal Inference on the Impacts of Subsidies

Abstract

This study investigates whether subsidies to state-owned enterprises (SOEs) in China's steel industry are distorting competitive neutrality. The Subsidy and Countervailing Measures Agreement of the World Trade Organizations defines ''specific'' and ''harmful'' subsidies as being subject to discipline, because they distort the allocation of resources. During the recession in the steel industry between 2008 to 2015, China produced excessively and exported aggressively at a lower price. This study hypothesizes that subsidies given by local governments to specific SOEs with undefined conditions softened the budget constraints of these SOEs and that the market equilibrium price would have been lower had no subsidy been provided. Using data from the financial statements of listed steel and iron firms and other relevant sources, I find that firms with operating deficits received subsidies that were large enough to compensate for their deficits. This preferential treatment of these specific SOEs induced them to engage in price cutting behavior, harming competitiveness in the market.

Cross border investment by state-owned enterprises

“…These characteristics -larger size, lower propensity to purchase existing assets and inclination to enter agreements with other firms -confirm the validity in the steel sector of some generally held expectations about state-owned enterprises. In particular, the preference for greenfield investment seems to be consistent with the larger need (Cuervo Cazurra et al, 2014, p. 935 [6]) and practice (Tham and Yeoh, 2020, p. 7 [10]) to engage in investment activity aimed at increasing the legitimacy of a foreign state-owned investor in a target jurisdiction. Building a new plant and increasing employment is likely to be better perceived than acquiring assets that the host jurisdiction may consider strategic.…”

“…9 As no single known data source contains all of the aforementioned information, the necessary data were compiled from primary and secondary research, and by leveraging four existing data sets. 10…”

“…Building a new plant and increasing employment is likely to be better perceived than acquiring assets that the host jurisdiction may consider strategic. Similarly, joining other firms in a cross-border deal may help ease concerns of foreign control of strategic assets (Cuervo Cazurra et al, 2014, p. 935 [6]; Tham and Yeoh, 2020, p. 7 [10]).…”

“…Based on the broad differences between state-owned and non-state owned enterprises, a concern surrounding state-owned enterprises is that their link to the state may distort competition (via the advantages they receive) with steel producers in the jurisdiction receiving the cross-border investment, or that state-owned enterprises may export overcapacity to the jurisdiction targeted by the investment or indeed both (Tham and Yeoh, 2020, p. 7 [10]).…”

“…Additionally, the targeting of regions that are geopolitically relevant but have volatile demand growth may have implications for excess capacity. As greenfield investment is carried out in those economies, should their steel demand grow insufficiently to absorb the additional capacity, excess capacity may arise in those economies (Tham and Yeoh, 2020 [10]).…”