Introduction: The Factory as Society

In 1978, the Chinese State-Owned Enterprise (SOE) was not merely an economic unit; it was a total social institution. Known as the danwei (work unit), the factory provided its workers with everything from the cradle to the grave: housing, healthcare, education, subsidized food, and even funeral services. Employment was permanent—the legendary “Iron Rice Bowl” (tiewan).

While this system guaranteed social stability and high equality, it was economically moribund. SOEs operated under what Hungarian economist János Kornai famously termed the “soft budget constraint.” Because the state captured all profits and covered all losses, efficiency was irrelevant. Managers were administrators, not entrepreneurs; their goal was to fulfill the plan quotas set by Beijing, not to innovate or cut costs. By the late 1970s, this industrial ossification was the primary drag on China’s modernization.

The reform of the SOEs proved to be the “hardest nut to crack” in the Chinese economic transformation. Unlike agriculture, which could be reformed by simply retreating and letting families farm, industrial reform required dismantling a complex web of pricing, employment, and social welfare obligations. The journey from the all-encompassing danwei to the modern, corporatized SOE was a tumultuous process involving dual-track pricing, massive asset restructuring, and the traumatic displacement of the industrial working class.

Expanding Autonomy: The “Power Release” (1978-1984)

The initial phase of industrial reform mirrored the logic of the rural reforms: decentralization. The leadership recognized that the hyper-centralized Soviet model stifled initiative. The solution was fangquan rangli—”devolving power and yielding profits.”

Beginning with pilots in Sichuan province in 1978 (under Zhao Ziyang), the state began to allow select factories to retain a small percentage of their profits for worker bonuses and reinvestment, rather than remitting 100% to the state treasury. This was the first crack in the monolith. It introduced a radical concept: the factory had interests distinct from the state.

This was formalized in 1984 with the “Factory Director Responsibility System.” Previously, the Party Secretary was the supreme authority in the factory. The new system attempted to shift power to the Factory Director, making him responsible for profit and loss. It was an attempt to separate ownership (state) from management (technocratic), theoretically allowing market signals to guide production decisions while keeping the assets in public hands.

The Dual-Track Price System: Growing Out of the Plan

However, autonomy was meaningless if managers couldn’t buy raw materials or sell products at realistic prices. The Soviet-style command economyCommand Economy Full Description:An economic system in which production, investment, prices, and incomes are determined centrally by the government rather than by market forces. It represents the antithesis of free-market capitalism. In a Command Economy, the “invisible hand” of the market is replaced by the “visible hand” of the state planning committee (Gosplan). The state dictates what is produced, how much is produced, and who receives it. There is no competition, and prices are set by decree to serve political goals rather than reflecting scarcity or demand. Critical Perspective:While theoretically designed to ensure equality and prevent the boom-bust cycles of capitalism, in practice, it created a rigid, inefficient bureaucracy. Without price signals to indicate what people actually needed, the economy suffered from chronic shortages of essential goods and massive surpluses of unwanted items. It concentrated economic power in the hands of a small elite, who enjoyed special privileges while the masses endured stagnation and hardship.
Read more set prices by fiat—often keeping energy and raw materials artificially cheap to subsidize heavy industry.

To solve this, China innovated the “Dual-Track Price System” (shuangguizhi) in the mid-1980s. This was a masterpiece of gradualism.

1. The Plan Track: Factories were still obligated to produce a certain quota of goods (steel, coal, cloth) to be sold at the low, state-fixed price.
2. The Market Track: Once the quota was met, the factory could produce surplus goods and sell them at the fluctuating market price.

This allowed the market to emerge at the margin without disrupting the existing supply chains that kept the cities fed and heated. Over time, the “plan” portion was kept static while the “market” portion grew with the economy. As Barry Naughton described it, China “grew out of the plan.”

While economically brilliant, the dual-track system was socially explosive. It created massive opportunities for arbitrage. Officials with access to goods at the low “plan” price could illegally resell them at the high “market” price. This corruption, known as guandao (official profiteering), fueled inflation and public anger, becoming a primary grievance driving the 1989 Tiananmen protests.

The Contract Responsibility System (1987-1992)

Following the political freeze of 1989, the government attempted to stabilize SOEs through the “Contract Responsibility System.” Similar to the rural reforms, factory directors signed multi-year contracts with the state, promising to deliver a fixed amount of tax and profit. Anything earned above that could be kept.

This boosted output, but it degraded the state’s fiscal capacity. Managers became adept at hiding profits or stripping assets to pay huge bonuses, knowing their tenure was short. By the early 1990s, the SOE sector was in a death spiral. Nearly two-thirds of SOEs were operating at a loss, kept alive only by “policy loans” from state banks. They had become “zombie firms,” absorbing national capital to produce goods nobody wanted, creating a massive buildup of bad debt that threatened to bankrupt the entire financial system.

The Hard Landing: “Grasp the Large, Let Go of the Small”

In the 1990s, Vice Premier (and later Premier) Zhu Rongji initiated the most brutal and decisive phase of reform. Recognizing that the state could no longer afford to support the entire industrial sector, Zhu formulated the policy of Zhua da fang xiao—”Grasp the large, let go of the small.”

1. Let Go of the Small: Thousands of small and medium-sized SOEs (tanneries, breweries, local machinery shops) were privatized, sold to their managers, merged, or simply allowed to go bankrupt. The state effectively withdrew from the competitive sectors of the economy.
2. Grasp the Large: The state concentrated its resources on a strategic core of massive enterprises in critical sectors: energy, telecommunications, banking, and defense. These were restructured into modern corporations, modeled on Western conglomerates and South Korean chaebols.

The Human Cost: Xiagang and the End of the Danwei

The necessary corollary to this restructuring was the destruction of the Iron Rice Bowl. From 1995 to 2002, China undertook one of the largest labor shedding programs in history. Approximately 30 to 40 million SOE workers were laid off.

To soften the blow, the government invented the euphemism xiagang (“stepping off the post”). Xiagang workers were technically not unemployed; they retained a nominal link to their unit and received a tiny stipend for a few years. In reality, they were cast into a market for which they were unprepared.

The psychological shock was profound. These workers had been the “masters of the country,” the celebrated proletariat. Overnight, they became the new urban poor. The danwei system crumbled—schools and clinics were spun off or privatized, and housing was sold to occupants. The social contract of the Maoist era was shredded. While mass protests occurred (the “rust belt” of Manchuria was particularly volatile), the state managed to contain them through a combination of payouts, repression, and the sheer speed of the transition.

Corporatization and the Rise of “National Champions”

For the survivors—the “Large” that were “Grasped”—the reform era culminated in corporatization. Under the Company Law of 1994, SOEs were converted into shareholding corporations. The state remained the majority shareholder, but minority stakes were listed on the Shanghai, Shenzhen, and Hong Kong stock exchanges.

This created the modern “State Capitalism” model. Entities like PetroChina, China Mobile, and the State Grid are not the clunky factories of 1978. They are massive, often profitable (due to monopoly positions), and aggressive multinationals. They operate under the oversight of SASAC (State-owned Assets Supervision and Administration Commission), created in 2003 to act as the shareholder for the central government.

Conclusion: The Hybrid Economy

SOE reform in China was not a linear transition from plan to market, but a metamorphosis of the state’s economic role. The state retreated from micromanaging the price of shoes and toothpaste, only to consolidate its control over the commanding heights of finance and infrastructure.

The reforms achieved their primary goal: efficiency. The loss-making dinosaurs are largely gone, replaced by a mixed economy where the private sector provides the dynamism and jobs, while the reformed SOE sector provides the infrastructure and strategic control. However, this success was purchased at an immense social cost, borne primarily by a generation of workers who were sacrificed on the altar of modernization. The “Iron Rice Bowl” is shattered, replaced by the porcelain bowl of the market—finer, more efficient, but easily broken.

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Historiographical Note

1. The “Growing Out of the Plan” Thesis
Barry Naughton is the central figure here. His work argues that China’s success was due to the lack of “shock therapy” (rapid privatizationPrivatization Full Description:The transfer of ownership, property, or business from the government to the private sector. It involves selling off public assets—such as water, rail, energy, and housing—turning shared public goods into commodities for profit. Privatization is based on the neoliberal assumption that the private sector is inherently more efficient than the public sector. Governments sell off state-owned enterprises to private investors, often at discounted rates, arguing that the profit motive will drive better service and lower costs. Critical Perspective:Critics view privatization as the “enclosure of the commons.” It frequently leads to higher prices for essential services, as private companies prioritize shareholder returns over public access. It also hollows out the state, stripping it of its capacity to act and leaving citizens at the mercy of private monopolies for their basic needs (like water or electricity).
Read more). By using the dual-track system, China allowed market institutions to develop organically around the planned economy until they eventually overshadowed it. This contrasts sharply with the “Big Bang” approach urged by Western advisors in Eastern Europe.

2. The “Soft Budget Constraint”
The theoretical framework provided by János Kornai remains essential. Scholars like Edward Steinfeld (Forging Reform) applied this to China, arguing that early reforms failed because they changed incentives without changing property rights—managers had autonomy but no bankruptcy risk. Steinfeld argues the real change only came when the budget constraints were hardened in the late 1990s.

3. The Sociology of Labour
Scholars like Ching Kwan Lee (Against the Law) and William Hurst (The Chinese Worker after Socialism) have shifted the focus from economic efficiency to social trauma. They document the “politics of survival” among laid-off workers, challenging the narrative of a smooth transition. They highlight the regional disparities: the transition was easier in the dynamic coast than in the decimated rust belt of the Northeast (Dongbei).

4. State Capitalism vs. Marketization
Recent scholarship by Yasheng Huang and Nicholas Lardy (Markets Over Mao) argues that while the 1980s were a period of true liberalization, the post-2000s (and especially the post-2012 era) have seen a “state advance, private sector retreat” (gu jin min tui). They posit that the reformed SOEs have become predatory monopolies that crowd out private innovation.

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Further Reading

• Naughton, Barry. Growing Out of the Plan: Chinese Economic Reform, 1978-1993 (Cambridge University Press, 1995).
  • The definitive technical account of the dual-track system and early industrial reform. Essential for understanding the mechanics of how the market was introduced without collapsing the plan.
• Steinfeld, Edward S. Forging Reform in China: The Fate of State-Owned Industry (Cambridge University Press, 1998).
  • Focuses on the crises of the 1990s. Steinfeld explains why early half-measures led to asset stripping and the “hospitalization” of firms, necessitating the radical surgery of the Zhu Rongji era.
• Hurst, William. The Chinese Worker after Socialism (Cambridge University Press, 2009).
  • A compassionate and rigorous look at the millions of xiagang workers. Hurst analyzes how different regions managed the layoffs and why some areas exploded in protest while others remained quiet.
• Lardy, Nicholas R. Markets over Mao: The Rise of Private Business in China (Peterson Institute, 2014).
  • Lardy provides a counter-narrative to the “state capitalism” view, arguing (at least until 2014) that the private sector was the true driver of growth and that SOEs had become less important than assumed.
• Dic Lo. Market and State in China’s Transition (Routledge, 2024 – Classic reprint or similar relevant recent analysis recommended for updated context).
  • (Alternatively, works by Yingyi Qian on “federalism, Chinese style” provide excellent context on how local governments managed these enterprises).