How Reform Worked in China The Transition from Plan to Market Yingyi Qian The MIT Press Cambridge, Massachusetts London, England © 2017 Massachusetts Institute of Technology All rights reserved No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher This book was set in Palatino LT Std by Toppan Best-set Premedia Limited Printed and bound in the United States of America Library of Congress Cataloging-in-Publication Data Names: Qian, Yingyi, 1956- author Title: How reform worked in China : the transition from plan to market / Yingyi Qian Description: Cambridge, MA : MIT Press, [2017] | Includes bibliographical references and index Identifiers: LCCN 2017007623 | ISBN 9780262534246 (pbk : alk paper) eISBN 9780262342704 Subjects: LCSH: China Economic policy 2000- | Central planning China | Central-local government relations China | Federal government China | Decentralization in government China | Mixed economy China Classification: LCC HC427.95 Q2526 2017 | DDC 338.951 dc23 LC record available at https://lccn.loc.gov/2017007623 ePub Version 1.0 For my parents Table of Contents Title page Copyright page Dedication Acknowledgments Introduction: A New Perspective on Reform How Reform Worked in China I Dual-Track Market Liberalization Reform without Losers: An Interpretation of China’s DualTrack Approach to Transition Pareto-Improving Economic Reforms through Dual-Track Liberalization II Unconventional Ownership of Firms Institutional Environment, Community Government, and Corporate Governance: Understanding China’s TownshipVillage Enterprises Insecure Property Rights and Government Ownership of Firms Public vs Private Ownership of Firms: Evidence from Rural China III Government and Reform: Federalism, Chinese Style Federalism, Chinese Style: The Political Basis for Economic Success in China Federalism as a Commitment to Preserving Market Incentives Regional Decentralization and Fiscal Incentives: Federalism, Chinese Style IV Initial Organizational Conditions and Reform 10 Why China’s Economic Reforms Differ: The M-Form Hierarchy and Entry/Expansion of the Non-State Sector 11 Incentives, Information, and Organizational Form 12 Coordinating Reforms in Transition Economies Index List of Tables Table 1.1 GDP Growth Rates by Province (percent) Table 1.2 Growth Rates of GDP and GDP Components (percent) Table 1.3 Dual-Track Market Liberalization Table 1.4 Industrial Output Share by Ownership (percent of total) Table 1.5 The Correlations between Local Revenue and Expenditure Table 1.6 Currency Seigniorage and Implicit Taxation on Bank Deposits (percent of GDP) Table 2.1 The Dual Tracks in Grain (million tons) Table 2.2 The Dual Tracks in Agricultural Goods (% of output value) Table 2.3 The Dual Tracks in Industrial Goods (million tons) Table 2.4 The Dual Tracks in Retail Sales (% of sales) Table 2.5 The Dual Tracks in Non-Agricultural Employment (million employees) Table 4.1 China: Shares of Industrial Output Value by Ownership (1978–1993) Table 6.1 Summary Statistics of Variables Table 6.2 Ownership and the Institutional Environment—The Logit Model Table 6.3 Ownership and the Institutional Environment—the Logit Model Average TVE Shares and Ex Ante Provincial Characteristics Table 6.4 Ownership and the Community Government’s Objectives: The Government’s Revenue Table 6.5 Ownership and the Community Government’s Objectives: Non-Farm Employment and Per Capita Income Table 9.1 Summary Statistics of Major Variables (1982–92) Table 9.2 The Discrepancy between the Ex Ante Contracts and Ex Post Implementation Table 9.3 Extra Remittances vs Extra Subsidies Table 9.4 The Correlations Between Local Revenue and Expenditure Table 9.5 Fiscal Incentives and the Development of the Non-State Sector Table 9.6 Fiscal Incentives and the Reform of the State Sector Table 9.7 The Endogeneity Problem: Provincial Marginal Revenue Retention Rate Table 9.8 The Endogeneity Problem: Provincial Marginal Revenue Retention Rate Dummy Table 10.1 China: Selected Macroeconomic Indicators 1978–1991 Table 10.2 China: Annual Consumption Per Capita (kilogram) Table 10.3 China: Living Space Per Person (square-meter) Table 10.4 China: Consumer Durable Per 100 Urban Households (sets) Table 10.5 China: Consumer Durable Per 100 Rural Households (sets) Table 10.6 China: Share of Gross Industrial Output Value by Ownership Table 10.7 China: Average Annual Growth Rate of Rural Enterprises 1981–1990 Table 10.8 China: Share of Selected Industrial Products Produced By Rural Enterprises 1990 Table 10.9 China: Share of Rural Enterprises in the National Economy 1979–1990 Table 10.10 China: Share of Industrial Output as Percent of the Non-State Sector 1985–1990 Table 10.11 China: Composition of Rural Enterprises 1984–1990 Table 10.12 China: Expansion of Individual Business (million) 1981–1988 Table 10.13 China: Distribution of State-Owned Industrial Enterprises by Administrative Levels (1985) Table 10.14 Comparison of Size of Enterprises in China, Eastern Europe, the Soviet Union and the West, 1988 (Employment/Enterprise) Table 11.1 Comparing Industrial and Regional Variance and Conditional Variance (by Province) Table 11.2 Comparing Industrial and Regional Variance and Conditional Variance (by Large Region) Table 11.3 Provincial Ranking in Economic Performance and Political Position Household Responsibility System, 175 Hoxby, Caroline, 174 Individual business, 291, 292 expansion of, 324 Industrial and regional shocks, 345–350 Industrial concentration, 305 Industrial market liberalization, 31 share of gross output value by ownership, 322 SOE sector in, 55 Information and incentives in different organizational forms, 338–344 Institutionalized degree of durability in federalism, 206 Institutions best-practice, 23, 47–52 environment of TVEs, 109–110 flawed, 8, 10 menu perspective on, 23 New Institutional Economics perspectives on, 22–28 transitional, 26–27, 47–52 Investment and finance approval by community government, 106–107, 158n15 financing of, 116–119 Japan, 365 Jin, Hehui, 40, 41, 116, 119 Jurisdictional competition, incentive effects of, 242–244 Khrushchev, Nikita, 297 Kornai, Janos, 75, 238 Labor market Chinese federalism and, 224–225 liberalization, 31–32, 70–71, 82–84 organized export and import in Sichuan Province, 226 Li, David D., 42 Li, Hongbin, 254 Limited liability constraint, 137, 157n6 Li Peng, 219 Living space per person, 321 Local governments See also Community government; Provincial governments affiliation of enterprises, 301–302 binding budgets, 148–149 degree of integration of business projects, 158n10 equilibrium under ownership by, 141–146 ex post link between local revenue and expenditure in, 267–271 extra-budgetary funds, 214, 256–257, 302 fiscal relations between central and, 255–257 further decentralization along regional lines, 301–303 as helping hands or grabbing hands, 37 limited liability constraint, 137, 157n6 ownership as organizational response to state predation, 139–146 ownership of TVEs, 35–36 ownership protecting firms, 135 ownership versus state ownership, 156n1 revenue redistribution across localities by, 146–149 Macroeconomic indicators, 1978–1991, 320 Maddison, Angus, 1, 18 Mandatory retirement, 84 Mao Zedong, 300 Market liberalization dual-track approach to (see Dual-track approach to liberalization) industrial, 31 labor, 31–32 product, 79–82 Market-preserving federalism, 203–204, 237–239, 308 balance of power in, 207 decentralization in, 205–206 economic effects of, 208–209 political foundations of, 204–208 predictions following inception of, 209–210 predictions with incomplete, 210–211 success of Chinese reform and, 201–204 theory of, 204–211 Maskin, Eric, 121, 254, 308, 364 McKinnon, Ronald, 241, 244 Menu perspective on institutions, 23 M-form hierarchy, 288–290, 296, 333–335, 353–354, 362–363 See also Organizational forms; U-form hierarchy of China, 298–301, 344–345, 358n9, 363 commitment through decentralization, 308–309 coordination, experimentation, and organizational flexibility, 370– 377 coordination and parallel experimentation, 377–379 coordination in transition economies, 379–385 costs and benefits of, 304–310 decentralized coordination in, 306 direct effects on non-state sector, 310–314 dual-price system and, 315–316 economy of scale in, 305 entrepreneurship development, 312–313 experimental approach, learning, and institutional changes, 309– 310, 329n40 harder budget constraint for non-state enterprises, 311 horizontal relationship between regions and emergence of markets in, 311–312 incentives in, 307–308 industrial concentration in, 305 information and incentives in, 338–344 interactions with other reform policies, 314–316 lessons of, 316–320 model, 335–338 model of coordination, 365–369 open-door policy and, 314–315 responses to external shocks in roles of central and higher regional governments in, 313–314 specialization in, 305 success of agriculture reforms and Migrant population, 215, 224–225 Milgrom, Paul, 135, 308, 353, 354, 362 Murphy, Kevin, 71, 97 Musgrave, Richard, 237, 251 Naughton, Barry, 168–169, 176 Nee, Victor, 168 New Deal policies, 386–387 New Institutional Economics, 22 Non-state sector, 290–292 direct effects of M-form hierarchy on, 310–314 entrepreneurship development and use of local knowledge in, 312– 313 harder budget constraints and M-form hierarchy in, 311 horizontal relationship between regions and emergence of markets in, 311–312 roles of central and higher regional governments in growth of, 313– 314 in rural areas, 294–295 sustained entry and expansion of, 292–296, 327n19 North, Douglass, 238 Oates, Wallace, 237, 251 Oi, Jean, 170 Oksenberg, Michel, 261 One Economics, Many Recipes, 11 Open-door policy, 314–315 Organizational forms, 333–335 See also M-form hierarchy; U-form hierarchy application to China, 344–353 evidence on conditional variances of industrial and regional shocks in, 345–350 evidence on regional yardstick competition, 350–353 information and incentives with different, 338–344 model, 335–338 proofs of propositions, 354–357 Ownership, 131–135, 151–152 See also Property rights; TownshipVillage Enterprises (TVEs) categories, 125n1, 290–292 community government’s objectives and, 170–171, 184–187, 188– 189 construction of variables in examining, 174–178 distinctions between state and local government, 156n1 equilibrium under local government, 141–146 estimation method, 171–174 institutional environment and, 167–170 interpreting China’s experience with, 149–151 by local governments as organizational response to state predation, 139–146 private, 137, 139–140, 292 proof of propositions on, 153–156 provincial variation of, 178–184 revenue redistribution across localities and, 146–149 shifts between periods, 157n8 simple model, 135–139 state (see State-owned enterprises [SOEs]) theory of the firm and, 134 types of firm, 132–135 Parallel experimentation and coordination, 377–379 Pareto-improving reform, 64 conditions for, 75–78 through dual-track liberalization, 89–98 Partial reform schemes, 71–72 Paserman, Daniele, 174 Plan quality versus fully liberalized market equilibrium quantity, 66– 72 Plan quantity greater than fully liberalized market equilibrium quantity, 72–75 Political foundations of market-preserving federalism, 204–208 Political reform, 202–203 Private enterprises, 292 construction of variables in examining, 174–178 estimation method, 171–174 provincial variation of ownership, 178–184 in rural areas, 294–295 TVE ownership and community government’s objectives and, 184– 187, 188–189 Private ownership degree of integration of business projects, 158n10 as organizational response to state predation, 139–140 simple model, 137 Private sector, 292 emergence of, 295–296 Product market liberalization, 79–82 Property rights, 103, 131 See also Ownership interpreting China’s experience with, 149–151 proof of propositions on, 153–156 security of, 111–116, 151–152 Provincial governments See also Community government; Local governments assessing credibility of fiscal contracting system in, 267–271 development of non-state enterprises and reform in state enterprises and, 271–277 ex post link between local revenue and expenditure in, 267–271 fiscal relations between central government and, 255–257 Provincial variation of ownership, 178–184 Purchasing Power Parity (PPP), 1–2, 14, 18 Qian, Yingyi on coordinating reforms in transition economies, 364 on federalism, 254 on organizational form, 334, 344, 354 on public versus private ownership in rural China, 162, 169 on success of Chinese reform, 40, 41 on Township-Village Enterprises (TVEs), 116, 119 Ratchet effect, 308 Rawski, Thomas, 10 Recycling of goods through the market, 86n6 Redistribution, revenue, 146–149 Reform, Chinese economic, 56–58, 131, 361 after Tiananmen Square, 218–220 agriculture, 21, 316, 379–385 constraining the government without reducing its revenue in, 42–47 coordination (see Coordination, reform) Deng’s southern tour, 1992 and, 220–221 design attributes, 362 dual-price system, 315–316 dual-track approach to liberalization in, 28–32 fiscal incentives for regional governments and, 252–254 fiscal relations between regional and provincial governments and, 255–257 formal timeline of, 285 gradualism in, 287, 317–318 interpreting China’s experience with, 149–151 of large state-owned enterprises, 52–56 level of industrialization and, 287 non-conventional ownership form of TVEs in, 32–37 non-state sector in, 290–292 open-door policy, 314–315 perspectives on institutions in, 22–28 policies of further decentralization along regional lines, 301–303 productive fiscal federalism in, 37–42 rationalization and institutionalization, 1993–1994, 221–222 regional competitions, 357n2 success of, 17–22, 201–204, 285–286 from transitional institutions to best-practice institutions, 47–52 transition as path dependent, 318 transition economy and, 379–385 Reform, political, 202–203 Regional competitions, 357n2 Regional yardstick competition, 350–353 Regulation on Township and Village Collective Enterprises of the People’s Republic of China, 104 Research and development (R&D), 21 Retirement, mandatory, 84 Revenue redistribution across localities, 146–149 Riker, William H., 245 Roberts, John, 308, 362 Rodrik, Dani, 11 Roland, Gérard, 48, 354 Roosevelt, Franklin D., 387 Rural collectives, 291 Rural Credit Cooperatives (RCCs), 106 Rural enterprises average annual growth rate, 323 composition of, 324 defined, 290–291, 326n9 non-state sector, 294–295 share in the national economy, 323 share of selected industrial products produced by, 323 TVE ownership and, 184–187, 188–189 Russia See also Soviet Union, the fiscal incentives in, 40–41, 253–254 government fiscal revenue as share of GDP, 45–46 privatization of farming in, 385 U-form in, 364 Sachs, Jeffrey, 72 School of Chinese Characteristics, 3–7 School of Universal Principles, 3–6, Security of property rights, 111–116 interpreting China’s experience with, 149–151 Shleifer, Andrei, 25, 71, 97, 253–254 Single-track full market liberalization, 64 Sloan, Alfred, 334 Smith, Al, 387 Soviet Union, the See also Russia agriculture reforms in, 379–385 changes to U-form hierarchy of, 296–298, 364 comparison of size of enterprises versus China, Eastern Europe, and the West, 325 decentralization of, 208, 215, 319, 327n23 economic reform in, 285–288, 361 as giant U-form, 334, 345, 363 Specialization, 305 Start-up private enterprises, 103 State-owned enterprises (SOEs), 28, 140–141, 158nn13–14 See also Ownership; Property rights conversion of, 326n11 decline of, 149–150, 161 differences between TVEs and, 103, 165–166, 193n5, 242 distribution by administrative levels, 325 failure in reform of, 52–56 fiscal contracting system and, 38–39 as state sector, 290 TVEs’ harder budget constraints than, 119–122 versus local government ownership, 156n1 Stone Group, 326–327n13 Subnational governments in federalism, 205 Summers, Lawrence, 14, 18 Sustainability of federalism, 244–246 Tiananmen Square, reform and decentralization after, 218–220 Tiebout, Charles, 237, 239, 251 Tirole, Jean, 354 Tong, James, 261 Township, Village, and Private Enterprises (TVPs), 294–295 Township-Village Enterprises (TVEs), 9, 27, 32–37, 161–164, 190 bank lending to, 194n22 characteristics of the governance of, 108–109 China’s economic reforms and, 164–166 construction of variables, 174–178 definitions and data sources of variables, 190–192 differences between SOEs and, 103, 165–166, 193n5, 242 estimation method, 171–174 evolution of, 123–125, 327n17 federalism and case for, 217–218 harder budget constraints than SOEs, 119–122 imperfect institutional environment, 109–110 introduction to, 101–104 investment and finance, 106–107, 116–119, 158n15 lessons from, 122–123 as non-state sector, 294–295 ownership and community government’s objectives, 170–171, 184– 187, 188–189 ownership and the institutional environment, 167–170 privatization of, 49–50 provincial variation of ownership, 178–184 role of community government and governance of, 104–107, 162– 163 rural enterprise categories and, 125n1 security of property rights and selection and rewarding of managers of, 107 theories of, 107–111, 166–171 use of after-tax profits for public expenditure in, 107, 126n8, 150– 151 Trade barriers, 215–216 Tragedy of the commons, 217 Transitional institutions, 26–27 becoming best-practice institutions, 47–52 Transition economies, reform in, 379–385 Triesman, Daniel, 25 U-form hierarchy, 288–290, 296, 333–335, 363 See also M-form hierarchy; Organizational forms commitment through decentralization, 308–309 coordination, experimentation, and organizational flexibility, 370– 377 coordination and parallel experimentation, 377–379 coordination in transition economies, 379–385 costs and benefits of, 304–310 decentralized coordination in, 306 of Eastern Europe and the Soviet Union, 296–298 economy of scale in, 305 experimental approach, learning, and institutional changes, 309– 310, 329n40 incentives in, 307–308 industrial concentration in, 305 information and incentives in, 338–344 model, 335–338 model of coordination, 365–369 responses to external shocks in, 306–307 Soviet Union as giant, 334, 345, 363 specialization in, 305 United States, the, 365, 386–387 Urban collectives, 291 Urban enterprises, 290–291 Vishny, Robert W., 71, 97 Wallich, Christine, 261 Wang, Yijiang, 42 Wegren, Stephen, 385 Wehrheim, P., 385 Wei, Shang-Jin, 48 Weingast, Barry R., 40, 41, 135, 245, 308 Whiting, Susan, 112 Williamson, Oliver, 13, 289, 344, 353 Woo, Wing Thye, 72 World Bank, 1, 23, 49, 385 World Trade Organization (WTO), 18 Xu, Chenggang, 254, 334, 344, 354, 364 Yeltsin, Boris, 364 Zhou, Li-An, 254 Zhuravskaya, Ekaterina V., 40, 254, 271 ... parts together demonstrate the central theme of the book: that examining how reform worked in China requires detailed analysis based on universal principles and taking into account the specific initial... collaborators The first chapter carries the same title as the main title of the book Written 15 years ago, it examines how reform worked in China through the lens of “transitional institutions.” The transitional... confuses the goal (i.e., where to finish) with the process (i.e., how to get there) and thus tends to ignore the intriguing issues of transition paths connecting the starting point and the goal