Provincial Snapshot—Liaoning: How a Rust Belt Province Stagnated and Why it Matters to China

A recent Chinese report on how to rejuvenate the economy of Jilin, one of the three provinces of China’s northeastern rust belt, has rekindled interest in the question of why this region has underperformed. In fact, China’s northeast has been stagnating for so long that Beijing began mooting plans to rejuvenate the area as far back as 15 years ago.

The new report argues that the root cause of the region’s stagnation is its preponderance of heavy industry. It recommends introducing more light industries, like textiles, in an effort to revitalize the region’s economy.

Yet this conclusion, especially since it is contained in a report commissioned by the province itself, is controversial. And no wonder: the region’s problem isn’t just a surfeit of heavy industry and a dearth of light industry but also a number of other problems that can be seen across China, even in the country’s most prosperous provinces. The region is actually a microcosm of the kinds of necessary structural reforms that have yet to be implemented across China. But looking deeply at the northeast is instructive because the debilitating effects of inaction on reforms have been made worse in these rust belt provinces because of the preponderance of state-owned enterprises (SOEs) and an unusually poor business climate.

To see how these two factors—SOEs and business climate—can make policy stasis worse, it’s useful to zero in on one of the region’s three provinces and then dig deeply—to show how reform choices taken or not taken can affect economic performance. I’ve chosen Liaoning, a neighbor of Jilin, which commissioned the abovementioned report.

Liaoning, Jilin, and a third northeastern province, Heilongjiang, are similar in culture, geography and their large stock of SOEs, so conclusions about Liaoning, which has an economy 50% larger than its two northeastern neighbors, can be applied to the region as a whole (see Figure 1).

This is the first in a series of provincial snapshots of Liaoning that I will post on Two Fen; all are intended to draw out lessons and their implications for China writ large. This post looks at the causes of Liaoning’s stagnation. Subsequent posts will look at its consequences and other aspects of what has gone wrong in the province, with an eye to China’s future economic policy choices.

Figure 1. Northeast SOEs Employ Many More People than the National Average
Source: National Bureau of Statistics.

Why Liaoning Matters to the Nation

Many of the economic illnesses in Liaoning are problems that China as a whole will need to overcome to avoid the so-called “middle-income trap”—that is, the failure of a developing country to achieve the status of a high-income country. And the two most nationally relevant of these challenges are the problem of SOEs and the business environment.

Prior to the launch of China’s economic reforms in 1978, Liaoning had one of the largest SOE sectors in the country. In 1980, just two years after Deng Xiaoping launched the reform program, SOEs accounted for a staggering 82% of Liaoning’s industrial output (smaller collectively-owned firms accounted for the rest). The SOE share of the province’s output has declined since then, a result of both the inefficiency of the SOEs themselves and Beijing’s strategy of “grasping the large, letting go of the small,” which permitted the privatization of smaller SOEs even as the state continued its support for the larger ones. As a result, SOE assets became concentrated in so-called “strategic” sectors (see Figure 2).

Today, however, Liaoning’s remaining SOEs—those that the government “grasped” tightly 20 years ago—are in trouble once again. The average debt to equity ratio of Liaoning SOEs is currently more than 50% higher than the level in the decade of the 2000s, suggesting that the financial situation of the province’s SOEs is even more fragile than before the last round of reforms.

Figure 2. Composition of Liaoning’s SOEs Based on Operating Income
Note 1: Operating income is the difference between revenue and expenses of the main business.
Note 2: Strategic sectors include areas like petrochemical, auto, steel, and utilities. 
Source: 2016 Statistical Yearbook of Liaoning.

But SOEs are not the only problem in Liaoning. Another, which can also be seen across the country as a whole, is the problem of an oppressive business environment. In the World Bank’s Doing Business index, China is currently ranked 78th, right below Tunisia. Yet even among its fellow upper middle-income countries—countries whose Gross National Income per capita is between $3,956 and $12,235—China currently only ranks 24th out of 51 countries. At a national level, Beijing has made improving China’s business environment a top priority. The high profile “free trade zone” experiment that was initially launched in Shanghai but now includes 11 cities is really an effort to improve business conditions, not just an exercise in the promotion of “free trade.” In the past two years, the General Office of the Chinese Communist Party, which is the party’s highest organ, has issued multiple documents on the imperative to improve the business environment.

And yet within China, perhaps no region has a worse reputation for its investment environment than the northeast. And in Liaoning, this poor reputation has been compounded by the relatively frequent occurrence of high-profile company defaults. Over the last few years, an expression frequently heard among Chinese businesspeople and investors is, “Never invest north of Shanhaiguan”—the Shanhaiguan Pass being a major geographic marker in the Great Wall of China, with Liaoning lying immediately north of this pass.

In Liaoning, therefore, the twin national level problems of poorly performing SOEs and a debilitating business environment are more concentrated, compared to the national average. And previous efforts to tackle these two problems in the province have proved unusually ineffective, offering insights and lessons that can be applied to China as a whole.

Stagnation and Ineffective Rescues

So what’s gone wrong with Liaoning’s efforts?

As the biggest and most industrialized of the three northeastern provinces, Liaoning once had the strongest economy in all of China. By 1978, Liaoning’s industrial output accounted for 10% of the national total. At that time, Liaoning’s economy was the third-largest provincial economy nationwide, and was only marginally smaller than that of Shandong and Jiangsu, both of which had populations far larger than Liaoning. This is why, during the planned economy era, Liaoning was widely seen as the strongest economy in the country.

And yet the fate of Liaoning and the northeastern area as a whole turned downward soon after China began to reform its economy in 1978. The country as a whole benefited from the new economic freedoms, but Liaoning and the northeast began to experience a long decline relative to their peers. To be sure, Liaoning’s economy still managed a decent pace of growth, with the regional economy and per capita GDP both increasing more than 10 times since 1978. However, Liaoning’s average growth rate has been significantly lower than the national average, and its share of the national economy has dropped from 6.3% to 3% to become only the 14th largest provincial economy (see Figure 3). In 1978, Liaoning’s economy was 20% larger than Guangdong’s, but the latter subsequently became the poster child of China’s vibrant market economy. By 2016, Liaoning’s economy was only about one third the size of Guangdong’s.

Figure 3. Liaoning’s Declining Weight in China’s National Economy
Note: The GDP numbers for the period of 2010-2015 have not been included because there is strong evidence that the figures for those years were manipulated.  
Source: National Bureau of Statistics.

The first national level plan to rejuvenate the northeast was released by the central government in 2003. A small leading group—a kind of interagency coordinating structure—led by then Premier Wen Jiabao and composed of more than 20 ministers of key government agencies was formed in December that year. This group still exists and is currently headed by Premier Li Keqiang. In addition, the National Development and Reform Commission, China’s most powerful economic planning agency, has established a division dedicated solely to revitalizing Liaoning and the two other northeastern provinces. Most recently, in 2016 Beijing released another plan to revitalize the region with 1.6 trillion yuan (~$240 billion) worth of investment.

However, despite Beijing’s efforts, the northeast generally and Liaoning in particular continue their relative decline. Last year, the Liaoning provincial government was caught manipulating GDP and fiscal revenue figures. After the data was revised, the official size of Liaoning’s economy was reduced by more than 20%. Using the new statistics, Liaoning currently accounts for just 3% of China’s national GDP, while the ratio was, ironically enough, higher at 4.4% when Beijing began its attempts to revitalize this region. The other two northeastern provinces have fared only slightly better. The combined economic weight of these three provinces in the national economy has dropped from 9.3% to 7% during the same period. The ineffectiveness of Beijing’s 15-year effort to revitalize this area suggests that, so far, Beijing hasn’t found an effective strategy.

Here, in sum, are the reasons Liaoning stagnated:

• The conventional explanation that the province has an overconcentration of heavy and aging industry is on point, but an insufficient explanation.
• Liaoning could have dealt with its SOEs through further rounds of privatization or other ownership reforms but instead compounded its SOE problem when the local government repeatedly meddled in the economy. Even SOE reform alone is no longer sufficient, then, to revitalize the local economy.
• Liaoning needed fundamental improvements in the local business environment but the most important of these would be to place substantive checks on government meddling in the economy. Not only did the local government continue to meddle but it also made things worse for the business climate by trying to revitalize the region through investment, which led to rising bad debts and an economic crash.

Can the new report’s recommendations for neighboring Jilin—for example, that fostering light industry will “fix” the province—make a major difference there or in Liaoning? I think not. Without SOE corporate governance reform and decisive steps to improve the investment climate, the report’s recommendations will not ultimately bring fundamental change to the northeast economy.

With this clearer picture of the causes of stagnation and the kind of reforms that will be needed to reverse it, subsequent posts in this “Provincial Snapshot” series, will dig into the consequences of what is happening in Liaoning, including demographic challenges and problems of industrial structure.