BEIJING - Shortly after the Communist Party took power in China, capitalists in Shanghai paraded through the streets with drums and flags, asking the Party to take over their businesses.

On Thursday, the Party will celebrate the 60th year of its rule over mainland China, having mostly abandoned its Marxist ideals for socialism with Chinese characteristics -- a messy mix of competitive capitalism and political monopoly.

The party is now deeply entwined in the economy, giving Beijing a remarkable amount of leverage over bank lending and sectors such as telecommunications and energy, but impeding further structural and political reform.

Close ties between the Party and business paves the way for reforms like stock listings, where government and state-owned enterprise (SOE) interests are aligned, but tend to obstruct changes that reduce the power of the Party.

Overall, China's heavy reliance on the state sector prevents the private sector from growing, hence limiting the growth of China's urban middle class, said Wang Zhengxu, senior research fellow at the University of Nottingham's China Policy Institute.

The urban population's income depends more heavily on the state ... preventing the growth of state-challenging attitudes.

SOEs are clawing back a bigger role, turning the tide after market-oriented reforms of the 1980s and 1990s allowed the private sector to flourish and reduce Party influence.

The state sector accounts for 30-40 percent of economic output, down from about 80 percent in the late 1970s, estimates Arthur Kroeber of Dragonomics in Beijing.

But over the last year, consolidation favoring SOEs, especially in steel, and the choice to keep the yuan currency essentially unchanged against the dollar, show a reassertion of control at the expense of market forces.

The recent advance of SOEs in both the central and local level is an enormous drag on economic reform and has implications on the world, said Victor Shih, who teaches political science at Northwestern University near Chicago.

Faced with a soft budget constraint and a government with deep pockets, Chinese SOEs are making massive investment in multiple sectors, driving out both domestic and foreign competition across the board.

The global economic downturn gave cash-rich state firms a shot at prime overseas projects that suddenly lacked funding.

Meanwhile, although China's export-oriented private firms were hit hard, the country's 4 trillion yuan ($585.9 billion) stimulus package was largely funnelled through state-owned banks to sectors such as infrastructure where SOEs are strong.

The collapse of big Wall Street names helped discredit Chinese advocates of a more open economy, and gave voice to those praising the Chinese model where the state plays the lead role.


The Party's intimate ties with business ensured enthusiastic support for economic reforms after Deng Xiaoping's dramatic tour of southern China in 1992, when the wily pragmatist outwitted conservatives who had dominated policy since a crackdown on pro-democracy protesters on Tiananmen Square in 1989.
Following those early reforms, agriculture in China is now dominated by private firms. They also make the bulk of the light manufactured goods and textiles that drive China's exports.

The role of slippage in the state share of aggregate output has been fairly steady, Kroeber said.

But state planning bodies, and the Party, retain a strong grip on infrastructure, telecommunications and banking -- allowing lending to those the Party favours.

Local governments use local SOEs to borrow money from banks to support investment growth, Shih said.

Signs of the attempt to give a lift to SOEs have been more evident in the steel sector, where nimble and ruthlessly competitive private and hybrid firms have grown to account for 45 percent of output, according to Macquarie Research.

Rizhao Steel, one of China's most active private steel firms, was forcibly taken over this month by Shandong Iron and Steel, itself a product of a recent merger of two SOEs.

The demise of Rizhao was part of a drive to bring the private mills to heel, a goal dear to the former planning officials who run the China Iron and Steel Association.

In two other cases this summer, union-backed workers at small, failing SOEs fought off takeovers by private steel conglomerates.

In China, where there are no independent unions, union involvement implies the proposed sales displeased Party bosses. ($1=6.827 Yuan)

(Editing by Benjamin Kang Lim and Dean Yates)