An economic analysis of the rise and decline of Chinese township and village enterprises 978-3-319-59770-6, 3319597701, 978-3-319-59769-0, 118-120-124-1

Table of contents :
Front Matter ....Pages i-xiii
Introduction (Cheng Jin)....Pages 1-17
TVEs: Theories and Methodology (Cheng Jin)....Pages 19-46
Township and Village Enterprises: History and Institutions (1958–1997) (Cheng Jin)....Pages 47-86
Ownership Structure of TVEs: TVE and Local Politics (Cheng Jin)....Pages 87-112
The Fall and Rise of State-Owned Enterprises (I): The Dual-Track Price System (Cheng Jin)....Pages 113-140
The Fall and Rise of State-Owned Enterprises (II): The Institutional Root of the Chinese Dual Head Economy (Cheng Jin)....Pages 141-167
TVE and the Economic Environment (Cheng Jin)....Pages 169-194
Conclusions (Cheng Jin)....Pages 195-208
Back Matter ....Pages 209-217

Citation preview

PALGRAVE STUDIES IN ECONOMIC HISTORY

AN ECONOMIC ANALYSIS OF THE RISE AND DECLINE OF CHINESE TOWNSHIP AND VILLAGE ENTERPRISES Cheng Jin

Palgrave Studies in Economic History Series editor Kent Deng London School of Economics London, United Kingdom

Palgrave Studies in Economic History is designed to illuminate and enrich our understanding of economies and economic phenomena of the past. The series covers a vast range of topics including financial history, labour history, development economics, commercialisation, urbanisation, industrialisation, modernisation, globalisation, and changes in world economic orders. More information about this series at http://www.springer.com/series/14632

Cheng Jin

An Economic Analysis of the Rise and Decline of Chinese Township and Village Enterprises

Cheng Jin South China University of Technology Guangdong, China East Asian Institute Tower Block #06-01 469A Bukit Timah Road 259770, Singapore

Palgrave Studies in Economic History ISBN 978-3-319-59769-0    ISBN 978-3-319-59770-6 (eBook) DOI 10.1007/978-3-319-59770-6 Library of Congress Control Number: 2017948159 © The Editor(s) (if applicable) and The Author(s) 2017 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Cover credit: TAO Images Limited / Alamy Stock Photo Printed on acid-free paper This Palgrave Macmillan imprint is published by Springer Nature The registered company is Springer International Publishing AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Contents

1 Introduction   1 1.1 Township and Village Enterprise and Economic Duality   1 1.2 Implications of TVE Studies: Macro and Micro Perspectives  4 1.3 Empirical and Theoretical Considerations: The Definition of Economic Environment  6 1.4 Research Method and Methodology   8 1.4.1 Definition of Township and Village Enterprise   8 1.4.2 Official Data Sources  10 1.4.3 Empirical Studies and the Using of Data  10 1.5 The Purpose of This Study and the Structure of the Book  12 References  14 2 TVEs: Theories and Methodology  19 2.1 A Brief Introduction to TVEs  19 2.2 A General Macro-Level Theory Review  20 2.2.1 Economic Growth and Economic Transition  20 2.2.2 M-Form Theory and Fiscal Feudalism  23 2.2.3 State Corporatism and Joint Liability  25 2.2.4 Economic Environment and Ambiguous Property Rights  26 v

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2.3 Comments on Macro Issues and Theories  28 2.4 Micro-Theory: Ownership Structure and Entrepreneurship 32 2.5 Implications  36 2.5.1 Junction of Institutions: The Represented M-Form Theory  36 2.5.2 Alternative Institutions  38 2.5.3 Macro and Micro: Economic Reform and Organizational Change  39 2.6 Conclusion  42 References  43

3 Township and Village Enterprises: History and  Institutions (1958–1997)  47 3.1 Introduction  47 3.2 Commune-Brigade Enterprises (CBEs) in the  Pre-reform Period: 1958–1978  50 3.2.1 The Origin of CBEs  50 3.2.2 CBE Operation Under Central Planning Economy 52 3.2.3 CBE Institutions: Strengths and Weaknesses  54 3.2.4 CBE and Central Government Decentralization  56 3.3 From Commune–Brigade Enterprises (CBEs) to  Township and Village Enterprises (TVEs): 1978–1984  58 3.3.1 1978 Reform and Its Institutional Foundations  58 3.3.2 Decentralization and Liberalization  61 3.3.3 The Role of Local Government in the Creation of CBE Property Rights  64 3.3.4 The Transformation of CBEs into TVEs  66 3.4 The Golden Age of TVEs: 1984–1997  69 3.4.1 The Development of TVEs and Their Increasingly Important Role in the Chinese Economy 69 3.4.2 Changes in Fundamental Institutions and  the Local Government  70

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vii

3.4.3 The Financial Market: TVEs and the Banking Sector 72 3.4.4 The Firm: State Relationship—The Different Roles of Central and Local Government  74 3.4.5 Changes in Central-Local Government Relationship and Their Impacts on TVEs  76 3.4.6 TVE Privatization in the Late 1990s  78 3.5 Conclusion  79 References  83

4 Ownership Structure of TVEs: TVE and Local Politics  87 4.1 Introduction  87 4.1.1 TVE Property Rights: Two Issues  87 4.1.2 Problems with the Ambiguous Property Rights Approach  89 4.1.3 Problems with TVE Institutions  90 4.2 From CBE to TVE: Changes in Incentives  92 4.2.1 Pattern Classification of Pre-reform CBEs  92 4.2.2 The Impact of Reform and CBE Transformation  94 4.3 The Nature of TVE Property Rights  96 4.3.1 TVE: An Interloper in the Central Planning System 96 4.3.2 Why Local Politics Matter  98 4.3.3 Why TVE Patterns Matter 101 4.3.4 Political Costs 104 4.3.5 Institutional Conditions of TVE Development 106 4.4 Conclusion 107 References 110 5 The Fall and Rise of State-Owned Enterprises (I): The Dual-­Track Price System 113 5.1 Introduction 113 5.2 The Dual-Track System: The Pre-1998 Economy and SOEs115 5.2.1 The Origin of the Dual-Track System 115

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5.2.2 The Nature of the Dual-Track System 118 5.2.3 Problems with the Dual-Track Price System: 1992 and the Factors Leading to the 1998 SOE Reform 120 5.3 SOEs After 1998: Monopoly and Primogeniture of  the State124 5.3.1 Restructuring SOEs: Zhua Da Fang Xiao 124 5.3.2 The Rise of the Power of the Centre and  Bank Reform 126 5.3.3 Impacts of 1998–2003 SOE Reform 129 5.3.4 Impacts of Banking Industry Reform to TVEs 132 5.4 The Rise of SOEs: Accident or Inevitability? 134 References 137

6 The Fall and Rise of State-Owned Enterprises (II): The Institutional Root of the Chinese Dual Head Economy 141 6.1 How to Measure and Identify Successful SOEs 141 6.2 From Central Planning to Dual-Track 143 6.2.1 The Legacy of the Central Planning System 143 6.2.2 The Central Planning System and the  State Sector 145 6.2.3 Why Did the Dual-Track System Work? 147 6.3 The Logic of SOE Reform: From Dual-­Track System to State Monopoly 150 6.3.1 The De-linking Between SOEs and the  State’s Fiscal Income 150 6.3.2 Restructuring Central and Local SOEs 152 6.3.3 SOEs After Reform 153 6.4 The Nature of the Chinese State Sector: From  Dual-Track System to State Monopoly 156 6.4.1 SOEs and the Market: The Logic of  Chinese SOE Reform 156 6.4.2 The Role of Regulator 158

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ix

6.4.3 Central Planning and State Monopoly: Conditions and Implications 160 6.5 Conclusion 163 References 166

7 TVE and the Economic Environment 169 7.1 Market Environment: Is There a Chinese Index? 169 7.2 The ‘Old’ Reform 172 7.2.1 The Economic Environment: The State Sector as the Dominant Component 172 7.2.2 The gongxiaoyuan (‘Salesman’) Phenomenon 174 7.2.3 The Rule of the State Sector: Dual-Track Pricing177 7.2.4 The Economic Environment for TVEs: Characteristics of the Pre-1998 Reform 181 7.3 The ‘New’ Reform 183 7.3.1 TVEs and the Impact of the 1998–2003 SOE Reforms 183 7.3.2 Late 1990s: Privatization and the Economic Environment186 7.4 The Nature of the Chinese Economic Environment 188 References 192 8 Conclusions 195 8.1 Structure of This Book 195 8.2 Conclusion I: The Micro Structure of TVE Ownership 196 8.2.1 Problems with Principal-Agent Model-Based Approach196 8.2.2 An Alternative Explanation: The Entrepreneur’s Political Role 198 8.3 Conclusion II: SOE Sector as the Economic Environment201 8.3.1 SOE and Dual-Track System as Economic Environment201

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8.3.2 The Demise of the Dual-Track System and  State Sector Reform 204 8.4 Conclusion 205 References 207

Index209

Abbreviations and Definitions

ABC ADBC BOC CBE CBRC CCAMC CCB CCP CDB CFWC CGWAMC CHAMC Chexim CHIL CIC COAMC COE CRF CWCLE ESS ICBC IPO

Agricultural Bank of China Agricultural Development Bank of China Bank of China Commune-Brigade Enterprise China Banking Regulatory Commission Cinda Asset Management Corporation China Construction Bank Chinese Communist Party China Development Bank Central Financial Work Commission China Great Wall Asset Management Corporation China Huarong Asset Management Corporation Export-Import Bank of China Central Huijin Investment Ltd China Investment Corporation Orient Asset Management Corporation Collective-Owned Enterprise China Reform Foundation China Work Committee for Large Enterprises Employees’ Shareholding Society Industrial and Commercial Bank of China Initial Public Offering xi

xii 

Abbreviations and Definitions

MBO NDRC NERI PBC RMB SASAC SAT SDPC SME SOE SPC TVE VAT WTO WWI

Management Buyout National Development and Reform Commission National Economic Research Institute People’s Bank of China Renminbi (the official currency of the People’s Republic of China) State-owned Assets Supervision and Administration Commission State Administration of Taxation State Development Planning Commission Small and Medium-sized Enterprise State-Owned Enterprise State Planning Commission Township and Village Enterprise Value-Added Tax World Trade Organization World War One

List of Figures

Fig. 1.1 China’s economic dualism (Before the 1990s privatization reform, the state sector’s output share was much greater than non-SOEs/TVEs, but after privatization the ratio of SOEs and non-SOEs output reversed.) Fig. 2.1 M-form theory and economic environment hypothesis Fig. 3.1 TVE outputs and employment, 1978–1983. Source: China Township and Village Enterprises Yearbook (zhongguo xiangzhen qiye nianjian, 中国乡镇企业年鉴), various volumes Fig. 3.2 TVE Output and GDP Growth. Source: China Township and Village Enterprises Yearbook (zhongguo xiangzhen qiye nianjian, 中国乡镇企业年鉴), various volumes Fig. 5.1 Changes in SOE’s average scale of operations: output and output growth rate. Date source: China Statistical Yearbook (zhongguo tongji nianjian, 中国统计年鉴), various years Fig. 5.2 SOE output and loans. Date source: China Statistical Yearbook (zhongguo tongji nianjian, 中国统计年鉴) Annual publication, various years Fig. 5.3 Share of China’s fixed assets investment in GDP.  Date source: China Statistical Yearbook (zhongguo tongji nianjian, 中国统计年鉴). Annual publication, various years

3 32

68 70 114 130

132

xiii

1 Introduction

1.1 T  ownship and Village Enterprise and Economic Duality A number of authors have argued that the Chinese township and village enterprises (TVEs) were the real engine of China’s economic transition (Fei 1998; Naughton 2006; Weitzman and Xu 1994). Evidence showing that in 1996, prior to privatization, TVEs accounted for more than 40 per cent of China’s industrial output in its manufacturing sector (China Statistical Yearbook 1997) certainly lends credence to this argument. Starting from a sector that in 1978 attracted virtually no attention, the subsequent record of TVEs can definitely be viewed as a major economic achievement, comparable with the success of China’s early post-1978 agricultural reforms. The implications of TVEs’ success are manifold. The importance of TVEs is seen not only in terms of accelerated rural industrialization and rising rural income (Oi 1999), which the TVEs facilitated. Even more significant has been the way in which the rise of TVEs fundamentally changed the pattern of China’s economic development and the evolution of Chinese firms. Throughout the 1980s and into the early 1990s, © The Author(s) 2017 C. Jin, An Economic Analysis of the Rise and Decline of Chinese Township and Village Enterprises, Palgrave Studies in Economic History, DOI 10.1007/978-3-319-59770-6_1

1

2   

1 Introduction

before private ownership became officially endorsed and accepted, TVEs played a very distinctive role in the Chinese economy. This role not only showed how non-state-owned firms could harmoniously exist and operate alongside the state sector (indeed, to the benefit of both), but it also provided one of the cornerstones of reform policies. Against a background in which the state sector has traditionally stood at the centre of the Chinese economy, exercising a high degree of monopoly power—and maintaining direct or indirect links with the rest of the economy—the relationship between state-owned enterprises (SOEs) and non-SOEs has since become, and remains, a much discussed and controversial topic. However, this relationship is much easier to understand when viewed and analysed through the prism of developments that took place some 20 years ago, when the industrial sector in China was being organized in a simple dualistic way—the ‘dualism’ being defined by the SOEs and TVEs: the validity of this approach is all the more apparent, bearing in mind that most recent institutional initiatives and developments in the industrial sector had their origin in this dualistic economic framework. From the view of Chinese Communist Party (CCP), the success of the TVEs was unexpected (Deng Xiaoping’s speech in 1993, see Deng (1994)). Following the success of the first post-1978 agricultural reforms, the ‘rise’ of the TVEs happened so suddenly and so smoothly that the CCP was persuaded that it would be possible to achieve accelerated and sustained economic growth merely by making quite small adjustments (especially through easing some of its tight controls over economic management) (Wu et al. 1999). This approach proved to be misguided, but it encouraged the CCP to use a simple—even simplistic—logic to pursue its reforms of the state-owned enterprises (SOEs), in so doing wasting years of time and thousands of billions of RMB. Even more important from the perspective of the economy as a whole, thanks to hesitancy in government policy formulation and implementation because of the CCP’s uncertainty about whether to prioritize further liberalization or the maintenance of its socialist tradition—throughout the whole of the 1980s and the first half of 1990s, the economy was dominated by two non-private economic entities (the SOEs and TVEs) (Li 1991). Thus, this duality—SOEs and TVEs—was perhaps the most distinctive characteristic of the Chinese economy in the reform era until the

1.1  Township and Village Enterprise and Economic Duality 

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mid-1990s. However, following rapid privatization, this economic structure was abruptly transformed into another dualistic structure: SOEs and private firms. While these changes were being made, SOEs consistently remained at the very heart of the CCP’s policymaking. In short, economic dualism has been a distinctive feature of China’s reform era. Its first manifestation is captured in the existence, during the 1980s and into the early 1990s, of a small TVE sector alongside a larger SOE sector (Fan 2000). But after a degree of economic liberalization in the early 1990s and privatization later in the 1990s, the major economic entities became the SOEs and the private sector—but with the SOE sector now assuming a smaller role (Zhang and Li 1998; Liu et al. 2008), as shown in Fig. 1.1. It was not only in terms of the share of the economy (i.e., industrial output value) but also in terms of firm-level performance that the previous position was reversed: during the first phase of China’s economic reform, the average economic performance (measured by growth in output) of non-state sector was clearly more buoyant than that of the state sector. By contrast, following privatization, the state sector’s performance overtook that of the private sector (Zhang 2008).

Fig. 1.1  China’s economic dualism (Before the 1990s privatization reform, the state sector’s output share was much greater than non-SOEs/TVEs, but after privatization the ratio of SOEs and non-SOEs output reversed.)

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1 Introduction

Thus the shift in China’s dualistic economic structure, which was mostly brought about by the decline of the TVEs, was also accompanied by a shift in efficiency—defined in financial terms—between the state and non-state sectors. What is surprising is that the changing nature of the dualistic structure of the Chinese economy and the pivotal role played by TVEs in facilitating the change have received so little attention in the literature on institutional change and industrial development in China during the reform era. This book seeks to help fill this gap and redress the existing emphasis on SOEs that has tended to characterize this literature.

1.2 Implications of TVE Studies: Macro and Micro Perspectives The tradition in TVE studies, or, stated from a different perspective, the tradition of the ‘gradualist school’ of thought among economists, has been to use evidence derived from macro economic conditions in order to throw light on and even explain individual firm’s economic performance at the micro level. This tradition can be traced through the work of three authors—Qian and Xu (1993a, 1993b), Li (1996) and Tian (2000, 2001)—all of whose work (as well as subsequent work based on their approach) took the view that the outstanding performance of Chinese firms before the mid-1990s reflected the combined impact of various changes in macro-economic—and especially institutional—conditions. Qian and Xu (1993a, 1993b) were the first to suggest that economic growth in the 1980s reflected the particular characteristics of China’s centrally planned economy. Li (1996) subsequently suggested that the distinctive features of China’s market environment were what made it possible for TVE entrepreneurs to perform better than SOE managers. Finally, Tian (2000, 2001) concluded that the incomplete nature of TVE ownership helped TVEs to outperform SOEs in a situation in which the market environment was still not fully developed. Common to all these explanations is a belief that macro/institutional conditions in China during the reform era have been too complex to be described and interpreted within a simple framework and that there is no clear causality between macro and micro changes. Something else that is

1.2  Implications of TVE Studies: Macro and Micro Perspectives 

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common to this literature is that they all use a principal-agent approach (and models derived from it) (e.g., Yao and Zhi 2000, Zhi 2001), which assumes that all parties in the government-firm relationship are selfish and will take opportunistic action if such action can improve their interests (Che 2002). Thus, local government and its agents (officials) can be regarded as predators—a characterization that can be applied to China’s market environment. However, against the background of such market imperfections, TVEs achieved economic success because their ownership was not clearly defined—as it can be regarded another imperfection from a neoclassical viewpoint. There is another group of writers, such as Oi (1999) and Sun (2002), who have adopted a basically interdisciplinary approach. They view TVE development as a result of cooperative engagement between local government and TVE entrepreneurs and have focused especially on the inputs from local government’s side—in other words, pro-governmental intervention. In general, this tradition in the literature has also accepted the assumption that imperfections have characterized China’s market environment, the only difference in their approach being that it views local government as selfless rather than predatory. These two views share the same supporting materials but display only slight difference in assumptions. But both are quite seriously lacking in theoretical and empirical backing. Nevertheless, the debate between them has generated further debates (e.g., Hu 1998; Huang and Zhao 2009), which have continued to attract widespread attention among those interested in the implications of the debate for current political and economic development. The gradualist tradition in China—the origins of which lie in the work of the Chinese economists mentioned above—and the pro-government tradition further influenced China’s policymaking and implementation in distinctive and important ways. Before the early 2000s, the thinking of China’s academia and policymakers was dominated by the gradualist tradition, in which neoclassical-style liberalization and the views embodied in the ‘Washington Consensus’ were important elements (Walker and Buck 2007). When, in the course of the privatization process of the late 1990s, interest groups—basically SOE managers and family members of government officials—captured the policymaking process (in regard,

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1 Introduction

for example, to SOEs and management buyouts [MBOs]), there was no institutional opposition from the major Chinese think tanks. The reason for this was simple. Although injustices attached to liberalization initiatives, Chinese mainstream economists argued that these were an acceptable price to pay for the attainment of improved long-term efficiency. More recently, however, changes in domestic and international political circumstances1 have led China’s policymakers to abandon the Washington Consensus and to avoid further liberal policy initiatives in order to prevent any political disruption that might damage the ruling position of the CCP.  The new orthodoxy that emerged—i.e., the pro-­ government view—sought to replace the thinking of the Washington Consensus with the so-called Beijing Consensus as the driver of China’s policymaking process (Ramo 2004). The empirical basis of the two views was the same—both acknowledged the very buoyant performance and growth record of the Chinese economy since 1978. But the conclusions they reached were quite different. According to proponents of the gradualist approach, China’s remarkable growth record reflected the liberalization tendencies of economic policies. By contrast, the pro-government party argued that this record owed most to effective CCP rule. However, neither party in this debate offered strong evidence to support its view, especially in terms of linkages between macro conditions—whether defined in terms of liberalization or a strong ruling party—and firm performance at the micro level.

1.3 E  mpirical and Theoretical Considerations: The Definition of Economic Environment With both the gradualist and pro-government approaches emphasizing the strong correlation between TVE performance and the economic environment, one of my major fieldwork concerns has been to investigate how in the real world TVE entrepreneurs view the economic environment. The answers that have emerged from my investigations suggest that their view is shaped by three factors: the nature of (local) ­government-­enterprise relations; the general institutional environment in which they operate; and the nature of their relationship with SOEs.

1.3  Empirical and Theoretical Considerations: The Definition... 

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First, both gradualist and pro-government approaches highlighted the key importance of the government-enterprise relationship. Interestingly, however, entrepreneurs revealed a slightly different attitude. All of them acknowledged and emphasized the importance of their relationship with the local government. But they also claimed to have the capacity to ‘handle’ the government: to secure support from local government, when necessary; or to persuade officials not to interfere too much in enterprise affairs. From a business survival viewpoint, the inference is that a TVE entrepreneur’s inability to ‘handle’ the local government suggested that he was incapable of successfully operating a firm—and the enterprises of most entrepreneurs in this category would fail early on. Thus, the empirical evidence suggests a different role for TVE entrepreneurs: as neither rent-seekers (as the mainstream literature might indicate) nor as able managers working under the supervision of local government. On the other hand, entrepreneurs showed greater concern—even after privatization, when most of them had become owners of their firms– about the general institutional environment in which they had to operate. Their view was that policy changes made by the central government could cause rapid change in the business environment—as long as the central government is capable to reverse any local government’s decision, or even restructure the local government. This might come about as a direct result of a policy initiative: for example, many entrepreneurs have clear recollections of the effect of the two monetary tightening initiatives of the 1990s, when Zhu Rongji was in charge of economic affairs (as Vice Premier (1993–1998) and Premier (1998–2003)). But it might also reflect the indirect influence of a change in central government policy on local economic and political conditions. These indirect effects of central policy may be unexpected—both by the policymakers and TVE entrepreneurs—but serious. For example, the 1998 restructuring of the banking system, originally intended to resolve the problem of SOEs’ non-performing loans, unexpectedly led to TVEs facing greater difficulty in securing bank loans than at any point since 1978. The SOE-TVE relationship has been another recurring theme of my research. Most TVE entrepreneurs regard the SOE-TVE relationship in the 1980s as having been much better than in later years (especially after 1998) and were much more favourable towards TVEs. Since most

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1 Introduction

industrial inputs needed by TVEs were directly or indirectly supplied by SOEs, the trading relationship between SOEs and TVEs was the dominant influence of TVEs’ costs. During the early phase of China’s economic reform until 1998, it was common for TVEs to use institutionalized off-market channels in order to obtain cheaper industrial supplies from SOEs, so that the SOE-TVE relationship effectively provided lowcost input channels for TVEs. However, the 1998 SOE reform cut this link, and forced TVEs to buy from a highly competitive input market, dominated by several monopolies. Inevitably, this new trading pattern has had a significant impact on TVEs’ costs. To sum up, we find some validity in both the gradualist and pro-­ government approaches. The core issue for TVE entrepreneurs was to deal with three major challenges arising out of the ruling power of the CCP (this serving as a proxy for the general economic environment).2 These were first, the uncertainties and inconsistencies in the CCP’s macro-­economic policies (for example, should liberalization policies be pursued?); second, excessive interference from local government; and third, the possibility that supply of inputs from SOEs might contract. The gradualist approach emphasizes the general institutional factors and argues that institutional instability and interventionist actions by local government mainly reflect the lack of proper market institutions. From this conclusion it was a short step to argue in favour of greater economic liberalization. The pro-government view has acknowledged the positive role of SOEs during the development of TVEs, but it has mistakenly regarded the links between SOEs and TVEs as reflecting the interventionist role of central government and local government’s active management.

1.4 Research Method and Methodology 1.4.1 Definition of Township and Village Enterprise There are two major changes in the definition of township and village enterprise. The first issue TVE definition contained is the ownership. The predecessor of TVE, commune-brigade enterprise (CBE), was defined

1.4  Research Method and Methodology 

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as ‘socialist collectively-owned economic entities’ at the beginning of China’s economic reform (State Council 1979a). Then, according to CCP Central Committee and the State Council, TVEs were defined as ‘firms. . .installed by commune or brigade (government), or operated by commune or brigade members cooperatively, or individual commune or brigade member’ (Central Committee of the Communist Party of China and State Council of the People’s Republic of China 1984). Thus, the 1984 official definition could be seen as a change in ownership: it allowed individuals to run business as sole (trading) households (geti hu, 个体 户). The 1996 Law on Township Enterprises clearly stated ‘Township and Village Enterprise refers to rural collective (owned) economic organizations or peasants invested. . . firms’—this had enlarged its ownership definition to privately owned, large—larger than sole (trading) households—scale firms. Second is the owner’s identity. One of the 1979 State Council orders stated that commune-brigade enterprises are ‘owned by the commune if initially installed by the commune, (and) owned by the brigade if initially installed by the brigade’, and should ‘prevents CBEs to be nationalised’ (State Council 1979b), and the 1984 regulation rule reconfirmed this point. Then the 1996 Law of Township Enterprise slightly eased this restriction, but it still ordered at least the major investor must be peasant or rural community. Such owner identity requirement also reflected in official data source: by 1997, the China Township and Village Enterprise Yearbook (so that data is for 1996) still defined TVEs as firms owned by rural people or communities. A significant change happened in the next year due to the new TVE registration rule published by the Ministry of Agriculture at the end of 1997 (Ministry of Agriculture 1997), in this new rule the actual physical location became the criterion of TVEs—as long as a firm (or its headquarter) is located in a rural area, it is defined as a TVE. The changes in TVE (CBE) definition show us how TVE (CBE) developed from a narrow category of enterprises to a vast scale of different firms. The 1996 Law of Township Enterprises together with 1997 registration rule converted the owner and ownership-based criterion of TVEs, to a simple physical location-based definition. Thus, in this research we follow the official term of TVE according to different historical periods,

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and especially for 1997 and the period afterwards we use the term ‘TVE’ to refer to rural SMEs, and we regard the 1997 TVE definition as the broadest TVE definition.

1.4.2 Official Data Sources There are several official sources of data used in this study. The first is the China Statistical Yearbook, and it is known as the most reliable source of China’s economic data. The second is the China Township and Village Enterprise Yearbook (now it has been renamed China Township and Village Enterprise and Agricultural Products Processing Industry Yearbook): the first volume was published in 1990 but the data starts from 1978. The third is data from regional (e.g., provincial) statistical yearbooks, as they offered some supplementary regional data. Lastly, yearbooks such as China Industry Economy Statistical Yearbook and Rural Statistical Yearbook of China also contain useful data. Most of these data could be accessed from following online databases: Apabi Yearbooks (中国年鉴资源全文数据库)3 China Yearbooks Full-text Database (中国年鉴网络出版总库)4 China Statistical Yearbooks Database (­ 中国经济社会发展统计数据 库)5

1.4.3 Empirical Studies and the Using of Data There are quite a number of TVE empirical studies, especially in late 1990s. Some regional TVE studies are based on governmental data; for example, Xu and Zhang’s (1997) research uses financial data submitted by TVEs to Suzhou government. Some survey-based researches also rely on government or semi-government branches to take surveys; one of them is the Qinghua (Tsinghua) University’s survey (Qin 1997, 1998) in 1997, as well as Yang and Fan (2008). Two issues in such research methods should be taken into consideration. First, the spatial distribution of TVEs may greatly affect the final outcome of empirical study. The TVE’s institutional environments are different from

1.4  Research Method and Methodology 

  11

region to region: for example the well-known Su’nan6 mode and Wenzhou7 mode refer to TVE institutions in Jiangsu and Zhejiang, two neighbouring provinces; and even within Zhejiang, there are a large number of ‘modes’ or ‘models’ referring to different TVE institutions; for example, Yiwu8 model and Lucheng9 model represent two completely different development modes. The multiformity of TVE institutions—and therefore firm’s organizational form and economic performance—was originated from the 1980s and early 1990s’ political economy. Before late 1990s, China neither had a complete set of formal institutions to regulate non-state-owned firm (for instance, the accounting rules), nor could it implement legal procedures to make economic boundaries clear between local governments and TVEs; this situation enabled local governments (and TVEs) to create different local institutions which supported different TVE development modes. Thus, the nationwide TVE multiformity must be considered— TVE development modes and institutions supported these modes that differed in each different county and town; in extreme cases different villages in the same township also had different TVE rules (thus Qin (1997, 1998) style survey, which contains more than 2000 samples in more than 1000 locations, is preferable). Second, the timing problem is also an issue. As TVE’s development can at least be traced back to 1980s, a long-term investigation is needed if a study tries to cover the major history of TVEs. One example is Yang and Fan’s (2008) research based on 2100 surveys from 1992 to 2000. Different timing points of empirical studies may present different institutional background, then would lead to different conclusions; for example, Zhou’s (1997) study on TVE assets formation in 1980s shows a completely different result from that of recent studies (e.g., Zhang et al. 2013; Jiang 2000; Xu and Zhang 1997). I started this study by interviewing dozens of TVE entrepreneurs in Jiangsu, Zhejiang and Shandong—the traditional TVE-concentrated provinces—and tried to figure out if there was a common route of TVE enterprise-government relationship that TVE entrepreneurs could follow; however, TVEs’ geographic multiformity and temporal differentiation issues emerged from interviews. When taking interviews in Jiangsu, I realized TVEs’ geographic multiformity was a result of the random initial conditions—possibly historical; for instance Jiangsu had managed to

12   

1 Introduction

fund itself to establish a number of small-scale COEs/SOEs in late Mao period. Most of such enterprises were given to lower level governments at the end of Culture Revolution and the early reform era. Then in late 1970s a number of these enterprises’ assets were given to CBEs and became the foundation of Jiangsu’s TVEs—so in the later ‘Su’nan mode’ we can still see the influence. In addition, local governments in 1980s and early 1990s had to develop their own procedures to deal with TVE affairs, and if such an arrangement works, it was likely to be self-­consolidated and finally become a certain local institution—the Wenzhou government was famous for its pro-private policies even since early 1980s. In order to overcome geographic multiformity and temporal differentiation, an empirical study may need to establish large sample-based, long-­ term observation survey data, which may go beyond the scope of a single volume book. In this book we have used existing data source: the official China Township and Village Enterprise Yearbook series can provide solid TVE data at both national and provincial levels, and thanks to National Bureau of Statistics—under its supervision most coastal provinces and cities could keep publishing annual statistical yearbooks which supplied city, county and township level data including TVEs’—we can access at least county level TVE data in most provinces. Besides the official data source, previous large sample-based surveys (e.g., Qin 1997, 1998; Xu and Zhang 1997; Yang and Fan 2008) also provided useful data.

1.5 T  he Purpose of This Study and the Structure of the Book The purpose of this book is to try to address two issues related to TVE development. The first is the relationship between the peculiar ownership structure of TVEs and interference by local government before late 1990s privatization. This topic has been well explored by principal-agent analysis within the mainstream literature. However, the approach I use here in order to investigate the government-enterprise relationship is more historical. In particular, through careful examination of the development of TVEs before the privatization surge of the late 1990s, we argue

 Notes 

  13

that the TVE entrepreneurs used two stratagems in order to successfully address the potential problem of excessive government intervention and interference with their activities. One was to offer local government an economic payoff (including bribes)—this was well discussed in principalagent theory-­based papers (e.g., Che (2002)). The other was to engage themselves with local government, and we will focus on the mechanism behind this engagement. Most collectively owned TVEs were privatized in the late 1990s privatization, so this part of our study is up to 1998. The second issue is related to the relationship between TVEs (and then rural SMEs after 1997–1998 privatization) and SOEs. In particular, we seek to trace the evolution of this relationship—especially before and after the 1998–2003 SOE reform—and to show how it has fitted into the general institutional environment. In particular, we focus on the time period before 2003. We try to demonstrate that the SOE institution, as the core element of the centrally planned economy, has been integrated so centrally into China’s basic political and economic institutional framework that changes taking place in SOE institutions were bound also to impact on TVEs. The structure of this book is as follows: Chapter 2 is a literature review, which also highlights and examines some of the relevant issues arising out of related research. Chapter 3 describes and analyses the antecedents, origins and development of TVEs. Chapter 4 introduces a framework of TVE-local government relations. In Chaps. 5 and 6 we examine the SOE sector and its place in China’s economic reform, and we analyse and comment on the implications of post1978 SOE reform for the rest of the Chinese economy, but especially the TVE sector. Chapter 7 uses TVEs as a case study for formulating an alternative explanation from that given in mainstream economic environment theory. In the final chapter we offer some concluding comments.

Notes 1. The Hu Jintao and Wen Jiabao administration (2003–2012/2013) was supportive of an increasingly nationalistic philosophy and attitudes and sought to show China in a distinctive light vis-a-vis Western society

14   

1 Introduction

(cf., for example, Chinese foreign policy analysts’ advocacy of ‘China’s peaceful rise’). 2. It is in this sense that it can be argued that both the gradualist and progovernment proponents ‘got it right’. 3. www.apabi.com/uc/?pid=yearbook.index&cult=CN (login required). 4. www.acad.cnki.net/Kns55/brief/result.aspx?dbPrefix=CYFD. 5. English version: http://tongji.oversea.cnki.net/oversea/engnavi/navidefault.aspx. Chinese version: http://tongji.cnki.net/kns55/navi/navidefault.aspx. 6. The Chinese ‘su’nan’ means southern Jiangsu. 7. Wenzhou is a city of Zhejiang. 8. Yiwu was a district of Jinhua city, Zhejiang. It was upgraded to a dependent city under Jinhua’s administration in 1988. Yiwu is one of the world’s largest light industry trade centres: buyers need to take a shuttle bus to travel between the miles-long market halls. 9. Lucheng is one of the downtown districts of Wenzhou city.

References Central Committee of the Communist Party of China and State Council of the People’s Republic of China. (1984).Guanyu kaichuang shedui qiye xin jumian de baogao zhongfa [1984] 4 hao, (Report of How to Create New Situations of Commune and Brigade Enterprises, Document No. 4, 1984, 1984 年中共 中央四号文件《关于开创社队企业新局面的报告》). Beijing: Central Committee of the Communist Party of China and State Council of the People’s Republic of China. Che, J.  (2002). Rent Seeking and Government Ownership of Firms: An Application to China’s Township—Village Enterprises. Journal of Comparative Economics, 30(4), 787–811. Deng, X. (1994). Deng Xiaoping wenxuan disan juan (Selected Works of Deng Xiaoping Vol. 3, 邓小平文选第三卷). Beijing: Renmin chuban-she. Fan, G. (2000). Lun tizhi zhuangui de dongtai guocheng—feiguoyou bumen de chengzhang yu guoyou bumen de gaige (On the Dynamic Process of Institutional Transition in China, 论体制转轨的动态过程—非国有部门 的成长与国有部门的改革). Economic Research Journal, 1, 11–61. Fei, X. (1998). Wo kandao de zhongguo nongcun gongyehua he chengshihua daolu (The Chinese Rural Society’s Industrialization and Urbanization Path

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in My View, 我看到的中国农村工业化和城市化道路). Zhejiang Social Sciences, 4, 3–6. Hu, J.  (1998). Zhongguo jingji changqi fazhan de yizhong keneng jizhi (A Possible Long-Term Development Mode of the Chinese Economy, 中国经 济长期发展的一种可能机制). Economic Research Journal, 3, 23–30;57. Huang, S., & Zhao, J. (2009). Zhuangui shiheng yu jingji de changqi he duanqi zengzhang: yige xunzu moxing (Unbalanced System Change and Economic Growth: An Rent-Seeking Model, 转轨失衡与经济的长期和短期增长: 一个寻租模型). Economic Research Journal, 8, 80–92. Jiang, C. (2000). Xiangzhen qiye chanquan gaige de luoji (The Logic of Township and Village Enterprises’ Property Rights Reform, 乡镇企业产权 改革的逻辑). Economic Research Journal, 10, 23–29. Li, D.  D. (1996). A Theory of Ambiguous Property Rights in Transition Economies: The Case of the Chinese Non-State Sector. Journal of Comparative Economics, 23(1), 1–19. Li, K. (1991). Lun woguo jingji de sanyuan jiegou (On the Three Elementary Based Economic Structure, 论我国经济的三元结构). Social Science in China, 3, 66–83. Liu, X., Zhang, P., & Zhang, X. (2008). Gaige niandai de jingji zengzhang yu jiegou bianqian (Economic Growth and Structural Changes in the Reform Era, 改革年代的经济增长与结构变迁). Shanghai: Shanghai People’s Press. Ministry of Agriculture of the People’s Republic of China. (1997). Xiangzhen qiye dengji beian guiding (The Registration Rule of Township and Village Enterprises, 乡镇企业登记备案规定). Beijing: Ministry of Agriculture of the People’s Republic of China. National Bureau of Statistics of China. (1997). China Statistical Yearbook (1997). Beijing: China Statistics Press. Naughton, B.  J. (2006). The Chinese Economy: Transitions and Growth. Cambridge, MA: The MIT Press. Oi, J. C. (1999). Rural China Takes Off: Institutional Foundations of Economic Reform. Berkeley: University of California Press. Qian, Y., & Xu, C. (1993a). The M-Form Hierarchy and China’s Economic Reform. European Economic Review, 37(2–3), 541–548. Qian, Y., & Xu, C. (1993b). Why China’s Economic Reforms Differ: M-Form Hierarchy and Entry/Expansion of the Non-State Sector. Economics of Transition, 1(2), 135–170. Qin, H. (1997). Shizi lukou kan xiangqi—qinghua daxue xiangzhen qiye zhuanzhi wenti diaocha yanjiu baogao shang (Viewing Township and Village Enterprises at the Crossroad—Qinghua University Research Report on

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Township and Village Enterprises’ Transformation I, 十字路口看乡企—清 华大学乡镇企业转制问题调查研究报告, 上). Reform, 6, 105–115. Qin, H. (1998). Shizi lukou kan xiangqi—qinghua daxue xiangzhen qiye zhuanzhi wenti diaocha yanjiu baogao xia (Viewing Township and Village Enterprises at the Crossroad—Qinghua University Research Report on Township and Village Enterprises’ Transformation II, 十字路口看乡企— 清华大学乡镇企业转制问题调查研究报告, 下). Reform, 1, 99–110. Ramo, J. (2004). The Beijing Consensus. London: Foreign Policy Centre. State Council of the People’s Republic of China. (1979a). Guanyu kuoda guoyou qiye jingying guanli zizhuquan de ruogan guiding (Several Provisional Regulations on Enlarging Operation and Management Autonomy in State-­ Owned Enterprises, 关于扩大国有企业经营管理自主权的若干规定). Beijing: State Council of the People’s Republic of China. State Council of the People’s Republic of China. (1979b). Guanyu fazhan shedui qiye ruogan wenti de guiding (Regulations on Issues About Commune-Brigade Enterprise’s Development, 关于发展社队企业若干问题的规定). Beijing: State Council of the People’s Republic of China. Sun, L. (2002). Fading Out of Local Government Ownership: Recent Ownership Reform in China’s Township and Village Enterprises. Economic Systems, 26(3), 249–269. Tian, G. (2000). Property Rights and the Nature of Chinese Collective Enterprises. Journal of Comparative Economics, 28(2), 247–268. Tian, G. (2001). A Theory of Ownership Arrangements and Smooth Transition. Journal of Institutional and Theoretical Economics, 157(3), 380–412. Walker, R., & Buck, D. (2007). The Chinese Road. New Left Review, 46, 39–66. Weitzman, M. L., & Xu, C. (1994). Chinese Township-Village Enterprises as Vaguely Defined Cooperatives. Journal of Comparative Economics, 18(2), 121–145. Wu, J., Chen, Q., & Xie, F. (1999). Guoqi gaige gongjian 15 ti (15 Issues in State-­ Owned Enterprises Reform,国企改革攻坚15题). Beijing: China Economic Press. Xu, Z., & Zhang, J.  (1997). Xiangzhen, ‘qiye zijin de gaosu zengzhang ji xiaoyi xiaohua’ (Rapid Funding Surging and Profit Declining of Township Village Enterprise, 乡镇企业资金的高速增长及效益下滑). Chinese Rural Economy, 3, 51–58. Yang, X., & Fan, J. (2008). 20 shiji 90 niandai zhongguo xiangzhen qiye biange jiqi defang xiaoying (Transformations and Local Effects of China’s Township and Village Enterprises in the 1990s, 20世纪90年代中国乡镇企业变革及 其地方效应). ACTA Geographica Sinica, 63(12), 1268–1276.

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Yao, Y., & Zhi, Z. (2000). Zhengfu juese dingwei yu qiye gaizhi de chengbai (The Positioning of Governmental Role and the Outcome of Enterprise’s Institutional Reform, 政府角色定位与企业改制的成败). Economic Research Journal, 1, 3–10. Zhang, J.  (2008). Zhongguo qiye de zhuanxing daolu (The Transition Path of Chinese Firms, 中国企业的转型道路). Shanghai: Shanghai People’s Press. Zhang, W., & Li, S. (1998). Diqujian jingzhen yu zhongguo guoyou qiye de minyinghua (Regional Competition and the Privatization of Chinese State-­ Owned Enterprises, 地区间竞争与中国国有企业的民营化). Economic Research Journal, 12, 13–22. Zhang, X., Xu, Z., & Qin, D. (2013). Minjian jiedai lilv yu minjian ziben de chulu: wenzhou anli (The Interest Rate of Private Borrowing and the Future of Private Capital: The Case Study of Wenzhou, 民间借贷利率与民间资本 的出路: 温州案例). Journal of Financial Research, 3, 1–14. Zhi, Z. (2001). Xiangzhen qiye gaizhi de lingyizhong jieshi (Another Explanation on Township Village Enterprise’s Privatization, 乡镇企业改制的另一种解 释). Economic Research Journal, 3, 12–18. Zhou, Q. (1997). ‘Kongzhiquan huibao’ he ‘qiyejia kongzhi de qiye’—‘Gongyouzhi jingji’ zhong qiyejia renli ziben chanquan de anli yanjiu (‘Control Rights Rewards’ and ‘Firms Controlled by Entrepreneurs’—The Human Capital Ownership of Entrepreneurs in ‘Non-Private Economy’, “控制权回报”和“企 业家控制的企业”—“公有制经济”中企业家人力资本产权的案例研究). Economic Research Journal, 5, 31–42.

2 TVEs: Theories and Methodology

2.1 A Brief Introduction to TVEs Privatisation has been spreading rapidly throughout China. A core question about this economic transition is how ownership can be defined more usefully and more accurately in terms of best-practice institutions (Qian 2003). Moreover, some critical questions remain about conventional property rights theory. Two of these are: (a) why did some of the so-called collectively owned enterprises, especially township and village enterprises (TVEs, also known as TVPs [township, village and private enterprises] in some early works—for example, Byrd and Lin (1990)), perform much better than other non-private sectors in China in the early reform days (Li 1996)? (b) Under what conditions can TVEs achieve economic success without clearly defined property rights—bearing in mind that both TVE’s output and scale experienced mushrooming growth during the 1980s and early 1990s (Qian 2003; Naughton 1994, 2006; Huang 2008)? Answers to these questions are likely to determine the answer to a more specific question: does an optimal transition path exist (Tian 2000)?

© The Author(s) 2017 C. Jin, An Economic Analysis of the Rise and Decline of Chinese Township and Village Enterprises, Palgrave Studies in Economic History, DOI 10.1007/978-3-319-59770-6_2

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As a whole, in this book we approach the optimal transition path through the prism of TVEs. More specifically, the central importance of the TVE problem can be viewed both empirically and at the theoretical level. In the real world, in the mid-1990s TVEs contributed one third of China’s GDP, and near two thirds of China’s total industry output value. During the period from the beginning of the reforms (late 1970s) to the Asian Crisis (1997–1998), TVEs kept up double digit growth rate of over 20%1; indeed, this was the major reason that China maintained GDP growth of over 10% in those years. Thus, the success of TVEs not only constitutes an achievement in terms of rural industrialization, but its significance can also be viewed from the wider aspects of China’s economic growth and economic transition (Huang 2008; Woo et al. 1994). At the theoretical level, the TVE as an organizational form lacks clearly defined ownership (Li 1996; Che and Qian 1998; Hsiao et al. 1998; Che 2002; Chang et al. 2003), and, according to mainstream theories, firms without clearly defined ownership also lack the necessary incentives that will enable entrepreneurs to operate their firms successfully. Although private ownership has been restored in China (Hsu 1999; Naughton 2006), TVEs are a singular process that was happened under the circumstance of before private ownership was widely accepted and endorsed by the Chinese legal system. The structure of this chapter is as follows: Sects. 2.2 and 2.3 present a brief review of relevant macro theories, with comments. Section 2.4 focuses on micro-level interactions between TVEs and government. Section 2.5 draws some basic implications from a methodological review, and concluding remarks are given in Sect. 2.6.

2.2 A General Macro-Level Theory Review 2.2.1 Economic Growth and Economic Transition At the macro level, attention is paid to the special status of the transition economy. As its name suggests, an economy in transition is essentially an economy that is in the process of moving towards a market-oriented system. The major purpose of economic transition is to restore the functions

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of the market and allow resources to be distributed by market means (Blanchard 1998). Usually, this refers to changes in both political and economic institutions (Lipton and Sachs 1990), and there is often an implicit requirement that political power should withdraw from most— if not all—economic affairs and leave them to the market. On the other hand, due to the fact that most transition economies are in developing countries, a common target is to accelerate economic growth in such countries (Rodrik 2003). Although growth is a huge topic, it can be narrowed down to one simple aim: a permanent increase in capital accumulation per unit of labour. There are various consequences of a rise in per capita availability of capital, such as increased output, personal disposable income growth and higher living standards. Changes in technology (technical progress), changes in saving behaviour and/or shocks from foreign economies may also result in changes in capital accumulation. More importantly, there is a necessary correlation between economic transition and economic growth (e.g., in Hayami and Ruttan style [Hayami and Ruttan 1971]). In most successful transition economies, fast economic growth takes place (although it may manifest itself in different ways) during the transitional process, and there is a widespread view that economic transition is the cause of economic development (or at least the main cause). This view is partly correct: a market-based resource distribution and reallocation system is considered to be the most efficient mechanism of resource allocation, and an efficient market mechanism will help the economy to accumulate capital in a stable and effective way, thereby facilitating economic growth. It is, however, incorrect to view economic transition as the same as economic growth, or to regard it as a sufficient condition for economic growth. Many other factors may generate an increase in capital accumulation; for instance, in the post-­ World War One (WWI) era the Soviet Union forced the agricultural sector (farmers) to contribute to capital accumulation and successfully built up its industrial sector using wealth squeezed from the rural sector. In the case of the Soviet Union, the market was absent, having been replaced by central planning bureaus, and the government changed the savings rate by force. The outcome was the achievement of growth alongside consumer goods shortages.

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The experience of China’s economic success—fast growth driven by the non-private sector(s)—in the past thirty years is perhaps one of the most dramatic stories of the twentieth-century economic history. From a historical view, it appears that political constraints were gradually removed from economic management, this process being accompanied by dramatic growth (Hsu 1999; Naughton 2006). Everything seems to satisfy the logic that economic transition cantered on the development of the market, and that recourse to market forces then brought about accelerated GDP growth. However, a deeper look into the detailed history of China’s economic reform suggests that this simple logic may not hold. First of all, contrary to what many may think, the deregulation process in China did not happen immediately after the Chinese Communist Party’s (CCP’s) decision to embrace economic reform at the end of the 1970s; rather, this took place very slowly (Sachs and Woo 1994). The term ‘gradualism’ is inappropriate to describe the steps the CCP followed. The CCP indeed decentralized its political power and released control of part of its fiscal income; but at the same time it still retained tight control of other resources. For instance, until 1988—ten years after the CCP’s initial reform decision—pricing rights for basic consumption goods (food, fuel, etc.) were in the hands of the central government. Indeed, Milton Friedman noticed this when he was invited to visit China, and recorded it in his autobiography. Another ten years later, Premier Zhu Rongji announced his decision that food and all important resources should remain under state control. Finally, grain trading (rice and wheat) regulations—grain being the major crop and food in China—were abandoned only in 2003 (and in some provinces, not until 2004) during the administration of Hu Jintao and Premier Wen Jiabao, although the same has not happened with fuel and is unlikely to do so in the foreseeable future. Similar examples may be found elsewhere. In fact, China’s central government is the strongest government in the world, both in terms of the scale of its budget and its involvement in economic affairs.2 It may be argued that the CCP’s other deregulatory actions have been tactical, and that the CCP allowed deregulation only because the cost of managing millions of trivial goods—price, quality, quantity—was too high. It is also reasonable to pose the question: did the CCP have a clear blueprint

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for reform towards a market economy in the Western meaning of this term? The answer may turn out to be no. It is important to understand that a market-oriented transition implies the need for changes in various institutions; for instance, the Washington Consensus (Williamson 1989) contains nearly a dozen institutional goals (likewise in Post-Washington Consensus [Birdsall and Fukuyama 2011]). Even in its briefest version, a good market economy must include the rule of law, secure property rights, fewer import/export regulations, a liberalized and effective financial system and political liberalization. Yet China has none of these. The question that must be raised here is: If market-oriented transition could not be as comprehensive as in some transition economies (e.g., Eastern Europe where the ‘big bang’ approach was followed), why and how has China been so successful—assuming that success can be measured by economic growth? A more specific observation is that China’s success in terms of economic growth would have been impossible without the success of a large number of non-state-owned enterprises (Putterman 1992), producing huge quantities of consumer goods and selling them domestically and internationally. How does a market without a full set of good market institutions operate efficiently, and what do firms do to keep themselves efficient in such a market environment? This is the key issue throughout this book and it is the question that we try to answer.

2.2.2 M-Form Theory and Fiscal Feudalism The first remarkable attempt to understand the political bedrock of China’s fast economic growth was made by Qian and Xu (1993a, b), who suggest that China has a political structure with a multi-layer-multi-­ regional form (the M-form economy). The M-form political structure enables regional government branches to compete with each other, and offers them incentives to stimulate economic growth. M-form theory also regards the political structure in Eastern European countries and the Soviet Union as ‘U-form’ economies (Qian 2000), in which ‘most enterprises [are] grouped by industry and under the direct supervision of ministries’.3 According to Qian and Xu, China’s economic reform after

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1978, captured in the trend towards ‘decentralization’, strengthened the fiscal and administrative capacities of provincial governments in China. Further, the decentralized political power would be transferred to assist in local development in particular circumstances. Qian and Xu discuss an alternative institutional framework (although they did not specify it in this way) to ‘good market’ institutions (those proved by practice), and the theory of M-form economy is one origin of the fiscal feudalism theory (Qian and Weingast 1997). More specifically, the major arguments of M-form theory are (1) unlike in Eastern Europe and the Soviet Union, an M-form economy does not require a centralized information centre, thus providing more flexibility to local government, and thereby reducing information costs during the reform era; (2) M-form political structure allows local government to share a portion of revenue (e.g., tax) collected from local economy and the more they could collect the greater portion they may obtain, offering local government the necessary incentives to help stimulate economic growth; (3) the crucial point Qian and Xu make is that within an M-form economy, economic and political units are more independent from the central planner. Their scale and specialization levels are much closer to those working in a market economy, and are thus more susceptible to reform. Stated thus, Qian and Xu’s propositions may be regarded as a description of the ‘pre-conditions’ of Chinese (gradual) transition. There are criticisms of the M-form and fiscal feudalism theories. Neither international cross-country nor domestic historical empirical works support the feudalism theory. From the excellent work of Hu (2001), we find that from 1949 to 1978 several fiscal decentralizations took place. Some of these initiatives conferred more fiscal independence than policies in the reform era, but they neither generated economic growth nor gave local government the incentive to create market institutions. Cross-­ country comparisons also suggest that there is no correlation between the degree of fiscal decentralization and economic growth.

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A significant weakness of M-form theory is that it ignores the ability of local government to interfere in economic affairs—something that is affected by changes in central government’s policies. One principle is that even though provincial CCP leaders may have an incentive to facilitate economic growth, they still have to face a long multiple-agent chain. Consider the scale of Chinese provinces: most are as large as, or larger than, the average European country. Thus, it is impossible for any regional authority to deal with a huge number of individual firms, and in reality it is normally the case that government officials at the lowest level are the agents of state involvement in economic affairs. In these circumstances the final outcome of political interference must be the combined result of actions by central government, the regional ruler and the executive officials at a very local level (say, county or township level). Oi (1999) and Park and Shen (2003) offer a micro-vision of how the lowest level rural government bureaucrats deal with economic affairs.

2.2.3 State Corporatism and Joint Liability State corporatism theory, which first emerged in Oi’s 1992 paper, views local government—mainly at township level—as a helping hand for local enterprises. Although many of Oi’s arguments are still in debate,4 the phenomenon she has observed is quite valid and distinctive. Oi found that local government was deeply involved in the daily business of local firms, and suggested that in most situations, officials acted like businessmen seeking to maximize company interests. The joint-liability hypothesis (Sun 2002) offers some even more valuable insights (than state corporatism theory). It has three main points: first, within the local community government officials have the authority to arrange debt transfers (Oi 1992, 1999). By insuring that a loan can be transferred to other firms when it becomes a bad loan, the security of bank loans can be strengthened and local firms can borrow more from banks. Second, local government controls the quota of bank loans. Officials cannot ensure that each firm within a local community’s joint-liability mechanism can secure the amount it initially wants, and so a quota for bank

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loans is allocated by local government officials. Third, local government is the final guarantor for all loans made to joint-liability firms. Local government will usually sign a legal contract to act as the third joint party of a loan, and it allows a debt to be transferred to its account as long as the fiscal situation allows it to pay that loan. This mechanism may work well if government officials can run a community’s joint-liability loans as a portfolio, but when the macroeconomic environment changes, the portfolio may be at risk. During the whole of the 1980s and in the first half of the 1990s, almost all coast township governments endorsed many loans for local firms, especially TVEs. This was also a cause of waves of rural government bankruptcies that occurred in the late 1990s and early 2000s (Jiang 2001), when China’s manufacturing sector was affected by the 1997–1998 Asian crises.

2.2.4 E  conomic Environment and Ambiguous Property Rights State corporatism and joint liability give only a positive view of how local governments help and benefit firms. But another side of government is ignored: namely, that local government also takes from firms. Early papers (Che and Qian 1998) suggest, for example, that local government agents may grab from firms a share of their profits for their own self-­ interest. Che’s 2002 paper makes clear that close links often exist between local collective-owned enterprises (COEs) (mainly TVEs) and officials. On the other hand, the use of government’s political power has also been discussed in a broader sense. Since Li’s (1996) first application of the term ‘economic environment’ to the TVE problem, a range of approaches and measurements have been developed. The idea of the economic environment has been part of economic thinking for a long time, and its neoclassical origins may be dated back to Krueger. Tian (2000, 2001) first linked the economic performance of Chinese firms with China’s economic environment. He defines the economic environment as a set of measurable institutions that can be reduced to a single index: for example, we may label and rank institutions as somewhere between ‘terrible’ (measured as 0 in the index) and ‘perfect’ (with a value

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  27

of 1). From this basis Tian found that when institutions were not located in the ‘perfect’ area (i.e., had an index measure close to unity), but fell somewhere in the middle of the index, firms with less clearly defined property rights were quite likely to show a better economic performance than those whose property rights were clearly defined. The logic of Tian’s explanation is simple: when the economic environment is perfect—which means that institutions are (in a neoclassical sense) optimal and market costs are minimized—firms perform best; if the economic environment is ‘bad’, in the sense that firms operating in the prevailing institutional framework face high transaction costs, firms will not survive; and when the economic environment is neither bad nor perfect, less clearly-defined property rights can reduce some of the running costs of firms, enabling their overall performance to be better than with clearly defined property rights. The economic environment hypothesis also predicts that if institutions move towards optimal status, property rights will become more clearly defined. The economic environment hypothesis seems to work well in forecasting ownership changes in China: in the late 1990s the CCP finally acknowledged the importance of private ownership, and massive privatization swiftly transferred most COEs—including TVEs—and small-scale state-owned enterprises (SOEs) into genuinely private firms. Following a similar approach to that of Tian, efforts were also made to develop an index that could measure the degree of market environment imperfection. Dozens of papers were written on the subject, based on surveys or statistics. The most famous and systematic of these is by the group led by Fan Gang: the research was carried out by the National Economic Research Institute (NERI), starting in 1997, and the first report was published in 2001. The NERI report is multi-province, multi-measurement based and offers both a national index of China’s marketization, individual marketization indexes for each province and a single index for a given measurement (such as financial liberalization, or private ownership protection) at both national and provincial levels. The problem that the market environment hypothesis encounters is as follows: as there are many variables in economic institutions, why should property rights happen to be the dependent variable? The standard answer is that a reduction in property rights is a kind of payoff to government

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in exchange for government support to remedy the negative effects of imperfect economic institutions. But there is no theory or evidence in political science that can support this view. The measurement of market environment also has to address a theoretical problem: namely, if economies can be measured by an index, does this mean that all institutional diversity can be viewed as a bias from a unique set of optimal institutions?

2.3 Comments on Macro Issues and Theories We may take the argument further. First, at the macro level, the decentralized information flow may be the bedrock of a trading market, especially of COEs (of which TVEs for many years formed the major element). China has never successfully developed a highly specialized central planning system.5 Although at the central government level China still runs a huge planning system for industrial products and raw materials, it has never achieved the full requirements to run all factory production. This means that even at its height, the central planning system could not plot daily inputs, even for most state-owned enterprises, forcing it to seek a way of exchanging goods. The central planner in China put pressure on regional political leaders to find a mechanism whereby goods could be exchanged between each other, between provinces or counties (and in some cases townships), in addition to relying on the central planning system. Central planners in the Soviet Union and Eastern Europe faced a similar problem, but to a lesser degree. Except during the years when communist ideology was most radical, the CCP’s central and lower bureaucrats always6 made a great effort to maintain multiple-level exchanges of industrial product. Most exchanges were based on monetary terms—enterprises paid cash to buy goods—and were in the form of formal contracts guaranteed by local governmental authorities. It is hard to distinguish how many COEs have been established purely for this cash-exchanging purpose, but the former TVEs—the commune-brigade enterprises (CBEs)—were surely of this kind. When sales and purchase channels were still unclosed—there are still formal demand and supply information spread through (or in some cases, out of ) government— enterprises and managers who had the right to engage in business with

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  29

others soon found that cash income was more attractive than fulfilling state quotas.7 When agreement was reached to the satisfaction of both parties, they reported to government and included the value of the final outcome to government statistics. Thus, each deal remained within the purview of planners, and such transactions were seemingly part of the planned economy. The need for most COEs and some SOEs to meet their own demand and supply requirements is probably the biggest difference between the Soviet-style and the Mao period Chinese economies. It is thus easier to understand why at the beginning of the reform CBEs swiftly found a position to occupy between the demand side and the supply side. The reason is to be found in the fact that they had been designed to play a similar role, and all their business connections and skills were still useful and applicable in the new reform era. The M-form theory may be adapted to a theoretical construct in which historical conditions take centre stage. Inherent in this construct is the suggestion that China had an organizational advantage within its political economy at the beginning of the reform process, and that within China’s political organizations regional officials at various—provincial, county, township and village—levels, enjoyed sufficient political autonomy to be able to assist in stimulating economic growth. The weakness of M-form theory (as mentioned above) is that it does not answer how local officials gained this capacity to help economic growth. After 1949 local officials were given major political power, but until 1978 this authority was not successfully converted into economic development. Hence the need to study the micro-structure of local officials’ political power—as, to some extent, has been achieved through state corporatism and joint-liability theory. Second, even if state corporatism and the joint-liability theory holds, its validity may be affected (as also mentioned) by changes in macroeconomic conditions. At the heart of state corporatism and joint-liability theory is the ability of local government to affect economic affairs. At the same time, local government capacity is itself subject to change, since the limits of their political power is decided by many factors beyond its control. For instance, when the banking system in China was part of the Ministry of Finance, local governments could not secure significant funding from the banking system. The reasons for this are complex,

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but basically the Bureau of Finance—local branches of the Ministry of Finance—hardened the budget constraint (at a time when SOEs’ budget was soft); Bureau of Finance officials were responsible for bad loans and decision-making powers about loans were held by county-level (or above) finance officials; by contrast, township officials had barely any influence over higher ranking officials’ decisions. The situation changed when the banking system was given more independence by the Ministry of Finance: now, township branch bankers were less influenced by either country-­ level bureaucrats or by their responsibility for specific loans. Instead, they developed closer relations with township leaders, who—along with local entrepreneurs—exercised the real control over local welfare allocations, from job opportunities and house location—in rural areas citizens had to apply for land to build their house on—to children’s education. In short, at this stage loans were extremely easy to secure. Since 1998, however, banking system reform initiated by Premier Zhu Rongji has changed the role of banks and tightened the lines of responsibility. Zhu gave banks more independence and compelled bankers to take responsibility for each loan they made. This so-called lifetime responsibility means that even if a bank manager has changed jobs, if any of the loans he has made becomes problematic he can be called back and remains subject to legal action until the money is paid back to the bank. As a result, after 1998, township government once more had little opportunity to help local firms to obtain loans on a regular basis. Another example is the sale of land use rights: in rural China, land is distributed by local government, which has the right to take such land from peasants and re-sell it to enterprises. In theory, compensation should be paid to the peasants; but in practice, the sales price is always much greater than such compensation, making it possible for the government to raise money from resales of farmland. In the early 1990s, the first province to host large numbers of manufacturers, Guangdong, found that enterprise demand for land was so high that it became extremely profitable to take over all the farmland on which it could lay its hands. Almost all coastal township governments in Guangdong made huge amounts of cash income through sale of land. Using this money, local government was able to improve infrastructure and invest in  local TVEs—some of these TVEs were super-large-scale firms—and part of the money was used to increase the government scale by employing more civil servants.

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  31

But by the late 1990s most available land had been sold, and manufacturers ceased to favour Guangdong because they could set up new factories in the Yangtze Delta at lower cost. Many of the township governments in coastal Guangdong were bankrupted, as they no longer had sufficient funding to support infrastructure construction, and they were forced to sell their shares in TVEs to local firms. In some townships or counties, even government buildings were sold to pay bank loans. As some papers on joint liability (e.g., Sun 2002) observe, such changes in local government financial capacity are highly dependent on fundamental elements, which are referred to as ‘economic environment’ in principal-agent theory-­based papers. There are basic conflicts between M-form theory and the economic environment hypothesis (not to mention the ambiguous property rights theory). M-form theory insists that there are some crucial conditions (Qian and Xu call them ‘initial conditions’) which are necessary for a transition economy to develop intermediate institutions, but the economic environment hypothesis regards the degree of institutional imperfection as a necessary condition. So, the M-form theory regards these initial conditions as steps towards ‘optimal’ institutions, whereas the economic environment hypothesis does not (see Fig. 2.1 below). From this difference derive various conclusions. M-form theory suggests that the intermediate institution itself is a kind of institutional progress towards an optimal institutional framework, and the economic environment hypothesis just assumes that these intermediate institutions are alternative and temporary, so they will be abandoned when other institutions have been changed. From an empirical perspective, what happened in the late 1990s seems to lend credence to the economic environment hypothesis. At this time, the CCP finally abandoned its ideology of anti-private ownership and made pragmatic compromises with the ethos of private ownership. So it was that quite suddenly most COEs (including TVEs) were privatized— just as David Li had predicted in his 1996 paper. Yet there remains the problem of why COEs emerged, grew and were successful only in China, but not in Eastern Europe or the former Soviet Union. Contingency is one explanation: in other words, it is argued that China alone developed collectively owned rural workshops during the Mao period. In fact, ­however, Czechoslovakia too had similar ownership arrangements

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M-form Theory Original Economic

Intermediate

Target Institutions

Institutions

Institutions

(Optimal)

Economic Environment Hypothesis Target Institutions (Optimal)

Original Economic Institutions

?

Alternative Institutions

Fig. 2.1  M-form theory and economic environment hypothesis

in terms of its industrial organization. So why did Czech firms with ambiguous property rights collapse in an economic environment that was superior to that of China (in terms of a marketization index, in the early 1980s Czechoslovakia’s score would have been much higher than that of China).

2.4 M  icro-Theory: Ownership Structure and Entrepreneurship A number of remarkable articles have sought to understand the nature of TVEs and how they spearheaded China’s economic growth. The literature about ambiguous property rights is central to these. As early as in 1994, the absence of clearly defined property rights was attracting attention (Weitzman and Xu 1994). Weitzman and Xu

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observed that property rights in TVEs were not clearly defined, and their explanation for this is that traditional Chinese culture may have favoured the development of cooperative behaviour—even if they failed to explain what exactly is meant by ‘traditional culture’ (let alone how it works). Thus, greater cooperation between community members goes some way to reducing the negative effect of the lack of economic incentives (caused by the absence of clearly defined private ownership). And because each community member can expect others to take similar action to maximize community welfare, there will be no efficiency loss caused by uncooperative behaviour (cf. the idea of the prisoner’s dilemma). Li (1996) brought the standard principal-agent method into the discussion of TVEs and incorporated the government as an important player. He argued that under the particular circumstances of China’s immature and imperfect market economy, ambiguous property rights could help these firms to obtain important inputs. The basic idea of Li’s model is that government intervention leads to profit sharing with the government. A firm (TVE) can choose to operate without involving the government, but if the firm’s earnings start to decline, the government has an opportunity to negotiate a rescue plan with the relevant entrepreneur. If the entrepreneur accepts this rescue plan, he will be obliged to hand over some part of his final output to government. Li’s underlying approach and methodology deserve attention. First, Li regards the government as an outside source of rescue that will only engage with a firm when it is in danger. In other words, unless the firm’s profits drop to a dangerous level, the government will not intervene and take a share of the firm’s ownership. It is easy to see the common point between Li and joint-liability theory, in which the government appears as a saviour. Second, Li suggests that government involvement comes in the form of the provision of monetary resources (say, cash input), and only happens at the time of the rescue. Third, in Li’s and most subsequent papers, rights of control are initially given to the entrepreneur. The right of control is crucial, since it is symbiotically related to an entrepreneur’s ability to exercise his entrepreneurship: thus, if the government (or government agent) intervenes and control rights are transferable, then entrepreneurship must be transferred to the government agent—­otherwise

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he cannot access sufficient information and take correct rescue actions (which is unacceptable both in reality and in theory). In general, Li’s model assumes that the government works as a compassionate outsider lender; as a result, the likelihood is that the potential rescue action will be the source of moral hazard—a TVE entrepreneur will undertake highrisk projects in the knowledge that he will be saved if the project goes wrong—rather than an ownership issue, because as Li’s model views ambiguous property rights in TVEs as a risk-sharing contract between local government and entrepreneurs, entrepreneurs have less incentive to seek to produce more efficiently. Α similar idea is also found in papers by Chang and Wang (1994), Che and Qian (1998) and Che (2002), but their different assumptions push them in different directions. The most significant improvement was made by Che (2002), who suggests that input from the government is continuous, and comes with several consequences. First, the agreement for government intervention must be made at the outset, not at any halfway stage. Second, as the production will end with zero output if governmental input is cancelled, the government agent enjoys more bargaining power throughout the production process. Third, also because of the threat of withdrawal, the entrepreneur and his assets will be held up (because his specific investment cannot be cashed once invested) by the government agent. In contrast with Li (1996), since governmental input does not contain any monetary, physical or human capital, withdrawing it will entail no cost, but will sink all the entrepreneur’s existing investment. However, if it happens as Che suggests, once a government agent is given too much bargaining power, the entrepreneur’s right of control will be threatened. If a firm’s destiny is in the hands of a government agent, why does this agent not grab more from the firm? If a government agent takes too much from the enterprise, this may reduce the entrepreneur’s incentive to seek higher profits, and therefore compromise the firm’s economic performance. To solve this, two assumptions have been introduced to explain why TVE entrepreneurs still have a high incentive to run TVEs well. One approach (this is the traditional approach widely used in a number of papers e.g., Li (1996), Che (2002)) is to strengthen entrepreneurs

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by adding asymmetric information to the theoretical framework. The asymmetric information assumption, which is a standard element of principal-agent-based models, was used by Li (1996) as early as 1996. Li assumes that the firm’s information is not available to the government agent at the initial stage, and the real status of the firm will be not revealed to the government until at some point through production; as mentioned, if conditions are unfavourable, intervention is an option. Li’s approach endows entrepreneurs with sufficient bargaining power, but in subsequent studies that bargaining power has been greatly damaged by assuming the absolute control of government agents over key inputs which can only be obtained from the government itself. For instance, Che (2002) assumes that an entrepreneur has private information about his managerial talent, and the marginal product value of his managerial talent is greater than the government agent’s expectation. But even if the entrepreneur has more private information about the real final output, a principal-agent-based model still shows strong potential for efficiency loss. The reason for this is that a government agent does not bear the risk of any possible loss—unlike in Li’s (1996) proposal—but has powerful control over crucial inputs; as a result, a grab will happen following the Nash equilibrium, which means that the government agent can claim a significant portion of the profits. Thus, any added informational restriction will help remedy the danger of a total loss. Che (2002) also tries to add another redemption mechanism: a government agent may be seduced by an entrepreneur’s rent-seeking activities, enabling the entrepreneur to secure a smaller payment that has to be paid to the government agent (rent-seeking cost). Because the sum of rent-seeking costs may be less than the reduction in the amount paid to the government, the entrepreneur’s rent-seeking behaviour will then have increased efficiency. The second approach is similar to Che’s rent-seeking assumption, but focuses on the entrepreneur’s entrepreneurship. Chen and Rozelle (1999) firstly approach the TVE problem by highlighting the manager’s special talent for running a firm. They suggest that the government agent may employ an entrepreneur with a profit-sharing contract designed to maximize the firm’s output (similar to Chang et al. 2003). Chen and Roselle ignore the fact that the threat of opportunism usually arises on the government’s rather than the entrepreneur’s side, but they acknowledge that

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the entrepreneur’s entrepreneurship is unique and that this may be used to work to his advantage. Zhou (1997, 2002) draws attention to the empirically demonstrated importance of entrepreneurship. He finds that entrepreneurial abilities may secure an entrepreneur’s control rights over the enterprise, which may in turn greatly reduce the possibility of opportunistic behaviour by a government agent. Another important phenomenon observed by Zhou is the use of the entrepreneur’s entrepreneurial skills in  local politics, which he terms ‘institutional entrepreneurship’: the entrepreneur’s activities in local politics are cited as another means of reducing the government agent’s opportunism. Zhou’s observation is actually another version of the political entrepreneur, or political entrepreneurship (e.g., Holcombe 2002), analysed in the next section.

2.5 Implications 2.5.1 J unction of Institutions: The Represented M-Form Theory We consider the TVE problem against the background of the transitional economy. As mentioned previously, concerns about TVEs are usually twofold: why do TVEs perform to a high standard? And why do TVEs exist? The second question is less frequently asked, because conventional thinking regards both questions to share the same answer. To an extent, they are indeed the same question: assuming that there already exist sound market institutions in China, firms will be organized in the best possible way in terms of ownership structure, and will perform as well as in those other economies with similarly sound market institutions. The problem is that different transitional economies are likely to start from different initial conditions. Such differences relate not only to geographical conditions (such as population and natural resources), but also to institutional conditions (including legal systems and the nature of prevailing ideologies). Thus, there is a range of institutional conditions, in which a degree of institutional change has taken place, but not sufficiently to have attained (expected) optimality.

2.5 Implications 

  37

Tian (2000, 2001) has generated a model, designed to explain the relationship between economic performance and institutional imperfections. To illustrate this, consider the starting point of a standard transition economy: an economy that was previously defined in terms of a centrally planned, ‘anti-market’ system, in which individual private ownership is banned. We also start from a situation in which institutions are static. Following the standard approach to dealing with imperfections in institutions, it is easy to assume that a single measurement exists for all possible choices of institutions. This is a very straightforward assumption, since institutions have usually been defined as sets of rules (e.g., North and Thomas 1973). This also reflects the basic idea of institutions: their work within a society can actually be seen as a set of rules, and here we assume that this set is a subset of a greater set of all rules. In a static situation—that is, with all institutions fixed—a society has a set of rules which must be obeyed by all individuals and organizations making up a given society. But within those rules allowance must be made for differences between certain groups of individuals and organizations. For example, a peasant living in rural China will be governed by different rules from those under which factory workers in a car workshop operate. That is to say, at a given point in time each individual or organization is exposed to and affected by only part of all the institutions that exist for the whole of society. In short, even if the overall institutional framework of a society embodies a plethora of rules, only a small proportion of these is applicable to a given situation, or a given individual (organization). Then the problem can be transferred to the relationship between economic performance, organizational form and institutional boundaries. If everything goes as Tian (2000, 2001) suggests in such circumstances, the institutions of a society are fixed and we can easily ascertain the efficiency loss caused by institutional distortion. This approach is widely used in studies dealing with the relationship between TVEs and imperfect institutions. For instance, in Tian’s model (2000, 2001), a single index ρ indicates the degree of market imperfection. The direct implication of this restriction is that if we need to improve society’s efficiency, we need to change institutions in order to obtain a new ρ, which indicates less institutional distortion.

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As a simple explanation of the above, if institutions are fixed and can only be changed by North-type institutional shift—permanent institutional changes throughout the whole of society—then institutional change is costly because of free-rider problems associated with collective action (Olson 1965). However, if we relax the fixed institution assumption, we may assume that individuals or organizations do not need to change the rules that universally apply to their society; instead, they simply make use of and adapt, to their own advantage, the institutional environment in which they exist. That is to say, individuals have two options available to them to change the institutions in which they live. One is to act collectively and permanently change society’s institution(s), but having to bear the cost of free-riders if they cannot prevail on every beneficiary to act individually. Another way is merely to change the small-scale institutions one wants to change, this requiring the individual to pay all the fees but freeing the payer from the problems of collective action. The costs of permanent institutional change and small-scale institutional change may differ, and a rational individual will choose to pursue the course of action that entails the lower cost. Thus, we can represent M-form theory in another way: If some changes have been made in a transitional economy, and these changes sufficiently lower some individuals’ cost of changing the institutional framework in which they live, then those individuals are likely to benefit from such type of institutional changes. Further, if for those affected individuals the economic gain from small-scale changes is greater than the cost of making them, institutional changes will take place on a small-scale discretely around those affected individuals.

2.5.2 Alternative Institutions We can view these small scale institutional changes as alternative institutions. When a society does not possess institutions which promote efficiency, there will be alternative institutions. Although alternative institutions can improve efficiency, they are different from formal institutions in two basic ways: (1) they are temporary; (2) they have no, or only few, externalities.

2.5 Implications 

  39

In general, alternative institutions cannot replace those that result from permanent, more comprehensive institutional change. Once a North-­ type institutional change has taken place, smaller or no fees are payable to maintain the new institutions. By contrast, alternative institutions will incur continuous charges. Thus, an alternative institution is always a second best choice in the long run. We may also use the difference between North-type institutional change and alternative institutions to explain the difference between the economic performance of China and that of Eastern Europe countries. This concept offers an important insight into TVE history. For example, it explains why first-generation TVEs declined very fast when their scale began to increase. More importantly, we find that the decline of alternative institutions is not necessarily connected with North-type institutional change. The success of alternative institutions depends purely on the costbenefit relationship between individuals’ alternative institution costs and potential benefits; and the determinable factors in an alternative institution do not have any positive correlation with North-type institutional progress.

2.5.3 M  acro and Micro: Economic Reform and Organizational Change By introducing the difference between North-type institutional change and small-scale individual-based institutional change, we can also reinterpret the use of local government and decentralization. There are two elements: the first is the cost of institutional changes. From the viewpoint of an individual entrepreneur, the institution he deals with is actually the person who ensures that rules will always be obeyed. Thus, a relationship between institutional change costs and decentralization can readily be found. As we have mentioned, the CCP decentralized its power at least twice before 1978, and the fundamental difference between preand post-1978 decentralization is that pre-1978 decentralization did not give sub-provincial bureaucrats—i.e., those at district (di qu, 地区: most district-level governments were cancelled in 1958), county, and township levels—the power to interfere in economic affairs. In contrast, post-­ 1978 reform works in three ways. Under the 1980 fiscal decentralization

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framework, it allows low-level local government, SOEs and COEs to retain fiscal revenues—something that had not previously been possible, following nationalization during the 1950s. Next, local officials have the right to set up new enterprises, as long as they can raise the funds locally. And last, more varied ownership of assets is allowable (e.g., private property rights). The first implication of the post-1978 reform policy was the ability of firms to use funds freely. Under central planning before 1978, SOEs and COEs were simply not permitted to retain any funds—whether profits, bank loans or government investment. Profits and unused funds had to be returned to government (to the Bureau of Finance in the case of SOEs; to local government for COEs). The second element is the cost of small-scale individual-based institutional change. Obviously such action has its limitations. For example, an entrepreneur in a small town and his major suppliers—officials—cannot extend the remit of their activities to county level unless the entrepreneur pays extra costs at the county level. This is the spatial limitation. But we would draw attention to a different point: namely, if macroeconomic conditions or the distribution of political power between different levels of government change, the existing institutional framework may no longer be relevant. It is easy to see that in this case the nature of institutional change lies in the ability of local government to use its political power to rearrange institutions at a community level, thereby affecting firms’ economic performance. However, if this political power is redistributed, then the ability of government officials to make such institutional changes also changes. Che (2002) has noticed the cost of entrepreneur’s rent-seeking behaviour, and regards this as a necessary cost of TVEs’ daily operations. However, this is based on the specific economic environment, in which the combination of fundamental institutions not only allows an entrepreneur to undertake rent-seeking, but also enables rent-seeking behaviour to be profitable. Under the assumption of non-North-Type institutional change, it is possible to understand the importance of entrepreneurship—and sometimes political entrepreneurship—in TVE activities. One core issue facing TVE has been that of the entrepreneur’s payments (‘payoffs’ may be a better term) to local government. We distinguish two types of payoffs. One of these, which was also highlighted by

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Oi (1999), is the payoff to the government treasury: this may benefit the government agent personally, albeit indirectly. For example, Che (2002) found that TVE entrepreneurs could keep as many people as possible on the payroll, in order to reduce the local unemployment rate, bringing certain political benefits to the government agent. Another type of payoff is more direct, as in the case of monetary payoffs to government agents, as bribes. Costs attach to both types of payoffs. What about entrepreneurs’ entrepreneurial abilities and skills? In the standard theory of market competition, entrepreneurship can be regarded as the entrepreneur’s human capital, and the more human capital an entrepreneur possesses, the greater the probability of that entrepreneur’s success in market competition. TVE entrepreneurs are subject to the same rule, and are even more dependent on entrepreneurship: without sufficient entrepreneurship the entrepreneur may not able to bear the necessary institutional costs and therefore be unable to set up a firm. But the story of entrepreneurship does not end here. Zhou (1997) finds that in some cases entrepreneurs seek ways to become involved in local CCP politics. From this perspective, TVE managers may be regarded as quasi-official local officials, although their rank is too low to be listed on the formal government roster. Even so, entrepreneurs seem rarely to have considered shifting to a different career path—most TVE entrepreneurs continue with their TVE career even if they have successfully managed to obtain some kind of government position. Zhou views this behaviour as a cost-saving attempt. According to Chen and Rozelle (1999), a government official is a person who has advantages in dealing with external (i.e., external to the firm) affairs, whereas an entrepreneur is someone who is good at the firm’s internal management. If neither a government official nor an entrepreneur can replace the other, the Coase theorem shows that one party will employ another.8 But these two characters are separate and each has a single talent. Zhou’s approach offers another possibility: a single individual may embody both roles. It is clear that once an entrepreneur has the opportunity to become an official, or a person with enforceable power in local politics, he is effectively endowed with the ability significantly to reduce institutional costs. It is in this sense that we speak of an entrepreneur having political entrepreneurship.

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2.6 Conclusion From a macro perspective, a transitional economy may not achieve a smooth and fast transition, and a long time may have to elapse before the institutional framework has been transformed in such a way as to allow it to function in the way in which it is required. It follows that what happens during the interim—that is, the transition—is worthy of our attention. The main purpose of this chapter has been to provide an overview of relevant TVE studies. It has also tried to briefly illustrate the framework used in this research. We focus on the huge difference—in practical business and economic operations—between pre-1978 and post-1978 Chinese economy. Huang (2008) names this difference ‘directional liberalism’ and believes that fundamental changes in institutions in China have caused this difference. Our quest is to explore these key fundamental changes. Key fundamental institutional changes in China’s early economic reforms made up the main body of ‘directional liberalism’. In what follows, we not only examine these fundamental changes, but also seek to identify subsequent changes in order to trace their impact on the development of China’s TVEs.

Notes 1. Except in 1989, the year of the political uprising known as the ‘Tiananmen Square Protests’. 2. In making this statement, I exclude those countries that have remained under central planning, such as North Korea and Cuba (countries whose economies are, however, very small). 3. Qian and Xu (1993b). 4. Basically Oi views most—if not all—local governments as saintly and full of moral responsibility. This is questionable both empirically and theoretically. 5. Two attempts were made in the 1950s and the 1970s. The first attempt, designed to set up a Soviet-style planning system with a heavy industry

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sector at its core, was supported by Stalin, and was heavily reliant on Soviet aid. But from 1957, after Khrushchev had taken power, growing differences between Khrushchev and Mao led to the abandonment of this model in favour of a more indigenous Chinese strategy. The second attempt was even weaker, and was borne out of the ideological fever of the Cultural Revolution. In both cases, industrial output growth was slowed significantly. 6. Even during the Great Leap Forward. 7. An attractive career in pre-reform China was to be a member of a sales staff. Such people were permitted to travel all over the country and received travel subsidies. 8. Chen and Roselle’s example is that of a government official employing an entrepreneur.

References Birdsall, N., & Fukuyama, F. (2011). The Post-Washington Consensus: Development After the Crisis. Foreign Affairs, 90(2), 45–53. Blanchard, O. (1998). The Economics of Post-Communist Transition. Oxford: Oxford University Press. Byrd, W.  A., & Lin, Q. (Eds.). (1990). China’s Rural Industry: Structure, Development and Reform. Oxford: Oxford University Press. Chang, C., McCall, B.  P., & Wang, Y. (2003). Incentive Contracting Versus Ownership Reforms: Evidence from China’s Township and Village Enterprises. Journal of Comparative Economics, 31(3), 414–428. Chang, C., & Wang, Y. (1994). The Nature of the Township-Village Enterprise. Journal of Comparative Economics, 19(3), 434–452. Che, J.  (2002). Rent Seeking and Government Ownership of Firms: An Application to China’s Township—Village Enterprises. Journal of Comparative Economics, 30(4), 787–811. Che, J., & Qian, Y. (1998). Insecure Property Rights and Government Ownership of Firms. The Quarterly Journal of Economics, 113(2), 467–496. Chen, H., & Rozelle, S. (1999). Leaders, Managers, and the Organisation of Township and Village Enterprises in China. Journal of Development Economics, 60(2), 529–557. Hayami, Y., & Ruttan, V. W. (1971). Agricultural Development: An International Perspective. Baltimore, MD: The Johns Hopkins Press.

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Holcombe, R.  G. (2002). Political Entrepreneurship and the Democratic Allocation of Economic Resources. The Review of Austrian Economics, 15(2–3), 143–159. Hsiao, C., Nugent, J., Perrigne, I., & Qiu, J.  (1998). Shares Versus Residual Claimant Contracts: The Case of Chinese TVEs. Journal of Comparative Economics, 26(2), 317–337. Hsu, I.  C.-Y. (1999). The Rise of Modern China (6th ed.). Oxford: Oxford University Press. Hu, Shudong. (2001). Jingji fazhanzhong de zhongyang yu defang guanxi—zhongguo caizheng zhidu bianqian yanjiu (The Relations Between the Central and Local Governments in Economic Development—Together with Research of China Fiscal Institutional Changes, 经济发展中的中央与地方关系—中 国财政制度变迁研究). Shanghai: Shanghai People’s Publishing House. Huang, Y. (2008). Capitalism with Chinese Characteristics: Entrepreneurship and the State. New York: Cambridge University Press. Jiang, C. (2001). Xiangzhen qiye rongzinan: xianzhuang, yuanyin yu sikao (Financial and Capital Troubles of the Country-Tow-Operated Enterprises: Present Situation, Causes and Reflections, 乡镇企业融资难:现状、原因 与思考). Jiang Huai Tribune, 1, 28–33. Li, D.  D. (1996). A Theory of Ambiguous Property Rights in Transition Economies: The Case of the Chinese Non-State Sector. Journal of Comparative Economics, 23(1), 1–19. Lipton, D., & Sachs, J. (1990). Creating a Market Economy in Eastern Europe: The Case of Poland. Brookings Papers on Economic Activity, 21(1), 75–148. Naughton, B. (1994). Chinese Institutional Innovation and Privatization from Below. American Economic Review, 84(2), 266–270. Naughton, B.  J. (2006). The Chinese Economy: Transitions and Growth. Cambridge, MA: The MIT Press. North, D. C., & Thomas, R. P. (1973). The Rise of the Western World: A New Economic History. Cambridge: Cambridge University Press. Oi, J. C. (1992). Fiscal Reform and the Economic Foundations of Local State Corporatism in China. World Politics, 45(1), 99–126. Oi, J. C. (1999). Rural China Takes Off: Institutional Foundations of Economic Reform. Berkeley: University of California Press. Olson, M. (1965). The Logic of Collective Action: Public Goods and the Theory of Groups. Cambridge: Harvard University Press.

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Park, A., & Shen, M. (2003). Joint Liability Lending and the Rise and Fall of China’s Township and Village Enterprises. Journal of Development Economics, 71(2), 497–531. Putterman, L. (1992). Dualism and Reform in China. Economic Development and Cultural Change, 40(3), 467–493. Qian, Y. (2000). The Process of China’s Market Transition (1978–1998): The Evolutionary, Historical, and Comparative Perspectives. Journal of Institutional and Theoretical Economics, 156(1), 151–171. Qian, Y. (2003). How Reform Worked in China? In D. Rodrik (Ed.), In Search of Prosperity: Analytic Narratives on Economic Growth (pp. 297–333). Princeton, NJ: Princeton University Press. Qian, Y., & Xu, C. (1993a). The M-form Hierarchy and China’s Economic Reform. European Economic Review, 37(2–3), 541–548. Qian, Y., & Xu, C. (1993b). Why China’s Economic Reforms Differ: M-Form Hierarchy and Entry/Expansion of the Non-State Sector. Economics of Transition, 1(2), 135–170. Qian, Y., & Weingast, B. R. (1997). Federalism as a Commitment to Reserving Market Incentives. Journal of Economic Perspectives, 11(4), 83–92. Rodrik, D. (2003). What Do We Learn From Country Narratives? In D. Rodrik (Ed.), In Search of Prosperity: Analytic Narratives on Economic Growth (pp. 1–19). Princeton, NJ: Princeton University Press. Sachs, J., & Woo, W. T. (1994). Understanding the Reform Experiences of China, Eastern Europe and Russia. Journal of Comparative Economics, 18(3), 23–48. Sun, L. (2002). Fading Out of Local Government Ownership: Recent Ownership Reform in China’s Township and Village Enterprises. Economic Systems, 26(3), 249–269. Tian, G. (2000). Property Rights and the Nature of Chinese Collective Enterprises. Journal of Comparative Economics, 28(2), 247–268. Tian, G. (2001). A Theory of Ownership Arrangements and Smooth Transition. Journal of Institutional and Theoretical Economics, 157(3), 380–412. Weitzman, M. L., & Xu, C. (1994). Chinese Township-Village Enterprises as Vaguely Defined Cooperatives. Journal of Comparative Economics, 18(2), 121–145. Williamson, J.  (1989). What Washington Means by Policy Reform. In J. Williamson (Ed.), Latin American Readjustment: How Much has Happened. Washington, DC: Institute for International Economics.

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Woo, W. T., Hai, W., & Jin, Y. (1994). Zhongguo qiye gaige jiujing huode le duoda chenggong (How Successful is the Chinese Enterprise Reform, 中国 企业改革究竟获得了多大成功). Economic Research Journal, 6, 20–32. Zhou, Q. (1997). ‘Kongzhiquan huibao’ he ‘qiyejia kongzhi de qiye’—‘Gongyouzhi jingji’ zhong qiyejia renli ziben chanquan de anli yanjiu (‘Control Rights Rewards’ and ‘Firms Controlled by Entrepreneurs’—The Human Capital Ownership of Entrepreneurs in ‘Non-Private Economy’, “控制权回报”和“企 业家控制的企业”—“公有制经济”中企业家人力资本产权的案例研究). Economic Research Journal, 5, 31–42. Zhou, Q. (2002). Chanquan yu zhidu bianqian: Zhongguo gaige de jingyan yanjiu (Property Rights and Institutional Transformation: The Chinese Experiences, 产权与制度变迁). Beijing: Social Science Literature Press.

3 Township and Village Enterprises: History and Institutions (1958–1997)

3.1 Introduction One of the core assumptions in the literature on township and village enterprises (TVEs) by Qian and Xu (1993), Tian (2000, 2001) and others is that economic institutions in China have been able to make a number of key adaptations in pursuit of better economic performance. In this chapter, a TVE is regarded as an intermediate institution, capable of embodying such institutional adaptation, the rationale for which may be found in neoclassical thinking: in a neoclassical framework, economic performance and efficiency are sensitive to institutions—the market, the legal system and the state. Tian (2000, 2001) concludes that economic environment has been a determinant of the economic performance of TVEs. In their early days, TVEs could not be legally owned by any single person or group of partners. Instead, a TVE is collectively owned by local citizens in the community. Formally, the nominal owner is this set of local citizens, and the local government keeps the nominal control rights as agent of the local citizens until a manager (changzhang,厂长) has been chosen as a government agent in a TVE. However, publicly announced © The Author(s) 2017 C. Jin, An Economic Analysis of the Rise and Decline of Chinese Township and Village Enterprises, Palgrave Studies in Economic History, DOI 10.1007/978-3-319-59770-6_3

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policies of the Chinese Communist party (CCP) throw little light on key questions, such as how to raise funds or allocate control rights. Few articles in the existing literature acknowledge the importance of these initial conditions of TVEs, as a result of which the importance of initial property rights allocation, ownership structure and social conditions has tended to be ignored (e.g., in Li’s model (1996) it is assumed that an entrepreneur can start up a business without any difficulty). In order to address these issues, early theoretical writings about TVES viewed ambiguous property rights in TVEs as a risk-sharing contract between local government and entrepreneurs. Early studies by Chang and Wang (1994), Che and Qian (1998) and Che (2002) suggest that ambiguous property rights are the basis on which property rights, including residual rights, are distributed between local government and entrepreneurs—but with ultimate control residing with government, offering necessary incentives for local government to give TVE entrepreneurs the political support they require. A more specific version of this theory is joint-liability theory (e.g., Sun 2002) in which local government is described as an ultimate source of insurance that enables TVE entrepreneurs to obtain collateral loans from banks. The literature on ambiguous property rights theory and similar articles (e.g., Tian 2000, 2001) offer a micro insight into TVEs’ cooperation with local government, on the basis of which they can secure economic (or political) resources needed to reduce distortions brought about by market imperfection. The second view suggests that institutional adaptation requires a basic institutional foundation of the kind that cannot be provided by the local communities’ entrepreneur-government framework. Qian and Xu (1993) argue that a variety of factors—including an autonomous tradition rooted in China’s political structure, factors inherited from the Mao period and the impact of post-1978 reform policies themselves— have been reflected in a redistribution of political powers to enable local government and entrepreneurs to implement institutional adaptation. This view can be expressed differently: namely, there are many kinds of political power and different levels of political decentralization, but for any given set of circumstances, only if political power is distributed in a particular way will local government be able to help promote economic growth. In this view, the political resources that TVEs can obtain not

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only depend on local political processes but are also determined by the nature of the political power that local government possesses. We would argue that the above views capture the TVE phenomena at two different levels. From a micro perspective, TVEs are the direct outcome of a bargaining process involving local government and TVE entrepreneurs. The contract made between two parties is likely to address a variety of issues, such as how political power is exercised (and how it is to be rewarded), under what circumstances political intervention should take place, etc. From a macro perspective, thanks to the evolution of relevant institutions, TVEs were able to outperform in nearly two decades. However, most institutional evolutions (which were helpful to TVEs) are changes in fundamental political or social structures—such as the organizational rules of local governments—which are out of local government’s control. Some attempts have been made to combine these two views; for instance, those of Tian (2000, 2001). However, Tian’s approach does not adequately capture the nature of property rights—in particular, it fails to show how the economic environment affects the allocation of property rights. At this point, it is important to emphasize that almost all of the literature on TVEs, from Li (1996) to Tian (2000, 2001) and Qian (2003), emphasizes the importance of the imperfect market environment and the connection between this imperfection and TVE property rights. Yet none of these authors clearly explains the relationship between the imperfect market environment and TVEs’ incomplete property rights. Furthermore, the concept ‘market environment’ refers to market institutions, in which property rights are normally included. This chapter seeks to show how TVEs emerged and developed—in other words, it seeks to capture the evolutionary nature of TVE development. As well as tracing post-1978 changes, this will require consideration to be given to the historical background, out which TVEs evolved. The major focus of this chapter is the change in the links between fundamental institutions and the political influence of local governments. As mentioned by Thun (2006), compared with central government, local governments are heavily involved in daily market activities at firm level. Firms usually only have the chance to deal with local government, and local government is the representative of the state authorities. In such circumstances, local government can be regarded as the redistributor of

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political resources at community level. This has important consequences in China because township governments exercise considerable power in social and economic affairs as overall arbiters in control of banks, tax offices, schools, courts, police and hospitals—in other words, almost all essential social and economic organizations. Thus, a market environment is necessarily linked to a local government. At the same time, under the implicit rules by which the CCP exercises its authority, local governments are executives of central government policy and any change in political power allocation directly affects local government. This chapter is organized as follows: Sect. 3.2 provides a brief historical overview of CBEs (TVEs) during the pre-reform era from 1958 to 1978; Sect. 3.3 discusses relevant institutional changes in the earliest phase of China’s economy reform (1978–1984), and how these changes impinged upon CBEs (TVEs); Sect. 3.4 provides a summary review of the history of TVEs from 1984 until 1997 as a prelude to further, more detailed analysis of this history in later chapters. The final section is a brief conclusion.

3.2 C  ommune-Brigade Enterprises (CBEs) in the Pre-reform Period: 1958–1978 3.2.1 The Origin of CBEs One common problem that local government agents faced in the Mao period was a shortage of cash. The origins of this problem were twofold. Firstly, in the 1950s market-based financial networks were replaced by the People’s Bank (which became China’s Central Bank in the early reform era), whose facilities were little more than those of a depository for ­savings—and all savings they collected went to the central planning financial system. As a result, the local economy was deprived of any source of market-based funding. Throughout the 1950s the CCP’s development strategy prioritized industry, especially heavy industry, and the CCP sought to copy the Soviet Union in promoting industrial growth by squeezing the rural sector (The Eighth National Congress of the Communist Party of China, 1956). The central government controlled most fund flows and directed these towards the strategic priority of heavy industry.

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During and after the Great Leap Forward (1958–1960), such funds came under even tighter control. In general—and despite a degree of decentralization in funding procedures at the time of the Great Leap Forward—it was extremely difficult for local government to secure any extra funds from central government. Meanwhile (the second source of the ­problem), China’s industrial and rural sectors faced considerable ­dislocation during the Great Leap Forward and the Cultural Revolution, further weakening central government’s economic and financial ­capacities—especially in regard to the rural economy, which was on the verge of bankruptcy. It is important to understand the fiscal status of township- and village-­ level government in pre-reform China, since this provided the motivation for central authorities to sanction the establishment of CBEs by local governments. By 1958, events of the previous decade—the Civil War between the CCP and Kuomintang (1946–1949), land reform (1950–1953) and the ‘high tide’ of collectivization (1955–1956)—had destroyed key elements of the traditional Chinese rural market, based on stable (if often iniquitous) landlord-tenant relations, and township-­ based regular agricultural product exchange. Because peasants could not secure a monetary income through market means, local governments in rural areas were deprived of tax income, and from the 1950s until the 1970s township- and village-level branches of government survived only on the basis of financial aid made available by central and provincial governments. The collapse of the Great Leap Forward exacerbated local governments’ fiscal status, as the ability of central government to offer monetary support became severely constrained. Against the background of the CCP’s economic policy failures in the rural sector during the Great Leap Forward, in 19581 Mao encouraged peasants to set up workshops to produce low-level manufacturing goods, which could be sold to state-­owned enterprises (SOEs) as a temporary means of resolving local cash shortages. These rural firms were called commune-brigade enterprises (CBEs) (shedui qiye, 社队企业). It is true that they were the source of cash to peasants and local governments (payments were usually s­ ubmitted to brigade-level officials): but it is clear that they also suffered from a number of weaknesses.

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3.2.2 CBE Operation Under Central Planning Economy In the absence of clearly defined property rights, local communes (or brigades) classified CBEs as ‘collectively owned’ units. There were two categories of CBEs: commune-level enterprises and brigade-level enterprises. The history of commune enterprises began later than that of brigade enterprises: most commune enterprises were larger in scale and produced more capital-intensive products, and the majority of them were established in the 1960s and 1970s, by which time funding had become a less pressing problem. Commune enterprises—basically, smaller-scale copies of Soviet-style firms—were usually operated by commune or county-level government, with formal organizational forms very similar to those of SOEs and county-level collectively owned enterprises (COEs). Brigade enterprises were widely established in the late 1950s, especially in coastal areas. The organizational form of the brigade enterprise was closer to that of a cooperative workshop, and usually did not require the appointment of a formal manager to organize production. It was very common for a brigade enterprise to have a nominal manager, who in fact was usually a sales person and was selected essentially for his or her communication skills. Incentive was a serious issue for both CBE operators and workers. For ideological and practical reasons, since CBEs were run by communes or brigades, only part of employees’ salaries could be directly paid to them in cash, with what remained being shared within the brigade. If an employee worked in a commune enterprise about 40 per cent of his salary would be transferred to the brigade to which he was attached, this being shared with other brigade members; if an employee worked in a brigade enterprise, his work was calculated in the form of work points (gongfen, 工分), and he was paid in the same way as brigade members working in the fields (or engaged in other agricultural operations) according to how many work points he had earned. A crucial point is that although CBE managers were paid a little more than the other enterprise workers, there was a mismatch between their efforts and the payment they received: if, for example, a manager increased the profits of his enterprise by 10 per cent, the reward for such efforts was either zero (in the case of commune enterprises), or minimal (in the case of brigade enterprises) in the sense

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that he received the same share of the incremental profits as any other member of his brigade. Access to the market was another problem. CBEs could not sell their products directly to the market; instead, their only target customers were SOEs—and sometimes large COEs. This narrow marketing channel principally reflected the regulation system that had evolved during the 1950s: in particular, since 1956 the only wholesale market for light industrial products was state monopoly wholesale firms (gongxiao she, 供 销社), and, except for SOEs and some large COEs, enterprises had no legal right to sell their products to gongxiao she (the wholesale market). For heavy industrial product, the situation was even more constrained for CBEs: here, distribution of products was part of the remit of the CCP’s central planning system, from which CBEs were completely excluded. Even when selling to SOEs, CBEs were starved of financing—in most cases, they could not obtain loans from any financial institution. Moreover, under the impact of the Great Leap Forward, neither the brigades nor their members had recourse to any funds of their own so that their ability to undertake physical capital investment was severely limited. Availability of skilled human capital was another constraint: the educational system managed by the CCP, which allocated jobs to college graduates,2 had no links with CBEs, which were therefore unable to recruit high-quality graduates. As a consequence, most CBEs could only select labour-intensive technologies that required little capital input— and were usually also low value-added. As a result of these constraints on marketing, product ranges and sales channels, most CBEs emerged in suburban areas around big cities, especially in the Yangtze Delta. The main reason for this spatial allocation was that this was the area in which China’s light industry had its origins, especially in Shanghai and its satellite cities (for example, Suzhou, Wuxi and Nantong), and it was this area that continued to generate most of China’s light industrial products until the rise of the Pearl River Delta in Guangdong province in the late 1980s. CBEs in the Yangtze Delta region supplied SOEs and large COEs with supplementary products— for instance, large gunny bags for factories used in transportation—at relatively low prices. During the rest of the Mao Era, this was the only

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regular channel (apart from rural-based agriculture) through which the rural sector could secure a monetary income. Although financial and technical constraints dictated the production and sales of labour-intensive and low-technology products, CBEs in the Yangtze Delta still benefited from potential customers for their light industrial products. However, as previous studies have argued (e.g., Zhang 2005), the main function of CBEs was to increase low-level rural governments’ and peasants’ monetary income, not finance capital accumulation. In fact, the organizational form of CBEs did not allow any surplus to be retained within enterprises—most profits were given to employees and government. Thus, the legacy of CBEs was institutional, rather than physical or monetary.

3.2.3 CBE Institutions: Strengths and Weaknesses Although most CBEs did not qualify as firms by modern standards, as discussed previously, they still left an institutional legacy for their successors. The core concept of CBEs was their ownership structure. Although they were collectively owned, they were quite different from traditional Chinese COEs. Normally, COEs were based at the county level, and county-level government maintained full control over them. A ‘standard’ COE had to give all its monetary income to the government, and this income became part of the government’s financial budget. This reflected the fact that COEs were a part of the central planning system—the annual output and investment of county-level COEs was included in the report of the county-level State Planning Commission (SPC) (jiwei, 计委),3 and all relevant statistics and information were forwarded to the national-level SPC, where national economic plans were formulated. But CBEs were different in two respects. Firstly, they formed no part of the public financial system. Under this system during the Mao period, brigade- and commune-level governments were not responsible for ­monetary income—in other words, only their agents appeared as payees in the central government’s bookkeeping. Indeed, in line with central government’s original formulation, the sole economic function of brigades was to supply agricultural products, implying that apart from ­payments

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for agricultural products through the planning system or financial aid, they should not have any other source of monetary income. Thus, in theory, brigade- and township-level governments were designed to operate as channels—money flowed through them, but was not retained by them—and they had no real budget. The consequence of brigade- and township-level governments’ designated financial role was that monetary income from CBEs was actually a kind of ‘free fund’, in the sense of being unaccounted for within the formal system. It was a grey zone: from the late 1950s CBE revenue was commonly distributed at brigade or township level, since there was no clear instruction from central government stipulating that CBE revenue should be spent in a certain way. Unlike COEs, a CBE was not a formal part of the governmental hierarchy, because the township-level government was the basic lowest-level branch of the formal government bureaucracy. The brigade ‘government’ itself was informal—brigade officials were not listed on the list of government employees and were regarded as volunteers—and it was viewed as an extension of township-level (commune) government. This left a vacuum in the form of a gap that existed between formal authority and individual bargaining power. As studies (e.g., Zhang 1998) have shown, most CBE decisions were made within the enterprise, outside the remit of government action. The only exception to this was if there was strong intervention from township- or county-level government agents, but this seldom happened. The manager of a CBE had absolute authority that, at least, was the theory, although in reality a CBE manager rarely if ever had the opportunity to exercise such authority, and since he was not required to deliver any profits to any accounting department at higher governmental level, there was no external residual claimant to whom the manager was financially responsible. This is very different from other COEs and SOEs. In a CBE, production—what to produce, how much to produce and when to produce it—was decided by its manager, not by the planning system. Moreover, the CBE manager also had ultimate control over any internal affairs of the CBE. For instance, a CBE manager uniquely could decide whether to employ or fire a worker: in the pre-reform age, in theory, there was no unemployment in urban sector because the central planning system allocated everyone a job and such decisions lay outside the power of SOE or COE managers.

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To understand the characteristics of CBEs, such enterprises must be seen as an additional part of China’s pre-reform economy. CBEs were originally created as a temporary measure to support endangered rural finance, and central planners gave no thought to how they could be made compatible with China’s existing planning system. In consequence, the activities of CBEs were remarkably free of intervention: there is no body to which CBEs had to submit income—and therefore no external residual claimant on its revenue or profits; there was no ultimate external controlling agency; and there were no rules governing whether government bureaucrats could or could not interfere in a CBE’s running operations. The anomalous absence in CBEs of any outside residual claimed or source of control was ignored since prior to the post-1978 reforms all CBEs were small, low-value-added workshops, and any surplus that was generated was rapidly disposed of by being distributed within the local community. This ownership structure was a firewall between the government and CBEs, behind which CBE managers could maintain control without having to share it with government officials. CBE entrepreneurs organized production to meet detailed and specific customer orders (usually from SOEs), or did so in accordance with their personal preferences (e.g., when orders from SOEs were merely in the form of something as simple as ‘carrying bags’, CBEs were free to decide style details). They were not responsible for fulfilling state quotas and were absolutely free from governmental monitoring of their production. However, this is not to say that there was an absolute institutional firewall to prevent government intervention. But since there were no large surpluses to be gained from CBEs, there was no incentive to create formal rules to control them, and occasional benefits were generally sufficient to satisfy local officials.

3.2.4 CBE and Central Government Decentralization The CBE institution reflects the special features that character China’s planned economy China’s planning economy. Unlike the Communist Party of the Soviet Union, the CCP had a long tradition of implementing and/or facilitating decentralization after 1949. Some studies have

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­ ighlighted the role of fiscal decentralization as one of the drivers of h China’s rapid economic growth in the reform era (e.g., Qian and Weingast 1997). But this is by no means the whole story. The history of fiscal decentralization can be traced back to 1951. Indeed, during the first half of the CCP’s rule (1949–1979) the Party used fiscal decentralization as a policy tool on at least four occasions. We argue here that the centre’s decentralization is also one of the key determinants of CBE development before 1978. Most fiscal decentralization policies during the Mao period were formulated as a means of helping the economy to recover from a disaster, or to relieve the central government of its financial burden. From 1951 to 1953, fiscal decentralization was for the first time adopted in order to enable local governments to take a share of fiscal income and thereby assume a degree of responsibility for the financial burden (State House (Zhengwu Yuan (政务院), which later became the State Council), 1951), although the income share allocated to local government was limited by the high level of expenditures associated with China’s involvement in the Korean War (1950–1953). The 1951 fiscal policy was in any case abandoned in 1953, when the First Five Year Plan was launched. The second phase of fiscal reform began in 1954, when Deng Xiaoping (then Minister of Finance) gave provincial governments a higher share of fiscal revenue than had been allocated in 1953—and established the basic fiscal structural framework that has been used in China down to the present day. The 1954 fiscal framework embraced three budgetary levels; central, provincial and county. At each of these levels, the Ministry of Finance (at provincial level, Department of Finance, and at county level, the Bureau of Finance) undertook independent management of its budget. In 1958 the central government decided to delegate even more fiscal authority to local government. First, a large number of SOEs formerly directly controlled by central government were transferred to local government administration (State Council, 1958), and local government was allowed to tax them (or, more precisely, to extract profits from them); second, the central authorities negotiated a ratio according to which fiscal income would be shared with local government, this ratio being fixed for five years. However, quite soon after this initiative was announced, the central government decided to withdraw some of local governments’

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fiscal rights, and in 1959 the five year fixed ratio was abandoned. The 1958 decentralization was a direct cause of CBE’s establishment: it was much easier for CBEs to be allowed to trade with SOEs when SOEs were under local government’s supervision. In 1971, central government again presented a fiscal decentralization plan (State Council 1970; Ministry of Finance 1971). This initially provided for local government to retain all excess income; subsequently, however, central government withdrew this dispensation and in 1972 it required local governments to remit half of excess income to the centre. In 1976 central government decided to return to a one-year term fixed share system, although the share due to local government was higher than it had been in 1958 and 1959. This system remained in place for four years until it was eventually overtaken by the 1980 fiscal reform (often referred to as China’s ‘fiscal decentralization’). The 1970s decentralization has an obvious positive impact to CBEs: local governments gave some of SOE assets (basically machinery) to CBEs, for free, and ordered SOEs to send CBEs some technicians—to help CBEs.

3.3 F rom Commune–Brigade Enterprises (CBEs) to Township and Village Enterprises (TVEs): 1978–1984 3.3.1 1978 Reform and Its Institutional Foundations The first wave of TVE (CBE) growth derived from the post-1978 rural economic reforms (Kojima 1993), which marked the start of China’s economic transition. These reforms not only sent signals to those potential entrepreneurs with information of ‘directional liberalism’ (Huang 2008) policies but also had a real critical impact on the CBEs. The immediate post-1978 reforms can be regarded as reversing the Cultural Revolution, as China embarked on a market-oriented economic transition. During the first stage of the reform (1978–1983), the CCP did not introduce its ‘opening up’ policy, famously captured in Deng Xiaoping’s motto ‘It doesn’t matter whether the cat is black or white, as long as

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it catches mice’ (Deng meant that with economic development as the priority, ideology could be ignored). Rather, it took a more pragmatic attitude towards economic affairs. The earliest economic reform initiatives were designed to be compatible with the central planning system, and even sought to strengthen that system. Deng initially focused on the heavy industry sector and transportation system (mainly the railway), and believed that if heavy industry could prosper, the national economy would quickly recover. From the point of view of firms, on the one hand post-1978 reform allowed firms to seek suppliers and customers outside the central planning system; on the other, the CCP continued to regulate private ownership. But from the point of view of the CCP, even enterprises trading outside the central planning system were to remain non-private. From the perspective of would-be private firms some basic requirements needed to be fulfilled, such as legal endorsement of private ownership, availability of access to markets and to banks, etc. If these requirements could not be satisfied, private ownership of firms was hardly a meaningful notion.4 Judged by these standards, China during 1978–1983 clearly failed to meet almost any of these basic requirements. But even if the institutional challenge could be met to meet these requirements, there remained another critical problem in the form of the refusal by SOEs and COEs (which, it will be recalled constituted the de facto wholesale market) to deal with individual firms, thereby isolating private firms from the market. The reason was not only ideological, but also practical: under the central planning system, prices were calculated according to production costs, not in accordance with the forces of supply and demand, and even the accounting cost used in central planning system did not precisely reflect the costs of production (actually, it is usually impossible to calculate the precise costs of industrial production because most inputs were delivered on request—prices were calculated in terms of the a­ verage cost of the whole state sector [we will discuss this in later chapters]). Such a system was hardly equipped to deal with other, outside enterprises (Jefferson and Xu 1991). For similar reasons, private entrepreneurs could not access bank loans or the capital market. Bear in mind too that private entrepreneurs were limited in terms of the scale of their production, since until 1987 they

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were not allowed to employ more than eight workers. In contrast to such problems which confronted privately owned forms, CBEs benefited from the reforms. Since the Mao period, CBEs were allowed to trade with SOEs and COEs. Given this institutional advantage—because CBEs were treated as COEs—CBEs could seek inputs and outputs from a broader range of sources than private firms. Access to inputs is a fundamental problem for private business (if it exists), but CBEs could overcome this by buying from SOEs and other COEs—which, incidentally, were virtually the only sources for the purchase of most raw materials and industrial products. The well-known dual-track pricing system (shuanggui zhi, 双轨制)5 was introduced in 1981 for some agricultural inputs and products and extended to include the industrial sector in 1983–1985.6 In other words, before 1985 there was no way in which private enterprises could purchase regulated raw materials and industrial products. The key to understanding the 1978–1983 transition lies in the changes to residual rights and the distribution of economic surplus that occurred during this period. The CCP partly removed its strict regulations relating to the redistribution of enterprise profits. At the same time, central government believed that it could resolve the inefficiency of SOEs (and some COEs) by giving SOE managers more control rights, which would give them greater authority in their firms. The rights to increased control given to CBE entrepreneurs stemmed from SOE reform, since this made it possible (a) for firms to retain part of their profits—that part derived from additional production (additional, that is, to the central government’s plans)7; (b) for firms to produce products on demand, rather than as part of the state plan; (c) after 1983, for firms (including COEs) no longer to be obliged to remit their profits to the state (instead a tax on profits was introduced). These initiatives were summarized as the ‘decentralization of power and transfer of profits’ (fangquan rangli, 放权让利).

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The CBEs’ situation was singular. Due to the fact that they had been outside direct state control for a long time, they had no obligation to remit any of their profit to the state, although they still needed to release surpluses to the brigade or commune. For the first time, the 1978–1983 reform offered CBEs the possibility of not having to share their monetary income with local governmental agents because of their status as a special type of COE (as COEs, CBEs were included in the reform (State Council 1983)). It deserves restating here that until 1978 most CBEs were still characterized by low-level technology, labour-intensive and small-scale operations and lacked monetary income—all these would be the ‘preconditions’ for TVE development in the transitional era (Qian and Xu 1993).

3.3.2 Decentralization and Liberalization One major goal of the 1978 reform was to replace the existing Soviet-­ style SOEs and COEs through the creation of much more efficient and productive enterprises. The CCP tried to fulfil this policy aim in two ways: by decentralization and liberalization. During the Mao period, fiscal decentralization took place throughout government hierarchies, but under the impact of reform it was extended to enterprises. SOEs and COEs (but not CBEs) were regarded as part of the state’s fiscal remit, and politicians in the late 1970s and 1980s focused their attention on finding a way forward that would enhance SOEs’ efficiency, while keeping them under state ownership. The core concept of post-1978 enterprise reform was ‘delegated rights’ (fangquan, 放权), which means that SOE/COE managers could arrange their managerial affairs more freely. After 1978, managers could retain part of their firm’s profits in the firm’s current account, and subsequently this share gradually increased until eventually the state no longer claimed any profits from firms. The question that arises from managers’ residual disposal rights relates to the use of these assets—in SOEs, a crucial problem with managers’ incentives is that their jobs were not guaranteed in the long term because SOE (and large COE) managers were basically bureaucrats rather than entrepreneurs. Within the huge and e­xtensive

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CCP government network, no insurance mechanism was available that could consolidate an SOE manager’s position—the redeployment of CCP government officials was quite frequent. However, CBE managers were not included in this bureaucratic system and it was possible for them to extend their career. The endowment of CBE managers with partial residual rights created a strong incentive to transform managers into entrepreneurs. The emergence of entrepreneurs in CBEs, but not in SOEs, was an unexpected outcome of enterprise reform—‘unexpected’, because reformist policymakers’ priority was to create genuine business entrepreneurship and to improve efficiency in SOEs rather than in CBEs. Liberalization is another characteristic discussed in the literature (e.g., Huang (2008)). The 1978 reform did not emerge as part of a liberal agenda in a modern sense of that term (cf. the Washington Consensus or the Post-Washington Consensus). Rather, the basic element of early reforms was to allow goods and resources to be exchanged through the market, while maintaining the functional role of the central planning system—an approach later referred to as the ‘dual-track’ system. In other words, resources were not immediately released from within the state orbit (as happened in the wake of Russia and Eastern Europe’s ‘shock therapy’ and ‘Big Bang’), so that the non-state-owned economy was not only qualified to compete for state resources, but also had suitable means of obtaining these resources. Interpreted in this way, liberalization had a slightly different meaning in the context of China during the late 1970s and early 1980s, since SOEs and COEs were not allowed to be privatized. The CCP believed that it could combine the central planning system with a limited market mechanism (even if the CCP never explicitly spelled out what was meant by a ‘limited market’), thereby providing a framework which would preserve both the central planning system and SOEs. Up until the early 1990s, decision makers in the CCP adhered to this strategy, the implication of which was that the legal and ­political environment for private firms was less friendly and positive than for SOEs. CBEs were given a special status: they had both legal and moral authority on behalf of rural development to deal with SOEs and governments,

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and to solicit economic support from banks and/or the state. First, CBEs were categorized as COEs, which (see above) meant that a TVE could take advantage of all the state’s policies in support of COEs and, more importantly, allowed it to trade in any restricted market (i.e., banned to private firms) alongside any SOE or COE. Second, TVEs were also seen as a crucial element in efforts to promote rural industrialization and to enhance rural welfare. Because of the China’s households registration system (known as hukou, 户口), rural residents did not have the right to work in the formal urban industrial sector where workers received preferential welfare treatment from the state. Part of the case in favour of TVEs was the promise they offered of higher living standards and welfare for their rural employees (CCP annual ‘Document No.1’ 19838). Another benefit of the new ‘liberal’ approach was that a TVE entrepreneur could also use informal means in order to compete for resources such as loans, fiscal aid or government contracts. Before the post-1978 enterprise reform, because of the strict rules regulating profits earned by CBEs, entrepreneurs were unable to use such resources for any marketing or lobbying purpose. Post-1978 enterprise reform allowed entrepreneurs to retain profits within the firm, and the new accounting rules (first announced in 1979, although their final version was not published until 1981) also gave entrepreneurs more flexibility in the use of funds. Two other special revised versions in 1982 and 1983 of the accounting rules (Ministry of Finance) even permitted CBEs to use the same accounting rules as those followed by foreign investment companies (waishang touzi qiye, 外商投资企业), where accounting procedures followed international norms. The preceding analysis indicates that the early decentralization and liberalization policies that took place in the initial stage of economic reform created—or, more accurately, strengthened—two linkages between TVEs (CBEs) and the major political and economic entities in China. Decentralization policy enlarged the scope of local governments’ authority and enabled them to establish quasi-private rights within a ­TVE/ CBE.  Liberalization policy established a new economic link between TVEs/CBEs and the state sector; more specifically, this link ran in a

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s­ingle direction from SOEs to TVEs, which means the SOE sector has the responsibility to supply TVE/CBEs cheap industrial goods, but not vice versa.

3.3.3 T  he Role of Local Government in the Creation of CBE Property Rights Decentralization and liberalization created and strengthened the institutional foundation of CBEs, enabling them to practise business more deftly. Nevertheless, some early literature (e.g., Li (1996)) referred to the ownership status of TVEs in terms of it being a ‘grey’ area, suggesting that their status was blurred (i.e., neither legal nor illegal). The first reason for regarding CBE property rights as ambiguous lay in the absence of proper legal definition and endorsement of CBEs’ control rights—something of critical importance in guaranteeing a firm’s ownership status. In contrast to CBEs in the pre-reform age, the range of CBE/ TVE products, the technology used in production and the number of enterprise employees would no longer be directly monitored by government bureaucrats, making it necessary to appoint an agent to undertake monitoring responsibilities in most CBE/TVEs. For example, sales by the Wuxi Antenna Company—a village-level TVE in Wuxi County (South Jiangsu)—totalled 5.83 million yuan RMB in 1985 (one year after CBEs was officially renamed as “TVEs”). In other words, a single village enterprise was generating sales revenue equivalent to one third of the entire GDP of a typical inland county at the time. This contrasted dramatically with conditions in the 1960s and 1970s, when most CBEs produced simple handmade products (for example, bamboo baskets used by urban residents as shopping bags—a major product of CBEs in Jiangsu and Zhejiang provinces), for which government agents needed no specific knowledge, marketing ability or management skills. In other words, changes in market demand in the reform era precipitated organizational and functional changes in CBEs, and forced CBE managers to become entrepreneurs with specialized human capital. However, here was a ­danger that human capital accumulated by a CBE manager might be wasted.

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For instance, local government could legitimately appoint a new manager to replace an old one. One advantage for CBE managers was that career rules governing government functionaries did not apply to them; as previously mentioned, CBE managers played only a semi-official role and were not included in the formal list of government employees. Even if there was no clear indication of how long a CBE manager’s career would last, arrangements to extend a CBE manager’s career could be made informally between manager and local government. This opportunity may be seen as an incentivizing mechanism for CBE managers seeking to extend their control of an enterprise. It also conferred on CBE managers a major benefit that was denied to their SOE counterparts, who had no opportunity to negotiate their status with the state. Another reason for the ambiguity of property rights lay in the fact that the government frequently intervened in the market. During the reform era, the state did not release all resources under its control to the private sector, as, for example, had been the case in Russia, where rapid privatization took place. Instead, the control of most resources was transferred from the state’s direct management to SOEs with monopoly powers. For example, the assets of the Ministry of Electricity were shared among four entities, each of which became a regional power supply monopoly. Similarly, other important markets were also occupied by state monopolies, which refused to deal with private firms. In the case of electricity, until the recent power supply reform, local power supply companies charged high connection fees and frequently threatened to cut off power supplies to non-state-owned firms unless they offered a bribe. One way in which CBEs sought to maintain stable power supplies was to seek intervention on their behalf by the relevant township government. Such intervention highlighted two aspects of CBEs’ position in the resource-­ seeking process: first, their status as part of the non-private economy made them eligible for government aid; second (additionally), their role outside the central planning system meant that resources were rarely automatically allocated to them. This special situation enabled CBEs to influence resource distribution at a township level, although in order to realize such influence they needed first to secure political support. At the same time, pervasive rules of reciprocity dictated that local government would

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usually require a quid pro quo in the form of some monetary payment by CBEs—whether formally or more secretly—in return for such political support. In effect, this constituted a contract of residual sharing between CBE (and later TVE) and local government and was another source of ambiguous property rights.

3.3.4 The Transformation of CBEs into TVEs The purpose of the 1978–1983 reform was to encourage and enable SOEs to improve their efficiency. From a broader perspective, this reform cannot be considered ‘liberal’ or ‘market-oriented’ because the central government’s original goal was to strengthen the central planning system.9 An unexpected outcome of this reform was the rise of TVEs. In 1984, the CCP decided to use the new name ‘township and village enterprises’ (TVEs) to replace CBEs in its official documents.10 As a result of this reform, CBE entrepreneurs found themselves given new bargaining power vis-à-vis government agents. Firstly, the reform authorized firms to retain their profits. Before 1978, the accounting system in China had forced all enterprises to hand over their profits to the government. Deng’s reform used a taxation system to collect monetary income from enterprises, so that CBE post-tax profits remained with the firms. In contrast to SOEs or COEs, profits retained by CBEs were legally protected by the CBE’s own institutional framework—village and township governments were not fully functioning financial bodies, responsible for detailed accounting, wealth storage, budgetary operations, etc., and could not collect additional (post-tax) profits from CBEs. Once firms had fulfilled their tax obligations, village and township governments had no scope for financial interference, which meant that local governments could not make any further claim of firms’ monetary income. Thus, CBE entrepreneurs could actually use some of the surplus money they earned for their own purposes, rather than simply handing it to government. Secondly, since CBE governance was monitored by government agents at the village or township (commune) level, usually without interference from other government agents, the number of government officials with

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whom CBE entrepreneurs had to deal was very small. As mentioned ­previously, the scale of government at village or township level is significantly smaller than that at county level: county-level (or higher) government was a fully-functional administration comprising many departments and committees. Such differences had major implications in terms of bargaining and resulted in contrasting entrepreneur behaviour between CBEs (on the one hand), and COEs and SOEs (on the other). For instance, a COE owned by county-level government was likely to have to negotiate with dozens of heads of different departments and committees, while a CBE might need to be in contact with one person—the township/village’s CCP secretary.11 Using this bargaining power, CBE entrepreneurs could secure political support from the local government, as long as appropriate agreement could be reached. The key here lay in the ability of CBE entrepreneurs to use residuals freely: under the 1983 reform policy, each CBE kept independent accounts and bookkeeping records which were beyond the reach of government officials, making it possible for them to leverage the political support they required from village- or township-level government agents. This was worthwhile, because the scale of village or township government was sufficiently small for negotiation costs to be much lower than those of SOEs. In particular, by negotiating with government, entrepreneurs could pursue two important objectives: first, to extend their careers as enterprise managers for as long as possible; second, to enhance their authority and strengthen their control rights over their firms. The importance of this combination of a longer expected career and enhanced control rights is well captured by Zhou (1997): if an entrepreneur could extend his career life sufficiently, and if his control rights were protected from government intervention, he would regard himself as a de facto owner of a private firm. During the reform era, unless the firm collapsed, most TVE entrepreneurs retained their position until health became too poor to enable them to carry out managerial work—and even in this case, the entrepreneur was likely to choose his successor. The point we seek to emphasize here is that although property rights in a typical CBE may have been incomplete— the entrepreneur had no formal right to claim ownership in his name,

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and could not stake a personal claim of monetary profits—other rights (e.g., control rights) held by the entrepreneur were likely to be sufficient to enable him to defend his business against encroachment or repossession by other parties. As entrepreneurs’ control over CBEs was extended and strengthened, there was a significant change in CBE behaviour in the early 1980s. Overall, annual investment by CBEs increased, and the range of goods produced by CBEs exceeded that of other industrial enterprises. This was, in turn, reflected in unprecedented growth in labour productivity (output per unit of labour), hastened by new investment and technological development. Indeed, the changing profiles of CBEs before and after the reforms are uniquely distinctive. Before reforms were launched at the end of 1978, most CBEs were satisfied with a role in support of SOEs. Since monetary income was distributed swiftly to individuals, no further accumulation could take place to facilitate technological upgrading. However, between 1978 and 1983 CBE output grew cumulatively by 106 per cent, while the corresponding figure for SOEs was only 44 per cent. CBE output per worker grew by 80 per cent in the same period, compared with the national industrial productivity growth of 22 per cent. In other words, CBE productivity growth was almost four times the average (see Fig. 3.1 below).

         







HPSOR\HHQXPEHU







RXWSXW

Fig. 3.1  TVE outputs and employment, 1978–1983. Source: China Township and Village Enterprises Yearbook (zhongguo xiangzhen qiye nianjian, 中国乡镇企业年 鉴), various volumes

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3.4 The Golden Age of TVEs: 1984–1997 3.4.1 T  he Development of TVEs and Their Increasingly Important Role in the Chinese Economy China renamed CBEs as TVEs in 1984. This was a signal that TVEs had become one of the major engines driving China’s rapid economic growth, worthy of the CCP’s attention for reasons other than ideology. TVEs’ contribution to GDP rose continuously until privatization, which began in 1997. The famous CCP 1984 ‘Document No. 1’12 (‘famous’, because it gave formal legal endorsement to household-based agriculture in China) highlighted the role of CBEs as an important source of rural income and therefore something to be encouraged. Later, in the 1984 ‘Document No. 4’,13 the central government decided to change the name of CBEs to TVEs, in the hope of making a distinction between the TVEs of the new reform era and the former Maoist CBEs. The importance of Document No. 4 lies not only in this change of name, but also in the further information on TVE funding, marketing and ownership which it provided. Thus, it acknowledged that (a) Individual peasants and combinations of individual peasants would henceforth be allowed to establish new TVEs; (b) TVEs would be permitted to buy inputs and to sell their products anywhere in China, through all possible market channels. TVEs in coastal areas (Jiangsu, Zhejiang and Shandong) widely benefited from the 1984 Document No. 4 and the Acts that followed (CCP ‘Document No. 1’141985; and CCP ‘Document No. 1’151986). The outcome of these TVE deregulation policies was remarkable. During 1982–1997, the nominal output of TVEs grew one hundred times [sic], compared with a 14-fold increase in national GDP (see Fig. 3.2 below). This phenomenal rate of expansion was regarded by some as nothing short of a miracle (e.g., Sun 2002). However, as Fig. 3.2 also shows, a short-term depression was sparked by the political upheavals of 1989, when TVEs’ output growth declined sharply (Jin and Qian 1998).

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Growth Rate (%)

               79(287387 *'3

Fig. 3.2  TVE Output and GDP Growth. Source: China Township and Village Enterprises Yearbook (zhongguo xiangzhen qiye nianjian, 中国乡镇企业年鉴), various volumes

3.4.2 C  hanges in Fundamental Institutions and the Local Government During the years of 1980s and first half of 1990s, there were two important institutional departures. First, the rise of the dual-track pricing system offered TVEs opportunities to obtain resources which had previously been impossible to obtain. From 1984–1985, the CCP decided to formally introduce the dual-track pricing system throughout the industrial products market. This process was only briefly interrupted by the 1989 Tiananmen event,16 and was shortly afterwards (in 1992) restored thanks to Deng’s personal intervention.17 Interestingly, until the Fifteenth National Congress of the CCP in 1997, the CCP’s refusal to offer formal legal protection for privately owned enterprises deterred most firms from following the path of private ownership. Thus, even if industrial resources (e.g., industrial inputs) were officially removed from the central planning system, it was still difficult for private firms to obtain these inputs from the market. By contrast, a TVE was able to maximize its use of the dual-­track system. The second institutional departure was the rapid process of decentralization that was taking place. In contrast to conventional analysis such as is contained in ‘fiscal feudalism’ theory, China’s fiscal system has shown regional variations (e.g., after the 1994 tax reform, there were six distinct regional fiscal income-sharing modes in China). One significant

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difference between China and other former socialist, transitional economies is that local governments in China have exercised huge power over economic, political and social development (as Mao (1966) put it,18 ‘all (things collected from local) should be given back to local government’19). When, in early 1980s central government relaxed its tight control over several sectors, such as banking, mining and wholesaling, local governments were quick to fill the vacuum left by the centre. During the decentralization process, township-level governments gained huge influence, which became the direct source of TVEs’ political support. As mentioned above, the more political support the township government could offer, the greater the ability of a TVE to obtain economic resources through non-market or grey channels. From the perspectives of central government policy and the macro-­ economy, several significant changes took place during this period. Firstly, TVEs were gradually granted complete and comprehensive market access. The CCP documents dating from 1984, 1985 and 198620 removed major obstacles that had hitherto prevented such enterprises from entering national product markets. Thereafter, except in restricted industries (telecoms, electricity, etc.), TVEs gradually became the major suppliers of consumer products, and also began to roll over their capital into heavy industries. Secondly, restrictions on private ownership were also gradually released. For the first time, the central government allowed management buy-outs to take place, and in 1993 SOE managers were able to take shares from SOEs, thereby beginning the privatization process began. Massive TVE privatization began in 1997, and in the years that followed TVEs’ property rights were converted to private ownership. In 1992, Deng Xiaoping called for more radical policies designed to reinvigorate the reform process, which was widely believed to have been interrupted by the events of 1989. One of the outcomes of Deng’s intervention was a credit boom in the banking system, brought about by increased loan issues by the banks. As a result, between 1992 and 1994 the growth rate of TVEs consistently increased. The consequence was economic overheating, and in 1994 the central government began to address double-digit inflation by tightening bank credit, causing a significant slowdown in firms’ output growth and in the rate of real GDP expansion in subsequent: As a result, TVE sector’s growth was also affected in the following 2-3 years (Fig. 3.2).

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3.4.3 T  he Financial Market: TVEs and the Banking Sector The financial market is used as an example from which to examine the institutions and the economic environment associated with TVEs. Until the 2000s,21 the banking system was the major source of funding for Chinese firms, giving it an extremely important institutional role within the economy. It is difficult to evaluate bank loan ratios among all the physical assets of TVEs in their early stages. However, it is universally true that before 1992 the banking system supplied almost all the funds that TVEs required,22 and it is therefore essential to consider how China’s banking system evolved during the reform era. Until recent reforms allowed private ownership and foreign involvement in the banking sector, Chinese banks were all SOEs. Indeed, state-­ owned banks represented a special, even unique, category of SOE. Before 1979, the major operator in the Chinese lending market was the People’s Bank of China (PBC), which was also China’s only legal bank. Besides the PBC, there were many rural cooperative credit associations under local government control (usually at county level), but administered by the PBC and, after 1978, operating as branches of the PBC. At this point in time (pre-1979), the PBC did not assume the role of a Central Bank, since under the central planning system there was no need for a lending market. Nor did banks carry any responsibility for bad loans, or similar problems, since their role was simply to carry out the orders of the central government. The special position of the banking sector also gave a distinctiveness to the relationship between TVEs and banks special. After 1979, the Agricultural Bank of China (ABC) was established in order to lend ­support to agricultural development. As such, it took over from the PBC all the rural credit cooperation associations. Given its remit to implement central government policy and serve the rural economy, the ABC rapidly became an important source of TVE funding. Meanwhile, from 1983 efforts began towards creating a modern banking system. Central to these efforts was the central government decision to make the PBC the Central Bank, and to establish four independent commercial banks, one of which was the ABC.

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TVEs’ special ownership arrangements conferred significant institutional advantages in obtaining bank loans. Firstly, because they were collectively owned, banks—especially the ABC—were ideologically predisposed not to refuse loan requests from TVEs. This was extremely important during the early reform era, when sources of funding were limited. Another significant factor relating to TVE bank loans is that before 1997 banks in China did not demand guarantees from firms because SOEs were directly controlled by the government, and there was no need for banks to worry about bad loans. TVEs made maximum use of this banking convention in securing loan funds. Although their ownership status enhanced their borrowing capacity, TVEs could not formally compete for bank loans with SOEs and large-­ scale COEs, which had all the institutional advantages of TVEs plus a priority status within the national economy that was legally endorsed by the state. However, TVEs were able to secure bank loans through informal means—for example, by conducting under-the-table transactions with bankers, or gaining the assistance of local government officials. As such, TVEs did engage in competition with SOEs for bank loans. Two characteristics of TVE loan behaviour may be highlighted at this point. Firstly, TVEs received loans through inside dealing with banks. Before the bank reforms of 1997–1998, a common feature of the corporate governance of major Chinese banks was that compared with the immense power which they wielded, bank managers took almost no responsibility for any failures arising out of their actions. This asymmetric power and poor governance encouraged corrupt practices and made possible the extension of increasingly risky loans. TVE entrepreneurs were the obvious winners in this game, since SOE managers neither wished nor were able to establish strong links with bankers. By making use of the resources available to them, TVE entrepreneurs could readily proffer financial inducements to bank managers, through the offer of luxury gifts, free travel or even direct cash bribes. In short, a good relationship with a bank manager was an important channel available to TVE entrepreneurs competing for bank loans. Secondly, TVEs also sought help from local politicians who could put pressure on banks.23 Before the 1997–1998 bank reform, lending activities were strongly influenced by local politics. The bedrock of such

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influence lies in the fact that local bank managers were appointed by local bureaucrats, and local government determined almost all personnel changes at local bank branches. Few bank managers wanted to risk their position, and tended to follow suggestions from the government about the dispatch of loans. Thus, if a TVE entrepreneur could persuade a local government official to press for a loan from a bank on behalf of the TVE, the loan was usually granted. With the help of local governments, the financial connection between TVEs and banks also served as a helping hand, or means, whereby local government or some form of government intervention could enhance TVEs’ financing capacity. Local government frequently persuaded TVEs to bribe bank managers—the legal system being under the control of local government—not only to secure sufficient funds, but also to exercise political power to influence lending and ensure that larger loans were distributed to TVEs. Analysis of the relationship between enterprise and government illustrates the circumstances under which local government could lend a helping hand.

3.4.4 T  he Firm: State Relationship—The Different Roles of Central and Local Government A core issue in studies of TVEs is the relationship between firms and government. In fact, two such relationships demand consideration: first, that between TVEs, and central government and the central planning system under the central government’s control ( or, as one might say, the SOE sector); second, between TVEs and local government (especially township government). In terms of the TVEs-central government relationship, as the history of TVEs shows, TVEs were not intended to be part of China’s central planning system; rather, they were expected to be self-funded and community based enterprises. The most significant aspect of the relationship between TVEs and the central government lies in the role of central authorities as the source of TVE’s legal status. The origin of this is to be found in the legalization of CBEs since the Mao Era, which conferred on them the status of being the only enterprise form that was not included in the remit

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of central planning. This is not to say that the central planning system did not impinge on TVE/CBEs: it did, but the role of the central planning system is only that of a giver, since before 1978 by making purchases from SOEs, CBEs received cash income—and this was the most valuable ‘prize’, or reward, available to CBEs from SOEs. The 1978 reform activated another route for delivering cash into to CBEs: the market. CBEs could secure significant (probably even greater) income from non-SOE customers, but they would also need industrial inputs which could only be supplied by SOEs (as indeed they—the SOEs, did). We will examine this relationship in greater detail in Chaps. 5 and 6. The link between TVEs and local government has been geographically closer than that between TVEs and central government. There are two major areas in which local government has been able to support TVEs. First, local government has been able to deliver political support for TVEs—especially in order to extend entrepreneurs’ careers. This kind of assistance may be regarded as support for the control of rights to TVEs. After 1978 entrepreneurs gradually gained the right to keep their firms’ profits within the firm, and they soon realized that control rights combined with use rights to residuals (profits) created a quasi-private ownership form which promised to confer similar benefits as those accruing from complete private ownership. The second area in which local government has been able to assist is in the provision of inputs needed by TVEs for daily production. With markets tightly regulated by the CCP, TVEs were dependent on local governments to secure access to inputs, such as bank loans, labour and land. This dimension is referred to in the literature as ‘imperfections of the market environment’ (Li 1996). An interesting question arising out of this analysis concerns the cost to an entrepreneur of having to negotiate the political support of central and local government. The answer to this question depends on the nature of the political support required by the entrepreneur. However, one generalization that can be made is that there was a correlation between the cost and the scale of government assistance (as well perhaps as the status of the government agent in question) that was required. Compared with their SOE counterparts, TVE entrepreneurs were likely to have to negotiate with only very few government agents. Even in extreme cases, in

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which there was conflict between TVE entrepreneurs and government agents, the number of targeted persons to negotiate with was still limited (Zhou 1997). However, this study differs from much of the existing literature in viewing the relationship between TVEs and government in terms of the economic interests of the various parties (this is discussed in detail in later chapters). The local government-entrepreneur relationship was based on TVE entrepreneurs’ bargaining power vis-à-vis local politicians and on the ability to maintain such bargaining power.24 One question that should be raised here is why the behaviour of SOE managers and TVE managers differs. A comparison of enterprise-government links of TVE entrepreneurs and SOE managers provides an easy answer. The sources of entrepreneurs’ authority determine the stability of their position. An SOE manager is helpless in the face of the changes within the Communist Party, because any small change in the bureaucratic system may affect his position, which, in turn, may permanently damage any expectations of future income streams. In contrast, the legality of a TVE entrepreneur’s authority is contingent only on local governmental agents (usually township-level Communist Party secretary).

3.4.5 C  hanges in Central-Local Government Relationship and Their Impacts on TVEs The dynamics of institutions in the historical evolution of TVEs are captured in the changing relationship between central and local governments. As Qian and Xu (1993) observe, there are strong links between the strengthening of local government and the rise of China’s non-state-­ owned economy. Our explanation of this is that a cycle of decentralization—recentralization characterized CCP policies in the reform era. The M-form theory (Qian and Xu 1993) captures the first phase of the central-local relationship in the reform era. In the late 1970s and during the whole of the 1980s, the combined impact of decentralization and liberalization policies was to relieve departments at central level of a degree of political power and control over economic resources. However, this power and these resources were not released to citizens and enterprises;

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rather, they were mostly transferred to lower-level government, with a significant increase in political power at township level. This essentially reflects the fact that when China’s reforms began, resources and institutions (e.g., banks and SOEs) that had overwhelmingly been under the direct administration of central-level departments in the pre-reform were not privatized; nor, as was the case in the former Soviet Union and Eastern Europe, did China embark on a process of political democratization. In short, although the central government’s ability to control social and economic affairs was weakened, much of the power that was released from the centre was absorbed by local governments. The central government had its reasons for giving power away: not to do so would mean going back to pre-reform institutions which had already proved inefficient. However, the only governmental body it could find to take on the political and economic powers it had abrogated was local government. As already mentioned, in order to secure the support that was needed, several conditions had to be fulfilled during TVE entrepreneurs’ negotiations with government. These included: that the government body be sufficiently small to enable TVEs to reduce negotiation costs; that local government should have the capacity to protect TVE entrepreneurs’ control rights in the long run; and that local government should have sufficient control over major economic resources to guarantee access by TVEs to these resources. The evidence suggests that decentralization measures ensured that these conditions were satisfied during the first two decades of China’s reform. The subsequent—second—phase was different. A significant and the earliest sign of recentralization came with the banking reforms, which began in 1993 (see CCP ‘Document No.6’, June 199325), when Zhu Rongji was Vice Premier (1993–1998) and President of the PBC. These reforms sought to reduce local government influence in the banking system by separating policy banks and commercial banks, and confirming the PBC’s position as China’s Central Bank. The reforms continued when Zhu became China’s Premier (1998–2003), eventually severing most of the links that had formerly existed between local government and the banking system. In addition to changes taking place in the banking system, from the mid-1990s a number of state monopoly companies was also established.

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These companies were set up on the basis of assets which had originally belonged to the state. In 1995, for instance, the telecommunications giant China Telecom was established: it was owned and fully funded by the Ministry of Posts and Telecommunications of China, and all its physical assets were from the state. These monopoly companies usually held concessions in certain markets. Apart from the emergence of state monopoly companies, another significant initiative was the 1994 fiscal reform. The previous ratio of fiscal income between local and central government had been 7:3, but the 1994 reform reversed this to 3:7.26 This adjustment not only increased central government income, but also tightened its direct control over the tax system. An illustrative example was the introduction of value-added tax (VAT) in 1994: VAT on sales was collected through the State Administration of Taxation (SAT, guoshui, 国税).27 Township governments had previously exercised huge influence in local tax bureau branches through their ability to compel tax breaks for designated firms or tax discounts to designated industries that came within the remit of local government. After 1994, local governments’ scope for intervening in tax matters became severely constrained.

3.4.6 TVE Privatization in the Late 1990s TVE privatization got under way during these recovery years, and the process was accelerated under the impact of the subsequent Asian Financial Crisis: between 1997 and 2000, for example 97 per cent of all collectively owned TVEs in Jiangsu (a regional of very high TVE concentration) were sold. A significant statistical change dates back to 2000, when the Bureau of Township Enterprises included calculations of the total number and output of TVEs, including all private and foreign invested firms, as long as they were physically located in a rural area, in its statistical coverage. This marked a remarkable change from the Law of Township Enterprises (Standing Committee of the National People’s Congress, 1996), in which collectively owned firms were regarded as the main body of TVEs. According to China’s taxation code brought by 1994 fiscal reform, most of local firms’ tax must be submitted to the central and local government could no longer tax them directly. Jiang (2000) and Yang and Fan

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(2008) regard the changes in taxation as the direct cause of TVE privatization: local government lost the majority of its fiscal budget which was used to support collectively owned TVEs. Therefore, the selling of (collectively owned) TVEs not only reduced local governments’ fiscal burden, but also gained local governments considerable amount of cash income. Jiang (2001) also suggests that by late 1990s the economic reward local government could get from the private sector was large enough to compensate the loss caused by selling of TVEs. We argue that the decline of collectively owned TVEs was a direct result of the abolishment of dual-track system, which will be discussed in detail in Chaps. 5 and 6.

3.5 Conclusion The history of Chinese TVEs suggests that their performance has been determined by many factors. Because of the absence, during the first half of China’s reform era, of a number of key market institutions, entrepreneurs were unable to manage and run their enterprise through methods and procedures that would be considered standard, or normal, in an economic environment in which most firms were privately owned. It was against a background of such market imperfections (Li 1996; Tian 2000, 2001) that TVEs emerged and grew rapidly in China. This chapter has given an outline of the history of Chinese TVEs. Historical conditions have made TVEs special: (a) Their legally defined ownership status is that of a non-private (collective) economic institution, but their governance has been totally different from that of other non-private firms. Within this institutional framework, TVE managers have been given some leeway to act as quasi-privately owned entities. By taking advantage of this, TVEs were able to realize the benefits of the entrepreneurial skills of their managers, which enabled them to perform more strongly than other non-private firms. In general, local government has played the role of an institutional adaptor, which supplies (adjusted) alternative institutions at the local level.

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(b) The ownership definition also gave TVEs access to key inputs that were not available through market channels. CBEs were defined as being part of the remit of central planning, and in the reform era TVEs inherited the huge benefits of this relationship. Indeed, this link may be said to have been the foundation of the TVE miracle. By way of a final concluding comment, I would draw attention to three important features that have characterized TVEs. The first relates to the bargaining power of TVE entrepreneurs. If it is difficult for TVE entrepreneurs to negotiate with local government, they will have to bear high negotiation costs. The second relates to local government’s ability to supply alternative institutions. China’s history in the reform era shows that the ability of local government to supply institutional goods depends on how much power central government allows it to exercise. The last relates to the requirement imposed on SOEs to supply industrial inputs to TVEs. Under the dual-track pricing system, SOEs were obliged to supply TVEs with industrial inputs and capital (although it was a ‘general’ obligation, as a whole SOEs still obeyed)—through the state-owned banking sector—in considerable quantities and at favourable prices. However, the role of SOEs as a source of goods and funding was susceptible to change in the face of any changes in the dual-track system. In the chapters that follow, we look in greater detail at all three of these aspects.

Notes 1. Another important 1958 measure was fiscal decentralization, which emerged out of the CCP’s rethinking on the Great Leap Forward (The Eighth National Congress of the Communist Party of China, 1958). 2. After 1949 the CCP gradually took over the universities and copied the Soviet educational system, whereby all graduate students were sent to their employers via the planning system. 3. SPC changed its name to National Development and Planning Commission in 1998, and again in 2003 changed to its current widely known name, the National Development and Reform Commission. 4. This neoclassically based notion is also captured in the market environment hypothesis, such as the Washington Consensus.

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5. Within the central planning system enterprises could purchase goods at a special ‘planning track price’, allowing planning track goods subsequently to be sold on the market at ‘market track prices’, which were significantly higher than planning track prices. 6. Byrd (1987, 1989) demonstrated that the dual-track pricing system was able to improve efficiency in a central planning economy. 7. In 1979, the State Council rolled out a draft of legislation, the most famous of which was ‘Several Prescriptions for the Extension of State Owned Enterprise Self-determination’, also known as the draft version of ‘Ten Clauses of Rights Endowments’ (kuoquan shitiao, 扩权十条). 8. ‘The Current Number of Rural Economic Policy Issues’ (dangqian nongcun jingji zhengce de ruogan wenti, 当前农村经济政策的若干问题). 9. SOE reform first took place in 1978 in Sichuan. In 1979, the CCP central conference announced that the CCP’s core task was to extend SOE reform to the national level. 10. In the late 1950s, when communes emerged, the transformation from township to commune was encouraged by the CCP, especially Mao. As part of Deng’s reform, communes were renamed and most chose to return to their old names. Thus, CBEs had to change their name simply because the communes no longer existed. 11. We will discuss the detailed role of CBE/TVE entrepreneurs in the next chapter. 12. ‘The Notice of the Communist Party of China Central Committee Rural Area Work in 1984’ (guanyu 1984 nian nongcun gongzuo de tongzhi, 关 于1984年农村工作的通知). 13. ‘Report of How to Create New Situations of Commune and Brigade Enterprises’ (guanyu kaichuang shedui qiye xin jumian de baoga, 关于开 创社队企业新局面的报告). 14. ‘To Further Invigorate the Rural Economy with Ten Policies’ (guanyu jinyibu huoyue nongcun jingji de shixiang zhengce, 关于进一步活跃农村 经济的十项政策). 15. ‘Regulations on the deployment of rural work in 1986’ (guanyu 1986 nian nongcun gongzuo de bushu, 关于1986年农村工作的部署). 16. In August 1989, the CCP and State Council issued a No.8 (Zhong Fa) Document, ‘Decision of Concerning the Further Checking Up and Re-certificating Companies’ (guanyu jinyibu qingli zhengdun gongsi de jueding, 关于进一步清理整顿公司的决定) which announced stricter

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regulatory rules for the wholesale market; later in October, the State Council cancelled dual-track prices for 77 goods and the price of these was directly regulated by the State Council (State Council Doc. No. 17 ‘Regarding the Further Checking up and Rectification of Various Types of Foreign Economic Relations and Trade Companies’ (guanyu qingli zhengdun gelei duiwai jingji maoyi gongsi de tongzhi, 关于清理整顿各类 对外经济贸易公司的通知), 1989). 17. Deng was officially retired in 1989, but in fact continued to wield supreme influence in the CCP. 18. Mao, Speech at an enlarged meeting of the Political Bureau of the Central Committee (zhongyang zhengzhiju kuoda huiyi shang de jianghua, 中央政治局扩大会议上的讲话) 20 March 1966. 19. Here Mao means from 1949–1966. 20. See notes 12, 13, 14 and 15. 21. Permission for non-state-owned firms to engage in IPOs on the Shanghai and Shenzhen stock markets (the two major Chinese stock markets) dates from 2003. 22. In 1992 and 1993 intermediate financial institutions began to emerge. 23. The reasons for government officials to intervene were various, ranging from seeking to enhance the welfare of the community or pursuing selfinterest (via commissions from TVEs). 24. This phenomenon is usually regarded as corruption; however, this is not wholly correct. The theory of corruption usually presents the exchange between entrepreneurs and government agents as a non-cooperative game determined by technologies of production and rent-seeking (Murphy et  al. 1993). One important difference between this type of corruption and TVE entrepreneurs’ behaviour is that the goods—either the institutional goods that help them to maintain semi-­private ownership or the physical goods used in production—are obtained by TVE entrepreneurs. 25. ‘Opinions about Current Economic Situations and How to Strength Macro-control’ (guanyu dangqian jingji qingkuang he jiaqiang hongguan tiaokong de yijian, 关于当前经济情况和加强宏观调控的意见). 26. Compensation was only made to provincial governments several years later. 27. SAT was established in 1994, and its branches became fully independent of local government in 1997.

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References Byrd, W. A. (1987). The Impact of the Two-tier Plan/Market System in Chinese Industry. Journal of Comparative Economics, 11(3), 295–308. Byrd, W. A. (1989). Plan and Market in the Chinese Economy: A Simple General Equilibrium Model. Journal of Comparative Economics, 13(2), 177–204. Chang, C., & Wang, Y. (1994). The Nature of the Township-Village Enterprise. Journal of Comparative Economics, 19(3), 434–452. Central Committee of the Communist Party of China. (1983). Dangqian nongcun jingji zhengce de ruogan wentí zhongfa [1983] 1 hao (The Current Number of Rural Economic Policy Issues, Document No. 1, 1983, 1983 年中 共中央一号文件《当前农村经济政策的若干问题》). Beijing: Central Committee of the Communist Party of China. Central Committee of the Communist Party of China. (1984). 1984 nian 1 hao wenjianzhonggong zhongyang guanyu 1984 nian nongcun gongzuo de tongzhi (The Notice of the Central Committee of the Communist Party of China Area Work, Document No.1, 1984, 1984 年中共中央一号文件《关于 1984 年农村工作的通知》). Beijing: Central Committee of the Chinese Communist Party. Central Committee of the Communist Party of China and State Council of the People’s Republic of China. (1985). 1985 nian 1 hao wenjian ‘zhonggong zhongyang guanyu 1984 nian nongcun gongzuo de tongzhi’ (To Further Invigorate the Rural Economy with Ten Policies, Document No.1, 1985 年中 共中央一号文件《关于进一步活跃农村经济的十项政策》). Beijing: Central Committee of the Communist Party of China and State Council of the People’s Republic of China. Central Committee of the Communist Party of China and State Council of the People’s Republic of China. (1986). Guanyu 1986 nian nongcun gongzuo de bushu (Regulations on the Deployment of Rural Work in 1986, Document No.1 1986, 1986 年中共中央一号文件《关于1986年农村工作的部署》). Beijing: Central Committee of the Communist Party of China and State Council of the People’s Republic of China. Central Committee of the Communist Party of China and State Council of the People’s Republic of China. (1989). Guanyu jinyibu qingli zhengdun gongsi de jueding zhongfa [1989] 8 hao (Decision of Concerning the Further Checking Up and Re-certificating Companies, Document No. 8, 1989, 1989 年中共中央八号文件《关于进一步清理整顿公司的决定》). Beijing: Central Committee of the Communist Party of China and State Council of the People’s Republic of China.

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Central Committee of the Communist Party of China and State Council of the People’s Republic of China. (1993). Guanyu dangqian jingji qingkuang he jiaqiang hongguan tiaokong de yijian zhongfa [1993] 6 hao (Opinions About Current Economic Situations and How to Strength Macro-Control, Document No. 6, 1993, 1993 年中共中央六号文件《关于当前经济情况和加强宏 观调控的意见》). Beijing: Central Committee of the Communist Party of China and State Council of the People’s Republic of China. Che, J.  (2002). Rent Seeking and Government Ownership of Firms: An Application to China’s Township—Village Enterprises. Journal of Comparative Economics, 30(4), 787–811. Che, J., & Qian, Y. (1998). Insecure Property Rights and Government Ownership of Firms. The Quarterly Journal of Economics, 113(2), 467–496. Government Administration Council of the Central People’s Government (State House). (1951). Guanyu caizheng fenji hou jige zhongyao wenti de guiding (Provisional Regulations on Several Important Issues After Fiscal Grading, 关于 财政分级后几个重要问题的规定). Beijing: Government Administration Council of the Central People’s Government. Huang, Y. (2008). Capitalism with Chinese Characteristics: Entrepreneurship and the State. New York: Cambridge University Press. Jefferson, G. H., & Xu, W. (1991). The Impact of Reform on Socialist Enterprises in Transition: Structure, Conduct, and Performance in Chinese Industry. Journal of Comparative Economics, 15(1), 45–64. Jiang, C. (2000). Xiangzhen qiye chanquan gaige de luoji (The Logic of Township and Village Enterprises’ Property Rights Reform, 乡镇企业产权 改革的逻辑). Economic Research Journal, 10, 23–29. Jiang, C. (2001). Xiangzhen qiye rongzinan: xianzhuang, yuanyin yu sikao (Financial and Capital Troubles of the Country-Tow-Operated Enterprises: present Situation, Causes and Reflections, 乡镇企业融资难:现状、原因 与思考). Jiang Huai Tribune, 1, 28–33. Jin, H., & Qian, Y. (1998). Public Versus Private Ownership of Firms: Evidence From Rural China. The Quarterly Journal of Economics, 113(3), 773–808. Kojima, R. (1993). Agricultural Organization: New Forms, New Contradictions. In R.  Ash & Y.  Y. Kueh (Eds.), Economic Trends in Chinese Agriculture (pp. 97–121). Oxford: Clarendon Press Oxford. Li, D.  D. (1996). A Theory of Ambiguous Property Rights in Transition Economies: The Case of the Chinese Non-State Sector. Journal of Comparative Economics, 23(1), 1–19. Ministry of Finance of the People’s Republic of China. (1971). Guanyu shixing caizheng shouzhi baogan de tongzhi (Notification Regarding Fiscal Revenue and

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4 Ownership Structure of TVEs: TVE and Local Politics

4.1 Introduction 4.1.1 TVE Property Rights: Two Issues The problem of property rights distribution in TVEs has always been a core issue in studies of TVEs and China’s economic transition and other related topics. The significance of the issue lies in the fact that for many years before the massive privatization of the mid-1990s, TVEs had been one of the major forces driving China’s rapid economic growth. Even after privatization, TVEs—on their broad definition (the definition followed in official statistical coverage after the mid-1990s)—still accounted for over 50 per cent of China’s industrial output as a whole. The TVE property rights problem involves two related issues. The first relates to the efficiency of TVE property rights. Li (1996) published the earliest study addressing the efficiency and ownership of TVEs, arguing that

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(a) the ambiguity of TVE property rights give TVEs an efficiency advantage over SOEs; (b) TVEs’ ambiguous property rights derive from the economic environment. In Li’s principal-agent model, ambiguous property rights are the means whereby control of enterprises is shifted from government to entrepreneurs, and government supervision can guarantee that the managerial efforts of entrepreneurs are maintained at an acceptable level. Li’s model hypothesizes the distribution of TVE property rights under certain conditions: as long as the performance of the firm remains above a critical level, control of the firm will stay in the hand of entrepreneurs; if, however, it falls below this threshold, the government will take it back. Though far from perfect, this model was not only adopted as the basic framework of most mainstream studies of TVEs throughout the whole of the 1990s and into the early twenty-first century, but also penetrated other fields. For instance, Oi (1999) outlined a theory of state corporatism after integrating Li’s and relevant later studies into her early sociological analysis (Oi 1992). The second issue with TVE property rights relates to their cost. So far in the literature about TVEs, two papers have noted the cost of property rights institutions and have made efforts to incorporate this in an endogenous model. Che (2002), Yao and Sheng (2002) and Fan and Chen (2005) draw attention to the instability of TVE property rights distribution and analyse its causes and effects from a variety of perspectives. Che translates the problem of the structure of the TVE system into a game between TVE entrepreneurs and local government agents, which is also the theoretical foundation of Li’s TVE theory. Che believes that in the face of governments’ pre-conditional legal right to claim TVE ownership, the effective tool by which TVE entrepreneurs maintain their control over an enterprise is rent-seeking. Fan and Chen (2005) highlight variations in the institutional organization of TVEs and the connection between those variations and those of other relevant institutions. Like the ambiguous property rights theory, Fan and Chen (2005) see the TVE institution itself as a second-best choice leading to suboptimal performance.

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4.1.2 P  roblems with the Ambiguous Property Rights Approach In the theory of ambiguous property rights, the mainstream approach explains the efficiency of the TVE property rights institution through recourse to principal-agent theory. However, the question is whether this theory is properly applicable to the TVE situation. In standard principal-­ agent theory, principals’ right of disposition is supported by law, and is thereby the source of their bargaining power when dealing with agents. In reality, however, because TVE assets originated in various forms, when local governments attempt to exercise their nominal ‘ownership’ right, the de facto right of disposition is usually challenged. Nevertheless, the existing literature dealing with TVE problems gives almost no illustrations of the use of the principal-agent framework, while also indicating a degree of instability in the disposal rights for local government. This weakness has its origins in the principal-agent theory framework itself: the problem that it focuses on is how, when there is no ambiguity in the ex ante or ex post disposal rights, principals and agents can contractually negotiate to share the output between them. The various sources of TVE assets and the variety of TVE institutional characteristics may result in no actual flow of control rights between local governments and entrepreneurs, in which case the principal-agent hypothesis may not hold. Moreover, from the point of incentives and property rights, the rise of China’s TVEs in the late 1970s and the first half of the 1980s was difficult to interpret and understand. Before the mid-1980s, private property rights, especially for enterprises, were almost completely non-existent (they were effectively banned), and when privately owned small-size businesses exceeded a certain threshold they faced rigid regulation by the state. Huang’s (2008) hypothesis of ‘directional liberalism’1 therefore cannot clearly explain the rise of TVEs during the 1980s. Such considerations suggest that two questions deserve to be investigated. First, in the initial stage of the reforms, although in a legal sense they were collectively owned, were TVEs in fact the product of the paternalism of local government, as suggested by state corporatism theory? Since TVEs and county-level COEs were both collectively owned, was the relationship between TVEs and local governments a microcosm of

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that between large-scale COEs and county-level governments? Second, during the period from late 1970s to early 1990s urban residents were generally better educated and wealthier than the rural population, while urban physical capital accumulation was also higher than in the countryside. From the point of view of institutional concessions, there were also collectively owned ‘neighbourhood factories’ (jiedao qiye, 街道企业) in the urban sector which were very similar to TVEs in terms of their ownership status. With greater human and physical capital and similar institutions at the micro level, why did most neighbourhood factories stay trapped in low value-added manufacturing throughout the 1980s? It incidentally deserves mentioning that Zhou (1997) raises a similar hypothesis to that of ‘directional liberalism’, attributing the high level of effort made by early TVE entrepreneurs to their expectations (the benefits they anticipated in the wake of continuing reforms).

4.1.3 Problems with TVE Institutions In economics, the work undertaken by Li (1996) provided the basis for the joint liability theory of local finance in the 1990s. This theory regards local governments, at the township and village levels in particular as the final owners of all local TVEs and deems that TVEs’ financing capacity actually derived from the local government’s repayment ability. The government’s repayment ability is determined by the asset quality of all the TVEs owned by local governments. In other words, local government effectively holds TVEs as a portfolio (Sun 2002). Consequently (according to the theory), if a TVEs falls into debt, local government will pay off all bad/non-performing loans. After the mid-1990s, China’s Central Bank tightened its monetary policy, thereby weakening the financial capacity of local governments. As a result, in most cases they were unable to exercise their right as nominal owners to cash in TVEs’ assets. Fan and Chen (2005) observe that the TVE institution is not the direct outcome of the transitional state of the economy. Rather, it is the intermittent stagnation associated with the excessive time that elapsed during the transition to a market economy that generated the peculiar ­institutional characteristics of TVEs. Fan and Chen use the term ‘transitional hybrid’ to describe the institutional character of TVEs. They believe

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that as the foundation of ambiguous property rights theory, the market environment, which is usually treated as an exogenous institution, in fact derives endogenously from the intermittent nature of the transitional process. Fan and Chen’s explanation of TVEs is actually an extension of ambiguous property rights theory in the macro and institutional dimensions. Following this theory, the exogenous ‘market environment’ determines the distribution of property rights between entrepreneurs and local governments, while also enabling local government agents to control their opportunist impulse to grab the wealth of TVEs when they are performing well. On the other hand, when a TVE’s performance deteriorates, agents of local governments will shoulder the responsibility of saving the enterprise. Fan and Chen argue that the institutional framework of TVEs is not only capable of dealing with external market risks, but can also address the dangers caused by institutional variations. This theory resonates with Fan’s early studies of economic transition (Fan 2000, 2003). Fan considers China’s economic transition as a problem arising from the difference in growth rates of two contrasting economic entities: the SOE sector (with its origins in the pre-1978 central planning system) and the non-SOE sector, which began to emerge in the 1980s. In Fan’s framework, when the non-SOE sector grows faster than the SOE sector, a gradual process of transition gets under way as a result of the efficiency differences between them. The problem with this theoretical approach is that logically, if it is to hold true, the two sectors must continue to operate within the frameworks of two different economic systems. When the two sectors both operate within an identical economic framework, linkages between them are bound to multiply and strengthen—not only in terms of trade and economic exchange, but also in terms of sharing of fundamental economic and legal institutions. In such circumstances, the growth rate may not precisely reflect the efficiency of each sector. Fan and Chen (2005) further argue that the institutional foundation of TVEs lies in the institutional characteristics of what may be thought of as their ‘parent’ institution—in other words, the CBEs that were ­established under the pre-1978 central planning system. From this premise, TVEs may be seen, to a greater or lesser extent, as adaptations of CBEs. In other words, the form they have taken is significantly dependent on the characteristics of the parent institution, and shaped by the way in which they have adapted to it. From Fan and Chen’s approach, it follows too that the efficiency

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difference between TVEs (and other non-SOEs) and SOEs is largely a function of the degree of institutional adaption to the former CBEs. Che (2002) regards TVEs’ rent-seeking activities as inherent in the nature of the TVE institution itself. According to this view, when TVE entrepreneurs cannot raise a legal claim to TVE ownership, local government agents can play two roles. First, they can act as the agent of the legal owner, but transfer actual control rights to the entrepreneurs while guaranteeing the state’s legal rights. Under these circumstances, rent-seeking would be seen as the equivalent of buying a key institution as a necessary condition for the successful operation of the enterprise. Second, when TVE entrepreneurs are able to pay extra rent to local government agents, the agents will be likely to offer more support to TVEs in return, as long as the marginal product of the enterprise exceeds that of the local government agents. However, Che’s theory still has the fundamental problem that local government agents’ opportunism would increase the return they seek from entrepreneurs, jeopardizing the performance of the enterprise. Therefore in a formal principal-agent model, in order to guarantee the performance of enterprises, their entrepreneurs must either rely on strong asymmetric information to dampen the rental expectations of government agents or must weaken the agents’ ability to request/cash TVE assets.2 Based on the extensions to ambiguous property rights theory raised by Che (2002) and Fan and Chen (2005), this chapter discusses the micro foundation of TVE’s property rights institution. The chapter is structured as follows: Sect. 4.1 gives a brief review of how the TVE (CBE) sector has maximized its opportunities since the late 1970s; Sect. 4.2 discusses TVEs’ relationship with local politics and the secure mechanism of TVE control rights; and Sect. 4.3 suggests some implications. The final part draws the conclusions.

4.2 From CBE to TVE: Changes in Incentives 4.2.1 Pattern Classification of Pre-reform CBEs At the beginning of China’s economic reforms, TVEs were a form of enterprise that existed only in rural areas and were collectively owned by communities such as towns (communes) and brigades. Before 1984,

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the official name of TVEs was ‘Commune and Brigade Enterprises’ (CBEs). The CBEs can be traced back to the late 1950s (see Chap. 3). In 1958, when the Great Leap Forward was launched and Rural People’s Communes were universally established throughout the Chinese countryside, township or lower-level government branches all suffered from a lack of cash income. This was the background against which the central government encouraged rural communities to set up enterprises and advocated the involvement of CBEs in trade (the exchange of products) under the central planning economy. From this perspective, CBEs can be regarded as an attempt by the central government to relieve financial pressure on local governments. TVEs (CBEs) can be classified into two categories: (a) CBEs that were established before China embarked on economic reform in the late 1970s; (b) TVEs (CBEs) that were formed during post-1978 economic reform. In general, pre-reform CBEs can be categorized into three types. The first category included those enterprises that were established before and during the early years of the Cultural Revolution (1966–1976). Many of these had their origins in central government’s decentralization initiatives, when some local COEs (usually at the county level) and a smaller number of SOEs were converted to CBEs. Between 1956 and 1958 (CCP 1956; CCP and State Council 1958) and again in 1970–1971 (State Council 1970), political and financial pressures encouraged the central government to advocate and implement decentralization designed to transfer the jurisdiction of SOEs or COEs to lower-level governments: hence, the relocation of enterprises to the administrative remit of ­township/commune local governments. Although later recentralization measures returned some of these enterprises to higher-level government control, many of them remained within the remit of township-level governments. The second category includes firms whose origins also lie in the decentralization initiatives of the late 1950s and the 1970s. In this case, however, the enterprises were new COEs, set up by local governments, especially at county and commune level.3 The third category includes brigade enterprises, which were mainly established by brigades (the institutional successor to the ‘higher-level

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agricultural producer cooperatives’ [collectives]) during the late 1950s and 1960s, and in the second half of the Cultural Revolution. The development of the brigade enterprises was relatively slow, and, at least until the onset of economic reform, they were regularly affected by political disorder and restrictions. One consequence of this is that brigade enterprises could neither borrow sufficient money from banks nor use their own profits4 to invest in physical capital. As a result, they were starved of effective investment funds and were therefore largely unable to produce higher-valueadded products. In the middle and later years of the Cultural Revolution, restrictions on brigade enterprises were, it is true, loosened. But since local finance—and agricultural production—improved towards the end of the Cultural Revolution, the importance of these enterprises declined.

4.2.2 The Impact of Reform and CBE Transformation Prior to economic reform, CBEs were commonly characterized by a lack of entrepreneurial control rights—just as was the case in SOEs and other COEs. This situation remained unchanged until the early 1980s, and during this period most county/commune-level CBEs were effectively treated as SOEs, their business operations being regarded as part of the planned economy. Meanwhile, although they enjoyed more operational autonomy, brigade enterprises’ accounting and salaries were still bound to the brigade and calculated at the brigade (not the enterprise) level. In particular, salaries were calculated on the basis of work points, which meant that a brigade enterprise employee’s salary was the same as that of all other brigade members (including, for example, agricultural labourers who had never worked in the brigade enterprise). Brigade enterprises also shared their cash account with the entire brigade, and were therefore unable to accumulate funds for further investment and expansion. Under the impact of the post-1978 reforms, the entrepreneurs in brigade enterprises were the first to acquire control rights over their firms. The agricultural reforms of the late 1970s and early 1980s transformed China’s agriculture from collectivized brigades to family-based farming within the new institutional framework of ‘Household Responsibility Systems’, which effectively acknowledged peasants’ right to use (but now own) farm land and went some way towards endorsing the privatization

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of agricultural production (Wen 2003). With this shift towards a mode of agricultural production that more market orientated than collectively orientated, the most important economic links between brigades and their members were broken, and the work points system, which had determined agricultural incomes within the previous collective framework of farm organization, was eliminated. As a result, brigade enterprises were freed from the work-points-based salary system and were allowed to keep separate accounts from those of the higher-level brigade administration. This development marked something of a watershed. It marked the first time since the 1950s that a firm’s financial operations were delinked from the planned economy (in this case, the local collective economy) and were allowed to become financially independent. When the separation of brigade enterprises from the planned economy took place during the late 1970s and early 1980s, the operation of most of the Chinese economy was still conducted within government (state) plans. Although brigade enterprises undertook manufacturing activities, they were not listed as a formal industrial sector within the central planning economy. Instead, they were regarded as part of the agricultural sector, any economic surplus of which was instantly taken (by the state) and consumed, since the work points system and related collective institutions precluded the possibility of the farm sector holding any financial assets. Until after 2000s, quite important residual elements of the agricultural economy remained within the purview of central planning. Most notably, the Grain Bureau remained committed to purchasing all that was produced by farmers. By contrast, brigade enterprises were not included in the planned economy, and their output was not purchased within this system. Another result of brigade enterprises’ delinkage from the collective economy was their exemption from the obligation of handing all income to brigades, even though almost all other industrial enterprises were compelled at this time to remit their profits to the government. In fact, apart from brigade enterprises, the profits and working capital accounts of SOEs and other COEs were still directly monitored by local government or accounting offices of relevant professional departments. We may therefore state that brigade enterprises were the first to gain a degree of financial autonomy during the early phase of China’s economic reform. Asimilarsituationwaslatertooccurincommuneenterprises.The1983–1984 ‘profit delivery by taxes’ (State Council and Ministry of Finance 1983)

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reform and early SOE reform initiatives (State Council 1983) changed the financial relationship between firms and government. Previously, enterprises had been required to remit all profits; but now, thanks to the reforms, they were exempted from this obligation, instead being required to pay a de facto company income tax. The reform initiative was primarily directed towards the SOEs, which were still under the tight control of the government and subject to its frequent interference. Since, however, most local commune/ township governments lacked the capability to undertake regular financial supervision of commune enterprise operations; this initiative had the effect of making them financially independent. Consequently, when agricultural operations were subsumed under so-called Responsibility Systems (zeren zhi, 责任制) (1978–1983), and when, a little later (1983–1984), enterprise reform got under way, the CBE institution offered a legal means of facilitating full financial control of their enterprises by entrepreneurs. Before 1983, TVEs/CBEs made up only a small fraction of the Chinese economy. But in the wake of the 1983–1984 reform, they became the fastest-growing sector, their number increasing tenfold between 1983 and 1985.

4.3 The Nature of TVE Property Rights 4.3.1 T  VE: An Interloper in the Central Planning System During the whole of the 1980s, TVEs were regarded as alien institutions by the urban sector and its residents. In 1984, a TVE entrepreneur wearing a comical old-fashioned hat, behaving rudely and looking silly, was even built into the annual Spring Festival Gala broadcast on China State Television, which most Chinese would not have missed. Far more serious was the acute discrimination that was directed against TVEs. Yet this universal urban prejudice seemingly failed to undermine the economic performance of TVEs: between 1984 (when CBEs were renamed TVEs) and 1989, they achieved average annual output growth of approximately 30 per cent, a figure that was much higher than recorded by SOEs (which was the economic bedrock of the urban sector at the time).

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What made the urban sector and its residents uncomfortable was the fact that TVEs (including TVE salesmen and entrepreneurs) existed and operated outside the central planning system, with most of their behaviour being unrestricted. Later on, attitudes changed, and by the late 1990s, the conduct of TVEs was more understandable and acceptable to people who had become used to dealing with firms that responded quickly to changing conditions—and, in particular, to market conditions rather than those dictated by central planners. In the 1980s, TVEs were more market-oriented than SOEs and stood out from the general economic environment because of the control which entrepreneurs now exercised over their enterprises. Although in the 1980s the scale of TVEs was generally smaller than that of SOEs,5 and although TVE entrepreneurs had less authority than the managers of SOEs, or Big Collective (da ji ti, 大集体)6 enterprises, with work forces comprising their hundreds or thousands of staff, there were two aspects in which the entrepreneurs enjoyed a clear advantage in terms of control rights. First, they enjoyed full control rights over the use of all TVE resources. In a typical TVE, the entrepreneur could decide on the type, quality, quantity, etc. of the goods that the enterprise produced, as well as on inputs and the allocation of profits (and by implication, investment). Such characteristics took such enterprises close to the standard economics textbook definition of a market-oriented firm, in which an entrepreneur could control ‘what to produce and how to produce’. In China at this time, in most SOEs and COEs such decisions were still partly or wholly determined and controlled by government plans. Second, in the 1980s and 1990s TVE entrepreneurs had the right to dispose of assets, and hire or fire employees, and could use their personal connections to borrow money from individuals or banks. This mode of management again made TVEs more like private firms than the more common SOEs or COEs of the time. Until the early 1990s, most SOE and COE employees in the urban sector were allocated by the government, rather than by enterprises. University graduates were directed to jobs in SOEs via the central planning system’s human resources department; other forms of labour, including skilled workers, were also allocated to SOEs and COEs via the central or local planning system, depending on the nature of the job and the size of the firm. Similarly, most bank loans to SOEs were arranged by government—a situation that has changed little, as the persistence of SOE bank loan quotas down to the present day indicates.

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4.3.2 Why Local Politics Matter The state corporatism theory elaborated by Oi (1992, 1999) advocates that during the development of TVEs, local government were able to coordinate the activities of TVEs with the rest of the local economy, acting paternalistically in the interests of the entire local economy. The underlying logic of this view is at variance with mainstream economics: the asymmetric information problem would rapidly increase managerial costs. This view also lacks empirical support: if governments had the capacity to succeed in managing a comparatively large number of TVEs, why could they not have been equally successful in managing SOEs (after all, in some coastal regions of China, the total output of a single town’s TVEs—and sometimes those of a single village—was greater than that of a typical large-scale SOE). However, on the basis of her empirical ­investigations, Oi highlighted the important finding that the operations of TVEs were consistently a preoccupation of local government. Thus, TVE entrepreneurs and their activities cannot be separated from local politics: stated slightly differently, local-level politics were deeply embedded in TVEs’ operations almost on a daily basis. In order to sustain their daily operations, TVE entrepreneurs had no choice but to engage with local government officials. Zhou (1997) similarly cites empirical evidence in order to show that engagement (economic and social) with local governments was an unavoidable necessity for TVE entrepreneurs.7 Based on the mainstream principal-agent model, Che (2002) sets out a similar theory. First, he argues that TVEs must secure continued political support from local government: this he sees as a key to maintaining their operations at an acceptable level. In order to obtain such support they must be prepared to direct, on a continuous basis, a certain level of economic resources to political lobbying. Che sees this political engagement as a rent-seeking cost (but not the Tullock (1967) type). Zhou’s (1997) version of TVE entrepreneurial rent-seeking argues that a necessary condition of successful TVE entrepreneurship is maintaining rent-seeking procedures at a relatively low cost. In short, being a good TVE entrepreneur means minimizing the cost of rent-seeking. All the above empirically based TVE theories highlight the critical importance of securing political support from local government. Such

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political support can determine whether an entrepreneur can retain complete control of the enterprise. This should be regarded as a key objective: if the entrepreneur lacks sufficient control, the TVE will simply become an executor of government orders (even the entrepreneur’s authority within the enterprise is unaffected); with greater autonomy, an entrepreneur may set his own preferred targets, such as maximizing profits or market share, rather than just following government goals. Since the ownership of TVEs was collective, in a legal sense the owners of TVEs were all the members of a local community—a town or village, depending on whether the TVE was township or village based. Managers of TVEs, unlike those of SOEs, were not formal government employees; as representatives of their local community (at least in name), the local government was therefore in a position to hire or fire them at any time. Accordingly, if TVE entrepreneurs needed to consolidate their right to control an enterprise in circumstances in which their jobs might be reallocated by local governments, it was essential that they should first find ground to defend. That is, they needed as much support as possible from the local government in order to minimize the possibility that local authorities would reduce a TVE manager’s tenure by transferring him to a different job. However, in a standard principal-agent model, as agents of local government local officials can expropriate an entrepreneur from a TVE at zero cost. When a rational agent faces a positive potential income, opportunistic behaviour is inevitable: most TVEs own at least some fixed assets that can be cashed in, and if officials are able to maintain production at a certain level (which equals a certain cash flow), the current value of enterprises will be quite high. Therefore, officials will seek to remove the entrepreneur and seize all the surplus value. Nearly all empirical studies (e.g., Zhou 2002) indicate that neither taking advantage of asymmetric information, nor using better and lower cost rent-seeking skills to maintain entrepreneurial control of TVEs will be possible in the long term. Even in special cases, such as where there is a family relationship or friendship with the entrepreneur, some local officials may ‘relinquish’ their power and choose to not taking opportunistic action to arbitrage from TVEs. In the long run, however, such irrational conduct by officials will be still restricted by two factors. The first is the fact that in the bureaucratic structure of Chinese local politics, the length of time that local officials can serve in township government is limited.

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Even an official who is not promoted will be shifted to a new position within five to ten years, and it is therefore very unusual in China—unlike the situation in some other developing countries—to find a situation where certain people or a political group is able to monopolize a local position for life. Thus, entrepreneurs rarely have to deal with the same township official on a long-term basis. Secondly, if an entrepreneur has achieved obvious business success in a certain TVE—as revealed by tax and bank records, etc.—then officials’ impulse to exercise their power may take precedence over any other factor. When the scale of a TVE enterprise is relatively small, officials may prefer to help the entrepreneur for little or no economic reward. But when the scale of the firm or profits starts to expand, the temptation by officials to derive some economic benefit from the firm may lead them to remove the entrepreneur from the TVE and cash in the assets. Wu (2010), a Chinese journalist, reports in detail on a dramatic case in which officials exiled the entrepreneur from Kelon Group, the largest manufacturer of white goods and the biggest refrigerator and freezer producer in China; the officials who took over the enterprise were rapidly ousted by new government officials, finally causing the decline of Kelon Group. TVE entrepreneurs’ purpose in participating in local politics is not— as Che or Zhou suggested—to create low cost rent-seeking methods that will reduce the rent-seeking cost, or cheat local officials. This is because if TVEs are already successful in the market, no matter what rent-­seeking methods (e.g., asymmetric information) they adopt, they will always command a high value through the eyes of government officials. In fact, technically speaking, this situation is fundamentally different from the basic assumption of principal-agent theory, where the concern is how the remaining value can be divided between two parties. In the TVE case, TVE entrepreneurs’ priority is to prevent any damage to the TVE’s main assets. So our question needs to be modified from ‘how to efficiently pursue rent-seeking’ to ‘how to prevent TVEs from being targeted as rent’. The way in which TVE entrepreneurs have protected themselves against opportunism is by taking part in local politics to stop any political interference designed to create TVE rents and arbitrage TVE assets.

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4.3.3 Why TVE Patterns Matter In his discussion of TVE ownership, Huang (2008) argues strongly that a large number of collectively owned TVEs are de facto private firms. If this is true, the risk of TVE assets being lost to local government agents’ opportunistic attacks is very high.8 At the very least, Huang’s argument is a reminder that the label ‘TVE’ embraces completely different types of enterprises, each with its own very distinctive attributes. Economic performance and management behaviour show a significant correlation with the origins of collectively owned TVEs: in particular, there are differences in performance and behaviour between those that originated as brigade (later called village) enterprises, and those TVEs that originated as commune enterprises. Such differences can ultimately be traced to the ways in which brigade/village enterprises and commune/ township enterprises were integrated into local politics. In theory, a brigade/village could only be a subcomponent of a commune/township, and the organizational framework of each was fundamentally different, especially in terms of China’s formal political institutions. First, until the recent reform to local government structure,9 township/commune government had been located at the bottom of the entire Chinese bureaucracy for many years, and its formal officials also represented the lowest level of civil service officers, appointed and monitored at higher government levels. By contrast, viewed from the perspective of China’s formal political institutional framework, brigades were not part of the state’s bureaucratic system or any kind of civil service structure, and were closer to being a politically autonomous body. Brigade heads (the brigade captain and the secretary of the brigade’s Communist Party Committee)10 were more politically independent than formal bureaucrats: first, unlike township or higher level officials, the secretary/captain had to be a local rural resident from the same brigade rather than someone chosen from the urban population11; and second, partly following the logic of the hukou system, there was no limit to the duration of a brigade secretary or captain’s stay in post. In theory, as long as they did not fail in the brigade level election (or brigade-level CCP election, in the case of the secretary),12 there was no restriction on the number of times they could be re-elected.

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In short, unless officials at the township level were prepared to take political risks (‘risks’, because once they failed, they stood to lose political authority), brigade secretaries could never be deposed13 if they decided to seek consecutive tenure. The political power wielded by brigade heads was such that in areas where TVE development was strong, the brigade secretary was usually the de facto controller of TVEs within the brigade, or was certain to enjoy a solid and stable relationship (often as brother or spouse, for instance) with the actual manager. Viewed from a strategic perspective, the position of brigade secretary in  local government had two characteristics: long-term stability and the ability to defend against external threats. As long as a brigade-level TVE entrepreneur could secure the position of brigade secretary,14 s/he could prevent any attempts to wrest control of TVEs from within the community/brigade. For successful entrepreneurs in business, acquiring political power at the brigade level, were neither difficult nor expensive. One extreme case was that of Wu Renbao from Huaxi brigade15 in Jiangsu Province. Wu was once county secretary in Jiangyin County,16 whose strong relations with central authorities in the CCP brought him nationwide fame and gave him a strong political voice in China. This gave him much greater political influence than any county or township-level local official in Jiangyin. However, although Wu acquired so much political influence at the national level, he never, even during the period when he was county secretary, relinquished his position as secretary of the Huaxi brigade17 which he had held since 1957. Not until 2003, when he retired because of old age, did Wu resign from office—whereupon his son succeeded him as new brigade secretary. Township/collectively owned TVEs also had some other redeeming features. Especially prior to privatization, township-level TVEs had advantages in terms of their ability to access key input and output markets, although their more complicated ownership origins18 and structure, compared with brigade-level TVEs, were reflected in them having different control rights structures. For example, in the buoyant economic conditions of the early 1990s, local governments set a large number of township TVEs through massive borrowing to create political rents, and it was very common for local government to use TVEs as piggybanks to arbitrage enterprise assets. If no appropriate entrepreneurs were available

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to make these enterprises profitable, and to establish sufficiently strong entrepreneurial control rights to protect firms against the effects of direct orders issued by the local government, these enterprises would eventually consume all their assets and leave some non-performing loans for local governments, which in most situations acted as guarantor. However, in some inland provinces a large number of successful township TVEs shared a common characteristic namely, active involvement by entrepreneurs in a wide range of political activities at county or municipal level. Since township local government officials were not elected, if those in actual control of TVEs were the main county or municipal government CCP members, there was no room for opportunism on the part of lower officials. As mentioned above, the principal-agent theory does not explain TVEs.19 The difference between TVEs and other non-private (state- or collectively owned) firms lies not in the nature of their ownership status, but in how government political influence was able to affect their operation. If the enterprise could be successfully isolated from political intervention—for example, if major operational decisions taken within the firm were based purely on entrepreneurial considerations—the entrepreneur could exercise some elementary property rights that might be called control rights or semi-ownership. There are two factors at work in the nurturing of TVE entrepreneur’s control right. First, an entrepreneur must have sufficient incentive to build up full control rights over the enterprise. The control right is a costly extension of planning economy-style managerial authority as exercised in a standard 1980s SOE or COE. The key difference between a TVE with entrepreneurial control rights and those COEs/SOEs in which they are absent is that in the former, the TVE manager’s position must be extendable into the long run to ensure that a TVE manager has secure of tenure in his post. By contrast, the managers of most other non-private enterprises are government-appointed officials and cannot enjoy the benefit of control rights, since extension of tenure is politically difficult (whether because it conflicts with the CCP’s fundamental rules or it is impossible to pass on the position to other family members or close friends). Only if it was likely that an entrepreneur could change his position to one in which he acted as quasi-owner would this costly move be worthwhile.

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Second, entrepreneurs’ established rights of control needed to have with a certain degree of protection. The vulnerable nature of TVE quasi-private ownership had its origins in the community-based nature of ownership, since political agents (local officials) might use administrative power to damage or destroy the entrepreneur’s control rights. Thus, it was incumbent on entrepreneurs to equip themselves with a suitable and affordable political tool(s) in order to defend themselves against such possibilities. The variety of political activities in which TVE entrepreneurs were involved can be interpreted as indicative of the need they felt to secure a degree of local political influence. The extent to which they were able to use and wield such influence determined the extent to which TVE ­entrepreneurs could successfully prevent officials from arbitraging the assets of their enterprises.

4.3.4 Political Costs The way in which TVEs (at brigade, commune or even county level) were set up was significantly affected by the cost to entrepreneurs of securing political guarantees that protected their right of control (Douhan and Henrekson 2007). Differences in costs were reflected in different TVE ownership structures. Take first the difference between brigade-owned and commune-owned enterprises, both of which were officially considered collectively owned entities. In the early part of China’s reforms, especially during the 1980s and into the early 1990s, the cost of securing political power in a brigade was relatively low, and the power was comparatively easy to retain. At that time, even in most coastal provinces, brigades were still agriculture-­ based, with no significant cash flow being available other than through government funding; and the brigade’s land—also collectively owned by the community—was not as valuable as it was to become in the 2000s. By contrast, the cost to enterprises of involvement in commune/county-­ level politics (including the cost of retaining power) was much higher than for a brigade. Indeed, a TVE entrepreneur might even find himself faced with the challenge of having to fund a full-time commune or county politician’s position. The level of such costs also depended on

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the stage of economic and social development that had been reached in the relevant region. Generally speaking, securing political power and influence in more highly developed economic regions was more costly than in less developed areas. In the mid and late 1980s, when the rapid expansion of TVEs was beginning to take place, regional economic gaps and inequalities in the distribution of income in China were already considerable. For instance, Chongqing, whose economy was one of the more advanced among inland provinces, had a population of 27 million and a GDP of about RMB 16 billion in 1985—the first year after the CCP had announced its decision to offer preferential support to TVEs. By contrast, in the same year the city of Wuxi in Southern Jiangsu, where CBEs originated, had a GDP of approximately RMB 8 billion and a population of 3.9  million. In other words, the per capita GDP of Wuxi was about 3.5 times greater than that of Chongqing. There is no doubt that in terms of base economic conditions, coastal provinces enjoyed huge advantages compared with their inland counterparts. With this in mind, no less significant is the finding that before the large-scale privatization of the 1990s, the concentration of brigade-level TVEs in coastal provinces (especially in South-eastern China) was much greater than in inland provinces, while commune-owned TVEs were more heavily concentrated in the interior regions of China. The second difference is between collectively and privately owned rural firms. Huang (2008) argues that privately run firms had sufficient strength to drive economic development, and he illustrates this through the example of Guizhou province. In Huang’s example (p. 82) Guizhou had more privately owned TVEs than those (TVEs) that were collectively owned in 1987, but the value-added part of the entire TVE sector in Guizhou (i.e., all private and collective firms in the rural sector) was RMB 977 million yuan. This contrasted starkly with the collectively owned enterprises’ GDP of 15,692  million yuan in Jiangsu Province’s TVE sector.20 Thus, the large number of privately owned enterprises in the 1980s may have not have reflected government preferential treatment or the ‘smartness’ of private entrepreneurs, but have simply resulted from the low level of economic surplus. In other words, entrepreneurs who did not have much surplus to protect had no consequent need to participate in local politics.

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In the case of TVEs, two factors affect the average cost of an entrepreneur’s political activities: the scale of CCP political organization—for example, whether it is at brigade, commune or county level—and the scale of enterprise business. The benefits of participating in larger political groups (commune, county) may be greater than those of participating in smaller groups, but the costs of doing so will increase accordingly. Second, protection of a small family-based business may not require any significant input to political activities, but large businesses need proper shield to ensure the safety of their assets from the danger of local officials’ taking over, and sometimes it is necessary to put the assets in the name of collective ownership.

4.3.5 Institutional Conditions of TVE Development The history of China’s TVEs highlights significant contrasts with the experience of economic transition of SOEs in China, and in former Soviet bloc. Qian and Xu (1993) discuss differences in political structures, with a particular focus on the most effective role of government in facilitating economic development. The experience of TVEs shows that a core task in promoting economic development is to incentivize entrepreneurs to engage in business activities. There are two significant differences between TVEs and the SOE sector: First, TVEs are physically limited to a single location, in contrast to a large-scale SOE, which can not only operate in multiple locations but also has a much more complex production chain. This carries the critically important inference that during the time SOEs were still governed by professional departments and the involvement of many government departments will be necessary to facilitate the continued operation of SOEs. SOEs therefore may become the goal of multiple government department officials’ rent-seeking activities and create political rents in different geographical or production chains. In such circumstances, when entrepreneurs try to establish quasi-private ownership of enterprises (by securing control rights) it will be very difficult to prevent simultaneous rent-seeking activities by many officials. By contrast, in TVEs entrepreneurs can simultaneously fulfil the roles of professional manager and

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local politician, enabling them to exercise robust control over the enterprise. Meanwhile, the obligation of most SOE managers to play a role as government officials limits their roles as entrepreneurs. One potential consequence is that they may be more inclined to join other government officials in rent-seeking activities and arbitraging enterprise assets. Second, the ambiguous property rights of TVEs derive from two key institutional factors: first, the systematic discrimination against private ownership, which left large-scale privately-owned enterprises without adequate legal protection; second, the necessary legalization which made it possible to set up community-owned enterprises with independent finance. Tian (2000, 2001) suggests that the ambiguous property rights of TVEs (e.g., ‘red-hat’ firms21) reflect entrepreneurial behaviour in a situation in which the economic environment is still in a transitional state. This explanation, however, is not wholly convincing: TVEs have emerged neither in other developing countries whose economic development and institutional environment resemble that of China in the 1980s, nor in any former socialist transitional economies. Although TVEs were legalized in the 1950s, the prosperity of China’s collectively owned TVEs only occurred when they gained legal protection and financial independence was satisfied. Before the late 1970s, the finance of TVEs/CBEs was under the control of the central planning economy, integrated with either collectivized agriculture or the state-owned industrial sector: during this period TVEs were not allowed to be financially independent. In the 1990s, however, liberalizing policies—especially the privatization of the late 1990s—sanctioned the transformation of TVEs into privately-­ owned enterprises, resulting in a rapid decline in the share of collectively owned TVEs.

4.4 Conclusion Since the mid-1990s, the principal-agent theory has been the main hypothesis whereby mainstream economics has explained the TVE phenomenon. This theory cannot, however, explain why there has been no large-scale opportunism among government officials at the expense of TVEs. This absence of opportunism is the main reason for TVEs’ suc-

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cess—an achievement that was the major element in the success of China’s economic transition during the 1980s and 1990s. Deficiencies in the principal-agent theory have also generated various alternative theories, such as the theory of state corporatism (Oi 1999). Three main findings have emerged from the analysis in this chapter: (a) The historical origins and antecedents of China’s TVEs are various. Even under collective ownership (that is, prior to privatization), the differences in their origins are the main reason why modes of TVE behaviour and interactions with local government have differed. (b) TVE entrepreneurs’ involvement in local political activities did not result in them becoming the agents of local officials; nor did it reduce the likelihood of government officials interfering with enterprises in rent-seeking activities. Entrepreneurial participation in political activities took place primarily in order to prevent enterprises from becoming the target of local officials. (c) The ultimate ownership status of TVEs, as well as the nature of the political participation of TVE entrepreneurs reflected China’s political and economic conditions in the 1980s.

Notes 1. ‘Directional liberalism’ argues that the main thrust of political reform in China in the early 1980s was a sufficient basis for enterprises to expect that future economic reform would result in the legalization of private property rights. By the same token, as such reforms took effect, entrepreneurs no doubt looked forward to acquiring ownership rights over most enterprises. 2. E.g., increase entrepreneur’s human capital/social capital rather than their physical capital. 3. This category also includes CBEs that were created out of former COEs, components of which were transferred to commune-level governments. 4. Brigade finances were based on ‘work points’, and required enterprises to transfer all their profits to the brigade’s cash account, most of the remaining cash being distributed to the brigade members.

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5. Until 1989, on average, a TVE had a workforce of fewer than six persons. 6. During the planning economy era, due to fiscal pressures, sometimes the government cannot offer enterprises or enterprise employees same level of salary and other welfares as SOEs, in such cases payment to firms and individuals are all at COE level which is less than standard SOEs. However these enterprises were functioning exactly the same way as SOEs under central planning system, and such enterprises were called Big Collective. 7. Note, however, that Zhou and Oi drew completely different conclusions from their empirical studies. 8. Huang also argues that the number of privately owned TVEs (as shown in catalogues of private firms and household b­ usinesses, which, during the 1980s and early 1990s, attracted different tax rates) was large. However, Huang uses selectively chosen data: the rise of China’s private sector reflected three major CCP permissive decisions: the first was permission given by the Chinese government to set up private firms in the form of small business (in certain specified industries and with limits to the scale); the second was the process of accelerated economic liberalization that followed Deng Xiaoping’s tour of Southern China; and the third was the process of outright privatization that got under way in 1996–1997. Huang eliminates pre-1985 data and TVE output data to make the growth of the private sector output look smoother. Use of a more comprehensive data set would show that the average scale of privately owned TVEs rapidly increased with each new liberalization policy, indicating that a significant ratio of ‘red hats’ (de facto private firms, even though they were officially designated as collectively owned) had been released back to private ownership. 9. Starting from the late 1990s. 10. The secretary of a brigade’s Communist Party Committee was usually the dominant figure. 11. All state bureaucrats held urban citizenship. 12. Such elections usually had a single candidate. 13. The only way in which this could happen was by selecting an alternative candidate. 14. By himself, or a person who is reliable to him. 15. Huaxi was a part of Huashi Commune (later renamed Huashi Town). Huashi is in Jiangyin County.

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6. Now Jiangyin City. 1 17. During the Great Leap Forward, Huaxi was renamed 17th Brigade of Huashi Commune. 18. See Chap.2. 19. This is because rational local government officials were not the owners of TVE assets either legally (according to law, all the owners were community members), nor their actual controllers. If we apply principal-agent theory here, we must introduce multiple-level agents. More importantly, community members, especially at the village or township level, did not have any means of getting the actual voting right over local government officials. 20. Jiangsu’s private TVE sector is relatively smaller (compare with collective TVEs); its total value in 1987 was 1936 million yuan. 21. Hongmaozi qiye (‘红帽子’企业) refers to private firms disguised their ownership by changing their legal ownership to non-­private (collective or state-owned).

References Che, J.  (2002). Rent Seeking and Government Ownership of Firms: An Application to China’s Township—Village Enterprises. Journal of Comparative Economics, 30(4), 787–811. Douhan, R., & Henrekson, M. (2007).The Political Economy of Entrepreneurship: An Introduction. Research Institute of Industrial Economics Working Paper No. 688. Research Institute of Industrial Economics, Stockholm. Fan, G. (2000). Lun tizhi zhuangui de dongtai guocheng—feiguoyou bumen de chengzhang yu guoyou bumen de gaige (On the Dynamic Process of Institutional Transition in China, 论体制转轨的动态过程——非国有部 门的成长与国有部门的改革). Economic Research Journal, 1, 11–61. Fan, G. (2003). Zhuangui jinji lilun yu guoyou qiye gaige (On the Transitional Economic Theory and the Reform of the Chinese State-Owned Enterprises 转轨经济理论与国有企业改革). Journal of Yunnan University (Social Sciences Edition), 5, 64–69. Fan, G., & Chen, Y. (2005). “Guodu xing zazhong”: zhongguo xiangzhen qiye de fanzhan ji zhidu zhuanxing (Transitional Hybrids: Development of TVEs and Institutional Transition in China, “过渡性杂种”:中国乡镇企业的发 展及制度转型). China Economic Quarterly, 4, 937–952. Huang, Y. (2008). Capitalism with Chinese Characteristics: Entrepreneurship and the State. New York: Cambridge University Press.

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Li, D.  D. (1996). A Theory of Ambiguous Property Rights in Transition Economies: The Case of the Chinese Non-State Sector. Journal of Comparative Economics, 23(1), 1–19. Oi, J. C. (1992). Fiscal Reform and the Economic Foundations of Local State Corporatism in China. World Politics, 45(1), 99–126. Oi, J. C. (1999). Rural China Takes Off: Institutional Foundations of Economic Reform. Berkeley: University of California Press. Qian, Y., & Xu, C. (1993). The M-form Hierarchy and China’s Economic Reform. European Economic Review, 37(2–3), 541–548. Sun, L. (2002). Fading Out of Local Government Ownership: Recent Ownership Reform in China’s Township and Village Enterprises. Economic Systems, 26(3), 249–269. State Council of the People’s Republic of China. (1958). Guanyu gongye qiye xiafang de jixiang guiding (Several Regulations of Decentralizing Industrial Enterprises, 关于工业企业下放的几项规定). Beijing: The State Council of the People’s Republic of China. State Council of the People’s Republic of China. (1970). Guanyu guowuyuan gonye jiaotong gebu zhishu qiye xiafang difang guanli de tongzyi (cao’an) (Notice of Decentralizing Subordinate Enterprises for Local Government Management from the Ministry of Industry and Transport of the State Council of the People’s Republic of China, 关于国务院工业交通各部直属企业下放地方管理的 通知(草案)). Beijing: State Council of the People’s Republic of China. State Council of the People’s Republic of China and the Ministry of Finance of China. (1983). Zhuanpi caizhengbu “guanyu guoying qiye ‘li gai shui’ shixing banfa (cao’an) de baogao” (Transfer the Ministry of Finance “Report on Trial Implementation of ‘Tax for Profit’ in the State Owned Enterprises (Draft)”), ( 转批财政部《关于国营企业‘利改税’试行办法(草案)的报告》). Beijing: The State Council of the People’s Republic of China. The Eighth National Congress of the Communist Party of China. (1956). Zhongguo gongchandang di baci quanguo daibiao dahui di yici huiyi jueyi (Congress Resolution in the Eighth National Congress of the Communist Party of the People’s Republic of China, 中国共产党第八次全国代表大会第一次会 议决议). The First Plenary Session of the Eighth Central Committee of the Communist Party of China. Beijing: The Eighth National Congress of the Communist Party of China. Tian, G. (2000). Property Rights and the Nature of Chinese Collective Enterprises. Journal of Comparative Economics, 28(2), 247–268. Tian, G. (2001). A Theory of Ownership Arrangements and Smooth Transition. Journal of Institutional and Theoretical Economics, 157(3), 380–412.

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Tullock, G. (1967).The Welfare Costs of Tariffs, Monopolies and Theft. Western Economic Journal, 5, 224-232. Wen, T. (2003). Bange shiji de nongcun zhidu bianqian (The Rural Institutional Changes in the Past Half Century, 半个世纪的农村制度变迁). Northern Economy, 8, 14–18. Wu, X. (2010). Da baiju II (Great Losing Battle, 大败局II). Hangzhou: Zhejiang People’s Publishing House. Yao, X., & Sheng, L. (2002). Xiangzhen qiye he guoyou qiye jingji xiaolv chayi de renli ziben chanquan fenxi (An Analysis of the Different Economic Efficiency between State-owned Enterprise and Township Enterprise Based on the Property Rights of Human Capital, 乡镇企业和国有企业经济效率 差异的人力资本产权分析). Economic Research Journal, 3(61-68), 95. Zhou, Q. (1997). ‘Kongzhiquan huibao’ he ‘qiyejia kongzhi de qiye’— ‘Gongyouzhi jingji’ zhong qiyejia renli ziben chanquan de anli yanjiu (‘Control Rights Rewards’ and ‘Firms Controlled by Entrepreneurs’—The Human Capital Ownership of Entrepreneurs in ‘Non-Private Economy’, “控制权回报”和“企业家控制的企业”—“公有制经济”中企业家人力 资本产权的案例研究). Economic Research Journal, 5, 31–42. Zhou, Q. (2002). Chanquan yu zhidu bianqian: Zhongguo gaige de jingyan yanjiu (Property Rights and Institutional Transformation: The Chinese Experiences, 产 权与制度变迁). Beijing: Social Science Literature Press.

5 The Fall and Rise of State-Owned Enterprises (I): The Dual-Track Price System

5.1 Introduction Since the time permission was given to establish private corporations in 1985, China’s economy has consisted of three distinct domestic economic entities: state-owned enterprises (SOEs), collectively owned enterprises (COEs) and ‘other enterprises’,1 of which privately owned firms constitute the main body. During the first twenty years of reform (1978–1997), COEs, and later the private sector, encroached on the economic share of SOEs. Until the mid-1990s, these three types of ownership each made up about a third of the Chinese industry (i.e., accounted for about one-third of national industrial output). With the rapid privatization of 1996–1997, collective enterprises quickly vanished, while the share of the private sector grew rapidly. By 2009, according to the 2010 version of China Statistical Yearbook, private sector output had reached three quarters of the total economic output of Chinese industry. At the same time, the average firm size and the profit level of the state sector also increased rapidly (see Fig. 5.1). Thus, in the first ten years of the twenty-first century there was a double boom, of the private and the state sectors. This chapter focuses on changes in the © The Author(s) 2017 C. Jin, An Economic Analysis of the Rise and Decline of Chinese Township and Village Enterprises, Palgrave Studies in Economic History, DOI 10.1007/978-3-319-59770-6_5

113

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5  The Fall and Rise of State-Owned Enterprises (I)... Scale of SOEs 1978–2008

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Fig. 5.1  Changes in SOE’s average scale of operations: output and output growth rate. Date source: China Statistical Yearbook (zhongguo tongji nianjian, 中国统计 年鉴), various years

relationships between China’s three major economic entities—SOEs, COEs and the private sector—which were basically caused by the state’s evolving policies. We argue that the need to reform SOEs is the most important factor driving the changes in economic policy in the later 1990s (Zhao 1999) and early 2000s. From this premise, the relationship between SOEs and other sectors may be regarded as the central issue in the Chinese economy, both in the past thirty years and in the foreseeable future. When discussing the market environment of the non-­state-­owned sector (incl. TVEs), we must first take into consideration the principal factor that shaped and is still shaping China’s economic environment: the state sector and the state that lies behind it. The issues with which this chapter is concerned are as follows: (a) the Chinese government’s SOE restructuring policies (also known more generally as SOE reform) under the impact of post-1978 reform initiatives; (b) changes in the state sector during the past thirty years of economic reform; (c) the economic and political factors that compelled the state to reform SOEs.

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5.2 T  he Dual-Track System: The Pre-1998 Economy and SOEs 5.2.1 The Origin of the Dual-Track System When China decided to embrace economic reform in 1978, one of the first things the state did was to start reforming SOEs. This reform lasted for nearly 20  years and was initially based on the Chinese notion of fangquan rangli, or the ‘decentralization of power and transfer of profits’ (fangquan rangli). Inherent in the core concept of fangquan rangli was recognition of the need to give greater autonomy to lower-level planners (governments), and directly reward—in material, economic terms—both lower-level planners and producers who achieved an output greater than the targeted level contained in the central/local government’s economic plan. This policy was a very effective way of addressing a major weakness of China’s central planning system: namely, that in the absence of effective economic incentives under central planning, SOEs had often failed to fulfil their planned output targets. As a result of such deficiencies, the central planner had faced two—partly, but not wholly related—types of shortage. The first was a widespread shortage of products, caused by underperforming SOEs that lacked proper incentives; the second reflected the ‘Cask Effect,2 and was caused by insufficient production inputs. To be more exact, the second type of shortage may be considered to have been the result of insufficient information, although even if lower-level planners had complete information about a shortage, they still did not have sufficient means to source input and increase output. Accordingly, in a society in which the main economic body is a central planning economy, decentralization reform, such as fangquan rangli, promised to promote output growth in enterprises and thereby help resolve output shortages; in addition, it provided lower-level planners with a more effective means of rectifying the insufficient output caused by the Cask Effect. The first attempt at enterprise reform in China took place in Sichuan Province in 1978. Initially, only six enterprises were involved, but following the positive outcome of the initiative, the state allowed more enterprises (mostly SOEs, but also a few COEs) to

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­ articipate. SOE reform in this early phase was dramatically fast, and p within little more than a year more than two-thirds of all firms throughout the Chinese economy had experienced reform. In the 1978–1979 reform, financial compensation for extra output generated by enterprises was the origin of the dual-track price system in the SOE sector. These extra payments caused the accounting prices of goods produced ‘within plan’ and those produced outside the plan (i.e., above-quota production) to diverge. In the early 1980s, the state made widespread use of price incentives in order to increase industrial output. For instance, in the petroleum industry, the state’s ‘within plan’ purchase price of crude oil was RMB 100 yuan/ton, whereas it paid 644 yuan/ton for above-quota output (Cheng 2006). Besides the stimulus of developments taking place in the SOE sector, the market-oriented reform of consumer goods also facilitated the emergence of the dual-track price system. Starting in 1977, private sellers had been allowed to participate in the retail industry,3 and a year later, China began to permit direct consumer goods transactions between retailers and manufacturers without going through the central planning and state-owned wholesale systems. In 1984, China officially endorsed the dual-track price system (State Council 1984a, 1984b), whereby SOEs were allowed to sell products within a 20 per cent floating price range on the base of the planning price. In terms of functionality, the dual-track price system had two main purposes: first (as mentioned above), it offered a framework in which the problem of output shortages could be addressed; second, it provided a degree of protection to SOEs by preventing input prices from rising to too high a level through the mitigating effect of planning prices (the plan track). In an economy in which production and distribution decisions are made within a system of central planning, the relationships between product price and costs, as well as between supply and demand, are of course not as close as they would be in a market economy. Under central planning, price tags are used essentially in order to ‘balance the books’— that is, to maintain a balance on the central planner’s balance sheet. When the dual-track price system was introduced into the SOE sector, book-­ keeping profits immediately fell, causing a deficit within the sector in the early 1980s. In the face of this emerging problem, the central planner was faced with two alternatives: either he could turn to the Treasury in order

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to compensate for the deficit, or he could grant SOEs the right to price their own products. The choice that was made in the early 1980s was to grant SOEs the right to price a certain category of products—namely, those products outside the central plan; and to cease the previous practice whereby SOEs were required to remit all their profits (while making up for the resultant shortfall by seeking monetary income from SOEs through the imposition of an income tax). In choosing this option, the Chinese government was motivated by two factors. First, it was aiming at deficit reduction. Enterprises that priced their own products could at least compensate part of the book loss caused by the new economic incentives as the dual-price schedules were extended to the consumer market and products were sold to consumers at higher prices. Meanwhile, during the late 1970s to early 1980s, as SOEs got the right to use some of their revenue freely, they spent a significant share of their profits on employee bonuses and other benefits, which had exacerbated the SOE deficit. To stop the increasing deficit the state tried to reduce SOE’s control over gross profit by introducing a high income tax rate. Second, the planning-track prices promised to help stabilize the running costs of the central planning system. As most transactions within the SOE sector still took place under the central planning system, when planning-track prices remained stable, SOEs, under the supervision of the central planners, had fewer problems in controlling inputs cost (thanks to the still relatively low level of plan track prices), which was crucial to keeping the SOE deficit under control. These two goals of the state impinged on long run policymaking processes, and generated two independent—though not wholly unrelated— impacts on Chinese economic reform. First, because the government consistently believed that SOEs as a whole would be able to attain a permanently profitable status, in the following two decades it formulated and implemented its economic reforms in the expectation that the SOE sector could be maintained intact. Second, in the early period of China’s economic reforms, changes in economic incentives led to a huge increase in SOE output, which effectively made the central planner path dependent on the dual-track price system, and prevented the abolition of that system as output continued to increase.

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5.2.2 The Nature of the Dual-Track System At the time of China’s early reform in the late 1970s and during the 1980s, about 80 per cent of GDP was produced in the state sector, and most of the rest was generated in the COE sector under the control of lower-level planners. The dual-track system was designed to act as an incentive to producers, with regard to the extent of the difference in prices of goods produced inside and outside the central plan. However, with the rise of township and village enterprises (TVEs)—also a type of COE, although (see Chap. 2) completely outside the control of the central planning system—and the growth of private enterprises, the state sector had to give careful consideration to its product pricing decisions. Thus, products—especially those sold to non-SOE sectors—were priced in accordance with the forces of demand and supply, at the so-called market price. From 1983, the non-state sector grew rapidly. Between 1983 and 1989, output of this sector expanded by 600 per cent, while output in the state sector increased by only 185 per cent during the same period. Under the impact of these emerging trends, the dynamics of relations between non-state sectors—especially TVEs, which by 1986 had already come to contribute 86 per cent of total output of the entire non-state sector—and the state sector began to change. First, in a number of competitive product markets, the non-state sector seized an absolute advantage over the state sector (Liu and Shi 2010). For instance, faced with competition from the more efficient non-state sector (mostly TVEs located in southeastern coastal provinces), state-owned textile enterprises, which previously had been the most important and profitable industrial sector in the economy and which had contributed greatly to SOE prosperity in the early and middle 1980s, began to suffer large-scale financial losses. In general, increasingly fierce competition of this kind was the direct cause of the rapid deterioration of SOE finances from the late 1980s into early 1990s. Second, in some non-competitive goods markets, the non-state sector was the source of major profits for the state sector, since non-state firms were forced to purchase industrial inputs from SOEs at prices much higher than those ‘within plan’. Under the dual-track price system, the

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non-state sector purchased products from SOEs at the ‘market-track’ price; as a result, the state sector was able to take a share of the surplus created by the rapid growth of the non-state sector. For example, in the late 1980s and early 1990s, in order to fulfil demand from non-SOEs, the steel industry—an industry still dominated by SOEs—sought approval from the state for plans to expand their production capacity (this, in turn, requiring large-scale increases in fixed assets investment). From the 1980s to the 1990s, most Chinese economic sectors pursued their activities in two spheres on the basis of the dual-track system. The first sphere was the state sector, which operated on the basis of the planned track, and had no contact with market forces until it encountered consumers in the final product market; the second part was the non-state sector, which was running ‘on’ the market track in terms of securing inputs and producing and selling its output. As the term ‘dual-­ track’ suggests, the division into two spheres derived wholly from price differences—in turn, reflecting SOEs’ monopoly of most key industrial inputs. After the implementation of the early 1980s reform policy, the state did not immediately lift existing market regulations. The consumer goods market for light industrial products was the first to be deregulated. This was followed by partial deregulation of the labour market, access to which was initially given to TVEs, and subsequently (though gradually) to the entire private sector. However, until reforms at the end of the 1990s (1998), SOEs alone continued to have privileged access to most industrial input markets. Through the whole of the 1980s and most of the 1990s, the economic connection between SOEs and the operation of the dual-track pricing system served to facilitate redistribution within the SOE sector. For instance, in the early 1980s, 98 per cent of the output of Bao Steel, the largest company in China’s steel industry, was sold via the planning track. Before its abandonment, the dual-track price system concealed the fact that some SOEs were potentially very profitable (as more recent developments have demonstrated). If some SOEs had been allowed to sell at the market-track prices, they would have achieved high revenues, but the dual-track system shifted these potential profits to SOEs that could secure cheap inputs via the plan-track and were closer to the final market—usually, light industrial enterprises.

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Because of the redistributive function of the dual-track price system, efficiency losses of some SOEs that directly competed with the non-state sector were underestimated or concealed. On the other hand, SOEs that were unable to benefit from or take advantage of the dual-track system, but still had to compete with the non-state sector, showed up real efficiency losses that were reflected in their financial statements and accounts. For example, from the end of the 1980s the state-owned textile enterprises suffered massive losses, as large numbers of TVEs established themselves in this industry. In the first decade of reform the dual-track price system had three outcomes: (a) the incentivizing impact of the system held address SOEs’ output shortages; (b) in most competitive markets, SOEs’ efficiency and productivity were below that of the non-state sector; (c) the dual-track price system showed itself capable of significantly increasing the economic returns of SOEs operating in non-­ competitive markets.

5.2.3 P  roblems with the Dual-Track Price System: 1992 and the Factors Leading to the 1998 SOE Reform The steady write-off of SOEs pushed the state to embark on further reform in 1992–1993. From the mid-1980s until 1991, between one sixth and one quarter of the Chinese government’s fiscal revenue was spent in subsidies to cover annual SOE losses. Nor did this include various hidden subsidies (e.g., in the form of tax reductions or reductions in the interest on bank loans) or subsidies given to state-owned food industries (e.g., the Grain Bureau and its subsidiaries). The 1992–1993 reform continued to follow the logic of fangquan rangli, which remained an important guiding principle, and gave SOE managers more administrative power. The effect of this reform was to separate most SOEs completely from the state’s fiscal system. This was subsequently legally enshrined in the Corporation Law (1993).

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The main purpose of the 1992–1993 reform was to address the soft budget constraint problem of the SOEs, by making the budget constraint harder. Nevertheless, when the separation of SOEs from the state took place, most of those enterprises still had large-scale funding requirements. As a result, most SOEs sought to obtain commercial bank loans, although a smaller number turned to the capital market (in so doing, bearing a higher cost burden). After the People’s Bank of China (PBC) was restructured as China’s Central Bank (1984) and until the Asian financial crisis in 1997, China had four major state-owned commercial banks4 which together with other ‘policy’ banks5 accounted for about 80 per cent of China’s bank lending. In making loans, state-owned banks showed a special preference for SOEs. For instance, in 1997, in addition to mortgage-backed fixed asset loans, total lending by state-owned banks to SOEs totalled 3430  billion RMB.  In the same year, the SOE sector as a whole took out 3650 billion RMB in loans. In other words, 94 per cent of all credit extended to SOEs came from state-owned banks. In contrast, total bank lending to non-state enterprises in 1997 was 1063 billion (about 30 per cent of the corresponding figure to SOEs), although SOEs generated an output valued at only 30 per cent of that of non-state manufacturing enterprises (excluding mining and utility companies). After the removal of the soft budget constraint, which reflected the close link between the state’s fiscal authorities and SOEs, state-owned banks effectively became the source of a budget constraint which continued to be soft. Three main reasons pushed state-owned banks to grant large loans to inefficient SOEs. First, before the 1998 bank reform, there was dual management of local branches of state-owned banks: that is, both local government and parent banks had the right to offer administrative guidance to local branches. Meanwhile, local government was the direct legal owner of local SOEs, and was therefore always inclined to direct loans to these enterprises. Second, before the twenty-first century the Chinese banking system discriminated against non-state enterprises, especially those in the private sector. Banking practice required private enterprises to provide some kind of guarantee in order to secure a loan, whereas SOEs were able to obtain fiduciary loans from banks. Third, the corporate governance structure of local state-owned banks

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was even weaker than that of most SOEs. Hard budget restrictions were entirely lacking: the extension of loans and the management of banks’ revenues were separated by different accounting procedures, making it difficult to track bad loans to the original decision. As a result of this deficient corporate governance structure, in making their loan decision, the managers of local banks extended preferential treatment to SOEs, often freely and uncritically meeting their credit demands. Lending procedures of this kind (unlike private company loans) did not require a complicated audit process and readily served to enlarge the book value of bank assets. Policymakers in the 1992–1993 reform placed their hopes for an increase in SOE efficiency on two possibilities. The first was that given greater autonomy, SOEs could create a similar governance structure to that of TVEs (see State Council 19926). If such improvements materialized, the state’s expectation was that SOE efficiency could be enhanced without massive privatization having to take place. In the event, this expectation was not realized. This may be attributed to policymakers’ failure to take into account the difference in ownership structure between SOEs and TVEs, especially in the fundamental respect that local SOEs were legally owned by county- or city-level local government branches, and to recognize that the relationship between them was completely different from the relationship between TVEs and township or lower- level government branches. The second possibility lays in the state’s belief, or hope, that as SOE output continued to expand, the increase in SOE income would compensate for any efficiency loss. In order to facilitate this outcome, in 1992 the state removed most price controls and regulations (most of these relating to consumer goods sold by SOEs). However, this action was based on the belief that the scale of the non-state sector (which was in competition with SOEs) was very small and that the state sector would therefore quickly be able to increase its income by selling its expanded output at market prices. But the underlying assumption was barely applicable to conditions in 1992, when the share of total industrial output contributed by SOEs had fallen to just 51 per cent, and when non-state enterprises were almost all concentrated in light-industrial production. In short, the

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forces of market competition weighed strongly against any attempt by SOEs to increase their prices. In contrast to the reforms of the 1980s, the 1992–1993 reform did not enhance SOEs’ prosperity. In the following years, the share of SOEs in national industrial output (except in mining and utility companies) declined by more than 10 per cent each year. Between 1991 and 1998, SOEs’ share of national output fell from 56 per cent to less than 27 per cent. The low operating efficiency of SOEs was also reflected in the many large non-performing loans that characterized the banking system. At the onset of the Asian financial crisis, the Chinese government discovered that the scale of bad loans accumulated by state-owned banks was sufficient to jeopardize the security of China’s entire financial system. According to statistics issued by the People’s Bank, in 1997 state-owned banks’ non-­ performing loans made up a quarter of China’s total bank lending, or the equivalent of 30 per cent of GDP in the same year. The emergency policy response of the government was to establish four asset management companies: the China Huarong Asset Management Corporation (CHAMC), China Great Wall Asset Management Corporation (CGWAMC), China Cinda Asset Management Corporation (CCAMC) and China Orient Asset Management Corporation (COAMC). Together, these took over 1400  billion RMB of non-performing loans from state-owned banks. Meanwhile, the Chinese government provided 270 billion RMB as supplementary capital funds to the four major state-owned banks through public finance by issuing 30-year special national bonds. The four major banks received another 570 billion RMB in loans from the Central Bank, and 820 billion RMB Treasury-guaranteed bonds were issued by the four asset management companies. In the second round of non-performing loan write-offs (2003–2005), the Chinese government again allowed state-owned banks to eliminate 780 billion RMB in bad loans and added US$ 60 billion in capital funds. Since 1998, the Chinese government has abandoned its attempt to improve the SOE sector as a whole and instead has focused on the restructuring of the state sector and state sector institutions—not least, by embracing corporatization.

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5.3 S  OEs After 1998: Monopoly and Primogeniture of the State 5.3.1 Restructuring SOEs: Zhua Da Fang Xiao At the heart of the SOE reforms which started in 1998 was the principle of zhua da fang xiao (‘invigorate large [state-owned] enterprises, while relaxing control over the small ones’—literally ‘grasp the large, let go the small’, 抓大放小). The origins of this reform initiative can actually be found in events that took place before the Asian financial crisis. That is, since the 1992–1993 SOE reform, China had been encouraging the privatization of some small-scale SOEs and COEs in selected areas, especially in Shandong Province. Indeed, before the 1997–1998 crisis, privatization was already proceeding quite rapidly, with as many as 22 per cent of small-scale SOEs having been privatized (Zhang and Yuan 2008). In addition to privatization, the Chinese government had also encouraged unprofitable medium- or small-scale SOEs to engage in mergers or face up to bankruptcy. After the crisis, however, the pace of SOE privatization and restructuring accelerated. Between 1996 and 1999, the number of state-owned and state-­ holding enterprises fell from 113,800 to 50,700; during the same period, more than half of SOEs were sold or declared bankruptcy (since the State Council systematically allows SOEs to declare bankruptcy (State Council 1994)). Meanwhile, the average annual output (GVO) per SOE rose from 32 to 70 million RMB. On the whole, the impact of the implementation of zhua da fang xiao was quickly to increase the average scale of SOEs output. However, in implementing the 1998 reform policy, the scale of SOEs was not the only determinant of whether to retain or sell an enterprise. For instance, in Northeast China (Liaoning Jilin and Heilongjiang provinces) a large number of SOEs of above-average size declared bankruptcy and were sold. As a result of large-scale layoffs of workers, in just three years (between 1998 and 2000), some 22 million SOE employees lost their jobs. About a quarter of the newly unemployed were in Northeast China, thanks to the bankruptcy of so many large scale SOEs in what had been the traditional heartland of China’s ­state-­owned industry. It should be noted that enterprises whose activities

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were directed towards military purposes were largely unaffected by the 1998 initiative, and non-economic factors meant that their status in the SOE sector remained unchanged. These apart, two major factors may be said to have shaped SOE restructuring. The first of these was the policy of zheng qi tuo gou (‘separate government functions from enterprise management’, 政企脱钩), introduced in 1998. In accordance with this principle, in 1998 the State Council cut the number of its ministerial-level institutions from 40 to 29; at the same time, it abolished most of its ‘professional departments’, (zhuanye bu, 专 业部, i.e., government departments that previously had been in charge of certain industries, such as the Ministry of Light Industry). As a result of these changes, SOEs previously owned and managed directly by professional departments were disposed of in two ways: some were kept under the administration of central government, although they were now officially part of the Ministry of Finance (Treasury); others were reallocated to local government according to their location and transformed into local SOEs. All SOEs that had been directly managed by these professional departments before 1998 were large scale (with a workforce in excess of 2000 employees), or medium scale (between 300 and 2000 employees). The second shaping influence was the level of industrial profitability achieved in the years immediately before the 1998 reform. For instance, during the 1998 reform, with international and domestic prices for resources such as coal and iron ore at comparatively low levels, and with output of SOEs in these industries depressed because of insufficient demand in the machinery market, a large number of coal, mining and machinery enterprises were transferred to local (city-level) governments, many of which were merged or privatized or simply went bankrupt. Heavy industries in Northeast China suffered especially badly during this process, as did state-owned textile enterprises throughout the country, which were forced to reduce their production capacity. The 1998 reform was undoubtedly a watershed in China’s post-1949 industrial history. It was the first time that action taken by the state resulted in a contraction in the scale of the state sector and it demonstrated the government’s recognition that SOEs would no longer constitute the ­largest sector in China’s economy. The reason for this fundamental change in direction is not difficult to find: since the late 1980s, total losses by

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SOEs were far in excess of the financial capacity of the government. The existence of SOEs on such a scale was simply no longer affordable. At the same time, however, those responsible for the 1998 reform were aware that sufficiently large SOEs in some specific industries had the potential to remain profitable, or become even more profitable. Accordingly, at the heart of the 1998 reform was a determination to eliminate the less profitable part of the SOE sector. It is no exaggeration to say that by restructuring its SOE sector, the 1998 reform reshaped the entire Chinese economy. First, the reform created a state sector in which almost all its constituent parts were large (in some cases, super-large) SOEs. Meanwhile, through a process of rapid privatization, almost all COEs—mainly TVEs—and small-scale SOEs were sold, thereby consolidating a private sector that was defined in terms of an agglomeration of medium and small-scale enterprises. Second, for the first time since the early 1950s, private firms replaced SOEs to assume a position of primacy in the economy. The industrial output share of private sector exceeded 50 per cent in 1998, and reached 70 per cent in 2005. Third, the 1998 reform led to the virtual disappearance of COEs. Since 1984, COEs had consistently accounted for about one third of Chinese GDP. Thanks to the rapid development of TVEs, the corresponding figure had grown to 40 per cent by the beginning of the 1990s, and thereafter it remained at this level. After 1998, however, the share of COEs rapidly declined to less than 10 per cent, and by 2008 it had fallen even further to less than 1.5 per cent. Fourth, the result of SOEs’ withdrawal from downstream industries is that their presence became more concentrated in upstream industries—their downstream position meanwhile being taken by private firms. After the 1992 reform, there also emerged very distinct differences in the profitability of downstream and the upstream industries, to the advantage of the latter, almost all of which were highly competitive.

5.3.2 T  he Rise of the Power of the Centre and  Bank Reform The next—2002–2003—reform was essentially a continuation of the 1998 reform. This was apparent from two perspectives. First, the central government further extended its administrative authority over SOEs.

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After the 1998 SOE reform, central government dispatched specially appointed commissioners to carry out inspections of enterprises, while the Central Work Committee for Large Enterprises (CWCLE) was given the responsibility of governing large SOEs. The loyalty of the inspection commissioners was to the State Council, not to any local authority, and they were put in charge of monitoring large SOEs. The CWCLEs responsibility extended to making important management appointments and dismissals. In the 2002–2003 reform, these two tasks were integrated into the ‘job description’ of the newly established State-owned Assets Supervision and Administration Commission of the State Council (SASAC). SASAC took over ownership of SOEs (except for their financial departments) from the Ministry of Finance, and also replaced local governments in the exercise of administrative power over state-owned assets of all local SOEs. Thus, it became one of the most powerful bureaucracies, disposing of huge economic resources, in China. Second, the number of SOEs further declined, while the average scale of the remaining enterprises increased correspondingly. SASAC identified 196 super-large SOEs as central enterprises under its direct governance. The number of these central enterprises contracted in the following years, but by 2009 the value of their total assets had reached 21,058 billion RMB in 2009 (Unirule Institute of Economics 2011). Although the number of SOEs throughout the country fell from 50,700 (1999) to 21,300 in 2008, their average annual output increased from 70 million RMB to 676 million RMB during the same period. At the same time as reforming SOEs, in 1998 China also began to reform its banking system. This process continued until the establishment of the China Banking Regulatory Commission (CBRC) and the Central Huijin Investment Ltd (CHIL),7 and later the launching of ­state-­owned banks’ IPOs (Initial Public Offerings). Banking reform was carried out in two phases: in 1998–1999 and in 2003. The first stage of financial reform, starting in 1998, changed China’s banking system in two critical ways. First, links between branches of state-­ owned banks and local government became much more tenuous. The Central Bank merged its provincial branches into nine regional branches, eliminating any influence that provincial government could bring to bear over the Central Bank’s supervision of state-owned banks. Meanwhile,

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in the knowledge that the Central Bank was not capable of supervising commercial banks, the state established a new institution—the Financial Work Committee of the CCP Central Committee (also known as the Central Financial Work Commission or CFWC)—which was directly monitored by the State Council. This organization was independent of the Central Bank. Indeed, its authority exceeded that of the Central Bank and local government, its powers extending to supervision of the professional ethics of the Central Bank, state-owned banks and other financial institutions. Between 1998 and 2003, the CFWC was the ultimate arbiter of China’s financial system, and it exercised supervisory rights over banks, insurance companies and investment banks. Second, the state pressed banks to revalue the risk of all their existing loans and other assets, and introduced a new strict risk control mechanism. For all existing loans from state-owned banks, the individuals who had made the lending decision were made to shoulder the responsibility for their non-payment. This was eventually to develop into lifetime individual responsibility (Ministry of Finance and the People’s Bank of China 2004). When a loan was found to be non-performing, state-owned banks were required to take legal action against the relevant responsible person. For new loan applications, the Central Bank ordered commercial banks to use departments independent of the loan department to carry out ex ante risk assessments prior to making any lending decision (The People’s Bank of China 1999). The 2003 reform of the banking industry maintained the momentum of the 1998 reform. First of all the temporary status of the CFWC was recognized in its replacement by the China Banking Regulatory Commission (CBRC). The 2003 reform also redefined the PBC’s role, leaving the PBC to focus on monetary policy while the CBRC took charge of daily bank supervision. Although the CBRC is not as powerful as the previous CFWC (which in fact was an organ of the CCP), it has a large supervisory system inherited from PBC which has enabled it to undertake branch-by-branch monitoring of each commercial bank. Second, Central Huijin Investment Ltd (CHIL), established in 2003, took over all shares of state-owned banks previously held by the Ministry of Finance, and, following the IPOs of major commercial banks, rapidly became their largest shareholder. CHIL was a sub-branch of the Ministry

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of Finance, and in 2007, was acquired by China’s sovereign wealth fund, the China Investment Corporation (CIC); however, the de facto and direct controller of CHIL (and later the CIC) was the State Council.

5.3.3 Impacts of 1998–2003 SOE Reform Before the 1998–2003 reform, the Chinese government faced two distinct, but related problems: the first was that the SOE sector was rapidly losing its competitive strength; second, that the financial sector was carrying an unacceptable level of non-performing loans. Thus, the initial purpose of the 1998–2003 reform was to address these problems and prevent any further deterioration in conditions. First, the 1998 reform greatly reduced the scale of the SOE sector in order to eliminate SOEs unable to compete with the non-state sector in competitive markets. By so doing, the state was able to improve the profitability of SOE assets and thereby minimize SOEs’ requests for immediate financial aid. Second, the state tried to reduce the risk of bank default through a massive injection of bank capital and by strengthening state-owned banks’ risk control mechanisms. The strict risk management carried out in banks after 1998 was particularly successful in keeping non-performing enterprises from obtaining loans from banks and thereby reduced the potential for the creation of more bad debts. As a result of reforms implemented between 1998 and 2000, the accumulation of further bad loans within SOEs was halted. Even so, the state did not cease its restructuring work among SOEs and in the banking system.8 The effect of such restructuring was to transform the SOE sector into a new form of economic organization that was totally different from SOEs under the central planning economy. It is noteworthy that after 2000, and especially since the 2003 reform, in 2007 the industrial value-­ output share of SOEs decreased from 30 per cent to less than 25 per cent, while the average annual growth rate of total asset value of SOEs reached more than 15 per cent in the same year—and in the case of central enterprises, 18 per cent: from 2005 to 2010, the total value of central enterprise assets rose from 10,500 to 24,300 billion RMB, an average annual rate of increase of 18.2 per cent (State Council Information Office, 22

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February 2011 Press Conference). This buoyant record was undoubtedly helped by the new relationship that had emerged between banks and SOEs. The banking sector continued to provide a large portion of SOE loans. When the share of SOE sector in the national industrial output and GDP continued to decline, the level of loans from banks to SOEs did not reflect this trend. For example, when the industrial output share of SOEs fell from 38.2 per cent in 2000 to 35.1 per cent in 2001, SOEs’ share of total enterprise loans declined by less than one percentage point (from 71.4 per cent to 70.7 per cent); and when SOE’s share continued to drop to 32.6 per cent in 2002, 70.1 per cent of total bank enterprise loans were still being made to SOEs (see Fig. 5.2). We may infer that following the completion of the 1998–2003 reform initiatives, the relationship between banks and SOEs was further consolidated. Second, in the wake of the reforms the gap between SOE and non-­ SOE loans and the contribution of those loans to output widened. Since banks preferred to grant loans to the SOE sector, the output of the non-­ SOE sector received increasingly less support from the banking system: in 2000, every 4.47 RMB non-SOE output could get a 1 RMB bank loan 













                  

SOE Output Share (%)

SOE Loan Share (%)

Fig. 5.2  SOE output and loans. Date source: China Statistical Yearbook (zhongguo tongji nianjian, 中国统计年鉴) Annual publication, various years

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compared to 1.11:1 in the SOE sector; in 2008, the gap had widened to 14.59 and 2.50. Banks’ preference for lending to SOEs was driven by state enterprises’ asset characteristics. First, SOEs undertook large amounts of fixed asset investments, which after 2000 consistently accounted for no less—and often more—than half of China’s annual total fixed asset investments. Since a large proportion of China’s fixed asset investments have been in the housing sector, the ratio of SOE fixed assets investment in the industrial sector was considerably higher than the figure given above. The large proportion of fixed assets investment gave banks, as lenders, greater security. Second, it is clear that the average profitability of SOEs was higher than that of non-SOEs. The point was made earlier that most SOEs were located in upstream industries, and their gross profit rates have generally been much higher than those of non-SOEs. After 2000, the average gross profit rate in upstream industries was more than 20 per cent, compared with 5 per cent in downstream industries (Gao et al. 2005; Gao 2006). The inference is that in order to achieve the same gross profit, downstream industries must generate four or five times the output of their upstream counterparts. Interestingly, there is a close correlation between this figure and our previous calculation of the proportion of bank loans granted to SOEs and non-SOEs. Although it is almost impossible to calculate the total scale of SOE and non-SOE assets, two sets of data can assist in estimating the SOE to non-SOE asset ratio. First, viewed from the perspective of external fund sources, after 2000, SOE loans consistently accounted for two-thirds of China’s total enterprise loans, compared with three quarters before 2000. Second, in terms of output, after 2004 the output of the SOE sector stabilized at a quarter of total industrial output, down from a third during 1995–2001. In short, after 2000 SOEs secured more external funding through bank loans than non-SOEs, and probably also enjoyed more internal funding (gross profits of SOEs cannot have been less than those of non-SOEs, and SOEs should therefore have had access to sufficient funding for investment purposes). Considering the fact that since 2003, even excluding housing sector investment, China’s fixed asset investment has still exceeded 30 per cent of GDP (see Fig. 5.3), it is reasonable to conclude that the SOE sector had a leading role in fixed asset investment.

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Fig. 5.3  Share of China’s fixed assets investment in GDP.  Date source: China Statistical Yearbook (zhongguo tongji nianjian, 中国统计年鉴). Annual publication, various years

5.3.4 Impacts of Banking Industry Reform to TVEs As we discussed in previous sections, the 1998–2003 SOE, and banking industry reform (banking sector reform is also a part of SOE reform), has generated two major effects. First, the banking sector reform tightened major Chinese banks’—all of them are state-owned or state controlled— risk control. The loan responsibility system introduced by the central government (see Chap. 3) together with measures taken by the central to fasten SOE’s corporate governance quality (Wu et al. 1999) amplified the bank sector’s aspirations to get risk-free, high quality assets. Second, the 1998–2003 SOE reform greatly increased the assets quality of remaining SOEs. The SOE reform not only wiped off low quality assets from the state sector’s balance sheet, but also enlarged the figures through endowing large-scale SOEs with monopoly power in key upstream markets. The outcome of these two reforms—or indeed one, as the CCP views the banking industry as a crucial part of the state sector—has double twisted the lending activities on the credit market at two levels. At the bank-enterprise level, as bank lending became more concentrate in SOE sector, other lending—such as the bank credit TVEs could obtain—has been diluted. TVEs was able to borrow near half of China’s total bank loan—by the end of 1997, TVEs account 54 per cent of China’s total bank loan balance, however, thereafter the TVE loan increases at a

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significant below average speed (Economic Daily 2001). As a result, non-­ SOEs (including all TVEs) only contribute around 30 per cent of China’s loan balance since 2004; meanwhile, they produce 70 per cent of China’s industrial output. From the view of loan–output ratio, there is a serious mismatch in Chinese banks’ loan distribution. But if we consider the fact that the profitability of SOEs’ firm assets is almost four times of the non-SOEs’ figure, this ratio becomes a natural outcome of bank’s rational calculation (see Sect. 3.3). At the enterprise (SOEs)-enterprise (TVEs) level, the insufficient loan has caused two major problems. First, the limited availability of bank loans has already become a road-­ block to hold back TVE’s scale economy, and, therefore, productivity. There is clear evidence which shows that the insufficient loan has a significant effect in slowing down the speed of assets formation in the non-SOE sector (Unirule Institute of Economics 2011). Due to the fact that TVEs have less access to financial institutions than other SMEs in urban sector, this effect brings TVEs more obstacles. The average TVE’s employee number did not grow in ten years since banking industry reform: it was 6.26 in 1998, and dropped to 6.23 in 2001 and increased a bit to 6.31 in 2007; during the same time period, the average SOE employee number has grown 118 per cent (Sonobe and Otsuka (2003) argue that this is mainly caused by privatization). Speaking from output per capita, the TVE sector dropped from two times of SOE sector, to 82 per cent of average SOE output per capita. Thus, TVEs experienced a comparatively (to SOEs) decrease in both scale and productivity since 1998, and the major cause was insufficient capital input brought by the 1998–2003 banking sector reform. Second, it has increased TVE’s financial costs—including a social cost to some certain regions. As Jiang (2000) observed, nationwide, TVEs were relying more and more on business credit—which means receivable accounts—rather than bank loans. The increased average accounts receivable could solve the shortage of formal bank loans in short term, but in long run it also adds the risk of chain-reaction bankruptcy. And consider a fact that Chinese TVEs within a same industry or industry chain are usually geographically agglomerated together, the increased chain debt actually made the whole region’s economy more vulnerable.

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There is another form of alternative finance, for example, such as Zhang et al. (2013) discussed the informal lending in Wenzhou—where private TVEs and other SMEs concentrate. The informal finance institutions again have negative effects besides their positive functions: (a) due to the asymmetric information between the lender and borrower, informal finance needs extra cost to secure the repayment, thus the interest rate will be significantly higher than bank lending (Ke 2002; Zhou and Bao 2013). (b) the informal finance in China is usually small scale, physically fragmented, so in long run it is not only cost inefficient, but also risky. Any macro environment change or just random events are all likely to cause informal finance to be unstable even collapse (Zhang et al. 2013). However, as Chen (2012) clarified, the major problem holding back SMEs’ (including TVEs) access to finance or other key factors markets is the incomplete SOE reform. Precisely, the 1998–2003 SOE reform created an asymmetric allocation of firm assets. On the one hand is the high revenue, almost risk-free SOE assets, and on the other hand is the low revenue, normal market risk SME assets, and the bank’s lending decision (thus loan distribution) just follows such rational lines. Chen’s suggestion was to remove the governmental protection shield—in Chen’s word ‘administrative monopolies’—and to capitalize SOEs so as to make SOEs more competitive rather than more frequently call for government intervention.

5.4 T  he Rise of SOEs: Accident or Inevitability? It is widely, if not universally, acknowledged that SOEs underwent a resurgence in the first decade of the twenty-first century. The main dispute among Chinese writers on the subject is about what has happened to their efficiency. Some believe that the improvement in their performance has derived from improvements in their efficiency (Zhang and Wang

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2004) and technical progress (Tu and Xiao 2006; Zhang 2005). Others argue that it is more a reflection of government redistributive policies or under-the-table transfer payments (Unirule Institute of Economics 2011). The former view explains the increased gross profit margin level of SOEs, but cannot explain the low returns on SOE assets. Furthermore, if SOEs can improve their efficiency by reforming the corporate governance structure, SOEs should surely have been able to achieve the same performance in competitive markets—something that has not happened (see above). If the improvement in SOEs’ performance has its origin in technical progress, then considering the large scale of asset investment by SOEs,9 the cost of the technical progress of SOEs must have been much higher than in the non-SOE sector. If, therefore, the technical progress argument is correct, we may infer that SOE’s technologies have been too expensive. The latter view can explain the low returns to SOE assets, but can hardly explain the changes in total SOE revenue. In fact before the 1998 reform, and during 1998 to 2000, if we include the funding transmitted through the banking system, the volume of monetary assistance from the state committed to the rescue of the SOE sector (including state-owned banks) took a very high ratio of China’s GDP/fiscal revenue—indeed, much more than any possible transfer payments or redistribution in the later period of SOE prosperity. In addition, SOEs commonly performed poorly from the end of the 1980s to 2000: even upstream SOEs’ financial statements before 1998 are not as strong as they became after the 2003 reform. Therefore it is worth considering the impact of previous (pre-2003) SOE reforms on SOE performance. Two fundamental problems affect the efficiency not only of SOEs, but also of almost all Chinese enterprises in the transition era. First, since the time of the dual-track price system, commodity trade between state and non-state sectors, including trade between the state-owned sector and residents, was influenced by ‘bureaucratic’ actions and behaviour. The state sector’s pricing was not all marketoriented and demand-supply based, even when goods were sold at prices under the guise of the ‘market-track’. Such transactions may have generated surpluses10 quite unrelated to any competitive market and which

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therefore could not be regarded as having resulted from market competition. Second, in the state sector, trading prices between SOEs have also not reflected competitive market conditions. Even after the abolition of the dual-track price system, the state sector continued to find ways to avoid trading of a truly competitive basis. Basically, there have been two ways in which the state sector has achieved this. One has been by pricing through bureaucratic channels, such as the National Development and Reform Commission (NDRC), or local government (for example, large SOEs have usually enjoyed preferential energy and water prices).11 The other is to integrate seller and buyer enterprises into a single enterprise, as most steel and petrochemical industry SOEs have done, thereby making it very difficult to trace the true costs by accounting methods. Under the impact of these two factors, most measurements of efficiency using priceor profit-level-based tools have been biased. Our conclusion is that we cannot therefore assess the efficiency of Chinese SOEs, or non-SOEs, simply by recourse to investigating their final financial performance. The rise of China’s SOEs poses three questions: (a) How did economic links between state and non-state sectors change during the reform? (b) How did the reform influence enterprises in (a) competitive markets, and (b) non-competitive markets? (c) What were the various impacts of the 1998–2003 SOE reform on China’s market environment, especially the market environment of those competitive products markets?

Notes 1. As defined by the National Bureau of Statistics of China. 2. Also known as Bucket Effect, means the capacity of a cask is determined by its shortest wooden board. 3. These mostly fell into the category of “sole (trading) households” (geti hu, 个体户).

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4. The Bank of China (BOC), the China Construction Bank (CCB), the Agricultural Bank of China (ABC), and the Industrial and Commercial Bank of China (ICBC). The Bank of Communications was another leading commercial bank in China. 5. Banks that had a policy remit included the Agricultural Development Bank of China (ADBC), China Development Bank (CDB), and the Export-Import Bank of China (Chexim). 6. ‘Regulation on the Transformation of Operational Mechanism of the Industrial Enterprises Owned by the Whole People’ (quanmin suoyouzhi gongye qiye zhuanhuan jingying jizhi tiaoli, 全民所有制工业企业转换 经营机制条例). 7. Both in 2003. 8. Most banks in China are de facto SOEs. 9. In fact, as with bank loans, thanks to governmental support, SOEs have also receive a lot more investment than non-SOEs in the capital market. 10. ‘Surplus’ here refers to the amount overcharged. 11. E.g. according to the State Planning Commission’s ‘Order No. 1138’ (1999), Chuantou Dianye Ltd (which produces phosphorus) enjoyed favourable energy prices until the order was finally rescinded by NDRC in 2011.

References Chen, Q. (2012). Guoqi gaige zhuanru guozi gaige (SOE Reform Once Again in the Spotlight, 国企改革转入国资改革). Caijing, 13, 80–85. Cheng, Z. (2006). Jiage gaige sanshi nian (Thirty Years of the Price Reform, 价格 改革三十年). Beijing: Chinese Market Press. Gao, S. (2006). Zai zhouqi de guaidian shang (On the Turning Point of the Cycle, 在周期的拐点上). Beijing: China Development Press. Gao, S., Luo, B., & Mo, Q. (2005). Maoyi shuncha yu tonghuo jinsuo (Trade Surplus and Deflation, 贸易顺差与通货紧缩). Beijing: EverBright Securities. Jiang, C. (2000). Xiangzhen qiye chanquan gaige de luoji (The Logic of Township and Village Enterprises’ Property Rights Reform, 乡镇企业产权 改革的逻辑). Economic Research Journal, 10, 23–29. Ke, R. (2002). Bid Rotating Saving and Credit Associations, as Insurance with or without Outside Financial Market: Comparison with Random Distribution.

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Conference Paper: The Second Annual Conference of Neoinstitutional Economics in China, Hangzhou. Liu, R., & Shi, L. (2010). Guoyou qiye de shuangchong xiaolv sunshi yu jingji zengzhang (The Dual Efficiency Loss of State-Owned Enterprises and Economic Growth, 国有企业的双重效率损失与经济增长). Economic Research Journal, 1, 127–137. Ministry of Finance of the People’s Republic of China, The People’s Bank of China and China Banking Regulatory Commission. (2004). Guanyu jiaqiang guoyou shangye yinhang buliang daikuan boli guocheng zhong zeren zhuijiu gongzuo de tongzhi (The Notification for the Ministry of Finance, the People’s Bank and the Banking Regulator Commission to Reinforce the Accountability in the Process of Dealing with the Non-Performing Loans, 关于加强国有商 业银行不良贷款剥离过程中责任追究工作的通知). Beijing: Ministry of Finance of the People’s Republic of China. The People’s Bank of China and China Banking Regulatory Commission, Cai Jing Zi No. 77. National Development and Reform Commission of the People’s Republic of China. (2011). Guojia fazhan gaigewei guanyu zhengdun guifan dianjia zhixu de tongzi (The Notification from the NDRC About Rectifying and Standardizing the Order of the Electric Price, 国家发展改革委关于整 顿规范电价秩序的通知). Beijing: National Development and Reform Commission of the People’s Republic of China, Fa Gai Jia Jian No. 1311. Sonobe, T., &Otsuka, K. (2003). Productivity Effects of TVE Privatization: The Case Study of Garment and Metal Casting Enterprises in the Greater Yangtze River Region. National Bureau of Economic Research (NBER) Working Papers 9621, NBER, Cambridge. State Council of the People’s Republic of China. (1984a). Guanyu guli he zhichi 18 ge shidian chengshi youshi guoyou qiye jianbing kunnan guoyou gongye shengchan qiye hou youguan yinhang daikuan he lixi chuli wenti de tongzhi (Notice on Handling the Problems of Bank Loans and Interest Rate After Encourage and Support Priory State-Owned Enterprises to Merge Difficult State-Owned Industrial Production Enterprises in 18 Trail Cities, 关于鼓励 和支持18个试点城市优势国有企业兼并困难国有工业生产企业后有 关银行贷款和利息处理问题的通知). Beijing: The State Council of the People’s Republic of China. State Council of the People’s Republic of China. (1984b). Guanyu jinyibu kuoda guoying gongye qiye zizhuquan de zanxing guiding (The Interim Provisions to Further Expand the Autonomy of State-Owned Industrial Enterprises, 关于进 一步扩大国营工业企业自主权的暂行规定). Beijing: State Council of the People’s Republic of China.

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State Council of the People’s Republic of China. (1992). Quanmin suoyouzhi gongye qiye zhuanhuan jingying jizhi tiaoli (Regulation on the Transformation of Operational Mechanism of the Industrial Enterprises Owned by the Whole People, 全民所有制工业企业转换经营机制条例). Beijing: State Council of the People’s Republic of China. State Council of the People’s Republic of China. (1994). Guanyu zai ruogan chengshi shixing guoyou qiye pochan youguan wenti de tongzhi (Notice of the State Council on the Relevant Issues Concerning the Pilot Implementation of Bankruptcy of a State-Owned Enterprise In Some Cities, 关于在若干城市 实行国有企业破产有关问题的通知). Beijing: The State Council of the People’s Republic of China. State Planning Commission of the People’s Republic of China. (1999). Guojia jiwei guanyu liyong ertan shuidianzhan fuyu dianliang zhigong gaohaoneng qiye yongdian wenti de pifu (A Reply from the State Planning Commission to the Problem of Providing High Electricity-Consuming Enterprises with Electricity Directly Generated from Ertan Hydropower Station Electric Surplus, 国家计委关于利用二滩水电站富余电量直供高耗能企业用 电问题的批复). Beijing: The State Planning Commission of the People’s Republic of China, Ji Ji Chu No. 1138. The People’s Bank of China. (1999). Shangye yinhang shishi tongyi shouxin zhidu zhiyin (A Guide for Commercial Banks to Implement the Unified Credit System, 商业银行实施统一授信制度指引). Beijing: The People’s Bank of China. The Unirule Institute of Economics. (2011). Guoyou qiye de xingzhi, biaoxian yu gaige, (The Nature, Performance, and Reform of the State-Owned Enterprises, 国有企业的性质、表现与改革). Beijing: The Unirule Institute of Economics. Tu, Z., & Xiao, G. (2006). Zhongguo gongye zengzhang moshi de zhuanbian— dazhongxing qiye laodong shengchanlv de feicanshu shengchan qianyan dongtai fenxi (The Change of the Growth Pattern of the Chinese Industries: An Advancing Dynamic Analysis of the Non-paramedic Production of the Large and Middle-Scale Enterprise Labour Capacities, 中国工业增长模式的转 变—大中型企业劳动生产率的非参数生产前沿动态分析). The World of Management, 10, 57–81. Wu, J., Chen, Q., & Xie, F. (1999). Guoqi gaige gongjian 15 ti (15 Issues in State-­ Owned Enterprises Reform, 国企改革攻坚15题). Beijing: China Economic Press. Xiangzhen qiye daikuannan nanzai nali (What are the Causes of Township Enterprises’ Difficulties to get Loans, 乡镇企业贷款难难在哪里), Economic Daily, 18 April 2001.

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Zhang, J. (2005). Ziben xingcheng, touzi xiaolv yu zhongguo de jngji zengzhang de shizheng yanjiu (An Empirical Study of the Capital Formation, the Investment Efficiency, and the Growth of the Chinese Economy, 资本形成、投资效率与 中国的经济增长的实证研究). Beijing: Tsinghua University Press. Zhang, J., & Wang, Q. (2004). Quanwei, qiye jixiao yu guoyou qiye gaige (The Authority, Firm Performance, and the SOE Reform, 权威、企业绩效与国 有企业改革). Social Science in China, 5, 106–117. Zhang, W., & Yuan, D. (2008). Zhongguo jingji gaige 30 nian (Thirty Years of China’s Economic Reform, 中国经济改革30年). Chongqing: Chongqing University Press. Zhang, X., Xu, Z., & Qin, D. (2013). Minjian jiedai lilv yu minjian ziben de chulu: wenzhou anli (The Interest Rate of Private Borrowing and the Future of Private Capital: The Case Study of Wenzhou, 民间借贷利率与民间资本 的出路: 温州案例). Journal of Financial Research, 3, 1–14. Zhou, C., & Bao, R. (2013). Nixiang xuanze, daode fengxian yu jingrong zhongjie jiaoyi chengben: yuanzi hehui de tourongzi xiaolv (The Adverse Selection, Moral Risk and Financial Intermediary Transaction Cost: The Efficiency of Investment and Financing ROSCA, 逆向选择、道德风险与 金融中介交易成本:缘自合会的投融资效率). Reform, 2, 142–150. Zhao, X. (1999). jingzhen, gonggong xuanze yu zhidu bianqian (Competition, Public Choice and Institutional Change, 竞争、公共选择与制度变迁). Discussion paper. China Center For Economic Research, Beijing.

6 The Fall and Rise of State-Owned Enterprises (II): The Institutional Root of the Chinese Dual Head Economy

6.1 H  ow to Measure and Identify Successful SOEs Almost all the relevant literature, especially that before 2003, highlights the low efficiency status of Chinese SOEs (see, for example Huang 2003; Zhou and Wang 2000; Sheng and Zhao 2012). More recently, however, the orthodox view has changed, as careful statistically based empirical studies (e.g., Zhang 2005; Wang 2005; Ma 2011; Hao et al. 2012; Wei and Rong 2012) have shown SOEs to have become increasingly prosperous. In fact, there is a wide gap between micro-level and macro-level statistical data relating to SOEs. Much commercial research (and company annual reports) has shown that SOEs listed on China’s (Shanghai and Shenzhen) and Hong Kong’s stock exchange markets have in recent years normally achieved a gross profit rate as high as 20 per cent–30 per cent. Even traditionally less profitable utility companies have shown themselves capable of attaining average profits rates of around 15 per cent. However, viewed from a macro perspective, the profits of SOEs is shown to have been close to zero, or even negative after the deduction of bank © The Author(s) 2017 C. Jin, An Economic Analysis of the Rise and Decline of Chinese Township and Village Enterprises, Palgrave Studies in Economic History, DOI 10.1007/978-3-319-59770-6_6

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loan interest discount (most SOEs enjoyed a 10 per cent concessionary rate on loans) and allowance for profit remitted to the State-owned Asset Supervision and Administration Commission (SASAC)1 (usually less than 20 per cent of net profits). The poor performance revealed in macro statistics can be traced back to the days before the 1998 reform (see above, Chap. 5), when the profitability of most SOEs was persistently rather (even in the mid-1980s and mid-1990s when the Chinese economy was booming and SOEs were becoming more prosperous). The inconsistency between the empirical micro and macro data suggest that one may have impracticability difficulty if using SOE financial data2 as the basis on which to assess the performance of SOEs. The ‘state-ownership attributes’ of China’s SOEs and are evidence of the different path from that predicted by orthodox transition economics theory, which these enterprises have actually followed in the reform era. Since 2000, and especially since 2003, the Chinese government has gradually given permission for off-market transactions with individuals and foreign investors to take place in ‘reserved’3 SOE stocks. More recently still, in 2005, the central authorities further allowed the ‘reserved’ stock to be transferred into normal stock, and if a SOE was listed on the Shanghai or Shenzhen stock exchange, its ‘reserved’ stocks were permitted to circulate in the open market. As a result of such partial privatization, the old-style SOEs— those in which the state was sole owner or held more than 50 per cent of shares—have almost vanished. From the perspective of equity structure, if those unofficially distributed shares are counted (for instance, many large energy SOEs, such as State Grid Corporation of China,4 carried out equity incentives which were off-registration forms of stock right), state-owned shares in most SOEs are now far below the 50 per cent level. Therefore in current parlance the concept of state-owned enterprises no longer refers to SOEs in the sense of ownership, but to those to which the government holds the control rights and whose management is composed of government officials. In the past ten years, a characteristic Chinese style of crony capitalism has emerged among SOEs, government officials, and private and nonprivate entrepreneurs with close connections to the government. Unlike the crony capitalism of other East Asian and Southeast Asian countries, in China’s SOEs divisional managers are government officials rather than

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individual capitalists. Meanwhile, SASAC and the National Development Reform Commission (NDRC) have assumed the responsibility for monitoring SOE’s internal management and external activities, including their investment and marketing strategies. From a political point of view, Chinese SOEs can be regarded as an extension of the government, these enabling central and local CCP officials to take direct economic advantage of their activities. This is fundamentally different from the East Asian ‘revolving door’ and the ‘pork barrel’ politics of Korea, Taiwan and Japan; neither does it follow the Southeast Asian model, with its reliance on ‘cliques’ (cf. Indonesia and Malaysia). Consequently, it is very difficult for professional managers and private sector actors to participate in fundamental policymaking of economic affairs (such as SOE policies) through lobbying. If we are looking for an analogy, we may say that SOEs in China bear a certain resemblance to government-­investment-based enterprises in Singapore, although in China they of course exist in much larger numbers and on a far greater scale. Through a systematic analysis of the background to the 1998–2003 reform China’s state sector, this chapter illustrates how, under the pressures of the Asian financial crisis towards the end of the 1990s, policymakers in China purposefully and rapidly restructured the SOE sector, based on its dual-track system, and successfully transformed SOEs into more efficient, productive and profitable monopoly enterprises.

6.2 From Central Planning to Dual-Track 6.2.1 The Legacy of the Central Planning System Under the central planning system, economic assessment of the state sector was generally based on a measurement of the performance of the sector as a whole, rather than on that of individual constituent enterprises. Before 1979 and in the early stages of the reform, SOEs profits were not representative of their efficiency, since in the face of excess demand for industrial products, the central planners were able to—and did— price goods at levels that succeeded in ‘withdrawing funds from circulation’ (zijin huilong 资金回笼) (Hu 2001). The practice of zijin huilong

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generated huge cash flows in some SOEs. It constituted a special form of monetary policy outside the banking system which enabled the central planning economy to use the sale of SOE products in order to transfer money that would otherwise circulate within the economy (i.e., M0) to SOEs. As M0 was reduced–even largely eliminated from the economy, successful implementation of the zijin huilong policy helped eliminate most price fluctuations. The major way in which this policy was carried out was by overcharging for products in short supply and balancing the increase in monetary stock by sales of industrial products to residents in the interests of price stabilization (and maximizing state fiscal income, since these two goals complemented one another). As a result, payments between SOEs—and most transactions were between SOEs—were not based on actual costs, nor on real supply and demand conditions. In the early stages of the economic reform, the way in which cost-benefit calculations were made in the state sector suggested two options when, in the 1980s, China began to contemplate market-­ oriented SOE reform. The first was to simply privatize the entire state sector at a single stroke—the notion of the ‘big bang’, which was later implemented in Russia and other Eastern European countries. The basic rationale of the big bang was that if some enterprises remained within the orbit of the centrally planned economy while others were removed from it, transactions between market-oriented and non-market-oriented enterprises would create chaos in the market. To some extent, the central planner would be of the fact that some enterprises acquired inputs at prices lower than the putative ‘market price’ (‘putative’ since the genuine domestic market in fact existed at this point in time).5 However this planner neither had accurate means of measuring by how much inputs were over- (or under) priced, nor could he prevent some enterprises benefiting from planning system while others did not. At the beginning of reforms, this became an issue on the political agenda in China, where it was not regarded as politically acceptable to leave ministries and other professional departments to decide which enterprise would, or would not, remain in the central planning system—not least because of the arbitrary element that would inevitably be introduced into the decision-making process. The second approach dictated that SOEs—and the entire central planning system—should be preserved, but without denying permission for

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a non-state sector to emerge and evolve. In this way, the central planners would only have to consider the price of products sold to the non-­ planning part of the economy, price settlements between SOEs within the planning system remaining untouched. This was the scheme initially adopted by the government at the beginning of the economic reform in an attempt to prevent splitting the state sector. It may be said to have succeeded—although only for a short time. In the first fifteen years of China’s economic reform, the state sector inherited a comprehensive subsidy from the central planning system, through the mechanism of the dual-track price system. Under this system, SOEs were obliged to sell products to other SOEs at fixed prices that were lower than the prices of products sold to non-SOEs. More importantly, SOEs had priority over non-SOEs in accessing and securing inputs. By the terms of the new arrangements, SOEs could obtain larger quantities of inputs than non-SOEs—and at a lower price.

6.2.2 T  he Central Planning System and the State Sector Under the impact of market-orientated reform, SOEs procured extra subsidies from the central planning system. Unlike the direct financial subsidies available to them, these subsidies were distributed by the central planning system in two ways: first, by obtaining inputs at a lower price through non-market (plan) rather than market means; second, by banning non-SOEs from selling certain products in order thereby to guarantee the price and quantity of products sold by SOEs (Jefferson et al. 1992). Both methods had existed in the pre-reform centrally planned economy, but before 1978 they were mainly used for the purpose of zijin huilong, and the cash flows generated by the SOEs were meanwhile fully controlled by the central planning system (more accurately, by the government). In the reform era, the central planning system, which had previously exercised authority over SOEs, transformed into an institutional framework designed to serve them. Meanwhile, in the first few years of reform, as the returns to government from SOEs declined, government revenue became increasingly divorced from state enterprises.

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Fan (2000, 2003) depicts the relationship between the state and non-­ state sectors during the reform era by means of a simplified two-sector model. In this model, the two sectors are isolated from one another, and the most significant difference between the two is the speed of output growth. Although Fan conceded that governmental subsidies and other factors might the SOEs’ share in the economy to contract more slowly than anticipated, in fact he underestimated the intimate relationship between the central planning system and SOEs, thus missed to predict a smaller in size but much stronger in profitability and monopoly power SOE sector. First, in the state sector, transactions between SOEs within the dominant central planning system were provided with a double hedge against ‘market risks’: (1) the majority of SOEs could acquire the inputs they needed at a stable price (mostly below market price), enabling them to run their business at a low cost; (2) except for a small number of enterprises that traded directly in the retail market, most SOEs could sell their products at a fixed price (which was based on the price of inputs plus a mark-up), the physical volume of sales being determined by centrally planned targets. In this way, SOEs were able to achieve a steady cash revenue flow independent of changes in the market. Secondly, in many cases, the so-called market track prices of most goods under the dual-track system were in fact determined not by the market, but by the central planning authorities, who acted not only as a typical monopoly seller when distributing goods to the market, but also as an arbiter of information. In the dual-track system, the information acquired by buyers from the state sector was far from complete. Unlike a conventional market, most buyers could not see bids from others and therefore had to rely on what sellers were charging. Under the dual-track system the prices of consumption goods were determined by market forces, but there rarely existed an open market price for any industrial inputs. As a result the state sector was in a position to practise price discrimination against each individual buyer. When transactions took place within the state sector, or between the state and the non-state sector, the central-planning system usually ­discriminated in favour of the state sector by offering better conditions than those available in the market. At the beginning of the 1980s, the financial revenue of the state sector plunged. This did not reflect so much deterioration in

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SOEs’ operations or in the business environment: indeed, the evidence suggests that the performance of state enterprises was no worse than it had previously been. Rather, because fiscal income was no longer collected through the zijin huilong mechanism, SOEs were deprived of what previously had been a major part of their cash flow. In other words, changes in China’s financial and fiscal policies impacted on SOEs. In general, however, SOEs suffered few or no losses till the end of the 1980s. Meanwhile, dual-track pricing under the overall direction of China’s planners reshaped the fundamental nature of the economic relationship between the state and non-state sectors, and between relationships among SOEs themselves. The dual-track system systematically raised the market-­ track price level: under this system, goods that the non-state sector could obtain from the state sector consisted of two elements: market-track products, which comprised output produced beyond the quota assigned to SOEs within the plan; and surplus state sector output planning-track inputs—obtained by SOEs within the plan, but not used in production—that were sold on to the non-state sector at market-track prices. Since most goods were distributed to the state sector beforehand through the central planning system, the market track provided an opportunity for the non-state sector to engage in collective bidding for any remaining products. However, in practice, most SOEs directly sold their surplus; for some, selling inputs was more profitable than producing and selling their own products. As a result, the revenue of SOEs can also be divided into two parts: income from sales officially and legally generated within the planning system (including both the sale of planning-track goods and market-track sales permitted by the planning system); and income from unofficial market sales of planning-track goods acquired from the state.

6.2.3 Why Did the Dual-Track System Work? The nature of the dual-track system was that of a state monopoly of the industrial sector, with the benefits of its monopoly status shared among all SOEs within the state sector. As stated above, SOEs benefited from this central planning system, which gave them absolute advantages over non-SOEs in both input and output markets.

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Under the dual-track system, the SOE sector had a priority claim on most of the important industrial inputs. This monopoly of inputs was composed of the following elements: (a) SOEs’ possession of natural resources: before the twenty-first century, most state-owned mining enterprises were readily able to obtain the necessary permission to access natural resources (land, drilling and exploration rights, etc.) for free; (b) the state-owned infrastructure: under the dual-track system, SOEs managing or running state-owned infrastructure were required to provide services to other SOEs free, or at the plan-track price; (c) labour: during the first two decades of China’s reform, most educated or skilled workers preferred to work in SOEs in order to take advantage of preferential welfare treatment (housing, children’s education, food subsidies, etc.); (d) bank loans: in China, the major sources of loan credit were exclusively state-owned banks, whose definition of an ‘enterprise loan’ was a loan that was available only to SOEs. For non-SOEs the only sources of credit were ‘private enterprise loans’ or ‘rural loans’, which came with very strict limitations.6 State-owned banks were not allowed to extend long-term loans7 to non-SOEs. SOEs were able to monopolize product markets for two main reasons. Firstly, under the central planning system, SOEs—especially large enterprises—were run by various professional departments which had regulatory powers that enabled them to prohibit other enterprises from entering the market. They continued to retain such power for two decades after the start of China’s economic reforms. Only in 1998 was the power and influence of professional departments weakened, although some of them (for example, the Ministry of Railways and the Ministry of Industry and Information Technology) continued to exercise control over SOEs—and, more importantly, retained the necessary regulatory power to vet and monitor new entrants into the relevant industries. Secondly, during the first fifteen years of economic reform, the Chinese government issued laws that continued to discriminate against non-SOEs: for example, private individual traders were not allowed to have a workforce greater than eight

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employees (this legislation was rescinded in 1987 thanks to the direct intervention of Deng Xiaoping). Meanwhile (in any case), most banks discriminatorily refused to lend to non-SOEs because of their smallness of scale, preventing them from entering capital-intensive industries. On the other hand, the dual-track system was a redistribution mechanism within the state sector. It was a mean of conferring some financial benefit to SOEs (which of course benefited from planning-track prices under the central planning system) struggling to gain a surplus from their monopoly position. The dual-track system had the function of compulsorily transferring financial resources from financially well-off enterprises to those that were more strapped. Its prices provided enterprises with low-cost inputs, even if they did not hold monopoly power over these inputs; and when they had surplus planning-track products, or could extract more profit by selling planning-track products directly rather than using them for production, they could reap the benefit of the difference between the planning-track and market-track prices. In general, therefore, the dual-track system used profits gained from monopoly enterprises to subsidize those that lacked the benefit of a monopoly status. Furthermore, through redistribution within the state sector, the dual-­ track system helped maintain some semblance of equality in terms of financial viability among different firms across the entire sector. However, there were certain conditions that had to be fulfilled, if the dual-track system were to sustain the state sector. Under the dual-track system, the viability of the state sector depended on whether total monopoly profits gained by the SOE sector as a whole could compensate for losses accruing to it as a result of the existence of the non-state sector. First, the number of markets that non-SOEs could enter was more important than the number of non-SOEs that were being established. In a competitive market, ownership is unlikely to be the definitive determinant of enterprise performance. In China, for example, the quality of management and managerial expertise in a certain number of SOEs was by no means below-average. However, from both theoretical and practical perspectives, a competitive market tends to rob enterprises of the capacity to subsidize other firms. Once a given market became competitive, SOEs in this market would lose their advantages, and could merely become a net beneficiary of subsidies from dual-track system (those financially well-off

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SOEs) or, at best, be financially independent; but they would no longer be in a position to be the source of financial transfers to other enterprises. Second, as the number and scale of non-SOEs both increased, the proportion of monopoly enterprises among SOEs plunged. In considering the significance of this development, what was in fact important was the ratio between the numbers of subsidy sources and subsidy recipients within the SOE sector. The dual-track system could only be sustained if the payment capacity of the sources of subsidies exceeded the financial losses of potential subsidy recipients. The reality is that as the number of SOEs propelled into the competitive market increased, the cluster of enterprises capable of offering subsidies contracted while the number of potential subsidy-recipients rose. Third, as the scale and number of enterprises participating in under competitive market conditions expanded, so their demand for inputs also increased. This was bound to enhance the ability to make ex gratia payments (or the ability to generate a surplus) of SOEs’ operating in an uncompetitive market too. Under the precondition that the central planning system was capable of maintaining the SOE monopoly over at least some key inputs, an increase in the scale of the competitive market was likely simultaneously to improve the bargaining power of SOEs and their sales volume.

6.3 T  he Logic of SOE Reform: From Dual-­ Track System to State Monopoly 6.3.1 T  he De-linking Between SOEs and the State’s Fiscal Income Before the SOE reform initiative of 1998, there were two categories of owners of SOEs: local government and central ministries (‘professional departments [ministries]’, as we have named them elsewhere in this book). Unlike the M-form/U-form model put forward by Qian and Xu (1993) and Qian et al. (2001), most Chinese theoretical economists used the analogy of a ‘layout of branch and lump segmentation’ (tiaokuai fen’ge, 条块分割—sometimes referred to in the literature as ‘matrix segmentation’) in order to describe China’s central planning system.

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In the state sector, following China’s comprehensive programme of nationalization in the first half of the 1950s, a number of professional departments (mainly ministries) were set up after the model of industrial organization in the Soviet Union, and relevant SOEs were allocated to an appropriate ministry within this hierarchy These enterprises, of which there were about 10,000  in the late 1950s, were directly administered and controlled by the central authorities. At the same time, smaller SOEs were put into the charge of local government authorities. From the 1960s until the end of the 1970s, the three-character Chinese phrase ‘release and tighten’ (fang he shou, 放和收) captured the inherent tension in this system, with jurisdiction over SOEs divided between central and local-level governments. For instance, during the Cultural Revolution, the policy emphasis was on ‘release’, and most SOEs were duly incorporated into local—especially provincial-level—government administration. Before 1978, the state sector and those collective enterprises that were effectively part of it8 were responsible for almost all the production and sales of industrial goods. The essence of the ‘release and tighten’ policy was symptomatic of the division of political responsibilities between central professional departments (ministries) and local governments—but also, since SOEs were the chief source of fiscal revenue under the central planning system, of the division of financial revenue between them. From the perspective of the state sector, whether the economy approximated to M-form or U-form depended upon whether or not the central planners were capable of handling the inputs and output of SOEs, and on the extent to which they could manage the SOEs under their control. Before the 1978 reform, Chinese SOEs were the most important source of the state’s fiscal income. Almost half of total revenue came from profits turned over to it by SOEs: in 1978, for example, China’s total state revenue was RMB 116 billion yuan, of which SOEs’ contribution was 57.2 billion (49.3 percent). This fiscal role of SOEs was rooted in the nature of the central planning economy, which sought to achieve economic balance by selling products to residents through SOEs (‘zijin huilong’—see above, Sect. 2.1). Under the central planning system, shortages of industrial products (especially light industrial products) were common, and so selling them was never a problem. The central planners were required only to adjust the price of industrial products according to

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the amount of currency in circulation. In short, before 1979 in China, the practice of ‘unified revenue and expenditure (tongshou tongzhi, 统收 统支)’9 was applied to SOEs, facilitating the direct remittance of their profits to the state. However, following the economic reform initiatives of the early 1980s, the central government no longer dealt with SOEs through the zijin huilong mechanism. Instead, from 1979 it adopted an allocation strategy, whereby 60 per cent of SOE profits were remitted to the state and the remaining 40 per cent was retained by the SOEs. Subsequently, in the tax revenue reforms of 1983–1984, the profits sharing (between government and enterprises) schedules were replaced by tax on income,10 levied at a rate as high as 55 per cent until 1988, when it was reduced to 33 per cent. During this period, SOEs profits contributed a declining share of China’s state revenue. By 1985, the state had to subsidize SOEs to the extent of 25 per cent of its fiscal revenue.11 In other words, SOEs were net recipients of subsidies from the state as early as during the first five years of China’s economic reform. With declining SOE profits, the structure of the state’s fiscal income also changed, as the role of SOEs in the state’s fiscal structure declined in importance. This situation lasted until 2003–2004. Thus, for almost twenty years from the early 1980s until the early 2000s, SOEs’ contribution to state fiscal income was negative, making them continuously dependent on government subsidies.

6.3.2 Restructuring Central and Local SOEs After the 1980s, local governments paid little attention to SOEs’ profit levels (Qian 2008). They were more concerned with SOEs’ achievements in other policy areas, such as improving employment (not to mention meeting the personal demands of local officials). The origins of this change can be found in the ‘profit delivery by taxes’ reform initiative. After this reform, income taxes became SOEs’ main source of payment to state revenue. Because local governments were unable to obtain a large share of these, officials sought to get access to and make use of SOEs’ pre-­ tax profits. This was an important factor contributing to the deterioration in SOEs’ economic performance. Following large-scale privatization in

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1997–1998, there were sharp reductions in employment in many small SOEs, as a result of which the overall size of the SOE workforce declined significantly. This was of course a reflection of the over-staffing that had previously characterized many Chinese SOEs. The central government’s 1998–2003 SOE reform was partly designed to release SOEs from excessive interference by local governments, and had two practical goals. The first was to transform the structure of the SOEs under the central professional departments (ministries), and reduce the influence of local government. In the reforms introduced between 1998 and 2003, central government finally established SASAC, and enterprises subordinate to central government were put under its direct leadership. This had two consequences: one was an enhancement of these enterprises’ bargaining power with local governments, especially at municipal level; the other was a hardening of the budget constraint through the strengthened ability of SASAC to restrain the budgets of central enterprises. The second goal was to separate small and medium-sized local SOEs from local government by encouraging massive privatization. Thus, local governments were able to obtain some of the private enterprise shares through their local SASAC. This reform reinforced the effect of the tax reform of 199412 (whereby the central government secured a large and stable share of tax revenue), and weakened local governments’ financial capacity. As a result, thereafter their expenditure began to exceed their revenue. SOEs were an ‘invisible purse’ for local governments, which attached greater significance to their control over expenditure than to their responsibility for their deficits. Moreover, restrictions on SOEs’ spending were much weaker than those on governmental expenses. The losses of SOEs could be made good by bank loans and financial subsidies, neither of which was part of the regular financial budget of local governments.13

6.3.3 SOEs After Reform As previously stated, the 1997–1998 Asian financial crisis was the direct cause of the 1998 SOE reform. It forced the Chinese government to confront the fragility of its financial system, especially that of banks.

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This fragility was rooted in massive uncollectible loans that had been extended to the state sector. In the 1990s, the performance of SOEs had meanwhile deteriorated in the face of the expansion of the competitive market. This was the background against which the Chinese government sought to rebuild the foundations of its financial system and continue reforming the SOEs. The early 1990s, especially in the wake of accelerated economic reforms precipitated by Deng Xiaoping, offered non-SOEs the best opportunity to borrow money since 1978. The resultant loan explosion reflected a massive easing of monetary policies at this time, though the monetary relaxation also directly contributed to the annual inflation rate rising to 20 per cent. Non-financial institutions that were able to get loans from banks also began to lend to non-SOEs, especially TVEs. These institutions—various kinds of government bodies, the army and SOEs themselves—could secure loans at a discounted interest rate from banks, which they then made available as new credit in order to profit from the interest rate difference between the discounted rate and the market interest rate. As a result of new investment which such activities facilitated, the average size of a non-SOE (especially TVEs) rapidly increased,14 and in 1993 the industrial output of non-SOEs in manufacturing exceeded that of SOEs for the first time. Even more significantly, non-SOEs began to enter capital-­intensive industries. Developments in the textile industry are illustrative of this trend. In the early period of economic reform, non-­ SOEs had entered the apparel industry on a considerable scale. But it was not until the beginning of 1990s that non-SOEs in Jiangsu, Zhejiang and Fujian began to enter the textile industry, which required considerable capital. The outcome of these developments was that by the end of the 1990s, the enormous state textile industry that had been such a prominent part of the Chinese economy since the 1950s had vanished. Similarly, since capital restrictions were no longer a constraint on the expansion of non-SOEs, as long as there was no specific regulation against their doing so they were able to enter any capital intensive industry. As a result, SOEs were increasingly compelled to compete with non-SOEs in almost all light industrial product markets. As of the end of 2003, it can be argued that the SOE reform and massive privatization had had the effect of modifying China’s

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dual-track system. They had not, however, caused its total vanishing than partial abandonment. For sure, such reforms reduced the scale of the state sector; but the major institutional underpinnings of the dualtrack system, which favoured the state sector, were still preserved. First, the political element of the traditional central planning system designed to serve and support the state sector has remained in place as a critically important part of China’s economic institutional framework. The core of the central planning system was the State Planning Commission (SPC), renamed the State Development Planning Commission (SDPC) in 1998 and, since 2003, the National Development and Reform Commission (NDRC), whose chief mission is that of economic regulation. The NDRC was not designed to monitor competitive consumption goods markets involving a large number of small and medium-sized enterprises (SMEs), but was mainly developed to concentrate on the SOEs monopolized markets. Second, far-reaching ownership reform strengthened SOE budget control. Strictly speaking, pure state ownership, in the sense in which this term would have been understood in the old central planning economy, no longer existed in most modern Chinese SOEs. Individuals and institutions held large numbers of SOE shares through three main sources: (a) the Employees’ Shareholding Plan: this came into effect at the beginning of the 1990s, when, with the assistance of trade unions, an Employees’ Shareholding Society (ESS) was set up in some enterprises (Zhang 2008). (b) the State Owned Shares Reduction Plan: before 2006, state-owned shares and legal person shares could not be traded on the open market. Off-market transactions were the only option, through which legal person (including private enterprises) were able to obtain large numbers of the original state-owned shares. (c) transactions on the public stock market. In the 1980s, China’s SOE stocks began to be circulated in overseas markets, Hong Kong being the first of these. From 1990, stocks issued by the original SOEs began to be traded on China’s stock markets.

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6.4 T  he Nature of the Chinese State Sector: From Dual-Track System to State Monopoly 6.4.1 S  OEs and the Market: The Logic of Chinese SOE Reform The slogan that famously encapsulated the 1998–2003 SOE reform was ‘grasp the large, let go the small’—that is, ‘manage large-scale enterprises well, while relinquishing control over small enterprises’ (zhuada fangxiao, 抓大放小). In fact, however, this reform initiative was not tied simply to the scale of enterprises. An ex post assessment, based on an examination of the outcome of the reforms, would suggest that three criteria were followed in dealing with China’s SOEs. First, there was a feeling that the reforms should ensure that those SOEs that survived should be of sufficiently large size. Increasing the scale of SOEs promised to improve the level of vertical integration and balanced out the shock that some enterprises were likely to experience due to loss of low-price inputs.15 The basic logic behind this part of the reform was that not even low-price inputs could make up for SOEs’ loss of efficiency in market transactions, and, SOEs should therefore be encouraged to minimize the number of intermediate transactions which they undertook. The second criterion was that SOEs must be allowed to enjoy monopoly powers in input markets. Before 1993, the SOE sector had almost monopoly control of all key natural resources, communications channels and broadcasting channels. However, in terms of individual firms, control over a certain resources (input) might be spread among a number of SOEs. For example, in 1998–1999 nearly 20 independent companies were in charge of China’s petroleum extraction, whereas by 2003 reforms had greatly reduced the number of oil companies, leaving very few companies in control of this key resource. Two consequences followed from such developments. The first was the likelihood of input markets becoming truly competitive was reduced.16 Second, SOEs needed to be able to defend themselves against intervention from local governments. Thanks

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to the ‘release and tighten’ policy, under the central planning economy there were several rounds of transfer of ownership of SOEs between local governments and the central government. Meanwhile, there were two ways in which promotion could be achieved within SOEs’ managerial hierarchy: an SOE manager may be promoted as a government official and assigned a role in government,17 or shifted from one SOE to another (usually such shifts took place within the same professional department, or ministry). In these circumstances, it was hard for SOEs to avoid local government intervention. Moreover, when the interests of SOEs collided with local government goals, prior to the 1998–2003 reforms the former tended to be subordinated to the latter. The third criterion was that SOEs should secure monopoly control over their product markets. After the 1998–2003 reform, one of the most prominent characteristics of the Chinese economy was the SOEs’ monopoly power in product markets. This kind of monopoly had two characteristics: (a) The qualifications for entering this type of market were controlled by the central planning system (more recently, the NDRC), and only SOEs had the right to participate. For example, in the telecommunications market the Chinese government used the number of licences issued to tightly control the number of competitors, while all SOEs and their licences were carefully maintained. (b) Non-SOE participants could enter some markets with a much smaller market share than that of SOEs. In these markets, non-SOEs were dependent on SOEs for their key inputs. In the petrol market, for example, non-SOE gas stations relied on two SOE suppliers, which therefore retained total control over the price. These two characteristics ensured that SOEs could avoid non-SOE competition, ensuring thereby that these markets could not become highly competitive. The most striking feature of the 1998–2003 SOE reform was the establishment of grand monopolized SOEs in targeted industries, intended to prevent these markets from becoming competitive. For example, in China’s pre-reform petrochemical industry, every petrochemical

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enterprise belonged to the China Petroleum Corporation. However, China Petroleum Corporation is a loose business alliance in which every enterprise was independent of the others, both financially and in its management. The 1998–2003 reform reshuffled the business alliance into two huge enterprises—China National Petroleum Corporation and the China Petrochemical Corporation Group—which were the major shareholders of PetroChina and Sinopec. PetroChina and Sinopec (including their parent firms) were subsidiary companies in charge of exploration, extraction, refining and gas services. After 1998, these two companies occupied more than 90 per cent of China’s petrochemical industry, and used every possible means, from business mergers to government bans, to exclude other companies from the market. For instance, firms other than these two companies and their main stockholders were banned by government from building new gas stations, while private firms were banned from purchasing oil fields from SOEs. If the market shares of the other two policy-oriented oil SOEs (China National Offshore Oil Corporation and China Aviation Oil—respectively, in charge of the exploitation of offshore oil and the supply of aviation oil) are excluded, the PetroChina and Sinopec’s market share would be higher than 90 per cent. In addition, PetroChina and Sinopec (and their parent companies) also have exclusive powers to run China’s oil imports.

6.4.2 The Role of Regulator After 2003, the most important governmental organization, also the regulator of China’s economy, was the NDRC (sometimes referred to as a ‘Mini State Council’). As already mentioned, the NDRC was the renamed successor to the SPC. Under central planning, SPC had been in charge of formulating economic plans for ministries and provincial governments as part of running the central planning system. The SPC was one of the administrative organizations under the State Council, which had the direct responsibility for monitoring every professional department (ministry)—in particular, their economic role and performance. From the start of the post-1978 economic reforms, the importance of the SPC began to decline as the macro-economic role of the ministries was gradually downgraded.

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Nevertheless, the significance of the SPC was rediscovered under its new guise as the NDRC. The key role of the NDRC was that of economic regulation, including regulating the price and quantity of outputs. Since 2003, almost all price regulation18 has been issued by the NDRC, whose regulatory oversight has included the following categories: grain, agricultural inputs (for example, fertilizers), water, key industrial products (for example oil), electricity, transportation and telecommunication, and service charges. The NDRC’s control over input and output prices was designed to fulfil the goal of minimizing declines in SOE output prices. In China’s mobile telecommunications industry, for example, the NDRC and Ministry of Industry and Information Technology consistently rejected one-way charge tariffs for mobile phones. They insisted on two-way charges—a different prices for the caller and call recipient—and also supported the telecom industry in charging extra fees for domestic distance dialling and roaming services. In order to increase market share or improve business returns, SOEs will naturally favour lowering prices. But through its power to set a floor price, the NDRC was able to suppress this impulse, thereby lowering the gross profits of SOEs. In addition to its price control role, the NDRC also consistently used micro-level direct controls to adjust the output of enterprises. It achieved this in two main ways: first, by using output restraints in order to limit the output of an individual firm (usually through controlling the firm’s production capacity)—in other words, firms were allowed to invest in the construction of major production facilities only after their plans had been approved by the NDRC; second, through its (the NDRC’s) control of permits and licences which large-scale enterprises needed if they were to be allowed to enter an industry, or by limiting the scale of an enterprise’s operations. By limiting output restraint and controlling access, the NDRC was able to keep non-SOEs out of certain markets and to avoid over competition between SOEs. After its establishment in 2003, the NDRC sought to use its control powers to prevent non-SOEs from challenging the monopoly status of SOEs and to avoid clashes between SOEs in order to ensure that their financial condition did not deteriorate. Compared with those of the SPC under the planned economy and dual-track system, the operational remit and level of management skills of the NDRC were fundamentally different.

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First, it no longer took part in formulating production plans, in the way in which the SPC had been responsible for allocating the inputs and output of enterprises. In the planning era, the SPC essentially assumed the role of SOE management, but the NDRC did not attempt to copy this. Although it limited the price and quantity of SOE outputs, it did not seek to influence their internal efficiency and marketing. Second, the NDRC monitoring remit was significantly narrower than that of the SPC. The focus of SPC activities was the whole economy, while that of the NDRC was a number of specific industries. Only in exceptional cases did the NDRC interfere with enterprises in competitive markets, its regulatory scope being limited to certain markets that were monopolized by SOEs (whether as buyers or as sellers).

6.4.3 C  entral Planning and State Monopoly: Conditions and Implications The transformation of the state sector from the dual-track system to a state monopoly may be said to have been the most important economic reform initiative in China since the 1990s. Its success was dependent on the fulfilment of two external conditions. Firstly, the state sector needed a strong regulator to protect its interests. Before the 1998–2003 reform, the SPC had failed in this role because of its absence of sufficient authority and management skills. It did not have the power to interfere in the non-state sector, and was therefore unable to prevent external competitors from competing with SOEs in both input markets (i.e., to stop non-SOEs from accessing key inputs) and output markets (to restrict entry by non-SOEs into specific markets). By contrast, the NDRC’s remit extended to regulating a much wider range of domestic economic activities, enabling it to eliminate any potential competitors that threatened a state monopoly. The SPC did not have the necessary management skills to handle conflicts among SOEs because of its status as part-owner of all SOEs. But the 1998–2003 reforms removed this function and transferred it to SASAC. As a result, the NDRC was no longer in the position of simultaneously owning and having to supervise SOEs’ internal affairs, and was therefore able to direct its attention to the

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overall interests of the entire state sector rather than just those of individual firms. Thus, the NDRC could focus on regulating competition and improving management by SOEs in order to protect their monopoly powers and ensure that poor corporate governance and/or the loss of monopoly powers did not cause them to fail. Secondly, the monopolized state-sector market had to be sufficiently large to guarantee SOEs’ monopoly rent. Before 1993, when the Chinese government had still not acknowledged the inevitability of introducing at least a degree of privatization among SOEs, the vast majority of Chinese economic activities were carried out within the state sector. From the perspective of rent extraction, a small non-state sector was not capable of generating a sufficient large surplus for the state sector. Before the end of the 1990s COEs had existed in the Chinese economy as another form of enterprise, accounting for up to a third of China’s GDP. Under both the planning economy and dual-track system, COEs also benefited from central planning, which meant that the state sector could not simply regard the collective sector as a supplier of rent in monopolized markets, since formal and informal ‘back door’ channels within the planning system enabled COEs to purchase inputs at below monopoly prices and even allowed them to pursue their economic operations in SOE monopolized markets. In short, the establishment of the state monopoly was based on two processes: the privatization of some SOEs and the entire collective sector and the expansion of the private sector. The state sector also faced challenges from within: in particular, it had to make sure that the key monopoly industries would not be invaded by the non-state sector. As early as the beginning of 1990s, China’s policymakers realized that if some key industries were monopolized by non-­ state-­owned enterprises they (the non-SOEs) would secure monopoly rent and come to exercise sufficient influence to cause economic or political instability. In addition, if an industry monopolized by non-SOEs was in a fundamental position, non-SOEs would gain rent from other monopolized (state) enterprises, to the potential detriment of the state sector’s monopoly interests.19 The implementation of the 1998–2003 reform was the means whereby the state sector was released from the dual-track system and transformed

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into a state monopoly. During this period, the state sector and its supervisors underwent two major changes. First, in the state sector, policymakers abandoned their previous practice—advocated on the basis of equity considerations—of using surpluses from successful enterprises to offset the poor performances of unsuccessful enterprises. This marked a definitive end of the dual-track system, under which SOEs with poor economic performance had always been able to enhance the appearance of their accounts by concealing their losses. Secondly, the state sector seized China’s key industries, and through the helpful intervention of policymakers, non-SOEs’ entry rights were blocked. As a result, the 1998–2003 reform split China’s industrial sector into two parts: monopoly industries (some were oligopolistic) and industries that were to a greater extent competitive, mainly comprising non-SOEs. From the end of the 1990s until the beginning of the 2000s, the transformation of the state sector into a state monopoly exercised a positive influence on China’s market-oriented reform. Under the dualtrack system, enterprises’ access to crucial inputs had largely depended on their ownership structure and their close links to the planning track. In the input market, market-track prices were determined not only by supply and demand conditions, but also the planner’s division of output between the two tracks. It was quite frequently the case that the same enterprise might find itself facing more than one price when buying or selling a given product because of different conditions confronting buyers and sellers that derived from their different ownership statuses. The dual-track price system did not achieve market clearing as China’s policymakers hoped and expected. In the input market, although the dual-track system went some way towards relieving shortages, markets were still distorted. When SOEs became state monopolies, the uncertainty—some would say chaos—associated with the dual-track system was removed.20 The economic role of the state sector changed substantially after it had undergone this comprehensive transformation. Under the dual-­ track system the state sector functioned in two ways: it could procure economic surplus via the planning part of the system such as through free accesses to natural resources, infrastructure and monopoly status;

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and it could reallocate this surplus. Given the scale of the state sector under the dual-track system and the reallocated targets, including the state and collective sectors, the scope of the redistribution of the SOEs’ industrial surplus embraced the entire urban sector and part of the rural sector—and involved not only the delivery of industrial goods to firms and individuals, but the provision of various social welfare to residents. From 1993, the distributional role of the state sector began to weaken and eventually expired. Thanks to the reforms, the retention of profits by state monopoly enterprises was a critically important factor, contributing to SOEs’ improved economic performance.

6.5 Conclusion The dual-track price system, introduced in the 1980s, sought to maintain a large-scale, independent state sector. However, thanks to policymakers in China having overestimated the efficiency of the state sector and its potential for improvement, for nearly twenty years of reform efficiency losses continued to accumulate, until the combination of bad loans from the financial sector and government debt (both visible and invisible) forced the government to introduce further urgent reforms in 1998–2003. The purpose of the 1998 reform initiative was not to force SOEs to participate in market competition. The policymakers had at last acknowledged the lack of market competition participation and now embarked on radical reform in an attempt to privatize most enterprises that were directly competing with non-SOEs. In support of the state sector, they also put in place a system of supervision, which formed a firewall between the state and non-state sectors enabling SOEs to maintain monopoly power in a number of specific industries and shield their monopoly status from encroachment by the non-state sector. This transformation of SOEs constituted the most significant change in China’s economy since they first embraced reforms in 1978. Thereafter, with the economy split into competitive markets and monopoly markets, the state sector came to enjoy unprecedented prosperity.

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Notes 1. Part of the remit of SASAC was then to decide whether funds should be collected by the Chinese Treasury or made available to fund new investment. 2. Under the unique corporate governance structure of SOEs, chains of agents often prevented SOE managers from focusing on profit maximization. However, there is abundant evidence that the state sector was able to monopolize upstream industries and industries, where they could procure economic rents from all economic actors (firms and individuals). The state sector received a sizeable surplus from these industries. 3. China had previously forbidden public market trading of state-owned shares. 4. Also known as China Grid. 5. This is because some industries were favoured by their position in the market or by their ability to access inputs cheaply from the planning system. 6. Most ‘rural loans’ were distributed to collectively owned TVEs. 7. For example, in Wenzhou city, which is regarded as the birthplace of China’s private economy in the reform era, the s­ tate-­owned banks were unable to satisfy entrepreneurial loan demand. But private lending was prohibited on pain of severe punishment. Lefeng Zheng, a local ‘banker’ who operated a rotating savings and credit association was sentenced to death and executed in 1986 (she was the last person executed under the socialist anti-capitalism law before it was abolished as part of the 1987 legal reform). The final liquidation result showed a loss of RMB 500,000 out of her total assets of 62,000,000. Her business was profitable, given that a liquidating action cost much more than 0.8%. 8. Mainly for cost reduction purposes, COEs were attached to the state sector. Their running costs were significantly lower than those of SOEs. 9. Tongshou tongzhi: this refers to the convention whereby the SOE revenue is directly remitted to the state, while all SOE costs and expenditures are paid directly from the state treasury. 10. Known as ‘profit delivery by taxes’ reform (li gai shui, 利改税 (State Council and Ministry of Finance, 1983)). 11. In 1985, the state’s fiscal revenue was RMB 200.5  billion, of which 50.7 billion yuan were used for SOE subsidies. 12. In this reform, the central and local government renegotiated the sharing ratio of tax income, leading to an increase in the central government’s share of tax income.

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13. In the 1998–2003 SOE reform, most small SOEs had been removed from the direct control of local governments, causing two problems in the local economy. First, although many SOEs were privatized, local governments still directly or indirectly held their shares or were liable for debts that were guaranteed by local government. Second, privatized enterprises still had top priority in terms of bank loans and government subsidies. 14. For example, the value-added per firm in COE sector (the majority are TVEs) grew from two million in 1992, reached 3.05 million in 1993, and further hit 4.27 million in 1994. 15. Caused by the disappearance of the dual-track system. 16. During the central planning era, the number of enterprises controlling input supplies had no effect on market structure since they were distributed according to priorities determined within the planning system. However, in the wake of economic reform, competitive markets emerged not only under the impact of increasing rivalry among SOEs, but also because of the state sector’s loss of monopoly over inputs due to the fact the state was unable to control large number of SOEs before 1998 restructure. For instance, in the 1990s the ownership of numerous small coal mines and oil fields was transferred from local SOEs to the nonstate sector, simply because of local governments’ and/or SOE managers’ wish to secure instant cash income. 17. For example, Jiang Zemin, the former president, in his early career was promoted from Changchun’s First Automobile Works as a senior manager. 18. The purchasing prices of rice and wheat were directly administered by the State Council. Some non-governmental services and utility prices (for instance, the taxi tariff, which was decided by local government authorities) also lay outside the remit of the NDRC. 19. However, before the SOE’s firewall, the NDRC, was finally put in place at the end of the 1990s, only a few private investors had access to sufficient funds to be able to invest in key monopoly industries. Foreign investment in monopoly industries was also blocked by policymakers (State Council 1995, 2002). As a result, there was not a great deal of competition in key state sector industries before they were transformed into monopolies. 20. By way of illustration, it is telling that in the rail transport sector, which was slow to abandon the dual-track system, the demands of some bidders were left unsatisfied. By contrast, much more efficient market clearing was apparent in the aviation industry, which was much quicker to abandon the system.

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References Fan, G. (2000). Lun tizhi zhuangui de dongtai guocheng—feiguoyou bumen de chengzhang yu guoyou bumen de gaige (On the Dynamic Process of Institutional Transition in China, 论体制转轨的动态过程——非国有部 门的成长与国有部门的改革). Economic Research Journal, 1, 11–61. Fan, G. (2003). Zhuangui jinji lilun yu guoyou qiye gaige (On the Transitional Economic Theory and the Reform of the Chinese State-Owned Enterprises 转轨经济理论与国有企业改革). Journal of Yunnan University (Social Sciences Edition), 5, 64–69. Hao, S.-c., Tian, J.-f., & Hu, T. (2012). Guoyou gongye qiye xiaolv de hangye jianyan (An Industry Inspection on the Efficiency of State-Owned Industrial Enterprises, 国有工业企业效率的行业检验). China Industrial Economics, 12, 57–69. Hu, Shudong. 2001. Jingji fazhanzhong de zhongyang yu defang guanxi—zhongguo caizheng zhidu bianqian yanjiu (The Relations Between the Central and Local Governments in Economic Development—Together with Research of China Fiscal Institutional Changes, 经济发展中的中央与地方关系—中国 财政制度变迁研究). Shanghai: Shanghai People’s Publishing House. Huang, Y. (2003). Selling China: Foreign Investment During the Reform Era. New York: Cambridge University Press. Jefferson, G. H., Rawski, T. G., & Zheng, Y. (1992). Growth, Efficiency, and Convergence in China’s State and Collective Industry. Economic Development and Cultural Change, 40(2), 239–266. Ma, R. (2011). Zhongguo guoyou qiye xiaolv yanjiu (Research on the Efficiency of State-Owned Enterprises in China, 中国国有企业效率研究). Shanghai Journal of Economics, 12, 20–28. Qian, T. (2008). Difang zhenfu, zhidu bianqian yu minying jingji fazhan, (Local Government, Institutional Changes and the Development of Private Economy, 地方政府、制度变迁与民营经济发展). Hangzhou: Zhejiang University Press. Qian, Y., Roland, G., & Xu, C. (2001). Attribute Coordination in Organizations. Annuals of Economics and Finance, 2(2), 487–518. Qian, Y., & Xu, C. (1993). Why China’s Economic Reforms Differ: M-Form Hierarchy and Entry/Expansion of the Non-State Sector. Economics of Transition, 1(2), 135–170. Sheng, H., & Zhao, N. (2012). China’s State-Owned Enterprises: Nature, Performance and Reform. Beijing: World Scientific Publishing Company.

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7 TVE and the Economic Environment

7.1 M  arket Environment: Is There a Chinese Index? In almost all of the literature about China’s economic transition, the most frequently mentioned term is perhaps ‘market environment’ or ‘economic environment’. A feature of the literature is that it almost always assumes that the market environment is an exogenous variable, although there is very little theoretical discussion of how such variables might be observed. In terms of empirical studies, the most systematic attempt at quantitative research on the market environment is captured in the ‘Index of Marketization of China’—including both national and provincial indexes—constructed by the National Economic Research Institute (NERI) of the China Reform Foundation (CRF) (zhongguo jingji gaige yanjiu jijin hui, 中国经济改革研究基金会). The NERI marketization index of China and other similar indexes share a similar goal, which is to track and measure the process of marketization in China and its regions; more specifically, it regards the activities of China’s private sector as the standard measurement by which to evaluate the market system. When the institutional environment is seen to favour the private sector or enhances © The Author(s) 2017 C. Jin, An Economic Analysis of the Rise and Decline of Chinese Township and Village Enterprises, Palgrave Studies in Economic History, DOI 10.1007/978-3-319-59770-6_7

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the performance of the private sector, the index is closer to its optimal value; and vice versa. Empirical evidence shows that after the implementation of the policy-­ driven process of privatization in the late 1990s, China’s private sector became the mainstay of the economy. As already discussed in previous chapters, the gradualist nature of China’s transition was different from that of both the former Soviet Union and other Central European socialist countries. Not least, within a twenty-year prior to large-scale privatization, the non-state sector (including the private sector) had already been growing. In the early 1990s, the industrial output of the non-state sector surpassed that of the state sector. Another noteworthy feature of China’s experience—one that was not matched in other transitional economies— is that when the economic reforms began in the late 1970s, the main body of non-SOE entities was concentrated in the collective sector, and more than half of them1 were TVEs located in the countryside. In an attempt to address the special nature of the collective sector in China’s economy, Tian (2000, 2001) uses mainstream approaches in order to explain and interpret the economic environment and property rights arrangements of collectively owned enterprises (COEs). Tian argues that since, at the time of his study, the economic environment was still in a transitional state and had not attained full market status, the ambiguities of property rights under ‘collective-ownership’ actually enabled COEs to perform better—at least in some certain capital intensive industries—than private-owned enterprises. Tian’s theory offers the most comprehensive explanation of ambiguous property rights to date. In previous chapters, we have proposed some amendments to Tian’s theory: at the micro level, opting for collective ownership rather than private ownership reflects institutional constraints on ownership arrangements and handful other institutions—and such arrangements are not closely linked to the ‘economic environment’ in any meaningful sense. Tian’s theory also contributes to an explanation of the economic performance of TVEs, which is essentially captured in the embedding of economic entities’ suboptimal property rights arrangements in the suboptimal economic environment. This explanation has been quite widely accepted as the theoretical basis for the construction of various kinds of economic environment indices.

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However, it is unreasonable to interpret the late-1990s privatization reform (including the privatization of most TVEs) as providing direct evidence of an improvement in China’s economic environment, since the main driver of the privatization policy was central government, and the outcome of local privatization was only important as a criterion by which to judge local government officials’ performances. The privatization of TVEs in most provinces took place in the first stage of the reforms between 1998 and 2003. Privatizing small-scale non-private enterprises, including COEs, was the earliest significant policy measure to address the financial crisis. Up to and including 1999, TVEs with above-average performance and profitability were involved in or had already undertaken privatization. In terms of time sequencing, the Chinese government set out its privatization policy before embarking on efforts to improve market conditions in and for the private sector. Thus, logically speaking, privatization cannot be regarded as a result of changes in the economic environment. It is not possible to compare the market environment before and after the 1998–2003 reform of TVEs because the definition of such enterprises was changed in the process of privatization itself: following privatization, the notion of the TVE became that of a geographical entity (e.g., Wang 2003), being described simply as only to ‘firms physically located in the rural area’. Assuming that empirical investigations make it possible to formulate some kind of unbiased ‘economic environment index’ measurement for the private sector, can the theory and the unbiased measurement be used in order to evaluate China’s transitional economy? These are the issues that are considered in the rest of this chapter. To anticipate the conclusion, our analysis leads us to believe that the answer to the question posed above is negative. In previous chapters we have discussed China’s economic policy from the late 1970s until the early twenty-first century. We have seen that many of China’s most important economic policy decisions were driven by SOEs and their interests. This is a reflection not just of ideology but, more importantly, also of the special status of the state sector in China’s economy. China’s economic environment has not been determined by straightforward market institutions, shaped by the forces of demand and supply; rather, to a significant extent, for many years it was the

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s­tructure and behaviour of the state sector that moulded that environment. Moreover, in the first twenty years of China’s economic reforms, the influence of the state sector on the economic environment and on the non-state sector (including TVEs) was almost certainly greater than market guidance mechanisms. Even after SOEs in some industries retreated from competitive markets, China’s major upstream industries and non-­ welfare infrastructure remained under the control of the state sector. In a quantitative or numerical sense, the most distinct characteristic of China’s economy has therefore been the coexistence of the state and non-state sectors. Since the late 1970s, the boundary between the two has shifted: initially (during the early phase of economic reform), the boundary was rather blurred; but following the restructuring of the state sector, between the late 1990s and the early years of the twenty-first century, each has come to acquire its own distinctive identity and status. Fan’s (2000) two-sector model can be applied to Chinese conditions only before the 1998–2003 reform, whether viewed from the perspective of theoretical hypotheses (based on the nature of the competition between the state sector and the non-state sector) or of empirical evidence (the gradual contraction of the state sector and growth of the non-­ state sector). Implicit in this is the belief that there have been two types of ‘modes of economic reform, divided by the 1998–2003 restructuring of the state sector: the first, which follows Fan (2000), was the “old” mode of gradualist reform pursued in the context of a weakening state sector; the second, as defined by Lin (2004), was the ‘new’ reform mode, pursued after 2003, which led to a strengthening of the state sector.

7.2 The ‘Old’ Reform 7.2.1 T  he Economic Environment: The State Sector as the Dominant Component In China’s economy, two factors have shaped and even defined the nature of the economic environment, broadly conceived. The first is the market factor—a prominent economic actor in so many textbooks: central to its

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role is the mechanism that uses price signals in order to achieve market equilibrium. The second is the planned economy (or some variant of the planned economy). The significance of the planned economy in the context of China’s economic environment derives from the gradualist nature of its (China’s) transition (Fan et  al. 2002). In contrast to the economic transition of Russia and other former communist countries, the gradual transformation of China’s state-owned sector has been a very distinctive feature: this distinctiveness is captured not only in the progressive reduction of its size in the economy, but also—and much more significantly—to its continued functioning as a key element of the economy. Before the integrative reforms of SOEs in the 1990s, the state sector played the role of direct ‘re-allocator’ in China’s economy. This role reflected the fact that the state sector constituted the major part of the economy in urban sector, determined families’ material living standards and welfare through payment of salaries, as well as non-cash methods (e.g. provision of medical care and education) and adjusted the income gap. All these functions of the state sector have been thoroughly discussed in the literature. Additionally, the state sector was the principal arbiter of reallocation across the whole of the industrial sector. Under the centrally planned system, one of the manifestations that the price signal was ‘distorted’ is that the performance of enterprises was evaluated on the basis of physical output, with prices being deliberately manipulated to adapt to output in order to ensure that the price of the final product always exceeded its cost. The result of this evaluation system is that when a profit criterion was used to evaluate industrial sector performance under central planning, that performance was necessarily related to the level of the firm’s physical output, but not necessarily related to efficiency indicators. Since China’s state sector did not implement rapid privatization or corporatization until quite late in the reform process, for about twenty years the state sector continued to dominate China’s entire industrial sector. A further consequence of this was that the reallocation function of the state sector within this sector was not weakened to any significant extent. Before the 1998–2003 SOE reform, the re-allocative role of the state sector in the industrial sector was vital to non-SOEs, especially COEs (of which TVEs were a principal component), since the degree of

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­ arketization of the industrial input market during this period remained m quite limited. Without recourse to the state sector, TVEs were not even able to obtain the essential industrial inputs they needed. It follows that for COEs (mostly TVEs), prior to the privatization reform the state sector’s re-allocative function in many ways constituted the most important part of the economic environment.

7.2.2 The gongxiaoyuan (‘Salesman’) Phenomenon For most of the 1980s and 1990s a distinctive feature of Chinese enterprises was the job, and role, of the gongxiaoyuan (供销员), or ‘supply and marketing/sales official/representative’. Although most SOEs and non-­ SOEs had a ‘supply and marketing branch (department)’ (gongxiaoke, 供 销科), only non-SOEs sent out large numbers of ‘salesmen’ in the conventional sense, non-SOE gongxiaoyuan could exert strong discretionary power through the use of a variety of incentives ranging from sales discounts to large-scale bribes. Three distinctive features characterized supply and marketing representatives and the work they did. First, in order to be appointed as a representative, it was essential that they had spent a significant amount of time working in their trading—partner enterprises; second, the main task of non-SOE representatives was to purchase inputs; third, the trading partner enterprises to which they were sent were normally SOEs. These characteristics and the nature of the role played by supply and marketing officials had their origin in China’s pre-1978 centrally planned economic system. Under China’s central planning system, economic plans directed by the Planning Commission (jiwei, 计委) were not sufficiently comprehensive to embrace all products and accommodate every circumstance, and when demand for seasonal products was influenced by the weather or planned output exceeded or failed to meet demand, unplanned transactions took place. For instance, Shanghai Milk Company (the predecessor of Bright Dairy and Food Co. Ltd), the largest manufacturer of milk products in China under the dual-track economy, has always purchased packing materials2 from its neighbouring non-SOEs. After the establishment of the central planning system, policymakers in China, in contrast

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to those in the former Soviet Union, were not capable of maintaining a wholly consistent vertical central plan: there always existed unplanned transactions3 between SOEs and SOEs, as well as between SOEs and non-SOEs. The dual-track price system, which first emerged in the early 1980s, caused the number of unplanned transactions among enterprises to expand dramatically, and all sorts of COEs, especially TVEs, began to seek a more diversified range of sources (industrial raw materials). However, from the late 1950s, when TVEs came into being, until the late 1990s, trade between SOEs and non-SOEs relied heavily on the coordinating functions carried out by the gongxiaoyuan. This dependence on gongxiaoyuan largely reflected the lack of two important elements in China’s economic institutional framework. First, in trade transactions between SOEs and non-SOEs there was no legal institution to protect contracts signed between the two parties. In the case of such transactions between SOEs, this problem did not arise, since protection was afforded by the planning system itself, rather than contracts. (The Law of the People’s Republic of China on Tenders and Bids, and the Contract Law of the People’s Republic of China, which addresses potential legal issues arising out of transactions between SOEs and non-SOEs, were not published until 1999.) Second, until the mid-or even late 1990s, China possessed neither a large-scale, stable market for raw materials nor a market for other industrial inputs. For instance, Shanghai Huadong Steel Market and Keqiao Textile City were set up as recently as 1992 and 1993, and did not become (respectively) the centre of the steel trade of Eastern China and the centre of China’s fabric trade until the late 1990s. Hitherto, China had exercised strict surveillance and control over swing transactions on bulk raw material markets. Non-SOEs’ deeds of resale, especially those of individuals or private enterprises, were classified as ‘speculation and profiteering’ (toujidaoba, 投机倒把), a criminal charge4 introduced in 1979 to the Criminal Law of The People’s Republic of China (and carrying a maximum sentence of death), which was not abolished until 1997. This policy was a major obstacle to the emergence of a comprehensive industrial input market in China. In the absence of more formal institutions, the existence of gongxiaoyuan provided a compensating5 informal de facto institution for ­non-­SOEs.

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There had long been cooperation between gongxiaoyuan and SOEs, although this relationship was a suboptimal solution in the absence of an effective contract. Nevertheless, one of the most salient features of the routine of sales departments of many of the most important SOEs—on almost a daily basis by the 1980s—was to receive visiting gongxiaoyuan from non-SOEs. This stable and long-term relationship (guanxi, 关系) between gongxiaoyuan and SOEs substituted for an official contract, which offered a degree of protection against the defaulting of any agreement, as well as providing the basis on which modifications to existing arrangements might be made. Second, the existence of gongxiaoyuan partially compensated for the absence of an industrial input market. From the 1980s to the early and mid-1990s, major industrial raw material supplies still remained within the remit of the state sector. However, because the geographical location of SOEs was determined by the evolution of the pre-1978 planned economy, only a limited number of any given kind of industrial input producers could be found within the same region. In short, until the second half of the 1990s, gongxiaoyuan were an effective and cost-effective substitute for genuine market-driven relations.6 Third, gongxiaoyuan were able to secure relatively favourable quasi-contractual terms for COEs. Because of the rent-seeking behaviour that was so common within the SOE sector, non-SOEs could achieve more efficient rent-­ seeking by establishing a long-term relationship between a gongxiaoyuan and relevant SOE(s), thereby gaining benefits in terms of price, quantity and stability in their trade with SOEs. TVEs’ accreditation of gongxiaoyuan to SOEs conferred on them (TVEs) a kind of privilege that was not available to private enterprises. Only enterprises whose ownership was classified as non-private were qualified to dispatch gongxiaoyuan equipped with a letter of recommendation or similar identity documents (for most of the 1980s, only the letter of recommendation presented by village and township governments or above, or issued by the SOEs themselves was acceptable to SOEs), and only gongxiaoyuan who possessed officially approved documents of this kind could travel legally.7 TVEs constituted the main body of COEs, and it was the all-important gongxiaoyuan mechanism that provided the opportunity for TVEs to engage direct in trade with SOEs, enabling them to obtain inputs from SOEs under the dual-track system. In short,

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by such means, collectively-owned TVEs had priority over private enterprises in securing such inputs, as well as accessing related information channels.

7.2.3 The Rule of the State Sector: Dual-Track Pricing As for the consumer goods market, it can be argued that the prototype of China’s dual-track system in the early 1980s was the black market that had been such a feature of the central planning economy in China before 1978, as indeed it had been in so many other centrally planned, transitional and wartime economies. Since China’s ‘central purchase and central supply’ mechanism under the planning system tended to generate scarcities and shortages, residents were forced to purchase consumer goods on the black market at prices that were higher than the official (rationing) prices. The expectation was that as the economic transition progressed and supplies improved, the black market would disappear. However, under the impact of China’s post-1978 economic reforms, some of the features of the black market became more permanent fixtures within the economy. In the consumer goods market, on the one hand, since central policymakers were reluctant to abandon subsidies to urban residents, SOEs had to continue to supply urban residents with low-priced consumer goods. On the other hand, thanks to the policy measures and incentives designed to encourage higher output, from the late 1970s to early 1980s the supply of agricultural goods and light industrial products increased rapidly. As a result, policymakers had neither the intent nor the ability to put in place subsidies for all consumer goods. At the beginning of the economic reforms, a dual-track pricing system—captured in the coexistence of a rationing price and retailing price—was established for food and light industrial products in the consumer goods market. In the consumer goods market the rationing quota was set far lower than that needed to meet de facto demand and supply, as a result of which throughout the market black market prices served as de facto ‘proper’ market prices. This situation continued until the late 1980s and early 1990s, and spawned a complicated transaction system8 involving

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f­ oreign exchange certificates in the durable consumer goods market. Non-­ rationing (market) prices were much higher than rationing prices across the whole consumer goods market, linking the dual-track system to the rationing system in this market. Before the abolition of the rationing ­system—especially that of the food product rationing system in 1993— the dual-track price system was a prevalent characteristic of China’s consumer goods market. In addition, rationing and non-rationing prices were still quite separate, even in state-owned retailing enterprises. For instance, when residents did not have sufficient ration coupons (peijiedu, 配给额度) to obtain durable consumer goods, they were forced to purchase such goods at prices above the rationing prices—either directly with cash or indirectly, using foreign exchange certificates. The dual-track price system was more complicated in the industrial input market. The term ‘dual-track’ would appear to indicate that under this system economic transactions between SOEs and non-SOEs involved only two prices: namely, the planning-track price (formulated as part of the central economic plans), and the market-track price (determined by market forces and therefore unconnected with such plans). In reality, however, this arrangement only applied to SOEs—and even for these enterprises, not always. In other words, even for transactions between SOEs, the simple dual-track price system did not apply, except for a very short time. After 1978, the fangquanrangli reform got under way. However, there was no consensus among the various provinces, industrial departments and central planners about which price system should be adopted in respect to any incremental (i.e., above quota) output, following the implementation of the fangquanrangli reform. The outcome was that SOEs decided the sales price of off-planning output according to their specific affiliation. As a result, since SOEs were affiliated to quite a wide variety of different local governments and departments, the price gaps between planning and off-planning output varied considerably. In short, there was no universal norm for the off-plan price.9 The 1984 price reform (State Council 1984) shaped the rudiments of the dual-track pricing system. This reform divided industrial products into three price categories: planning price, self-sale price (zixiaojia, 自销价) and market price (off-planning price). It was stipulated that the s­ elf-­sale

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price should be no more than 20 per cent above the planning price, while the market price should be 20 per cent or more above the planning price. By 1985 (State Price Control Bureau and State Commodities Bureau 1985) the regulation governing the floor below which the off-­planning price was not allowed to fall was abandoned, and SOEs were allowed to sell at a price ‘slightly lower than the market price’. Thus, the two offplanning prices were unified into a single price. It is, however, important to bear in mind that the self-sale price (determined by region or industry), the three-price system of 1984 and the dual-track price system in 1985 were all designed only to regulate transactions between SOEs. For non-SOEs there was another dual-track price system, comprising the market price (the actual purchase price paid by non-SOEs, also referred to as the ‘delivered price’10) and the off-plan price of SOEs. That is to say, SOEs’ off-plan sale price under the dual-track system was lower than non-SOEs’ actual purchase price. This price gap was mainly a result of the insufficient output of SOEs, and for the whole of the 1980s and into the early 1990s, non-SOEs’ output increased faster than that of SOEs. From 1980 to 1993, for example, non-SOEs’ output increase was 12.7 per cent points greater than the corresponding increase generated by SOEs. Nevertheless, SOEs still produced the majority of all industrial inputs: for instance, their output in 1993 accounted for 82.3 per cent of that of the whole extractive industry, with some basic raw materials, such as petroleum, reaching 99.8 per cent. As a result, the state sector’s inadequate output performance caused continuous hunger for inputs on the part of non-SOEs, and the price gap derived from this hunger. Under this system, it was easier for TVEs than for private sector businesses to obtain inputs because SOE sales (circulation) were accessible exclusively to the non-private sector. Before the liberalization policy of 1993, private firms were forbidden from directly purchasing goods produced by SOEs; they were not permitted access to stocks held by SOEs either. When the state sector sold its goods at the off-plan price, private firms were not qualified to acquire them through direct trade. In short, when there was a shortage of inputs, TVEs and other COEs could acquire such products at prices close to SOEs’ off-plan prices, but the private sector could only obtain them by paying the higher market price.

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Before the abolition of the dual-track system in China’s industrial sector, the input distribution system we have described, dominated by the state sector, confirmed input costs according to the form of enterprises ownership, allowing TVEs to secure inputs at discounted prices because of their nominal collective ownership status. On the other hand, in terms of sales in the consumer goods market, prior to the 1998 reform China’s main retail channels, especially wholesalers, were all controlled by the state sector; even as late as 2004, seven of the ten biggest wholesalers in the market were SOEs. It was easier for SOEs and COEs to enter the retail market than it was for private enterprises. When producers sold products to retailers, state-owned retailers’ typically gave producers a long- or short-term draft guaranteed by a bank. SOEs and COEs could present the draft to a bank and use it to obtain a bridging loan, or they could give it to their suppliers as a payment guarantee. However, if private firms wanted to cash their draft for extra funds, which in accordance with the business practices of China’s state-owned banks, would have been regarded as a loan. This process was not only complicated in terms of the procedure (extra guarantees were required) and took a great deal of time, but could be fruitless since banks often rejected requests of this kind from private firms.11 Meanwhile, since drafts endorsed by or to private firms were not guaranteed, it was difficult to get them accepted by other manufacturers (Zhang and Ji (2003) discussed the changes in financial sector over the TVE privatization). All this imposed an additional cost on the activities of private firms entering the state-owned retail system. Under the state-owned retail system, except for products sold at the ration price by SOEs through the plan track, consumers paid a flat price for goods. The profit level was therefore largely decided by input purchase conditions: specifically, whether or not a firm could obtain the required inputs, and at what price these inputs could be purchased. Since these conditions were all determined by a firm’s ownership status, we may conclude that ownership form was a dominant determinant of the cost of firm’s inputs. As a result, distinct cost differences were generated among SOEs, collectively owned TVEs and private firms.

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7.2.4 T  he Economic Environment for TVEs: Characteristics of the Pre-1998 Reform As discussed above, before the 1998–2003 reforms were launched, previous economic reforms in China had been characterized first, by an attempt by policymakers to maintain the overall integrity of the state sector, and second, by those policymakers’ efforts to use the dual-track price system as the basis for redistribution within the state sector. A variety of factors gave rise to these two characteristics of China’s transitional economy, such as the existence of a relatively weak tax system and of an inadequate welfare system which was not sufficiently comprehensive to be able to embrace the whole of society. From the perspective of this book, it is an important observation that these characteristics and their influence constituted the dominant factor shaping China’s economic environment during the first two decades of reform. The way in which the pre-1998 economic system was organized had shaped the economic environment of TVEs at least in three ways. First, the coexistence of a large-scale state sector and the dual-track system enabled TVEs to profit in the inputs market. When surpluses were redistributed within the state sector through the dual-track system, the TVE sector benefited from being a free rider (e.g., Wang (1997), Guo and Liu (2003) discussed the overdeployment of factors in the TVE sector). Because various collectively owned and other kinds of de facto private firms operated under the name of COE as members of the non-private sector, SOEs could not always easily identify genuine non-private firms. Accordingly, they had little option but to treat all firms equally in selling them inputs. It was no doubt hoped that the dual-track system would take account of such ambiguities and difficulties. But that system was essentially designed to facilitate the subsidizing of COEs, which were viewed as components of the state sector alongside the SOEs, and functioned, like SOEs, as constituent elements of the central planning system. From the 1980s, because of the dramatic rise in the share of TVEs among COEs, the operation of the dual-track system effectively channelled to TVEs almost all the subsidies from SOEs that were made available for COEs. In effect, SOEs were subsidizing the TVE sector, whose

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activities increasingly approximated to those of the private sector than to those of the state sector. This resulted in serious conflict between SOEs and TVEs in the 1980s and 1990s: supporters of SOEs attacked TVEs openly in newspapers and on television, accusing them of ‘undermining the foundation of socialist society’ (挖社会主义墙角 by poaching SOEs’ surpluses). Second, TVEs were also able to acquire invisible subsidies from the state sector through the agency of local government. In the first phase of the reforms the economic importance of the state sector loomed as large as it had done under central planning, and some of its activities continued to fall outside the remit of the central government. As a result, before the 1998 reform, local governments continued to exercise control rights over local SOEs, including branches of state-owned banks. But after the 1998 reform, since SOEs’ profits were controlled by the Ministry of Finance and had to be remitted to the national treasury rather than to local government, local governments were more inclined to engage in transactions that supported local COEs—mainly comprising TVEs. When transactions took place on terms of trade that favoured TVEs, local government could hope to share in TVEs’ profits, or at least benefit from TVEs’ expenditure (e.g., from over employment, as in Sonobe and Otsuka (2003), or Fan and Yuan (2002)). By contrast, even in circumstances in which SOEs were suffering losses, their expenditure was to a large extent separate from local government finances. As a result, making up such losses was not the responsibility of local government, but that of the Ministry of Finance or state-owned banks. Another way in which local government commonly subsidized TVEs was by demanding that state-owned banks should grant loans to TVEs. Because the managers of local branches of state-owned banks were appointed by local government, it was almost impossible for them to refuse such demands. Third, the state sector was able effectively to weaken the private sector in order to improve TVEs’ competitiveness. With the state sector in control of most transactions—including sales of inputs and consumer goods—in all sectors of the Chinese economy, the dominance of the state sector served to weaken the private sector. Before the state sector began to contract, private firms not only suffered economic discrimination at the hands of SOEs, but were also undermined by SOEs through legislative

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devices. For instance, the activities of the private sector were constrained by the danger that making profits from the wholesale consumer goods, grain and steel markets might be construed as having committed a criminal offence. Because of the difficulty of unambiguously identifying and classifying private and non-private sector activities (see above), the state sector could not prevent TVEs from gaining a foothold in the desirable COE sectors (for example, the rise of Huaxi Village—located in South Jiangsu and sometimes described as the richest village in China—had its origins in its participation in iron and steel market speculation). TVEs were mainly concentrated in the light industrial sector and especially the consumer goods market. SOEs were far less efficient than non-SOEs in these markets, and since only the private sector could compete with TVEs, SOEs fulfilled the role of doorkeepers for TVEs. As the empirical evidence shows, before the 1998–2003 reforms, supposedly collectively owned TVEs in the southern half of Jiangsu Province (Sunan, 苏 南) made up the main body of the local economy, and their economic performance outshone that even of Wenzhou (Zhejiang Province), where the private sector dominated the economy and markets. It is revealing, however, that when the state sector retreated from the highly competitive consumer goods market, the positions of the two regions were reversed.

7.3 The ‘New’ Reform 7.3.1 T  VEs and the Impact of the 1998–2003 SOE Reforms As mentioned above, at the heart of the 1998–2003 SOE reforms were the following three initiatives: (a) the reduction in the scale of the state sector and its withdrawal from highly competitive markets; (b) the merging of SOEs, thereby enhancing the vertical and horizontal integration of the state sector, and minimizing the frequency of market transactions and competition among SOEs; (c) the strengthening of regulation in selective areas in order to guarantee the monopoly power of SOEs.

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These reforms had two major effects on the state sector. First, the internal attrition of the state sector was minimized. Before the reform, the state sector was large and vulnerable. Some SOEs were profitable, but the expenditure burden carried by the state sector as a whole was extremely heavy. Thus, the state sector had the responsibility of subsidizing loss-­ making SOEs and COEs and other enterprises that performed badly; it was charged with the provision of welfare for urban residents Like a leaking pipe, in the first twenty years of China’s reform this expenditure burden not only exhausted the entire state sector surplus, but also required subsidy payments to be forthcoming from the central government fiscal budget. The 1998–2003 reforms gradually stopped the leakages, maximizing the state sector surplus and enhancing its surplus capacity. Official Chinese sources often used the term ‘core competitiveness’ to capture the state sector’s surplus capacity although this capacity derived in truth not from competition but from the exercise of monopoly powers. However, before the establishment of the National Development and Reform Commission (NDRC), the state sector’s ability to exercise such powers, even in the case of SOEs that were natural resource based, was increasingly under threat from private enterprises and COEs, as local governments began to sell rights to exploitation and management, which had originally been controlled by SOEs, exclusively to non-SOEs. The NDRC addressed this problem by legitimizing SOEs’ privileges and forcing non-SOEs to leave these markets; in extreme cases, non-SOEs were allowed to operate alongside SOEs, but under the supervision of SOEs and by doing so to keep these markets to continue under the monopoly power of the state sector. These developments also influenced COEs, and fundamentally changed the economic environment of TVEs after the 1998–2003 reforms: The greatest effect of the 1998–2003 reforms on TVEs was to halt the subsidization of COEs by the state sector. Before 1998, SOE support for COEs came mainly from two sources: the dual-track price system and loans from state-owned banks. The dual-track price system was abolished in the major consumer goods market in 1992–1993, but it remained in the industrial goods market until about 1998. The abolition of the dual-­ track price system had a double impact on TVEs: first, they no longer

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had price or access advantages in obtaining industrial goods. After the dual-track system ended, the state sector raised the prices of industrial inputs very sharply and freely sold these inputs to all enterprises at the same price. TVEs therefore lost their special relationship with SOEs, and the role of gongxiaoyuan was replaced by that of a conventional ‘salesman’, as we understand the term today. Second, the demise of the dual-track system eradicated previous differences in treatment, in terms of market access, between private enterprises and COEs. In the financial system, thanks to the ongoing reform of state-owned banks, lower-level local governments were no longer able to interfere in banks’ debt and credit business, making it impossible for COEs any longer to enjoy preferential loan treatment over private enterprises. The other significant effect of the 1998–2003 reforms on COEs was to banish TVEs from a number of markets or limit their ability to enter markets. Before 1998, thanks to the privileges afforded to COEs by local governments and/or in order to increase local government income, in certain provinces a large number of TVEs entered industries that had previously been the exclusive preserve of SOEs. Thus, TVEs entered the coal industry in Shanxi Province and Neimenggu (Inner Mongolia), petroleum extraction in Xinjiang and oil processing and production in the provinces of Shandong, Fujian, Hunan and Hubei. After the 1998 reform, the NDRC adopted a series of measures which it used to banish non-SOEs from those industries. For example, the oil fields of Xinjiang petroleum extraction enterprises were compulsorily nationalized’, and a large number of downstream oil enterprises compulsorily purchased by SOEs; and energy price increases after 2007 forced some privatized non-state-owned coal enterprises in Shanxi Province and Inner Mongolia to be nationalized. An even clearer example of this trend was that of Tieben Steel (a steel enterprise located in Jiangsu Province), which in 2004 sought to compete for market share with neighbouring state-owned steel enterprises through an output expansion plan,12 and an associated budget of 10.6 billion RMB. The response of the central government was to stop the investment and put the senior enterprise management into prison on criminal charges of tax evasion.

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7.3.2 L ate 1990s: Privatization and the Economic Environment By the late 1990s and early 2000s, a number of important institutional and political initiatives were responsible for China’s economic system moving in a direction which favoured the private sector. First, following the privatization—with very little preparation—of almost all enterprises in competitive markets (1997–2000), the Chinese government went to great effort to legalize most market behaviour of private firms in order to prevent the collapse of these competitive markets because of the lack of a basic legal framework. With SOEs having left these markets in large numbers, the original industrial and market regulations designed to protect SOEs were no longer needed. Consequently, private firms’ market access expanded rapidly during these years, as they gained many of the privileges that had previously been the exclusive preserve of non-private firms (for example, the ability to speculate in commodity markets and to engage in direct foreign trade transactions). More importantly, it became much easier for private firms to obtain inputs: this was attributable not only to the disappearance of the dual-track system (which facilitated the emergence of transparent price changes), but also to the elimination of almost all obstacles to private firms entering the inputs market. A corollary of these developments was that a large number of professional industrial input markets were formed to target private firms. Second, in 2001 China entered the World Trade Organization (WTO)—an event which carried great significance for consumer goods manufacturers, the majority of which were private firms. In order to meet the needs of WTO accession, China undertook a major review of existing legislation, and abolished large number of domestic laws that were at variance with the terms of WTO membership (most previous regulations designed to limit the activities of private firms were rescinded, and private businesses in most markets were liberalized). Furthermore, after joining the WTO, both developed and many developing countries outsourced to China, focusing especially on labour-intensive consumer goods production—a development that had the effect of swiftly amplifying product markets.

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Third, because so many SOEs had disappeared from the scene, resources originally allocated to SOEs—for example, bank loans, land, etc.—became accessible to the private sector. With the devaluation of assets caused by the 1997–1998 Asian financial crisis, the private sector simultaneously experienced increasing financial capacity and decreasing capital prices, accelerating its capital deepening process. The period from 1999 to 2000 was the only period since the beginning of economic reform in 1979 when the level of bank loans per unit of SOE output decreased. In these two years it was easier for private firms to obtain bank loans than it had been at any other time. These changes were equally important for SOEs. In terms of the input market (including circulation and logistics channels) before the 1998–2003 reforms significant inefficiencies attached to the manner in which not only the private sector, but also state-owned enterprises, accessed this market: a large proportion of output was allocated to other SOEs by the planning system at the plan-track price and the rest was purchased by COEs and SOEs at market-track price, which was lower than the ‘true’ market price. Enhanced access to the market by the private sector allowed SOEs and private enterprises to trade in a more direct and efficient market. Thus, the new characteristics of China’s major input markets became apparent: a few state-owned suppliers monopolized the product markets, the demand side comprised a large number of private firms, and the abolition of the complicated dual-track transaction structure strengthened SOEs’ bargaining power. Before China joined the WTO, the main sales target of non-SOE economic activities had been the domestic market. After 2001, China’s fast-­growing foreign trade increased private sector demand for industrial raw materials. However, while it liberalized the domestic market, the state did not liberalize the input market: with the establishment of the NDRC, the state gathered the majority of industrial inputs together into a small group of SOEs and made it legally impossible for domestic or foreign competitors to enter major industrial input markets. For example, PetroChina and Sinopec were granted the franchise for importing oil and petroleum products, and apart from a limited number of smallscale petroleum ­corporations, all of which were SOEs dealing in certain specialized markets, other enterprises were banned from importing such

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products.13 Similarly, the import quota of iron ore was apportioned by an industry association composed of several major steel industry SOEs. Meanwhile, China’s commodity and capital market was only semi-­ liberalized. The government only relaxed the purchase and sales regulations for non-SOEs participating in the competitive market. In the case of markets—whether from the supply or demand side—comprising monopoly SOEs, from 2003 onwards, such regulations were adjusted in such a way as to facilitate the consolidation of SOEs and increase their average size. This policy initiative and resulting changes in the economic environment all had their origins in the guidelines which had been used in the restructuring of the state sector from 1998 to 2003. The withdrawal of the state sector from competitive markets created a liberalized light industrial goods market that most consumers and foreign buyers could access. SOEs’ efforts were concentrated on meeting the needs of the private sector; their business now focused mainly on industrial products of upstream industries which remained a relatively long distance from consumers. The effect of these changes was to make SOEs’ monopoly powers in these markets much greater than in any other market.

7.4 T  he Nature of the Chinese Economic Environment After China embarked on its economic reform in the late 1970s, the economic environment of its enterprises was shaped by three main components: price, the degree of market openness and the nature of the government-enterprise relationship. During more than thirty years of economic transition these three elements were in constant change under the impact of China’s economic development trajectory and adjustments—new departures and retrenchments—of state policies. However, we would argue strongly that during these three decades the single most important influence shaping the economic environment was the 1998–2003 reform initiative. With the implementation of these reforms, China’s economic environment reached a turning point.

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First, the role of the dual-track price system was subsumed into a new set of arrangements. The original idea behind the system was that the use of two price tracks would determine the input and output prices of all SOEs, while perpetuating degrees of price differentials between firms, depending on whether they were state-, collective- or privately owned. The 1998–2003 reform merged SOEs within their relevant supply chains, integrating firms involved in upstream to downstream operations to ensure that the production of major industrial goods and services took place within a single enterprise before the final product was released to the market. Second, the state refocused its political and economic controls within the Chinese economy towards specific markets. The 1998–2003 reform abrogated almost all of the functions of the Central Planning Commission, and replaced this body with the NDRC, whose remit was to oversee and supervise those industries in which SOEs continued to exercise monopoly powers. These adjustments shaped the degree of market openness: they were accompanied by rapid deregulation of the consumer goods market and strengthened control of upstream markets. Third, the previous close (even symbiotic) link between non-SOEs and local government was broken, while the linkage of central government to SOEs was reaffirmed. Under the impact of the reforms, the capacity of local government to influence local SOEs was dramatically reduced, and local government lost most of its ability to reallocate resources on a large scale from SOEs to non-SOEs. On the other hand, thanks to the reduction of the number of SOEs and the expansion of their average size, central government was able to use the NDRC as a vehicle for controlling major large-scale state enterprises. Before the 1998–2003 reform, a large number of small-scale SOEs, TVEs and other COEs occupied a secondary, supplementary, intermediate position in China’s economic environment (Tan 1998; Zhang and Feng 2000; Chen 2000). On the one hand these enterprises derived some benefits from the dual-track system, heavy market regulation and the political intervention of local governments—although such benefits were not as great as those accruing to large-scale upstream SOEs. On the other hand, they competed in the product market with private firms that derived no benefit from the prevailing economic environment.

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From this perspective, we may infer that this economic environment was characterized by three salient features. First, (upstream) SOEs were free of competition, faced with little or no competitive pressure from the market in the pursuit of profits. Second, while small/intermediate scale or downstream, non-private enterprises could derive some benefit from the economic environment, they also had to participate in market competition. Corporate governance structure played a key role here: enterprises that could successfully convert from corporate governance to semi-­private business operations—these were mainly TVEs and a small number of other COEs—were more likely to survive such competition. Third, although private firms could not access any surplus from SOEs, they did face competition. However, the 1998–2003 reforms transformed these non-private firms that had played such a secondary role in private enterprises, thereby reducing the dimensions of China’s economic environment to two main constituent elements. This was essentially because the state made it impossible any more for surpluses from SOEs enjoying monopoly profits to be transferred or reallocated to other enterprises. We consider Tian’s (1995, 2000, 2001) theory to be an incomplete description of China’s economic environment. Tian mistakenly regards surplus—spilling over from SOEs to the benefit of TVEs before the 1998–2003 reforms—as a competitive advantage derived wholly from TVEs’ strong micro-level corporate governance structure. The theoretical inference is that there was no linear causality between the economic environment and enterprise performance, at least in the case of China. The relationship between economic environment and enterprise performance reflected the impact of institutional factors that systematically allowed some of the monopoly profits of SOEs to accrue to TVEs, and underestimating, at least to some extent, the strength of the SOE performance. Consequently, it is important to distinguish between (a) the increase in efficiency resulting from improvement in the corporate governance structure, (b) the efficiency increase reflecting the correction of resource misallocation and (c) enhanced profitability brought about by redistributive factors. In fact, when assessing enterprise performance through the prism of the surrounding economic environment, surveys usually regard

 Notes 

  191

profitability as the principal goal of economic activity. However, this view ignores the fact that profit is determined not only by neo-classical endogenous factors, such as market liberalization and corporate governance structure, but also by exogenous factors. At least in the case of China’s transitional economy, since the government still owns and controls a large proportion of economic resources—and since market operations reflect the combined workings of market institutions and government intervention—it is not appropriate to assess institutional and enterprise performances simply on the basis of a single factor—the market—based on the marketization index. The economic performance of an enterprise reflects the effects of micro-level and macro-level forces: the former, captured in the governance structure of firms; the latter, in the nature of the market structure (this being the main determinant of input and output prices). No doubt, there are various links between the two. But the relationship is not purely one of causality.

Notes 1. In 1978 the industrial output of China’s commune and brigade enterprises (CBEs) was RMB 49  billion yuan, while that of its collectively owned enterprises (COEs) was RMB 95 billion yuan. 2. For instance, ice cream packing material or popsicle sticks. The demand for these products could not be planned because of the unpredictability of the weather, and few SOEs could supply according to demand. 3. Under the central planning system, it was simple to deal with this kind of transaction. Generally, bulk transactions between SOEs could be recorded afterwards, and small transactions with non-SOEs were settled using enterprises’ reserves (petty cash). The scale of these transactions was very small before the 1978 reform, but they persisted for a very long time. 4. As long as the total price of sold goods was in excess of 10,000  yuan (approximately 1900 dollars at the 1980s exchange rate) of the transaction fell into the category of criminal speculation. 5. That is, it compensated for the lack of formal institutions. 6. This continued to be the case until the professional market was formed in the late 1990s.

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7. In the 1980s and early 1990s there was still a serious anti-loitering law in China. Travel, especially by non-urban residents, was strictly limited. 8. Under the foreign exchange regulations, individuals were not allowed to hold foreign currency, but the government issued foreign exchange certificates, so that foreign currencies had to be converted to foreign exchange certificates according to the official rate. The foreign exchange certificates could be used to purchase imported commodities (including durable consumer goods) without ration certificates, generating a premium between foreign exchange certificates (which had a face value expressed in RMB) and RMB. 9. The terminology of the ‘off-plan’ price did not exist at that time. The term that was most commonly used was ‘self-sale’, which referred to enterprises’ product sales outside their plans. 10. Daochangjia, 到厂价. 11. It was a major part of the business of some black market money shops to cash drafts for private firms; when they did so, they always charged a mark-up (usually expressed as a certain percentage of the draft’s face value). This was especially common in business practices in places like Wenzhou, where the private sector was more developed. 12. After 2003, China’s economy moved into an expansionary phase, and a large number of infrastructure projects (especially railways) were approved, with budgets of more than 1000 billion RMB. One consequence of this was a major increase in the demand for iron and steel. 13. Since China lacked natural gas, its chemical materials and refined oil were all petroleum-based products.

References Chen, J.  (2000). zhidu bianqian yu xiangcun feizhenggui zhidu—zhongguo xiangzhen qiye de caichan xingcheng yu kongzhi (Institutional Change and Rural Informal Institution—The Formation and Control of Properties of China’ s Township Enterprises, 制度变迁与乡村非正规制度–中国乡镇 企业的财产形成与控制). Economic Research Journal, 80, 48–55. Fan, G. (2000). Lun tizhi zhuangui de dongtai guocheng—feiguoyou bumen de chengzhang yu guoyou bumen de gaige (On the Dynamic Process of Institutional Transition in China, 论体制转轨的动态过程——非国有部 门的成长与国有部门的改革). Economic Research Journal, 1, 11–61.

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Fan, G., Wang, X., & Zhu, H. (2011). Zhongguo shichanghua zhishu (NERI INDEX of Marketization of China’s Provinces 2011 Report, NERI 中国市场 化指数). Beijing: Economic Science Press. Fan, J., & Yuan, Z. (2002). ‘Xiangzhen qiye jiuye zengzhang quhuan shi yuanyu qi ziben mijihua qingxiang ma—xiangzhen qiye jiuye de jiegou fenxi’ (Does the Employment Growth Slowdown in Township and Village Enterprises Caused by its Capital Intensification—A Structural Analysis on TVE’s Employment, 乡镇企业就业增长趋缓是缘于其资本密集化倾向吗— 乡镇企业就业的结构分析). Chinese Rural Economy, 8, 47–57. Fan, S., Zhang, X., & Robinson, S. (2002). Zhongguo jingji zengzhang he jiegou tiaozheng (Structural Change and Economic Growth in China, 中国 经济增长和结构调整). China Economic Quarterly, 2(1), 181–198. Guo, W., & Liu, Z. (2003). Huigu yu fansi: xiangzhen qiye de jishu xuanze lujin he bijiao youshi (Review and Rethink: Technological Path and Comparative Superiority of Township and Village Enterprises, 回顾与反思: 乡镇企业的 技术选择路径和比较优势). Issues in Agricultural Economy (Monthly), 10, 30–35. Lin, J.  Y. (2004). Zisheng nengli, jingji fazhan yu zhuanxing lilun yu shizheng (Viability, economic development and theory and empirical studies on economic transition, 自生能力经济发展与转型理论与实证). Beijing: Peking University Press. Sonobe, T., & Otsuka, K. (2003). Productivity Effects of TVE Privatization: The Case Study of Garment and Metal Casting Enterprises in the Greater Yangtze River Region. National Bureau of Economic Research (NBER) Working Papers 9621, NBER, Cambridge. State Council of the People’s Republic of China. (1984). Guanyu jinyibu kuoda guoying gongye qiye zizhuquan de zanxing guiding (The Interim Provisions to Further Expand the Autonomy of State-Owned Industrial Enterprises, 关于进 一步扩大国营工业企业自主权的暂行规定). Beijing: State Council of the People’s Republic of China. State Council of the People’s Republic of China. (1985). The State Administration for Commodity Prices and The State Administration for Commodity Reserve. Guanyu fangkai gongye shengchan ziliao chaochan zixiao chanpin jiage de tongzhi (Notice on Opening the Price of over-Fulfilling Self-Sale Production of Industrial Production Raw Material, 关于放开工业生产资料超产自销 产品价格的通知). Beijing: The State Council of the People’s Republic of China. Tan, Q. (1998). Cong qiye de xingzhi kan xiangzhen jiti qiye chanquan gaige de fangxiang (Prospective Futures of Collective-Owned Township Enterprises

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Based on Firm Properties, 从企业的性质看乡镇集体企业产权改革的方 向). Chinese Rural Economy, 3, 13–20. Tian,G. (1995). zhongguo xiangzhen qiye de chanquan jiegou jiqi gaige (Property Rights Structure and Reform on China’s Rural and Township Enterprises, 中国乡镇企业的产权结构及其改革). Economic Research Journal, 3, 13, 35–39. Tian, G. (2000). Property Rights and the Nature of Chinese Collective Enterprises. Journal of Comparative Economics, 28(2), 247–268. Tian, G. (2001). A Theory of Ownership Arrangements and Smooth Transition. Journal of Institutional and Theoretical Economics, 157(3), 380–412. Wang, X. (1997). Dui Xiangzhen qiye zengzhang de chongxin guji (Re-estimate the Growth of Village and Township Enterprises, 对乡镇企业增长的重新 估计). Economic Research Journal, 1, 31–39. Wang, X.-p. (2003). Xiangzhen qiye zhudao de quyu chanye kongjian yanjiu (Study on Regional Industrial Space Dominated by the Village and Township Enterprise, 乡镇企业主导的区域产业空间研究). Economic Geography, 23(3), 299–303. Zhang, J., & Feng, Q. (2000). Jiti suoyouzhi xiangzhen qiye gaizhi de yige fenxi kuangjia, (An analytical Framework of Restructure of Collective Township Enterprises, 集体所有制乡镇企业改制的一个分析框架). Economic Research Journal, 8, 12–20. Zhang, J., & Ji, H. (2003). Nongcun jinrong yu Xiangzhen qiye minyinghua: yige zongshu (Rural Finance and the Village and Township Enterprise’s Privatization: A Literature Review, 农村金融与乡镇企业民营化: 一个文 献综述). Reform, 4, 93–98.

8 Conclusions

8.1 Structure of This Book The research contained in this book has fallen into two parts. The first part has addressed the nature of the evolving relationship between TVEs and local government in China. In particular, it investigates how TVE entrepreneurs have used institutionalized power in order to secure the political influence they have needed to defend the financial independence and stability of TVEs. The broad focus of the second part of this book is the role of state-owned enterprises (SOEs) in China’s economic transition. To be specific, it seeks to analyse the functions of one of the institutional pillars of the state sector—the dual-track price system—and to show how the TVEs used this institutional framework in order to tap the surplus of SOEs and the whole economy. Most of the existing literature (e.g., Li 1996; Oi 1992, 1999; Tian 2000, 2001; Chang and Wang 2004; Zhang 1996, etc.) takes the ‘ambiguous’ property rights in TVEs to reflect causality between China’s imperfect market environment—whether the line of causality runs from property rights to market environment or vice versa. One of the main objectives of this study has been to examine, in detail—and taking each © The Author(s) 2017 C. Jin, An Economic Analysis of the Rise and Decline of Chinese Township and Village Enterprises, Palgrave Studies in Economic History, DOI 10.1007/978-3-319-59770-6_8

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on its own terms—the ownership structure of TVEs, and the economic environment in which they have operated. We have argued that the ownership structure of TVEs evolved out of and reflects distinctive historical developments and conditions. Further, we suggest that the reason why the economic environment seems to have favoured TVEs is that surplus resources have spilt over from the SOE sector and flowed into the TVE sector—as most of the existing literature takes the view that the ownership structure of TVEs evolved out of the economic environment. Our view, however, is that it is crucial to regard each factor separately, as we have tried to do in this research. In the first part of this book, we examine issues relating to TVE managers’ effort levels. We analyse the application of mainstream contract theory and related approaches, and propose an alternative explanation in an attempt to overcome a number of weaknesses in the mainstream methodology. Thereafter, we investigate the role and functions of SOEs and related state institutions as part of China’s economic environment, and argue that changes taking place in the SOE sector have had major implications for China’s TVEs. Finally, we analyse some of the problems that arise in the application of an economic, or market, environment index in empirical studies.

8.2 C  onclusion I: The Micro Structure of TVE Ownership 8.2.1 P  roblems with Principal-Agent Model-Based Approach The first problem here relates to the micro structure of TVE ownership: there exists a well-developed principal-agent model-based framework, but we argue strongly that the basic assumptions underlying this framework—especially about those pertaining to the implementation capacity of local government—are not correct. First, if the mainstream hypothesis holds, the appointment and dismissal of TVE manager will be determined by representatives (i.e.,

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township officials) of local government. However, if we apply the principal-­agent model in order to analyse the behaviour of TVEs, there is a danger that the enterprise owner’s management process under the professional manager system will be confused with the government’s management process under the planning economy. Prior to the SOE reform in 1998, in the government-dominated SOE and COE sectors: (a) the government officials not only selected the enterprise manager, but were also involved in day-to-day enterprise operations; (b) since they were responsible for day-to-day monitoring of firms, the government officials have up-to-date information about firm operation; (c) the appointment of an enterprise manager was not entirely based on the economic performance of the enterprise. If we accept the assumption that no cost will accrue to the government as a result of appointing a new TVE manager, we shall have to recognize that there is no significant difference between TVEs, SOEs and large (county-level) COEs. If this were the case, it would be difficult—if not impossible—to explain why the operations and performance of TVEs have been so different from those of the non-private enterprises mentioned in the previous sentence. Second, the approach based on the principal-agent model generates the conclusion that the local government—and its agent(s)—can obtain income from TVEs at a low cost. If this inference holds, then, following the basic principles of contract theory, when the TVE manager lacks sufficient institutional mechanisms to protect against extractions by local government, TVEs’ assets will be cashed by the local government (e.g., in a simple Hart-Grossman style two-stage model). This is different from the circumstances of state- and/or some collectively owned enterprises. Before the abolition of the dual-track pricing system, SOEs and COEs were both integrated into the central planning system. Because of the inherent pressures and constraints of that system and the need to ensure that sufficient supplies of goods were made available to the planning ministries, local government was unable to encash the assets of SOEs or COEs. However, TVEs lay outside the central planning system, as a

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result of which they did not enjoy the same protective shield that was available to their state-owned (or collectively owned) counterparts. The purpose of applying principal-agent model is to explain why the agent exerts a higher level of effort. The explanation given in the model holds as long as it can be demonstrated that there is sufficient incentive for the principal to monitor the agent rather than seeking to gain from the enterprise by pursuing self-interest. However, in the case of TVEs, local government officials—in the role of the principal—are not the owners of the enterprise. Thus, the level of their incentives cannot be guaranteed and nor therefore can the quality of their supervision of TVE managers. On the other hand, at the heart of the principal-agent model is the issue of the distribution of profits between the owner and the operator of an enterprise, and the extent to which the principal can secure greater bargaining power. However, empirical evidence (Jiang 2000) drawn from studies of the development of TVEs demonstrates unambiguously that the majority of TVEs’ revenue was used to expand the scale of their operations, rather than being passed to the local government. Che (2002) used the framework of principal-agent theory as the basis on which he proposed a theoretical solution to why the local government might engage in extractive exploitation of TVEs. Zhou (1997) used a similar approach, but based on empirical investigations. Che argues that TVEs could encourage local government to reduce their exploitation of TVEs, through rent-seeking. However, Che’s approach is at odds with the basic theoretical underpinnings of principal-agent theory. One of the basic hypotheses set out in this model is that the principal has complete information about output (ex post facto), but the rent-seeking activities in Che’s model cannot in fact substitute for this basic assumption.

8.2.2 A  n Alternative Explanation: The Entrepreneur’s Political Role One of the important findings of this study relates to the link between TVE entrepreneurs and local politics. Some TVE entrepreneurs joined the local government rather than use external rent-seeking activities, with the result that TVEs’ level of disbursements to local government

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was reduced. Because of the distinctive characteristics of the institutional framework of the planned economy in the Mao period, the lowest-level local officials enjoyed a certain degree of autonomy. Given the resource shortages that existed at grassroot levels, the granting of such autonomy to local government officials may be regarded as a shirking of its responsibilities by the central government. In other words, by encouraging the emergence of a self-governing community within the rural communes, the central authorities were able to avoid the responsibility of funding localities’ needs, while continuing to exercise its claims on local products (especially agricultural output) through the planning system. At the end of the 1970s, as some of the functions of the system of central planning were being redefined and even phased out, the rural community effectively ceased to be a significant component of the planned economy (Kojima 1993). TVE entrepreneurs took advantage of such institutional resources. First, in the self-governing community (i.e., the commune and brigade), some local officials at the lowest level of administration were not part of the formal CCP bureaucratic system, and the requirements of their position and livelihood were met by community members. For part-time, non-professional politicians, the cost of holding these posts was relatively small, and such positions made a suitable target for TVE entrepreneurs to seize. Second, because the local officials at this lowest level were able to extend their positions indefinitely, once TVE entrepreneurs had taken over such posts, it was extremely difficult for higher level officials to remove them. As long as the lowest-level officials in a self-governing community could protect their positions from any challenge from within the local community, it was very difficult for agents outside that community to replace the incumbent with a new appointee. In short, as long as officials at this lowest level could assert and maintain their authority within the local community, the stability of their position was effectively guaranteed by the nature of the bureaucratic framework of the CCP’s political organization. Third, once TVE entrepreneurs were assured of stable and long-term political support from their community, TVEs could be said to have gained de facto independence. We argue that it is not only the principal-agent structure that can provide a high level of incentives. Rather, as is suggested in the work

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of Zhou (1997), Che (2002) and Huang (2008), who make similar assumptions, some kind of de facto ownership can also provide such incentives. Further, we argue that the essential basis on which TVEs could successfully maintain this kind of de facto ownership, was by exercising political control over the community (which was the ultimate legal or political claimant on TVE ownership). By being able to exercise stable and long-­term political control in this way, TVE managers could be, and were, protected against the disruptive impact of intervention by higher-level government officials in TVE activities. If a TVE entrepreneur could exercise political control over their community while simultaneously managing a well-functioning and efficiently operating enterprise, the likelihood is that he would be able to secure sufficient economic resources to support (and maintain) his political power. Thus, a virtuous circle could be established, facilitating the indefinite extension of political power. With TVE entrepreneurs having established political control over their communities, those communities in turn were able to provide the entrepreneurs with a political ‘shield’ against encroachment from outside—one subsequently given legal endorsement through enacted legislation. This shield has been strong enough to protect any collectively owned assets held at the self-governing-community level,1 and by sheltering behind this shield a TVE entrepreneur could reasonably assume and expect that TVE assets would not be targeted by local government. In their work, Che (2002) and Zhou (1997) hypothesized that TVE assets would be a target of local politicians’ rent-seeking activities, encouraging TVE entrepreneurs to become involved in politics in order to reduce the rent-seeking cost. In contrast to this approach, we argue that TVE entrepreneurs have been motivated to try to establish control over the political agenda at community level in order thereby to prevent TVE assets from becoming targets of political rent-seeking activities. This conclusion, which is arguably grounded in theoretical reasoning, is the key to understanding TVE entrepreneurs’ high level of effort in TVE operations. This finding promises to contribute to existing TVE and transition theories in two respects. First, it offers an alternative explanation of the micro mechanism of the TVE sector’s outstanding performance in the 1980s and early 1990s.

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Unlike any principal-agent model-based theory, we have sought to explain the high level motivation of TVE entrepreneurs without introducing extreme assumptions, such as that entrepreneurs are especially skilled in concealing financial information (Che 2002), or are very adept at manipulating local politics (Zhou 1997). By emphasizing and illuminating the relationship between TVE entrepreneurs and government, we have tried to provide a micro foundation of TVE behaviours. Second, if our argued alternative micro foundation of TVE performance is accepted, then our theory promises to make a contribution to some current issues in transitional economic debate. One immediate implication is that the study advanced here offers the basis of a view that contradicts the idea that local governments not only promote TVEs to cooperate with other firms or the government, but may also improve the quality of TVEs’ corporate governance (Oi 1999). Further, our theory may also help towards a better understanding of the role of local Chinese government in the reform era.

8.3 C  onclusion II: SOE Sector as the Economic Environment 8.3.1 S  OE and Dual-Track System as Economic Environment Until the late 1990s, the SOE sector dominated—even defined—the Chinese economy to the extent that government departments were effectively the servants of the state sector. It is a short step from this statement to argue that the state sector (including the legal and political framework in which it was set) still constituted the most important element in the market environment during the earliest phase of China’s post-1978 reforms. Through the analysis of each stage of this gradualist economic reform process—but focusing especially on the dual-track price system that operated from the early 1980s until the middle of the 1990s—we find that the dual-track price system not only worked to transfer payments within the state sector by allocating revenue from high-revenue SOEs to more poorly performing enterprises, but was also the source

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of a spillover effect resulting in resources leaking from the state sector to other non-private enterprises. Analyses of SOEs from late 1980s to 1998 sometimes describe the SOE sector as a weak patient, often as a drag to China’s near two digital economic growth. Although SOEs was condemned for its low efficiency, leading up to 1997, it still monopolized almost all China’s upstream product markets, dominated communication and banking industry: it was indeed the monarch of Chinese economy. Further, throughout the 1980s, since TVEs—apart, that is, from the state sector itself—were the largest non-private part of China’s economy, the spillover of revenue from the state sector essentially subsidized the TVE sector. This spillover effect and the effective subsidization of TVEs by the state sector that it made possible are the main reasons why the economic environment so favoured the TVE sector during the 1980s and into the early 1990s. The subsidy comprised three main elements: (a) TVEs were able to purchase industrial inputs at the market-track price, which was lower than the market price. Since the private sector was not eligible to participate in trading under the dual-track system and could only purchase inputs from markets operating outside that system, cost advantages thereby accrued to TVEs. (b) The ability of TVEs to enter those distribution channels open only to the non-private sector meant that they were able to access the majority of domestic markets. In effect, non-SOEs (including TVEs) that had access to these distribution channels benefited from a de facto subsidy (which contains institutional economic rents—the access to retailing markets). (c) TVEs were able to secure loan quotas from state-owned banks. The quota that TVEs obtained comprised two elements: the first was the part that was shared with other COEs; the second was the part that was exclusively made available to TVEs as policy loans. For the years before the late 1990s, the interest rate charged on loans by state-­ owned banks was consistently below the real inflation rate in China. In short, these loans granted to TVEs not only offered them financial support, but also conferred on them the additional benefit of an interest rate subsidy.

8.3  Conclusion II: SOE Sector as the Economic Environment 

  203

Prior to the second half of the 1990s the de facto subsidy provided by the state sector to TVEs was made possible by the nature of China’s political and economic institutional framework, which effectively worked to the benefit of non-private enterprises. From this perspective, the most important part of this institutional framework was the dual-track price system. We have argued in this study that, contrary to the views of mainstream writers (e.g., Fan (2000)), the dual-track price system itself was not a transition plan (as such), designed to promote the development of the private sector. Rather, its intention was to enhance supply through the use of price incentives in the non-private sector. The dual-track system—partly a political device—was designed to maintain low input prices while maximizing the output surplus, and it was not designed to generate market prices of the kind that would have resulted from the operation of demand and supply forces. Thus, when they were allowed to participate in the dual-track system, enterprises such as TVEs—no matter whether operating on the plan-track or the market-track—secured institutionalized subsidies from the system. Our findings have two implications. First, the productivity gap between TVEs and SOEs before privatization has been overestimated. Most studies regard SOEs in the 1980s and early 1990s as a drag on the Chinese economy: for example, Zhang (2008) concluded on the basis of per capita output data that average SOE efficiency was only one third of that of TVEs. Those who have sought to counter the view that SOEs were inefficient have usually (e.g., see Jin 2002) done so by using as a pretext the extra welfare that SOEs offered its employees. However, our analysis has demonstrated that the role of SOEs under the dual-track price system went far beyond merely dispatching welfare packages to SOE employees or other specific citizen groups (e.g., SOE employees’ families). More importantly, SOEs were a vehicle for the redistribution of income within the whole industrial sector, in contrast with the role of TVEs as pure ‘takers’ from the dual-track system. Second, the SOE sector’s ‘catch up’ in efficiency has also been exaggerated. Studies usually conclude that the SOE sector’s productivity has been consistently improved since late 1990s/early 2000s: for example, Bai et  al. (2006) suggested that the improvement in corporate governance quality was the main factor contributing to SOE productivity

204   

8 Conclusions

growth. However, here we view this phenomenon as a result of SOE sector restructuring—since the abolishing of dual-track system, the large scale SOEs have been able to divest themselves of both small-size SOEs and TVEs, and retain the extra revenue for themselves.

8.3.2 T  he Demise of the Dual-Track System and State Sector Reform From the mid-1990s, China embarked on a fundamental restructuring of SOEs—a reform process that accelerated during and after the 1997–1998 Asian Financial Crisis. These reforms have generated several outcomes. In terms of the physical constituent elements of the economy, reorganization made the SOE sector smaller in its overall scale, but the downsizing also led to an increase in the average size of enterprise (many SOEs becoming large or ‘super-large’ entities); meanwhile, other non-private enterprises were rapidly privatized. In terms of the relationship between enterprises, de-linking of TVEs from the planning system has meant that in the wake of privatization, they faced the same economic environment as other private enterprises. The most important consequence of the SOE reforms was the elimination of the redistribution of surpluses within the state sector through dual-track system. This was achieved mainly by reducing the size of the state sector so that the need to subsidize loss-making enterprises became redundant. There were two main ways in which this was realized: (a) vertical integration within the SOE sector through mergers meant that most transactions were brought within the remit of a single enterprise, eliminating the need for external transactions. In short, non-SOEs were no longer able to obtain an ‘extra surplus’ by becoming a trading partner of SOEs. (b) the reforms provided for the exclusion from the SOE sector of those enterprises which had previously required additional subsidies (and which had continued to consume the surplus of the state sector without generating any revenue). From the early 1990s, such enterprises were privatized and removed from the state sector.

8.4 Conclusion 

  205

The changes in the economic environment resulting from the SOE reforms had a negative impact on China’s TVEs. First, the TVE sector was excluded from the dual-track system, and was no longer able to obtain subsidies when purchasing important industrial inputs. TVEs that had relied on cheap inputs suffered significant losses. Especially badly hit were capital-intensive industrial TVEs concentrated in the southern half of Jiangsu and in the Shandong Peninsula, which had previously benefited from raw materials obtained from the state sector, as well as loans to facilitate their fixed assets investment. Second, through horizontal integration and the consequent reduction of the level of competition in markets dominated by SOEs, state enterprises operating in key industrial input markets enjoyed increased opportunities to charge monopoly rents to all non-SOEs. As a result, TVEs not only had to compete to obtain the inputs they needed, but were also required to pay additional monopoly rents. Having become used to enjoying the institutional benefits of the dual-track pricing system, TVEs found it difficult to adjust to these changes, and they experienced asset devaluation. In general, large-­scale TVEs that had previously been collectively owned faced declining profitability, whereas smaller-scale, more labour-intensive private firms (for example, around Wenzhou in Zhejiang) became more competitive. During the Asian Financial Crisis, currency deflation increased TVEs’ purchasing power and enabled them subsequently to enjoy a degree of asset appreciation. This partly masked a declining profit trend among TVEs, although in more recent years (say, since 2002–2003), the TVE sector has encountered a general reduction in profits as a result of rising input prices.

8.4 Conclusion It is perhaps useful to conclude by summarizing the main points of this book. The core issue of ‘the TVE problem’ has widely been regarded as the nature of the relationship between the ownership structure of TVEs (which has clearly impinged on its economic performance) and the economic environment (defined in terms of China’s economic institutional framework).

206   

8 Conclusions

First—and most important—this study has separated these two components. It has argued that there is no causality between China’s institutional framework and TVE ownership structure. Instead, we have argued that the ambiguous nature of the ownership structure was the outcome of a set of identifiable and specific institutions, rather than of any vaguely defined general institutions. The key issue was the maintenance of political control over China’s self-governing community. On the one hand, the self-governing community could claim ownership of communitybased enterprises, and this ownership was extremely difficult to usurp, even by higher levels of government. On the other hand, the heads of self-­governing community were also able to secure unlimited continuous tenure. Thus, as long as a TVE entrepreneur could maintain control over the community, the exercise of such control was sufficient incentive to enable the entrepreneur to perform as the quasi-owner of the enterprise. Second, this study has addressed the link between China’s economic environment, and the economic performance of TVEs. As the dominant sector in the Chinese economy until 1998, SOEs not only took the biggest share of Chinese economy in terms of both GDP and industrial output, but also operated as de facto branches of government (enjoying concomitant privileges that enabled it to tap a surplus, whether from its access to free natural resources or powers in terms of market access). We have argued that the economic environment in China before 1998 tilted in favour of SOEs, as well as of those non-private enterprises. We have also tried to provide an explanation for the negative correlation between the SOE sector’s performance and the overall scale of TVE sector.2 In short, a significant part of TVEs’ outstanding economic performance is attributable to the fact that TVEs were subsidized by the SOE sector, above all through the dual-track system.

Notes 1. In the recent case of the Wukan (乌坎) protests (in southern Guangdong province), until the intervention of the top level of the CCP, it was very difficult (if not impossible) to revoke local community (village level) heads tenure or touch the collectively owned assets under the community’s control. 2. SOEs used to perform well at the beginning of reform (Zhao 1999).

 References 

  207

References Bai, C.-E., Lu, J., & Tao, Z. (2006). Guoyou qiye gaizhi xiaoguo de shizheng yanjiu (An Empirical Study on the Effects of Ownership Reform in China, 国有企业改制效果的实证研究). Economic Research Journal, 69, 4–13. Chang, C., & Wang, Y. (2004). The Nature of the Township-Village Enterprise. Journal of Comparative Economics, 19(3), 434–452. Che, J.  (2002). Rent Seeking and Government Ownership of Firms: An Application to China’s Township—Village Enterprises. Journal of Comparative Economics, 30(4), 787–811. Fan, G. (2000). Lun tizhi zhuangui de dongtai guocheng—feiguoyou bumen de chengzhang yu guoyou bumen de gaige (On the Dynamic Process of Institutional Transition in China, 论体制转轨的动态过程——非国有部 门的成长与国有部门的改革). Economic Research Journal, 1, 11–61. Huang, Y. (2008). Capitalism with Chinese Characteristics: Entrepreneurship and the State. New York: Cambridge University Press. Jiang, C. (2000). Xiangzhen qiye chanquan gaige de luoji (The Logic of Township and Village Enterprises’ Property Rights Reform, 乡镇企业产权 改革的逻辑). Economic Research Journal, 10, 23–29. Jin, P. (2002). Guoyou qiye genben gaige lun (On Fundamental Reform of State-­ Owned Enterprises, 国有企业根本改革论). Beijing: Beijing Press. Kojima, R. (1993). Agricultural Organization: New Forms, New Contradictions. In R.  Ash & Y.  Y. Kueh (Eds.), Economic Trends in Chinese Agriculture (pp. 97–121). Oxford: Clarendon Press Oxford. Li, D.  D. (1996). A Theory of Ambiguous Property Rights in Transition Economies: The Case of the Chinese Non-State Sector. Journal of Comparative Economics, 23(1), 1–19. Oi, J. C. (1992). Fiscal Reform and the Economic Foundations of Local State Corporatism in China. World Politics, 45(1), 99–126. Oi, J. C. (1999). Rural China Takes Off: Institutional Foundations of Economic Reform. Berkeley: University of California Press. Tian, G. (2000). Property Rights and the Nature of Chinese Collective Enterprises. Journal of Comparative Economics, 28(2), 247–268. Tian, G. (2001). A Theory of Ownership Arrangements and Smooth Transition. Journal of Institutional and Theoretical Economics, 157(3), 380–412. Zhang, J.  (2008). Zhongguo qiye de zhuanxing daolu (The Transition Path of Chinese Firms, 中国企业的转型道路). Shanghai: Shanghai People’s Press.

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Zhang, S. (Ed.). (1996). Zhongguo zhidu bianqian de anli yanjiu, Vol.1 (Case Studies on China’s Institutional Change, 中国制度变迁的案例研究). Shanghai: Shanghai People’s Press. Zhao, X. (1999). jingzhen, gonggong xuanze yu zhidu bianqian (Competition, Public Choice and Institutional Change, 竞争、公共选择与制度变迁). Discussion paper. China Center For Economic Research, Beijing. Zhou, Q. (1997). ‘Kongzhiquan huibao’ he ‘qiyejia kongzhi de qiye’— ‘Gongyouzhi jingji’ zhong qiyejia renli ziben chanquan de anli yanjiu (‘Control Rights Rewards’ and ‘Firms Controlled by Entrepreneurs’—The Human Capital Ownership of Entrepreneurs in ‘Non-Private Economy’, “控制权回报”和“企业家控制的企业”—“公有制经济”中企业家人力 资本产权的案例研究). Economic Research Journal, 5, 31–42.

Index1

A

ABC. See Agricultural Bank of China (ABC) ADBC. See Agricultural Development Bank of China (ADBC) Agricultural Bank of China (ABC), 72, 73, 137n4 Agricultural Development Bank of China (ADBC), 137n5 alternative institutions, 38–9, 79, 80 ambiguous property rights, 26–8, 31–4, 48, 66, 88–92, 107, 170, 195 authority central, 51, 57, 74, 102, 142, 145, 151, 199 fiscal, 57, 121 local, 99, 127 local governmental, 28, 49, 63, 128, 151, 165n18

managerial, 55, 60, 97, 103 moral, 62 political, 29, 102 autonomy financial, 95 operational, 94 political, 29, 101 B

banking system, 7, 29, 30, 71, 72, 77, 121, 123, 127, 129, 130, 135, 144 Bank of China (BOC), 137n4 banks, 7, 25, 30, 31, 40, 48, 50, 59, 63, 71–5, 77, 94, 97, 100, 120–3, 126–35, 137n4, 137n8, 137n9, 141, 148, 149, 153, 154, 164n7, 165n13, 180, 182, 184, 185, 187, 202

Note: Page number followed by ‘n’ refers to end notes.

1

© The Author(s) 2017 C. Jin, An Economic Analysis of the Rise and Decline of Chinese Township and Village Enterprises, Palgrave Studies in Economic History, DOI 10.1007/978-3-319-59770-6

209

210  Index

Bao Steel, 119 bargaining power, 34, 35, 55, 66, 67, 76, 80, 89, 150, 153, 187, 198 behaviour, opportunistic, 36, 99 Bid Rotating Saving, 137 Big Collective, 97, 109n6 BOC. See Bank of China (BOC) brigade enterprises, 52, 93–5 brigades, 9, 52–5, 61, 92–5, 101, 102, 104, 106, 108n4, 109n10, 191n1, 199 brigade secretary, 101, 102 C

capital market, 59, 121, 137n9, 188 cash income, 29, 30, 75, 79, 93, 165n16 CBE. See commune-brigade enterprise (CBE) CBE entrepreneurs, 56, 60, 66, 67 CBRC. See China Banking Regulatory Commission (CBRC) CCAMC. See China Cinda Asset Management Corporation (CCAMC) CCB. See China Construction Bank (CCB) CCP. See Chinese Communist Party (CCP) CCP Central Committee, 9, 128 CDB. See China Development Bank (CDB) Central Bank, 50, 72, 77, 90, 121, 123, 127, 128 Central Financial Work Commission (CFWC), 128

Central Huijin Investment Ltd (CHIL), 127–9 central planning economy, 52–4, 81n6, 93, 95, 107, 115, 129, 144, 151, 155, 157, 177 central planning system, 28, 53–5, 59, 62, 65, 66, 70, 72, 74, 75, 81n5, 91, 96–7, 109n6, 117, 118, 143–51, 155, 157, 158, 174, 181, 191n3, 197 Central Work Committee for Large Enterprises (CWCLE), 127 CFWC. See Central Financial Work Commission (CFWC) CGWAMC. See China Great Wall Asset Management Corporation (CGWAMC) CHAMC. See China Huarong Asset Management Corporation (CHAMC) CHIL. See Central Huijin Investment Ltd (CHIL) China Banking Regulatory Commission (CBRC), 127, 128 China Cinda Asset Management Corporation (CCAMC), 123 China Construction Bank (CCB), 137n4 China Development Bank (CDB), 137n5 China Great Wall Asset Management Corporation (CGWAMC), 123 China Huarong Asset Management Corporation (CHAMC), 123 China Investment Corporation (CIC), 129

 Index    

China Orient Asset Management Corporation (COAMC), 123 China Reform Foundation (CRF), 169 Chinese collective enterprises, 113, 151 Chinese Communist Party (CCP), 2, 3, 6, 8, 9, 22, 25, 27, 28, 31, 39, 41, 48, 50, 51, 53, 56–63, 66, 67, 69–71, 75–7, 80n1, 80n2, 81n9, 81n10, 81n16, 82n17, 93, 101–3, 105, 106, 109n8, 128, 132, 143, 199, 206n1 Chinese economy, 2, 4, 6, 13, 29, 42, 69–70, 95, 96, 114, 116, 126, 142, 154, 157, 161, 182, 189, 201–3, 206 Chinese government, 109n8, 114, 117, 120, 123, 124, 129, 142, 148, 153, 154, 157, 161, 171, 186, 201 Chongqing, 105 CIC. See China Investment Corporation (CIC) COAMC. See China Orient Asset Management Corporation (COAMC) coastal provinces, 12, 104, 105, 118 COE. See collective-owned enterprise (COE) collective-owned enterprise (COE), 12, 26–9, 31, 40, 52–5, 59–63, 66, 67, 73, 89, 90, 93–5, 97, 103, 108n3, 109n6, 113–15, 118, 124, 126, 161, 164n8, 165n14, 170, 171, 173–6, 179–85, 187, 189, 190, 191n1, 197, 202

211

commune-brigade enterprise (CBE), 8, 9, 28, 50–68 Communist Party of China, 9, 50 companies, asset management, 123 competition, 41, 73, 118, 122, 123, 136, 157, 159, 161, 163, 165n19, 172, 183, 184, 190, 205 competitive markets, 120, 129, 135, 136, 149, 150, 154, 160, 163, 165n16, 172, 183, 186, 188 consumer goods market, 119, 177, 178, 180, 183, 184, 189 control rights, 33, 36, 47, 48, 60, 64, 67, 68, 75, 77, 89, 92, 94, 97, 102–4, 106, 142, 182 CRF. See China Reform Foundation (CRF) Cultural Revolution, 43n5, 51, 58, 93, 94, 151 CWCLE. See Central Work Committee for Large Enterprises (CWCLE) D

decentralization, 48, 51, 56–8, 60–4, 70, 71, 76, 77, 80n1, 93, 115 fiscal, 24, 39, 57, 58, 61, 80n1 Deng Xiaoping, 2, 57, 58, 71, 109n8, 149, 154 directional liberalism, 42, 58, 89, 90, 108n1 dual-track price system, 113–37, 145, 162, 163, 175, 178, 179, 181, 184, 189, 195, 201, 203 dual-track pricing, 60, 70, 80, 81n6, 119, 147, 177–80, 197, 205

212  Index

dual-track system, 62, 70, 79, 80, 115–23, 143, 146–63, 165n15, 165n20, 176–81, 185, 186, 189, 201–5

financial capacities, 31, 51, 90, 126, 153, 187 financial institutions, 53, 82n22, 128, 133 fiscal feudalism, 23–5, 70 fiscal reform, 57, 58, 78

E

East Asian, 142, 143 Eastern Europe, 23, 24, 28, 31, 39, 62, 77 Eastern European, 23, 144 economic duality, 1–4 economic environment, 6–8, 13, 26–8, 31, 40, 47, 49, 72, 79, 88, 97, 107, 114, 169–92, 196, 201–6 economic transition, 1, 19–23, 58, 87, 91, 106, 108, 169, 173, 177, 188, 195 efficiency losses, 33, 35, 37, 120, 122, 163 enterprise performance, 149, 190, 191 entrepreneurs, 4–8, 11, 13, 20, 30, 33–6, 39–41, 43n8, 48, 49, 56, 58–64, 66–8, 73–7, 79, 80, 81n11, 82n24, 88–92, 94, 96–100, 102–8, 108n1, 108n2, 142, 195, 198–201, 206 entrepreneurship, 32–6, 40, 41, 62, 98 environment, institutional, 6, 7, 10, 13, 38, 107, 169

G

gongxiaoyuan, 174–7, 185 government brigade-and township-level, 55 county-level, 52, 54, 55, 67, 90 lower-level, 12, 77, 93, 122 government agents, 26, 33–6, 41, 47, 50, 55, 64, 66, 67, 75, 76, 82, 88, 91, 92, 101 government-enterprise relationship, 7, 12, 188 government intervention, 13, 33, 34, 56, 67, 74, 134, 157, 191 government officials, local, 26, 73, 74, 98, 103, 110n19, 171, 198, 199 Greater Yangtze River Region, 138, 193 Great Leap Forward, 43n6, 51, 53, 80n1, 93, 110 H

households, 9, 63, 109n8, 136n3

F

fangquan rangli, 60, 115, 120 finance, 30, 54, 56, 90, 94, 107, 108n4, 118, 123, 134, 182 informal, 134 financial aid, 51, 55, 129

I

ICBC. See Industrial and Commercial Bank of China (ICBC) imperfections, institutional, 31, 37

 Index    

incentives, 20, 23–5, 33, 34, 48, 52, 56, 61, 62, 89, 92–6, 103, 115–18, 142, 174, 177, 198–200, 203, 206 income, fiscal, 22, 57, 70, 78, 144, 147, 150–2 industrial inputs, 8, 70, 75, 80, 118, 119, 146, 148, 174–6, 178, 179, 185–7, 202, 205 output, 1, 3, 20, 43n5, 87, 113, 116, 122, 123, 126, 130, 131, 133, 154, 170, 191n1, 206 products, 28, 53, 54, 59, 60, 70, 119, 122, 143, 144, 151, 154, 159, 177, 178, 188 Industrial and Commercial Bank of China (ICBC), 137n4 industries banking, 128, 132–4, 202 capital-intensive, 149, 154, 170 downstream, 126, 131 monopoly, 161, 162, 165n19 industries, textile, 154 Initial Public Offering (IPO), 82n21, 127, 128 Inner Mongolia, 185 inputs, 5, 8, 28, 33–5, 53, 59, 60, 69, 70, 75, 80, 97, 102, 106, 115–19, 133, 144–51, 156, 157, 159–62, 164n5, 165n16, 174–82, 185–7, 189, 191, 202, 203, 205 institutional change, 4, 36, 38–40, 42, 50 institutional change, small-scale individual-based, 38–40 institutions fundamental, 40, 42, 49, 70–1

213

intermediate, 31, 47 legal, 91, 175 optimal, 27, 28, 31 parent, 91 IPO. See Initial Public Offering (IPO) J

Jiangsu, 11, 12, 14n6, 64, 69, 78, 102, 105, 110n20, 154, 183, 185, 205 Jiangyin County, 102, 109n15, 110n16 joint-liability theory, 25, 26, 29, 33, 48, 90 L

legalization, 74, 107, 108n1 lending, 72–4, 121–3, 128, 131, 132, 134, 164n7 lending activities, 73, 132 lending decision, 128, 134 liberalization, 2, 3, 5, 6, 8, 23, 27, 61–4, 76, 109n8, 179, 191 literature, mainstream, 7, 12 loans, 7, 25, 26, 30, 31, 40, 48, 53, 59, 63, 71–5, 90, 97, 103, 120–3, 128–34, 137n9, 142, 148, 153, 154, 163, 164n6, 164n7, 165n13, 180, 182, 184, 185, 187, 202, 205 local government, 5–8, 11–13, 24–6, 28–31, 34, 39, 40, 42n4, 47–51, 57, 58, 61, 63–7, 70–3, 79, 80, 82n27, 89–91, 93, 95, 98, 99, 101–3, 108,

214  Index

local (cont.) 110n19, 115, 121, 122, 125, 127, 128, 136, 150–3, 156, 157, 164n12, 165n13, 165n16, 165n18, 171, 178, 182, 184, 185, 189, 195–201 government agent, 26, 50, 88, 91, 92, 101 institution, 11, 12 official, 29, 40, 41, 56, 99, 100, 102, 104, 106, 108, 152, 199 local politics, 36, 41, 49, 73, 76, 87–110, 198, 201

M-form theory, 23–5, 29, 31, 36–8, 76, 150, 151 Ministry of Agriculture, 9 Ministry of Finance, 29, 30, 57, 58, 63, 95, 125, 127, 128, 164n10, 182 monopolies(ly), 2, 8, 53, 65, 77, 78, 100, 119, 124–34, 143, 146–63, 164n2, 165n16, 165n19, 183, 184, 188–90, 202, 205 N

M

management skills, 64, 159, 160 Mao, 12, 29, 31, 43n5, 48, 50, 51, 53, 54, 57, 60, 61, 71, 74, 81n10, 82n18, 82n19, 199 markets access, 71, 119, 185, 186, 206 competition, 41, 123, 136, 163, 190 conditions, 97, 136, 150, 171 conditions, competitive, 136, 150 environment, 4, 5, 23, 27, 28, 49, 50, 75, 80n4, 91, 114, 136, 169–72, 195, 196, 201 environment, imperfect, 49, 195 institution, 8, 23, 24, 36, 49, 79, 171, 191 non-competitive, 120, 136 openness, 188, 189 track, 81n5, 119, 135, 146, 147, 149, 162, 178, 187, 202, 203 marketization index, 27, 32, 169, 191

National Development and Reform Commission (NDRC), 80n3, 136, 137n11, 143, 155, 157–61, 165n18, 165n19, 184, 185, 187, 189 National Economic Research Institute (NERI), 27, 169 NDRC. See National Development and Reform Commission (NDRC) negotiation costs, 67, 77, 80 NERI. See National Economic Research Institute (NERI) non-SOEs, 2, 3, 75, 91, 92, 118, 119, 130, 131, 133, 135, 136, 137n9, 145, 147–50, 154, 157, 159–63, 170, 173–6, 178, 179, 183–5, 187, 189, 191n3, 202, 204, 205 non-state sector, 3, 4, 118–20, 122, 129, 135, 136, 145–7, 149, 160, 161, 163, 170, 172 Northeast China, 124, 125

 Index     O

opportunism, 35, 36, 92, 100, 103, 107 ownership collective, 106, 108, 170, 180 quasi-private, 75, 104, 106 structure, 12, 32–6, 48, 54, 56, 87–110, 122, 162, 196, 205, 206 P

PBC. See People’s Bank of China (PBC) peasants, 9, 30, 37, 51, 54, 69, 94 People’s Bank of China (PBC), 72, 77, 121, 128 People’s Republic of China, 9, 175 PetroChina, 158, 187 planned economy, 4, 13, 29, 56, 94, 95, 144, 145, 159, 173, 176, 199 planners, 29, 147, 162 planners, central, 24, 28, 56, 97, 115–17, 143–5, 151, 178 planners, lower-level, 115, 118 planning system, 28, 42n5, 55, 56, 80n2, 144, 145, 147, 161, 164n5, 165n16, 175, 177, 187, 199, 204 policies, release and tighten, 151, 157 policy makers, 5–7, 62, 122, 143, 161–3, 165n19, 174, 177, 181 political activities, 103, 104, 106, 108 political influence, 49, 102–4, 195 political power, 21, 22, 24, 26, 29, 40, 48–50, 74, 76, 77, 102, 104, 105, 200

215

portfolio, 26, 90 Post-Washington Consensus, 23, 62 prices, market-track, 119, 147, 149, 162, 178, 187, 202 prices, planning-track, 117, 149, 178 principal-agent theory, 89, 100, 103, 107, 108, 110n19, 198 private ownership, 2, 20, 27, 31, 33, 37, 59, 70–2, 75, 107, 109n8, 170 private sector, 3, 65, 79, 109n8, 113, 114, 119, 121, 126, 143, 161, 169–71, 179, 181–3, 186–8 privatization, 1, 3, 5, 7, 12, 13, 65, 69, 71, 78–9, 87, 94, 102, 105, 107, 108, 109n8, 113, 124, 126, 133, 142, 152, 161, 170, 171, 173, 174, 180, 186–8, 203, 204 privatization, massive, 27, 87, 122, 153, 154 productivity, 68, 120, 133, 203 professional departments, 95, 106, 125, 144, 148, 150, 151, 153, 157, 158 property rights, 19, 23, 40, 48, 49, 52, 64–7, 71, 87–8, 91, 92, 96–107, 108n1, 170, 195 provinces, inland, 103, 105 R

recentralization, 76, 77, 93 reform era, 2–4, 12, 24, 29, 50, 57, 64, 65, 67, 69, 72, 73, 76, 79, 80, 142, 145, 146, 164n7, 201 reforms, bank, 73, 121, 126–9 reforms, price, 178

216  Index

rent-seeking, 7, 35, 40, 82n24, 88, 92, 98–100, 106–8, 176, 198, 200 resources, economic, 71, 76, 77, 98, 127, 191, 200 RMB, 2, 64, 105, 116, 121, 123, 124, 127, 129, 130, 151, 164n7, 164n11, 185, 191n1, 192n8, 192n12 S

SASAC. See State-owned Asset Supervision and Administration Commission (SASAC) SDPC. See State Development Planning Commission (SDPC) sectors, non-private, 19, 22, 179, 181, 183, 202, 203 Shanxi Province, 185 SOE reform, 8, 13, 60, 81n9, 96, 114, 116, 120–4, 127, 129–32, 134–6, 144, 150–8, 165n13, 173, 183–5, 197, 204, 205 SOEs. See state-owned enterprises (SOEs) SOE-TVE relationship, 7–8 Southeast Asian, 142, 143 Soviet Union, 21, 23, 24, 28, 31, 50, 56, 77, 151, 170, 175 SPC. See State Planning Commission (SPC) state corporatism, 25–6, 29, 88, 89, 98, 108 State Council, 9, 57, 58, 61, 81–2n16, 81n7, 93, 95, 96, 116, 122, 124, 125, 127–9,

158, 164n10, 165n18, 165n19, 178 State Development Planning Commission (SDPC), 155 State-owned Asset Supervision and Administration Commission (SASAC), 127, 142, 143, 153, 160, 164n1 state-owned banks, 72, 80, 121, 123, 127–9, 135, 148, 164n7, 180, 182, 184, 185, 202 state-owned enterprises (SOEs), 2–8, 12, 13, 27–30, 40, 51–3, 55–68, 71–7, 80, 81n9, 88, 91–9, 103, 106, 107, 109n6, 113–37, 141–65, 171–90, 191n2, 191n3, 195–7, 201–6, 206n2 State Planning Commission (SPC), 54, 80n3, 137n11, 155, 158–60 surplus, 54, 56, 60, 61, 66, 95, 99, 105, 119, 135, 137n10, 147, 149, 150, 161–3, 164n2, 181, 182, 184, 190, 195, 196, 203, 204, 206 T

towns, 92, 98, 99 Township and Village Enterprise (TVE), 1–13, 19–43, 47–82, 87–110, 114, 118–20, 122, 126, 132–4, 154, 164n6, 165n14, 169–92, 195–206 township governments, 26, 30, 31, 50, 65–7, 71, 74, 78, 96, 99, 176 transition path, 20 TVE. See Township and Village Enterprise (TVE)

 Index    

TVE entrepreneurs, 4–8, 11, 13, 34, 41, 48, 49, 63, 67, 73–7, 80, 82n24, 88, 90, 92, 96–100, 102–4, 108, 195, 198–201, 206 TVE institutions, 11, 88–92 TVE privatization, 71, 78–9, 180 TVEs, collectively-owned, 177 U

Unirule Institute of Economics, 127, 133, 135

217

W

Wen, T., 13n1, 95, 112 Wenzhou, 11, 12, 14n7, 14n9, 164, 164n7, 183, 192n11, 205 workers, factory, 37 workers, skilled, 97, 148 work points, 52, 94, 95, 108n4 World Trade Organization (WTO), 186, 187 WTO. See World Trade Organization (WTO) Wuxi, 53, 64, 105 Z

V

value-added tax (VAT), 78 VAT. See value-added tax (VAT)

Zhejiang, 11, 14n7, 14n8, 64, 69, 154, 183, 205 Zhu Rongji, 7, 22, 30, 77