CHAPTER 6

Sustainable Capitalism and State Capitalism: China’s Path

Overview

The U.S. model of free-market capitalism played a dominant force in the Cold War against communism, which set the agenda for economic governance and development until the financial crisis of 2008. The future of the world economic order becomes more uncertain with new challenges from alternative economic models, including models of capitalism adopting more state control as practiced in Brazil, Russia, India, and, especially, China. China is experiencing strong growth by embracing globalism and revamping the core principles of free-market capitalism. Meanwhile, the state still actively manages economic growth, including the deployment of industrial policy and financial and regulatory tools to foster industrial catch-up and technological development. China maintains state ownership of key enterprises, including the financial sector.

While China’s so-called “state capitalism” practice certainly challenges the free-market status quo, it is worthwhile to examine whether such a path offers viable ways to organize capitalist production and market institutions, triggering any deviation in the global policy consensus (McNally 2013).

State Capitalism and China’s Historic Remarkable Growth

SOE and the “Vertical Structure.”

The term “state capitalism” has various meanings, but it is usually characterized by the dominance of a significant number of state-owned enterprises (SOEs) and active involvement in the employment of industrial policy and financial and regulatory tools by the state. Major emerging economies all experience some form of state capitalism, usually referred to as a hybrid system, in which the state is controlling an essential share of the economy while the private sector mainly operates in the free market.

In China, the market-oriented reforms started in 1978 and established a “socialist market economy with Chinese characteristics,” which led to a fast expansion of the private sector, but SOEs remained an essential part of the economy. Li, Liu, and Wang (2015), through their research, proposed a “vertical structure” to describe a crucial unique feature of China’s state capitalism. In such a “vertical structure,” SOEs have monopolized key upstream industries, including financial, telecommunication, and energy sectors, and also have continually consolidated this power through management transfer and government-arranged mergers. Meanwhile, downstream industries include manufacturers of consumer goods, and service sectors, such as retailing, have been liberalized and mostly open to private competition. The key upstream sectors are still mainly controlled by the state, while the downstream industries operate under capitalism.

When competitive non-SOEs expanded due to productivity growth and factor accumulation in the market-driven downstream industries, it generated a higher demand for intermediate goods and services (such as energy and financial products) monopolized by the SOEs in those upstream industries. Therefore, even without any productivity and efficiency improvement, the upstream SOEs flourished more than the non-SOEs in the competitive downstream sectors through rent extraction. Furthermore, the enhanced trade liberalization symbolized by China’s entry to the World Trade Organization (WTO) in December 2001 created more external demand for the downstream tradeable, which ultimately enabled upstream SOEs to extract even more rents in the process of globalization (Li et al. 2015). “Vertical structure” offers a perfect description of China’s unique state capitalism model. It also provides a good explanation of the rapid growth of Chinese economy without taking the U.S. type of free-market capitalism approach.

To examine closer China’s “vertical structure,” China’s SOEs system is based on “vertically integrated groups” of large state-owned and related companies. Each group has a ”central holding company,” named the State-Owned Assets Supervision and Administration Commission (SASAC), which is the majority shareholder as a “core company” of the country. The individual group, in turn, owns a majority of shares in the state-owned companies that comprise the group, usually including a finance company that provides cash management and financing resources to group members. Altogether, these some 120 vertically integrated groups control SOEs that are all subject to government control via SASAC. According to Lin and Milhaupt (2011), total SOE assets accounted for 62 percent of China’s GDP in 2010. There are also intragroup linkages via alliances, joint ventures, and cross-shareholding. Besides, the Chinese Communist Party (CCP) structure exists parallel to the “vertically integrated groups” structure. The Organization Department of CCP is decisive in selecting top executives of the SOEs, and in turn, some SOE executives hold positions in government and the CCP. Even the most prestigious senior executives of China’s SOEs are cadres first and company men second, who naturally care more about pleasing their party bosses than about the market and customers. Besides, financial institutions controlled by the state also impact the SOEs through their financing resources, which are mainly loans from the state-owned banks in China. There are more than one chain of command from top to bottom as implied by this structure shown in Figure 6.1: “These hierarchical structures are embedded in dense networks—not only of other firms but also of party and government organs, and exchange and collaborate on many matters of production and policy implementation” (Lin 2017).

Figure 6.1 A network anatomy of Chinese state-owned enterprises (SOEs)1

The implications of this system for a market competition run very deep. SOEs are generally exempt from antitrust enforcement. As the Economist observed, the Chinese government “enforces rules selectively, to keep private-sector rivals in their place,” and firms controlled by foreign capital can be blocked from acquiring local firms. The ongoing expansion

of the state sector of China’s economy limits the growth potential of the private sector. It also favors SOEs over foreign companies in some domestic markets (Lubman 2012).

It is vital to understand past, present, and future of China’s “vertical structure” and many links between state ownership and the SOEs through “vertically integrated groups.” Both have been playing critical roles in China’s state capitalism.

World’s Factory and Growth Powerhouse

Thanks to the unique “vertical structure” and China’s access to the global market after the “Open Door Policy” announced in 1978, China experienced 10.2 percent annual growth rate averaged from 1983 to 2012 (Figure 6.2) and has become the world’s second-largest economy next to the United States since 2010.

Figure 6.2 China’s annual GDP growth from the year 2000 to 2017 compared to the world and the United States2

Having experienced a lengthy process of negotiations, China entered the WTO in 2001. Soon after that, from 2003 to 2007, China’s exports were growing at an annual rate of more than 25 percent, and in some years peaked at 35 percent. In 1990, China’s exports accounted for only two percent of the world’s exports and its manufacturing industry made up only three percent of the world’s total. Less than two decades later, in 2017, China produced half of the global manufacturing output, and its exports jumped to 14 percent of the world’s total. China surpassed the United States to become the world’s largest international merchandise trader in 2013. After another two years, it replaced the United States as the top exporter in the world in 2015 (Figure 6.3) and won the name of the “world’s factory” to reflect China’s essential position in the global market (Cheng 2018).

Figure 6.3 Exports of goods and services (current U.S.$). China has been in a rapid catch-up mode to surpass the United States since it joined the WTO in 20013

China has been viewed as the largest contributor and powerhouse of world economic growth since the global financial crisis in 2008. Recently, even its projected slower GDP growth remains impressive by the global and U.S. standards (Figure 6.2).

Rebalancing of the Economy with Challenges

China is entering a new chapter of its remarkable development story, undergoing an economic transition to slower but, hopefully, more balanced and sustainable growth. As Figure 6.2 demonstrates, China’s GDP growth has been on course to gradually decline since 2010 as the economy went through structural adjustments toward a “new normal.” GDP growth was at 7.8 percent in 2013, 7.3 percent in 2014, and 6.9 percent in 2015, indicating that growth has already fallen from the rapid growth period of 1983 to 2012 (World Bank Group 2017).

The future of China’s “world’s factory” is also facing uncertainty. Primarily, the “world’s factory” was built upon its low costs to keep it competitive. However, these costs gradually and inevitably grew over time and weakened the country’s fundamental comparative advantage to compete on a global scale. Through its “vertical structure,” upstream-inefficient SOEs monopolized energy and financial sectors with higher prices to extract rent, both central and local governments imposed heavy taxes, and the strong exchange rate of the Chinese currency Yuan (CNY), all contributed to the rising costs.

The recent trade war between the two largest economies of the world, the United States and China, gives the “world’s factory” another blow. China needs advanced technology for its manufacturing activities, but it can’t solely rely on its own research and development. In the past, China resorted to forcing technology or intellectual property transfer or using illegal ways to get new technologies in a short amount of time, which became a cause of the U.S.–China trade dispute. The trade war will potentially lower Chinese products’ market share in the United States. It may eventually result in the decline of China’s status of the “world’s factory” (Cheng 2018). China and its sustainability in the future are facing multiple challenges, especially in the following areas.

Limitations on SOEs’ Rent Extraction Model

One side effect of China’s “vertical structure” is that, although the strength of SASAC’s control over the firms it oversees may vary in practice, insiders exercise control in each SOE, which causes fragile corporate governance. Shareholders have no control of the firms and no voice in corporate affairs and cannot access the courts in China. Limited transparency means that corporate misgovernment is easy to happen and conceal (Lubman 2012), which results in an overall lower return on assets (ROA) compared to private enterprises all the time. The gap has been widening since the 2008 financial crisis (Figure 6.4).

A recent economic transition with a much slower growth rate and external tensions would cause the “vertical structure” unstabilized. China’s downstream private industries are losing the momentum due to the shrinking global market and disinvestment of foreign companies. They will be strangled by the upstream SOE monopoly and lose international competitiveness if upstream SOEs fail to lower mark-ups and improve productivity. Meanwhile, the rise of domestic wages endogenously to a high enough level with industrialization would only make things worse (Li et al. 2015). In reality, ROA of both China’s state and private industrial firms started to decline after 2011 (Figure 6.4). SOEs underperformed with much lower ROA (2.9%) versus private firms (around 10%) in the most recent years. Overall, the rent extraction model used to benefit upstream SOEs is hard to continue. However, based on the political considerations, China decided to strengthen the state control in its economy through “trustworthy” SOEs, which led to the recent increase of the share of SOEs’ fixed-asset investment since 2015 (Figure 6.5), though SOEs’ ROA kept decreasing (Figure 6.4). Both internal weakness and external threats make the sustainability of China’s “vertical structure” debatable.

Figure 6.4 Return on assets of China’s state and private industrial firms, 1996–2016

Source: China NBS

Figure 6.5 The SOEs started to increase their share of fixed-asset investment after 2013

Source: CEIC, The Economist

Environmental and Public Health Challenges

Another challenge is from the rapid growth of the “world’s factory” itself. Manufacturers in the developed markets are expected to comply with specific basic guidelines concerning health and safety regulations, protection of the environment, and wage and hour laws. Chinese factories are known for not strictly following most of these rules and guidelines, even in a permissive regulatory environment. Chinese factories have long shift hours, and the workers are not provided with proper compensation and insurance. Some factories and construction companies even have policies where the workers are paid only once a year, a way to keep them from quitting their jobs before the year is out. Environmental protection laws are routinely unenforced, especially when local government weighs current tax income more than the long-term environmental sustainability. Therefore, as a common practice, Chinese factories cut down on waste management costs, which result in severe air and water pollution. According to a World Bank report, 16 of the world’s top 20 most polluted cities were in China in 2013.4 China’s CO2 emissions (kg per PPP $ of GDP) in manufacturing and service have been much higher than the world average and roughly double the level of the United States, though it has been reduced significantly since 1990 (Figure 6.6).

Figure 6.6 CO2 emissions (kg per PPP $ of GDP)5

China is also on top of the total CO2 emissions list (Table 6.1), which ranks as number one in the world and accounts for 27.2 percent of global emissions and almost double the United States at the second place in 2017.

Table 6.1 Where most of the world’s CO2 emissions come from, sorted by country6

Rank	Country	Emissions in 2017 (MtCO2)	% of global emissions
#1	China	9,839	27.2%
#2	United States	5,269	14.6%
#3	India	2,467	6.8%
#4	Russia	1,693	4.7%
#5	Japan	1,205	3.3%
	Top 15	26,125	72.2%
	Rest of World	10,028	27.7%

A direct consequence of such massive CO2 emissions is its negative impact on air quality and public health. As shown in Figure 6.7, China suffered at an annual death rate of 117 per 100,000 population caused by air pollution in 2018, which put it on an embarrassing top five list despite its achievement as the world’s second-largest economy.

Figure 6.7 Air quality has a significant impact on public health

Source: World Health organisation; Statista; Health Effects Institute, State of Global Air 2018

Climate change resulting from CO2 emissions is also anticipated to increase the risks of natural catastrophes. In fact, China is one of the countries most affected by natural disasters, especially earthquakes, drought, and flooding, and its poor and vulnerable are disproportionately hurt because they often live in high-risk areas (World Bank Group 2017).

The environmental challenge becomes a top priority issue on China’s current agenda and becomes a direct threat to its future development.

Capital Investment and Financial Distress

Financial resources are indispensable to cope with the challenges of SOEs’ “vertical structure” and the environmental threat that China is facing. Unfortunately, China’s investment-driven growth model makes its overlevered financial market itself another big challenge. There are risks from China’s significant stock of accumulated debt and the possible growth in recent years due to a disorderly deleveraging of the economy. The increase in corporate and local government leverage in China since the global financial crisis in 2008 has been hasty (Figure 6.8). The lessons learned from other emerging markets suggest that such rapid rises in the credit-to-GDP ratio are often ensured by slower economic growth and potential financial crisis. The slowing economic growth, the piled-up corporate and local government debt, the decline in corporate profitability, and ROA, together with overcapacity in specific sectors, have raised concerns about the overall credit quality in China (World Bank Group 2017).

Furthermore, China’s economic growth is expected to drop more due to the lower contribution from labor as China’s working-age population is expected to decrease. Also, total factor productivity (TFP) growth is expected to be lower as the massive reallocation of resources, including labor, within the economy is expected to decline. China will need to transform to a new growth model based on advanced technology and higher productivity, which will require reversing the declining contribution to growth from TFP (Figure 6.9). The projected TFP growth could remain relatively high by international standards, depending on the extent of structural reforms that promote market competition and upgrading of technologies (World Bank Group 2017).

Figure 6.8 China’s gross debt exploded to almost three times its GDP with the biggest increase in the nonfinancial corporations7

Source: IIF © FT

However, China’s GDP growth is still heavily reliant on capital investment (Figures 6.9 and 6.10), which is, by far, the number one driver of its economic development. The investment-driven model would only make things worse to increase financial distress and create a dilemma for the already over levered situation.

Figure 6.9 Growth accounting for China

Source: World bank Calculations and China NBS

Figure 6.10 China’s demand became even more dependent on investment8

Source: Haver Analytics © FT

“New Normal” and “Green Growth”

To respond to China’s tough challenges, the Chinese government, with the vast resources under its control, is supposed to play the most critical role in developing new strategies. In May 2014, President Xi Jinping introduced the term “New Normal” to describe an economy with lower but more efficient and equitable growth. The specific path of “New Ideas, New Thoughts, New Strategies on State Governance” are reflected in China’s 13th Five Year Plan (FYP) 2016–2020. In order to transit to the “New Normal,” the state is committed to promoting innovation and further opening up structural reforms, streamlining bureaucracy, implementing stricter environment protection, and delegating power and resources to lower levels of governments.

To deal with the sustainability concerns, the Chinese government comes up with another solution called “Green Growth,” which can be defined as maximizing economic growth and development while stopping

rising trends in natural resource use, CO2 emissions, and environmental degradation. Clearly, the government seeks a transition to green growth with lower greenhouse gas emissions. “New Normal” and “Green Growth” emphasized by the 13th FYP for 2016 to 2020 reflects a shift in China’s growth model from the “world’s factory” to pursue high rates of return while promoting environmental sustainability and making investments in “greening” growth (World Bank Group 2017).

World Bank Group (2017) also offered its own solution and issued The Systematic Country Diagnostic (SCD) for China identifying the key challenges and opportunities for China to achieve the “Twin Goals of ending extreme poverty and boosting shared prosperity in a sustainable manner.” Table 6.2 provides a summary of China’s SCD prepared by the World Bank Group.

Table 6.2 China’s Systematic Country Diagnostic (SCD) priorities and potential reforms identified by the World Bank Group9

SCD Priorities	Potential Reforms
Manage the transition to a slower but more balanced and economically sustainable growth.	• Structural reforms may require accepting slower growth now to establish the basis for a more balanced and sustainable growth in the future. • Promote market competition and the private sector by reducing market constraints and ensuring level playing fields. • Address the significant stock of debt in the financial and corporate sectors. • Strengthen local government fiscal and debt management capacity, including by enhancing fiscal transparency. • Promote greater innovation in the economy, including by strengthening intellectual property rights, expanding basic research, and helping firms strengthen their managerial capacity.
Address the economic and social instability that may result from the economic transition.	• Address the economic and social losses that may result from the industrial restructuring planned by the government, through targeted temporary income support, active labor market programs, and robust social security programs.
Reduce the disparity in access to quality public services.	• Address remaining barriers to migration by continuing to reform the hukou system to reduce the bias against migrants in urban areas. • Make the intergovernmental fiscal systems (transfers) more progressive, and rebalance the intergovernmental allocation of revenues and expenditures. • Address the large disparities in public spending on education to equalize education opportunities for the poor, including for early childhood education, and implement a quality assurance system. • Improve the availability of affordable quality health care in rural areas and strengthen health insurance for the poor. • Provide stronger incentives and enhanced supervision for local governments to focus on service delivery, beyond the current dominant focus on investments and growth.
Improve farm productivity and efficiency in rural areas, thereby reducing the income gap with urban areas.	• Establish more efficient and sustainable climate-smart agricultural production systems with green ecology–oriented agricultural subsidies. • Promote rural land transfers, greater farm scale, and the specialization and professionalization of agricultural operations. • Promote the application of new technologies, such as information communication technologies and ecommerce platforms, to the agriculture sector.
Make fuller use of market mechanisms to promote green growth and more efficient, sustainable use of natural resources.	• Continue to pursue market reforms to promote competition in the energy markets and expand the use of market instruments to manage pollution and climate change. • Strengthen the focus on environmental sustainability in the cadre management system, including by clarifying the acceptable tradeoffs with economic growth. • Adjust resource and energy prices, including the tax regime, to fully reflect environmental costs. • Mobilize private sector financing and encourage private sector participation in pollution cleanup and restoration. • Strengthen the governance and institutions for the environment, including with regard to the monitoring and enforcement of environmental laws and regulations. • Improve the availability of critical environmental ­information.

“New Normal” and “Green Growth” as the state-level strategies set a clear tone for China’s future path toward sustainable development under state capitalism.

Ongoing SOE Reforms with More Determined Directions

In state capitalism, the future direction of the “vertical structure” is vital to the success of China’s new sustainable development strategies. In November 2013, CCP, the actual decision maker of the state, after affirming the continued importance of SOEs in the economy to provide public goods and promote strategic industries, including natural and financial resources, military security, and technology, announced the transformation of China’s SOEs as part of a wide-ranging economic and social reform program in the following areas:

1. Boosting efficiency and commercial orientation. The announced SOE reform plans highlight ownership diversification and the reorganization of state-owned capital investment and operating companies. According to the announcement, government functions of SOEs would be separated from enterprise management, and numerous state-owned capital investment companies and operating companies would be established by founding new entities and regrouping existing ones. In July 2014, the SASAC, which supervises the central SOE groups, announced that six SOEs had been selected for a pilot program to deepen mixed-ownership reform, to increase private ownership in SOEs.
2. Ensuring a more level-playing field. In China’s transition to a more market-driven economy, it will take well-designed and implemented actions to ensure a level-playing field, which would put greater competitive pressures on incumbent firms, including SOEs, to raise their productivity. In China, a level-playing field means fair and transparent treatment between enterprises with or without state ownership. Relevant reforms could include requiring a market rate of return on state equity capital and removing perceived government-implicit guarantees of SOE borrowing. It could consist of equal access to land, natural resources, and government subsidies as well as equal treatment in regulations, tax, government procurement, and administrative approvals. As part of this effort, in 2016, the State Council issued an opinion on the establishment of a fair competition review system, which mandates competitive assessment of policy measures and scrutiny of monopolistic conduct by the Anti-Monopoly Law.
3. Establishing a sound modern corporate structure and corporate governance. The mixed-ownership reform is expected to increase the role of private stakeholders in SOEs and is designed to increase the transparency of the decision-making process and improve management skills at the executive level.

The overall direction of SOE reform is moving toward a more market-driven model with diversified ownership to raise capital and improve corporate governance. Meanwhile, how successful can China reform its SOEs while maintaining SOEs’ upstream position in the “vertical structure” is worth further observation.

Take the Lead on Renewable Energy

To deal with the urgent environmental threats, as a commitment made at the state level, China’s Nationally Determined Contribution (NDC) targets a cut in the country’s CO2 emissions per unit of GDP by 60 to 65 percent from 2005 level by 2030.

Based on World Bank estimates, China already spends approximately 1.2 percent of its annual GDP on environmental protection each year, mostly on industrial pollution. China is anticipated to reduce environmental degradation and resource depletion by six percent of gross national income (GNI) by 2030, which indicates a significant improvement (World Bank Group 2017). Such a large scale of investment surpassed any countries and regions in the world in 2013 and reached its record high of $132.6 billion in 2017 (Figure 6.11), which resulted in the development of renewable energy in China attracting global attention in recent years.

Figure 6.11 China takes the lead on renewable energy in terms of total investment

Source: Bloomberg New Energy Finance

As another critical effort of CO2 emissions reduction, electric and plug-in hybrid vehicles are growing fast, with a current global fleet of 5 million battery electric vehicles and plug-in hybrid cars as of 2019. Again, China has led the world with its number of electric and hybrid vehicles delivered since 2016. In 2018, its electric and hybrid a concise deliveries were roughly four times the United States (Figure 6.12).

Figure 6.12 Global plug-in deliveries of BEV and PHEV10

* BEV, battery electric vehicle; PHEV, plug-in hybrid car. The chart refers to light vehicles.

At present, China also leads the world renewable energy production in terms of wind and solar power capacity. With large-scale industrial applications, renewable energy costs have fallen substantially. Looking at the history of photovoltaic (PV) technology: the price of PV modules decreased from about 30 Yuan (Chinese currency) per watt in 2007 to about 10 Yuan in 2012, and further reduced to just 2 Yuan by 2017. In 2012, China’s installed capacity of solar and wind power was only 3.4 GW and 61 GW, respectively, while the annual electricity generated by renewables was 2.1 percent of China’s total consumption. By 2017, China’s solar and wind power capacity increased to 130.06 GW and 168.5 GW, respectively, and the share of renewables was growing to 5.3 percent of China’s electricity supply.

Figure 6.13 Implementation of China’s debt-to-equity swap program from 2017 to 2019

Source: State Council of China: National Development and Reform Commission of China; China Banking and Insurance Regulatory Commission

The successful development of China’s renewable energy fully illustrates the effectiveness of China’s approach to on-grid tariff subsidies offered by the government. The on-grid tariff policy, through which the government can make renewable energy production more competitive and attractive to businesses and investors, shows its advantage to anchor the revenue of power generation throughout the entire life cycle. By taking China’s approach, government subsidies convey a clear price signal to investors and can adequately support the early-stage development of renewable energy (Lin 2018).

State capitalism demonstrated the advantage of its capability to put in huge investment and subsidies with support from the state government and achieve astounding results in a very short period in addressing environmental issues with effective solutions, such as electric vehicles and renewable energy.

Debt-to-Equity Swap and Green Investment

Overlevered excessive debts burden the Chinese financial system as a serious threat that the Chinese government has labeled as one of its “three critical battles” (which refer to the battles against major risks in the Chinese economy, the other two named poverty and environmental pollution) to sustain economic growth and stability. Utilizing its unique strength of state capitalism, the Chinese government developed a plan to slow the growth of new lending and reduce the existing bank loans through multiple approaches that include the debt-to-equity swap program.

In the debt-to-equity swap program, not only the state-owned banks but also more private enterprises are getting involved as equity investors in some heavily indebted state-owned enterprises to reduce their debt ratio. The share of executed swaps involving private firms, though still relatively small as 6.5 percent of all signed swap contracts (24 of the 367 signed contracts) in April 2019, significantly grew from 1.2 percent (1 of 81 signed contracts) at the end of September 2017.

According to the recent data released by the State Council, the swap program has expanded in scale since 2017. By the end of April 2019, 40 percent of the signed swap deals by value have been executed. It indicates good progress in the swap program, which is a leap forward from 14 percent at the end of 2017 (Figure 6.13).

According to the State Council’s Opinions on Vigorously, Steadily and Properly Reducing Corporate Leverage Ratios announced in October 2016, besides the debt-to-equity swap program, the following approaches are listed as primary tools to address the high leverage issue:

1. Promoting mergers and restructuring of enterprises;
2. Modernizing corporate governance and strengthening self-regulation;
3. Revitalizing existing corporate assets;
4. Optimizing debt structure of enterprises;
5. Implementing corporate bankruptcy; and
6. Expanding equity financing.

Again, with intervention from the state, a set of tools are implemented to address the challenge of excessive debt. Although the latest data shows that China’s implementation of the debt-to-equity swap program has improved, the program has done little to curtail the overlevered situation. China is constrained by its policy of not letting market forces play a truly decisive role in pricing the swaps. Without such a capability, the Chinese government and its swap program may still not be able to win this chosen battle (Huang 2019).

Besides its effort of deleveraging the economy, a new direction of capital investment initiated by the Chinese government is “The Belt and Road Initiative (BRI),” which was proposed by China in 2013. BRI is expected to mobilize tens of trillions of dollars for much-needed infrastructure development in emerging market economies (Figure 6.14). According to the World Bank, approximately 70 percent of global greenhouse gas emissions come from the construction and operation of infrastructure, which includes power, transportation, and buildings. As the BRI-related countries will host most of the world’s new infrastructure constructions in the coming decades, if the Paris Agreement goals are to be reached, it is crucial that these projects are green and low carbon.

Figure 6.14 The Belt and Road Initiative involving infrastructure development and investments in Asia, Europe, Africa, and the Middle East11

In November 2018, the Green Finance Committee of China Society for Finance and Banking and the City of London’s Green Finance Initiative jointly launched a set of voluntary principles, the Green Investment Principles (GIP) for the BRI. Other significant contributors to the drafting of these GIP include the World Economic Forum, UN-supported Principles for Responsible Investment network, the Belt and Road Bankers Roundtable, the Green Belt and Road Investor Alliance, and the Paulson Institute. The GIP document calls for lenders, investors, and corporates that invest and operate in the BRI region to ensure the projects they invest are aligned with the requirements of the Paris Agreement and environmental sustainability. The GIP proposed to incorporate ESG metrics into the corporate governance of related firms. Recommended practices include utilizing green financial instruments, measuring and releasing environmental and climate information, and adopting green supply chain management.

As of the end of June 2019, 29 global institutions, including all major Chinese banks engaged in the BRI countries and some of the largest financial institutions from the related nations, have signed up to the GIP. By doing so, the signatories are fully committing to sustainability and demonstrating their ESG responsibility for the emerging world. The GIP will also create a win-win situation by bringing benefits to its signatories and supporters, giving them better access to innovative green investment products and opportunities for cofinancing green projects in the rapidly growing BRI region and best practices in environmental and climate risk management (Jun 2019).

China is using its state-controlled resources to fight two battles at the same time to deleverage through debt-to-equity swap program and to make a new green investment through the BRI. Both are hard to imagine and have very little chance to be successful without the strength of its state capitalism system.

Conclusion

As a fast-growing emerging economy, China is facing similar yet unique challenges in its path toward sustainable development. China attempts to cope with its challenges with a system different from free-market capitalism adopted by the United States. China has been implementing a “socialist market economy with Chinese characteristics,” which, indeed, is a state capitalism system in which the state is actively managing economic growth and capital and resource allocation.

China developed its unique “vertical structure” benefiting SOEs and, recently, “New Normal” and “Green Growth” strategies to explore its way of sustainable capitalism under state control. It managed to make some progress, especially the impressive ones in electric vehicle deliveries and renewable energy production.

It may look like China has a way out. However, it is still too early to judge whether China’s state capitalism path is a better approach leading toward healthy prosperity and sustainability over the long run.

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