A Legal Theory of State-Owned Enterprises

State-owned enterprises (SOEs) remain dominant in some sectors even after large-scale privatization. The usual explanations point to ideology, political economy, or economic efficiency. Those explanations matter, but they do not fully explain the Chinese case. 

A better explanation starts with law. State ownership persists in some sectors because governing firms through law is sometimes more costly than governing them through ownership. Where legal institutions are weak, incomplete, or unreliable, state ownership can become a practical substitute for rule-based governance. The real issue, then, is not just whether the state wants to own firms. It is whether the legal system can support private ownership at an acceptable cost. Privatization often means legalization, not liberalization. Even after privatization, the state frequently continues to regulate private enterprises, and the shift from public to private ownership requires drawing and enforcing the boundaries between public power and private property at significant social cost. 

Most debates about privatization treat state ownership as an independent variable and ask whether state ownership is associated with inefficiency or worse performance. But a more basic question remains: what affects state ownership and private ownership as dependent variables? One useful way to think about this problem comes from the transaction-cost tradition and from later law-and-economics work on incomplete contracts, opportunism, and institutional choice. In settings where law is incomplete, enforcement is expensive, adjudication is unreliable, and regulatory commitments are hard to make credible, private ownership can generate large regulatory costs. Under those conditions, state ownership may survive not because it is ideal in principle, but because it lowers the total costs of governance. 

This reframes the debate over SOEs. The central tradeoff is not between state ownership and markets in the abstract. It is between the higher ownership costs of SOEs and the regulatory costs of governing private firms through law. Those regulatory costs include the costs of lawmaking, enforcement, and the opportunistic behavior of both the government and private actors under conditions of uncertainty, bounded rationality, and asset specificity. They operate through both supply-side and demand-side channels: they can make governments reluctant to privatize, and they can also deter private investment where the legal and regulatory environment is too uncertain or too weak to sustain credible commitments. 

A further implication, and one that existing studies do not sufficiently highlight, is that stronger property rights are not a free lunch. The point is not simply that stronger protection can make regulation harder. The deeper point is that the effects of regulation on private property are reciprocal in nature. Government regulation imposes costs on private firms, but avoiding those harms by strengthening protection for private firms also imposes costs on the state’s regulatory flexibility and on the public interests that regulation is meant to protect. The harm caused by public regulation on private enterprises is reciprocal. Once that is recognized, the policy problem is no longer just how to strengthen property rights. It is how to reduce regulatory costs without undermining credible commitments or necessary policy adjustment. 

Legal protection for private firms is also hierarchical. It is stronger in some sectors and weaker in others. That variation reflects the intensity of regulatory goals, the strategic importance of a sector, and the institutional cost of limiting state intervention. Evidence from compensation cases in administrative litigation suggests that private firms receive weaker practical protection in sectors where regulatory goals are pressing and the risks created by legal incompleteness are especially high. That pattern closely tracks the uneven persistence of state ownership. The legal system does not protect all private firms equally. It protects them hierarchically, and that hierarchy helps shape who remains private, who becomes private, and where the state continues to own. 

Courts matter here for a reason that goes beyond ordinary dispute resolution. The sustainability of private participation depends in part on whether courts can distinguish legitimate regulatory adjustment from opportunistic state conduct and whether they can make legal commitments more credible. Where that happens, private participation becomes more durable. Where it does not, private ownership becomes much harder to sustain. This is especially visible in the Public-Private Partnership (PPP) context, where more independent courts are associated with stronger protection for private investors and lower state ownership shares. 

Corporatization should also be understood more carefully. The corporate form can perform important finance and governance functions: limited liability, entity shielding, delegated management, transferable shares, and investor ownership. But those functions do not operate in the same way in the SOE context. Where the government remains the dominant shareholder, where creditors monitor differently, and where bankruptcy constraints are weak, some of the usual advantages of the corporate form are more limited. Corporatization can therefore facilitate financing and organizational restructuring without amounting to a full transition away from state ownership. It changes legal form, but it does not by itself eliminate the institutional reasons for state ownership or collapse the spectrum between state and private ownership. 

The larger point is that SOEs are best understood not only as economic actors or political instruments, but also as organizational responses to the limits of law. Their persistence reflects more than policy preference or inefficiency. It reflects the cost of using law as a substitute for ownership.  

This post draws on the author’s recent book, A Legal Theory of State-Owned Enterprises: The China Experience, published by Cambridge University Press. 

James Si Zeng is Associate Professor of Law at the University of Hong Kong.