Factories Without Profits: How China’s Leaders Keep the Lights On to Avoid Unrest
China’s economy, a juggernaut that transformed the nation into the world’s manufacturing powerhouse, now faces a delicate balancing act. President Xi Jinping’s government is grappling with a paradox: how to eliminate unprofitable, inefficient firms to curb overcapacity and deflation while preserving jobs to avoid social unrest. This tension, rooted in the nation’s slowing $19 trillion economy, has left policymakers navigating a landscape where industrial losses are at their highest since 2001. The stakes are high, as mass layoffs could erode public support and destabilize a system that prioritizes social stability above all else. Drawing from scenes of struggling factories and the broader economic context, it’s clear that China’s approach to its “zombie” firms—those kept alive by subsidies and loans—reflects both the resilience and fragility of its economic model.
According to the latest report by Bloomberg News, the heart of this challenge is a factory like Shaanxi Qinyang Changsheng Brewing Co., a 69-year-old liquor plant in northwestern China. Here, workers manually label bottles of baijiu, the nation’s beloved spirit, in a process that seems out of step with China’s high-tech ambitions. The firm, unprofitable since 2020, employs 300 workers, including some under a government poverty alleviation program. Megan Xiao, the 35-year-old daughter of the company’s chairman, captures the human cost of potential closure: “If we shut down, our workers will lose their income and won’t be able to receive a pension. Closing would cause huge social problems for our area.” Her words reflects a reality replicated across China, where local officials and company owners prioritize job preservation over efficiency, even as firms like Shaanxi Qinyang churn out goods in an oversaturated market.
This reluctance to let failing firms die stems from a deep-seated fear of social unrest. Neil Thomas, a fellow for Chinese politics at the Asia Society Policy Institute’s Center for China Analysis, explains, “Unemployed individuals are seen as having less to lose from protesting and so pose a greater risk.” This fear is not abstract; the 2022 nationwide protests that forced Xi to abandon the Covid Zero policy demonstrated the Communist Party’s sensitivity to public discontent. With manufacturing accounting for one-fifth of China’s workforce—more than double the share in the United States, according to Deutsche Bank AG—layoffs could quickly sour the public’s support for Xi’s defiant stance against external pressures, such as the tariff showdown with the United States. Even after a truce reduced U.S. tariffs from 145% to 30%, exports to the U.S. have dwindled, imperiling millions of jobs.
China’s current predicament contrasts sharply with its reforms in the 1990s, when Premier Zhu Rongji shuttered thousands of inefficient state-owned enterprises. Those tough measures, though painful, paved the way for a decade of double-digit growth by attracting foreign investment and boosting efficiency. However, today’s landscape is different. The industries plagued by overcapacity, such as solar, electric vehicles (EVs), and lithium-ion batteries, are often driven by private firms, not state-owned enterprises, limiting Beijing’s direct control. Moreover, national security concerns, heightened by competition with the U.S., have made stability a top priority, reducing tolerance for disruptions caused by mass layoffs. The result is a proliferation of zombie firms, with consultancy firm Kearney estimating a 27% surge in such companies in 2023, though they represent only 3.4% of all firms.
The case of Dayun Automobile Co. in Yuncheng, Shanxi, illustrates the complexities of this issue. Once a thriving truck manufacturer, Dayun pivoted to EVs after sales peaked in 2017, aiming to produce premium sedans marketed as Chinese Bentleys. But in China’s hyper-competitive EV market, with 140 brands vying for dominance and fewer than 20 expected to be profitable by decade’s end, according to consultancy Alixpartners, Dayun struggled. Its prospectus from a failed 2020 IPO attempt reveals heavy reliance on government support: one-third of its trucks were sold to a Yuncheng government-owned firm, tax benefits accounted for over 10% of profits, and EV subsidies between 2017 and 2018 equaled a fifth of its earnings. Despite this backing, Dayun faced cashflow issues, leading to a court-ordered restructuring in November after downsizing half its staff. Yet, it continues to produce trucks, buoyed by local belief that “the government would never allow” it to fail, as Zhao Xinzheng, a former Dayun salesman turned diner owner, asserts.
Zhao’s broader observation about China’s economy—“Once people discover a good industry, they swarm in and eat up the profits at lightning speed”—points to a structural issue: “involution-style competition.” This term, popularized online, describes the destructive cycle of overwork and diminishing returns caused by excess capacity. Both Xi and the premier pledged in March to address this problem, but local incentives complicate reform. Bureaucrats are evaluated primarily on economic growth, encouraging them to attract investment and offer tax breaks or subsidies, even when these prop up unviable firms. Last year, China’s State Council introduced rules banning such preferential policies without higher approval, and top officials urged banks to cut credit to zombie firms. Yet, inertia persists, as local officials prioritize stability and revenue over efficiency.
Shanxi, a province littered with abandoned coal mines, exemplifies these challenges. Nearly 40% of its industrial firms recorded losses last year, almost double the national average. As Beijing shifts investment from infrastructure and real estate to advanced manufacturing, provinces like Shanxi have embraced the “new three” energy industries. But Shanxi’s inland location raises costs for importing components and exporting goods, and its supply chain lacks competitiveness, as Zhao notes. Dayun’s highway toll exemptions and financial rewards for setting up in Shanxi highlight the government’s role in distorting market dynamics, yet these measures couldn’t save the firm from restructuring.
The legal system further complicates efforts to wind down failing firms. Wu Jian, a senior partner at Zhonglun W&D Law Firm in Beijing, explains that convincing courts to accept bankruptcy cases is difficult because judges are held accountable for maintaining social order. A 2021 legal paper notes that court officials must visit protesters’ homes to resolve complaints, with failure during major government events risking penalties like demotion. This contributes to what Louis Kuijs, chief Asia-Pacific economist at S&P Global Ratings, describes: “Defaults and bankruptcies are remarkably rare in China, compared to other economies.” While China has improved its bankruptcy system—tripling concluded cases from 2020 to last year with specialized courts—these courts number only about 100 out of over 3,000 nationwide, limiting their impact.
The economic fallout of preserving zombie firms is significant. Excess production fuels deflation at home and prompts anti-dumping tariffs abroad, from Europe to Latin America and the U.S. A yearslong property crisis has made consumers thriftier, reducing demand for goods already in oversupply. Meanwhile, the labor market is weakening, with platforms like Zhaopin Ltd. quietly ceasing to provide wage data, a sign of growing sensitivity to economic discontent. David Li Daokui, a Tsinghua University economics professor and policy adviser, proposes a quota system to restrict output in overcapacity industries, allowing firms to sell quotas to competitors and incentivizing exits. Such a system could align local and central priorities, but implementing it against entrenched bureaucratic interests remains a challenge.
At Shaanxi Qinyang, Chairman Xiao Yuxiang is adapting to survive, planning a non-alcoholic rice wine to appeal to younger, sober consumers and comply with new rules banning alcohol at government functions. Yet, he too calls for more state intervention, suggesting licenses for liquor producers based on job creation and tax contributions to curb competition and allow weaker firms to exit. His frustration is palpable: “So far we don’t see any determination from the government to solve the problem. The economy’s improvement will probably depend on the timing and strength of such resolve.” His words reflect a broader sentiment that Beijing’s resolve, while rhetorically strong, faces practical hurdles in execution.
China’s leadership stands at a crossroads. The 1990s reforms showed that bold action can yield long-term gains, but today’s economic and geopolitical context demands a different approach. Shutting down unprofitable firms risks mass layoffs and unrest, threatening the social stability that underpins the Communist Party’s legitimacy. Yet allowing zombie firms to persist drains resources, exacerbates deflation, and undermines healthy competitors. Xi’s government must navigate this tightrope, balancing the immediate need for jobs with the long-term imperative of economic efficiency. The scenes at Shaanxi Qinyang and Dayun reflect not just the struggles of individual firms but the broader challenge of reforming an economy that has outgrown its old playbook. Whether Beijing can muster the resolve to act decisively, as Xiao urges, will shape China’s economic trajectory for years to come.